<PAGE>

                ANNUAL REPORT FOR SMALL BUSINESS ISSUERS SUBJECT
                     TO THE 1934 ACT REPORTING REQUIREMENTS

                    U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                              ____________________


                                  FORM 10-KSB


               [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the fiscal year ended December 31, 2000
                                            -----------------
                                       or

             [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

            For the transition period from _________ to ___________

                         Commission File Number 0-28483

                          Pinnacle Data Systems, Inc.
         -------------------------------------------------------------
              (Exact name of small business issuer in its charter)

<TABLE>
<S>                                             <C>
                    Ohio                                      31-1263732
---------------------------------------------    ------------------------------------
(State or other jurisdiction of incorporation    (I.R.S. Employer Identification No.)
               or organization)

      6600 Port Road, Groveport, Ohio                           43125
-----------------------------------------                    ----------
(Address of principal executive offices)                      (Zip Code)
</TABLE>

                Issuer's telephone number:    (614) 748-1150
                                              --------------
<PAGE>

Securities registered under Section 12(b) of the Exchange Act:


            Title of each class               Name of each exchange on which
                                                        registered
     Common Shares, without par value             American Stock Exchange
     --------------------------------             -----------------------


Securities registered under Section 12(g) of the Exchange Act:

                                      None
                                      ----

     Indicate by check mark whether the Issuer (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the Issuer
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

     Yes    X      No
          -----        -----


     Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of Issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.    [ ]

     State Issuer's revenues for its most recent fiscal year.   $25,316,439
                                                                -----------

     The aggregate market value of the voting and non-voting common equity held
by non-affiliates, computed on the basis of the closing sale price on the
American Stock Exchange of the common shares as of March 26, 2001, was
$12,648,248.

     On March 26, 2001, the Issuer had outstanding 5,443,004 common shares
without par value, which is the Issuer's only class of common equity.

                      Documents Incorporated by Reference
                      -----------------------------------

Portions of the Registrant's Definitive Proxy Statement to be filed for its 2001
Annual Meeting of Shareholders are incorporated by reference into Part III of
this Annual Report on Form 10-KSB.
<PAGE>

                               TABLE OF CONTENTS
<TABLE>
<CAPTION>

<S>           <C>                                                             <C>
PART I......................................................................   1
 Item 1.      Description of Business.......................................   1
 Item 2.      Description of Property.......................................  10
 Item 3.      Legal Proceedings.............................................  10
 Item 4.      Submission of Matters to a Vote of Security Holders...........  10
PART II.....................................................................  13
 Item 5.      Market for Common Equity and Related Stockholder Matters......  13
 Item 6.      Management's Discussion and Analysis or Plan of Operation.....  14
 Item 7.      Financial Statements and Supplementary Data...................  21
 Item 8.      Changes in and Disagreements with Accountants on
              Accounting and Financial Disclosure...........................  44
PART III....................................................................  45
 Item 9       Directors, Executive Officers, Promoters and Control Persons;
              Compliance with Section 16(a) of the Exchange Act.............  45
 Item 10.     Executive Compensation........................................  45
 Item 11.     Security Ownership of Certain Beneficial Owners and Management  45
 Item 12.     Certain Relationships and Related Transactions................  45
 Item 13.     Exhibits and Reports on Form 8-K..............................  46
SIGNATURES..................................................................  50

</TABLE>

                                       i
<PAGE>

INFORMATION REGARDING FORWARD-LOOKING STATEMENTS.  Portions of this Annual
Report on Form 10-KSB (including information incorporated by reference) include
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995.  The words "believe", "expect", "anticipate",
"project", and similar expressions, among others, identify "forward-looking
statements", which speak only as of the date the statement was made.  Such
forward-looking statements are subject to risks, uncertainties and other
factors, which could cause actual results to materially differ from those
projected, anticipated or implied.  The most significant of such risks,
uncertainties and other factors are described in Item 6 of this Form 10-KSB. We
undertake no obligation to update or revise any forward-looking statements,
whether as a result of new information, future events, or otherwise.

                                     PART I


Item 1.    Description of Business.

Background

We design, assemble and sell computer products and provide computer repair and
other related services primarily to Original Equipment Manufacturers (OEMs) in
industries such as telecommunications, medical systems, process control, and
enterprise.  During 2000, we reported revenue of approximately $25.3 million,
net income of approximately $1 million, and total assets of approximately $15.5
million.  Approximately 83% of our revenue is generated from product sales and
approximately 17% is generated from services.

Our products are custom designed to meet the needs of our customers.  Often
customers have special computer system requirements that can not be met by off-
the-shelf products alone.  We help customers by engineering, designing,
assembling and modifying computer equipment to meet customers' particular needs.
We take circuit board type products manufactured by Sun Microsystems, Inc., one
of the world's largest producers of computer systems, and combine it with
technology that we engineer and develop, such as customized circuit boards,
enclosures, power supplies and other engineered computer components requested by
customers and assemble them along with other off the shelf computer peripherals
into finished products for customers. Our products are based upon high
performance computer processor technology from Sun Microsystems, Inc. In a
typical system that we manufacture, approximately 50% of the components will be
Sun products, 30% of the components will be off-the-shelf peripheral products
such as power supplies and disk drives, and 20% will be products that we design
and develop. These percentages will vary from product to product and our latest
products are starting to include higher percentages of components and
configurations designed and developed by us. By adding our own internally
developed products and engineering capabilities to Sun's off-the-shelf board
technology, we are able to offer solutions with minimal non-recurring
engineering (product design) charges. These are turnkey, application-specific
computer circuit boards and entire computer systems that our customer imbeds
into the customer's products. See "Products."

                                       1
<PAGE>

We also offer end-of-life management and complete service and support to OEMs.
Many manufacturers will include Sun Microsystems' boards and components in their
own products.  If Sun stops manufacturing that board or component, then the
equipment manufacturer is left without a source to supply it with the parts
needed to build its own products.  Our end of life product management allows our
customers to maximize their investment in technology by providing continued
support for products no longer supported by the manufacturer. This allows OEMs
to eliminate or delay the engineering and software development charges required
to integrate new technology.

We also provide repair services for advanced technology systems, and printed
circuit board assemblies. Our repair services are all depot repair, which means
that the malfunctioning part is sent to us for repair.  We do not provide any
repairs outside of our facilities. Our repair services are focused on UNIX
computer equipment and currently are limited predominantly to equipment
manufactured by Sun Microsystems, Inc.  We are partnering with Sun Microsystems
to provide streamlined distribution of Sun parts to Sun customers using an
online information management system that connects the two companies. Sun is
billed monthly under the Distribution and Service Agreement. We also offer a
repair service whereby we will, overnight, exchange a malfunctioning or broken
electronic component or part for a similar component or part in our inventory.
We will then repair the malfunctioning or broken component and include that part
in our inventory as a replacement.  We also generate revenue from the sale of
spare parts and components.

We believe that the services segment of our business provides a competitive
advantage to us in connection with our product sales, because we can offer the
purchasers of our products a more complete answer to their system needs by
providing not only products, but also service and support after the sale.  We
also believe that the product segment of our business provides us with a
competitive advantage in connection with the services we provide, because
product development and engineering activities keep us current with the latest
technology and how to repair it.  We consider our product and services segments
to be equally important.

Almost all of our products and services are based on Sun's SPARC architecture.
If for any reason Sun or its products began to experience significant
difficulties in the market place or in operations or otherwise it could
materially and adversely affect us.

We believe that our relationship with Sun Microsystems provides a significant
advantage to us.  We have a number of contracts with Sun under which Sun
provides to us proprietary designs for its products or which enable us to
utilize and sell Sun circuit board technology and operating systems or other
software to our customers. Additionally, in 1997, we were accepted into the Sun
Microelectronics' Partners Program.  As a member of this program, our personnel
make marketing calls on Fortune 500 companies, together with sales
representatives of Sun, to provide complete technology solutions to mutual
customers. In March 1999, we entered into a Repair Services Agreement with Sun
Microsystems, Inc. under which we provide repair and testing services on Sun
circuit boards and related components, and maintain an inventory for Sun of
repaired boards and components.  We then provide streamlined distribution of
these components and parts to Sun Enterprise Service Division's stocking
locations, field engineers or customers

                                       2
<PAGE>

using an online information management system that connects the two companies.
See "Contractual Relationships with Sun Microsystems, Inc. and its Affiliates".

We are much smaller in size than Sun Microsystems, Inc.  In its most recently
completed fiscal year, ending June 30, 2000, Sun reported revenue of
approximately $16 billion, over 600 times greater than our current level of
annual revenue. While we are relatively insignificant to Sun, we are
significantly dependent upon our relationship with Sun.  In 2000, approximately
14% of our sales were services sales made to Sun under a services agreement and
approximately 7% of our sales were product sales to Sun made under purchase
orders.  In the same period, approximately 20% of our purchases of inventory
were made from Sun.  Additionally, we have entered into license agreements with
Sun pursuant to which we sell products and services to third parties, which
aggregated to approximately 45% of sales for 2000.  For information about the
various contracts we have with Sun, and the amount of revenue generated under
each agreement. See "Contractual Relationships with Sun Microsystems, Inc. and
its Affiliates".

If all of our relationships with Sun were to end, our operations would be
adversely affected, particularly in the short term.  However, we would continue
to sell products to OEM's, and we would continue to provide repair and other
services to TPM's and end-users.  We would also continue to pursue providing
repair-related services to other OEM's.  We believe that a complete severing of
all of the various Sun relationships is unlikely, because those relationships
are diverse, and independent of one another.

Sun could elect to discontinue buying services from us, but because of the size
and breadth of the services provided, we believe it would take several months
for Sun to implement a replacement vendor or vendors to provide those services.

Development of the Business During Recent Years

Service Developments: During the last four years the focus of our repair
--------------------
services has changed from providing repairs for TPMs to providing repairs for
OEMs.  We have also become a direct part of Sun's repair system through our
partnering under Sun's Virtual Logistics Network (VLN).

In 1996, we began providing depot repair services to OEMs. In early 1997, we
entered into a joint venture as a minority partner of LogistixPDSi Services in
Northern California to provide repair services to the OEM marketplace.  In
connection with this venture, we established a repair depot facility within the
headquarters of the majority partner in Fremont, California. The joint venture
entity was not successful and losses occurred during 1997.

In November 1997, we were offered an opportunity to establish a dedicated repair
depot for Sun Microsystems in California.  We terminated our participation in
the joint venture, hired the joint venture employees and established a facility
within the distribution center of our customer, Sun Microsystems.  In late 1998,
in anticipation of accepting a larger role in Sun's service business model, we
closed the California facility and consolidated our operations in Columbus,
Ohio.

                                       3
<PAGE>

In January 1999, we became a phase one implementation partner with Sun
Microsystems in Sun's Virtual Logistics Network (VLN), which is a real-time
spare/repair parts supply chain management system.  While continuing to provide
repair services to Sun, we began providing inventory management, order
fulfillment, and logistics management services to Sun.  Later in 1999, we
received a meritorious performance supplier award from Sun for our participation
in the VLN.

Product Developments: Prior to 1997 our products consisted of a variety of
--------------------
circuit boards and assemblies that we re-engineered and manufactured to meet a
customer's particular need.  These products were typically imbedded into our
customers' proprietary products.

In 1997 and 1998, we began designing, integrating and manufacturing custom
computer systems for OEMs.  We developed and manufactured products for a
relatively large number of customers.  These products tended to involve varying
levels of components designed and developed by us and wide ranges of
technological development.

In late 1999 and 2000 we strove to focus our efforts on narrower ranges of
products to achieve greater leverage of our technological developments and to
focus on larger systems with higher percentages of components or configurations
that we designed and developed. We made significant additions to our engineering
staff to develop products for the future. During the last year the size of the
orders for computer systems increased.  The number of product customers
generating at least $100,000 declined from 14 in 1999 to 11 in 2000.  However,
whereas the six largest product customers in 1999 generated sales of
approximately $6.3 million, the six largest customers in 2000 generated sales of
$18.2 million.

