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  **U.S. SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, DC 20549****FORM 10-QSB**(Mark one)   þ **Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934******For the quarterly period ended June 30, 2006****   o **Transition report under Section 13 or 15(d) of the Exchange Act******For the transition period from                      to**                    ****Commission file number 1-12707****Pinnacle Bancshares, Inc.**(Exact Name of Small Business Issuer as Specified in Its Charter)   Delaware 72-1370314   (State or Other Jurisdiction of (I.R.S. EmployerIncorporation or Organization) Identification No.)1811 Second Avenue, Jasper, Alabama 35502-1388(Address of Principal Executive Offices)(205) 221-4111(Issuer’s Telephone Number, Including Area Code)     Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d)of the Exchange Act during the past 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filing requirements for the past90 days.Yes  þ     No  o     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 ofthe Exchange Act).Yes  o     No  þ     The number of shares outstanding of each of the issuer’s classes of common equity, asof August 10, 2006: 1,483,078 shares of common stock.     Transitional Small Business Disclosure Format (check one):Yes  o     No  þ  
 

 
**CONTENTS**       Page**PART I FINANCIAL INFORMATION**         **Item 1. Financial Statements**     Unaudited Condensed Consolidated Statements of Financial Condition at June 30, 2006 and December 31, 2005.  3  Unaudited Condensed Consolidated Statements of Operations for the three and six-months ended June 30, 2006, and 2005.  4  Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the six months ended June 30, 2006, and 2005.  5  Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006, and 2005.  6  Notes to Unaudited Condensed Consolidated Financial Statements.  7  **Item 2. Management’s Discussion and Analysis or Plan of Operation**  10  **Item 3. Controls and Procedures**  14      **Part II OTHER INFORMATION**         **Item 2. Unregistered Sales of Equity Securities and Use of Proceeds**  15  **Item 4. Submission of Matters to a Vote of Security Holders**     **Item 6. Exhibits**     **Signatures**  16  Ex-31.1 Section 302 Certification of the CEO & CFO Ex-32.1 Section 906 Certification of the CEO & CFO
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**PART I – FINANCIAL INFORMATION****Item 1. Financial Statements****PINNACLE BANCSHARES, INC.****UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**           June 30,  December 31,   2006  2005 ASSETS:        Cash and cash equivalents $3,755,645  $3,784,867 Interest-bearing deposits in other banks  16,919,896   13,368,882 Securities available-for-sale  74,893,004   80,653,931 FHLB stock  532,100   507,300 First National Bankers Bancshares stock  525,000   525,000 Loans held for sale  2,693,688   374,192 Loans receivable, net of allowances for loan lossesof $1,421,027 and $1,383,410, respectively  109,614,487   106,255,517 Real estate owned, net  244,374   381,229 Premises and equipment  6,575,618   5,892,093 Goodwill  306,488   306,488 Bank owned life insurance  5,254,697   5,096,157 Accrued interest receivable  1,346,742   1,372,733 Other assets  2,274,538   1,730,328        Total assets $224,936,277  $220,248,717                 LIABILITIES AND STOCKHOLDERS’ EQUITY:        Deposits $200,420,481  $192,551,915 Subordinated debt  3,093,000   3,093,000 Borrowed funds  0   2,375,000 Official checks outstanding  1,742,810   1,088,302 Accrued interest payable  1,212,533   786,133 Other liabilities  636,208   944,393        Total liabilities  207,105,032   200,838,743                 STOCKHOLDERS’ EQUITY:        Common stock, par value $.01 per share; 2,400,000 authorized; 1,827,813issued at June 30, 2006 and December 31, 2005, respectively; 1,478,078 and1,541,178 outstanding at June 30, 2006 and December 31, 2005, respectively  18,278   18,278 Additional paid-in capital  8,479,921   8,479,921 Treasury shares, at cost (349,735 and 286,635 shares at June 30, 2006 andDecember 31, 2005, respectively)  (4,426,381)  (3,488,724)Retained earnings  16,741,137   16,405,863 Accumulated other comprehensive loss, net of tax  (2,981,710)  (2,005,364)       Total stockholders’ equity  17,831,245   19,409,974        Total liabilities and stockholders’ equity $224,936,277  $220,248,717        See accompanying notes to these condensed consolidated financial statements.
