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U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-QSB (Mark one) xQuarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 For the quarterly period ended September 30, 2004 oTransition report under Section 13 or 15(d) of the Exchange Act For the transition period fromto Commission file number 1-12707 Pinnacle Bancshares, Inc. 
 Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
    
    72-1370314
(I.R.S. Employer
Identification No.)
 1811 Second Avenue, Jasper, Alabama 35502-1388 
  (205) 221-4111 
 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 was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes  x  No  o The number of shares outstanding of each of the issuers classes of common equity, as of November 15, 2004: 1,549,678 shares of common stock. Transitional Small Business Disclosure Format (check one): Yes  o  No  x




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CONTENTS PagePART I            FINANCIAL INFORMATIONItem 1. Financial StatementsUnaudited Condensed Consolidated Statements of Financial Condition at September 30, 2004 and December 31, 2003.
    
    
    3Unaudited Condensed Consolidated Statements of Operations for the three and nine-months ended September 30, 2004 and 2003.
    
    
    4Unaudited Condensed Consolidated Statements of Stockholders Equity for the nine-months ended September 30, 2004 and 2003.
    
    
    5Unaudited Condensed Consolidated Statements of Cash Flows for the nine-months ended September 30, 2004 and 2003.
    
    
    6Notes to Unaudited Condensed Consolidated Financial Statements.
    
    
    7Item 2. Managements Discussion and Analysis
    
    
    10Item 3. Controls and Procedures
    
    
    14Part II            OTHER INFORMATIONItem 2.
Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    15Item 6. Exhibits and Reports on Form 8-K
    
    
    15Signatures
    
    
    16EX-31.1  SECTION 302 CERTIFICATION OF THE CEO & CFOEX-32.1  SECTION 906 CERTIFICATION OF THE CEO & CFO
 2




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PART I   FINANCIAL INFORMATION 
 Item 1. Financial Statements PINNACLE BANCSHARES, INC. 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
 September 30,
    
    December 31,2004
    
    2003ASSETS:Cash and cash equivalents
    
    $
    3,192,280
    
    
    $
    3,519,377Interest-bearing deposits in other banks
    
    
    2,204,693
    
    
    
    256,294Securities available-for-sale
    
    
    85,381,472
    
    
    
    83,325,381FHLB stock
    
    
    557,500
    
    
    
    732,400Loans held for sale
    
    
    874,482
    
    
    
    1,428,190Loans receivable, net of allowances for loan losses
of $1,253,495 and $1,467,128, respectively
    
    
    102,431,324
    
    
    
    105,477,419Real estate owned, net
    
    
    452,555
    
    
    
    1,023,026Premises and equipment
    
    
    5,811,590
    
    
    
    5,790,124Goodwill
    
    
    306,488
    
    
    
    306,488Bank owned life insurance
    
    
    4,727,044
    
    
    
    4,514,902Accrued interest receivable
    
    
    1,179,035
    
    
    
    1,362,440Other assets
    
    
    645,095
    
    
    
    838,150Total assets
    
    $
    207,763,558
    
    
    $
    208,574,191LIABILITIES AND STOCKHOLDERS EQUITY:Deposits
    
    $
    180,165,932
    
    
    $
    179,939,397Subordinated debt
    
    
    3,093,000
    
    
    
    3,093,000Borrowed funds
    
    
    2,580,000
    
    
    
    3,465,000Official checks outstanding
    
    
    638,786
    
    
    
    1,481,801Accrued interest payable
    
    
    510,438
    
    
    
    439,729Other liabilities
    
    
    758,146
    
    
    
    724,068Total liabilities
    
    
    187,746,302
    
    
    
    189,142,995STOCKHOLDERS EQUITY:Common stock, par value $.01 per share; 2,400,000 authorized; 1,816,780
and 1,800,813 issued at September 30, 2004 and December 31, 2003,
respectively; 1,549,678 and 1,562,611 outstanding at September 30, 2004
and December 31, 2003, respectively.
    
    
    18,168
    
    
    
    18,008Additional paid-in capital
    
    
    8,374,884
    
    
    
    8,219,941Treasury shares, at cost (267,102 shares and 238,202 shares at
September 30, 2004 and December 31, 2003, respectively)
    
    
    (3,207,162
    )
    
    
    (2,743,245
    )Retained earnings
    
    
    15,290,598
    
    
    
    14,508,277Accumulated other comprehensive loss, net of tax
    
    
    (459,232
    )
    
    
    (571,785
    )Total stockholders equity
    
    
    20,017,256
    
    
    
    19,431,196Total liabilities and stockholders equity
    
    $
    207,763,558
    
    
    $
    208,574,191
 See accompanying notes to these condensed consolidated financial statements. 3




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PINNACLE BANCSHARES, INC. 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003INTEREST REVENUE:Interest on loans
    