Organizational Developments: In early 1999, we entered into a 10-year lease for
---------------------------
56,000 square feet of space for our operations in a building located in a
foreign-trade zone in Groveport Ohio, a suburb of Columbus.  In January 2000, we
amended our lease to expand the amount of square feet under lease to
approximately 113,000.  We sold the building in which we previously housed
operations.

In early 2001, we undertook an internal departmental reorganization.  We
realigned our divisions along the service and product business segments.  Our
chief operating officer became the vice president of the service group.  The
vice president of sales and marketing became the vice president of the product
group.  The intent of the reorganization was to increase the focus and
efficiency of the respective groups.

Background of Industry

Original equipment manufacturers in the telecommunications, medical systems,
process control and enterprise markets embed advanced technology systems in
their products to enhance functionality and performance. OEMs select a platform
for their products based on the performance and availability required by the
application. Management believes that OEMs who choose Sun Microsystem's SPARC
platform make this decision based on the speed of Sun Microsystems processor
technology and the stability of the UNIX operating system. Management further
believes that the reliability and speed of Sun processors combined with the

                                       4
<PAGE>

stability of Sun's Solaris operating systems provides excellent performance and
system availability.

To fully integrate these systems into their products, OEMs often have special
requirements that cannot be met by off-the-shelf products manufactured by Sun
Microsystems. Traditionally, these companies modified off-the-shelf components
to meet their specific needs, utilizing either in-house engineering resources or
outside engineering firms to create custom system configurations. In doing so,
these OEMs incurred significant non-recurring engineering (NRE) charges to cover
development costs. As the pace of technology has increased and competition has
intensified in these markets, OEMs are now less willing to incur the time and
expense required to develop custom systems. Instead, they are looking for
sources, such as us, that can provide application-specific systems and products
with minimal engineering development time and expense.  We believe OEMs will
continue to look for ways to reduce product development time and cost without
compromising their ability to customize technology to their application.

At the same time, there is a growing base of OEM products built around
technology that is no longer being supported by the manufacturer. These OEMs are
faced with having to modify software and reconfigure their product to
incorporate new technology that does not enhance their systems' performance
simply because their existing technology is no longer being supported by the
manufacturer. As a result, OEMs are looking for ways to extend the life of their
current technology.  Some of these OEM's contract with entities to provide end
of life management, that may include manufacturing and/or repair of the products
not supported or manufactured by the OEM.

In the repair business there has been a trend during the last several years
towards outsourcing in the electronics repair industry which we believe will
continue in the future.  We believe that this is due to:  (1) the desire of OEMs
to focus resources on their primary business, (2) the accelerated pace of new
product introductions which is necessary for OEMs to keep pace with competition,
(3) the need to reduce costs, which can be accomplished by converting fixed
costs of an internal service department into variable costs by outsourcing the
service, and (4) the difficulties inherent in servicing a wide range of
equipment produced by multiple vendors, as data centers have moved from using
predominantly one company's hardware to using equipment from multiple vendors in
many locations.

Products

Our products include complete systems, specially designed products, including
boards and attach cards, and software. We resell some hardware and software
manufactured by Sun Microsystems and other OEM's, as well as products developed
internally by our engineers. Complete systems bring together hardware and
software from multiple sources into fully integrated systems.

One type of product we develop and manufacture is known as a "High Availability"
system.  This includes redundant system components with sophisticated failover
software.  This allows systems to continue to operate despite failure of any
component by the instantaneous transfer of system functions to the redundant
backup system.  These products have been purchased by

                                       5
<PAGE>

companies primarily in the telecommunications industry that cannot afford a
system failure or even the time delay involved in rebooting a system.

We have also developed products that allow OEMs to more fully integrate SPARC
technology into their technology systems.  These products include power
supplies, specially modified motherboards, transition cards, and I/O boards.

We engage in research and development in connection with designing new products
for customers.  This work is done in response to requests from customers with
specific product requirements.  Upon completion of design and testing of the
newly developed product, we typically receive orders for production of that
product from the customer.  During 2000 and 1999 we incurred $1,127,339 and
$552,143, respectively, for research and development.  These expenses were not
paid by our customers but are typically recouped over time as part of the cost
of the developed products that are sold to customers.

Software

We are a SunSoft Master Distributor and are authorized to provide our customers
with the right to use Solaris, Sun Microsystem's UNIX operating system. We also
resell failover software as part of our "High Availability" systems.

Services

We repair products that have been developed, manufactured, marketed and sold by
other companies, and which generally have a well-established installed base as
well as products developed internally.  We also design and manufacture
customized modifications to products of other companies for integration into
existing systems.  Due in part to the capital costs necessary to maintain
adequate inventory and equipment to service large OEMs and TPMs, we have focused
our services on products manufactured primarily by Sun Microsystems, Inc. and
have built an inventory of Sun Microsystems components and parts.

Depot Repair Services: We provide OEMs, TPMs and end-users who maintain their
---------------------
own equipment the opportunity to outsource repairs of their proprietary products
or products produced by third parties.  The entity that is actually providing
the maintenance service in the field will place an order with us for the repair
of defective components or parts.  The time of completion of the repair will be
scheduled, with higher charges for shorter time frame repairs.  We offer our
customers a choice of 5-day and 15-day repair and return services.  We also
maintain an extensive inventory of spare components and offer the ability to
provide replacement components or parts overnight from our existing inventory in
exchange for the defective component or part, which is then repaired and
included in inventory.  For repairs not requiring overnight service, the entity
maintaining the equipment in the field sends the defective component or part to
us.  Our electronic technicians then repair the component or part, test it, and
ship it back to the customer.  Since inception, we have specialized in the
repair of hardware manufactured by Sun Microsystems, Inc.  These systems are
typically high-end workstations able to perform multi-tasking functions.

                                       6
<PAGE>

Sun Microsystems Logistics Management Services: In August 1999, we entered into
----------------------------------------------
an agreement with Sun Microsystems, Inc. to provide to Sun's Enterprise Services
Division test and repair services, and inventory and logistics management
services.  Under this program, called the Virtual Logistics Network (VLN), we
are partnering with Sun Microsystems to provide streamlined distribution of Sun
components and parts to Sun customers using an online information management
system that connects the two companies. We also provide management and logistics
services to other vendors/partners of Sun that participate in the VLN.

Spare Parts Sales: Spare parts sales include sales of repaired parts, new parts,
-----------------
and reclaimed parts.  There is a demand in the computer industry for the
necessary parts and components to provide repair services.  New components are
often difficult to obtain and costly to purchase.  We are able to provide a wide
variety of parts at a significant discount compared to the cost of comparable
new parts.  Our spare parts capabilities enhance the efficiency of our other
service offerings.  We either supply the spare parts from our own inventory when
we have a surplus of a particular part or component, or we acquire the requested
parts from brokers or other suppliers of used equipment.  We sometimes dismantle
used equipment to obtain used components.  We maintain an inventory consisting
primarily of Sun Microsystems' spare parts and components.

Contract Manufacturing and Engineering: In certain cases, an OEM will outsource
--------------------------------------
the design and manufacture of a product to us.  The outsourcing of manufacturing
enables the OEM to transfer its internal manufacturing responsibilities to us,
thereby enabling the OEM to reduce manufacturing costs and improve its return on
assets.  Our contract manufacturing services primarily involve products which
have high engineering, technical and test content, and low to medium production
requirements.  We will also merge technology from a standard workstation to a
customer's product with private labeling.  In connection with these services, we
will obtain orders for custom engineering and manufacturing services from
entities which are customers of Sun Microsystems.  These customers are using the
Sun operating system software and want to continue to use the sun software in
workstations, data servers or other applications not manufactured and sold by
Sun.  We will design and engineer modifications to the Sun component boards to
fit the desired customized use and will then build the custom designed products
for the customer.  The end product is a component board or computer system that
does not resemble the original Sun Microsystems board or system, but operates
the Sun software and performs the same functions as the Sun board or system.
Each product is unique and custom designed to the customer's specifications.
Some of these products use commercially available parts configured to produce
the desired function.  In other cases, the custom-built product contains
components or functions conceived and developed by our personnel.

End of Life Management: End of Life Management services bring together our board
----------------------
design and manufacturing, parts stocking, and repair capabilities to extend the
life of technology that is no longer supported by the manufacturer. We will
enter into an end of life service contract with our customers, which may include
depot repair of installed technology as well as acquisition or manufacture of
products that have been end-of-lifed (discontinued) by the manufacturer.

Extended Warranty Services.  In 1992, we began initial marketing efforts to
--------------------------
provide customers with extended warranty support services.  Generally, we will
extend warranty of the OEM's product for a fixed fee.  We are willing to develop
warranty programs specifically tailored to

                                       7
<PAGE>

meet a customer's needs with the goal of fulfilling as many of the customer's
repair needs as is required.

Contractual Relationships with Sun Microsystems, Inc. and its Affiliates

In August 1999, we entered into an agreement with Sun Microsystems, Inc. to
provide to Sun's Enterprise Services Division test and repair services, and
inventory and logistics management services.  The agreement has a one-year term
and renews automatically for additional one-year terms.  In 2000, we generated
approximately $3.4 million of revenue from this agreement, or approximately 14%
of total revenue and 81% of service revenue.  We consider this agreement to be
of critical importance to our future viability, and consider it to be the basis
of our prospects for future growth of the service segment.  See "Services - Sun
Microsystems Logistics Management Services".

We design and sell products under various technology license agreements with Sun
Microsystems.  Two of the license agreements are of material importance to our
viability.  It is not possible to cite the respective operating earnings
contributions of the products sold under the two license agreements, as we do
not allocate labor and overhead costs to individual products.  Consequently, the
respective revenue contributions are cited below. If either of these agreements
is terminated it would significantly impede our ability to perform our design
and manufacturing services.

In October 1997, we entered into a Development and Manufacturing License
Agreement with Sun Microelectronics, a division of Sun Microsystems, Inc.
pursuant to which we have been licensed to develop, manufacture and sell
products based upon and using the Sun PCI card and Open Boot PROM technology.
We use this license in the custom design of products. The license enables us to
use the Sun technology and make engineering or design changes to meet customers'
specific needs. We generated revenue from these products of approximately
$792,000 in 1999 and $7.1 million in 2000 (approximately 9% and 34% of total
product revenue, respectively).  We expect the portion of our products based on
this license to increase in future years.  Consequently, the importance of this
license to us is likely to increase in future years.  This license agreement was
for a term of three years expiring in October 2000, but was automatically
extended by its terms an additional year to October 2001.  The license is
subject to automatic renewals for one-year periods unless either party gives
notice of non-renewal. The license can be terminated earlier upon default.

In May 1994, we entered into a microprocessor platform design license agreement
with Sun Microsystems Computer Corporation, acting through its SPARC Technology
Business Division, pursuant to which we have been licensed to develop,
manufacture and sell products based upon and using the Sun SPARC microprocessor
technology. We use this license in the custom design of products.  The license
enables us to use Sun technology and make engineering or design changes to meet
customers' specific needs. We generated revenue from these products of
approximately $1.7 million in 1999 and $2.4 million in 2000 (approximately 19%
and 12% of total product revenue, respectively).  The technology of this license
is utilized in customer projects that began prior to 1997.  It has not been
utilized in any new customer projects since before 1997. We do not anticipate
that we will develop any new products based on the

                                       8
<PAGE>

technology licensed under this agreement, although we will continue to sell
products that we have developed under this license. Consequently, the importance
of this license to us is likely to decline in future years. A license fee in the
amount of $35,000 was paid in full upon execution of the license. This license
agreement is for a term of 7 years expiring in 2001, subject to automatic
renewal for one-year periods unless either party gives notice of non-renewal.
The license can be terminated earlier upon default.

