<PAGE>   1
                                    FORM 10-K

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                   For the fiscal year ended December 28, 1996

                                       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: 0-21892

                              PINNACLE MICRO, INC.
             (Exact name of Registrant as specified in its charter)

              Delaware                                        33-0238563
    (State or other jurisdiction of                        (I.R.S. Employer
    incorporation or organization)                        Identification No.)

                               19 Technology Drive
                                Irvine, CA 92618
               (Address of principal executive offices) (Zip code)

                                  714-789-3000
               (Registrant's telephone number including area code)

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

           Securities registered pursuant to section 12(g) of the Act:
                    Common Stock, par value $0.001 per share

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X  No
                                       --    --

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

As of March 17, 1997, 10,744,017 shares of the Registrant's Common Stock were
outstanding. As of March 17, 1997, the aggregate market value of the
Registrant's Common Stock, held by non-affiliates of the Registrant was
approximately $20,381,000 based on the closing sales price of $3.19 per share of
the Common Stock as of such date, as reported by The NASDAQ National Market.

Information required by Part III is incorporated by reference to portions of the
Registrant's Proxy Statement for the 1997 Annual Meeting of Shareholders which
will be filed with the Securities and Exchange Commission within 120 days after
December 28, 1996.


                               Page 1 of 101 pages
<PAGE>   2
                                     PART I

      THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
   SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
  EXCHANGE ACT OF 1934. ACTUAL RESULTS AND EVENTS COULD DIFFER MATERIALLY FROM
    THOSE PROJECTED AS A RESULT OF THE RISK FACTORS SET FORTH IN THIS REPORT.

ITEM 1. BUSINESS

         Pinnacle Micro, Inc., (the "Company") is a designer, manufacturer,
supplier and reseller of removable optical storage systems. The Company's
products read from and write data to optical media. In 1996, the Company changed
its core business from reselling products manufactured by others to research,
development and manufacturing. The Company's manufactured products range from
the Vertex 2.6 Gigabyte ("GB") drive to its 4.5 terabyte multiple disk optical
library systems ("optical library"). The Company resells under its own brand
name 3.5" magneto optical ("MO") products and compact disc ("CD") recording
systems manufactured by others.

         The Company was incorporated in California in May 1987 and
reincorporated in Delaware in May 1993. The Company's headquarters is located at
19 Technology Drive, Irvine, California 92618, and that telephone number is
(714) 789-3000. The Company's operations are located at 4410 ArrowsWest Drive,
Colorado Springs, Colorado 80907, and that telephone number is (719) 264-1000.

PRODUCTS

Magneto Optical Products

         The Company's MO drive products combine proprietary firmware,
electronics design, application specific integrated circuits ("ASICs") with
optical mechanical storage subassemblies ("OMAs") manufactured by a third party.
The Company's core technology and lead product is the Apex 4.6 GB 5.25" MO
Drive. The Company primarily directed its 1996 efforts toward the successful
redesign, testing and manufacture of Vertex and Apex MO drives. The Company
believes that its Apex product is the highest capacity 5.25" form factor,
rewritable, random access removable optical drive currently available. The
Vertex 2.6 GB product is based upon the Apex technology. The Company's optical
storage systems are compatible with most personal computer and workstation
operating systems, including Windows NT, Windows 95, Macintosh OS, DOS, Windows
and UNIX. External systems attach to a computer system and include a power
supply, OMA, drive electronics, firmware, software, a SCSI cable and, where
necessary, a SCSI interface card. Internal systems do not include a power
supply. In 1997, PC-compatible Apex and Vertex are shipped with Seagate Backup
Director software (not available for Unix or Mac environments). The Company
provides a one year warranty against defects in material and workmanship for all
of its products. The Company's 3.5" 640 MB Tahoe product will be discontinued in
1997.

         The Tahoe and Vertex 5.25" optical storage systems conform to certain
industry standards, which allow for disk interchangeability among systems and
compatibility with future generations of 3.5" and 5.25" systems, respectively.
The Company's Apex 4.6 GB product also reads 2.0 GB media, but not lower
capacity media.

         The Company's Sierra 1.3 GB product was phased out in 1996 and replaced
by the Vertex 2.6 GB and Apex 4.6 GB products.

Network Optical Library Systems

         The Company also manufactures and sells a line of optical libraries
based on its Apex technology with storage capacities ranging from 75 GB to 4.5
terabytes. Prior products were based upon the Sierra 1.3 GB drive. The library
mechanisms are obtained from third party suppliers and are integrated by the
Company into its library systems. These library systems are most often used in
client/server or other networked environments and are free standing, fully
enclosed units with robotic arms that move 5.25" optical disks to and from one
or more internally mounted drives. A small number of Apex libraries were sold in
1996. The Company believes that library sales are a significant potential market
for the Company and the Apex technology. In 1996, the Company moved away from
use of its proprietary software for optical libraries in favor of using third
party software to reduce software development costs and increase the
marketability of the optical libraries.

         In 1996, the Company determined that sales of optical library required
product and software engineering support not previously provided. An
applications engineering team was hired in the first quarter of 1997 for this
purpose.


                                        2
<PAGE>   3
CD Recorder Systems

         The Company distributes compact disc-recorder ("CD-R") systems under
its own brand name and has done so since 1993. This product line was the
Company's primary source of revenue in the first half of 1996. The Company's
CD-R systems are comprised of a drive assembly manufactured by a third-party
supplier, which the Company differentiates from products of its competitors
through added software, firmware and packaging. The RCD-5040 replaced the
RCD-5020 in 1996. The current product, introduced in the fourth quarter of 1996,
is the RCD-4x4. CD-R products are combined with Adaptec's "EZCD Pro" software
for PC environments, the Company's proprietary CD-R recording software ("CD
Burner") for Mac environments and "Gear" software from Electroson for Unix
environments, to create a complete CD-R system. The Company also bundles its
proprietary backup software, "Disk Archive 95" with Windows compatible products.
For multimedia Macintosh computers applications, the Company bundles "Toast"
software from Astarte. CD-R systems are used to create custom CDs for low volume
data reproduction and distribution. CDs created in a standardized "ISO 9660"
format can be utilized in most CD-ROM drives and players. The CD-R can be used
with Macintosh, IBM, and Unix compatible personal computers.