    $
    1,809,241
    
    
    $
    2,025,875
    
    
    $
    5,512,816
    
    
    $
    6,376,902Interest and dividends on securities
    
    
    845,160
    
    
    
    729,002
    
    
    
    2,436,099
    
    
    
    2,195,738Other interest
    
    
    8,749
    
    
    
    3,726
    
    
    
    24,188
    
    
    
    19,3622,663,150
    
    
    
    2,758,603
    
    
    
    7,973,103
    
    
    
    8,592,002INTEREST EXPENSE:Interest on deposits
    
    
    801,150
    
    
    
    872,850
    
    
    
    2,357,928
    
    
    
    2,918,569Interest on borrowed funds
    
    
    40,078
    
    
    
    43,399
    
    
    
    104,434
    
    
    
    142,687Interest on subordinated debentures
    
    
    35,674
    
    
    
    0
    
    
    
    134,822
    
    
    
    0876,902
    
    
    
    916,249
    
    
    
    2,597,184
    
    
    
    3,061,256NET INTEREST INCOME BEFORE PROVISION FOR
LOAN LOSSES
    
    
    1,786,248
    
    
    
    1,842,354
    
    
    
    5,375,919
    
    
    
    5,530,746PROVISION FOR LOAN LOSSES
    
    
    147,000
    
    
    
    347,000
    
    
    
    441,000
    
    
    
    882,000NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES
    
    
    1,639,248
    
    
    
    1,495,354
    
    
    
    4,934,919
    
    
    
    4,648,746NONINTEREST INCOME:Fees and service charges on deposit accounts
    
    
    231,363
    
    
    
    228,956
    
    
    
    720,604
    
    
    
    689,098Service fee income, net
    
    
    41,370
    
    
    
    41,130
    
    
    
    123,615
    
    
    
    121,145Fees and charges on loans
    
    
    41,857
    
    
    
    71,780
    
    
    
    156,893
    
    
    
    142,904Bank owned life insurance
    
    
    70,714
    
    
    
    71,406
    
    
    
    212,142
    
    
    
    214,216Net gain (loss) on sale or write-down of:Loans held for sale
    
    
    105,487
    
    
    
    290,561
    
    
    
    432,350
    
    
    
    783,604Real estate owned
    
    
    2,703
    
    
    
    57,685
    
    
    
    (14,703
    )
    
    
    6,948Premises and equipment
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    13,500Securities available-for-sale
    
    
    (295,537
    )
    
    
    14,063
    
    
    
    (373,841
    )
    
    
    390,303197,957
    
    
    
    775,581
    
    
    
    1,257,060
    
    
    
    2,361,718NONINTEREST EXPENSE:Compensation and benefits
    
    
    833,455
    
    
    
    799,318
    
    
    
    2,554,261
    
    
    
    2,382,926Occupancy
    
    
    267,185
    
    
    
    280,827
    
    
    
    781,117
    
    
    
    802.496Marketing and professional
    
    
    55,661
    
    
    
    72,978
    
    
    
    173,052
    
    
    
    182,176Other
    
    
    226,613
    
    
    
    251,750
    
    
    
    760,474
    
    
    
    792,5391,382,914
    
    
    
    1,404,873
    
    
    
    4,268,904
    
    
    
    4,160,137INCOME BEFORE INCOME TAXES
    
    
    454,291
    
    
    
    866,062
    
    
    
    1,923,075
    
    
    
    2,850,327INCOME TAX EXPENSE
    
    
    144,933
    
    
    
    294,855
    
    
    
    641,917
    
    
    
    980,116NET INCOME
    
    $
    309,358
    
    
    $
    571,207
    
    
    $
    1,281,158
    
    
    $
    1,870,211Basic earnings per share
    
    $
    0.20
    
    
    $
    0.36
    
    
    $
    0.82
    
    
    $
    1.17Diluted earnings per share
    
    $
    0.20
    
    
    $
    0.36
    
    
    $
    0.80
    
    
    $
    1.15Cash dividends per share
    
    $
    0.11
    
    
    $
    0.10
    
    
    $
    0.32
    
    
    $
    0.30Weighted average basic shares outstanding
    
    
    1,549,678
    
    
    
    1,565,684
    
    
    
    1,560,079
    
    
    
    1,593,528Weighted average diluted shares outstanding
    
    
    1,585,223
    
    
    
    1,606,058
    
    
    
    1,599,711
    
    
    
    1,623,478
 See accompanying notes to these consolidated financial statements. 4




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PINNACLE BANCSHARES, INC. 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 AccumulatedCommon Stock
    
    AdditionalPaid-in
    
    Treasury
    
    Retained
    
    OtherComprehensive
    
    TotalStockholdersShares
    
    Amount
    
    Capital
    
    Stock
    
    Earnings
    
    (Loss) Income
    
    EquityBALANCE, December 31, 2002Comprehensive income:
    
    
    1,792,086
    
    
    $
    17,921
    
    
    $
    8,131,746
    
    
    $
    (1,497,777
    )
    
