**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




**FORM
      10-K**





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


**FOR
      THE FISCAL YEAR ENDED DECEMBER 31, 2006**





**OR**





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





**Commission
      File Number 0-28488**





**ZONES,
      INC**


(Exact
      name of registrant as specified in its charter)





**Washington**
            
            **91-1431894**(State
                of Incorporation)
            
            (I.R.S.
                Employer Identification Number)**1102
                15****th****Street SW, Suite 102****Auburn,
                Washington**
            
            **98001-6509**(Address
                of Principal Executive Offices)
            
            (Zip
                Code)





**(253)
      205-3000**


(Registrant's
      Telephone


Number,
      Including Area Code)





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


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





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.  Yes  ̈ No x




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act.  Yes  ̈ No x





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





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





The
      aggregate market value of the Common Stock held by non-affiliates as of the
      registrant’s most recently completed second quarter, June 30, 2006, was
      approximately $39,820,756, based upon the last sales price per share of $6.37
      as
      reported by the NASDAQ Global Market.





The
      number of shares of the registrant's Common Stock outstanding as of February
      23,
      2007 was 13,159,560.





**DOCUMENTS
      INCORPORATED BY REFERENCE**





Portions
      of the definitive Proxy Statement for the Registrant’s Annual Meeting of
      Shareholders to be held on April 26, 2007 have been incorporated by reference
      into Part III of this Annual Report on Form 10-K.













**ZONES,
      INC.**


**FORM
      10-K ANNUAL REPORT**


**FOR
      THE YEAR ENDED DECEMBER 31, 2006**


**TABLE
      OF CONTENTS**





**PART
      I**





Page
                No.Item
                1.
            Business
            3Item
                1A.
            Risk
                Factors
            9Item
                2.
            Properties
            12Item
                3.
            Legal
                Proceedings
            12Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            13Item
                4A.
            Executive
                Officers of the Registrant
            13





**PART
      II**





Item
                5.
            Market
                for Registrant’s Common Equity, Related Shareholder
                Matters and Issuer Purchases of Equity Securities
            13Item
                6.
            Selected
                Financial Data
            14Item
                7.
            Management’s
                Discussion and Analysis of Financial Condition and
                Results of Operations
            16Item
                7A.
            Quantitative
                and Qualitative Disclosures about Market
                Risk
            23Item
                8.
            Financial
                Statements and Supplementary Data
            24Item
                9.
            Changes
                in and Disagreements with Accountants on Accounting and
                Financial Disclosure
            24Item
                9A.
            Controls
                and Procedures
            24Item
                9B.
            Other
                Information
            24





**PART
      III**





Item
                10.
            Directors,
                Executive Officers and Corporate
                Governance
            24Item
                11.
            Executive
                Compensation
            24Item
                12.
            Security
                Ownership of Certain Beneficial Owners and Management
                and Related Stockholder Matters
            24Item
                13.
            Certain
                Relationships and Related Transactions, and Director
                Independence
            25Item
                14.
            Principal
                Accounting Fees and Services
            25





**PART
      IV**





Item
                15.
            Exhibits
                and Financial Statement Schedules
            25Signatures
            27





2
 *Table
            of Contents*





**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 the Company
      operates, management’s beliefs, and certain assumptions made by management.
      These statements are made pursuant to the safe harbor provision of the Private
      Securities Litigation Reform Act of 1995.  All
      statements, trends, analyses and other information contained in this report
      relative to trends in net sales, gross margin and anticipated expense levels,
      as
      well as other statements, including words such as “anticipate,” “believe,”
“plan,” “expect,” “estimate,” “intend,” and other similar expressions,
      constitute forward-looking statements. These forward-looking statements involve
      risks and uncertainties, and actual results may differ materially from those
      anticipated or expressed in such statements. Potential risks and uncertainties
      include, among others, those set forth in Item 1A of this Annual Report.
      Particular attention should be paid to the cautionary statements involving
      future profitability and sales levels, pressure on margins, reliance on vendor
      support and relationships, state tax uncertainties, the industry’s rapid
      technological change and the Company’s exposure to inventory obsolescence.
      Except as required by law, the Company undertakes no obligation to update any
      forward-looking statements, whether as a result of new information, future
      events or otherwise.





**General**





Zones,
      Inc. (the “Company,” “We”) is a single-source direct marketing reseller of
      name-brand information technology (“IT”) products to the small-to-medium-sized
      business market (“SMB”), enterprise accounts and public sector accounts. Zones
      sells products through outbound and inbound account executives, catalogs and
      the
      Internet. Zones offers more than 150,000 products from leading manufacturers,
      including 3Com, Adobe, Apple, Cisco, Epson, HP, IBM, Kingston, Lenovo,
      Microsoft, Sony and Toshiba.





Incorporated
      in 1988, Zones, Inc. is headquartered in Auburn, Washington. Buying information
      is available at http://www.zones.com or by
      calling 800-258-2088. The Company’s investor relations information can be
      accessed online at www.zones.com/IR.





**Industry
      Background**





We
      believe that the direct marketing reseller (“DMR”) channel has reached a level
      where most corporate IT customers have selected their vendor of choice, either
      direct through DMRs or indirect through value-added resellers (“VAR”). Future
      growth of the channel will be predicated on increased corporate profit levels,
      which can support an investment in new technology. Generally, we believe that
      in
      2007 the DMR channel will grow at market rate, with our core business with
      the
      SMB expected to outpace the market. To exceed the market rate of growth overall,
      individual DMR vendors must take market share from their direct and indirect
      competitors.





Customers
      make their IT purchasing decisions primarily based on service offerings, product
      selection, availability, convenience and price. DMRs offer a broad product
      and
      service selection, purchasing convenience and fast delivery. The DMR channel
      serves a fragmented market whose projected annual sales are in the
      multi-billions of dollars. DMRs are characterized by a low-cost structure
      characterized by few fixed costs, rapid inventory turns, centralized sales
      forces and highly automated internal processes, including the use of the
      Internet and electronic data interchange (“EDI”) links with major vendors and
      customers to streamline operations. Our strategy as a solution provider
      emphasizes a fulfillment model that integrates the procurement and resale of
      technology and related accessory product lines, and is supported by sales
      specialists, as well as value-added configuration and logistics services.





We
      believe that customer decisions are based on the level of service they expect
      in
      relation to what they are willing to pay. Most DMRs have evaluated other
      indirect providers to determine which added services will differentiate and
      enable DMRs to gain market share from manufacturers selling direct and from
      other VARs. We continuously work with our vendor partners to maintain awareness
      of and to capitalize on new product announcements and purchasing trends. In
      particular, we are focused on the shift by commercial business customers to
      mobile technologies, their need for additional storage and security, and the
      anticipated introduction of new software solutions.





3
 *Table
            of Contents*





**Our
      Business**





Our
      business is the procurement and fulfillment of IT solutions to the SMB,
      enterprise customers and the public sector marketplace. Our core business is
      focused on providing name-brand products at competitive prices to the commercial
      business and public sector markets within the United States. We believe that
      small business customers, meaning those with 50 to 100 computer users, are
      characterized by transactional purchasing, in contrast to medium-sized business
      customers, meaning those with 100 to 1000 computer users, who are
      relationship-driven with more frequent transactions. We believe that SMB
      customers have a high adoption rate for IT solutions and prefer a single-source
      provider to handle their procurement from end to end. Enterprise customers,
      defined as customers within the Fortune 2000 and having more than 1000 computer
      users, generally demand a much higher level of customer service. The public
      sector market is made up of three primary customer types: state and local
      government, federal government and education. These sectors require special
      pricing and participation in bid processes.





As
      value-adds to our customers, we offer asset tagging, configuration and other
      third-party services, we also maintain integration of customers’ business needs
      and processes through ZonesConnect, the Company’s robust, automated Web-based
      procurement system.





**Our
      Business Strategy**





We
      acquire and develop ongoing relationships with commercial and public sector
      accounts primarily through dedicated teams of outbound sales account executives
      (“AE”). Although outbound telemarketing is our primary customer contact, we also
      reach customers through an integrated marketing and merchandising strategy
      that
      utilizes e-marketing and direct marketing vehicles, catalogs for demand response
      opportunities and corporate branding, customized Web stores for its commercial
      customers through ZonesConnect, and our recently introduced Business Development
      organization which includes a remote field sales force.





We
      believe that our ability to grow in 2007 will depend on organic growth within
      our current account portfolio and increased reach, utilizing our growing force
      of field sales AEs, into the larger end of medium-sized customers and enterprise
      customers. We believe organic growth will develop as tenure and productivity
      increase in our existing AE base, driving an increase in the share of each
      customer’s total IT purchases. Additionally, we are committed to our 2006
      decision to add dedicated marketing and sales support staff to focus on
      businesses at the smaller end of our SMB customer base, which is believed to
      be
      more transaction oriented. The field sales force will be focused on the
      identification, penetration and closure of new business customers to add to
      the
      existing client portfolio. Our business model relies on building and maintaining
      relationships with our customers to provide solutions to solve their
      needs.





We
      strive
      to offer exemplary customer service in each transaction, which we define as
      Five
      Star Service. Five Star Service is founded on these principles: exceeding
      expectations, providing outstanding customer service, performing flawless
      execution, demonstrating the highest level of personal integrity, and placing
      the customer first. We strive to offer the most competitive value based
      on:





·
            **Price.**Zones offers competitive pricing to its customers.


·
            **Availability.**With more than 150,000 products available from more than 2,000 vendors,
                Zones strives to deliver the products its customers need.


·
            **Information.**The technology industry is constantly changing with new and upgraded
                products and services, so Zones AEs receive continuous training throughout
                their careers. This allows them to serve as a knowledgeable extension
                of
                each customer's team.


·
            **Fulfillment.**Zones strives to deliver every order complete and on time.


·
            **Service.**Zones offers a breadth of services and sales specialists to support
                the
                customer IT relationship. For example, the Company’s customized online
                order management system, ZonesConnect, helps its customers reduce
                administrative costs and streamline the purchasing process. With
                additional services such as asset tagging, imaging, and product upgrades,
                Zones is a proactive business partner throughout the sales cycle.





Our
      specific areas of concentration for realizing growth in our share of the
      IT-procurement market are:





*Business
      Development Organization* .
      To
      drive market share growth, we have invested in client segmentation and
      geographical expansion, which has led to the introduction of the Business
      Development organization. This organization is responsible for creating an
      organization of remote, geographically dispersed AEs focused on acquisition
      of
      new customers and development of existing customers. This field sales force,
      along with its management team, is expected to grow to 20 team members by the
      end of the first quarter 2007. This team will be divided into two populations:
      AEs who will call on the larger end of medium-sized customers and AEs who will
      call on enterprise customers.





4
 *Table
            of Contents*





*AE
      Hiring, Training and Development* .
      We
      continually seek to attract, retain and motivate high-quality personnel. We
      intend to continue to increase AE headcount, but at a lower rate of growth
      due
      to our focus on improving the success rate of existing AEs. The increase in
      success rate should lower turnover and, in turn, reduce our expected 2007 hiring
      requirements. Management focuses on training and coaching AEs on best practices,
      product knowledge and how to access supportive collateral on the available
      marketing and merchandising programs and promotions. We focus on our
      relationship-based model, in which our AEs develop long-term relationships
      with
      customers through frequent telephone contact, knowledgeable technical advice,
      individual attention, quality service and convenient one-stop shopping.





*Expansion
      of Customer Base.* Relationships
      with our commercial business and public sector accounts represent future growth
      opportunities. We continue to refine our customer management program, lead
      generation and related processes to increase and accelerate customer
      acquisition. During 2007, we believe our customer management program is designed
      to better understand the purchasing patterns and product needs of each customer,
      and thereby increase operational efficiencies in the selling process and
      minimize loss of revenues during account transition from one AE to another.





*Product
      Breadth and Depth* .
      We are
      dependant upon relationships with key vendors for opportunistic product
      purchases to enhance margins. Through a strategic mix of products and vendors,
      we offer our customers a broad selection at competitive pricing. We generally
      stock 20% of our product offerings, which represent 80% of total revenue, in
      our
      warehousing facilities. The remaining items are offered to our customers through
      virtual warehousing partnerships with key distributors and vendors via
      electronic data interchange (“EDI”). We use our warehouses and EDI partners to
      fulfill all our customers’ needs with broad product availability. We place
      individual orders directly with our EDI partners, who then assemble these orders
      and ship them directly to our customers.





*Services.* We
      offer
      custom configuration services, such as the installation of accessories and
      expansion products, loading of software, imaging for custom applications and
      configuration of network operating systems, as well as IT lifecycle support
      services and supply chain management services. Many of these services are
      performed at our distribution centers and benefit our customers by reducing
      the
      cost and time necessary to deploy new products into their existing technology
      environments.





**Sales
      and Marketing**





We
      reach
      our customers through an integrated marketing and merchandising strategy
      designed to attract customers through dedicated e-marketing and direct marketing
      vehicles, catalogs for demand-response opportunities and corporate branding,
      and
      customized Web stores for corporate customers using our ZonesConnect service.
      Throughout the year, marketing refines the characteristics of our target
      customers in each market and creates specific marketing collateral to reach
      that
      audience.





*Outbound
      Telemarketing* .
      As of
      December 31, 2006, we had a staff of 342 sales AEs who actively pursued sales
      to
      commercial business accounts and public sector institutions by establishing
      one-to-one relationships through outbound telemarketing. The primary targets
      for
      AEs in the SMB department are the small-to-medium-sized business customers,
      while enterprise-customer AEs focus on companies within the Fortune 2000. These
      commissioned AEs develop long-term relationships with their accounts through
      frequent telephone contact, knowledgeable technical advice, individual
      attention, quality service and convenient one-stop shopping.





*Business
      Development Field Sales* .
      In
      October 2006, we began investing in a strategy to create a remote,
      geographically dispersed sales force. Business Development management and the
      field sales AEs will identify and access customers within the larger end of
      the
      medium-sized-business and enterprise-business segments in an effort to increase
      our existing portfolio with new customers.





*Extranet
      Commerce* .
      We
      offer no-fee dedicated Web stores for our customers through ZonesConnect. These
      dedicated sites provide the customer with various benefits, including secure
      online purchasing, license trackers, 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 our larger customers with specific online procurement
      needs.





5
 *Table
            of Contents*





*Internet
      Commerce.* Our
      electronic commerce site on the Internet, Zones.com, provides a sales channel
      to
      both supplement and enhance our person-to-person sales model and to provide
      customers detailed product information and the convenience of online purchasing.
      We drive traffic to this site by featuring the Internet address throughout
      our
      direct-mail vehicles and on our promotional communications and advertising.
      We
      also utilize marketing through e-catalogs, as well as online price promotions
      and affiliations.





*Direct
      Mail.* We
      market products through targeted mailings of direct-mail vehicles, such as
      catalogs, product inserts and targeted customer mailings. The Company utilizes
      its direct mail vehicles as part of a customer acquisition and retention
      strategy, as well as a direct marketing tool and branding vehicle to drive
      significant traffic to its online site, Zones.com, and to our 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 this type
      of
      funding available from our vendors fluctuates quarterly both in dollars and
      as a
      percentage of sales. 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.





*Database
      Marketing* .
      We
      maintain a proprietary database containing approximately 35,000 customer records
      and we have built a prospecting database of more than 150,000 commercial leads.
      In the commercial business market, we attract new customers by providing
      qualified leads to our AEs, warming the leads with catalogs and direct mail,
      and
      building relationships through outbound telephone calls. Retention of customers
      and account development is supported by catalog, direct mail and e-marketing
      vehicles. Catalog circulation is based on customer records, prospective customer
      inquiries, and mailing lists obtained from list brokers, product manufacturers,
      trade magazine publishers, association memberships and other sources. We
      regularly analyze and update our database and other available information to
      keep data current and to enhance customer response and order rates.




**Products
      and Merchandising**





We
      offer
      customers access to more than 150,000 hardware, software, peripheral and
      accessory products and services, for users of Windows-based and Mac computers,
      from over 2,000 manufacturers through our catalogs, Internet site and sales
      force.





*Computers
      and Servers* .
      We
      offer a large selection of desktop, laptop and tablet PC systems and servers
      from leading manufacturers, such as Acer, Apple, Gateway, Hewlett-Packard,
      Intel, Fujitsu, IBM, Lenovo, Panasonic, Sony and Toshiba.





*Peripherals
      and Accessories* .
      We
      carry a full line of peripheral products, such as printers, monitors, keyboards,
      handhelds (PDAs), memory, storage devices, projectors, scanners and digital
      cameras, as well as various accessories and printing supplies, such as toner
      cartridges, storage media and cables. Brands offered include APC, Apple, Belkin,
      Canon, Edge, Epson, Hewlett-Packard, InFocus, Kingston, Kodak, Fuji, Lexmark,
      Logitech, LG, NEC, Nikon, Okidata, palmOne, Planar, Panasonic, Samsung, Sony,
      Targus, Toshiba, ViewSonic, and Xerox.