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**PINNACLE BANCSHARES, INC.****UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**                   **Three Months Ended**  **Six Months Ended**   **June 30,**  **June 30,**   2006  2005  2006  2005 INTEREST REVENUE:                Interest on loans $2,138,658  $1,845,037  $4,223,802  $3,605,315 Interest and dividends on securities  829,246   953,230   1,668,672   1,849,328 Other interest  264,432   16,100   465,813   49,582                 3,232,336   2,814,367   6,358,287   5,504,225 INTEREST EXPENSE:                Interest on deposits  1,565,558   1,011,299   2,972,821   1,934,099 Interest on subordinated debentures  62,408   47,337   120,515   90,443 Interest on borrowed funds  0   36,117   14,694   72,353                 1,627,966   1,094,753   3,108,030   2,096,895              NET INTEREST INCOME BEFORE PROVISIONFOR LOAN LOSSES  1,604,370   1,719,614   3,250,257   3,407,330 PROVISION FOR LOAN LOSSES  112,500   147,000   247,500   303,000              NET INTEREST INCOME AFTER PROVISION FORLOAN LOSSES  1,491,870   1,572,614   3,002,757   3,104,330              NONINTEREST INCOME:                Fees and service charges on deposit accounts  214,392   227,825   421,938   416,249 Service fee income, net  33,391   38,074   67,683   77,622 Fees and charges on loans  32,562   37,394   73,205   68,413 Bank owned life insurance  79,270   74,600   158,540   149,200 Net gain (loss) on sale or write-down of:                Loans held for sale  140,632   93,290   207,061   207,147 Real estate owned  (11,492)  (2,113)  (11,492)  1,624 Securities available-for-sale  60   0   60   (3,750)Premises and equipment  14,737   0   14,737   0                 503,552   469,070   931,732   916,505              NONINTEREST EXPENSE:                Compensation and benefits  842,037   824,377   1,707,660   1,687,086 Occupancy  271,000   270,042   554,360   545,361 Marketing and professional  90,158   91,769   181,817   181,103 Other  241,314   260,333   521,489   544,006                 1,444,509   1,446,521   2,965,326   2,957,556              INCOME BEFORE INCOME TAXES  550,913   595,163   969,163   1,063,279 INCOME TAX EXPENSE  175,180   188,394   301,772   330,455              NET INCOME $375,733  $406,769  $667,391  $732,824              Basic earnings per share $0.25  $0.26  $0.44  $0.47 Diluted earnings per share $0.25  $0.26  $0.43  $0.46 Cash dividends per share $0.11  $0.11  $0.22  $0.22 Weighted average basic shares outstanding  1,497,178   1,549,222   1,519,056   1,550,775 Weighted average diluted shares outstanding  1,525,258   1,577,604   1,547,101   1,581,292 See accompanying notes to these condensed consolidated financial statements.
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**PINNACLE BANCSHARES, INC.****UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY****FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005**                                                   **Accumulated**              **Additional**          **Other**  **Total**   **Common Stock**  **Paid-in**  **Treasury**  **Retained**  **Comprehensive**  **Stockholders’**   **Shares**  **Amount**  **Capital**  **Stock**  **Earnings**  **(Loss) Income**  **Equity**    BALANCE, December 31, 2004  1,821,780  $18,218  $8,418,897  $(3,220,730) $15,571,155  $(873,110) $19,914,430 Comprehensive income:                            Net income  0   0   0   0   732,824   0   732,824 Change in fair value of securities available-for-sale, net of tax  0   0   0   0   0   (130,665)  (130,665)                            Comprehensive income                          602,159 Exercise of stock options  6,033   60   61,024               61,084 Repurchase of common stock (11,333 shares at cost)  0   0   0   (165,856)  0   0   (165,856)Cash dividends declared ($.22 per share)  0   0   0   0   (341,050)  0   (341,050)   BALANCE, June 30, 2005  1,827,813  $18,278  $8,479,921  $(3,386,586) $15,962,929  $(1,003,775) $20,070,767                                 BALANCE, December 31, 2005  1,827,813  $18,278  $8,479,921  $(3,488,724) $16,405,863  $(2,005,364) $19,409,974 Comprehensive loss:                            Net income  0   0   0   0   667,391   0   667,391 Change in fair value of securities available-for-sale, net of tax  0   0   0   0   0   (976,346)  (976,346)                            Comprehensive loss                          (308,955)Repurchase of common stock (63,100 shares at cost)  0   0   0   (937,657)  0   0   (937,657)Cash dividends declared ($.22 per share)  0   0   0   0   (332,117)  0   (332,117)   BALANCE, June 30, 2006  1,827,813  $18,278  $8,479,921  $(4,426,381) $16,741,137  $(2,981,710) $17,831,245    See accompanying notes to these condensed consolidated financial statements.