    $
    12,716,579
    
    
    $
    587,009
    
    
    $
    19,955,478Net income
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    1,870,211
    
    
    
    0
    
    
    
    1,870,211Change in fair value of securities available-
for-sale, net of tax
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (1,017,877
    )
    
    
    (1,017,877
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    

    
    852,334Repurchase of common stock (87,000 shares at cost)
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (1,070,939
    )
    
    
    0
    
    
    
    0
    
    
    
    (1,070,939
    )Cash dividends declared ($.30 per share)
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (478,406
    )
    
    
    0
    
    
    
    (478,406
    )BALANCE, September 30, 2003
    
    
    1,792,086
    
    
    $
    17,921
    
    
    $
    8,131,746
    
    
    $
    (2,568,716
    )
    
    $
    14,108,384
    
    
    $
    (430,868
    )
    
    $
    19,258,467BALANCE, December 31, 2003
    
    
    1,800,813
    
    
    $
    18,008
    
    
    $
    8,219,941
    
    
    $
    (2,743,245
    )
    
    $
    14,508,277
    
    
    $
    (571,785
    )
    
    $
    19,431,196Comprehensive income:Net income
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    1,281,158
    
    
    
    0
    
    
    
    1,281,158Change in fair value of securities available-
For-sale, net of tax
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    112,553
    
    
    
    112,553Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,393,711Exercise of stock options
    
    
    15,967
    
    
    
    160
    
    
    
    154,943
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    155,103Repurchase of common stock (28,900 shares at cost)
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (463,917
    )
    
    
    0
    
    
    
    0
    
    
    
    (463,917
    )Cash dividends declared ($.32 per share)
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (498,837
    )
    
    
    0
    
    
    
    (498,837
    )BALANCE, September 30, 2004
    
    
    1,816,780
    
    
    $
    18,168
    
    
    $
    8,374,884
    
    
    $
    (3,207,162
    )
    
    $
    15,290,598
    
    
    $
    (459,232
    )
    
    $
    20,017,256
 See accompanying notes to unaudited condensed consolidated financial
statements. 5




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PINNACLE BANCSHARES, INC, 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 For the Nine Months EndedSeptember 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    1,281,158
    
    
    $
    1,870,211Adjustments to reconcile net income to net cash provided by operating activities:Depreciation
    
    
    370,129
    
    
    
    350,116Provision for loan losses
    
    
    441,000
    
    
    
    882,000Accretion, net
    
    
    (384,879
    )
    
    
    (148,449
    )Increase in cash surrender value of Bank owned life insurance
    
    
    (212,142
    )
    
    
    (214,216
    )Net (gain) loss on sale or write down of:Loans held for sale
    
    
    (432,350
    )
    
    
    (783,604
    )Securities available-for-sale
    
    
    373,841
    
    
    
    (390,303
    )Real estate owned and other assets
    
    
    14,703
    
    
    
    (6,948
    )Premises and Equipment
    
    
    0
    
    
    
    (13,500
    )Proceeds from sale of loans
    
    
    31,356,725
    
    
    
    63,920,515Loans originated for sale
    
    
    (30,370,667
    )
    
    
    (61,259,720
    )Decrease in accrued interest receivable
    
    
    183,405
    
    
    
    167,720Decrease (increase) in other assets
    
    
    194,555
    
    
    
    (201,920
    )Increase (decrease) in accrued interest payable
    
    
    70,709
    
    
    
    (82,248
    )Decrease in other liabilities
    
    
    (34,907
    )
    
    
    (15,607
    )Net cash provided by operating activities
    
    
    2,851,280
    
    
    
    4,074,047CASH FLOWS FROM INVESTING ACTIVITIES:Net loan repayments
    
    
    2,419,536
    
    
    
    10,623,095Net change in interest bearing deposits in other banks
    
    
    (1,948,399
    )
    
    
    (1,182,441
    )Purchase of securities available-for-sale
    
    
    (63,731,524
    )
    
    
    (83,990,000
    )Proceeds from the sale of securities available-for-sale
    
    
    46,689,977
    
    
    
    40,632,903Proceeds from maturing, called, and payments received on securities available-for-sale
    
    
    14,937,787
    
    
    
    39,597,363Proceeds from sale of FHLB stock
    
    
    174,900
    
    
    
    0Purchase of premises and equipment
    
    
    (391,595
    )
    
    
    (390,385
    )Proceeds from sales of premises and equipment
    
    
    0
    
    
    
    26,210Proceeds from sales of real estate owned
    
    
    980,072
    
    
    
    1,312,306Net cash (used in) provided by investing activities
    
    
    (869,246
    )
    
    
    6,629,051CASH FLOWS FROM FINANCING ACTIVITIES:Net increase in passbook, NOW and money market deposit accounts
    
    
    1,849,002
    
    
    
    1,676,643Proceeds from sales of time deposits
    
    
    14,279,725
    
    
    