*Networking
      and Storage* .
      We
      provide networking and network storage products, such as switches, hubs,
      routers, modems, cabling, firewalls, Voice over IP (VOIP), wireless devices,
      tape and disk backup, and SAN and NAS solutions. Brands offered include 3Com,
      Apple, Avaya, Avocent, Belkin, Cisco, D-Link, EMC, Emulex, Hewlett-Packard,
      Hitachi Data Systems, IBM, Intel, Iomega, La Cie, Linksys, Netgear, Nortel
      Networks, Overland Storage, QLogic, Polycom, Quantum, Seagate, SonicWALL, Sony,
      Tandberg Data (Exabyte), and Western Digital, among others.





*Software* .
      We sell
      a wide variety of packaged software and licensing programs in business, personal
      productivity, connectivity, utility, language, educational, entertainment and
      other categories. We offer products from larger, well-known manufacturers,
      as
      well as numerous specialty products from new and emerging software development
      companies. Brands offered include Adobe, Citrix, Computer Associates, Corel,
      IBM, Microsoft, Novell, Symantec, Quark and VMware, among
      others.





We
      are a
      Microsoft Certified Large Account Reseller, and, as such, can offer our large
      customers multiple methods of purchasing Microsoft software. This enables us
      to
      sell Select and Enterprise Agreement contracts designed for medium- to
      large-sized commercial and academic customers.





Our
      category merchandising group determines the manufacturers’ products that will be
      featured in our Internet, catalog and internal ERP offerings and negotiates
      the
      terms and conditions of product coverage. The merchandising department reviews
      product availability and determines stocking strategy, as well as reviews its
      managed stock keeping units (“SKU”), so that we are offering differentiating
      programs and competitive pricing. Each managed SKU also has component and add-on
      information to assist the AE in the selling process. Our merchants have aligned
      their processes, pricing, stocking strategies, marketing programs, quotas,
      communication methodology and training to the priorities set by each sales
      department. The merchandising group negotiates with manufacturers and
      distributors to provide us with incentives in the form of rebates, discounts
      and
      trade allowances.





6
 *Table
            of Contents*





**Purchasing**





We
      utilize our purchasing and inventory management capabilities to support our
      primary business objective of providing name-brand products at competitive
      prices. Our purchasing team works to develop and maintain relationships with
      a
      broad base of reliable, high-quality suppliers. The team works to obtain the
      lowest overall acquisition cost in an effort to enable us to provide competitive
      pricing to our customers while achieving acceptable margins.





We
      acquire products directly from manufacturers such as Apple, Hewlett-Packard,
      IBM
      and Lenovo, as well as through distributors such as Ingram Micro, Synnex and
      Tech Data, among others. In 2006, we purchased approximately 55.9% of our
      merchandise from distributors, a decrease from 62.6% in 2005. We believe that
      our overall sourcing strategy enables us to take advantage of significant
      special offers, discounts and supplier reimbursements, while also minimizing
      inventory costs. We believe we have excellent relationships with our suppliers
      and we attempt to take advantage of all appropriate discounts.





We
      utilize a blend of stocking and drop-ship procurement in executing our inventory
      management strategy. We generally stock 20% of our total product offerings
      that
      represent up to 80% of total net sales. The remaining products are provided
      to
      our customers primarily through virtual warehousing partnerships with key
      distributors and manufacturers. Through these relationships, we are able to
      offer a broad selection of products and to 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 with our ERP system,
      which lowers administrative overhead.





At
      December 31, 2006, we maintained an investment in inventory of $21.4 million,
      and our inventories turned an average of 24 times in 2006. This compares to
      an
      investment in inventory of $19.7 million at December 31, 2005, and average
      inventory turns of 26 during 2005. Our investment in inventory grew at December
      31, 2006 due to on-hand customer-specific inventory.





**Order
      Fulfillment and Distribution**





We
      distribute products virtually through our EDI arrangement with our vendors,
      as
      well as through our warehouses in Bensenville, Illinois and Seattle, Washington.





We
      provide and operate a full-service warehouse and distribution center in
      Bensenville, Illinois to support our nationwide customer base and a customized
      fulfillment center in Seattle, Washington to support our West Coast customers.
      The warehouse personnel utilize our systems, policies and procedures to receive,
      record and warehouse inventory shipments from product suppliers, fill and ship
      customer orders, and return inventory to product suppliers when requested.
      We
      also use our warehouse facilities to house special buys, constrained product
      and
      other high-velocity product. The Bensenville, Illinois warehouse is responsible
      for the returned merchandise that will be returned to vendors, returned to
      general inventory, repaired or liquidated. We offer limited return rights within
      14 days on our product sales, and we maintained an allowance for sales returns,
      net of cost, as of December 31, 2006 and 2005 of $101,000 and $108,000,
      respectively. Our returns as a percentage of gross sales decreased slightly
      to
      2.1% in 2006 compared to 2.2% in 2005. Product returns are closely monitored
      to
      identify trends in product offerings, to enhance customer satisfaction and
      to
      reduce overall returns.





Orders
      received are electronically transmitted on a dedicated data line to our
      distribution centers, where a packing slip is printed out for order fulfillment,
      and inventory availability is then automatically updated on all of our
      information systems. All inventory items are barcoded 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 8:00 p.m. Eastern
      Time  can
      generally be delivered overnight. Upon request, orders may also be shipped
      for
      Saturday delivery, by ground service or by other overnight delivery
      services.





7
 *Table
            of Contents*





**Technical
      Support and Customer Service**





We
      maintain a staff of dedicated technical support personnel who provide pre-
      and
      post-sale technical support, both for our AEs and customers.  In addition
      to a broad base of A+ certifications, the team also maintains a number of
      distinguished manufacturer certifications, including Cisco CCNA/CCDA, VMware
      VCP, Microsoft MCSE/MCSA, APC Gold, IBM CDAT, EXAct and nSeries, HP Server
      and
      SAN architect (MASE), Symantec Enterprise Vault & Data Protection and many
      other hardware-specific technical certifications.





Pre-sales
      support is utilized primarily by our AEs to assist 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.





We
      also
      employ 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, as well as online tools that allow customers to
      self-serve routine inquiries. We believe these comprehensive support options
      improve the quality of our recommended technology solutions, reduce product
      returns, increase customer satisfaction and encourage repeat
      business.





**Systems**





We
      have
      committed significant resources to the development of sophisticated management
      information, telecommunication, catalog production and other systems, which
      are
      employed in virtually all aspects of our business, including marketing,
      purchasing, inventory management, order processing, product distribution,
      accounts receivable, customer service and general accounting functions. During
      2006, we continued to develop and enhance our sales interface for order entry.
      Our graphical user interface ties all of the core systems together to give
      AEs a
      common view of customers, products, inventory and orders, and to streamline
      order processing as well as to reduce the training time for new AEs. We are
      continually examining technological advances to increase the productivity of
      our
      team members.





**Team
      Members**





At
      December 31, 2006, we had 661 team members: 342 in the sales force, 38 in its
      warehousing and distribution, and 281 team members in administrative overhead
      departments. We consider our employee relations to be good. We also have 37
      people under outsourced contract in India performing various back-office and
      IT
      functions in support of our United States operations. We have never had a work
      stoppage and do not believe that any team members are represented by a labor
      organization. We emphasize the recruiting and training of high-quality personnel
      and strive to promote to positions of increased responsibility from within.





*Sales
      Team Education*


The
      Company provides a balanced training program consisting of classroom and
      practical on-the-job learning within an outbound sales environment. Zones New
      Hire Development takes an integrated approach in developing the new hires’
skills for acquiring and developing customers using a relationship-building
      sales methodology. AEs learn to utilize various internal and external systems
      and receive hardware and software product education.





*Mission
      & Values*


The
      Company is dedicated to creating a learning organization of empowered
      individuals to serve its customers with integrity, commitment and passion.
      It
      strives to achieve this by creating 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.





**Seasonality**





Sales
      to
      our commercial business customers have not historically experienced significant
      seasonality throughout the year. By contrast, sales to the public sector market
      are historically higher in the third quarter than in other quarters due to
      the
      buying patterns of federal government and education customers. If sales to
      public sector customers increase as a percentage of overall sales, we as a
      whole
      may experience increased seasonality in future periods.





8
 *Table
            of Contents*





**Trademarks**





We
      conduct our business in the United States primarily under the service mark
      Zones® which is registered with the United States Patent and Trademark Office.
      We believe that these and any of our other marks have significant value and
      are
      an important factor in the marketing of our products.





**Regulatory
      and Legal Matters**





In
      addition to federal, state and local laws applicable to all corporations and
      employers in general, the direct marketing business is subject to the Federal
      Trade Commission’s Merchandise Mail Order Rule and related regulations. We are
      also subject to laws and regulations relating to truth-in-advertising, Anti-Spam
      and other fair trade and privacy practices. We have implemented programs and
      systems to promote ongoing compliance with these laws and
      regulations.





**Available
      Information**





We
      make
      available free of charge on our website, at www.zones.com/IR, our annual report
      on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K,
      and
      amendments to those reports filed or furnished pursuant to Section 13(a) or
      15(d) of the Exchange Act, as soon as reasonably practicable after
      electronically filing or furnishing such material to the Securities and Exchange
      Commission (“SEC”).





Additionally,
      all materials that we file with the SEC can be viewed and copied at the SEC’s
      Public Reference Room at 450 Fifth Street NW, Washington, DC 20549, or via
      the
      SEC’s website at www.sec.gov. Information on the operation of the Public
      Reference Room can be obtained by calling 1-800-SEC-0330.




Our
      Audit
      Committee Charter, Compensation Committee Charter and Nominating and Governance
      Committee Charter are also available on our website or upon written or verbal
      request. Requests for copies of any of these documents should be directed in
      writing to Zones, Inc. Investor Relations, 1102 15 th Street
      SW, Suite 102, Auburn, WA 98001-6509.





**Item
                1A.**
            **Risk
                Factors**





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





**Our
      operating results are difficult to predict and may adversely affect our stock
      price.**


Our
      operating results are difficult to forecast, and there are a number of factors
      outside of our control, including:


·
            purchasing
                cycles of commercial and public sector customers;


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


·
            more
                manufacturers going direct;


·
            industry
                announcements of new products or
                upgrades;


·
            industry
                consolidation;


·
            cost
                of compliance with new legal and regulatory
                requirements;


·
            general
                economic conditions; and


·
            variability
                of vendor programs.


Based
      on
      those and other risks, there can be no assurance that we will be able to
      maintain the profitability we have experienced going forward.





**We
      experience variability in our net sales and net income on a quarterly
      basis.**


There
      is
      no assurance that we will sustain our current sales or income levels. Sales
      and
      income may decline for any number of reasons, including:


·
            a
                decline in corporate profits leading to a change in corporate investment
                in IT-related equipment;


·
            increased
                competition;


·
            more
                manufacturers going direct;


·
            changes
                in customers’ buying habits;


·
            the
                loss of significant customers;


·
            changes
                in the selection of products available for resale; or


·
            general
                economic conditions.


A
      decline
      in sales levels could adversely affect our business, financial condition, cash
      flows or results of operations.





9
 *Table
            of Contents*





**Our
      narrow gross margins magnify the impact of variations in our operating costs.**


There
      is
      intense price competition and pressure on profit margins in the computer
      products industry. A number of manufacturers are also providing their products
      direct to customers. Various other factors also may create downward pressure
      on
      our gross margins, such as the quarter-to-quarter variability in vendor programs
      and an increasing proportion of sales to enterprise, public sector or other
      competitive bid accounts on which margins could be lower. If we are unable
      to
      maintain or improve gross margins in the future, this could have an adverse
      effect on our business, financial condition, or results of
      operations.




**Our
      increased investments in our hiring, retaining and productivity of our sales
      force may not improve our profitability or result in expanded market share.**


We
      ended
      2006 with 342 account executives compared to 250 in 2005. We expect to continue
      to increase account executive headcount, but at a lower rate of growth due
      to
      corporate initiatives to lower turnover thus reducing hiring requirements in
      2007. However, there are no assurances that we will be able to hire to our
      expected levels, or recruit the quality individuals that we hope to hire, or
      that the individuals hired will remain employed for an extended period of time,
      or that we will not lose existing account executives. The productivity of
      account executives has historically been closely correlated with tenure. Even
      if
      we do retain our account executives, there are no assurances that they will
      become productive at historical levels. Additionally, there are no assurances
      that the locations of our call centers will continue to attract qualified
      account executives, or that we will be able to remotely manage and retain the
      new account executives.





**Certain
      of our key vendors provide us with incentives and other assistance, and any
      future decline in these incentives and other assistance could materially harm
      our profit margins and operating results.**


We
      have a
      variety of relationships with our vendors that in the past have contributed
      significantly to profit margins. For example, certain product manufacturers
      and
      distributors provide us with incentives in the form of rebates, volume incentive
      rebates, cash discounts and trade allowances. Our
      current vendor programs continue to be refined and there are no assurances
      that
      we will attain the level of vendor support in the future that we
      have obtained in the past . In
      addition, many of our vendors provide us with cooperative advertising funds,
      which reimburse us for expenses associated with specific forms of advertising.
      Industry-wide, the trend has been for manufacturers, distributors and vendors
      to
      reduce these incentives and curtail these programs. If these forms of vendor
      support decline, or if we are otherwise unable to take advantage of continuing
      vendor support programs, or if we fail to manage the complexity of these
      programs, our business, financial condition, cash flows or results of operations
      could be adversely affected.




**We
      are controlled by a principal stockholder.**


Firoz
      H.
      Lalji, our Chairman and Chief Executive Officer, beneficially owns 52.4% of
      the
      outstanding shares of Zones common stock, excluding shares that he may acquire
      upon exercise of stock options that he holds. The voting power of these shares
      enables Mr. Lalji to significantly influence our affairs and the vote on
      corporate matters to be decided by our shareholders, including the outcome
      of
      elections of directors. This effective voting control may preclude other
      shareholders from being able to influence shareholder votes and could impede
      potential merger transactions or block changes to our articles of incorporation
      or bylaws, which could adversely affect the trading price of our common stock.
      We are also certified as a Minority Business Enterprise based on Mr. Lalji’s
      maintenance of voting control. The certification allows us to compete for
      certain sales opportunities. A decrease in Mr. Lalji’s level of voting power
      through the issuance of additional equity capital could have an adverse effect
      on our ability to retain certain customers or compete for certain sales
      opportunities.




**We
      may not be able to compete successfully against existing or future competitors,
      which include some of our largest vendors.**


** The
      computer products industry is highly competitive. We compete with other national
      direct marketers, including CDW Corporation, Insight Enterprises, Inc. and
      PC
      Connection, Inc. We also compete with product manufacturers, such as Apple,
      Dell, Hewlett-Packard, IBM and Lenovo, which sell direct to end-users, in
      addition to competition with specialty computer retailers, computer and general
      merchandise superstores, and consumer electronic and office supply stores.
      Many
      of our competitors compete principally on the basis of price and have lower
      costs. We believe that competition may intensify in the future due to market
      conditions and consolidation. In the future, we may face fewer, but larger
      or
      better-financed competitors. Additional competition may also arise if other
      methods of distribution emerge in the future. There can be no assurance that
      we
      will be able to compete effectively with existing competitors or new competitors
      that may enter the market, or that our business, financial condition, cash
      flows
      or results of operations will not be adversely affected by intensified
      competition.





10
 *Table
            of Contents*




**We
      are exposed to inventory obsolescence due to the rapid technological changes
      occurring in the personal computer industry.**


The
      computer industry is characterized by rapid technological change and frequent
      introductions of new products and product enhancements. To satisfy customer
      demand and obtain greater purchase discounts, we may be required to carry
      significant inventory levels of certain products, which subject us to increased
      risk of inventory obsolescence. We participate in first-to-market and
      end-of-life-cycle purchase opportunities, both of which carry the risk of
      inventory obsolescence. Special purchase products are sometimes acquired without
      return privileges, and there can be no assurance that we will be able to avoid
      losses related to such products. Within the industry, vendors are becoming
      increasingly restrictive in guaranteeing return privileges. While we seek to
      reduce our inventory exposure through a variety of inventory control procedures
      and policies, there can be no assurance that we will be able to avoid losses
      related to obsolete inventory.