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**PINNACLE BANCSHARES, INC,****UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**           **For the Six Months Ended**   **June 30,**   **2006**  **2005** **CASH FLOWS FROM OPERATING ACTIVITIES:**        Net income $667,391  $732,824 Adjustments to reconcile net income to net cash provided by operating activities:        Depreciation  249,941   247,694 Provision for loan losses  247,500   303,000 Accretion, net  (104,777)  (57,971)Increase in cash surrender value of Bank owned life insurance  (158,540)  (149,200)Net (gain) loss on sale or write down of:        Loans held for sale  (207,061)  (207,147)Securities available-for-sale  (60)  3,750 Real estate owned  11,492   (1,624)Premises and equipment  (14,737)  0 Proceeds from sale of loans  12,254,246   15,641,546 Loans originated for sale  (14,366,681)  (15,807,919 Decrease (increase) in accrued interest receivable  25,991   (52,982)Increase (decrease) in other assets  55,197   (107,929)Increase in accrued interest payable  426,400   166,058 (Decrease) increase in other liabilities  (308,185)  52,516        Net cash (used in) provided by operating activities  (1,221,883)  762,616        **CASH FLOWS FROM INVESTING ACTIVITIES:**        Net loan (originations) repayments  (3,505,818)  (4,225,273)Net change in interest bearing deposits in other banks  (3,551,014)  (999,902)Purchase of securities available-for-sale  0   (13,191,025)Proceeds from the sale of securities available-for-sale  0   4,000,000 Proceeds from maturing, called and payments received on securities available-for-sale  4,159,006   3,667,677 Proceeds from sale of Federal Home Loan Bank stock  0   1,500 Purchase of Federal Home Loan Bank stock  (24,800)  (225,000)Purchase of First National Bankers Bancshares, Inc. stock  0   (525,000)Purchase of premises and equipment  (935,665)  (158,544)Proceeds from sales of assets  16,936   0 Proceeds from sales of real estate owned  155,716   253,025        Net cash used in investing activities  (3,685,639)  (11,402,542)       **CASH FLOWS FROM FINANCING ACTIVITIES:**        Net increase in passbook, NOW and money market deposit accounts  2,013,641   1,336,000 Proceeds from sales of time deposits  17,387,534   14,079,769 Payments on maturing time deposits  (11,532,609)  (8,023,226)(Decrease) increase in borrowed funds  (2,375,000)  3,895,000 Increase in official checks outstanding  654,508   76,867 Proceeds from exercise of stock options  0   61,084 Repurchase of common stock  (937,657)  (165,856)Payments of cash dividends  (332,117)  (341,050)       Net cash provided by financing activities  4,878,300   10,918,588        **NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS**  (29,222)  278,662          CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD  3,784,867   3,451,046        CASH AND CASH EQUIVALENTS AT END OF PERIOD $3,755,645  $3,729,708        SUPPLEMENTAL DISCLOSURES:        Cash payments for interest on deposits, borrowed funds, and subordinated debentures $2,681,680  $1,930,839 Cash payments for income taxes  476,000   380,013 Real estate acquired through foreclosure  30,353   180,543      See accompanying notes to these condensed consolidated financial statements.
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**PINNACLE BANCSHARES, INC**.**NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS****1.****BASIS OF PRESENTATION****:**The accompanying unaudited condensed consolidated financial statements include theaccounts of Pinnacle Bancshares, Inc. (the “Company”) and Pinnacle Bank (the “Bank”), theCompany’s wholly owned subsidiary. All significant intercompany transactions and accounts havebeen eliminated in consolidation.In the opinion of management, all adjustments (all of which are normal recurring accruals)necessary for a fair presentation of the results of such interim periods have been included. Theresults of operations for the three and six month periods ended June 30, 2006, are notnecessarily indicative of the results of operations which may be expected for the entire year.These unaudited condensed consolidated financial statements should be read in conjunction withthe audited financial statements and the notes thereto included in the Company’s Annual Report onForm 10-KSB for the year ended December 31, 2005. The accounting policies followed by the Companyare set forth in the summary of Significant Accounting Policies in the Company’s auditedconsolidated financial statements.