Sales and Marketing

We focus our marketing efforts on large OEMs and on TPMs.  We have not
traditionally maintained a field sales organization, and have recently utilized
independent manufacturers' representative firms to generate sales opportunities.
We are currently reducing our dependence on manufacturing representatives and
are developing a direct field sales force.  During 2000, we had revenue from
three customers that represented approximately 63% of sales.  Our largest
customer in 2000, Bayer Diagnostics, accounted for approximately 28% of sales
during 2000.  During 1999, we had revenue from three customers that represented
approximately 56% of sales. Our largest customer in 1999, Sun Microsystems,
accounted for approximately 29% of our sales.

Competition

Competition for our specially designed products come from two primary sources:
(1) other companies that provide similar products, and (2) products that are
competitive with Sun Microsystems' products.

A number of companies are now targeting the telecommunications industry, due to
the continued growth in this market that is expected in the future.  Many of
these companies are more established than us and have substantially greater
financial and other resources than we do.  We believe we can differentiate
ourselves from the competition through the strength of our close relationship
with Sun Microsystems, our ability to offer a complete turnkey product/service
solution, our unique product set, and our focus on providing off-the-shelf
solutions wherever possible.

Primary competitive factors in the repair industry are price, scope and quality
of a company's repair services and know-how.  We compete with the in-house
repair centers of OEMs and TPMs for end-of-life programs and for repair
services.  While we believe we offer a cost-effective repair solution to OEMs
and TPMs and, therefore, believe these entities are our primary potential
customers, there is no assurance that these entities will choose to outsource
their repair needs and will not become our competitors.  These entities could
also choose to compete directly with us for the services of unrelated OEMs and
TPMs and for end-users.  In addition to competing with OEMs and TPMs, we also
compete with a number of independent organizations similar to us.

In the contract manufacturing area, we compete against numerous entities that
focus specifically on turnkey contract manufacturing.  Many of the OEMs, TPMs
and contract manufacturers with which we compete have significantly greater
manufacturing, financial, technical and marketing resources than we do.
Similarly, some of the independent depot repair businesses may generate

                                       9
<PAGE>

significantly more revenues than us and may have greater manufacturing,
financial, technical and marketing resources than we do.


Employees

As of March 26, 2001, we had a total of 103 employees, 99 of whom were full-
time.  None of our employees are subject to collective bargaining agreements,
and we consider our relationship with our employees to be good.

Item 2.           Description of Property

We lease approximately 113,000 square feet of office, warehouse, laboratory and
production space in a building located at 6600 Port Road, Groveport, Ohio.  We
entered into a ten-year lease commencing May 1, 1999.  We have the option to
extend the term of the lease for an additional five years.  The building is in
good condition.  We believe that this space is adequate for the foreseeable
future.  We believe that there is additional space for lease in this building,
if we need additional space.  See Item 6, Management Discussion and Analysis.

In May 1999, we sold a 19,200 square foot building in which we formerly
conducted our operations.  The sale resulted in a gain of $85,922.


Item 3.           Legal Proceedings    .

We are not currently a party to any legal proceedings.

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

No matters were submitted to a vote of shareholders during the fourth quarter of
2000.

                 Executive Officers and Significant Employees of the Registrant.

Set forth below is information about the executive officers and other
significant employees:


<TABLE>
<CAPTION>
         Name                  Age                         Position
-----------------------    ------------  ---------------------------------------------
<S>                        <C>           <C>
John D. Bair                   35        Chairman of the Board, President, and Chief
                                         Executive Officer

C. Robert Hahn                 48        Vice President, Service Group

Christopher L. Winslow         39        Vice President, Product Group

Thomas J. Carr                 47        Treasurer, Chief Financial Officer

Laura A. Palko                 39        Director of Human Resources

Joy S. Bair                    30        Secretary
</TABLE>

                                       10
<PAGE>

John D. Bair, one of our founders, currently serves as chief executive officer
and president.  He has served as a director since inception, as the chairman of
the board and chief executive officer since May 1996, and as president since
1998.  He served as secretary from inception until October 1998.  Mr. Bair holds
a Bachelor of Science Degree in Computer and Information Science from the
College of Engineering at The Ohio State University.  Mr. Bair is the spouse of
Joy Bair.

C. Robert Hahn is an executive officer and has served as vice president, product
group since March 2001.  He previously served as chief operating officer and
vice president from June 1998 until March 2001.  He served as president of the
company from June 1996 to June 1998, and as vice president of sales and
marketing from October 1994 to June 1996.  He has served as a director since
December 1995.  Mr. Hahn previously worked for six years as general manager of
Cranel, Inc., a distributor of computer peripheral products.  Mr. Hahn holds a
Bachelor Degree in Business Administration and a Master of Business
Administration degree, both from Ohio University, and has been certified as a
Certified Production and Inventory Manager by the American Production and
Inventory Control Society.

Christopher L. Winslow is an executive officer and has served as vice president,
product group since March 2001. He previously served as as vice president of
marketing after joining us in September 2000.  Prior to joining us, Mr. Winslow
was executive vice president of Metatec International, a software manufacturing
and logistics company. Previously, Mr. Winslow led the broadband
telecommunications product group for CompuServe Network Services, now an
MCI/Worldcom company. He earned a BA in Business Administration from The Ohio
State University.

Thomas J. Carr is an executive officer and has served as treasurer and chief
financial officer since May 1996. He joined us as controller in September 1995.
He served as a director from May 1996 until December 2000. Previously, Mr. Carr
was president for three years of Celtic Resources, a business consulting firm.
Mr. Carr taught general computer courses at Columbus State Community College for
two years.  He served as controller and director of financial planning for six
years at CompuServe Incorporated of Columbus, Ohio.  Mr. Carr holds a Bachelor
Degree in Accounting and a Master of Business Administration degree, both from
The Ohio State University.

Laura A. Palko joined us in September 2000 as director of human resources.
Prior to joining us, Ms. Palko was quality systems/human resource Manager for
Lake Shore Cryotronics, Inc., a design and manufacturing company focused on
temperature and magnetic measurement and control.  Previously, Ms. Palko served
in a variety of management positions over seven years with AT&T Network Systems,
now known as Lucent Technologies.  Ms. Palko holds a Bachelor

                                       11
<PAGE>

Degree in Journalism and a Master of Labor and Human Resources, both from The
Ohio State University.

Joy S. Bair has served as Secretary since October 1998.  From October 1997 until
October 1998 she served as assistant secretary.  Ms. Bair was previously
employed by us from June 1990 until April 1993, serving in several positions
including accounting manager.  Ms. Bair holds a Bachelor of Science Degree in
Actuarial Science and a Master of Education Degree in Mathematics, both from The
Ohio State University.  Ms. Bair is the spouse of John Bair.

                                       12
<PAGE>

                                    PART II

Item 5.           Market for Common Equity and Related Stockholder Matters.


(a)  Market Information. Since September 7, 2000, our common stock has traded on
     ------------------
     the American Stock Exchange under the stock symbol "PNS."  Set forth below
     is the range of high and low sales prices of the common shares on the
     American Stock Exchange during the last two fiscal quarters of 2000,
     beginning on September 7, 2000.


<TABLE>
<CAPTION>
                                                                        Range of Sales Prices
                                                                        ---------------------
                                                                        High            Low
                                                                    -------------  -------------
<S>                                                                 <C>            <C>
Fiscal Year 2000
     Third quarter (from September 7 to September 30)..............         $6.19          $4.13
     Fourth quarter (ended December 31)............................          7.38           3.00
</TABLE>

From April 1996 until September 6, 2000, our common stock traded on the OTC
Bulletin Board under the stock symbol "PNDS."  Set forth below is the range of
high and low bid prices for our common stock during the four quarters of 1999
and the first three quarters of 2000 through September 6, 2000.

<TABLE>
<CAPTION>
                                                                            Bid Prices
                                                                            ----------
                                                                        High            Low
                                                                    -------------  -------------
<S>                                                                 <C>            <C>
Fiscal Year 2000
     First quarter (ended March 31)................................         $3.75          $0.81
     Second quarter (ended June 30)................................          3.84           1.86
     Third quarter (through September 6)...........................          6.13           3.00
Fiscal Year 1999
     First quarter (ended April 1).................................         $1.31          $0.63
     Second quarter (ended July 2).................................          1.34           0.69
     Third quarter (ended October 1)...............................          1.31           0.75
     Fourth quarter (ended December 31)............................          1.22           0.72
</TABLE>

The foregoing bid prices were obtained from the National Quotation Bureau Pink
Sheets and reflect inter-dealer prices without retail mark-up, mark-down or
commission and may not represent actual transactions.

(b)  Holders.  On March 26, 2001, there were 86 holders of record of the Shares.
     -------
     Most of the Shares not held by officers and directors are held in street
     name.

(c)  Dividends.  During the past five years, we have not paid cash dividends.
     ---------
     Payments of dividends are within the discretion of our board of directors.
     In addition, under the

                                       13
<PAGE>

     terms of a loan agreement with a bank, we are prohibited from declaring or
     paying dividends to common shareholders and from redeeming stock from
     shareholders.



Item 6.           Management's Discussion and Analysis or Plan of Operation

The following discussion should be read in conjunction with the Financial
Statements and Notes contained herein.

The following sections contain forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve risks and uncertainties, and the cautionary statements set
forth below identify important factors that could cause actual results over the
next few quarters to differ materially from those predicted in any such forward-
looking statements.  Such factors include, but are not limited to, adverse
changes in general economic conditions, including adverse changes in the
specific markets for our products and services, adverse business conditions,
decreased or lack of growth in the computing industry, adverse changes in
customer order patterns, including any decline or change in product orders from
any of the three customers that made up approximately 63% of our revenue during
2000, increased competition, any adverse change in Sun Microsystems' business or
our relationship with Sun, around whose computing platforms our business is
based, lack of acceptance of new products, pricing pressures, lack of adequate
financing to take advantage of business opportunities that may arise, lack of
success in technological advancements, risks associated with our new business
practices, processes and information systems, and other factors.

Results of Operations

Year ended December 31, 2000 compared to year ended December 31, 1999

SALES

Sales were $25,316,439 in 2000, an increase of 107% over sales of $12,202,701 in
1999.

Product sales were $21,047,803 for 2000, an increase of 132% over 1999. The
increase in product sales was primarily attributable to a shift in our customer
base from smaller to larger customers, most of which began generating revenue in
late 1999 and early 2000. The number of product customers generating at least
$100,000 declined from 14 in 1999 to 11 in 2000.  However, the six largest
product customers in 1999 generated sales of approximately $6.3 million, whereas
the six largest customers in 2000 generated sales of $18.2 million.  We will
continue to add to our customer base as we pursue the strategy of acquiring
larger customers with larger projects, which could result in greater short-term
volatility in product revenue and profit.

Service sales for 2000 were $4,268,636, which was 36% higher than in 1999. We
provide repairs and logistics management services for a specific list of
electronic computer circuit boards and other computer components for one large
and several smaller Original Equipment Manufacturer

                                       14
<PAGE>

(OEM) customers. During the first quarter of 2000, we began providing additional
logistics and material management services to our largest customer, resulting in
higher revenue. We also provide engineering design services to OEMs.

Our relative levels of growth of product and service sales continued a multi-
year trend of an evolution in the mix of the two types of sales.  Product sales,
as a percentage of total sales have grown from 56% in 1996, to 65% in 1997, to
69% in 1998, to 74% in 1999, to 83% in 2000.  Service sales, as a percentage of
total sales, have gone from 44%, to 35%, to 31%, to 26%, to 17% over the same
years.

GROSS PROFIT

Our gross profit increased from $3,121,049 in 1999 to $6,387,998 in 2000, an
increase of 105%. Overall, we have experienced some economies of scale in 2000.
Direct labor declined from 6.7% of sales to 6.1%.  Overhead declined from 8.9%
to 5.6%, despite a significant increase in facility costs associated with
doubling the size of our facility.