         The Company's Apex and Vertex product lines provided the primary source
of revenue during the second half of 1996. The Company expects the CD-R product
line and business to continue to provide important revenue and product mix
contributions to Pinnacle's business.

"Ready to Store" RTS Program

         The Company's independent software vendors ("ISV") program is intended
to assure compatibility between the Company's products and important software
products, in order to increase market acceptance of Apex technology. The Company
identified software compatibility and certification as key areas of improvement
for 1997, as optical library purchases often depend first on software selection.
Participants include Avail Systems, Dantz, FileNet Corporation, Keyfile, Micro
Design International, Inc., Optical Technology Group, Inc., Optika Imaging
Systems, Inc., Optisys, Inc., Pegasus Disk Technologies, Inc., Seagate Software,
Inc., Software Architects, Tracer Technologies, Inc., and Watermark Software,
Inc.

Optical Storage Media

         In 1996, the Company distributed and sold rewritable 3.5" and 5.25"
optical storage media with an unformatted capacity of 230, 540 and 640 MB (3.5")
and 1.2, 1.3 GB, 2.3, 2.6 GB 4.2 and 4.6 GB (5.25"), for use with the Company's
and other manufacturers' MO systems. In 1997, the Company intends to discontinue
sales of 230 and 640 MB 3.5" media and sales of 650 MB, 1.3 GB 5.25" media. The
Company sells proprietary media for the Apex product. The Company also markets
and sells recordable CD media for use with its CD-R products.

         The Company believes that its 4.6 GB media is the highest density 5.25"
media currently available. Except for the Company's Apex 4.6 GB drive system and
media, all of the Company's 3.5" and 5.25" optical storage systems presently
conform to standards that have been adopted by the International Standards
Organization (ISO), the American National Standards Institute (ANSI) and the
European Computer Manufacturers Association (ECMA). These standards allow for
disk interchangeability among systems and compatibility with future generation
systems based on the same media dimensions. Vertex media is ANSI/ISO compliant,
but it is not ECMA compliant. The Company purchases all media from third party
suppliers and resells the media under Company trademarks.

SALES, MARKETING AND DISTRIBUTION

         Market and industry trends are toward ever-increasing memory and
storage capacity. The Apex technology is a leading removable, rewritable and
reliable solution, for near on-line and archival storage. Markets for Apex
technology include archiving, desk top publishing, multi-media, graphic design,
medical imaging, network storage, near on-line storage and other data-intensive
uses.

         The Company believes that it retains a large amount of brand "equity"
and recognition from previous investments in advertising. Extended delays of the
Apex introduction, however, adversely affected the Company's and to some extent
the MO industry's credibility within existing vertical markets. The Company is
redirecting its marketing strategy to build on its brand recognition and address
these issues and to expand its presence in the optical library arena. The
Company also 


                                        3
<PAGE>   4
believes that a business opportunity exists at the high-end of
removable, rewriteable storage market for archiving and backup and is working to
develop that opportunity.

         The Company sells its products through distributors, value-added
resellers ("VARs") and systems integrators. The Company no longer sells directly
to dealers. Due to delays in releasing its Apex technology, the Company does not
expect significant OEM sales for several quarters. Smaller OEMs are expected to
place orders in second quarter of 1997 but such purchases are not assured. Major
OEM customers are currently testing and evaluating the Apex product. The Company
also sells to end users directly through its internal sales force. The Company's
distributor channel consists both of national and regional distributors. The
Company's largest distributor, Ingram Micro, Inc., accounted for approximately
18%, 15%, and 15% of net sales in 1996, 1995 and 1994, respectively. No other
customer accounted for more than 10% of the Company's net sales during these
periods.

         In conformance with industry practice, the Company generally provides
distributors with stock balancing and price protection rights. This permits
distributors to return slow moving products to the Company for credit and
provides price adjustments for inventories of the Company's products held by
distributors if the Company subsequently lowers the prices of those products. In
1996, steps were taken to reduce these costs and manage the distributor business
more efficiently.

         The Company's international sales are currently made through a network
of distributors and resellers, which market and distribute the Company's
products worldwide. International and export sales accounted for approximately
30%, 35% and 29% of net sales in 1996, 1995 and 1994, respectively. (See Note 11
of Notes to Financial Statements). In 1996, the Company had international sales
offices located in Japan and the Netherlands. The Japanese office was closed in
the fourth quarter of 1996 as a cost savings measure. The Company intends to
improve its foreign sales operations and plans to increase foreign sales through
distributors. The risks of international sales include, among other things,
finding and retaining good managers, local or regional competition, currency
fluctuations, export and import controls and government regulation and tariffs.

         Customer service and technical support of the Company's products are an
integral part of the Company's business. Customer service and technical support
were an area of customer dissatisfaction in 1996 which management is striving to
address in 1997.

RESEARCH AND DEVELOPMENT

         In 1991, the Company established a research and development facility in
Colorado Springs, Colorado to develop proprietary optical technology, including
systems, mechanical, firmware, electronics design and ASICs. During 1995 and
1996, the Company's research and development efforts were principally directed
towards completing the development of the Apex product and then to solving
manufacturing yield issues. Now that Apex is in full production, plans are in
place to develop the successor product. The availability of research and
development funds depends upon the Company's revenues and profitability.
Reductions in such expenditures could impair the Company's ability to innovate
and compete in its targeted markets.