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**2.****EARNINGS PER SHARE:**The following table represents the earnings per share calculations for the three andsix-month periods ended June 30, 2006 and 2005:                       **Per**           **Share** **For The Three Months Ended** **Net Income**  **Shares**  **Amount** **June 30, 2006**            Basic earnings per share $375,733   1,497,178  $0.25            Dilutive securities      28,080                 Diluted earnings per share $375,733   1,525,258  $0.25                                  **Per**           **Share** **For The Three Months Ended** **Net Income**  **Shares**  **Amount** **June 30, 2005**            Basic earnings per share $406,769   1,549,222  $0.26            Dilutive securities      28,382                 Diluted earnings per share $406,759   1,577,604  $0.26                                  **Per**           **Share** **For The Six Months Ended** **Net Income**  **Shares**  **Amount** **June 30, 2006**            Basic earnings per share $667,391   1,519,056  $0.44            Dilutive securities      28,045                 Diluted earnings per share $667,391   1,547,101  $0.43                                  **Per**           **Share** **For The Six Months Ended** **Net Income**  **Shares**  **Amount** **June 30, 2005**            Basic earnings per share $732,824   1,550,775  $0.47            Dilutive securities      30,517                 Diluted earnings per share $732,824   1,581,292  $0.46           **3. RECENT ACCOUNTING PRONOUNCEMENTS:**In December 2004, the FASB issued SFAS No. 123 (revised 2004), *Share-Based Payment*, whichrevised SFAS No. 123, *Accounting for Stock-Based Compensation*. This statement supercedes APBOpinion No. 25, *Accounting for Stock Issued to Employees*. The revised statement addresses theaccounting for share-based payment transactions with employees and other third parties,eliminates the ability to account for share-based compensation transactions using APB 25 andrequires that the compensation costs relating to such transactions be recognized in theconsolidated statement of operations. The Company adopted SFAS No. 123(R) on January 1, 2006.The impact of its adoption had no impact on the consolidated statements of financial conditionor statements of operations for the Company as all options outstanding were fully vested.In February 2006, the FASB issued SFAS No. 155, *Accounting for Certain Hybrid FinancialInstruments – an amendment of FASB Statements No 133 and 140.*This statement amends SFAS No.133, *Accounting for Derivatives and Hedging Activities*and SFAS No. 140, *Accounting forTransfers and Servicing of Financial Assets and Extinguishments of Liabilities*, and allows theentity to re-measure at fair value a hybrid financial instrument that contains an embeddedderivative that otherwise would require bifurcation from the host, if the holder irrevocablyelects to account for the whole instrument on a fair value basis. Subsequent changes in the
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fair value of the instrument would be recognized in earnings. SFAS No. 155 is effective forall financial instruments acquired or issued after the beginning of an entity’s first fiscalyear that begins after September 15, 2006. The Company does not expect the adoption of SFASNo. 155 to have a material impact on the consolidated statements of financial condition orstatements of operations of the Company.In March 2006, the FASB issued SFAS No. 156, *Accounting for Servicing of Financial Assets*– *anamendment of FASB Statement No. 140*. SFAS No. 156 amends SFAS No. 140, with respect to theaccounting for separately recognized servicing assets and liabilities. The statementaddresses the recognition and measurement of separately recognized servicing assets andliabilities and provides an approach to simplify efforts to obtain hedge-like accounting.SFAS No. 156 is effective as of the beginning of the first fiscal year that begins afterSeptember 15, 2006. The Company does not expect the adoption of SFAS No. 156 to have amaterial impact on the consolidated statements of financial condition or statements ofoperations of the Company.In June 2006, the FASB issued Interpretation (“FIN”) No. 48, *Accounting for Uncertainty inIncome Taxes – an interpretation of the FASB Statement No. 109.*This Interpretation prescribesa recognition threshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken, or expected to be taken in a tax return, and providesguidance on derecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. This is effective for fiscal years beginning afterDecember 15, 2006. The Company is currently assessing the impact, if any, that the adoption ofthis interpretation will have on its financial statements.
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**Item 2. Management’s Discussion and Analysis or Plan of Operation****Forward-Looking Statements:**This Quarterly Report on Form 10-QSB contains forward-lookingstatements. Additional written or oral forward-looking statements may be made by the Company fromtime to time in filings with the SEC or otherwise. The words “believe,” “expect,” “seek” and“intend,” and similar expressions identify forward-looking statements, which speak only as of thedate the statement is made. Such forward-looking statements are within the meaning of that term inSection 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended. Such statements may include, but are not limited to, projections of incomeor loss, expenditures, acquisitions, plans for future operations, financing needs or plans relatingto services of the Company, as well as assumptions relating to the foregoing. Forward-lookingstatements are inherently subject to risk and uncertainties, some of which cannot be predicted orqualified. Future events and actual results could differ materially from those set forth in,contemplated by or underlying the forward-looking statements.The Company does not undertake, and specifically disclaims, any obligation to publicly release theresults of revisions, which may be made to forward-looking statements to reflect the occurrence ofanticipated or unanticipated events or circumstances after the date of such statements.