    14,481,290Payments on maturing time deposits
    
    
    (15,902,192
    )
    
    
    (23,144,604
    )Decrease in borrowed funds
    
    
    (885,000
    )
    
    
    (1,675,000
    )Decrease in official checks outstanding
    
    
    (843,015
    )
    
    
    (655,180
    )Proceeds from the exercise of stock options
    
    
    155,103
    
    
    
    0Repurchase of common stock
    
    
    (463,917
    )
    
    
    (1,070,939
    )Payments of cash dividends
    
    
    (498,837
    )
    
    
    (478,406
    )Net cash used in financing activities
    
    
    (2,309,131
    )
    
    
    (10,866,196
    )NET DECREASE IN CASH AND CASH EQUIVALENTS
    
    
    (327,097
    )
    
    
    (163,098
    )CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    3,519,377
    
    
    
    3,862,956CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    3,192,280
    
    
    $
    3,699,858SUPPLEMENTAL DISCLOSURES:Cash payments for interest on deposits and borrowed funds
    
    $
    2,526,475
    
    
    $
    3,143,504Cash payments for income taxes
    
    
    640,000
    
    
    
    1,110,938Real estate acquired through foreclosure
    
    
    424,304
    
    
    
    687,607
 See accompanying notes to unaudited condensed consolidated financial
statements. 6




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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 the accounts of Pinnacle Bancshares, Inc. (the Company) and
Pinnacle Bank (the Bank), the Companys wholly owned subsidiary. All
significant intercompany transactions and accounts have been eliminated in
consolidation. In the opinion of management, all adjustments (none of which are other than
normal recurring accruals) necessary for a fair presentation of the results
of such interim periods have been included. The results of operations for the
three and nine month periods ended September 30, 2004, are not necessarily
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 with the audited financial statements and the notes thereto
included in the Companys Annual Report on Form 10-KSB for the year ended
December 31, 2003. The accounting policies followed by the Company are set
forth in the summary of Significant Accounting Policies in the Companys
audited consolidated financial statements. 7




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2. EARNINGS PER SHARE: The following table represents the earnings per share calculations for the
three and nine-month periods ended September 30, 2004 and 2003: PerShareFor The Three Months Ended
    
    Net Income
    
    Shares
    
    AmountSeptember 30, 2004Basic earnings per share
    
    $
    309,358
    
    
    
    1,549,678
    
    
    $
    0.20Dilutive securities
    
    
    
    
    
    
    35,545Diluted earnings per share
    
    $
    309,358
    
    
    
    1,585,223
    
    
    $
    0.20
 PerShareFor The Three Months Ended
    
    Net Income
    
    Shares
    
    AmountSeptember 30, 2003Basic earnings per share
    
    $
    571,207
    
    
    
    1,565,684
    
    
    $
    0.36Dilutive securities
    
    
    
    
    
    
    40,374Diluted earnings per share
    
    $
    571,207
    
    
    
    1,606,058
    
    
    $
    0.36
 PerShareFor The Nine Months Ended
    
    Net Income
    
    Shares
    
    AmountSeptember 30, 2004Basic earnings per share
    
    $
    1,281,158
    
    
    
    1,560,079
    
    
    $
    0.82Dilutive securities
    
    
    
    
    
    
    39,632Diluted earnings per share
    
    $
    1,281,158
    
    
    
    1,599,711
    
    
    $
    0.80
 PerShareFor The Nine Months Ended
    
    Net Income
    
    Shares
    
    AmountSeptember 30, 2003Basic earnings per share
    
    $
    1,870,211
    
    
    
    1,593,823
    
    
    $
    1.17Dilutive securities
    
    
    
    
    
    
    29,655Diluted earnings per share
    
    $
    1,870,211
    
    
    
    1,623,478
    
    
    $
    1.15
 3. STOCK BASED COMPENSATION: In accordance with the provision of Statement of Financial Accounting Standards
(SFAS) No. 123, Accounting for Stock-Based Compensation, the Company has
elected to continue to record compensation cost under APB Opinion No. 25,
Accounting for Stock Issued to Employees, and accordingly does not recognize
compensation cost due to the fact that all options granted were priced at the
fair market value of the underlying stock on the date of grant. Had
compensation cost been determined, consistent with SFAS No. 123, the impact on
the Companys net income would not have been material. 8




