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 s 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:

 
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Price. Zones offers competitive pricing to its customers.

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

 
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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.

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

 
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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.

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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.

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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.

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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.

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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.

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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.

R is k 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:

 
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purchasing cycles of commercial and public sector customers;

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

 
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more manufacturers going direct;

 
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industry announcements of new products or upgrades;

 
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industry consolidation;

 
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cost of compliance with new legal and regulatory requirements;

 
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general economic conditions; and

 
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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:

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

 
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increased competition;

 
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more manufacturers going direct;

 
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changes in customers’ buying habits;

 
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the loss of significant customers;

 
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changes in the selection of products available for resale; or

 
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general economic conditions.

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

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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.

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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.

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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.