**Critical Accounting Policies:**The accounting principles followed by the Company and the methods ofapplying these principles conform with United States generally accepted accounting principles andwith general practices within the banking industry. The Company’s critical accounting policiesrelate to the allowance for loan losses and real estate owned. These policies require the use ofestimates, assumptions and judgments and are based on information available as of the date of thefinancial statements. Accordingly, as this information changes, the financial statements couldreflect different estimates, assumptions and judgments. Certain policies inherently have a greaterreliance on the use of estimates, assumptions and judgments and, as such, have a greaterpossibility of producing results that could be materially different than originally reported. Thesepolicies require the use of subjective and complex estimates, assumptions and judgments that areimportant to the portrayal of the Company’s financial condition and results.The allowance for loan losses is maintained at a level which management considers to be adequate toabsorb losses inherent in the loan portfolio. Management’s estimation of the amount of theallowance is based on a continuous evaluation of the loan portfolio and includes such factors aseconomic conditions, analysis of individual loans, overall portfolio characteristics, delinquenciesand the balance of any impaired loans (generally considered to be nonperforming loans, excludingresidential mortgages and other homogeneous loans).Management reviews the adequacy of the allowance for loan losses on a continuous basis by assessingthe quality of the loan portfolio and adjusting the allowance when appropriate. Management’sevaluation of certain specifically identified loans includes a review of the financial conditionand capacity of the borrower, the value of the collateral, current economic trends, historicallosses, workout and collection arrangements, and possible concentrations of credit. The loan reviewprocess also includes a collective evaluation of credit quality within the mortgage and installmentloan portfolios. In establishing the allowance, loss percentages are applied to groups of loanswith similar risk characteristics. These loss percentages are determined by historical experience,portfolio mix, regulatory influence, and other economic factors. Each quarter this review isquantified in a report to management, which uses it to determine whether an appropriate allowanceis being maintained. This report is then submitted to the Audit Committee and to the Board ofDirectors quarterly.Changes in the allowance can result from changes in economic events, changes in thecreditworthiness of the borrowers, or changes in collateral values. The effect of these changes isreflected when known. Though management believes the allowance for loan losses to be adequate as ofJune 30, 2006, ultimate losses may vary from estimations.Real estate owned acquired through foreclosure is carried at the lower of cost or fair value lessexpected selling costs. Any excess of the recorded investment over fair value, less estimated costsof disposition of the property, is charged to the allowance for loan losses at the time offoreclosure. Subsequent to foreclosure, real estate owned is
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evaluated on an individual basis for changes in fair value. Declines in fair value of the asset,less costs of disposition below its carrying amount, require an increase in the valuation allowanceaccount. Future increases in fair value of the asset, less cost of disposition, may cause areduction in the valuation allowance account, but not below zero. Increases or decreases in thevaluation allowance account are charged or credited to income. Costs relating to the developmentand improvement of property are capitalized, whereas costs relating to the holding of property areexpensed.The recognition of gains and losses on the sale of real estate owned is dependent upon whether thenature and terms of the sale and future involvement of the Bank in the property meet certainrequirements. If the transaction does not meet these requirements, income recognition is deferredand recognized under an alternative method in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 66, *Accounting for Sales of Real Estate.***Comparison of Financial Condition as of December 31, 2005 and June 30, 2006:**Total assets were$224.9 million at June 30, 2006, compared to $220.2 million at December 31, 2005. Net loansincreased $3.4 million, to $109.6 million at June 30, 2006, compared to $106.2 million at December31, 2005. This increase was due primarily to an increase in loans secured by real estate of $1.9million and an increase in commercial loans of $2.0 million. These increases were offset by adecrease in consumer loans of $500,000. Total securities available-for-sale were $74.9 million atJune 30, 2006, compared to $80.7 million at December 31, 2005.Cash and cash equivalents and interest-bearing deposits in other banks at June 30, 2006 totaled$20.7 million, compared to $17.2 million at December 31, 2005. The Company is maintaining thislevel of liquidity in order to fund current loan commitments and other loan originations in 2006and reduce risk from rising interest rates.At June 30, 2006, the investment portfolio of $74.9 million consisted primarily of U. S. agencysecurities and mortgage-backed securities. The entire investment portfolio is classified as“available-for-sale,” which is carried at fair value with the unrealized gains/losses reflecteddirectly in stockholders’ equity, net of taxes.Total deposits increased $7.9 million, to $200.4 million June 30, 2006, from $192.5 million atDecember 31, 2005. This increase was primarily due to an increase in time deposits of $5.9 millionand an increase in NOW and money market deposit