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4. RECENT ACCOUNTING PRONOUNCEMENTS: In December 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46 (revised December 2003), Consolidation of Variable
Interest Entities(FIN 46R),which addresses how a business enterprise should
evaluate whether it has controlling financial interest in an entity through
means other than voting rights and accordingly should consolidate the entity.
FIN 46R replaces FASB Interpretation No. 46, Consolidated of Variable Interest
Entities (FIN46),which was issued January 2003. Pinnacle Bancshares, Inc.
will be required to apply FIN 46R to all entities subject to this
Interpretation no later than the end of the first reporting period that ends
after December 15, 2004. This interpretation must be applied to those entities
that are considered to be special-purpose entities no later than as of the end
of the first reporting period that ends after December 15, 2003. For any variable interest entities (VIEs) that must be consolidated under FIN
46R that were created before January 1, 2004, the assets, liabilities and
non-controlling interest of the VIE initially would be measured at their
carrying amounts with any difference between the net amount added to the
balance sheet and any previously recognized interest being recognized as the
cumulative effect of an accounting change. If determining the carrying amounts
is not practicable, fair value at the date FIN 46R first applies may be used to
measure the assets, liabilities and non-controlling interest of the VIE. Pinnacle Bancshares, Inc. has applied FIN 46R in accounting for Pinnacle
Capital Trust I (Trust), established on December 22, 2003. Accordingly, in
the accompanying consolidated statement of financial condition the Company has
included in other assets our investment in the Trust of $93,000 and also
included, in subordinated debt, the balance owed the Trust of $3,093,000.
Except as related to the Trust, the application of this Interpretation is not
expected to have a material effect on Pinnacle Bancshares, Inc.s consolidated
financial statements. In April 2003, the FASB issued Statement of Financial Accounting Standard
(SFAS) No. 149, Amendment of Statement 133 on Derivative Instruments and
Hedging Activities. The Statement amends and clarifies accounting for
derivative instruments, including certain derivatives instruments embedded in
other contracts, and for hedging activities under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. This Statement is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of this Statement
did not have a material impact on the Companys consolidated financial
position or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. This Statement is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. On November 7, 2003, the FASB deferred
indefinitely the classification and measurement provisions related to mandatory
redeemable non controlling interest. The adoption of this Statement and the
amendment did not have a material impact on the Companys consolidated
financial position or results of operations. In March 2004, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) 105, Application of Accounting Principles to Loan
Commitments, which summarizes the views of the staff regarding the application
of generally accepted accounting principles to loan commitments accounted for
as derivative instruments. The SAB requires that the fair value measurement of
a loan commitment that is accounted for as a derivative includes only
differences between the guaranteed interest rate in the loan commitment and a
market interest rate, excluding any expected future cash flows related to the
customer relationship or loan servicing. This SAB is effective for loan
commitments entered into after March 31, 2004. The Company adopted SAB 105 on
April 1, 2004, and the effect was not material. In March 2004, the FASBs Emerging Issues Task Force reached a consensus of
EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments.The guidance prescribes a three-step model
for determining whether an investment is other-than-temporarily impaired and
requires disclosures about unrealized losses on investments. The disclosure
requirements are effective for annual reporting periods ending after June 15,
2004. However, the FASB has approved issuing a staff position to delay the
requirements to record impairment. The Company has adopted the disclosure
requirements of this EITF. 9




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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-looking statements. Additional written or oral forward-looking
statements may be made by the Company from time 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 the
date the statement is made. Such forward-looking statements are within the
meaning of that term in Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. Such
statements may include, but are not limited to, projections of income or loss,
expenditures, acquisitions, plans for future operations, financing needs or
plans relating to services of the Company, as well as assumptions relating to
the foregoing. Forward-looking statements are inherently subject to risk and
uncertainties, some of which cannot be predicted or qualified. 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 the results of revisions, which may be made to forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements. Critical Accounting Policies:The accounting principles followed by the
Company and the methods of applying these principles conform with United States
generally accepted accounting principles and with general practices within the
banking industry. The Companys critical accounting policies relate to the
allowance for loan losses and real estate owned. These policies require the use
of estimates, assumptions and judgments and are based on information available
as of the date of the financial statements. Accordingly, as this information
changes, the financial statements could reflect different estimates,
assumptions and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions and judgments and, as such, have a greater
possibility of producing results that could be materially different than
originally reported. These policies require the use of subjective and complex
estimates, assumptions and judgments that are important 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 to absorb losses inherent in the loan portfolio.
Managements estimation of the amount of the allowance is based on a continuing
evaluation of the loan portfolio and includes such factors as economic
conditions, analysis of individual loans, overall portfolio characteristics,
delinquencies and the balance of any impaired loans (generally considered to be
nonperforming loans, excluding residential mortgages and other homogeneous
loans). Management reviews the adequacy of the allowance for loan losses on a
continuous basis by assessing the quality of the loan portfolio and adjusting
the allowance when appropriate. Managements evaluation of certain
specifically identified loans includes a review of the financial condition and
capacity of the borrower, the value of the collateral, current economic trends,
historical losses, workout and collection arrangements, and possible
concentrations of credit. The loan review process also includes a collective
evaluation of credit quality within the mortgage and installment loan
portfolios. In establishing the allowance, loss percentages are applied to
groups of loans with similar risk characteristics. These loss percentages are
determined by historical experience, portfolio mix, regulatory influence, and
other economic factors. Each quarter this review is quantified in a report to
management, which uses it to determine whether an appropriate allowance is
being maintained. This report is then submitted to the Audit Committee and to
the Board of Directors quarterly. Changes in the allowance can result from changes in economic events, changes in
the creditworthiness of the borrowers, or changes in collateral values. The
effect of these changes is reflected when known. Though management believes
the allowance for loan losses to be adequate as of September 30, 2004, ultimate
losses may vary from estimations. Real estate owned acquired through foreclosure is carried at the lower of cost
or fair value less expected selling costs. Any excess of the recorded
investment over fair value, less estimated costs of disposition of the
property, is charged to the allowance for loan losses at the time of
foreclosure. Subsequent to foreclosure, real estate owned is 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 allowance account. Future increases in fair value of 10