         In 1996, 1995 and 1994 the Company's research and development
expenditures were approximately $6,006,000, $4,978,000 and $2,708,000,
respectively. These expenses related primarily to the operations of the
Company's engineering team located in Colorado Springs, Colorado.

MANUFACTURING AND SUPPLIERS

Manufacturing Facilities and Reorganization

         Through the third quarter of 1996, the Company had manufacturing
facilities in Irvine, California and Colorado Springs, Colorado. In the fourth
quarter, the Company closed its manufacturing operations in Irvine and
consolidated manufacturing in Colorado Springs, see Item 2, Properties below. A
new facility was identified for all (manufacturing, research and development)
Colorado operations, and the move to the new facility was completed in the first
quarter of 1997. The Company's manufacturing operations consist of final
assembly and testing, quality assurance, packaging and shipping.

Suppliers


                                       4
<PAGE>   5
         OMAs, Apex media and certain of the ASICs and other components used in
the Company's products are obtained from single sources. These strategic
relationships provide for the sharing of technology and the joint development of
OMA subassemblies, including the development of enhancements to such components.
The Company also purchases from third party suppliers circuit boards, integrated
circuits and other components used in its products. The Company's dependence on
third-party suppliers involves several risks, including limited bargaining power
over pricing, availability, quality and delivery schedules for such components.
There is also the risk that a large supplier may be using the Company to develop
a market for later entry by the supplier. The Company believes that second
sources are available for all components other than OMAs, Apex media and certain
integrated circuits. There can, however, be no assurance that the Company could
obtain all required components from second sources on terms as favorable as
those in place, if at all. If the Company's ability to obtain critical
components from its sole source suppliers for its products were impaired or
interrupted for any reason, the Company would not be able to establish
alternative sources and integrate replacement components into its systems
without substantial disruption to the Company's operations.

Inventory

         Delays in manufacturing Apex and Vertex products caused the Company's
inventories to increase during 1996, with adverse effects upon the Company's
liquidity. In its transition in 1996 to an engineering and manufacturing company
from a reseller of goods manufactured by others, the Company experienced
difficulties in manufacturing operations, especially inventory management. These
difficulties were heightened by long lead time components, and the relocation
and consolidation of manufacturing operations in Colorado Springs. The Company
is taking the steps it believes necessary to bring its inventory down to
appropriate levels.

Backlog

         Before the production difficulties with the Apex product, the Company
generally shipped its products within a few days of receipt of an order and did
not have a significant backlog. In 1996, the Company carried a significant
backlog of orders for Apex and Apex - related products into the fourth quarter,
such that most Apex shipments in the fourth quarter were against backlog. The
Company completed shipping against the Apex backlog in the first quarter of
1997. There was no significant backlog in prior periods for comparison. The
prior Apex backlog is not believed to be indicative of foreseeable demand in
future quarters.

COMPETITION

         The newest optical technology, digital video disc ("DVD"), received
much publicity in 1996. Consumer versions of DVD-ROM players recently began
shipping, while computer data versions have not. The Company currently does not
expect rewriteable DVD-ROM technology to be available until late 1998 at the
earliest. Initial DVD capacity points are expected to be substantially below
those of what MO is expected to reach in that timeframe.

         The market for data storage products is competitive and changing,
characterized by price erosion and short product life cycles. The Company's
products compete directly with other optical storage products and removable
storage products. Competition also comes from storage products based on
alternative technologies such as hard disk drives and tape drives. The Company's
optical storage systems compete directly with those manufactured by Sony
Corporation, Hitachi, Ltd., Hewlett-Packard Company, Fujitsu Ltd., Panasonic,
Iomega, Syquest, MOST, Inc., Ricoh, Ltd., Phillips, N.V. and others. Most of
these companies have larger technical staffs, greater brand name recognition and
market presence, larger marketing and sales organizations and greater financial
resources than those of the Company. Certain of the Company's suppliers of
mechanical optical storage subassemblies also develop and market optical storage
systems that compete with those of the Company. Potential direct competitors
include certain computer storage peripheral manufacturers and business storage
systems manufacturers or developers, who may introduce optical storage products
or incorporate a competitive product in their own products. The major
competitive factors in the data storage market include product performance,
capacity, price, size and appearance, reliability, as well as the timing of new
product introductions. There can be no assurance that products based on
competing technologies will not have an adverse effect on the market for optical
data storage products.

         While the Company believes that its optical storage products should
compete favorably for applications that require removable, reliable, random
access storage, certain other products such as hard disk drives, tape drives or
other alternative storage technologies, separately or together in various
combinations, may compete more favorably for other applications. Hard disk
drives and tape drives may be less costly alternatives where removable storage
and data security are not required. Iomega Corporation's Jazz drive, a removable
storage product, appears to be selling well at its price and storage capacity.


                                       5
<PAGE>   6
The optical storage market is still developing. Hard disk drives are beginning
to compete in cost per megabyte. In the optical media market, the Company
competes as a reseller with a number of other companies, primarily on the basis
of price/performance and purchasing convenience. Optical media manufacturing is
limited to a few companies whose future decisions may affect the Company's media
business. There can be no assurance that the Company will be able to compete
successfully with manufacturers and other resellers of media or that competition
will not have a material adverse effect on the Company's results of operations.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

         The Company seeks to obtain the appropriate proprietary rights
protection for new technology it develops. The Company attempts to protect its
trade secrets and other proprietary information through agreements with
customers and suppliers, proprietary information agreements with employees and
consultants and other security measures. There can be no assurance that the
Company will be successful in protecting its proprietary technology. Actual
protection and its assumed benefits may differ materially from Company goals as
a result of the intellectual property rights and licensing strategies of the
Company's competitors and of other licensors.