The gross margin on product sales increased to 22% for 2000, compared to 20% in
1999.  The improvement was attributable entirely to declines in labor and
overhead as a percentage of sales.  Material costs as a percentage of sales
increased 1.2% in 2000.  The primary reason for the relative increase in
material costs was the fact that a few large product projects were in the
research and development stage during 2000, which usually involves component
changes, resulting in some scrap and higher material usage than typically is
found in the production stage.  Material costs of product sales are
overwhelmingly our largest cost item.  Consequently, changes in those costs have
the largest potential to impact our profitability.

The gross margin on our service sales was 42% in 2000, as it was in 1999.  The
continued shift from TPM to OEM service resulted in a reduction in the cost of
materials from 18% to 9%.  The decline in material costs as a percentage of
service revenue was offset by an increase in the cost of labor from 21% of
revenue to 29% of revenue, due to the addition in 2000 of inventory and
logistics management services, which are less material intensive and more labor-
intensive.

Our overall gross margin declined slightly from 25.6% in 1999 to 25.2% in 2000.


OPERATING EXPENSES

Operating expenses totaled $4,529,329 for 2000, compared with $2,555,657 for
1999.  The 77% increase from 1999 to 2000 was less than the 107% rate of growth
of sales or the 105% rate of growth of gross profit. The majority of the
increase came from higher wages from an expanded engineering and technical
staff; approximately 20% of which were employed to support current revenue and
approximately 80% of which were employed to prepare for anticipated future
growth.  The other major expense categories contributing to the increase were
facility costs, relating to our relocation to a larger building in 1999 and then
doubling our total leased space in early 2000; higher outside sales commissions;
and higher professional fees, relating to becoming a fully SEC-reporting company
and becoming listed on the American Stock Exchange.

                                       15
<PAGE>

As a percentage of sales, operating expenses decreased from 21% in 1999 to 18%
in 2000.  Income from operations increased 229% to $1,858,669 (7% of sales) for
2000, from $565,392 (5% of sales) in 1999.


OTHER INCOME AND EXPENSE

In anticipation of higher sales volumes and higher accounts receivable and
inventory levels, we entered into a new financing package with Key Bank in March
2000.  The arrangement included an installment loan of $400,000 and a revolving
line of credit. The two new loans were used to liquidate loans we had with our
previous bank. At December 31, 2000 the balance of the line of credit was
$4,803,309. Primarily as a result of our increased use of our line of credit to
support higher accounts receivable and inventory, interest expense in 2000 grew
148%, from $92,473 in 1999 to $229,177 in 2000.

In May 1999, we sold the building in which we previously conducted operations.
The building sale resulted in a gain before taxes of $85,922.  In 2000 we
experienced a loss of $11,802 on the disposal of office furniture and computer
equipment.  Combined with interest expense, the net other expense for 2000 was
$240,979 compared to $6,551 in 1999, a difference of $234,428.

INCOME TAXES AND NET INCOME

The improved income from operations exceeded the increase in net other expense,
and resulted in income before income taxes of $1,617,690 for 2000 (6% of sales),
compared to $558,841 for 1999 (5% of sales), and increase of 189%.
Consequently, income tax expense increased, from $207,675 in 1999 to $604,000 in
2000.  Net income was $1,013,690 (4% of sales) in 2000, compared to $351,166 (3%
of sales) in 1999, an increase of 189%.  Without the building sale in 1999, net
income would have been 2% of sales.

Our basic earnings per share improved from $0.07 for 1999, to $0.20 for 2000.
Fully diluted earnings per share improved from $0.07 for 1999, to $0.18 for
2000.  Without the building sale, earnings per share in 1999 would have been
$0.06.


Year ended December 31, 1999 compared to year ended December 31, 1998

SALES

Sales were $12,202,701 in 1999, an increase of 35% over sales of $9,032,332 in
1998.

Product sales were $9,036,646 for 1999, an increase of 47% over 1998. The 47%
increase in product sales was fully attributable to new customers obtained in
1999.  The number of product customers that generated at least $100,000 in sales
increased from 7 in 1998 to 14 in 1999.

                                       16
<PAGE>

Service sales for 1999 were $3,044,099, which was 12% higher than in 1998.  The
increase in service sales resulted primarily from higher volumes of repairs from
our largest OEM customer.  We provide repairs and logistics management services
for a specific list of electronic computer circuit boards and other computer
components for one large and several smaller OEM customers.  The volumes of
those listed components grew in 1999, more components were added to the list,
and we provided services for additional customers.

GROSS PROFIT

Total gross margin was 26% in 1999, up from 20% in 1998.

The gross margin on product sales was 20% in 1999, compared to 18% in 1998.  The
improvement was primarily attributable to declines in component costs.

The gross margin on service sales increased to 44% in 1999, from 29% in 1998.
The predominant factor in the difference in margins on service sales resulted
from an inventory writedown of $300,000 we took in the 3rd quarter of 1998.
Without the writedown, the gross margin on service sales in 1998 would have been
40%.  A major factor in the gross margin improving to 44% in 1999 was a
significant reduction in labor and overhead costs, resulting from our decision
to close our depot repair facility in California.  That facility was opened at
the request of our largest service customer in the first quarter of 1998.  When
that customer elected in late 1998 to implement its new vendor model that did
not require a West Coast depot, we closed the California facility, thereby
reducing labor and overhead costs.

OPERATING EXPENSES

Operating expenses totaled $2,555,657 for 1999, compared with $1,751,213 for
1998.  The 46% increase from 1998 to 1999 exceeded the rate of growth of sales,
but was less than the rate of growth of gross profit.  The increase came
primarily from higher wages from an expanded professional technical staff,
higher depreciation resulting from fixed asset purchases, facility costs
resulting from our relocation to a larger facility, and higher professional
fees, which included one-time recruiting fees relating to professional technical
staff hiring.  As a percentage of sales, operating expenses increased from 19%
in 1998 to 21% in 1999.

Income from operations improved to $565,392 (5% of sales) in 1999, from $88,885
(1% of sales) in 1998.

OTHER INCOME AND EXPENSE

In May 1999, we sold our building in which we conducted operations, and
relocated to a larger facility, which we lease.  The sale of the building
resulted in a gain before taxes of $85,922.

In anticipation of higher sales volumes, we entered into a new financing package
with Star (now Firstar) Bank in the first quarter of 1998.  The package included
an installment loan of $300,000 and a revolving line of credit. The two new
loans were used to liquidate loans we had with our previous bank, which included
a mortgage loan on our building. At December 31, 1999 the

                                       17
<PAGE>

balance of the line of credit was $1,300,000. Primarily as a result of our
increased use of its line of credit, interest expense in 1999 grew 11% from
1998.

INCOME TAXES AND NET INCOME

The improved income from operations, combined with the one-time gain on the sale
of our building, resulted in income before income taxes of $558,841 for 1999,
compared to $5,333 for 1998.  Income tax expense increased from $4,745 in 1998
to $207,675, or 37% of income before income taxes in 1999.  Net income was
$351,166 in 1999, compared to $588 for 1998.

Our basic and fully diluted earnings per share improved from less than one cent
per share in 1998, to $0.07 for 1999.


LIQUIDITY AND CAPITAL RESOURCES

During 2000, we used $3,394,806 of cash in our operating activities, compared to
a use of cash of $806,970 in 1999.  The largest use of cash was an increase of
$6,010,467 in inventory.  Several factors contributed to the substantial
increase in inventory.  During the fourth quarter of 2000 we used our expanded
line of credit to acquire several long-lead-time components that we use in our
customer products, in order to improve our ability to make customer shipments on
time.  Some large customer projects were delayed beyond the end of 2000 because
of one or more components being backordered from a supplier, after we acquired
the majority of the components for those projects.  These delays resulted in
approximately $3 million of additional inventory being on hand at December 31,
2000.  Those projects are expected to be completed and the inventory liquidated
late in the first quarter and early in the second quarter of 2001.  The amount
of this customer backlog is at a historical high.

We also made a substantial one-time buy of components during the last week of
2000 in order to avoid significant price increases in those components.  The
total one-time buy was approximately $1.7 million.  Those components are
expected to be consumed in customer product projects over the first two quarters
of 2001.

Without the $4.7 million of inventory cited above, the December 31, 2000
inventory total, when compared to anticipated sales in the following quarter,
would have been comparable to our historical inventory levels. We expect to
maintain a substantial investment in inventory for the foreseeable future in
order to support our product sales.

Another use of cash was the increase in accounts receivable of $2,901,819. The
increases in inventory and accounts receivable were partially mitigated by
increases in our liabilities during 2000, particularly accounts payable, which
increased by $3,651,854, and accrued expenses and taxes, which increased by
$194,298.  Expanded credit from our vendors was crucial to our ability to
increase our purchases of inventory components to support our increased product
sales.

We used $630,772 of cash in our investing activities in 2000, compared to
$296,678 in 1999.  Most of the investments were for furniture and computer
equipment for new employees.  We

                                       18
<PAGE>

also invested in leasehold improvements in our new facility. In 1999 our
investment of $444,293 in fixed assets was offset by proceeds of $147,615 from
the sale of our building.

In March 2000, we entered into a new loan agreement with Key Bank in order to
increase our borrowing capacity and to reduce our interest rates.  The initial
package with Key included a revolving line of credit and a $400,000 term loan
requiring 36 monthly principal and interest payments of $12,627.  Both
instruments had an interest rate of prime minus 0.25%.  The line of credit
initially had a limit of the lower of $2,500,000, or a percentage of our
eligible accounts receivables and inventory.  In August 2000, the limit of the
line of credit was increased to $7,000,000 and the interest rate was reduced to
prime minus 0.85%.  The loan agreement also includes a $250,000 lease line of
credit for purchases of equipment and furnishings. The loan agreement requires
us to meet certain financial targets and to comply with certain other covenants,
including restrictions on paying dividends, incurring additional indebtedness
and liens, guarantees of other obligations, and reorganizations.  Our
obligations under the loan agreement are collateralized by substantially all of
our assets.

The initial draw on the line of credit was approximately $1,475,000.  Combined
with the $400,000 term loan, the proceeds were used to retire a term loan and
line of credit at Firstar Bank.  The payoffs of those loans were approximately
$175,000 and $1,700,000, respectively.  At December 31, 2000, the line of credit
balance was $4,803,309.  The balance on the term loan was $300,000.  We have not
yet made any draws against the lease line of credit.

In 2000, our overall financing activities provided cash of $4,026,155 compared
to $1,103,843, in 1999.  Long-term debt increased by a net of $110,047 and the
line of credit increased by $3,503,309.  We also received $412,799 from the
exercise of stock options and warrants.  As a result of the stock option and
warrant exercises and net income earned during 2000, total stockholders equity
has increased from $2.4 million to $4.1 million.

During 1999, we consumed $806,970 of cash in its operating activities.  The
foremost use of cash in 1999 was inventory, which increased by $1,392,474 from
the beginning of 1999.  Much of the increase in inventory was attributable to
anticipated future sales growth.  Another minor factor in the increase in
inventory was an increased number of requests from product customers for
delivery of prototype/evaluation systems.  Another factor was the request of
some product customers that we hold in stock a quantity of their specific-
designed systems on hand for immediate delivery.  In these cases, the customer
is committed to purchase these products within a specified period of time under
a volume purchase agreement.  We also made some one-time component purchases, in
some cases to take advantage of price discounts, and in other cases to secure
the availability of components that were no longer going to be manufactured.

Other asset categories that increased in 1999, thereby using cash, were accounts
receivable and prepaid expenses, which increased by $1,001,407 and $38,134,
respectively.  These uses of cash were partially offset by increases in accounts
payable of $724,274, in accrued liabilities and taxes of $331,791, and in
unearned revenues of $16,123.