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the asset, less cost of disposition, may cause a reduction in the valuation
allowance account, but not below zero. Increases or decreases in the valuation
allowance account are charged or credited to income. Costs relating to the
development and improvement of property are capitalized, whereas costs relating
to the holding of property are expensed. The recognition of gains and losses on the sale of real estate owned is
dependent upon whether the nature and terms of the sale and future involvement
of the Bank in the property meet certain requirements. If the transaction does
not meet these requirements, income recognition is deferred and recognized
under an alternative method in accordance with Statement of Financial
Accounting Standards (SFAS) No. 66, Accounting for Sales of Real Estate. Comparison of Financial Condition as of December 31, 2003 and September 30,
2004:Total assets were $207.8 million at September 30, 2004, compared to
$208.6 million at December 31, 2003. Net loans receivable were $102.4 million
at September 30, 2004, compared to $105.5 million at December 31, 2003. Total
securities available-for-sale were $85.4 million at September 30, 2004,
compared to $83.3 million at December 31, 2003. At September 30, 2004, the investment portfolio of $85.4 million consisted
primarily of U. S. agency securities 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 reflected directly in stockholders
equity, net of taxes. During the nine months ended September 30, 2004, the Bank
had $14.9 million in agency securities called. Also during the nine month
period ended September 30, 2004, the Bank sold $46.7 million in agency
securities. Net losses of $374,000 were realized on these sales. The proceeds
from these calls, and sales of securities available-for-sale, combined with the
proceeds from loan principal repayments and Federal Home Loan Bank (FHLB) of
Atlanta advances, were used by the Bank to purchase $63.7 million in agency
securities with an average yield of 4.09%. Total deposits were approximately $180.2 million at September 30, 2004,
compared to $180.0 million at December 31, 2003. On December 22, 2003, the Company established Pinnacle Capital Trust I (the
Trust), a wholly-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 of issuing 30-year capital trust
preferred securities (Trust Preferred Securities) in the aggregate amount of
$3,000,000 and using proceeds from the issuance of the common and preferred
securities to purchase $3,093,000 of junior subordinated debentures
(Subordinated Debentures) issued by the Company. The sole assets of the Trust
are the Subordinated Debentures. The Companys investment in the Trust is
included in other assets in the accompanying consolidated balance sheet at
September 30, 2004 and the $3,093,000 obligation of the Company is included in
subordinated debt. During the nine-months ended September 30, 2004, the Bank periodically borrowed
funds on a short-term basis from the FHLB of Atlanta. During the nine-months
ended September 30, 2004, the Bank used proceeds from borrowed funds to
purchase agency securities as part of managing the Banks investment portfolio.
The maximum amount outstanding during the nine-months ended September 30, 2004
was $10.0 million. The average amount outstanding during the nine-months ended
September 30, 2004 was $2.1 million. Stockholders equity was $20.0 million at September 30, 2004, compared to $19.4
million at December 31, 2003. Results of Operations-Comparison of the Three and Nine-Months Ended September
30, 2004 and 2003:For the three-months ended September 30, 2004, net income
was $309,000, compared with net income of $571,000 for the three months ended
September 30, 2003. For the nine months ended September 30, 2004, net income
was $1,281,000 compared with net income of $1,870,000 for the nine months ended
September 30, 2003. The decrease in net income for the nine months ended
September 30, 2004 was primarily attributable to a decrease in net gains on the
sale of loans held for sale and available-for-sale securities of $351, and
$764, respectively. During the third quarter of 2004 the Company restructured a
portion of its portfolio in response to changes in interest rates and incurred
losses in the quarter of approximately $296,000 in connection with these
transactions. The net interest margin was 3.71% and 3.70% for the three and nine months ended
September 30, 2004, compared to 3.73% and 3.68% for the three and nine months
ended September 30, 2003, respectively.As market rates continued to stabilize
at lower levels during the three and nine months period ended September 30,
2004, the Companys cost of funds decreased more rapidly than rates on loans
and investments, contributing to the improved 11