         Certain of the Company's products are subject to patents or
intellectual property rights held by third parties. The Company seeks and
obtains license rights, including indemnification against infringement of such
patents or intellectual property rights, as necessary. The high technology
industry, including the data storage industry, has seen a great increase in
patent and related litigation in the past decade. Other entities may hold
patents or have applications on file, which, if valid or enforced, could
adversely affect the Company's use of certain of its technologies and processes.
There can be no assurance that the Company will be successful in obtaining
acceptable license rights and terms if in fact licenses are necessary. The
Company anticipates that it may have continuing obligations and expenses related
to licensing third party technology. There can be no assurance that third
parties will not assert infringement claims against the Company in the future or
that any such assertion may not require the Company to enter into royalty
arrangements or costly litigation.

         The Company has patent applications pending in the United States and
intends to file additional patent applications relating to the designs employed
within certain of its products, both hardware and software. There can, however,
be no assurance that any patents applied for will be granted.

EMPLOYEES

         As of March 17, 1997, the Company employed 166 full-time employees.
There was a significant turnover in employees in 1996, as a result of the
manufacturing restructuring, the reorganization of the sales force and the
change from a founder-managed business to a company run by professional
managers. The Company laid off 36 employees in 1996. The Company's future
success will depend in large part upon its ability to attract and retain highly
qualified technical, marketing, engineering and management personnel. The
Company's employees are not represented by any collective bargaining agreements,
and the Company has never experienced a work stoppage.

BACKGROUND RISK FACTORS

         In addition to the specific risks described elsewhere in this Form
10-K, the Company is subject to certain general risks which include but are not
limited to:

         Technological Competition. The Company's future depends materially on
its ability to timely develop and efficiently manufacture new optical storage
products to meet changing customer requirements and evolving industry standards.
Generally speaking, this requires offering higher storage capacities, faster
data transfer rates and lower data access times at the same or reduced costs. In
addition, market acceptance of MO solutions generally, aesthetic appeal and
software compatibility can be important competitive advantages or disadvantages.
The computer industry in general, and the market for the Company's products in
particular, is characterized by rapidly changing technology, evolving industry
standards, frequent new product introductions and significant price competition,
resulting in short product life cycles and reductions in unit selling prices
over the life of a specific product. Given the Company's limited working capital
resources, new product decisions are of fundamental importance to the Company's
prospects. The announcement, introduction or market expectation of new products
based on new or enhanced technologies, such as the DVD technology announcements
in 1996, the emergence of new industry standards, widely accepted operating
systems or significant price reductions on competitors' products may adversely
affect the sales and prices of the Company's products and the Company's results
of operations.


                                       6
<PAGE>   7
         There can be no assurance that there will be continued acceptance of
the Company's existing products or that the Company's future products will
achieve market acceptance at acceptable margins. There can be no assurance that
the Company will not experience significant delays in the introduction of new
products in the future, as it has in the past, which could have a material
adverse effect on the Company's results of operations.

         Fluctuations in Quarterly Operating Results. The Company's quarterly
operating results can fluctuate significantly depending on factors such as
timing of product introductions by the Company and its competitors, market
acceptance of new products and enhanced versions of the Company's existing
products, possible seasonality in the fourth quarter, changes in pricing
policies by the Company and its competitors, currency fluctuations and the
timing of expenditures on advertising, promotion and research and development.
In addition, the Company's component purchases, production and spending levels
are made based upon forecasted demand for the Company's products. Any
significant shortfall in forecasted demand could have an immediate adverse
impact on the Company's quarterly results of operations and financial condition.
Past results are not necessarily indicative of future performance for any
particular period, especially given the fundamental changes in the Company's
business in 1996, and there can be no assurance that the Company will experience
revenue growth and profitability in future periods.

         International Trade, Foreign Exchange Dependent Purchases; Currency
Fluctuations. The risks of international trade include foreign government
regulation, the difficulties of finding and retaining competent management,
miscommunication, local preferences and changes in taxes and duties. The
Company's OMA suppliers, media suppliers and a number of the Company's other
component suppliers are located in Japan, which subjects the Company to risks of
changes in government policies and regulatory requirements, transportation
delays and the imposition of tariffs and export controls. In the past the
Company experienced losses arising from changes in the Japanese Yen vs. U.S.
dollar exchange rates. In 1996, the Company reduced its currency risk by
converting most of its purchase contracts to be denominated in U.S. dollars.
There can be no assurance that the Company's future results of operations will
not be adversely affected by currency fluctuations.

ITEM 2. PROPERTIES

         The Company leases facilities in Irvine, California and Colorado
Springs, Colorado. In the fourth quarter, Irvine manufacturing operations and
two separate Colorado Springs facilities were consolidated into one facility in
Colorado Springs. The combined and reorganized engineering, manufacturing and
shipping operations were relocated, as of the first quarter of 1997, to a new
55,000 square foot facility in Colorado Springs at 4410 ArrowsWest Drive. All
engineering, manufacturing and shipping will be conducted at that facility for
the foreseeable future.

         The Irvine facility, following the transfer of manufacturing operations
to Colorado Springs, exceeds the Company's requirements. The Company is pursuing
subtenants for the former Colorado Springs facilities and the Irvine facility.
The Company plans to relocate Irvine-based executive, administrative, sales,
technical support and human resources staff to a smaller, more cost effective
facility.