                                       19
<PAGE>

Our investing activities in 1999 consumed $296,678 in cash.  Purchases of
furniture and computer equipment consumed $444,293 of cash, but were offset by
the sale of our land and building, which generated $147,615.

For 1999, principal payments on our long-term debt and capital lease totaled
$89,657.  Those payments were partially offset by proceeds of $43,500 from the
exercise of employee incentive stock options.  However, our principle means of
funding our operations in 1999 were draws on our bank line of credit, which
totaled $1,150,000.  At December 31, 1999, the balance was $1,300,000.

As we continue to grow, we will need to obtain additional working capital, to
support higher levels of accounts receivable and inventory and we will need to
fund additional investments in capital equipment.  The amount of additional
capital we will need will depend, in part, on the relative growth of our product
and service segments.

We believe that if we continue with steady growth of both business segments, the
new bank loan agreement will be sufficient to meet our immediate financing
needs.  However, we believe that we would need to raise additional debt and/or
equity capital in order to fund larger product sales opportunities that may
arise.  We are currently investigating several alternatives. Those alternatives
include a higher line of credit and specific bank financing for customer sales
projects, and for fixed asset acquisitions.  We are also pursuing expanded
credit terms from some suppliers for specific projects.  For the longer term we
will consider additional debt or equity financing.

                                       20
<PAGE>

Item 7.            Financial Statements.

                                       21
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                                FINANCIAL REPORT

                           DECEMBER 31, 2000 AND 1999


                                       22
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                               TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                                   Page
                                                   ----
<S>                                               <C>
INDEPENDENT AUDITORS' REPORT                         24

FINANCIAL STATEMENTS
  Balance Sheets                                  25-26
  Statements of Income                               27
  Statements of Changes in Stockholders' Equity      28
  Statement of Cash Flows                         29-30
  Notes to Financial Statements                   31-43

</TABLE>

                                       23
<PAGE>

To the Board of Directors and Stockholders
Pinnacle Data Systems, Inc. (dba PDSi)
Columbus, Ohio

                          Independent Auditors' Report
                          ----------------------------

          We have audited the accompanying balance sheets of Pinnacle Data
Systems, Inc. (dba PDSi) as of December 31, 2000 and 1999, and the related
statements of income, changes in stockholders' equity and cash flows for the
years then ended.  These financial statements are the responsibility of the
Company's management.  Our responsibility is to express an opinion on these
financial statements based on our audits.

          We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

          In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Pinnacle Data
Systems, Inc. (dba PDSi) as of December 31, 2000 and 1999, and the results of
its operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.


/s/ Hausser + Taylor LLP



Columbus, Ohio
February 28, 2001

                                       24
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                  (DBA PDSi)

                                BALANCE SHEETS


                          December 31, 2000 and 1999
                          --------------------------

<TABLE>
<CAPTION>


                               ASSETS                                 2000                 1999
                               ------                                 ----                 ----

<S>                                                               <C>                   <C>
CURRENT ASSETS
  Cash                                                             $      35,873        $     35,296
  Accounts receivable, net of allowance for doubtful
   accounts of $8,000 and $10,000, respectively                        5,373,900           2,470,081
  Inventory (Note 1)                                                   8,517,925           2,677,281
  Other prepaid expenses                                                 134,471             135,039
  Deferred income taxes (Note 8)                                         247,000             132,000
                                                                   -------------        ------------
                                                                      14,309,169           5,449,697
                                                                   -------------        ------------
PROPERTY AND EQUIPMENT (Note 1)
  Leasehold improvements                                                 189,389              59,481
  Furniture and fixtures                                                 286,290             221,303
  Computer equipment and related software                              1,241,864           1,069,388
  Shop equipment                                                         305,809             283,125
  Vehicle                                                                 21,846              21,846
                                                                   -------------        ------------
                                                                       2,045,198           1,655,143
  Less accumulated depreciation and amortization                         871,368             798,925
                                                                   -------------        ------------
                                                                       1,173,830             856,218
                                                                   -------------        ------------
OTHER ASSETS
  Deposits                                                                18,112              18,112
                                                                   -------------        ------------
                                                                          18,112              18,112
                                                                   -------------        ------------
                                                                   $  15,501,111        $  6,324,027
                                                                   =============        ============

</TABLE>



  The accompanying notes are an integral part of these financial statements.

                                       25
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                  (DBA PDSi)

                                BALANCE SHEETS

                          December 31, 2000 and 1999
                          --------------------------


<TABLE>
<CAPTION>




                LIABILITIES AND STOCKHOLDERS' EQUITY                       2000            1999
                ------------------------------------                    -----------      ----------
<S>                                                                     <C>              <C>
CURRENT LIABILITIES
  Line of credit (Note 2)                                               $ 4,803,309      $1,300,000
  Current portion of long-term debt (Note 3)                                138,459          64,521
  Accounts payable                                                        5,431,070       1,779,216
  Accrued expenses:
    Wages and payroll taxes                                                 322,284         204,420
    Vacation                                                                 93,650          61,733
    Profit sharing plan (Note 7)                                             76,098          48,625
    Income taxes                                                            168,634         190,221
    Other                                                                    93,923          55,292
  Unearned service revenue                                                   42,340          61,253
                                                                        -----------      ----------
                                                                         11,169,767       3,765,281
                                                                        -----------      ----------
LONG-TERM LIABILITIES
  Long-term debt, less current portion (Note 3)                             166,667         130,558
  Deferred income taxes (Note 8)                                             41,000          14,000
                                                                        -----------      ----------
                                                                            207,667         144,558
                                                                        -----------      ----------
                                                                         11,377,434       3,909,839
                                                                        -----------      ----------
STOCKHOLDERS' EQUITY (Notes 4 and 5)
  Preferred stock; no par value; 4,000,000 shares authorized;
   no shares issued or outstanding                                                -               -
  Common stock; no par value; 10,000,000 shares authorized;
   5,394,504 and 4,874,804 shares issued
   and outstanding, respectively                                          2,028,437       1,615,638
  Additional paid-in capital                                                497,506         214,506
  Retained earnings                                                       1,597,734         584,044
                                                                        -----------      ----------
                                                                          4,123,677       2,414,188
                                                                        -----------      ----------
                                                                        $15,501,111      $6,324,027
                                                                        ===========      ==========
</TABLE>

  The accompanying notes are an integral part of these financial statements.

                                       26
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                  (DBA PDSi)


                             STATEMENTS OF INCOME

                    Years Ended December 31, 2000 and 1999
                    --------------------------------------

<TABLE>
<CAPTION>



                                                                  2000              1999
                                                               -----------       -----------
<S>                                                            <C>               <C>
SALES
  Product sales                                                $21,047,803       $ 9,058,296
  Service sales                                                  4,268,636         3,144,405
                                                               -----------       -----------
                                                                25,316,439        12,202,701
                                                               -----------       -----------

COST OF SALES
  Product sales                                                 16,444,797         7,250,882
  Service sales                                                  2,483,644         1,830,770
                                                               -----------       -----------
                                                                18,928,441         9,081,652
                                                               -----------       -----------
GROSS PROFIT                                                     6,387,998         3,121,049
                                                               -----------       -----------
OPERATING EXPENSES
  Selling, general and administrative                            4,529,329         2,555,657
                                                               -----------       -----------
INCOME FROM OPERATIONS                                           1,858,669           565,392
                                                               -----------       -----------
OTHER INCOME (EXPENSE)

  Gain (loss) on disposal of property and equipment                (11,802)           85,922
  Interest expense                                                (229,177)          (92,473)
                                                               -----------       -----------
                                                                  (240,979)           (6,551)
                                                               -----------       -----------
INCOME BEFORE INCOME TAXES                                       1,617,690           558,841

INCOME TAXES (Note 8)                                              604,000           207,675
                                                               -----------       -----------
NET INCOME                                                     $ 1,013,690       $   351,166
                                                               ===========       ===========
BASIC EARNINGS PER COMMON SHARE (Note 9)                       $      0.20       $      0.07
                                                               ===========       ===========
DILUTED EARNINGS PER COMMON SHARE (Note 9)                     $      0.18       $      0.07
                                                               ===========       ===========

</TABLE>

  The accompanying notes are an integral part of these financial statements.

                                       27
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                  (DBA PDSi)


                 STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

                    Years Ended December 31, 2000 and 1999
                    --------------------------------------


<TABLE>
<CAPTION>


                                                Common Stock
                                       ----------------------------
                                                                                Additional                              Total
                                       Outstanding                               Paid-In             Retained       Stockholders'
                                         Shares              Amount              Capital             Earnings           Equity
                                         ------              ------             ---------            --------        ------------
<S>                                   <C>                <C>                 <C>                  <C>               <C>


BALANCE - December 31, 1998               4,816,804       $  1,572,138         $     214,506      $       232,878    $  2,019,522

  Options exercised                          58,000             43,500                     -                    -          43,500

  Net income                                      -                  -                     -              351,166         351,166
                                         ----------       ------------         -------------      ---------------    ------------

BALANCE - December 31, 1999               4,874,804          1,615,638               214,506              584,044       2,414,188

  Options and warrants exercised            519,700            412,799                     -                    -         412,799

  Tax benefits from employee stock                -                  -               283,000                    -         283,000

  Net income                                      -                  -                     -            1,013,690       1,013,690
                                         ----------       ------------         -------------      ---------------    ------------
BALANCE - December 31, 2000               5,394,504       $  2,028,437         $     497,506      $     1,597,734    $  4,123,677
                                         ==========       ============         =============      ===============    ============

</TABLE>



The accompanying notes are an integral part of these financial statements.

                                       28
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                  (DBA PDSi)


                           STATEMENTS OF CASH FLOWS

                    Years Ended December 31, 2000 and 1999
                    --------------------------------------


<TABLE>
<CAPTION>

                                                                               2000                 1999
                                                                               ----                 ----
<S>                                                                        <C>                   <C>
CASH FLOWS FROM OPERATING ACTIVITIES
  Net income                                                               $   1,013,690         $    351,166
                                                                           -------------         ------------
  Adjustments to reconcile net income to net cash used
   in operating activities:
    Depreciation and amortization                                                344,063              329,844
    Provision for doubtful accounts                                               (2,000)               1,000
    Inventory reserves                                                           127,117               (1,906)
    Provision for deferred taxes                                                 (88,000)             (41,325)
    Tax benefit from employee stock option plans                                 283,000                    -
    (Gain) loss on disposal of property and equipment                             11,802              (85,922)
    (Increase) decrease in assets:
      Accounts receivable                                                     (2,901,819)          (1,001,407)
      Inventory                                                               (6,010,467)          (1,392,474)
      Prepaid expenses and other assets                                              569              (38,134)
    Increase (decrease) in liabilities:
      Accounts payable                                                         3,651,854              724,274
      Accrued expenses and taxes                                                 194,298              331,791
      Unearned revenues                                                          (18,913)              16,123
                                                                           -------------         ------------
        Total adjustments                                                     (4,408,496)          (1,158,136)
                                                                           -------------         ------------
          Net cash used in operating activities                               (3,394,806)            (806,970)
                                                                           -------------         ------------

CASH FLOWS FROM INVESTING ACTIVITIES
  Purchases of property and equipment                                           (630,772)            (444,293)
  Proceeds from sale of property and equipment                                         -              147,615
                                                                           -------------         ------------
          Net cash used in investing activities                                 (630,772)            (296,678)
                                                                           -------------         ------------
CASH FLOWS FROM FINANCING ACTIVITIES
  Net proceeds from line of credit                                             3,503,309            1,150,000
  Principal payments on long-term debt                                          (289,953)             (69,022)
  Long-term borrowings                                                           400,000                    -
  Principal payments on capital lease obligation                                       -              (20,635)
  Proceeds from stock options exercised                                          412,799               43,500
                                                                           -------------         ------------
          Net cash provided by financing activities                            4,026,155            1,103,843
                                                                           -------------         ------------

</TABLE>


  The accompanying notes are an integral part of these financial statements.