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margin. The yield on interest-earning assets decreased from approximately 5.60%
and 5.71% in the three and nine month periods ended September 30, 2003,
respectively,to approximately 5.53% and 5.48% in the three and nine month
period ended at September 30, 2004. These decreases were due to decreases in
market interest rates as well as a decrease in the average balance of interest
earning assets. The cost of funds was 1.86% at September 30, 2004 and 2003. Net interest income before the provision for loan losses for the three months
ended September 30, 2004, was $1,786,000 compared with $1,842,000 in the same
period last year. Net interest income before the provision for loan losses for
the nine months ended September 30, 2004, was $5,376,000 compared with
$5,531,000 in the same period last year. The decreases were primarily due to
decreases in interest revenue of $95,000 and $620,000 for the three and nine
months ended September 30, 2004, respectively, compared with the same periods
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 historical experience, the amount of
non-performing loans, collateral values and general economic conditions. The
provisions for loan losses were $147,000 and $441,000 for the three and nine
months ended September 30, 2004, respectively, compared to $347,000 and
$882,000 for the three and nine months ended September 30, 2003, respectively.
The decreases in the provisions for loan losses for the three and nine month
periods ended September 30, 2004, as compared to the prior year period, were
primarily the result of decreased charge-offs as well as a decrease in
non-accrual loans. It is managements opinion that the allowance for loan
losses at September 30, 2004 was adequate to absorb losses related to the
portfolio of loans. Management will continue to analyze the Banks exposure to
losses. Although management believes that it uses the best information
available to make such determinations, future adjustments to allowances may be
necessary, and net earnings could be significantly affected if circumstances
differ substantially from the assumptions used in making the initial
determinations. Net interest income after the provision for loan losses for the three months
ended September 30, 2004, was $1,639,000 compared with $1,495,000 in the same
period last year. Net interest income after the provision for loan losses for
the nine months ended September 30, 2004, was $4,935,000, compared with
$4,649,000 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, decreased $578,000 in the three-month period ended September 30, 2004,
as compared to the three-month period ended September 30, 2004. The decrease
was due primarily to a decrease in the gain on sale of securities
available-for-sale of $310,000, due to the Company restructuring a portion of
its portfolio in response to changes in interest rates. Also a decrease in net
gain on sale of loans held for sale of $185,000, an increase in the loss on
sale of real estate owned of $55,000 and a decrease in all other non-interest
income of $28,000. Non-interest income decreased $1.1 million in the
nine-month period ended September 30, 2004, as compared to the nine-month
period ended September 30, 2004. The decrease was due primarily to a decrease
in the gain on sale of securities available-for-sale of $765,000, a decrease
in net gain on sale of loans held for sale of $351,000. Non-interest expense decreased $22,000 in the three-month period ended
September 30, 2004, as compared to the corresponding prior year period. This
was primarily a result of a decrease in Occupancy expense of $14,000, a
decrease in Marketing and Professional expense of $17,000 and an increase in
all other non-interest expense of $25,000. These decreases were offset by an
increase in compensation and benefits of $34,000. Non-interest expense
increased $109,000 in the nine-month period ended September 30, 2004 as
compared to the corresponding prior year period. This was primarily due to an
increase in compensation and benefits of $171,000. This increase was offset by
a decrease in occupancy expense of $21,000, a decrease in marketing and
professional expense of $9,000 and a decrease in all other non-interest
expense of $32,000. Asset/Liability Management: The modeling techniques used by the Company
simulate net interest income and impact on fair values under various rate
scenarios. Important elements of these techniques include the mix of floating
versus fixed rate assets and liabilities, and the scheduled, as well as
expected, re-pricing and maturing volumes and rates of the existing balance
sheet. Under scenarios simulating hypothetical 100, 200 and 300 basis point
rate increases applied to all fixed rate interest earning assets and
interest-bearing liabilities, the Company would expect net losses in fair value
of the underlying instruments of approximately ($366,000), ($1,531,000), and
($2,774,000), respectively. Under scenarios simulating hypothetical 100, 200
and 300 basis point rate decreases 12




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applied to all fixed rate interest earning assets and interest-bearing
liabilities, the Company would expect net gains (losses) in fair values of the
underlying instruments of approximately $604,000, ($206,000), and ($1,025,000),
respectively. These hypotheticals are not precise indicators of future events.
Instead, it is a reasonable estimate of the results anticipated if the
assumptions used in the modeling techniques were to occur. Changes in interest rates can affect loans and other interest-earning assets,
including the Banks investment portfolio. A significant change in interest
rates could have a negative impact on the Companys operating income and
portfolio market value. The following table details purchases under the Companys stock repurchase
program during the nine months ended September 30, 2004. Total Number of
    
    Maximum NumberTotal Number
    
    
    
    
    
    Shares Purchased
    
    of Shares that Mayof Shares
    
    Average Price
    
    As Part of Publicly
    
    Yet Be PurchasedPeriod
    
    Purchased
    
    Paid per Share
    
    Announced Programs
    
    Under the ProgramsJanuary 1-31, 2004
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0February 1-29, 2004
    