ITEM 3. LEGAL PROCEEDINGS

         In the fourth quarter of 1995, the Company reached a settlement
agreement with the plaintiffs who filed the November 20, 1994, class action
complaint against the Company, certain of its officers and directors and the
Company's then independent auditors, Ernst & Young LLP. The complaint alleged
various violations of federal securities laws and claimed unspecified
compensatory damages and related fees and costs. The complaint was filed in the
United States District Court for the Central District of California under the
case name of Kurtz, et al. v. Blum, et al., Case No. SACV94-1043-GLT. Pursuant
to this settlement, the Company's insurance carrier paid $925,000 in cash in
December 1995, pursuant to a Directors and Officers liability policy purchased
by the Company. In 1996, the Company issued shares of the Company's common stock
valued at $1,400,000 to the plaintiff class and its attorneys.

         The Company and certain members and former members of its senior
management have been the subject of an investigation by the Securities and
Exchange Commission (the "SEC") relating principally to the restatement of the
Company's previously-reported financial results for 1993 and 1994. The Company
and its management believe that they fully cooperated with the investigation.
The resignation of the Company's prior independent public accountants on
February 20, 1996, led to additional inquiries by the SEC. These inquiries
relate principally to the accounting matters discussed in Note 12 of Notes to
Financial Statements (1995 adjustments).


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<PAGE>   8
         On March 15, 1996, a complaint was filed against the Company and
certain of its officers and directors in a securities class action lawsuit which
alleges that Company management engaged in improper accounting practices and
made certain false and misleading statements. The complaint claims unspecified
compensatory damages and related fees and costs. The complaint was filed in the
United States District Court for the Central District of California under the
case name Wills, Cohen, et al. v. William Blum et al., Case No. SACV96-261GLT.
The Company denies all allegations and intends to vigorously contest the suit.
The ultimate outcome of this matter cannot presently be determined. However, any
adverse determination with respect to the pending lawsuit could have a material
adverse effect on the financial statements. The Company may incur significant
legal costs relating to this suit in 1997. (See Note 9 of Notes to Financial
Statements).

         The Company is also subject to other legal proceedings and claims which
arise in the normal course of business. While the outcome of these proceedings
cannot be predicted with certainty, the Company does not believe that the
outcome of these other legal matters will have a material adverse effect on the
Company's financial statements.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders, through the solicitation
of proxies or otherwise.


                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The Company's common stock is traded on the Nasdaq National Market tier
of the Nasdaq Stock Market under the symbol PNCL. The following table sets
forth, for the periods indicated, the range of high and low bid prices for the
Company's common stock. These prices have been retroactively adjusted to reflect
the 50% stock dividend made effective on December 15, 1995. Such prices do not
include adjustments for retail mark-ups, mark-downs or commissions.

<TABLE>
<CAPTION>
                                                      High              Low
<S>                        <C>                    <C>              <C>       
1995:                      1st Quarter            $   9.583        $    6.333
                           2nd Quarter                9.333             5.833
                           3rd Quarter               15.833             7.833
                           4th Quarter               19.667            11.333

1996:                      1st Quarter               16.500             7.250
                           2nd Quarter               12.000             6.625
                           3rd Quarter                9.000             4.875
                           4th Quarter                8.750             2.000
</TABLE>

         There were 1,095 security holders of record as of March 17, 1997. Other
than S Corporation distributions to the Company's existing stockholders in
connection with the termination of the Company's S Corporation status on July 1,
1993, the Company has not paid cash dividends and intends to retain earnings for
use in the business for the foreseeable future. Under the terms of the Company's
revolving line of credit agreement (see Note 4 of the Notes to Financial
Statements), the Company is contractually restricted from paying cash dividends.

ITEM 6. SELECTED FINANCIAL DATA

         The following selected financial data should be read in conjunction
with the Financial Statements and the accompanying notes and the management's
discussion and analysis of financial condition and results of operations
appearing elsewhere herein. The statement of operations data for the years ended
December 28, 1996, December 30, 1995 and December 31, 1994, and the balance
sheet data at December 28, 1996 and December 30, 1995, is derived from, and
should be read in conjunction with, the audited financial statements included
elsewhere herein. The statement of operations data set forth below with respect
to 1993 and 1992 and the balance sheet data at December 31, 1992, is derived
from unaudited financial statements not included in this Form 10-K. The balance
sheet data at December 31, 1994 and December 31, 1993, is derived from audited
financial statements not included in this Form 10-K.


                                       8
<PAGE>   9
<TABLE>
<CAPTION>
FISCAL YEAR ENDED                                                   DEC. 28,     DEC. 30,     DEC. 31,    DEC. 31,    DEC. 31,
In thousands except per share data                                    1996         1995         1994        1993        1992
                                                                    --------     --------     --------    --------    --------
<S>                                                                 <C>          <C>          <C>         <C>         <C>
STATEMENT OF OPERATIONS DATA:
   Net sales ....................................................   $ 59,921     $ 81,844     $ 65,382    $ 38,887    $ 22,920
   Gross profit .................................................     11,829       21,952       19,784      11,990       7,532
   Income (loss) from operations ................................    (18,463)      (3,274)       4,231       1,267       1,423
   Net income (loss) ............................................    (20,833)      (2,459)       2,736       1,629       1,331
   Net income (loss) per share (1) ..............................      (2.52)       (0.31)        0.35          --          --

PRO FORMA STATEMENT OF OPERATIONS DATA (2):
   Pro forma net income .........................................   $     --     $     --     $     --    $    858    $    870
   Supplementary pro forma net income per share (1) .............         --           --           --        0.12        0.15

<CAPTION>
                                                                    DEC. 28,     DEC. 30,     DEC. 31,    DEC. 31,    DEC. 31,
In thousands                                                          1996         1995         1994        1993        1992
                                                                    --------     --------     --------    --------    --------
<S>                                                                 <C>          <C>          <C>         <C>         <C>
BALANCE SHEET DATA:
   Working capital ..............................................   $ 12,710     $ 15,527     $ 17,105    $ 14,787    $  2,354
   Total assets .................................................     40,238       32,005       28,855      22,129       7,297
   Notes payable and long-term debt .............................      9,698           --        1,439          55         240
   Stockholders' equity .........................................      8,503       16,741       18,911      15,814       3,021
</TABLE>

(1)      The net income (loss) per share and the supplementary pro forma net
         income per share have been retroactively restated to reflect the 1995
         stock dividend. (See Note 6 of Notes to Financial Statements).