**We
      may not be able to maintain existing or build new vendor relationships, which
      may affect our ability to offer a broad selection of products at competitive
      prices and negatively impact our results of operations.**


We
      acquire products directly from manufacturers, such as Hewlett-Packard, IBM
      and
      Lenovo, as well as from distributors such as Ingram Micro, Synnex, Tech Data
      and
      others. Certain hardware manufacturers limit the number of product units
      available to DMRs. Substantially, all of our contracts and arrangements with
      vendors are terminable without notice or upon short notice. If we do not
      maintain our existing relationships or build new relationships with vendors
      on
      acceptable terms, including favorable product pricing and vendor consideration,
      we may not be able to offer a broad selection of products or continue to offer
      products at competitive prices. Termination, interruption or contraction of
      our
      relationships with our vendors could have a material adverse effect on our
      business, financial condition, cash flows or results of operations.





**If
      we fail to achieve and maintain adequate internal controls, we may not be able
      to produce reliable financial reports in a timely manner or prevent financial
      fraud.**


We
      will
      continue to document and test our internal control procedures on an ongoing
      basis in order to satisfy the requirements of Section 404 of the
      Sarbanes-Oxley Act of 2002, which requires annual management assessments of
      the
      effectiveness of internal controls over financial reporting and a report by
      an
      independent registered public accounting firm addressing such assessments if
      applicable. During the course of our testing we may from time to time identify
      deficiencies which we may not be able to remediate. In addition, if we fail
      to
      achieve or maintain the adequacy of our internal controls, as such standards
      are
      modified, supplemented or amended from time to time, we may not be able to
      ensure that we can conclude on an ongoing basis that we have effective internal
      controls over financial reporting in accordance with Section 404 of the
      Sarbanes-Oxley Act of 2002. Effective internal controls, particularly those
      related to revenue recognition, are necessary for us to produce reliable
      financial reports and are important in helping prevent financial fraud. If
      we
      cannot provide reliable financial reports on a timely basis or prevent financial
      fraud, our business and operating results could be harmed, investors could
      lose
      confidence in our reported financial information, and the trading price of
      our
      stock could drop significantly.




**We
      face many uncertainties relating to the collection of state sales and use tax.**


We
      collect and remit sales and use taxes in states in which we have voluntarily
      registered and/or have a physical presence. Various states have sought to
      require the collection of state and local sales taxes on products shipped to
      the
      taxing jurisdiction’s residents by DMRs. The United States Supreme Court held in
      1992 that it is unconstitutional for a state to impose sales or use tax
      collection obligations on an out-of-state company whose contacts with the state
      were limited to the distribution of catalogs and other advertising materials
      through the mail and the subsequent delivery of purchased goods by United States
      mail or by common carrier. We cannot predict the level of contact, including
      electronic commerce and Internet activity, which might give rise to future
      or
      past tax collection obligations based on that Supreme Court case. Many states
      aggressively pursue out-of-state businesses, and legislation that would expand
      the ability of states to impose sales tax collection obligations on out-of-state
      businesses has been introduced in Congress on many occasions. A change in the
      law could require us to collect sales taxes or similar taxes on sales in states
      in which we have no presence and could potentially subject us to a liability
      for
      prior year sales, either of which could have a material adverse effect on our
      business, financial condition, and results of operations.





**We
      rely on our distribution centers and certain distributors to meet the product
      needs of our customers.**


We
      operate warehouse and distribution centers in Bensenville, Illinois and in
      Seattle, Washington. There are no assurances that our warehouse locations will
      best support our customer base. Additionally, certain distributors also
      participate in our logistics operations through electronic data interchange.
      Failure to develop and maintain relationships with these and other vendors
      would
      limit our ability to obtain sufficient quantities of merchandise on acceptable
      commercial terms and could have a material adverse effect on our business,
      financial condition, cash flows or results of operations.





11
 *Table
            of Contents*





**We
      are heavily dependent on commercial delivery services.**


We
      generally ship our products to customers by DHL, Eagle, FedEx, United Parcel
      Service and other commercial delivery services and invoice customers for
      delivery charges. If we are unable to pass on to our customers future increases
      in the cost of commercial delivery services, our profitability could be
      adversely affected. Additionally, strikes or other service interruptions by
      such
      shippers could adversely affect our ability to deliver products on a timely
      basis.





**We
      may not be able to attract and retain key personnel.**


Our
      future success will depend to a significant extent upon our ability to attract,
      train and retain skilled personnel. Although our success will depend on
      personnel in all areas of our business, there are certain individuals that
      play
      key roles within the organization. Loss of any of these individuals could have
      an adverse effect on our business, financial condition, cash flows or results
      of
      operations.





**We
      may be impacted by the loss of a major customer.**


From
      time
      to time we have customers that represent more than 10% of total sales. For
      the
      years ended December 31, 2006 and 2005, there were no customers that
      individually represented more than 10% of total net sales. The concentration
      of
      credit risk associated with any major customer could have a material adverse
      effect on our business, financial condition, cash flows or results of
      operations.




**Our
      systems are vulnerable to natural disasters or other catastrophic events.**


Our
      operations are dependent on the reliability of information, telecommunication
      and other systems, which are used for sales, distribution, marketing,
      purchasing, inventory management, order processing, customer service and general
      accounting functions. Interruption of our information systems, Internet or
      telecommunication systems could have a material adverse effect on our business,
      financial condition, cash flows or results of operations.





**Privacy
      concerns with respect to list development and maintenance may materially
      adversely affect our business.**


If
      third
      parties or our team members are able to penetrate our network security or
      otherwise misappropriate our customers’ personal information or credit card
      information, we could be subject to liability. We also mail catalogs and send
      electronic messages to names in our proprietary customer database and to
      potential customers whose names we obtain from rented or exchanged mailing
      lists. World-wide public concern regarding personal privacy has subjected the
      rental and use of customer mailing lists and other customer information to
      increased scrutiny. Any domestic or foreign legislation enacted limiting or
      prohibiting these practices could negatively affect our business.




**Our
      stock price may be volatile.**


There
      is
      relatively limited trading of our stock in the public markets, and this may
      impose significant practical limitations on any shareholder’s ability to achieve
      liquidity at any particular quoted price. Efforts to sell significant amounts
      of
      our stock on the open market may precipitate significant declines in the prices
      quoted by market makers. The limitation on shareholder liquidity resulting
      from
      this relatively thin trading volume could be exacerbated if our stock were
      to be
      delisted from the NASDAQ Global Market. The NASDAQ Global Market imposes a
      requirement for continued listing that the value of shares publicly held,
      excluding those held by directors, officers and beneficial owners, exceed
      certain minimums. A potential future delisting of our common stock could result
      in significantly reduced circulation of our common stock, more limited press
      coverage, reduced interest by investors in the common stock, adverse effects
      on
      the trading market, downward pressure on the price for and liquidity of our
      stock, and reduced ability to issue additional securities or to secure
      additional financing.





**Item
                2.**
            **Properties**





We
      currently lease approximately 125,000 square feet of space for our corporate
      headquarters, including our telemarketing operations, in Auburn, Washington;
      approximately 27,000 square feet of space for our fulfillment warehouse facility
      in Seattle, Washington; approximately 70,000 square feet of space for our
      logistics warehouse in Bensenville, Illinois; and approximately 23,000 and
      200
      square feet of space for telemarketing sales offices in Portland, Oregon and
      Kansas City, Missouri, respectively.





**Item
                3.**
            **Legal
                Proceedings**





From
      time
      to time, we are a party to various legal proceedings, claims, disputes or
      litigation arising in the ordinary course of business. We believe that the
      ultimate outcome of any current proceedings, individually or in the aggregate,
      will not have a material adverse effect on our business, financial condition,
      cash flows or results of operations.





12
 *Table
            of Contents*





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





None.





**Item
                4A.**
            **Executive
                Officers of the
                Registrant**





*Firoz
      H. Lalji* ,
      age 60,
      has served as the Company’s 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 more than 140 camera specialty stores
      in
      eight western states.





*Christina
      Corley* , age
      39,
      was appointed President and COO of Zones, Inc. in October 2006. She had
      previously held the positions of Executive Vice President for Zones, Inc. from
      April 2005 to October 2006, and served as President of Corporate PC Source
      (“CPCS”), a wholly owned subsidiary of the Company, from March 2003 to April
      2005. Prior to the acquisition of CPCS by the Company, Ms. Corley was Chief
      Executive Officer and President of CPCS from 1999 to 2003. From 1996 to 1999,
      Ms. Corley served as Vice President of Sales and Marketing for VisionTek
      Corporation. From 1994 to 1996, Ms. Corley served as the General Manager for
      the
      Midwest Division of Dataflex Corporation.





*Ronald
      P. McFadden* ,
      age 50,
      has served as Senior Vice President and Chief Financial Officer of Zones, Inc.
      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.
      Between 1984 and 1991 he served as Vice President of Finance for Interpace
      Industries.





*P.
      Sean Hobday* ,
      age 37,
      was appointed Executive Vice President Sales for Zones, Inc. in February 2005.
      Prior to this, Mr. Hobday served as President of Zones Corporate Solutions,
      a
      wholly owned subsidiary of the Company, since September 2003. Prior to that,
      Mr.
      Hobday was Vice President of Enterprise Sales for the Company since September
      2001. From March 2000 to September 2001, Mr. Hobday served as Director of Client
      Development for the Company. From February 1999 to March 2000, Mr. Hobday served
      as Account Executive for the Company. From 1996 to 1998, Mr. Hobday served
      as
      Managing Director of Blue Ice Leisure in Sydney, Australia, an Austral-Asian
      division of First Team Sports *.*





*Tom
      Ducatelli* ,
      age 41,
      joined Zones, Inc. in October 2006 as the Executive Vice President Business
      Development. Previously, Ducatelli served as Senior Vice President of U.S.
      Sales
      at Tech Data Corporation, a $20 billion multi-national distributor of IT
      products. Prior to that, he served as senior Vice President of Sales and
      Business Development for Dallas-based CompuCom Systems, Inc., a $1.7 billion
      IT
      reseller and solution provider he joined in 1994. Prior to CompuCom, Ducatelli
      spent six years as a national sales executive with mid-range computer
      manufacturer Digital Equipment Corp.





*Anwar
      Jiwani* ,
      age 52,
      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, Related Shareholder
                Matters and Issuer Purchases of Equity
                Securities**





The
      Company’s Common Stock is quoted on the NASDAQ Global 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,****2006**
            
            **2005****High**
            
            **Low**
            
            **High**
            
            **Low**First
                quarter
            
            $
            7.73
            
            $
            4.90
            
            $
            6.55
            
            $
            3.18Second
                quarter
            
            
            7.70
            
            
            5.86
            
            
            4.15
            
            
            2.90Third
                quarter
            
            
            10.83
            
            
            6.08
            
            
            4.48
            
            
            3.70Fourth
                quarter
            
            
            14.44
            
            
            7.17
            
            
            5.50
            
            
            4.03




13
 *Table
            of Contents*




As
      of
      March 9, 2007, the Company had approximately 4,000 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.





Securities
      authorized for issuance under equity compensation plans are incorporated by
      reference from the Proxy Statement for the Company’s 2007 Annual Meeting of
      Shareholders under the caption “Equity Compensation Plan
      Information.”





Since
      2004, the Company has repurchased a total of 1,441,240 shares of its common
      stock at a total cost of $7.2 million under its repurchase program
      authorized by its Board of Directors. Share repurchases may be made from time
      to
      time in both open market and private transactions, as conditions warrant, at
      then prevailing market prices. The following table presents share repurchases
      for the years ended December 31, 2006, 2005 and 2004 (dollars in
      thousands):








**Year**
            
            **Total
                number of shares purchased**
            
            **Amount
                paid**2006
            
            
            568,400
            
            $
            3,9882005
            
            
            424,450
            
            $
            1,8132004
            
            
            448,390
            
            $
            1,348




As
      of
      December 31, 2006, $979,000 in shares of the Company’s common stock
      remained available for repurchase under the program. In February 2007, the
      Board
      of Directors authorized a continuation of the Company’s share repurchase
      program, pursuant to which the Company increased the total amount authorized.
      As
      of February 2007, $3.0 million in shares of the Company’s common stock is
      available for repurchase under the program. The current repurchase program
      is
      expected to remain in effect through February 2008, unless earlier
      terminated by the Board or completed.




**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, 2006 and 2005 and the statement of operations data for the
      years
      ended December 31, 2006, 2005 and 2004 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,
      2004, 2003 and 2002 and the statement of operations data for the years ended
      December 31, 2003 and 2002 have been derived from audited consolidated financial
      statements and notes thereto not included in this Annual Report on Form 10-K.





14
 *Table
            of Contents*





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.”





**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003****2**
            
            **2002****(In
                thousands, except per share data and operating
                data)****Statement
                of Operations Data:**Net
                sales
            
            $
            577,027
            
            $
            566,553
            
            $
            495,563
            
            $
            460,772
            
            $
            414,643Cost
                of sales
            
            
            505,508
            
            
            505,997
            
            
            438,426
            
            
            410,078
            
            
            371,725Gross
                profit
            
            
            71,519
            
            
            60,556
            
            
            57,137
            
            
            50,694
            
            
            42,918Selling,
                general and administrative expenses
            
            
            48,434
            
            
            43,618
            
            
            42,284
            
            
            43,252
            
            
            40,294Advertising
                expense
            
            
            7,159
            
            
            6,618
            
            
            7,082
            
            
            6,597
            
            
            1,354State
                tax (benefit) expense1,3
            
            
            
            
            
            
            
            
            
            
            
            (2,103
            )
            
            2,145Income
                (loss) from operations
            
            
            15,926
            
            
            10,320
            
            
            7,771
            
            
            2,948
            
            
            (875
            )Other
                (income) expense, net
            
            
            270
            
            
            503
            
            
            314
            
            
            379
            
            
            (58
            )Income
                (loss) before income taxes
            
            
            15,656
            
            
            9,817
            
            
            7,457
            
            
            2,569
            
            
            (817
            )Provision
                (benefit) from income taxes
            
            
            5,971
            
            
            3,766
            
            
            2,805
            
            
            1,001
            
            
            (302
            )Net
                income (loss)
            
            $
            9,685
            
            $
            6,051
            
            $
            4,652
            
            $
            1,568
            
            $
            (515
            )Basic
                income (loss) per share
            
            $
            0.73
            
            $
            0.45
            
            $
            0.34
            
            $
            0.11
            
            $
            (0.04
            )Weighted
                average shares used in computation of basic income (loss) per
                share
            
            
            13,195
            
            
            13,382
            
            
            13,549
            
            
            13,644
            
            
            13,587Diluted
                income (loss) per share
            
            $
            0.66
            
            $
            0.42
            
            $
            0.32
            
            $
            0.11
            
            $
            (0.04
            )Weighted
                average shares used in computation of diluted income (loss) per
                share
            
            
            14,756
            
            
            14,527
            
            
            14,469
            
            
            13,739
            
            
            13,587**Balance
                Sheet Data:**Working
                capital
            
            $
            41,675
            
            $
            33,398
            
            $
            27,024
            
            $
            20,884
            
            $
            20,587Total
                assets
            
            
            120,695
            
            
            117,354
            
            
            102,144
            
            
            92,885
            
            
            79,952Interest
                bearing short-term debt
            
            
            
            
            
            11,972
            
            
            7,372
            
            
            8,683
            
            
            226Long-term
                debt, net of current portion
            
            
            6
            
            
            21
            
            
            1,307
            
            
            1,667Total
                shareholders’ equity
            
            $
            49,482
            
            $
            41,317
            
            $
            36,551
            
            $
            32,701
            
            $
            31,097**Selected
                Operating Data (unaudited):**Number
                of shipments
            
            
            406,475
            
            
            398,437
            
            
            421,836
            
            
            473,098
            
            
            506,877Average
                order size4
            
            $
            1,451
            
            $
            1,455
            
            $
            1,195
            
            $
            982
            
            $
            821Sales
                force, end of period
            
            
            342
            
            
            250
            
            
            281
            
            
            234
            
            
            239





1 During
      the fourth quarter of 2003, the Company reached final resolution and settled
      with the Washington State Department of Revenue regarding the tax years 1996
      through 1999. The Company recorded a benefit for this resolution of $2.1
      million.


2 On
      March
      31, 2003, the Company acquired Corporate PC Source, Inc. pursuant to a Stock
      Purchase Agreement. Corporate PC Source’s results of operations are included in
      the Company’s consolidated financial statements for the periods after the date
      of acquisition.


3 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.