accounts of $2.0 million. This increase was due tomore competitive rates offered by the Bank to attract new deposit customers.Total borrowed funds decreased $2.4 million, to $0 at June 30, 2006, from $2.4 million at December31, 2005. This decrease was due to the Company paying off $2.4 million of warrants payable duringthe six-months ended June 30, 2006.On December 22, 2003, the Company established Pinnacle Capital Trust I (the “Trust”), awholly-owned statutory business trust. The Company is the sole sponsor of the trust and owns$93,000 of the Trust’s common securities. The Trust was created for the exclusive purpose ofissuing 30-year capital trust preferred securities (“Trust Preferred Securities”) in the aggregateamount of $3,000,000 and using proceeds from the issuance of the common and preferred securities topurchase $3,093,000 of junior subordinated debentures (“Subordinated Debentures”) issued by theCompany. The sole assets of the Trust are the Subordinated Debentures. The Company’s investment inthe Trust is included in other assets in the accompanying consolidated balance sheet at June 30,2006 and the $3,093,000 obligation of the Company is included in subordinated debt. Interestexpense on Subordinated Debentures was $62,000 and $121,000 for the three and six months ended June30, 2006, respectively, compared to $47,000 and $90,000 for the three and six months ended June 30,2005. The increase was due to an increase in the average rate paid from 6.0% in the three and sixmonths ended June 30, 2005 to 8.0% in the three and six months ended June 30, 2006.Stockholders’ equity decreased $1.6 million, to $17.8 million at June 30, 2006, from $19.4 millionat December 31, 2005. This decrease was primarily attributable to the repurchase of 63,100 sharesof common stock at a cost of $937,657 and a $976,346 decrease in the fair value of the Company’savailable-for-sale securities portfolio, which is marked to fair value. The interest rate risk inthe Company’s portfolio is monitored closely.**Results of Operations-Comparison of the Three and Six-Months Ended June 30, 2006 and 2005:**For thethree-months ended June 30, 2006, net income was $376,000 compared with net income of $407,000 forthe three months ended June 30, 2005. For the six-months ended June 30, 2006, net income was$667,000 compared with net
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income of $733,000 for the six months ended June 30, 2005. The decrease in net income wasattributable in part to a decrease in the Company’s net interest margin due to increases in marketinterest rates. As market rates increased during the three and six months ended June 30, 2006, theCompany’s cost of funds increased more rapidly than rates on investments and loans. As a result,the Company’s net interest margin was 3.10% and 3.20% for the three and six months ended June 30,2006, as compared to 3.50% for the three and six months ended June 30, 2005. If market ratescontinue to increase, the Company expects that the margin will continue to decline.The yield on interest-earning assets increased from approximately 5.70% and 5.59% in the three andsix months period ended June 30, 2005 to approximately 6.30% and 6.20% in the three and six monthsperiod ended June 30, 2006. These increases were due to increases in market interest rates. Thecost of funds increased from approximately 2.34% at June 30, 2005, to approximately 3.19% at June30, 2006 due to increases in market rates.Net interest income before the provision for loan losses for the three months ended June 30, 2006,was $1,604,000, compared with $1,720,000 in the same period last year. Net interest income beforethe provision for loan losses for the six months ended June 30, 2006, was $3,250,000, compared with$3,407,000 in the same period last year. The decrease was primarily due to increases in interestexpense on deposits of $554,000 and $1,039,000 for the three and six months ended June 30, 2006respectively. These increases were offset by an increase in interest revenue of $418,000 and$854,000 for the three and six months ended June 30, 2006, respectively, compared with the sameperiods last year.Provisions for loan losses are made to maintain the allowance for loan losses at adequate levels.The allowance for loan losses reflects management’s estimates, which take into account historicalexperience, the amount of non-performing loans, collateral values and general economic conditions.The provision for loan losses was $112,500 and $247,500 for the three and six months ended June 30,2006, compared to $147,000 and $303,000 for the three ad six months ended June 30, 2005. It ismanagement’s opinion that the allowance for loan losses at June 30, 2006 was adequate to absorblosses related to the portfolio of loans. Management will continue to analyze the Bank’s exposureto losses. Although management believes that it uses the best information available to make suchdeterminations, future adjustments to allowances may be necessary, and net earnings could besignificantly affected if circumstances differ substantially from the assumptions used in makingthe initial determinations.Net interest income after the provision for loan losses for the three months ended June 30, 2006,was $1,492,000, compared with $1,573,000 in the same period last year. Net interest income afterthe provision for loan losses for the six months ended June 30, 2006, was $3,003,000 compared with$3,104,000 in the same period last year.Non-interest income, which includes fees and service charges, income from real estate operations,the sale of loans, bank owned life insurance and other income, increased $34,482, in thethree-month period ended June 30, 2006, as compared to the three-month period ended June 30, 2005.This increase was due primarily to an increase in the gain on sale of loans held for sale of$47,342, an increase in gain on sale of assets of $14,737 and an increase in BOLI income of$4,670. These increases were offset by an increase in the loss of sales of real estate owned of$9,379, a decrease in fees and service charges on deposit