(2)      Effective May 1, 1989, the Company elected to be taxed as an S
         Corporation. Accordingly, the provisions for income taxes for the
         periods from May 1989 to June 30, 1993 were computed by applying the
         California franchise tax rate for S Corporations of 2.5% to pretax
         earnings. The pro forma data are unaudited and reflect provisions for
         federal and state income taxes (assuming an effective tax rate of 36.3%
         and 36.5% for the years ended December 31, 1993 and 1992, respectively)
         as if the Company had not elected to be treated as an S Corporation
         during these periods. In accordance with a regulation of the SEC, the
         pro forma net income per share for the years ended December 31, 1993
         and 1992 reflect the effect of an assumed issuance of 301,352 average
         shares and 422,565 average shares, respectively, at the initial public
         offering price of $7.00 per share, which would have generated
         sufficient cash to pay an S Corporation distribution in an amount equal
         to retained earnings at June 30, 1993 and December 31, 1992,
         respectively.

                                       9
<PAGE>   10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

 THIS SECTION CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION
  27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE
    ACT OF 1934. ACTUAL RESULTS AND EVENTS COULD DIFFER MATERIALLY FROM THOSE
   PROJECTED AS A RESULT OF THE RISK FACTORS STATED HERE AND THROUGHOUT THIS
                                     REPORT.

GENERAL

         In 1996, the Company incurred a net loss of $20,833,000 on total sales
of $59,921,000. In its transition in 1996 from a reseller of OEM products to an
engineering and manufacturing company, the Company experienced delays in the
relaunch of its Vertex and Apex products as well as increased competition and
price pressure on its older RCD products. These were major contributing factors
to the net loss for 1996. The Company's future depends upon its ability to
develop markets for Apex technology, timely launch successor products and
continue its transformation to an engineering company. The Company has limited
time and resources to develop markets for the Apex technology. If demand for
Apex cannot be developed to satisfactory levels and sustained, the Company may
have liquidity constraints.

         The Vertex 2.6 GB product was announced in March 1996, and relaunched
in June 1996. The Apex 4.6 GB product was redesigned, extensively tested and in
full production by the end of the fourth quarter. The Company's goal to become a
successful research, development and manufacturing company will entail a
comprehensive change in corporate culture, increased working capital
requirements, separate R&D and manufacturing engineering functions, and will
require its operations to manufacture efficiently and manage inventory more
effectively.

Significant events affecting the Company in 1996 included:

         In March 1996, a complaint was filed against the Company and certain of
its officers and directors in a securities class action lawsuit alleging that
the Company's former management engaged in improper accounting practices and
made certain false and misleading statements. No provision for any liability
which may result from this matter has been made in the Company's financial
statements. An adverse determination with respect to the pending lawsuit could
have a material adverse effect on the Company. In 1997, the Company may incur
significant legal costs relating to this lawsuit. (See Note 9 of Notes to
Financial Statements).

         In July 1996, the Company sold $10,000,000 principal amount of 8%
convertible debentures in an offshore private placement. (See Note 5 of Notes to
Financial Statements). The proceeds of this placement were used to repay the
Company's outstanding loan balance in July 1996 and for working capital
purposes. Substantially all the debentures were converted during the third and
fourth quarters of 1996 and the first quarter of 1997 into nearly 2.5 million
shares of the Company's common stock.

         During 1996, the Company recorded restructuring charges of $3,028,000
for costs associated with the Company's planned consolidation and transfer of
manufacturing operations to Colorado Springs, Colorado and the closing of its
branch office in Japan. The Company also recorded $1,200,000 for estimated costs
associated with changes to a major component contract with a key supplier. (See
Note 7 of Notes to Financial Statements).

         In December 1996, the Company sold an additional $5,000,000 principal
amount of 6% convertible debentures pursuant to an offshore private placement.
Approximately $1,312,000 of the convertible debentures were converted as of
March 18, 1997, resulting in the issuance of approximately 430,000 shares of the
Company's common stock. The proceeds from this offering were used entirely for
the Company's liquidity needs at the end of the fourth quarter of 1996 and
during the first quarter of 1997. As of March 18, 1997, debentures aggregating
$11,212,000 have been converted into 2,806,943 shares of common stock at
conversion prices ranging from $2.10 to $6.44 per share. In addition, 68,540
shares of common stock were issued for interest payable on converted debentures.

         In 1996, the Company significantly changed the composition of its board
of directors and its senior management. At the beginning of the year, the
founders of the Company, William Blum, Scott Blum and James Hanley occupied
senior management positions. The Company hired new managers, including Jonathan
Eddison, Vice President and General Counsel, and Kenneth C. Campbell, then
Executive Vice President Technology, now President. In May, William Blum, a
founder, retired and resigned his positions as President, CEO and director. Mr.
Lawrence Goelman, an outside director, 


                                       10
<PAGE>   11
became CEO and President. Roger Hay joined the Company as Executive Vice
President and Chief Financial Officer in June.

         While the new management team was able to restructure the Company's
financing agreements (see Notes 4 and 5 of Notes to Financial Statements), and
to relaunch Vertex and Apex, the founders and the new management did not always
agree on their respective roles. Scott Blum resigned as an officer on October 1,
1996 but remained on the board of directors.