4 Average
      order size is calculated by dividing gross sales by the number of shipped
      orders.




15
 *Table
            of Contents*





**Item
                7.**
            **Management’s
                Discussion and Analysis of Financial Condition and
                Results of Operations**





This
      section contains forward-looking statements based on management’s current
      expectations, estimates and projections about the industry in which the Company
      operates, management’s beliefs, and certain assumptions made by management.
      These statements are made pursuant to the safe harbor provision of the Private
      Securities Litigation Reform Act of 1995.  All
      statements, trends, analyses and other information contained in this report
      relative to trends in net sales, gross margin and anticipated expense levels,
      as
      well as other statements, including words such as “anticipate,” “believe,”
“plan,” “expect,” “estimate,” “intend.” and other similar expressions,
      constitute forward-looking statements. These forward-looking statements involve
      risks and uncertainties, and actual results may differ materially from those
      anticipated or expressed in such statements. Potential risks and uncertainties
      include, among others, those set forth in Item 1A of this Annual Report.
      Particular attention should be paid to the cautionary statements involving
      future growth; account executive hiring and productivity; increased expenses
      of
      being a public company; pressure on margin; competition; state tax
      uncertainties; rapid technological change and inventory obsolescence; reliance
      on vendor relationships; dependence on personnel; potential disruption of
      business from information systems failure; reliance on outsourced distribution;
      variations in gross profit margin percentages due to vendor programs and
      credits, product and customer mix, pricing strategies, and economic conditions.
      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.





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





**Overview**


Zones,
      Inc. is a direct marketing reseller of technology hardware, software and
      services. The Company procures and fulfills IT solutions for the SMB market
      (between 50 and 1000 computer users), enterprise customers (greater than 1000
      computer users) and the public sector (education and state and local
      governments). Relationships with SMB, enterprise customers, and public sector
      institutions represented 98.0%, 96.5% and 91.2% of total net sales during 2006,
      2005 and 2004, respectively. The remaining sales were from inbound customers,
      primarily consumers and small office/home office accounts purchasing mostly
      Mac
      platform products.





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





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





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





The
      Company is dedicated to creating a learning community of empowered individuals
      to serve its customers with integrity, commitment and passion. At December
      31,
      2006, the Company had 661 team members in its consolidated operations, 342
      of
      whom were inbound and outbound account executives. The majority of the Company’s
      team members work at its corporate headquarters in Auburn, Washington.





16
 *Table
            of Contents*





The
      Company makes additional company information available free of charge on its
      website, www.zones.com/IR .





**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 of America, and requires management to make use of certain
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities as of the date
      of the financial statements and the reported amounts of revenues and expenses
      during the reported periods. The Company bases its estimates on historical
      experience and on various other assumptions that are believed to be reasonable
      under the circumstances, the results of which form the basis for making
      judgments about carrying values of assets and liabilities that are not readily
      apparent from other sources. Actual results could differ from those estimates,
      and revisions to estimates are included in the results for the period in which
      the actual amounts become known.





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 therefore 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.*


The
      Company recognizes revenue on product sales when persuasive evidence of an
      arrangement exists, delivery has occurred, prices are fixed or determinable,
      and
      ability to collect is probable. 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’s shipping terms dictate that the passage of title
      occurs upon receipt of products by the customer except for the last seven
      calendar days of each fiscal quarter, when all shipments are insured in the
      name
      of the customer. For these seven days, passage of risk of loss and title occur
      at the shipping point.




The
      majority of the Company’s net sales relate to physical products. These sales are
      recognized on a gross basis with the selling price to the customer recorded
      as
      net sales and the acquisition cost of the product recorded as cost of sales.
      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. Amounts billed for shipping and handling are
      recorded as revenue. Pursuant to EITF 99-19 “Reporting Revenue Gross as a
      Principal versus Net as an Agent,” when the Company sets prices, has inventory
      risk and has credit risk, revenues are recorded gross. Third-party extended
      warranties, third-party software maintenance products and third-party services
      sold by the Company (for which the Company is not the primary obligor) are
      recognized gross in revenues and cost of sales when the Company sets prices
      and
      has inventory risk and credit risk. If any of those criteria are not present,
      revenue and cost of sales are recorded net. The Company’s warranty sales are
      generally recorded net. When the sale is recorded, the Company has no further
      obligation to fulfill. The Company only recognizes revenue when all criteria
      of
      Staff Accounting Bulletin No. 104 (“SAB 104”), "Revenue Recognition" have been
      met.




Additionally,
      the Company offers limited return rights within 14 days on its product sales.
      The Company has demonstrated the ability to make reasonable and reliable
      estimates of product returns based on significant historical experience. If
      actual credits were to deviate significantly from the Company’s estimates, its
      results of operations could be adversely affected. The Company had allowances
      for sales returns, net of cost, of $101,000 and $108,000 at December 31, 2006
      and 2005, respectively.




*Valuation
      of Current Assets, Allowance for Doubtful Accounts and Estimation of 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 that arise from product returns, standard vendor price
      protection programs, cooperative advertisement reimbursements 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, the denial of price protection, cooperative reimbursement,
      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.





17
 *Table
            of Contents*





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 states in which it is registered
      and/or has a physical presence. 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 considered
      future taxable income in assessing the need for a valuation allowance against
      its deferred tax assets. The Company believes that all net deferred tax assets
      shown on its balance sheet as of December 31, 2006, are more likely than
      not to be realized in the future and no valuation allowance is necessary. In the
      event that actual results differ from those estimates or that those estimates
      are adjusted in future periods, the Company may need to record a valuation
      allowance, which would reduce deferred tax assets and the results of operations
      in the period the change is made.





*Goodwill.*


In
      accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill
      will be tested for impairment at least annually, or when events indicate that
      impairment exists. The Company performs the assessment annually on March 31.
      The
      Company completed the impairment review required by SFAS No. 142 on March 31,
      2006 and determined that its goodwill was not impaired. There have been no
      significant business changes since the last assessment.





**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,****2006**
              
              **2005**
              
              **2004**Net
                  sales
              
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %Cost
                  of sales
              
              
              87.6
              
              
              89.3
              
              
              88.5Gross
                  profit
              
              
              12.4
              
              
              10.7
              
              
              11.5SG&A
                  expenses
              
              
              8.4
              
              
              7.7
              
              
              8.5Advertising
                  expense
              
              
              1.2
              
              
              1.2
              
              
              1.4Income
                  from operations
              
              
              2.8
              
              
              1.8
              
              
              1.6Other
                  expense, net
              
              
              0.1
              
              
              0.1
              
              
              0.1Income
                  before income taxes
              
              
              2.7
              
              
              1.7
              
              
              1.5Provision
                  from income taxes
              
              
              1.0
              
              
              0.7
              
              
              0.6Net
                  income
              
              
              1.7
              %
              
              1.0
              %
              
              0.9
              %**Product
                  Mix:**Notebook
                  & PDAs
              
              
              12.4
              %
              
              15.3
              %
              
              14.7
              %Desktops
                  & Servers
              
              
              20.3
              
              
              20.1
              
              
              21.3Software
              
              
              17.7
              
              
              15.9
              
              
              16.8Storage
              
              
              9.1
              
              
              9.1
              
              
              8.7NetComm
              
              
              4.9
              
              
              4.2
              
              
              4.4Printers
              
              
              8.2
              
              
              11.3
              
              
              9.6Monitors
                  & Video
              
              
              10.4
              
              
              9.6
              
              
              10.3Memory
                  & Processors
              
              
              6.2
              
              
              5.4
              
              
              5.0Accessories
                  & Other
              
              
              10.8
              
              
              9.1
              
              
              9.2Total
              
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %




*Comparison
      of Years Ended December 31, 2006 and 2005*





*Net
      Sales.* Consolidated
      net sales increased 1.8% to $577.0 million in 2006 compared to $566.6 million
      in
      2005. Consolidated outbound sales to commercial and public sector accounts
      increased 3.4% to $565.3 million in 2006 from $547.0 million in 2005. Sales
      to
      the Company’s SMB customers increased 18.1% to $222.1 million in 2006, compared
      to $188.2 million in 2005. The Company’s 2007 SMB growth initiatives will focus
      on small 50-to-100 seat customers, as well as assisting AEs to reach their
      expected productivity levels as tenure increases. Sales to the Company’s
      enterprise customers decreased 4.0% to $301.8 million for the year ended
      December 31, 2006, compared to $314.5 million in 2005. During 2005, one customer
      represented $48.5 million of enterprise net sales related to a specific one-time
      product roll-out during the second half of the year. The Company’s 2007
      enterprise customer sales initiative includes the formation of a field sales
      force to supplement the outbound call center sales force. Net sales to public
      sector customers decreased 5.9% to $39.2 million in 2006 from $41.6 million
      in
      2005. Inbound sales to the Company’s legacy Mac-platform consumer and small
      office/home office (“SOHO”) customers declined 37.3% to $14.0 million, or 2.4%
      of net sales.





18
 *Table
            of Contents*





*Gross
      Profit.* Consolidated gross profit increased to $71.5 million in 2006 compared to $60.6
      million in 2005. Gross profit as a percentage of net sales increased to 12.4%
      in
      2006, compared to 10.7% in 2005. The change is due to an increase in the gross
      profit earned on total net sales as compared to 2005, and an increase in the
      amount of vendor programs recorded in 2006. Gross profit margins as a percent
      of
      sales will continue to vary due to changes in vendor programs, product and
      customer mix, pricing strategies and economic conditions. The Company expects
      its gross profit margin to decline in 2007 from historical levels due to the
      Company’s field sales initiative and expected sales increases to existing large
      customers as large enterprise customers tend to record lower gross profit sales.
      The Company categorizes its warehousing and distribution network costs in
      selling, general and administrative expenses. Due to this classification, the
      Company’s gross profit may not be comparable to that of other companies that
      categorize warehousing and distribution network costs as a cost of
      sales.





*Selling,
      General and Administrative Expenses* .
      SG&A expenses increased to $48.4 million for 2006 from $43.6 million in
      2005, and increased as a percentage of net sales to 8.4% in 2006, compared
      7.7%
      in 2005. The increase in SG&A expenses was due to the following:





·
            Salaries,
                wages and benefits increased $4.4 million during 2006 as compared
                to the
                prior year. The increase was primarily due to increased headcount.
                The
                Company focused on growing its sales account executive headcount,
                particularly with the addition of its Portland, Oregon call center.
                Also,
                the Company recorded increased expenses associated with incentive
                compensation programs and commissions paid as a result of the increased
                sales volume and profitability, and stock compensation expense.


·
            The
                Company’s state tax expense decreased $411,000 in 2006 as compared to the
                prior year. This primarily relates to decreased Business and Occupation
                tax (an excise tax based on gross receipts) to the State of
                Washington.


·
            Facilities
                expense increased $254,000 for the year ended December 31, 2006 due
                to the
                additional rent expense associated with the Portland, Oregon call
                center,
                which was opened in the first quarter of
                2006.


·
            The
                Company’s professional fees increased $485,000 during 2006. This is
                primarily due to an increase in consulting fees associated with the
                Company’s outsourcing arrangement in India, as well as recruiting fees
                associated with the additional sales account executive
                headcount.


·
            Depreciation
                expense declined $164,000 for the year ended December 31, 2006 as
                compared
                to 2005. This decline was primarily due to more of the Company’s assets
                becoming fully depreciated.





For
      the
      periods ending December 31, 2006 and 2005, warehousing and distribution network
      costs totaled $2.1 million and $2.2 million, respectively. With regard to 2007,
      the Company’s initiative to create a field sales force will increase the
      Company’s SG&A expenses and it is anticipated that the existing operations
      will subsidize this investment until it reaches breakeven by the end of the
      year.





*Advertising
      Expenses, Net* .
      The
      Company produces and distributes catalogs at various intervals throughout the
      year, and also engages in other activities, to increase the awareness of its
      brand and stimulate demand response. The Company’s net cost of advertising
      increased to $7.2 million in 2006 from $6.6 million in 2005.




·
            Gross
                advertising expense increased to $8.9 million for fiscal year 2006
                compared to $7.0 million in fiscal year 2005. The increase was primarily
                due to expenses related to corporate and customer events.


·
            The
                Company’s gross advertising reimbursements also increased to $1.7 million
                in 2006 from $429,000 in 2005. The Company’s advertising expense increases
                were offset by the corresponding reimbursement increase, which was
                used to
                pay for incremental marketing activities.





*Interest
      Expense.* Interest
      expense was $419,000 in 2006, compared to $594,000 in 2005. The Company’s use of
      its line of credit to fund the expansion of accounts receivable and inventory
      incurred interest expense of $383,000 and $480,000 for the periods ended
      December 31, 2006 and 2005, respectively. The interest rate on the working
      capital line is tied to the Prime Rate. The effects of increases in the Prime
      Rate during 2006 where offset by a reduction in the Company’s usage of the
      working capital line of credit compared to 2005. The remaining expense was
      due
      to interest owed on the outstanding note payable to the former shareholders
      of
      CPCS, which was paid off in April 2006.





19
 *Table
            of Contents*





*Other
      Income.* Other
      income was $149,000 in 2006, compared to $91,000 in 2005.





*Income
      Tax Provision.* The
      income tax provision for 2006 was $5.9 million, compared to $3.8 million during
      2005. The effective tax rates expressed as a percent of income were 38.1% and
      38.4% for the years ended December 31, 2006 and 2005, respectively.





*Net
      Income.* Net
      income for fiscal year 2006 was $9.7 million, or $0.66 per diluted share, as
      compared to net income of $6.1 million, or $0.42 per diluted share, for fiscal
      year 2005.





*Comparison
      of Years Ended December 31, 2005 and 2004*





*Net
      Sales.* Consolidated
      net sales increased 14.3% to $566.6 million in 2005 compared to $495.6 million
      in 2004. The increase in sales resulted primarily from an increase in sales
      to
      its outbound customers. Consolidated outbound sales to commercial and public
      sector accounts increased 21.1% to $547.0 million in 2005 from $451.7 million
      in
      2004, and they now represent 96.5% of the Company’s total net sales. Sales to
      the Company’s SMB customers increased 13.1% to $188.2 million in 2005, compared
      to $168.9 million in 2004. Sales to the Company’s enterprise customers increased
      29.3% to $314.5 million for the year ended December 31, 2005, compared to $243.2
      million in 2004. One customer represented $48.5 million of enterprise net sales
      related to a specific one-time product roll-out which occurred during the second
      half of 2005. Net sales to public sector customers increased 4.9% to $41.6
      million in 2005 from $39.7 million in 2004. Inbound sales to the Company’s
      legacy Mac-platform consumer and small office/home office (“SOHO”) customers
      declined 55.4% to $22.3 million, or 3.9% of net sales. This decline was
      anticipated as the Company’s focus is on outbound sales customers who respond to
      the relationship-based selling model.





*Gross
      Profit.* Consolidated gross profit increased to $60.6 million in 2005 compared to $57.1
      million in 2004 primarily due to increased sales volume. Gross profit as a
      percentage of net sales decreased to 10.7% in 2005, compared to 11.5% in 2004,
      due primarily to strategic cost concessions to a customer in support of
      significant sales in the second half of 2005. Gross profit margins as a percent
      of sales will continue to vary due to changes in vendor programs, product mix,
      pricing strategies, customer mix and economic conditions. The Company
      categorizes its warehousing and distribution network costs in selling, general
      and administrative expenses. Due to this classification, the Company’s gross
      profit may not be comparable to that of other companies that categorize
      warehousing and distribution network costs as a cost of sales.





*Selling,
      General and Administrative Expenses* .
      SG&A expenses increased 3.2% to $43.6 million for 2005 from $42.3 million in
      2004, and declined as a percentage of net sales to 7.7% in 2005, compared to
      8.5% in 2004. The increase in SG&A expenses was impacted by the Company’s
      increase in sales volume, as well as the following:





·
            Salaries,
                wages and benefits increased $1.0 million during 2005 as compared
                to the
                prior year. The increase was primarily due to increased incentive
                programs
                and commissions paid as a result of the increased sales volume.


·
            The
                Company’s state tax expense increased $437,000 in 2005 as compared to the
                prior year. This primarily relates to increased sales to customers
                in
                Washington State, a state in which Business and Occupation tax (an
                excise
                tax based on gross receipts) is
                remitted.


·
            The
                Company’s professional fees increased $434,000 during 2005. This is
                primarily due to an increase in consulting fees associated with its
                outsourcing arrangement in India.


·
            Depreciation
                expense declined $456,000 for the year ended December 31, 2005 as
                compared
                to 2004. This decline was primarily due to the Company’s decision to make
                enhancements to its fully depreciated enterprise systems rather than
                purchasing a new product.


·
            Credit
                card processing fees during 2005 declined $257,000 as compared to
                2004.
                This decline is due to the Company’s increase in outbound sales, which
                tend to purchase on open account versus credit card.





For
      the
      periods ending December 31, 2005 and 2004, warehousing and distribution network
      costs totaled $2.2 million and $1.9 million, respectively.





*Advertising
      Expenses, Net* .
      The
      Company produces and distributes catalogs at various intervals throughout the
      year, and also engages in other activities, to increase the awareness of its
      brand and stimulate demand response. The Company’s net cost of advertising
      decreased to $6.6 million in 2005 from $7.1 million in 2004.