                                       29
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                  (DBA PDSi)


                     STATEMENTS OF CASH FLOWS (CONTINUED)


                    Years Ended December 31, 2000 and 1999
                    ---------------------------------------

<TABLE>
<CAPTION>




                                                                               2000          1999
                                                                             --------       -------
<S>                                                                          <C>            <C>
INCREASE IN CASH                                                                  577           195

CASH - Beginning of year                                                       35,296        35,101
                                                                             --------       -------
CASH - End of year                                                           $ 35,873       $35,296
                                                                             ========       =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
    Interest paid                                                            $225,099       $92,770
                                                                             ========       =======
    Income taxes paid, net of refunds                                        $422,587       $84,180
                                                                             ========       =======
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING TRANSACTIONS

    During 2000, the Company capitalized $42,706 of inventory
    as computer equipment.

    In May 1999, the Company sold its land, building and
    improvements.  Of the proceeds, $401,547 was used to pay off
    the remaining mortgage balance.

    During 1999, the Company capitalized $144,891 of inventory
    as computer equipment.

</TABLE>

  The accompanying notes are an integral part of these financial statements.

                                       30
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 1.   Summary of Significant Accounting Policies

     A.   Nature of Business - Pinnacle Data Systems, Inc. (dba PDSi) (the
          Company) designs, manufactures and integrates SPARC-based board and
          system-level data transmission products for Original Equipment
          Manufacturers (OEMs).  The Company also provides OEM board and
          component-level depot repair and worldwide support for electronic
          equipment such as computers, peripherals and printed circuit board
          assemblies.

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

     C.   Fair Value of Financial Instruments - Carrying amounts of certain of
          the Company's financial instruments including cash, accounts
          receivable, accounts payable, and other accrued liabilities,
          approximate fair value because of their short maturities. The
          Company's line of credit and long-term debt approximate fair value as
          the interest rates on these obligations approximate current rates
          available based upon the relative stability of prime.

     D.   Concentration of Credit Risk - Financial instruments, which
          potentially subjects the Company to a concentration of credit risk
          principally consist of accounts receivable. The Company grants credit
          to its customers, which are varied in terms of size, geographic
          location and financial strength. Customer balances are continually
          monitored to minimize the risk of loss.

          For 2000, the Company had three customers that generated revenues of
          approximately $7,111,000, $5,341,000, and $3,581,000 or 28%, 21%, and
          14%, respectively, of total revenue.  In the Statements of Income,
          approximately $3,445,000 is included in service sales and $12,588,000
          is included in product sales.  In addition, these customers
          represented 41%, 12%, and 11% of accounts receivable at December 31,
          2000.

          For 1999, the Company had three customers that generated revenues of
          approximately $3,486,000, $1,285,000, and $2,006,000 or 29%, 11%, and
          16%, respectively, of total revenue.  In the Statements of Income,
          approximately $2,348,000 is included in service sales and $4,429,000
          is included in product sales.  In addition, these customers
          represented 19%, 18%, and 20% of accounts receivable at December 31,
          1999.

     E.   Revenue Recognition - Revenue from product sales is recognized upon
          shipment to customers.  Revenue from service sales is generally
          recognized as the service is provided which consists of: (i) repairing
          products produced by third parties, (ii) earning a fee by exchanging
          with a customer a replacement component or part for a defective
          component or part; and (iii) servicing contracts to certain customers
          generally for six to twelve months; for which, revenue is deferred and
          recognized in income on a straight-line basis over the contract
          period.

                                       31
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 1.   Summary of Significant Accounting Policies (Continued)


   F.     Inventories - Inventories are valued at average cost, not in excess of
          market.

          Inventory at December 31, 2000 and 1999 was comprised of the
          following:

          <TABLE>
                                                        2000              1999
                                                      ---------         ---------
          <S>                                        <C>              <C>
          Component parts (raw materials)            $5,842,956        $1,880,742
          Work-in-process                             1,882,018           368,122
          Finished goods                                792,951           428,417
                                                     ----------        ----------
                                                     $8,517,925        $2,677,281
                                                     ==========        ==========
          </TABLE>

          The carrying values of component parts and finished goods represent
          management's estimate of their net realizable value.  Such value is
          based on forecasts of repair/trade-in activity in the ensuing years.
          Such forecasts are based on historical information, known contracts,
          and management's expertise in computer hardware life cycles.  The
          computer hardware industry is characterized by rapid technological
          advancement and change.  Should demand for repair/trade-in hardware
          prove to be significantly less than anticipated, the ultimate
          realizable value of such products could be substantially less than the
          amount shown in the balance sheet.

   G.     Statement of Cash Flows - For purposes of the statement of cash flows,
          the Company considers all short-term instruments purchased with a
          maturity of three months or less to be cash equivalents.  There were
          no cash equivalents at December 31, 2000 or 1999.

   H.     Property and Equipment - Property and equipment are recorded at cost.
          Depreciation and amortization is provided on the straight-line method
          for financial reporting purposes over the estimated useful lives of
          the respective assets.  Expenditures for maintenance and repairs are
          charged to operations as incurred, while expenditures for additions
          and improvements are capitalized.  The vehicle is depreciated over 3
          years.  Furniture and fixtures, computer equipment and related
          software, and shop equipment are depreciated over useful lives ranging
          from 3 to 7 years.  Leasehold improvements are being amortized over
          the shorter of useful life or remaining lease term.  Depreciation and
          amortization expense amounted to $344,063 and $329,844 for the years
          ended December 31, 2000 and 1999, respectively.

   I.     Advertising - All of the Company's advertising costs are of the
          nondirect-response type. The Company expenses all advertising costs as
          incurred or at the time the advertising takes place.

   J.     Life Insurance - The Company has purchased, and is the beneficiary, of
          three term life insurance policies on key employees of the Company.
          The total amount of coverage at December 31, 2000 and 1999 was
          $3,250,000.

                                       32
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 1.   Summary of Significant Accounting Policies (Continued)

   K.     Stock-Based Compensation - The Company has implemented Statement
          of Financial Accounting Standards (SFAS) No. 123, "Accounting for
          Stock-Based Compensation".  This standard encourages the adoption of
          the fair value-based method of accounting for employee stock options
          or similar equity instruments, but continues to allow the Company to
          measure compensation cost for those equity instruments using the
          intrinsic value-based method of accounting prescribed by Accounting
          Principles Board Opinion No. 25, "Accounting for Stock Issued to
          Employees."  Under the fair value-based method, compensation cost is
          measured at the grant date based on the value of the award.  Under the
          intrinsic value-based method, compensation cost is the excess, if any,
          of the quoted market price of the stock at the grant date or other
          measurement date over the amount the employee must pay to acquire the
          stock.  The Company intends to continue the use of the intrinsic
          value-based method.

          As a result, this standard does not have any effect to the Company's
          financial statements other than to require disclosure of the pro forma
          effect on net income of using the fair value-based method of
          accounting. The Company has made the disclosures required by SFAS No.
          123 as of December 31, 2000 and December 31, 1999 and for the years
          then ended. (see Note 5).

   L.     Research and Development - Research and development costs are charged
          to operations when incurred and are included in operating expenses.
          The amounts charged for the years ended December 31, 2000 and 1999
          were $1,127,339 and $522,143, respectively.

   M.     Effects of Recent Accounting Pronouncements - In December 1999, the
          Securities and Exchange Commission issued Staff Accounting Bulletin
          ("SAB") No. 101, "Revenue Recognition in Financial Statements."  The
          guidance in SAB 101 required adoption during the fourth quarter of
          2000 and the effects, if any, were required to be recorded in the
          financial statements.  Management evaluated the effects of SAB No. 101
          and  determined it does not have an effect on its operating results or
          financial position.

Note 2.   Line of Credit

          At December 31, 2000, the Company had a $7,000,000 bank line of credit
          with monthly interest payments at prime (9.50% December 31, 2000)
          minus 0.85%. The line of credit  continues until both parties reach a
          mutual written agreement to terminate. The line is payable on demand
          and is collateralized by a "Blanket Lien" on all assets of the
          Company.  The amount available under the line of credit is subject to
          borrowing base restrictions as outlined in the agreement.  In
          addition, the agreement restricts the payment of cash dividends.

          At December 31, 1999, the Company had a $2,000,000 bank line of credit
          at an interest rate of prime (8.50% December 31,1999). The line was
          payable on demand and was collateralized by a "Blanket Lien" on all
          assets of the Company.  The amount available under the line of credit
          was subject to borrowing base restrictions as outlined in the
          agreement. The line was to mature in September 2000, but was replaced
          with the aforementioned new agreement in February 2000.

                                       33
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS

Note 3.    Long-Term Debt

          Following is a summary of long-term debt at December 31:

<TABLE>
<CAPTION>
                                                   2000           1999
                                                 --------       --------
<S>                                              <C>            <C>
3.9% vehicle loan, payable in monthly
installments of $401, including interest
through January 2002.                            $  5,126       $ 10,079

Prime minus .25% note payable in
monthly installments of $12,627
including interest through
February 2003; collateralized by
substantially all assets of the Company.          300,000              -

Prime rate note payable in monthly
installments of $5,000 plus interest
through January 2003; collateralized by
substantially all assets of the Company.
This note was paid in March 2000.                       -        185,000
                                                 --------       --------

Total long-term debt                              305,126        195,079
Less current portion                              138,459         64,521
                                                 --------       --------

                                                 $166,667       $130,558
                                                 ========       ========
</TABLE>
          Aggregate maturities on long-term debt for the years ending after
          December 31, 2000 is as follows:

<TABLE>
<S>                                              <C>
2001                                             $138,459
2002                                              133,333
2003                                               33,334
                                                 --------
                                                 $305,126
                                                 ========
</TABLE>

                                       34
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 4.   Stockholders' Equity

   A.     Authorized Shares - On June 24, 2000, the shareholders approved
          amendments to the Company's Articles of Incorporation to increase the
          authorized number of common shares from 5,000,000 to 10,000,000.

   B.     Preferred stock  - On June 24, 2000, the shareholders authorized
          4,000,000 preferred shares.  None of these shares were issued or
          outstanding at December 31, 2000.

Note 5.   Stock Options and Warrants


          The Company adopted the Pinnacle Data Systems, Inc., 1995 Stock Option
          Plan (the Plan) on December 19, 1995.  Any employee who has been
          granted a discretionary option may purchase Company common stock over
          a ten-year period, at the fair market value at time of grant.  (If the
          grantee owns more than 10% of the Company's stock at the time of the
          grant, the purchase price shall be at least 110% of the fair market
          value and the options expire five years from the date of grant.)  The
          aggregate number of common shares of the Company, which could have
          been granted under the plan, was 1,200,000 shares.  All incentive
          options available under the plan shall be granted by December 19,
          2005.  On February 16, 2000, the Board of Directors amended the
          Pinnacle Data Systems, Inc., 1995 Stock Option Plan, which was
          subsequently approved by the shareholders on June 24, 2000, to
          increase the number of shares reserved for issuance to 2,400,000
          common shares.

          On March 22, 2000, the Company adopted the Pinnacle Data Systems,
          Inc., 2000 Directors Stock Option Plan (Director Plan) which was
          subsequently approved by the shareholders on June 24, 2000.  Under the
          Directors Plan, 500,000 shares are reserved for issuance to Directors
          who are not employees of the Company (Outside Director). Any Outside
          Director who has been granted a discretionary option may purchase
          Company common stock over a ten-year period, at the fair market value
          at time of grant.  Before the adoption of the Director Plan, previous
          issuance of stock options to Outside Directors were made by entering
          into individual stock option agreements.

          Although the Board of Directors has the authority to set other terms,
          the options are generally exercisable one year from the date of grant.