account of $13,433 and decrease in allother non-interest income of $9,455. Non-interest income increased $15,227 for the six-monthperiod ended June 30, 2006, as compared to the six-month period ended June 30, 2005. This increasewas due primarily to an increase in BOLI income of $9,340, an increase in gain on sale of assetsof $18,487 an increase in fees and service charges on deposit accounts of $5,689, an increase infees and charges on loans of $4,792. These increases were offset by an increase in the loss ofsales of real estate owned of $13,116 and decrease in service fee income, net of $9,939, an adecrease in all other non-interest income of $26.Non-interest expense decreased $2,012 in the three-month period ended June 30, 2006, as comparedto the corresponding prior year period. This was primarily a result of a decrease in all othernon-interest expense of $19,672. This decrease was offset by a increase in compensation expense of$17,660. Non-interest expense increased $7,770 in the six-month period ended June 30, 2006, ascompared to the corresponding prior year period. This increase was primarily a result of anincrease in compensation expense of $20,574 and an increase in occupancy expense of $8,999. Theseincreases were offset by a decrease in all other non-interest income of $21,803.**Asset/Liability Management**: The modeling techniques used by the Company simulate net interestincome and impact on fair values under various rate scenarios. Important elements of thesetechniques include the mix of
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floating versus fixed rate assets and liabilities, and the scheduled, as well as expected,repricing and maturing volumes and rates of the existing balance sheet. Under a scenariosimulating a hypothetical 50, 100 and 200 basis point rate increase applied to all interest-earningassets and interest-bearing liabilities, the Company would expect net losses in fair value of theequity in the underlying instruments of approximately ($193,000), ($480,000) and ($1,137,000)respectively. Under a scenario simulating a hypothetical 50, 100 and 200 basis point rate decrease,the Company would expect net changes in projected net income for the first year of approximately$587,000, $1,047,000 and $1,845,000, respectively. This hypothetical is not a precise indicator offuture events. Instead, it is a reasonable estimate of the results anticipated if the assumptionsused in the modeling techniques were to occur.The rate environment is a function of the monetary policy of the Federal Reserve Board (“FRB”). Theprincipal tools of the FRB for implementing monetary policy are open market operations, or thepurchases and sales of U.S. Treasury and federal agency securities. The FRB’s objective for openmarket operations has varied over the years, but the focus has gradually shifted toward attaining aspecified level of the federal funds rate to achieve the long-run goals of price stability andsustainable economic growth. The federal funds rate is the basis for overnight funding and drivesthe short end of the yield curve. Longer maturities are influenced by FRB purchases and sales andalso expectations of monetary policy going forward. The FRB began to increase the targeted levelfor the federal funds rate in June 2004 after reaching an all-time low of 1.00% in mid-2003. Thetargeted fed funds rate increased at each Federal Open Market Committee meeting by 25 basis pointsand ended June 29, 2006 at 5.25%. Each FRB rate increase becomes more challenging to offset. Theability to delay deposit rate increases and less aggressive repricing of the maturing certificateof deposit portfolio has allowed the Company to offset the negative impact of recent FRB ratemovements. The continued flattening of the yield curve has exerted downward pressure on the netinterest margin and net interest income. The Company is most impacted at this time by the increasein short term interest rates which continues to put upward pressure on transaction deposit ratesand short term borrowings from the Federal Home Loan Bank (FHLB”) of Atlanta. Under traditionalmeasures of interest rate gap positions, the Company believes that it is moderately liabilitysensitive in the short-term. Changes in interest rates can affect loans and other interest-earningassets, including the Bank’s investment portfolio. A significant change in interest rates couldhave a negative impact on the Company’s operating income and portfolio market value.**Stock Repurchases:**The following table details the purchases under the Company’s stock repurchaseprogram during the six months ended June 30, 2006.                   **Total**     **Total Number of** **Maximum Number**  **Number** **Average Price** **Shares Purchased** **of Shares that May**  **of Shares** **Paid per** **As Part of Publicly** **Yet Be Purchased****Period** **Purchased** **Share** **Announced Programs** **Under the Programs**January 1-31, 2006  0   0   0  $63,936 February 1-28,2006  0   0   0   0 March 1-31, 2006  0   0   0   0 April 1-30, 2006  0   0   0   0 May 1-31, 2006  58,800   14.87   58,800   5,136 June 1-30, 2006  4,300   14.72   4,300   74,736    Total  63,100  $14.86   63,100   74,736           On June 28, 2006, the Company announced a supplemental stock repurchase program toacquire an additional 5% of the Company’s outstanding shares outstanding upon completion of itscurrent repurchase program, or 73,900 shares. The stock repurchase program is intended to improveliquidity in the market for the common stock, to increase per share earnings and book value, and toprovide a higher rate of return for the Company’s funds. The Company may consider additionalrepurchase programs in the future.**Capital Resources:**Historically, funds provided by operations, mortgage loan principal repayments,deposits and short-term borrowings have been the Bank’s principal sources of funds. In addition,the Bank has the ability to obtain funds through the sale of mortgage loans, through borrowingsfrom the FHLB of Atlanta and other borrowing sources. At June 30, 2006, the Bank’s total loancommitments, including construction loans in process, unused lines of credit and letter of credits,were approximately $37.0 million. Management believes that the Bank’s liquidity and other sourcesof funds are sufficient to fund all commitments outstanding and other cash needs. The Company and