20
 *Table
          of Contents*




·
            Gross
                advertising expense decreased to $7.0 million for fiscal year 2005
                compared to $7.6 million in fiscal year 2004. The decline was primarily
                due to a reduction in circulation of the Company’s catalogs. During 2005,
                the Company produced and distributed 5.0 million catalogs, compared
                to 7.7
                million in 2004.


·
            The
                Company’s gross advertising reimbursements also decreased to $429,000 in
                2005 from $564,000 in 2004.




*Interest
      Expense.* Interest
      expense was $594,000 in 2005, compared to $404,000 in 2004. The Company’s use of
      its line of credit to fund the expansion of accounts receivable and inventory
      incurred interest expense of $480,000 and $305,000 for the periods ended
      December 31, 2005 and 2004, respectively. The interest rate on the working
      capital line is tied to the Prime Rate. The Prime Rate increased to 7.0% at
      December 31, 2005, compared to 5.0% at December 31, 2004. The remaining expense
      was due to interest owed on the outstanding note payable to the former
      shareholders of CPCS.





*Other
      Income.* Other
      income was $91,000 in 2005, compared to $90,000 in 2004.





*Income
      Tax Provision.* The
      income tax provision for 2005 was $3.8 million, compared to $2.8 million during
      2004. The effective tax rates expressed as a percent of income were 38.4% and
      37.6% for the years ended December 31, 2005 and 2004, respectively.





*Net
      Income.* Net
      income for fiscal year 2005 was $6.1 million, or $0.42 per diluted share, as
      compared to net income of $4.7 million, or $0.32 per diluted share, for fiscal
      year 2004.





**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**


*Working
      Capital.*


The
      Company’s total assets were $120.7 million at December 31, 2006, of which $111.4
      million were current assets. At December 31, 2006 and 2005, the Company had
      cash
      and cash equivalents of $9.2 million and $3.2 million, respectively, and had
      working capital of $41.7 million and $33.4 million, respectively. The increase
      in working capital was primarily a result of the Company’s operating results
      which led to decreases in the Company’s usage of its line of credit, and the
      repayment of outstanding notes payable which reduced its current liabilities.





*Stock
      Repurchase Program.*


Since
      2004, the Company has repurchased a total of 1,441,240 shares of its common
      stock at a total cost of $7.2 million under its repurchase program
      authorized by its Board of Directors. Share repurchases may be made from time
      to
      time in both open market and private transactions, as conditions warrant, at
      then prevailing market prices. The following table represents share repurchases
      for the years ended December 31, 2006, 2005 and 2004 (dollars in
      thousands):








**Period**
            
            **Total
                number of shares purchased**
            
            **Amount
                paid**2006
            
            
            568,400
            
            $
            3,9882005
            
            
            424,450
            
            $
            1,8122004
            
            
            448,390
            
            $
            1,348




As
      of
      December 31, 2006, $979,000 in shares of the Company’s common stock
      remained available for repurchase under the program. In February 2007, the
      Board
      of Directors authorized a continuation of the Company’s share repurchase
      program, pursuant to which the Company increased the total amount authorized.
      As
      of February 2007, $3.0 million in shares of the Company’s common stock is
      available for repurchase under the program. The current repurchase program
      is
      expected to remain in effect through February 2008, unless earlier
      terminated by the Board or completed.




Approximately
      92% of the Company’s sales are processed on open account terms offered to its
      customers, which increases the Company’s accounts receivable balance. To finance
      these sales, the Company leverages its secured line of credit for timing
      differences in cash inflows and cash outflows to invest in the growth of its
      business. The secured line of credit is utilized from time to time to invest
      in
      capital purchases, to purchase inventory for general stock as well as for
      certain customers, and to take full advantage of available early pay discounts.




21
 *Table
            of Contents*




At
      December 31, 2006, the Company had $40.0 million available under a secured
      line
      of credit with a major financial institution.  The credit facility is
      collateralized by accounts receivable and inventory, and it can be utilized
      as
      both a working capital line of credit and a flooring facility used to purchase
      inventory from several suppliers under certain terms and conditions.  This
      credit facility has an annual automatic renewal which occurs on November 26
      of
      each fiscal year. Either party can terminate this agreement with 60-days written
      notice prior to the renewal date.  The working capital and inventory
      advances bear interest at a rate of Prime + 0.50%. The Company’s line of credit
      is defined by quick turnover, large amounts under the flooring facility, and
      short maturities. All amounts owed under the Company’s line of credit are due on
      demand. Inventory advances do not bear interest if paid within terms, usually
      30
      days from advance date.  The facility contains various restrictive
      covenants relating to tangible net worth, leverage, dispositions and use of
      collateral, other asset dispositions, and merger and consolidation of the
      Company. At December 31, 2006, the Company was compliant with all covenants
      of
      this facility. At December 31, 2006, there were no amounts owed for working
      capital advances, and $14.4 million was owed to this financial institution
      for
      flooring arrangements related to inventory purchases.




The
      Company believes that its existing available cash and cash equivalents,
      operating cash flow, and existing credit facilities will be sufficient to
      satisfy its operating cash needs, and up to the remaining balance of $3.0
      million authorized in the Company’s stock repurchase program, for at least the
      next 12 months at its current level of business. However, if the Company’s
      working capital or other capital requirements are greater than currently
      anticipated, the Company could be required to reduce or curtail its stock
      repurchase program and seek additional funds through sales of equity, debt
      or
      convertible securities, or through increased credit facilities. There can be
      no
      assurance that additional financing will be available or that, if available,
      the
      financing will be on terms favorable to the Company and its
      shareholders.





*Cash
      Flows.*


The
      primary factors that affected fiscal year 2006 cash flow from operations were
      account and vendor receivables, inventory financing, and the increase in accrued
      liabilities and deferred rent. Account and vendor receivables decreased $4.8
      million due to aggressive collection efforts. Inventory financing increased
      by
      $5.9 million. The inventory financing balance change is due to purchasing and
      payment cycles. Accrued liabilities and deferred rent increased $4.3 million.
      This increase was primarily due to accrued incentive compensation.





Net
      cash
      used in investing activities was $1.8 million for the year ended December 31,
      2006. Cash outlays for capital expenditures were $1.8 million for the years
      ended December 31, 2006 and 2005. Capital expenditures were primarily for
      leasehold improvements for the Company’s corporate headquarters and continued
      improvement, and other enhancements, of the Company’s information systems. The
      Company intends to continue to upgrade its internal information systems as
      a
      means to increase operational efficiencies.





The
      most
      significant components of the Company’s financing activities are the
      purchase of the Company’s common stock under its share repurchase
      program, net change in the Company’s secured line of credit, and net change
      in book overdraft. For the year ended December 31, 2006, the Company repurchased
      $4.0 million of its common stock under its share repurchase program. Net changes
      in the Company’s line of credit and book overdraft were a decrease of $10.7
      million and $2.9 million, respectively. The Company’s financing activities for
      the year ended December 31, 2006 also included the payment of an amount due
      on
      the note payable issued in its acquisition of CPCS. The Company paid the final
      payment during the second quarter of 2006. For the years ended December 31,
      2006
      and 2005, the Company paid the former shareholders of CPCS $1.3 million each
      year.





**Contractual
      Obligations**


The
      following table summarizes our contractual payment obligations and commitments
      as of December 31, 2006:





**Payments
                Due by Period**Total
            
            Less
                than 1 year
            
            1-3
                years
            
            3-5
                years
            
            More
                than 5 yearsOperating
                Leases (a)
            
            $
            16,665
            
            $
            2,236
            
            $
            4,480
            
            $
            3,870
            
            $
            6,079Purchase
                Obligations (b)
            
            
            9,508
            
            
            9,508Total
            
            $
            26,173
            
            $
            11,744
            
            $
            4,480
            
            $
            3,870
            
            $
            6,079






(a)
            Represents
                the Company’s commitments under operating leases associated with contracts
                that expire at various times. One of the commitments is the Company’s
                Auburn, Washington headquarters, which is leased from a related
                party.


(b)
            Purchase
                obligations represents the amount of open purchase orders the Company
                has
                outstanding with its vendors. These obligations may be canceled prior
                to
                shipment at the Company’s
                discretion.





22
 *Table
            of Contents*





**Other
      Matters**


*New
      Accounting Pronouncements.*


In
      September 2006, the FASB issued SFAS No. 157 (SFAS 157), *Fair
      Value Measurements* .
      SFAS
      157 defines fair value, establishes a framework for measuring fair value and
      expands disclosures about fair-value measurements required under other
      accounting pronouncements, but does not change existing guidance as to whether
      or not an instrument is carried at fair value. SFAS 157 is effective for the
      Company’s fiscal year 2008. The Company is currently evaluating the impact of
      adopting SFAS 157.





In
      September 2006, the SEC released Staff Accounting Bulletin 108 (SAB 108), *Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements* . The
      intent of SAB 108 is to reduce diversity in practice for the method
      companies use to quantify financial statement misstatements, including the
      effect of prior year uncorrected errors. SAB 108 establishes an approach
      that requires quantification of financial statement errors using both an income
      statement and a cumulative balance sheet approach. SAB 108 is effective for
      fiscal years beginning after November 15, 2006, and the Company will adopt
      the new requirements on January 1, 2007. The
      Company does not believe that the adoption of SAB 108 will have a significant
      effect on its financial statements.





In
      July
      2006, the FASB issued FASB Interpretation No. 48 (FIN 48), *Accounting
      for Uncertainty in Income Taxes: an Interpretation of FASB Statement No.
      109* , *Accounting
      for Income Taxes* .
      FIN
      48  clarifies
      the accounting for uncertainty in income taxes recognized in a company’s
      financial statements and prescribes a recognition threshold and measurement
      attribute for the financial statement recognition and measurement of a tax
      position taken or expected to be taken in an income tax return. FIN 48 also
      provides guidance on derecognition, classification, interest and penalties,
      accounting in interim periods, disclosure and transition. Only tax positions
      that meet the more-likely-than-not recognition threshold at the adoption date
      will be recognized or continue to be recognized. The cumulative effect of
      applying Interpretation 48 will be reported as an adjustment to retained
      earnings at the beginning of the period in which it is adopted. FIN 48 will
      be
      adopted by the Company on January 1, 2007. The Company currently **** does
      not
      believe that the adoption of Interpretation 48 will have a significant effect
      on
      its financial statements.





In
      June
      2006, the FASB ratified the consensus reached on Emerging Issues Task Force
      (EITF) Issue No. 06-03, “ *How
      Sales Taxes Collected from Customers and Remitted to Governmental Authorities
      Should Be Presented in the Income Statement (that is, Gross Versus Net
      Presentation).”* The
      EITF
      reached a consensus that the presentation of taxes on either a gross or net
      basis is an accounting policy decision that requires disclosure. EITF 06-03
      is
      effective for the first interim or annual reporting period beginning after
      December 15, 2006. Amounts collected from members, which under common trade
      practices are referred to as sales taxes, are and have been recorded on a net
      basis. The Company has no intention of modifying this accounting policy.
      Therefore, the adoption of EITF 06-03 will not have any effect on the Company’s
      financial statements.





**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,
      2006.
      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.





**Item
                8.**
            **Financial
                Statements and Supplementary
                Data**


The
      information required by this item is included in this report beginning at page
      29.





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


None.





**Item
                9A.**
            **Control
                and
                Procedures**


At
      the
      end of the period covered by this report, the Company carried out an evaluation,
      under the supervision and with the participation of the Company's management,
      including the Company’s Chief Executive Officer and Chief Financial Officer, of
      the Company’s disclosure controls and procedures pursuant to Exchange Act Rule
      13 a-15(e). Based upon that evaluation, the Chief Executive Officer and Chief
      Financial Officer concluded that the Company’s disclosure controls and
      procedures are effective.





23
 *Table
            of Contents*





During
      the fourth quarter of 2006, there were no changes in the Company’s internal
      control over financial reporting that have materially affected, or are
      reasonable likely to materially affect, the Company’s internal control over
      financial reporting.





**Item
                9B.**
            **Other
                Information**


None.





**Part
      III**





**Item
                10.**
            **Directors,
                Executive Officers and Corporate
                Governance**


The
      information required by this item is contained in, and incorporated by reference
      from, the Proxy Statement for the Company’s 2007 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.





The
      Board
      of Directors has determined that John Bauer qualifies as an “audit committee
      financial expert” as such term is defined by the SEC and that Mr. Bauer meets
      the independence criteria set forth in the applicable rules of Nasdaq and the
      SEC for Audit Committee Membership.




The
      Company’s Code of Business Conduct and Ethics has been approved by its Board of
      Directors and applies to all of its team members and directors, including its
      principal executive officer, principal financial officer and principal
      accounting officer. The Company’s Code of Business Conduct and Ethics covers all
      areas of professional conduct including, but not limited to, conflicts of
      interest, disclosure obligations, insider trading, confidential information,
      as
      well as compliance with all laws, rules and regulations applicable to its
      business.




A
      copy of
      the Company’s Code of Business Conduct and Ethics is available at its website at www.zones.com/IR .
      In the
      event that an amendment to, or a waiver from, a provision of the Company’s Code
      of Business Conduct and Ethics that applies to any of its officers or directors
      is necessary, the Company intends to post such information on its website at
      www.zones.com/IR.




The
      Company will provide without charge to any person, upon request of such person,
      a copy of its Code of Business Conduct and Ethics. Requests should be directed
      in writing to Zones, Inc. Investor Relations, 1102 15 th Street
      SW, Suite 102, Auburn, WA 98001-6509.





**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 2007 Annual Meeting of Shareholders
      under the caption “Executive Compensation.”





**Item
                12.**
            **Security
                Ownership of Certain Beneficial Owners and Management
                and Related Stockholder
                Matters**


The
      information required by this item is contained in, and incorporated by reference
      from, the Proxy Statement for the Company’s 2007 Annual Meeting of Shareholders
      under the caption “Stock Ownership of Management and Certain Other
      Holders.”





**Item
                13.**
            **Certain
                Relationships and Related Transactions, and Director
                Independence**


The
      information required by this item is contained in, and incorporated by reference
      from, the Proxy Statement for the Company’s 2007 Annual Meeting of Shareholders
      under the caption “Certain Relationships and Related Transactions.”





**Item
                14.**
            **Principal
                Accountant Fees and
                Services**


The
      information required by this item is contained in, and incorporated by reference
      from, the Proxy Statement for the Company’s 2007 Annual Meeting of Shareholders
      under the caption “Principal Accounting Firm Fees.”





**Part
      IV**





**Item
                15.**
            **Exhibits
                and Financial Statement
                Schedules**


(a)
            1.
                Financial Statements:


The
      financial statements of Zones, Inc. and the Report of Independent Registered
      Public Accounting Firm is included herein beginning on page 29.




24
 *Table
          of Contents*




2.
      Financial Statement Schedules:





See
      Schedule II, Valuation and Qualifying Accounts





3.
      Exhibits:





Exhibit
                No.
            Description
            Filed
                Herewith
            Incorporated
                by ReferenceForm
            Exhibit
                No.
            File
                No.
            Filing
                Date3.1
            Restated
                Articles of Incorporation of Multiple Zones International, Inc.
            
            S-1
            3.1
            333-04458
            6/5/963.2
            Articles
                of Amendment of Multiple Zones, Inc.
            
            S-8
            4.2
            333-110750
            11/25/033.3
            Amended
                and Restated Bylaws of Multiple Zones International, Inc.
            
            10-K
            3.1
            000-28488
            3/4/054.1
            Form
                of Common Stock Certificate of Zones, Inc.10.1
            Multiple
                Zones International, Inc. Amended and Restated 1993 Stock Incentive
                Plan*
            
            10-K
            10.1
            000-28488
            3/4/0510.2
            Multiple
                Zones International, Inc. Amended and Restated 1999 Director Stock
                Option
                Plan*
            
            14-A
            Appendix
                A
            000-28488
            3/25/0410.3
            Form
                of Stock Option Agreement (used for grants to executive officers
                after
                March 31, 1996)*
            
            S-1
            10.4
            333-04458
            6/5/9610.4
            Form
                of Stock Option Agreement (used for grants to outside
                directors)*
            
            S-1
            10.16
            333-04458
            6/5/9610.5
            Multiple
                Zones International, Inc. 401(k) Plan*
            
            S-1
            10.5
            333-04458
            6/5/9610.6
            Multiple
                Zones International, Inc. Employee Stock Purchase Plan*
            
            S-1
            10.6
            333-04458
            6/5/9610.7
            Amendment
                of 1996 Employee Stock Purchase Plan
            
            10-Q
            10.3
            000-28488
            8/14/0310.8
            Form
                of Indemnification Agreement between Multiple Zones International,
                Inc.
                and certain executive officers and outside directors*
            
            S-1
            10.15
            333-04458
            6/5/9610.9
            Amended
                and Restated Indemnification Agreement
            
            10-Q
            10.1
            000-28488
            11/14/0310.10
            Loan
                and Security Agreement dated November 25, 2002 between Zones, Inc.
                and
                TransAmerica Commercial Finance
            
            10-K
            10.20
            000-28488
            2/26/0310.11
            Amended
                and Restated Loan and Security Agreement dated April 11, 2003 between
                Zones, Inc., Corporate PC Source, Inc. and Transamerica Commercial
                Finance
                Corporation
            
            10-Q
            10.1
            000-28488
            8/14/0310.12
            Zones,
                Inc. 2003 Equity Incentive Plan*
            
            14-A
            
            000-28488
            3/20/0310.13
            Stock
                Purchase Agreement, dated March 31, 2003, by and among Zones, Inc.
                and
                Corporate PC Source, Inc. and Christina Corley, Robert Frauenheim,
                individually and as Trustee of the Robert Frauenheim Declaration
                of Trust
                dated September 17, 1997, and Daniel Frauenheim.
            