                                       35
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 5.        Stock Options and Warrants (Continued)

          The following table is a summary of option activity:


<TABLE>
<CAPTION>
Stock Option Plan                                   2000                             1999
                                                    ----                             ----
                                                           Weighted                         Weighted
                                                           Average                          Average
Employee Stock Option                                      Exercise                         Exercise
Agreements                                 Number            Price           Number           Price
                                         ----------         ------        ----------         ------
<S>                                   <C>               <C>            <C>               <C>
  Outstanding, beginning of year          1,145,600          $0.85           927,800          $0.78
  Granted                                   231,400           3.95           301,800           1.05
  Exercised                                 455,200           0.84            58,000           0.75
  Cancelled                                  12,200           0.94            26,000           0.77
                                         ----------         ------        ----------         ------
  Outstanding, end of year                  909,600          $1.64         1,145,600          $0.85
                                         ==========         ======        ==========         ======
Exercise price range of options
  outstanding                                    $0.63 to $5.25                  $0.63 to $1.38

Director Stock Option
Agreements
  Outstanding, beginning of year            150,000          $0.85           118,000          $0.92
  Granted                                    36,000           3.88            52,000           1.03
  Exercised                                  20,000           1.03                 -              -
  Cancelled                                       -              -            20,000           1.75
                                         ----------         ------        ----------         ------
  Outstanding, end of year                  166,000          $1.48           150,000          $0.85
                                         ==========         ======        ==========         ======

Exercise price range of options
  outstanding                                  $0.75 to $3.88                   $0.75 to $1.75

</TABLE>

          On June 23, 1999, the Company cancelled the 20,000 Director Stock
          Options at $1.75 and reissued the 20,000 options at $1.03.

                                       36
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 5.        Stock Options and Warrants (Continued)

          The following table summarizes information concerning outstanding and
          exercisable options at December 31, 2000:

<TABLE>
<CAPTION>
                                                Options Outstanding
                      ---------------------------------------------------------------------------
    Range of                                       Weighted-average              Weighted-average
    Exercise              Number                 Remaining Contractual            Exercise Price
     Price              Outstanding                 Life (in years)                 Per Share
---------------        -------------             ---------------------           ----------------
<S>                  <C>                    <C>                                      <C>
$0.63 - 0.97               549,400                         5.62                        $0.76
$1.03 - 1.38               259,000                         8.31                         1.05
$2.28 - 5.25               267,200                         9.24                         3.94
------------             ---------                         ----                        -----
 Total                   1,075,600                         7.17                        $1.62
============             =========                         ====                        =====
</TABLE>

<TABLE>
<CAPTION>
                                 Options  Exercisable
                      ---------------------------------------------
    Range of                                       Weighted-average
    Exercise              Number                    Exercise Price
     Price              Exercisable                   Per Share
------------           ---------------            -----------------
<S>                    <C>                        <C>
$0.63 - 0.97                   549,400                   $0.76
$1.03 - 1.38                   259,000                    1.05
$2.28 - 5.25                         -                       -
------------                   -------                   -----
 Total                         808,400                   $0.85
============                   =======                   =====
</TABLE>

          December 31, 1999, 963,800 outstanding options were exercisable.  The
          weighted-average exercise price for outstanding options was $0.91 at
          December 31, 1999.

          The options outstanding at December 31, 2000 are exercisable through
          periods ranging from September 2002 through December 2010.

          Pro forma information regarding net income and earnings per share is
          required by SFAS 123, and has been determined as if the Company had
          accounted for its employee stock options under the fair value method
          of that Statement. As noted in Note 1.K., the Company is continuing to
          utilize the intrinsic value-based method for accounting for employee
          stock options or similar equity instruments; therefore, the Company
          has not recorded any compensation cost in the Statements of Income for
          stock-based employee compensation awards.

                                       37
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 5.   Stock Options and Warrants (Continued)

          For purposes of pro forma disclosures, the estimated fair value of the
          options is amortized to expense over the options' vesting period.  The
          Company's pro forma income and earnings per share are as follows for
          the year ended:

<TABLE>
<CAPTION>
                                                           2000             1999
                                                        ----------        --------
<S>                                                     <C>               <C>
Net income - as reported                                $1,013,690        $351,166
Net income - pro forma                                  $  730,480        $328,127
Basic earnings per common share-as reported             $      .20        $    .07
Basic earnings per common share-pro forma               $      .14        $    .07
Diluted earnings per common share - as reported         $      .18        $    .07
Diluted earnings per common share - pro forma           $      .13        $    .06
Weighted-average fair value of options granted
during  the year                                        $     3.93        $   1.04
</TABLE>
          The fair value of each option grant is estimated on the grant date
          using the Black-Scholes option pricing model with the following
          weighted average assumptions for the year ended:

<TABLE>
<CAPTION>
                                                       2000            1999
                                                      ------          ------
<S>                                                   <C>             <C>
Risk-free interest rate                                 5.6%            6.0%
Dividend yield                                            0%              0%
Volatility factor                                     66.68%          56.39%
Weighted average expected life in years                 9.5             7.0
</TABLE>

          The Black-Scholes option pricing model was developed for use in
          estimating the fair value of traded options that have no vesting
          restrictions and are fully transferable.  In addition, option pricing
          models require input of highly subjective assumptions including the
          expected stock price volatility.  The Company uses projected
          volatility rates which are based upon historical volatility rates
          trended into the future.  Because the Company's stock options have
          characteristics significantly different from those traded options, and
          because changes in the subjective input assumptions can materially
          affect the fair value estimate, in management's opinion, the existing
          models do not necessarily provide a single measure of the fair value
          of the Company's options.

     .    Stock Warrants - As part of the April 1996 offering circular, the
          underwriter was granted warrants to purchase 100,000 shares of common
          stock at $1.38 per share.  The warrants became exercisable in May 1997
          and expire in April 2001.  During 2000, 44,500 warrants were
          exercised.

                                       38
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 6.   Operating Leases

          The Company leases office equipment under operating leases that
          expires in 2002.  Additionally, commencing in 1999, the Company
          entered into a lease for its new operating facility that has a term
          through 2009.

          Minimum future lease payments under operating leases as of December
          31, 2000 are as follows:

          <TABLE>
                         <S>                            <C>
                         2001                           $  465,440
                         2002                              488,890
                         2003                              516,390
                         2004                              547,898
                         2005                              589,216
                      Thereafter                         2,119,141
                                                        ----------
                                                        $4,726,975
                                                        ==========
          </TABLE>

          Total lease payments charged to operations for the years ended
          December 31, 2000 and 1999 amounted to $388,732 and $140,200,
          respectively.

Note 7.   Profit Sharing and 401(k) Savings Plan

          The Company maintains a qualified cash or deferred compensation plan
          under section 401(k) of the Internal Revenue Code.  The plan covers
          all employees age 21 or over with one year of service.  Under the
          plan, employees may elect to defer from 1% to 12% of their salary,
          subject to Internal Revenue Code limits.

          The Company, at its discretion, may match 100% of employee
          contributions up to 6% of wages deferred with a maximum contribution
          of $3,000 per employee in 1999 and $4,500 per employee in 2000.
          Matching contribution expense of $76,098 and $48,625 has been accrued
          for 2000 and 1999, respectively.


Note 8.   Income Taxes

          Deferred income taxes arise from temporary differences resulting from
          income and expense items reported for financial accounting and tax
          reporting purposes in different periods.  Deferred taxes are
          classified as current or long-term, depending on the classification of
          the assets and liabilities to which they relate.  Deferred taxes
          arising from temporary differences that are not related to an asset or
          liability are classified as current or long-term depending on the
          periods in which the temporary differences are expected to reverse.

                                       39
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 8.   Income Taxes (Continued)

          The components of the deferred tax asset (liability) consisted of the
          following at December 31:

<TABLE>
<CAPTION>
                                                    2000            1999
                                                  --------        --------
<S>                                               <C>             <C>
Current:
  Federal                                         $209,000        $122,000
  State                                             26,000           7,000
  City                                              12,000           3,000
                                                  --------        --------
                                                  $247,000        $132,000
                                                  ========        ========

Noncurrent:
  Federal                                         $(35,000)       $(13,000)
  State                                             (4,000)           (700)
  City                                              (2,000)           (300)
                                                   -------         -------
                                                  $(41,000)       $(14,000)
                                                  ========        ========
</TABLE>

          Net deferred tax assets in the accompanying balance sheets include the
          following components:

<TABLE>
                                                    2000           1999
                                                  --------       --------
<S>                                               <C>            <C>
Assets
  Inventory reserves                              $127,000       $ 70,000
  Allowance for doubtful accounts                    3,000          3,000
  Bonus accrual                                     47,000         14,000
  Vacation accrual                                  38,000         23,000
  Other                                             32,000         22,000
                                                  --------       --------
                                                  $247,000       $132,000
                                                  ========       ========

Liabilities
  Depreciation                                    $ 41,000       $ 14,000
                                                   -------        -------
                                                  $ 41,000       $ 14,000
                                                  ========       ========
</TABLE>
          The components of the tax expense (benefit) for the year ended
          December 31, were as follows:


                                       40
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 8.   Income Taxes (Continued)

<TABLE>
<CAPTION>
                                                    2000            1999
                                                  --------        --------
<S>                                               <C>             <C>
Current:
  Federal                                         $626,000        $225,000
  State                                             30,000          11,000
  City                                              36,000          13,000
                                                  --------        --------
                                                   692,000         249,000
                                                  --------        --------

Deferred:
  Federal                                          (65,000)        (36,200)
  State                                            (15,700)         (3,400)
  City                                              (7,300)         (1,725)
                                                  --------        --------
                                                   (88,000)        (41,325)
                                                  --------        --------

Total                                             $604,000        $207,675
                                                  ========        ========
</TABLE>

          The following sets forth the differences between the provision for
          income taxes computed at the federal statutory rate of 34% and that
          reported for financial statement purposes:

<TABLE>
                                                    2000           1999
                                                  --------       --------
<S>                                               <C>            <C>
Income tax provision at statutory rate            $550,000       $190,000
Add:
Tax effect of permanent differences                  8,000          4,800
State income taxes, net of federal
income tax provision                                23,000          8,100
Tax credits                                         11,000          3,000
Other, net                                          12,000          1,775
                                                  --------       --------
Total income tax provision                        $604,000       $207,675
                                                  ========       ========
</TABLE>

          The Company's income tax payable for federal, state, and local
          purposes has been reduced by the tax benefits associated with the
          exercise of employee stock options.  The Company receives an income
          tax benefit calculated as the difference between the fair market value
          of the stock at the time of exercise and the option price, tax
          effected.   These tax benefits were credited directly to additional
          paid-in capital, reduced taxes payable, and amounted to $283,000 for
          the year ended December 31, 2000.  There was no tax benefit recorded
          for the year ended December 31, 1999.

                                       41
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 9.   Earnings Per Common and Common Equivalent Share

          Earnings per common and common equivalent share were computed by
          dividing net income by the weighted average number of shares of common
          stock outstanding during the year.  At December 31, 2000 and 1999, the
          number of common shares was increased by the number of shares issuable
          on the exercise of outstanding stock options and warrants when the
          market price of the common stock exceeds the exercise price of the
          options and warrants.  This increase in the number of common shares
          was reduced by the number of common shares that are assumed to have
          been purchased with the proceeds from the exercise of the options;
          those purchases were assumed to have been made at the average price of
          the common stock during that part of the year when the market price of
          the common stock exceeded the exercise price of the options.

          The following data show the amounts used in computing earnings per
          share (EPS) and the effect on income and the weighted-average number
          of shares of dilutive potential common stock.