         John Koehler, Ph.D., and Hans Imhof joined the board of directors in
the fourth quarter. Mr. Goelman resigned on December 6, 1996, and Mr. Charles
Laverty also resigned.

         In a related development, Mr. Kenneth Campbell became President on
December 8, 1996 and joined the board of directors. At the same time, Roger Hay
was elected to the board, Scott Blum resigned as a director, and William Blum
rejoined the board. Scott Blum and William Blum entered into a standstill and
voting agreement dated December 8, 1996 pursuant to which they agreed (1) to
vote for the Company's board as constituted on December 8 or its nominees,
provided William Blum or his nominee was on the slate recommended by the board;
(2) to preserve Company confidential information and avoid interference with
management; and (3) to refrain from seeking to form or joining a group for the
purpose of acquiring or selling a controlling interest in the Company. In return
the Company agreed to register certain shares held by the Blums for resale if
requested to do so.

         There is no assurance that the standstill agreement will serve to
prevent further disagreements between the founders and the directors, or between
the founders and management, or that such disagreements will not become an issue
after the standstill agreement expires in December 1997.

         Delays in the manufacturing of the Apex and Vertex products caused the
Company's inventories to increase significantly in 1996, adversely impacting the
Company's liquidity and capital resources.

         During 1996, the Company carried a significant backlog of orders for
Apex and Apex-related products. Most shipments by the Company of Apex and
Apex-related products in the fourth quarter of 1996 were against the backlog.
The Company completed shipping against the backlog for Apex products during the
first quarter of 1997.

         See "Liquidity and Capital Resources" below for more information
concerning the Company's capital needs.


                                       11
<PAGE>   12
RESULTS OF OPERATIONS

         The following table sets forth certain statement of operations data as
a percentage of net sales for the fiscal years indicated:

<TABLE>
<CAPTION>
                                                  1996        1995        1994
                                                  -----       -----       -----
<S>                                               <C>         <C>         <C>
Net sales:
   Optical storage devices ..................     100.0%       99.3%       92.3%
   Components ...............................        --         0.7         7.7
                                                  -----       -----       -----
       Total net sales ......................     100.0       100.0       100.0
                                                  -----       -----       -----
Cost of sales:
   Optical storage devices ..................      80.3        72.6        62.8
   Components ...............................        --         0.6         7.0
                                                  -----       -----       -----
       Total cost of sales ..................      80.3        73.2        69.8
                                                  -----       -----       -----
   Gross profit .............................      19.7        26.8        30.2
                                                  -----       -----       -----
Operating expenses:
   Selling, general and administrative ......      32.6        22.1        18.6
   Research and development .................      10.0         6.1         4.1
   Nonrecurring charges .....................       7.9         2.6         1.0
                                                  -----       -----       -----
       Total operating expenses .............      50.5        30.8        23.7
                                                  -----       -----       -----
Operating income (loss) .....................     (30.8)       (4.0)        6.5
Interest income .............................       0.1         0.2         0.3
Interest expense ............................      (0.9)         --          --
Non-cash interest expense ...................      (2.9)         --          --
                                                  -----       -----       -----
Income (loss) before income taxes ...........     (34.5)       (3.8)        6.8
Income tax expense (benefit) ................       0.3        (0.8)        2.6
                                                  -----       -----       -----
   Net income (loss) ........................     (34.8)%      (3.0)%       4.2%
                                                  =====       =====       =====
</TABLE>

COMPARISON OF 1996 TO 1995

         Net Sales. Net sales of optical storage devices decreased 26% to
$59,921,000 in 1996. The decrease was primarily attributable to the decline in
the average sales price of older RCD products as competition increased as
additional manufacturers entered the market. Additionally, while unit sales of
5.25" optical storage devices in 1996 were greater than in 1995, the average
sales prices of Apex and Vertex in 1996 was less than the average sales price of
its predecessor, Sierra, in 1995. As a result, sales for 5.25" optical storage
devices was approximately unchanged between 1996 and 1995.

         Sales of components were $535,000 in 1995; there were no comparable
sales in 1996. The 1995 component sales were to a key supplier of the Company.

         Gross Profit. Gross profit from optical storage devices decreased 45.9%
to $11,829,000 in 1996, and decreased as a percentage of optical storage device
revenue to 19.7% in 1996 from 26.9% in 1995. Increased competition in the RCD
market place and the continued delay in production of Apex and Vertex, which
replaced the end of life Sierra, each contributed to the decreased gross profit.
The Company's gross margin as a percent of net sales increased to 24.8% in the
fourth quarter of 1996 as the Company began to ship Apex.

         Selling, General and Administrative. Selling, general and
administrative expenses increased 8.0% to $19,565,000 in 1996 and increased as a
percentage of net sales to 32.6% in 1996 from 22.1% in 1995. During 1996,
expenses were reduced by $478,000, or 0.8% of net sales, due to gains in foreign
currency denominated transactions as the U.S. dollar appreciated against the
Japanese Yen. In contrast, expenses were increased by $473,000, or 0.6% of net
sales during 1995 due to losses on such transactions. The 1996 net increase was
primarily the result of the expansion of the sales and administrative staff. The
Company expects that selling, general and administrative expenses will decrease
in 1997 due to the Company's plans to reduce costs in the process of realigning
its operations.

         Research and Development. Research and development expenses increased
20.7% to $6,006,000 in 1996, and increased as a percentage of net sales to 10.0%
in 1996 from 6.1% in 1995. The increases in research and development expenses
were primarily due to the expansion of the research and development staff, and
expenses associated with its research and development facility. The majority of
these increased costs related to the support of the Apex product 


                                       12
<PAGE>   13
development. The Company expects that research and development expenses in 1997
will focus primarily on development of Apex II.