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the Bank are required to maintain certain levels of regulatory capital. At June 30, 2006, theCompany and the Bank exceeded all regulatory capital requirements.**Asset Quality Ratios:**           June 30, December 31,  2006 2005Nonperforming loans as a percent of total loans  0.34%  0.22%Nonperforming assets as a percent of total assets  0.27%  0.28%Allowance for loan losses as a percent of total loans  1.29%  1.28%Allowance for loan losses as a percent of nonperforming loans  380.97%  586.02%**New Branch Office**: In recent years, the Company has expanded its operations in the Birmingham,Alabama metropolitan area. A new full-service branch office in Gardendale, Alabama was opened onAugust 7, 2006. Additional annual expenses associated with the new branch and additional commerciallending personnel were approximately $100,000 in the six months ended June 30, 2006. The Companycurrently intends to expand further in the Birmingham market and other markets contiguous with theCompany’s current market area as appropriate opportunities become available.**Item 3. Controls and Procedures**The Company carried out an evaluation, under the supervision and with the participation of theCompany’s management, including the Company’s Principal Executive Officer and Principal FinancialOfficer, of the effectiveness of the design and operation of the Company’s disclosure controls andprocedures as of June 30, 2006. Based upon that evaluation, the Company’s Principal ExecutiveOfficer and Principal Financial Officer concluded that the Company’s disclosure controls andprocedures, as designed and implemented, are effective in alerting him in a timely manner tomaterial information relating to the Company (including its consolidated subsidiaries) required tobe included in the Company’s periodic SEC filings.There has been no change in the Company’s internal control over financial reporting during the lastfiscal quarter that has materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.Disclosure controls and procedures are designed to ensure that information required to be disclosedin reports filed by the Company under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosurecontrols are also designed with the objective of ensuring that such information is accumulated andcommunicated to the Company’s management, including the Principal Executive Officer and PrincipalFinancial Officer to allow timely decisions regarding required disclosures. Disclosure controlsinclude internal controls that are designed to provide reasonable assurance that transactions areproperly authorized, assets are safeguarded against unauthorized or improper use and transactionsare properly recorded and reported.Any control system, no matter how well conceived and operated, can provide only reasonableassurance that its objectives are achieved. The design of a control system inherently haslimitations, including the controls’ cost relative to their benefits. Additionally, controls can becircumvented. No cost-effective control system can provide absolute assurance that all controlissues and instances of fraud, if any, will be detected.Pursuant to Section 404 of the Sarbanes-Oxley Act, the Company will be required under rules adoptedby the SEC to include in its annual reports a report by management on the Company’s internalcontrol over financial reporting and an accompanying auditor’s report. In March 2005, the SECextended the Section 404 compliance date for the Company and other non-accelerated filers. Underthe extension, the Company must begin to comply with these requirements for its fiscal year endingDecember 31, 2007. The Company expects that Section 404 compliance will significantly increase itsregulatory compliance costs.
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**PART II – OTHER INFORMATION****ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds**Information regarding the Company’s purchases of equity is described on page13 underItem 2. “Management’s Discussion and Analysis or Plan or Operation.”**ITEM 4. Submission of Matters to a Vote of Security Holders**On May 24, 2006, the Company held its Annual Meeting of Stockholders at which thefollowing matters were considered and voted on.          **PROPOSAL I-ELECTION OF DIRECTORS**             **NOMINEES** **FOR** **WITHHELD** **TERM**James W. Cannon  1,215,422   99,060   2009 Robert B. Nolen Jr.  1,213,922   100,560   2009 Max W. Perdue  1,215,293   99,189   2009           There were no abstentions or broker non-votes.          **PROPOSAL II-RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS**Ratification of the appointment of KPMG, LLP as independent auditors of the Company for the fiscalyear ending December 31, 2006.         **FOR** **AGAINST** **ABSTAINED**1,306,876  4,386   3,220           There were no broker non-votes**ITEM 6. Exhibits**Exhibit 31.1- Certifications of Chief Executive Officer and Chief Financial Officer pursuantto Section 302 of the Sarbanes-Oxley Act of 2002.Exhibit 32.1 Certifications of Chief Executive Officer and Chief Financial Officer pursuant toSection 906 of the Sarbanes-Oxley Act of 2002
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**SIGNATURES**In accordance with the requirements of the Exchange Act, the registrant has caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.         PINNACLE BANCSHARES, INC         DATE: August 14, 2006 BY: /s/ Robert B. Nolen Jr.             Robert B. Nolen, Jr.      President and Chief      Executive Officer      (Principal Executive Officer and      Principal Financial Officer)             /s/ Marie Guthrie             Marie Guthrie      Treasurer      (Principal Accounting Officer)  
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