    
    9,900
    
    
    $
    17.85
    
    
    
    9,900
    
    
    
    25,300March 1-31, 2004
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0April 1-30, 2004
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0May 1-31, 2004
    
    
    5,000
    
    
    $
    14.32
    
    
    
    5,000
    
    
    
    20,300June 1-30, 2004
    
    
    14,000
    
    
    $
    15.40
    
    
    
    14,000
    
    
    
    6,300July 1-31, 2004
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0August 1-31, 2004
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0September 1-31, 2004
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Total
    
    
    28,900
    
    
    $
    16.05
    
    
    
    28,900
    
    
    
    6,300
 On April 25, 2003, the Company announced a stock repurchase program to acquire
up to 80,000 shares of common stock. As of September 30, 2004, the Company had
repurchased 73,700 shares at an average price of $14.70 per share .On June 10,
2004, the Company announced a supplemental stock repurchase program to acquire
an additional 5% of the Companys outstanding shares outstanding upon
completion of its current repurchase program, or 77,169 shares. This program
supplements the Companys current repurchase program. The repurchase programs
are dependent upon market conditions and other requirements, and there is no
guarantee as to the exact number of shares to be repurchased by the Company. 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 borrowings from the FHLB of
Atlanta and other borrowing sources. At September 30, 2004, the Banks total
loan commitments, including construction loans in process, unused lines of
credit and letter of credits, were approximately $22.0 million. Management
believes that the Banks liquidity and other sources of funds are sufficient to
fund all commitments outstanding and other cash needs. The Company and the Bank
are required to maintain certain levels of regulatory capital. At September
30, 2004, the Company and the Bank exceeded all regulatory capital
requirements. As of September 30, 2004, the $3.0 million of Trust Preferred Securities
qualifies as Tier I Capital under current regulators definitions. If these
Trust Preferred Securities had not been included in the consolidated capital
calculations, the Company would have still been classified as well capitalized. 13




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Item 3. Controls and Procedures The Company carried out an evaluation, under the supervision and with the
participation of the Companys management, including the Companys Principal
Executive Officer and Principal Financial Officer, of the effectiveness of the
design and operation of the Companys disclosure controls and procedures as of
September 30, 2004. Based upon that evaluation, the Companys Principal
Executive Officer and Principal Financial Officer concluded that the Companys
disclosure controls and procedures, as designed and implemented, are effective
in alerting him in a timely manner to material information relating to the
Company (including its consolidated subsidiaries) required to be included in
the Companys periodic SEC filings. In addition, the Company reviewed its internal controls under the supervision
of the audit committee. There has been no change in the Companys internal
control over financial reporting during the last fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. Disclosure controls and procedures are designed to ensure that information
required to be disclosed in 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. Disclosure controls are
also designed with the objective of ensuring that such information is
accumulated and communicated to the Companys management, including the
Principal Executive Officer and Principal Financial Officer to allow timely
decisions regarding required disclosures. Disclosure controls include internal
controls that are designed to provide reasonable assurance that transactions
are properly authorized, assets are safeguarded against unauthorized or
improper use and transactions are properly recorded and reported. Any control system, no matter how well conceived and operated, can provide only
reasonable assurance that its objectives are achieved. The design of a control
system inherently has limitations, including the controls cost relative to
their benefits. Additionally, controls can be circumvented. No cost-effective
control system can provide absolute assurance that all control issues and
instances of fraud, if any, will be detected. Effective as of December 31, 2005, the Company will become subject to Section
404 of The Sarbanes-Oxley Act of 2002. Section 404 requires management to
assess and report on the effectiveness of the Companys internal controls over
financial reporting. Additionally, it requires the Companys independent
registered public accounting firm to report on managements assessment as well
as report on its own assessment of the effectiveness of the Companys internal
controls over financial reporting. Management is currently establishing
policies and procedures to assess and report on internal controls, and will
retain an outside firm to assist it in determining the effectiveness of the
Companys internal controls over financial reporting. It is anticipated that
the additional cost of such compliance activities in 2005 will be approximately
$75,000. There can be no assurance as to the successful completion of such
assessment and as to the reported results offered by management and the
independent registered public accounting firm. Inability to complete the
assessment and unfavorable reports could have an adverse affect on the Company. 14




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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 securities is described
on pages 12 and 13 under Item 2. Managements Discussion and Analysis or Plan
of Operation. 
 ITEM 6. Exhibits Exhibits Exhibit 31.1- Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 32.1 Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 15




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SIGNATURES In accordance with the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. PINNACLE BANCSHARES, INCDATE: November 15, 2004
    
    BY:
    
    /s/ Robert B. Nolen Jr.Robert B. Nolen, Jr.President and Chief
Executive Officer(Principal Executive Officer and
Principal Financial Officer)/s/ Marie GuthrieMarie Guthrie
Treasurer
(Principal Accounting Officer)
 16