            8-K
            2.1
            000-28488
            4/3/0310.14
            Office
                lease dated June 9, 2003 between Zones, Inc and Fana Auburn
                LLC
            
            10-Q
            10.2
            000-28488
            8/14/0310.15
            Form
                of Stock Option Agreement (used for grants under the 2003 Stock Equity
                Plan)*
            
            10-K
            10.25
            000-28488
            2/26/0410.16
            Commercial
                Lease Agreement dated March 19, 2004 between Corporate PC Source
                and AMB
                Property II, L.P.
            
            10-Q
            10.4
            000-28488
            5/13/0410.17
            Amendment
                No. 2 to Amended and Restated Loan and Security Agreement dated January
                9,
                2004 between Zones Inc. and its subsidiaries, and Transamerica Commercial
                Finance Corporation
            
            10-Q
            10.5
            000-28488
            5/13/0410.18
            Subordination,
                Non-disturbance, and Attornment Agreement dated June 22, 2004 between
                US
                Bank National Association, Zones, Inc. and Fana Auburn LLC
            
            10-Q
            10.1
            000-28488
            8/11/04




25
 *Table
            of Contents*




10.19
            Interest
                Termination and Settlement Agreement, dated September 27, 2004, by
                and
                among Zones, Inc. and Christina Corley, Robert Frauenheim, individually
                and as Trustee of the Robert Frauenheim Declarations of Trust dated
                September 17, 1997, and Daniel Frauenheim
            
            8-K
            10.1
            000-28488
            9/29/0410.20
            Form
                of Unsecured, Subordinated Promissory Note
            
            8-K
            10.2
            000-28488
            9/29/0410.21
            Summary
                of Zones, Inc. Board Meeting Fees and Basic Compensation
            
            10-Q
            10.1
            000-28488
            8/10/0510.22
            Notice
                of Grant of Director Stock Option pursuant to the Zones, Inc 2003
                Equity
                Incentive Plan
            
            10-Q
            10.2
            000-28488
            8/10/0510.23
            Office
                Lease dated September 2005 between Zones, Inc. and the Trustees Under
                the
                Will and of the Estate of James Campbell, Deceased
            
            10-Q
            10.1
            000-28488
            11/9/0510.24
            Office
                Lease dated December 2005 between Zones, Inc. and Montgomery Park
                I, LLC
            
            10-K
            10.28
            000-28488
            2/24/0610.25
            Amendment
                to Office Lease between Zones, Inc and Fana Auburn LLC
            
            10-Q
            10.1
            000-28488
            5/12/0610.26
            Summary
                of the Zones, Inc. Senior Management Bonus Program*
            
            8-K
            99.2
            000-28488
            2/12/0710.27
            Summary
                of the Zones, Inc. Executive Vice President Bonus Program*
            
            8-K
            99.1
            000-28488
            2/12/0721.1
            Subsidiaries
                of the Registrant
            X23.1
            Consent
                of Grant Thornton LLP, Independent Registered Public Accounting
                Firm
            X23.2
            Consent
                of PricewaterhouseCoopers LLP, Independent Registered Public Accounting
                Firm
            X31.1
            Certification
                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002 and the regulations promulgated thereunder
            X31.2
            Certification
                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002 and the regulations promulgated thereunder
            X32.1
            Certification
                of Chief Executive Officerpursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and the
                regulations promulgated thereunder
            X32.2
            Certification
                ofChief
                Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
                of
                2002 and the regulations promulgated thereunder
            X*
            Management
                contract or compensatory plan or arrangement




26
 *Table
            of Contents*





**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.




ZONES,
                INC.Date:
                February 27, 2007By:
            /S/   
                FIROZ H. LALJIFiroz
                H. Lalji, Chairman and Chief Executive Officer/S/   
                RONALD P. MCFADDENRonald
                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.





Signature
            
            Title
            
            Date/S/   
                JOHN H. BAUER
            
            Director
            
            February
                27, 2007John
                H. BauerLARRY
                BENAROYA
            
            Director
            
            February
                27, 2007Larry
                Benaroya/S/   
                CATHI HATCH
            
            Director
            
            February
                27, 2007Cathi
                Hatch/S/   
                WILLIAM C. KEIPER
            
            Director
            
            February
                27, 2007William
                C. Keiper/S/   
                KENNETH M. KIRKPATRICK
            
            Director
            
            February
                27, 2007Kenneth
                M. Kirkpatrick/S/   
                FIROZ H. LALJI
            
            Director
            
            February
                27, 2007Firoz
                H. Lalji




27
 *Table
            of Contents*





**ZONES,
      INC.**


**INDEX
      TO CONSOLIDATED FINANCIAL STATEMENTS**








Consolidated
                Financial Statements:Consolidated
                Balance Sheets
              December
                31, 2006 and 2005
            29Consolidated
                Statements of Operations
              Twelve
                months ended December 31, 2006, 2005 and 2004
            30Consolidated
                Statement of Shareholders’ Equity
              Twelve
                months ended December 31, 2006, 2005 and 2004
            31Consolidated
                Statements of Cash Flows
              Twelve
                months ended December 31, 2006, 2005 and 2004
            32Notes
                to Consolidated Financial Statements
            33Report
                of Grant Thornton LLP, Independent Registered Public Accounting
                Firm
            45Report
                of PricewaterhouseCoopers LLP, Independent Registered Public Accounting
                Firm
            46Schedule
                II - Valuation and Qualifying Accounts
            47





28
 *Table
            of Contents*





**ZONES,
      INC.**


**CONSOLIDATED
      BALANCE SHEETS**


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


**December
                    31,****2006**
                
                **2005****ASSETS**Current
                    assets:Cash
                    and cash equivalents
                
                $
                9,191
                
                $
                3,195Receivables,
                    net of allowances of $1,936 and $1,562 at December 31, 2006 and
                    2005,
                    respectively
                
                
                65,699
                
                
                68,318Vendor
                    receivables
                
                
                12,556
                
                
                14,750Inventories
                
                
                21,385
                
                
                19,736Prepaid
                    expenses
                
                
                1,076
                
                
                922Deferred
                    income taxes
                
                
                1,473
                
                
                1,346Total
                    current assets
                
                
                111,380
                
                
                108,267Property
                    and equipment, net
                
                
                3,771
                
                
                3,810Goodwill
                
                
                5,098
                
                
                5,098Deferred
                    income taxes
                
                
                251Other
                    assets
                
                
                195
                
                
                179Total
                    assets
                
                $
                120,695
                
                $
                117,354**LIABILITIES
                    AND SHAREHOLDERS' EQUITY**Current
                    liabilities:Accounts
                    payable
                
                $
                42,592
                
                $
                45,359Inventory
                    financing (Note 5)
                
                
                14,385
                
                
                8,469Accrued
                    liabilities
                
                
                12,728
                
                
                9,069Line
                    of credit
                
                
                
                
                
                10,700Notes
                    payable to former shareholders of CPCS, Inc.
                
                
                
                
                
                1,272Total
                    current liabilities
                
                
                69,705
                
                
                74,869Note
                    payable for purchase of fixed asset
                
                
                6
                
                
                21Deferred
                    income taxes
                
                
                
                
                
                35Deferred
                    rent obligation
                
                
                1,502
                
                
                1,112Total
                    liabilities
                
                
                71,213
                
                
                76,037Commitments
                    and contingencies (Note 8)Shareholders'
                    equity:Common
                    stock, no par value, 45,000,000 authorized; 13,157,719 and 13,265,049
                    shares issued and outstanding at December 31, 2006 and 2005,
                    respectively
                
                
                35,983
                
                
                37,503Retained
                    earnings
                
                
                13,499
                
                
                3,814Total
                    shareholders' equity
                
                
                49,482
                
                
                41,317Total
                    liabilities and shareholders' equity
                
                $
                120,695
                
                $
                117,354





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





29
 *Table
            of Contents*





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


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




**Year
                        ended December 31,****2006**
                    
                    **2005**
                    
                    **2004**Net
                        sales
                    
                    $
                    577,027
                    
                    $
                    566,553
                    
                    $
                    495,563Cost
                        of sales
                    
                    
                    505,508
                    
                    
                    505,997
                    
                    
                    438,426Gross
                        profit
                    
                    
                    71,519
                    
                    
                    60,556
                    
                    
                    57,137Selling,
                        general and administrative expenses
                    
                    
                    48,434
                    
                    
                    43,618
                    
                    
                    42,284Advertising
                        expense
                    
                    
                    7,159
                    
                    
                    6,618
                    
                    
                    7,082Income
                        from operations
                    
                    
                    15,926
                    
                    
                    10,320
                    
                    
                    7,771Interest
                        expense
                    
                    
                    419
                    
                    
                    594
                    
                    
                    404Other
                        income
                    
                    
                    (149
                    )
                    
                    (91
                    )
                    
                    (90
                    )Other
                        expense, net
                    
                    
                    270
                    
                    
                    503
                    
                    
                    314Income
                        before income taxes
                    
                    
                    15,656
                    
                    
                    9,817
                    
                    
                    7,457Provision
                        for income taxes
                    
                    
                    5,971
                    
                    
                    3,766
                    
                    
                    2,805Net
                        income
                    
                    $
                    9,685
                    
                    $
                    6,051
                    
                    $
                    4,652Basic
                        income per share
                    
                    $
                    0.73
                    
                    $
                    0.45
                    
                    $
                    0.34Weighted
                        average shares used in computing basic income per share
                    
                    
                    13,195
                    
                    
                    13,382
                    
                    
                    13,549Diluted
                        income per share
                    
                    $
                    0.66
                    
                    $
                    0.42
                    
                    $
                    0.32Weighted
                        average shares used in computing diluted income per share
                    
                    
                    14,756
                    
                    
                    14,527
                    
                    
                    14,469





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





30
 *Table
            of Contents*





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENT OF SHAREHOLDERS' EQUITY**


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





Common
                Stock
            
            Retained
                EarningsShares
            
            Amount
            
            (Deficit)
            
            TotalBalance,
                January 1, 2004
            
            
            13,659,371
            
            $
            39,590
            
            $
            (6,889
            )
            $
            32,701Purchase
                and retirement of common stock
            
            
            (448,390
            )
            
            (1,348
            )
            
            
            
            
            (1,348
            )Exercise
                of stock options
            
            
            296,746
            
            
            453
            
            
            
            
            
            453Tax
                effect of stock options exercised
            
            
            
            
            
            93
            
            
            
            
            
            93Net
                income
            
            
            
            
            
            
            
            
            4,652
            
            
            4,652Balance,
                December 31, 2004
            
            
            13,507,727
            
            
            38,788
            
            
            (2,237
            )
            
            36,551Purchase
                and retirement of common stock
            
            
            (424,450
            )
            
            (1,813
            )
            
            
            
            
            (1,813
            )Exercise
                of stock options
            
            
            181,772
            
            
            316
            
            
            
            
            
            316Tax
                effect of stock options exercised
            
            
            
            
            
            212
            
            
            
            
            
            212Net
                income
            
            
            
            
            
            
            
            
            6,051
            
            
            6,051Balance,
                December 31, 2005
            
            
            13,265,049
            
            
            37,503
            
            
            3,814
            
            
            41,317Purchase
                and retirement of common stock
            
            
            (568,400
            )
            
            (3,988
            )
            
            
            
            
            (3,988
            )Exercise
                of stock options
            
            
            461,070
            
            
            1,412
            
            
            
            
            
            1,412Excess
                tax benefit from stock options exercised
            
            
            
            
            
            651
            
            
            
            
            
            651Stock-based
                compensation
            
            
            
            
            
            405
            
            
            
            
            
            405Net
                income
            
            
            
            
            
            
            
            
            9,685
            
            
            9,685Balance,
                December 31, 2006
            
            
            13,157,719
            
            $
            35,983
            
            $
            13,499
            
            $
            49,482





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





31
 *Table
            of Contents*





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(in
      thousands)**




**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**Cash
                flows from operating activities:Net
                income
            
            $
            9,685
            
            $
            6,051
            
            $
            4,652Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:Depreciation
            
            
            1,831
            
            
            1,966
            
            
            2,468Non-cash
                stock-based compensation
            
            
            405Excess
                tax benefit from exercise of stock options
            
            
            (651
            )Deferred
                tax asset
            
            
            (413
            )
            
            2,854
            
            
            2,272Tax
                effect of stock option exercise
            
            
            
            
            
            212
            
            
            93(Increase)
                decrease in assets and liabilities:Receivables,
                net
            
            
            4,813
            
            
            (19,130
            )
            
            (3,973
            )Inventories
            
            
            (1,649
            )
            
            (2,330
            )
            
            (5,918
            )Prepaid
                expenses and other assets
            
            
            (171
            )
            
            29
            
            
            138Accounts
                payable
            
            
            128
            
            
            3,133
            
            
            6,618Inventory
                financing
            
            
            5,916
            
            
            (5,837
            )
            
            (443
            )Income
                taxes payable
            
            
            353
            
            
            107Accrued
                liabilities and deferred rent
            
            
            4,347
            
            
            1,717
            
            
            (206
            )Net
                cash provided by (used in) operating activities
            
            
            24,594
            
            
            (11,228
            )
            
            5,701Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (1,792
            )
            
            (1,826
            )
            
            (2,029
            )Net
                cash used in investing activities
            
            
            (1,792
            )
            
            (1,826
            )
            
            (2,029
            )Cash
                flows from financing activities:Net
                change in book overdrafts
            
            
            (2,894
            )
            
            7,975
            
            
            1,112Net
                change in line of credit
            
            
            (10,700
            )
            
            4,600
            
            
            (1,750
            )Payments
                of note payable
            
            
            (1,287
            )
            
            (1,286
            )
            
            (862
            )Excess
                tax benefit from exercise of stock options
            
            
            651Purchase
                and retirement of common stock
            
            
            (3,988
            )
            
            (1,813
            )
            
            (1,348
            )Proceeds
                from exercise of stock options
            
            
            1,412
            
            
            316
            
            
            453Net
                cash provided by (used in) financing activities
            
            
            (16,806
            )
            
            9,792
            
            
            (2,395
            )Net
                increase (decrease) in cash and cash equivalents
            
            
            5,996
            
            
            (3,262
            )
            
            1,277Cash
                and cash equivalents at the beginning of the year
            
            
            3,195
            
            
            6,457
            
            
            5,180Cash
                and cash equivalents at the end of the year
            
            $
            9,191
            
            $
            3,195
            
            $
            6,457Supplemental
                cash flow information:Cash
                paid for interest
            
            $
            489
            
            $
            554
            
            $
            335Cash
                paid for income taxes
            
            $
            6,019
            
            $
            594
            
            $
            260Noncash
                investing and financing activity:Cancellation
                of note payable for acquisition of CPCS
            
            
            
            
            
            
            
            $
            1,544Note
                payable replacing earn-out provision of CPCS acquisition
            
            
            
            
            
            
            
            $
            2,744Non-cash
                reduction to note payable for purchase price adjustment of
                CPCS
            
            
            
            
            
            
            
            $
            295Note
                payable for fixed asset purchase
            
            
            
            
            
            
            
            $
            35





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





32
 *Table
            of Contents*





**ZONES,
      INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**1.** **Description
      of Business**





Zones,
      Inc. (the ”Company”) is a single-source direct marketing reseller of name-brand
      information technology products to the small-to-medium-sized business market,
      enterprise accounts and public sector accounts. The Company sells these products
      through outbound and inbound account executives, catalogs and the Internet.
      The
      Company offers more than 150,000 products from leading manufacturers, including
      3Com, Adobe, Apple, Cisco, Epson, HP, IBM, Kingston, Lenovo, Microsoft, Sony
      and
      Toshiba.





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





*Principles
      of Consolidation.*


The
      accompanying consolidated financial statements include the accounts of the
      Company and its majority owned subsidiary. Inter-company 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.





*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. The 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. 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 each reporting
      period based on historical collection experience, customer credit worthiness
      based on published information and other known factors. Accounts receivable
      are
      written off as bad debt when it is deemed to be uncollectible.