<TABLE>
<CAPTION>
                                                                         2000          1999
                                                                      ----------    ----------
<S>                                                                   <C>           <C>
 Income available to common stockholders
 used in basic EPS and diluted EPS                                    $1,013,690    $  351,166
                                                                      ==========    ==========

Weighted average number of common shares
used in basic EPS                                                      5,065,521     4,860,138

Effect of dilutive securities:
Stock options and warrants                                               653,965       248,126
                                                                      ----------    ----------

Weighted number of common shares and
dilutive potential common stock used in
diluted EPS.                                                           5,719,486     5,108,264
                                                                      ==========    ==========
</TABLE>

          Options and warrants on 0 and 2,000 shares, respectively, of common
          stock were not included in computing diluted EPS for the years ended
          December 31, 2000 and 1999, respectively, because they were not
          "in-the-money".

Note 10.  Operating Segments

          The Company's reportable segments include Product Sales and Service
          Sales which are explained in Item 1 of the Company's form 10KSB,
          including a discussion of principle markets and distribution. The
          other column listed below reflects items that are not allocated to
          segments.  These items primarily represent assets and expenses for
          various administrative functions within the Company. The Company
          evaluates performance based on operating earnings of the reportable
          segments.

                                       42
<PAGE>

                          PINNACLE DATA SYSTEMS, INC.
                                   (DBA PDSi)

                         NOTES TO FINANCIAL STATEMENTS


Note 10.  Operating Segments  (Continued)


          Segment information for the years ended December 31, 2000 and 1999,
          was as follows:

<TABLE>
<CAPTION>
                                                     2000
                           --------------------------------------------------------
                             Product        Service
                              Sales          Sales          Other          Total
                           -----------    ----------    -----------     -----------
<S>                        <C>            <C>           <C>             <C>
Sales                      $21,047,803    $4,268,636    $         -     $25,316,439
Gross profit                 4,603,006     1,784,992              -       6,387,998
Operating earnings           1,988,640     1,001,086     (1,131,057)      1,858,669
Depreciation and
  amortization                 293,631        42,430          8,002         344,063
Interest expense               195,585        28,262          5,330         229,177
Total assets                13,229,011     1,911,601        360,499      15,501,111
Capital expenditures           315,212       114,890        200,670         630,772

<CAPTION>
                                                     1999
                         ----------------------------------------------------------
                             Product        Service
                              Sales          Sales          Other          Total
                           -----------    ----------    -----------     -----------
<S>                        <C>            <C>           <C>             <C>
Sales                       $ 9,058,296    $3,144,405    $        -     $12,202,701
Gross profit                  1,807,414     1,313,635             -       3,121,049
Operating earnings              526,137       858,315      (819,060)        565,392
Depreciation and
  amortization                   49,501       148,370       131,973         329,844
Interest expense                 63,806        24,968         3,699          92,473
Total assets                  4,363,504     1,721,295       239,228       6,324,027
Capital expenditures            200,547        96,346       147,400         444,293
</TABLE>

                                       43
<PAGE>

Item 8.   Changes in and Disagreements with Accountants on Accounting and
          Financial Disclosure.

None.

                                       44
<PAGE>

                                    PART III


Item 9.     Directors, Executive Officers, Promoters and Control Persons;
            Compliance with Section 16(a) of the Exchange Act.

Information about our directors and nominees for directors is incorporated by
reference to our proxy statement for our year 2001 annual meeting of
shareholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A of the Exchange Act, under the Caption: "Proposal One:  Election
of Directors."  Information relating to executive officers and significant
employees is included at the end of Part I of this Form 10-KSB and is hereby
incorporated herein by reference.


Item 10.    Executive Compensation

Incorporated by reference to our proxy statement for our year 2001 annual
meeting of shareholders, to be filed with the Securities and Exchange Commission
pursuant to Regulation 14A of the Exchange Act, under the Caption:  "Principal
Holders of Voting Securities" and "Proposal One: Election of Directors."


Item 11.    Security Ownership of Certain Beneficial Owners and Management

Incorporated by reference to our proxy statement for our year 2001 annual
meeting of shareholders, to be filed with the Securities and Exchange Commission
pursuant to Regulation 14A of the Exchange Act, under the Caption:  "Executive
Compensation."


Item 12.    Certain Relationships and Related Transactions.

None.

                                       45
<PAGE>

Item 13.    Exhibits and Reports on Form 8-K.

(a)  LISTING OF EXHIBITS.  The following is a listing of Exhibits either filed
     -------------------
     with this report or incorporated by reference :


<TABLE>
<CAPTION>
                                                                        If Incorporated by Reference,
   Exhibit                                                            Document with which Exhibit was
     No.                  Description of Exhibit                       Previously Filed with the SEC
   -------                ----------------------                       -----------------------------
<S>            <C>                                           <C>
3(a)            Amended and restated articles of              Registration Statement on Form 10-SB filed with the
                incorporation                                 Securities and Exchange Commission on December 13,
                                                              1999.

3(b)            Amendments to Amended and restated            Form SB-2 filed with the Securities and Exchange
                articles of incorporation, adopted June       Commission September 21, 2000.
                26, 2000

3(c)            Amended and restated code of regulations      Registration Statement on Form 10-SB filed with the
                                                              Securities and Exchange Commission on December 13,
                                                              1999.

3(d)            Amendment to Amended and Restated Code of     Annual Report on Form 10-KSB filed with the
                Regulations                                   Securities and Exchange Commission on March 30, 2000.

3(e)            Amendments to Amended and Restated Code of    Form SB-2 filed with the Securities and Exchange
                Regulations, adopted June 26, 2000            Commission September 21, 2000.

4               Instruments defining the rights of           Form SB-2 filed with the Securities and Exchange
                security holders, including indentures       Commission September 21, 2000.

10(a)           Technology license agreement between         Registration Statement on Form 10-SB filed with the
                Pinnacle Data Systems, Inc. and Sun          Securities and Exchange Commission on December 13,
                Microsystems, Inc. dated May 12, 1994        1999.

10(b)           Development and manufacturing license        Registration Statement on Form 10-SB filed with the
                agreement between Pinnacle Data Systems,     Securities and Exchange Commission on December 13,
                Inc. and Sun Microsystems, Inc. dated        1999.
                October 27, 1997
</TABLE>

                                       46
<PAGE>

<TABLE>
<CAPTION>
                                                                        If Incorporated by Reference,
   Exhibit                                                            Document with which Exhibit was
     No.                  Description of Exhibit                       Previously Filed with the SEC
   -------                ----------------------                       -----------------------------
<S>            <C>                                         <C>
10(c)           Repair services agreement between Pinnacle   Registration Statement on Form 10-SB filed with the
                Data Systems, Inc. and Sun Microsystems,     Securities and Exchange Commission on December 13,
                Inc. dated March 29, 1999                    1999.

10(d)           Employment agreement between Pinnacle Data   Contained herein.
                Systems, Inc. and John D. Bair dated as of
                January 1, 2001

10(e)*          Employment agreement between Pinnacle Data   Registration Statement on Form 10-SB filed with the
                Systems, Inc. and C. Robert Hahn dated       Securities and Exchange Commission on December 13,
                October 29, 1997                             1999.

10(f)           Amendment to Employment agreement between    Contained herein.
                Pinnacle Data Systems, Inc. and C. Robert
                Hahn dated March 23, 2001

10(g)*          Employment agreement between Pinnacle Data   Registration Statement on Form 10-SB filed with the
                Systems, Inc. and Thomas J. Carr dated       Securities and Exchange Commission on December 13,
                October 29, 1997                             1999.

10(h)*          Standard form Director stock option          Registration Statement on Form 10-SB filed with the
                agreement between Pinnacle Data Systems,     Securities and Exchange Commission on December 13,
                Inc. and individual members of the Board     1999
                of Directors

10(i)*          Employment agreement and stock option        Registration Statement on Form 10-SB filed with the
                agreement between Pinnacle Data Systems,     Securities and Exchange Commission on December 13,
                Inc. and David J. Richards dated July 22,    1999.
                1998

10(j)*          Pinnacle Data Systems, Inc. 1995 stock       Registration Statement on Form 10-SB filed with the
                option plan                                  Securities and Exchange Commission on December 13,
                                                             1999.

</TABLE>

                                       47
<PAGE>

<TABLE>
<CAPTION>
                                                                        If Incorporated by Reference,
   Exhibit                                                            Document with which Exhibit was
     No.                  Description of Exhibit                       Previously Filed with the SEC
   -------                ----------------------                       -----------------------------
<S>            <C>                                          <C>
10(k)*          Amendment No. 1 to Pinnacle Data Systems,    Annual Report on Form 10-KSB filed with the
                Inc. 1995 Stock Option Plan                  Securities and Exchange Commission on March 30, 2000.

10(l)*          Pinnacle Data Systems, Inc. 2000 Directors   Annual Report on Form 10-KSB filed with the
                Stock Option Plan                            Securities and Exchange Commission on March 30, 2000.

10(m)           Real estate contract on sale of building,    Registration Statement on Form 10-SB filed with the
                dated March 17, 1999                         Securities and Exchange Commission on December 13,
                                                             1999.

10(n)           Lease agreement between Pinnacle Data        Registration Statement on Form 10-SB filed with the
                Systems, Inc. and Duke Realty Limited        Securities and Exchange Commission on December 13,
                Partnership dated March 9, 1999              1999.

10(o)           First Lease Amendment between Pinnacle       Annual Report on Form 10-KSB filed with the
                Data Systems, Inc. and Duke Realty Limited   Securities and Exchange Commission on March 30, 2000.
                Partnership dated January 5, 2000

10(p)           Business Loan Agreement between Pinnacle     Contained herein.
                Data Systems, Inc. and Key Bank National
                Association dated August 10, 2000.

10(q)           Warrant to Purchase Common Shares dated      Form SB-2 filed with the Securities and Exchange
                April 23, 1996                               Commission September 21, 2000.

21              List of Subsidiaries                         Contained herein

23              Independent Auditors' Consent                Contained herein

24              Powers of Attorney                           Contained herein
</TABLE>

                                       48
<PAGE>

-----------------------------

       *Executive Compensation Plans and Arrangements required to be filed
pursuant to Reg. 601(B)(10) of Regulation S-B.


No other exhibits are required to be filed herewith pursuant to Item 601 of
Regulation S-B.

  (b)           REPORTS ON FORM 8-K
                -------------------

  No Form 8-K reports were filed during the fourth quarter of the Company's
  fiscal year ended December 31, 2000.

  (c)           EXHIBITS
                --------

  The exhibits in response to this portion of Item 13 are submitted as a
  separate section of this report following the signatures.

                                       49
<PAGE>

                                   SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

                                   PINNACLE DATA SYSTEMS, INC.


Date : March 29, 2001              By    /s/ John D. Bair
                                      ---------------------------
                                         John D. Bair, President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.

Signature                     Title                              Date
---------                     -----                              ----

/s/ John D. Bair              Chairman, President, Chief     March 29, 2001
------------------------      Executive Officer and
John D. Bair                  Director (principal
                              executive officer)


/s/ Thomas J. Carr*           Chief Financial Officer,       March 29, 2001
------------------------      and Treasurer,
Thomas J. Carr                (principal financial and
                              principal accounting officer)


C. Robert Hahn*               Vice President-Service Group,  March 29, 2001
------------------------      and Director
C. Robert Hahn


Hugh C. Cathey*               Director                       March 29, 2001
------------------------
Hugh C. Cathey

Paul H. Lambert*              Director                       March 29, 2001
------------------------
Paul H. Lambert

Thomas M. O'Leary*            Director                       March 29, 2001
------------------------
Thomas M. O'Leary

Robert V.R. Ostrander*        Director                       March 29, 2001
------------------------
Robert V.R. Ostrander



*The undersigned, by signing his name hereto, does sign this document on behalf
of the person indicated above pursuant to a Power of Attorney duly executed by
such person.

By       /s/ John D. Bair              March 29, 2001
         ----------------
         John D. Bair,
         Attorney-in-Fact

                                       50