*Inventories.*


Inventories
      consist primarily of computer hardware and software. Inventory
      is valued at the lower of cost or market value. The Company decreases the value
      of inventory for estimated obsolescence equal to the difference between the
      cost
      of inventory and the estimated market value based upon an aging analysis of
      the
      inventory on hand, specifically known inventory-related risks, and assumptions
      about future demand and market conditions. If future demand or actual market
      conditions are less favorable than those projected by management, additional
      inventory write-downs may be required.





The
      Company currently buys a significant portion of its products from four
      suppliers. Purchases from Ingram Micro, Tech Data, Synnex and IBM represented
      21.4%, 13.9%, 12.6% and 11.4%, respectively, of the Company’s total product
      purchases in 2006. Purchases from Ingram Micro, Tech Data, Synnex and
      Hewlett-Packard represented 19.1%, 18.2%, 15.7% and 12.5%, respectively, of
      the
      Company’s total product purchases in 2005. Purchases from Ingram Micro, Synnex
      and Tech Data represented 22.5%, 12.0% and 10.3%, respectively, of the Company’s
      total product purchases in 2004. No other vendor supplied more than 10.0% of
      the
      Company’s total product purchases in 2006, 2005 or 2004. 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 two to five years
      and
      other property and equipment range from three to 11 years. Capital leases are
      amortized based on the straight-line method over the estimated useful lives
      of
      the related assets or lease term, whichever is shorter (generally three to
      11
      years). Expenditures for maintenance and repairs are charged to expense as
      incurred, while additions, renewals and betterments are capitalized. The Company
      evaluates the carrying value of long-lived assets based upon current and
      anticipated undiscounted cash flows, and it recognizes its impairment when
      it is
      probable that such estimated future cash flows will be less than the asset
      carrying value. No impairments were identified in 2006, 2005 or
      2004.





Capitalized
      internal software development costs totaled $642,000 and $659,000 for the years
      ended December 31, 2006 and 2005, respectively.





33
 *Table
            of Contents*





*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. A valuation allowance is created when it is believed
      it is
      more likely than not that the Company will not utilize a portion or all of
      the
      net deferred tax assets.





*Goodwill.*


In
      accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill
      is tested for impairment annually on the purchase date or sooner when events
      indicate that potential impairment exists. All goodwill relates to the purchase
      of CPCS.





The
      changes in the carrying amount of goodwill for the years ended December 31,
      2006
      and 2005 are as follows:





Balance
                as of January 1, 2005
            
            $
            5,098Impairment
                lossBalance
                as of December 31, 2005
            
            
            5,098Impairment
                lossBalance
                as of December 31, 2006
            
            $
            5,098





*Use
      of Estimates.*


The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States requires management to make estimates
      and assumptions that affect the reported amounts of assets and liabilities,
      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
      ability to collect 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’s shipping terms dictate that the passage of title
      occurs upon receipt of products by the customer except for the last seven
      calendar days of each fiscal quarter, when all shipments are insured in the
      name
      of the customer. For these seven days, passage of risk of loss and title occur
      at the shipping point.





The
      majority of the Company’s net sales relate to physical products. These sales are
      recognized on a gross basis with the selling price to the customer recorded
      as
      net sales and the acquisition cost of the product recorded as cost of sales.
      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. Amounts billed for shipping and handling are
      recorded as revenue. Pursuant to EITF 99-19 “Reporting Revenue Gross as a
      Principal versus Net as an Agent,” when the Company sets prices, has inventory
      risk and has credit risk, revenues are recorded gross. Third-party extended
      warranties, third-party software maintenance products and third-party services
      sold by the Company (for which the Company is not the primary obligor) are
      recognized gross in revenues and cost of sales when the Company sets prices
      and
      has inventory risk and credit risk. If any of those criteria are not present,
      revenue and cost of sales are recorded net. The Company’s warranty sales are
      generally recorded net. When the sale is recorded, the Company has no further
      obligation to fulfill. The Company only recognizes revenue when all criteria
      of
      Staff Accounting Bulletin No. 104 (“SAB 104”), "Revenue Recognition" have been
      met.





34
 *Table
            of Contents*





*Cost
      of Sales.*


Cost
      of
      sales primarily consists of the purchase price of products and services sold
      by
      the Company. Cost of sales also includes inbound and outbound shipping charges
      to the Company, vendor rebates and cash discounts that are recorded when earned
      as a reduction to cost of sales, physical inventory adjustments, and vendor
      consideration classified as a reduction of cost of sales. Vendor
      rebates from product rebates that require certain volumes of product sales
      or
      purchases are recorded only after the related milestones are
      met.





*Selling,
      General and Administrative Expenses.*


Selling,
      general and administrative expenses include payroll, team member benefits and
      other headcount-related costs, cost of fulfillment (including warehousing),
      credit card processing and bad debts costs, facilities, professional fees and
      administration costs, and depreciation and amortization.





*Advertising
      Expenses.*


The
      Company produces and distributes catalogs at various intervals throughout the
      year, and also engages in other activities, to increase the awareness of its
      brand and stimulate demand response. The costs to produce and distribute
      individual catalogs, including paper, printing, postage, production and design
      costs, and for other marketing initiatives, such as trade shows, direct mail
      pieces, and customer or vendor events, are capitalized and amortized to selling
      expense during the period in which the catalogs are mailed or the event takes
      place. Capitalized advertising costs of $298,000 and $184,000 were included
      with
      prepaid expenses at December 31, 2006 and 2005, respectively. The Company
      receives cooperative advertising expense reimbursements from vendors who support
      the Company’s marketing and advertising activities. The following table presents
      the gross amounts that are netted together in the Company’s advertising expense
      line item.





**2006**
            
            **2005**
            
            **2004**Gross
                advertising expense
            
            $
            8,858
            
            $
            7,047
            
            $
            7,646Gross
                advertising reimbursements
            
            
            (1,699
            )
            
            (429
            )
            
            (564
            )Advertising
                expense
            
            $
            7,159
            
            $
            6,618
            
            $
            7,082








*Other
      Income/Expense.*


Other
      income/expense includes interest income earned on cash and cash equivalents,
      net
      of interest expense. Interest expense includes fees associated with the
      Company’s working capital line as well as accrued interest associated with the
      notes payable to the former shareholders of CPCS recorded as part of the
      acquisition.





*Comprehensive
      Income.*


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




*Stock
      Compensation.*


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





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





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





Total
      stock-based compensation expense recognized in the consolidated statement of
      earnings for the year ended December 31, 2006 was $405,000, before income taxes,
      and did not have a material impact on net income or earnings per share.
  The Company used the criteria in SFAS No. 123R to calculate and
      establish the beginning balance of the additional paid-in capital pool (“APIC
      pool”) related to the tax effects of employee stock-based compensation, and also
      used the criteria to determine the subsequent effect on the APIC pool and
      consolidated statements of cash flows of the tax effects of employee stock-based
      compensation awards that were outstanding upon adoption of SFAS No. 123R.
      The tax benefit for stock options exercised during the year ended December
      31,
      2006 was $651,000.





35
 *Table
            of Contents*





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





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




**Year
                    ended December 31,****2005**
                
                **2004**Net
                    income - as reported
                
                $
                6,051
                
                $
                4,652Less:Total
                    compensation cost determined under fair value based method for
                    all awards,
                    net of tax
                
                
                (808
                )
                
                (827
                )Net
                    income - pro forma
                
                $
                5,243
                
                $
                3,825Basic
                    income per share - as reported
                
                $
                0.45
                
                $
                0.34Diluted
                    income per share - as reported
                
                $
                0.42
                
                $
                0.32Basic
                    income per share - pro forma
                
                $
                0.39
                
                $
                0.28Diluted
                    income per share - pro forma
                
                $
                0.36
                
                $
                0.26





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 2005 and 2004, respectively: expected volatility
      of 186% and 183%, risk-free interest rate of 4.05% and 3.43%, and expected
      lives
      of 5 years.





Disclosures
      for the 2006 are not presented because the amounts are recognized in the
      consolidated financial statements.





There
      were no options granted in the twelve months ended December 31, 2006. The
      current expense for all outstanding options granted prior to January 1,
      2006 has been recognized in the consolidated statement of earnings for the
      twelve months ended December 31, 2006. Forfeitures are estimated and revised,
      if
      necessary, in subsequent periods if actual forfeitures differ from those
      estimates. As of December 31, 2006, there is $245,000 of total unrecognized
      pre-tax compensation expense related to nonvested stock options granted under
      the Company’s stock option plans. This cost is expected to be recognized over a
      weighted-average period of 1.4 years.





*Segment
      Reporting*


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





A
      summary
      of the Company’s operations by product mix is detailed in Note 13.





36
 *Table
            of Contents*




*Reclassifications*


Certain
      reclassifications of prior years’ balances have been made to conform to the
      fiscal year 2006 presentation. Such reclassifications had no effect on
      shareholders’ equity or net income as previously reported.




*Recent
      Accounting Pronouncements*


In
      September 2006, the FASB issued SFAS No. 157 (SFAS 157), *Fair
      Value Measurements* .
      SFAS
      157 defines fair value, establishes a framework for measuring fair value and
      expands disclosures about fair-value measurements required under other
      accounting pronouncements, but does not change existing guidance as to whether
      or not an instrument is carried at fair value. SFAS 157 is effective for the
      Company’s fiscal year 2008. The Company is currently evaluating the impact of
      adopting SFAS 157.





In
      September 2006, the SEC released Staff Accounting Bulletin 108 (SAB 108), *Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements* . The
      intent of SAB 108 is to reduce diversity in practice for the method
      companies use to quantify financial statement misstatements, including the
      effect of prior-year uncorrected errors. SAB 108 establishes an approach
      that requires quantification of financial statement errors using both an income
      statement and a cumulative balance sheet approach. SAB 108 is effective for
      fiscal years beginning after November 15, 2006, and the Company will adopt
      the new requirements on January 1, 2007. The
      Company does not believe that the adoption of SAB 108 will have a significant
      effect on its financial statements.





In
      July
      2006, the FASB issued FASB Interpretation No. 48 (FIN 48), *Accounting
      for Uncertainty in Income Taxes: an Interpretation of FASB Statement No.
      109* , *Accounting
      for Income Taxes* .
      FIN
      48  clarifies
      the accounting for uncertainty in income taxes recognized in a company’s
      financial statements and prescribes a recognition threshold and measurement
      attribute for the financial statement recognition and measurement of a tax
      position taken or expected to be taken in an income tax return. FIN 48 also
      provides guidance on derecognition, classification, interest and penalties,
      accounting in interim periods, disclosure and transition. Only tax positions
      that meet the more-likely-than-not recognition threshold at the adoption date
      will be recognized or continue to be recognized. The cumulative effect of
      applying Interpretation 48 will be reported as an adjustment to retained
      earnings at the beginning of the period in which it is adopted. FIN 48 will
      be
      adopted by the Company on January 1, 2007. The Company currently **** does
      not
      believe that the adoption of Interpretation 48 will have a significant effect
      on
      its financial statements.





In
      June
      2006, the FASB ratified the consensus reached on Emerging Issues Task Force
      (EITF) Issue No. 06-03, “ *How
      Sales Taxes Collected from Customers and Remitted to Governmental Authorities
      Should Be Presented in the Income Statement (that is, Gross Versus Net
      Presentation).”* The
      EITF
      reached a consensus that the presentation of taxes on either a gross or net
      basis is an accounting policy decision that requires disclosure. EITF 06-03
      is
      effective for the first interim or annual reporting period beginning after
      December 15, 2006. Amounts collected from members, which under common trade
      practices are referred to as sales taxes, are and have been recorded on a net
      basis. The Company has no intention of modifying this accounting policy.
      Therefore, the adoption of EITF 06-03 will not have any effect on the Company’s
      financial statements.





**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 .





37
 *Table
            of Contents*





**4.** **Property
      and Equipment**




Property
      and equipment consist of the following (in thousands):





**December
                31,****2006**
            
            **2005**
            
            **Estimated
                Useful Lives**Equipment
            
            $
            15,831
            
            $
            15,679
            
            
            2
                to 5 yearsComputer
                software/Web development
            
            
            18,105
            
            
            17,436
            
            
            2
                to 5 yearsFurniture
                and fixtures and leasehold improvements
            
            
            1,662
            
            
            1,357
            
            
            3
                to 11 years35,598
            
            
            34,472Less
                accumulated depreciation and amortization
            
            
            (31,827
            )
            
            (30,662
            )Property
                and equipment, net
            
            $
            3,771
            
            $
            3,810




**5.** **Line
      of Credit**





At
      December 31, 2006, the Company had a $40,000,000 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
      has an annual automatic renewal, which occurs on November 26 of each fiscal
      year. Either party can terminate this agreement with 60 days written notice
      prior to the renewal date.  The working capital and inventory advances bear
      interest at a rate of Prime + 0.50%. The Company’s line of credit is defined by
      quick turnover, large amounts and short maturities. All amounts owed under
      the
      Company’s line of credit are due on demand. Inventory advances do not bear
      interest if paid within terms, usually 30 days from advance date.  There
      were no working capital advances outstanding at December 31, 2006, but the
      Company had working capital advances of $10.7 million at December 31, 2005.
      The
      flooring arrangement included $14.4 million owed to this financial institution
      related to inventory purchases at December 31, 2006, compared to $8.5 million
      at
      December 31, 2005.





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,
      2006
      and 2005, the Company had book overdrafts of $10.2 million and $13.1 million,
      respectively, which are recorded as a component of accounts payable on the
      accompanying balance sheet.





The
      facility contains various restrictive covenants relating to tangible net worth,
      leverage, dispositions and use of collateral, other asset dispositions, and
      merger and consolidation of the Company. The Company was in compliance with
      all
      the covenants contained in the agreement at December 31, 2006.





**6. 
       Accrued Liabilities and Other**




Accrued
      liabilities consist of the following (in thousands):





**December
                31,****2006**
            
            **2005**Accrued
                payroll
            
            $
            4,932
            
            $
            3,842Accrued
                taxes
            
            
            3,268
            
            
            2,823Accrued
                advertising
            
            
            50
            
            
            20Accrued
                interest
            
            
            7
            
            
            104Other
                accruals
            
            
            4,471
            
            
            2,280Total
            
            $
            12,728
            
            $
            9,069




38
 *Table
            of Contents*





**7.** **Income
      Taxes**





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





**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**Current
            
            $
            6,384
            
            $
            912
            
            $
            533Deferred
            
            
            (413
            )
            
            2,854
            
            
            2,272Total
            
            $
            5,971
            
            $
            3,766
            
            $
            2,805







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





**December
                31,****2006**
            
            **2005**Assets:Allowance
                for doubtful accounts
            
            $
            728
            
            $
            585Merchandise
                inventory
            
            
            302
            
            
            331Deferred
                rent obligation
            
            
            549
            
            
            418Accrued
                liabilities and other
            
            
            443
            
            
            424$
            2,022
            
            $
            1,758Liabilities:Property
                and equipment
            
            
            (298
            )
            
            (447
            )(298
            )
            
            (447
            )Net
                deferred tax asset
            
            $
            1,724
            
            $
            1,311





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




**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**Statutory
                rate
            
            
            35.0
            %
            
            34.0
            %
            
            34.0
            %State
                income tax, net of federal benefit
            
            
            2.0
            
            
            2.0
            
            
            2.7Stock
                compensation
            
            
            0.5Other
            
            
            0.6
            
            
            2.4
            
            
            0.9Effective
                tax rate
            
            
            38.1
            %
            
            38.4
            %
            
            37.6
            %








**8.** **Commitments
      and Contingencies**





*Operating
      Leases*


The
      Company leases its offices, returns warehouse facility, and other equipment
      under non-cancelable operating leases that expire through 2016. Under the terms
      of certain leases, the Company is responsible for its share of taxes, insurance
      and common area charges. At December 31, 2006, future minimum payments under
      operating leases were as follows (in thousands):





2007
            
            $
            2,2362008
            
            
            2,3242009
            
            
            2,1562010
            
            
            1,9842011
            
            
            1,886Thereafter
            
            
            6,079Total
            
            $
            16,665




Certain
      portions of the Company’s lease agreements provide for scheduled rent increases
      during the lease terms. Minimum rental expenses are recognized on a
      straight-line basis over the terms of the lease. Rental expense, which is
      recorded on a straight-line basis, totaled $3.1 million, $2.5 million and $2.2
      million for the years ended December 31, 2006, 2005 and 2004,
      respectively.





39
 *Table
            of Contents*





*Related
      Party*


In
      June
      2004, Fana Auburn LLC, a company owned by an officer and majority shareholder
      of
      the Company, purchased the property and buildings in which the Company’s
      headquarters are located, subject to the Company’s existing 11-year lease. Under
      the terms of the lease agreement, the Company will pay lease payments
      aggregating from $1.0 million to $1.3 million per year, plus apportioned real
      estate taxes, insurance and common area maintenance charges. For the years
      ended
      December 31, 2006, 2005 and 2004 the Company paid Fana Auburn LLC $1.6 million,
      $1.7 million and $543,000, respectively, related to the lease. The Company’s
      Audit Committee reviewed and approved this related party transaction, and also
      the potential corporate opportunity, recognizing that in the future the Company
      may have to renew and renegotiate its lease and that such renewal and
      renegotiation would also present a related party transaction, which would be
      subject to further Audit Committee review and consideration. In May 2006, after
      the Company’s Audit Committee reviewed and approved this related party
      transaction, the Company signed an amendment to the lease agreement. Pursuant
      to
      the terms of the amendment, Fana Auburn LLC has agreed to increase the rentable
      square feet by approximately 18,923 square feet. The additional square feet
      will
      increase the annual lease payment by $259,000. Effective January 1, 2007, the
      Company will have approximately 125,196 rentable square feet located at 1102
      15 th Street
      SW, Auburn, WA.





*Notes
      Payable*


On
      March
      31, 2003, the Company acquired Corporate PC Source, Inc. (“CPCS”) pursuant to a
      Stock Purchase Agreement (“SPA”). Under the terms of the SPA, the Company issued
      notes to the former shareholders of CPCS. The Company paid the final payment
      during the second quarter of 2006. For the years ended December 31, 2006 and
      2005, the Company paid the former shareholders of CPCS $1.3 million each year.





*Legal
      Proceedings*


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





**9.** **Shareholders'
      Equity**





*Stock
      Options*


In
      1993,
      the Company adopted a Stock Incentive Plan (the “Plan”) whereby the Company
      issued incentive or nonqualified stock options, restricted shares, stock units
      or stock appreciation rights to certain team members. As of December 31, 2006,
      only stock options had been granted under the Plan. The term of each option
      granted was for such periods as determined by the Board of Directors, but not
      for more than ten years from date of grant. Options may 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, 2006.





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, 2006 were 80,000 shares at option prices of $0.73
      -
      $12.00 per share. The maximum number of shares to be granted under this plan
      was
      325,000. As of December 31, 2006, the Company had indefinitely suspended this
      program and therefore had no available shares.





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 rights. 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 periods as determined by the Board of Directors, but
      not for more than ten years from date of grant. Options will 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 1,175,000.





40
 *Table
            of Contents*




Information
      regarding the stock option plans is as follows:


**Options**
              
              **Weighted-Average
                  Exercise Price**
              
              **Options**
                **Exercisable**Outstanding,
                  January 1, 2004
              
              
              3,329,682
              
              
              2.68
              
              
              1,310,817Granted
              
              
              925,300
              
              
              2.95Exercised
              
              
              (296,746
              )
              
              1.53Canceled
              
              
              (684,843
              )
              
              3.70Outstanding,
                  December 31, 2004
              
              
              3,273,393
              
              
              2.63
              
              
              1,471,617Granted
              
              
              282,200
              
              
              3.38Exercised
              
              
              (181,772
              )
              
              1.74Canceled
              
              
              (306,102
              )
              
              1.77Outstanding,
                  December 31, 2005
              
              
              3,067,719
              
              
              2.84
              
              
              2,181,673GrantedExercised
              
              
              (461,070
              )
              
              3.06Canceled
              
              
              (36,358
              )
              
              4.70Outstanding,
                  December 31, 2006
              
              
              2,570,291
              
              $
              2.78
              
              
              2,138,483
 
 There
        were no options granted in the year ended December 31, 2006. For the years
        ended
        December 31, 2005 and 2004, the weighted-average fair value of options granted
        was as follows:
 
 **Year
                  ended December 31,****2005**
              
              **2004**Exercise
                  price equals market price
              
              $
              2.29
              
              $
              2.58
 
 The
        following tables summarize information about fixed-price stock options
        outstanding at December 31, 2006:
 
 **Options
                    Outstanding****Range
                    of**
                  **Exercise
                    Prices**
                
                **Number
                    Outstanding**
                  **at
                    December 31, 2006**
                
                **Weighted-Average**
                  **Remaining
                    Contractual Years**
                
                **Weighted-Average**
                  **Exercise
                    Price**$
                    0.73 - $ 0.96
                
                
                446,980
                
                
                5.90
                
                $
                0.91$
                    1.05 - $ 1.06
                
                
                501,000
                
                
                6.59
                
                
                1.06$
                    1.07 - $ 2.92
                
                
                602,682
                
                
                6.94
                
                
                2.40$
                    2.99 - $ 3.13
                
                
                430,846
                
                
                7.03
                
                
                3.00$
                    3.19 - $ 5.81
                
                
                446,811
                
                
                4.55
                
                
                4.38$
                    6.00 - $15.00
                
                
                141,972
                
                
                2.06
                
                
                10.66$
                    0.73 - $15.00
                
                
                2,570,291
                
                
                6.02
                
                $
                2.78
 
 
 **Options
                  Exercisable****Range
                  of**
                **Exercise
                  Prices**
              
              **Number
                  at**
                **December
                  31, 2006**
              
              **Weighted-Average**
                **Exercise
                  Price**$
                  0.73 - $ 0.96
              
              
              373,430
              
              $
              0.91$
                  1.05 - $ 1.06
              
              
              384,802
              
              
              1.06$
                  1.07 - $ 2.92
              
              
              468,182
              
              
              2.32$
                  2.99 - $ 3.13
              
              
              323,386
              
              
              3.00$
                  3.19 - $ 5.81
              
              
              446,711
              
              
              4.38$
                  6.00 - $15.00
              
              
              141,972
              
              
              10.66$
                  0.73 - $15.00
              
              
              2,138,483
              
              $
              2.94
 
 **10.** **Earnings
        Per Share**
 
 The
        Company has 45,000,000 common shares authorized, and 13,157,719 issued and
        outstanding at December 31, 2006. The Company has also granted options to
        purchase common shares to the team members 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).




41
 *Table
            of Contents*




**Year
                  ended December 31,****2006**
              
              **2005**
              
              **2004****Basic
                  earnings per share:**Net
                  income
              
              $
              9,685
              
              $
              6,051
              
              $
              4,652Weighted-average
                  shares used in computing basic income per share
              
              
              13,195
              
              
              13,382
              
              
              13,549Basic
                  income per share
              
              $
              0.73
              
              $
              0.45
              
              $
              0.34**Diluted
                  earnings per share:**Net
                  income
              
              $
              9,685
              
              $
              6,051
              
              $
              4,652Weighted-average
                  shares used in computing basic income per share
              
              
              13,195
              
              
              13,382
              
              
              13,549Stock
                  Options
              
              
              1,561
              
              
              1,145
              
              
              920Weighted-average
                  shares used in computing diluted income per share
              
              
              14,756
              
              
              14,527
              
              
              14,469Diluted
                  income per share
              
              $
              0.66
              
              $
              0.42
              
              $
              0.32




For
      the
      years ended December 31, 2006, 2005 and 2004, 106,258, 516,045 and 501,087
      shares, respectively, attributable to outstanding stock options were excluded
      from the calculation of diluted earnings per share because the effect was
      anti-dilutive.





**11.** **Deferred
      Income 401(k) Plan**





The
      Company offers a deferred income 401(k) plan to substantially all full-time
      team
      members with a minimum of six months of service. Participants may make
      tax-deferred contributions of up to 60% of annual compensation subject to
      certain limitations specified by the Internal Revenue Code. The Company provides
      a discretionary match as recommended by its Compensation Committee and voted
      upon by its Board of Directors on a quarterly basis. During 2006, 2005 and
      2004,
      the Company’s Board of Directors approved a match in each of the quarters. For
      fiscal years 2006, 2005 and 2004, the Company provided a 50% match for all
      team
      member contributions, up to 6% of the team member’s annual compensation, subject
      to certain limitations specified by the Internal Revenue Code. During fiscal
      2006, 2005, and 2004, the Company expensed $389,000, $362,000 and $315,000,
      respectively, relating to employer contributions under the plan.





**12.** **Stock
      Repurchase Program**





Since
      2004, the Company has repurchased a total of 1,441,240 shares of its common
      stock at a total cost of $7.2 million under its repurchase program
      authorized by its Board of Directors. Share repurchases may be made from time
      to
      time in both open market and private transactions, as conditions warrant, at
      then prevailing market prices. The following table presents share repurchases
      for the years ended December 31, 2006, 2005 and 2004 (dollars in
      thousands):




**Period**
            
            **Total
                number of shares purchased**
            
            **Amount
                paid**2006
            
            
            568,400
            
            $
            3,9882005
            
            
            424,450
            
            $
            1,8132004
            
            
            448,390
            
            $
            1,348




42
 *Table
            of Contents*




As
      of
      December 31, 2006, $979,000 in shares of the Company’s common stock
      remained available for repurchase under the program. In February 2007, the
      Board
      of Directors authorized a continuation of the Company’s share repurchase
      program, pursuant to which the Company increased the total amount authorized.
      As
      of February 2007, $3.0 million in shares of the Company’s common stock is
      available for repurchase under the program. The current repurchase program
      is
      expected to remain in effect through February 2008, unless earlier
      terminated by the Board or completed.




**13.** **Segment
      Information**





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





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




**December
                  31,****2006**
              
              **2005**
              
              **2004**Notebook
                  & PDAs
              
              $
              71,477
              
              $
              86,861
              
              $
              72,672Desktops
                  & Servers
              
              
              117,148
              
              
              113,779
              
              
              105,636Software
              
              
              102,055
              
              
              90,199
              
              
              83,415Storage
              
              
              52,785
              
              
              51,453
              
              
              43,198NetComm
              
              
              28,325
              
              
              23,968
              
              
              21,936Printers
              
              
              47,479
              
              
              63,964
              
              
              47,406Monitors
                  & Video
              
              
              59,761
              
              
              54,460
              
              
              50,939Memory
                  & Processors
              
              
              35,815
              
              
              30,407
              
              
              24,807Accessories
                  & Other
              
              
              62,182
              
              
              51,462
              
              
              45,554




Substantially
      all of the Company’s net sales for the years ended December 31, 2006, 2005 and
      2004 were made to customers located in the United States. All of the Company’s
      assets at December 31, 2006 and 2005 were located within the United States.
      No
      one customer represented more than 10% of total sales for the years ended
      December 31, 2006, 2005 and 2004.





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            of Contents*




**14.** **Selected
        Quarterly Financial Data (Unaudited)**
 
 The
        following information is for the years ended December 31, 2006 and
        2005:
 
 (in
        thousands, except per share data)
 **December
                  31, 2006**
              
              **First**
                **Quarter**
              
              **Second**
                **Quarter**
              
              **Third**
                **Quarter**
              
              **Fourth**
                **Quarter**Net
                  sales
              
              $
              133,998
              
              $
              145,210
              
              $
              137,900
              
              $
              159,919Cost
                  of sales
              
              
              117,411
              
              
              125,822
              
              
              121,522
              
              
              140,753Gross
                  profit
              
              
              16,587
              
              
              19,388
              
              
              16,378
              
              
              19,166SG&A
                  expenses
              
              
              11,862
              
              
              12,765
              
              
              11,291
              
              
              12,516Advertising
                  expenses, net
              
              
              1,802
              
              
              1,768
              
              
              1,717
              
              
              1,872Income
                  from operations
              
              
              2,923
              
              
              4,855
              
              
              3,370
              
              
              4,778Other
                  expense
              
              
              178
              
              
              122
              
              
              (19
              )
              
              (11
              )Income
                  before income taxes
              
              
              2,745
              
              
              4,733
              
              
              3,389
              
              
              4,789Provision
                  for income taxes
              
              
              1,040
              
              
              1,816
              
              
              1,309
              
              
              1,806Net
                  income
              
              $
              1,705
              
              $
              2,917
              
              $
              2,080
              
              $
              2,983Basic
                  earnings per share1
              
              $
              0.13
              
              $
              0.22
              
              $
              0.16
              
              $
              0.23Diluted
                  earnings per share1
              
              $
              0.12
              
              $
              0.20
              
              $
              0.14
              
              $
              0.20
 
 **December
                  31, 2005**
              
              **First**
                **Quarter**
              
              **Second**
                **Quarter**
              
              **Third**
                **Quarter**
              
              **Fourth**
                **Quarter**Net
                  sales
              
              $
              126,331
              
              $
              127,630
              
              $
              152,758
              
              $
              159,834Cost
                  of sales
              
              
              111,569
              
              
              113,093
              
              
              138,146
              
              
              143,189Gross
                  profit
              
              
              14,762
              
              
              14,537
              
              
              14,612
              
              
              16,645SG&A
                  expenses
              
              
              11,199
              
              
              10,978
              
              
              10,068
              
              
              11,373Advertising
                  expenses, net
              
              
              1,738
              
              
              1,401
              
              
              1,608
              
              
              1,871Income
                  from operations
              
              
              1,825
              
              
              2,158
              
              
              2,936
              
              
              3,401Other
                  expense
              
              
              61
              
              
              51
              
              
              191
              
              
              200Income
                  before income taxes
              
              
              1,764
              
              
              2,107
              
              
              2,745
              
              
              3,201Provision
                  for income taxes
              
              
              673
              
              
              811
              
              
              1,055
              
              
              1,227Net
                  income
              
              $
              1,091
              
              $
              1,296
              
              $
              1,690
              
              $
              1,974Basic
                  earnings per share1
              
              $
              0.08
              
              $
              0.10
              
              $
              0.13
              
              $
              0.15Diluted
                  earnings per share1
              
              $
              0.08
              
              $
              0.09
              
              $
              0.12
              
              $
              0.14
 
 1 Earnings
        per share is computed independently for each of the quarters presented,
        therefore the sum of the quarterly earnings per share may not equal the total
        computed for the year due to shares issued each quarter.




44
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            of Contents*




**Report
      of Grant Thornton LLP, Independent Registered Public Accounting
      Firm**




Board
      of
      Directors and Shareholders of


Zones,
      Inc.




We
      have
      audited the accompanying consolidated balance sheets of Zones, Inc. as of
      December 31, 2006 and 2005, and the related consolidated statements of
      operations, shareholders’ equity, and cash flows for each of the two years in
      the period ended December 31, 2006. These financial statements are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these financial statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. The Company is not required to
      have, nor were we engaged to perform, an audit of its internal control over
      financial reporting. Our audit included consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of Zones, Inc. as of December 31,
      2006
      and 2005, and the results of its operations and its cash flows for each of
      the
      two years in the period ended December 31, 2006, in conformity with accounting
      principles generally accepted in the United States of America.





Our
      audit
      was conducted for the purpose of forming an opinion on the basic consolidated
      financial statements taken as a whole.  The consolidated financial
      statement schedule listed in Item 14 as of and for the years ended December
      31,
      2006 and 2005 is presented for purposes of additional analysis and is not a
      required part of the basic consolidated financial statements.  This
      schedule has been subjected to the auditing procedures applied in the audit
      of
      the basic consolidated financial statements and, in our opinion, is fairly
      stated in all material respects in relation to the basic consolidated financial
      statements taken as a whole.







Grant
      Thornton, LLP


Seattle,
      Washington


February
      16, 2007





45
 *Table
            of Contents*





**Report
      of PricewaterhouseCoopers LLP, Independent Registered Public Accounting
      Firm**




To **** the
      Shareholders of


Zones,
      Inc.




In
      our
      opinion, the accompanying consolidated statement of income, shareholders’ equity
      and cash flows listed in the index appearing under Item 15(a)(1) present fairly,
      in all material respects the results of operations and cash flows of Zones,
      Inc
      and its subsidiaries for the year ended December 31, 2004 **** 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 are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these financial statements based on our audit. We conducted our
      audit
      of these statements in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards 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 audit provides a reasonable basis for our
      opinion.







PricewaterhouseCoopers
      LLP


Seattle,
      Washington


February
      28, 2005





46
 *Table
            of Contents*





**ZONES,
      INC.**




**SCHEDULE
      II - CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS**








Description
            
            Balance
                at beginning of period
            
            Charges
                to costs and expenses
            
            Charges
                to other accounts
            
            Deductions
            
            Balance
                at end of periodYear
                Ended December 31, 2006Allowance
                for doubtful accounts
            
            $
            1,562
            
            $
            772
            
            $
            
            
            $
            398
                (a
            )
            $
            1,936Year
                Ended December 31, 2005Allowance
                for doubtful accounts
            
            $
            2,666
            
            $
            458
            
            $
            
            
            $
            1,562
                (a
            )
            $
            1,562Year
                Ended December 31, 2004Allowance
                for doubtful accounts
            
            $
            2,734
            
            $
            297
            
            $
            
            
            $
            365
                (a
            )
            $
            2,666





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






47