         Nonrecurring charges. Nonrecurring charges were $4,721,000 and
$2,132,000 in 1996 and 1995, respectively. Included in nonrecurring charges are
costs associated with the Company's restructuring, a contract modification in
1996 and litigation settlement charges in 1995 and certain professional fees
related to the restatements and related legal matters. The 1996 restructuring
charge of $3,028,000 was for costs associated with the Company's planned
consolidation and transfer of manufacturing operations to Colorado Springs,
Colorado and the closing of its branch office in Japan. These restructuring
charges principally reflect the costs associated with early termination of
existing leases, losses from the disposal of assets and severance costs
resulting from work force reductions. (See Notes 7 and 9 of Notes to Financial
Statements).

         Interest Income and Interest Expense. Interest income was $84,000 and
$187,000 and interest expense was $549,000 and $35,000 in 1996 and 1995,
respectively. While the Company only borrowed on its line of credit sporadically
during 1995, it was frequently in a borrowing position on its line of credit in
1996. Additionally, the Company issued convertible debentures in amounts of
$10,000,000 in July 1996 and $5,000,000 in December 1996 which accrued interest
at 8% and 6%, respectively. (See Notes 4 and 5 of Notes to Financial
Statements).

         Non-cash Interest Expense Related to Convertible Debentures. Non-cash
interest expense results from issuing debentures which are convertible at a
discount from market price of the common stock. The non-cash interest recorded
on the convertible debentures is amortized over the periods which the debentures
first become convertible and will have no effect on stockholders' equity and
operating income. The Company expects an additional non-cash interest charge of
$786,000 to record the effect of the deferred interest expense in 1997. (See
Note 5 of Notes to Financial Statements).

         Income Taxes. Income tax expense was $184,000 and income tax benefit
was $663,000 for 1996 and 1995, respectively. (See Note 8 of Notes to Financial
Statements).

COMPARISON OF 1995 TO 1994

         Net Sales. Net sales of optical storage devices were approximately
$60,345,000 and $81,309,000 in 1994 and 1995, respectively, representing an
increase of approximately 35%. The increase was primarily attributable to
increased unit sales across all product lines, introduction of the RCD-1000 in
the fourth quarter 1994 and increased international sales. Increased units sales
were partially offset by a continuing decline in the average unit sales prices
of the Company's products. International and export sales increased by
approximately 48% from $19,112,000 in 1994 to $28,291,000 in 1995.

         Sales of components were $5,037,000 and $535,000 in 1994 and 1995,
respectively. These components, which are electronic chips used in the Company's
optical storage products, were purchased in anticipation of greater demand for
these products than actually materialized. The Company sold these excess
electronic chips throughout 1994. The contract for the purchase of these
electronic chips expired in January 1995, at which time electronic chip sales
decreased substantially. The 1995 component sales were to a key supplier of the
Company.

         Gross Profit. Gross profit of optical storage devices increased from
$19,301,000 in 1994 to $21,872,000 in 1995, but decreased as a percentage of
optical storage devices sales from 32.0% to 26.9%. The decreased gross profit
percentage resulted from aggressive product pricing and increased component
costs as a result of the weak U.S. dollar in comparison to the Japanese Yen
during much of 1995. In addition, the Company purchases many of the components
used in its systems from Japanese suppliers. These transactions are largely
denominated in Japanese Yen and the Company's gross profit and gross profit
margin can be significantly impacted by fluctuations in the foreign currency
markets.

         Gross profit of components was $483,000 or 9.6% of component sales in
1994, compared to $80,000 or 15.0% in 1995. The Company provides essentially no
value added activities related to these sales.

         Selling, General and Administrative. Selling, general and
administrative expenses were $12,149,000 and $18,116,000 in 1994 and 1995,
respectively, and represented approximately 18.6% and 22.1% of net sales. During
1995, $473,000 of the expenses, or 0.6% of net sales, were due to losses in
foreign currency denominated transactions due to the decline of the U.S. dollar
against the Japanese Yen, compared to similar losses of approximately $195,000,
or 0.3% of net sales, in 1994. The increase in expenditures was also the result
of increases in advertising, marketing and trade show expenditures, the
expansion of the sales and administrative staff, and the expenses related to
sales offices in The Netherlands and Japan, which were expanded during 1995.


                                       13
<PAGE>   14
         Research and Development. Research and development expenses were
$2,708,000 and $4,978,000 in 1994 and 1995, respectively, and represented
approximately 4.1% and 6.1% of net sales. The increases in research and
development expenses were primarily due to the expansion of the research and
development staff, increased costs associated with third party software and
hardware development contracts and expenses associated with its research and
development facility. The majority of these increased costs related to the
support of the Apex product development.

         Nonrecurring charges. Nonrecurring charges were $696,000 and $2,132,000
in 1994 and 1995, respectively. Included in nonrecurring charges are litigation
settlement charges and certain professional fees related to the restatements and
related legal matters. (See Notes 7 and 9 of Notes to Financial Statements).

         Provision for Income Taxes. The provision for income taxes was
$1,713,000 for 1994, or an effective income tax rate of approximately 38.5%. The
income tax benefit was $663,000 for 1995. (See Note 8 of Notes to Financial
Statements).

LIQUIDITY AND CAPITAL RESOURCES

         Cash and cash equivalents at December 28, 1996 increased by $1,849,000
from the December 30, 1995 balance. This increase in available cash balances at
December 28, 1996 occurred entirely due to the proceeds from the Company's
second offshore private placement of $5,000,000 which occurred just prior to
year-end. Operating activities used cash and cash equivalents of $14,889,000,
$713,000 and $1,912,000 in 1996, 1995 and 1994, respectively. Inventories
increased by $7,167,000 in 1996. The 1996 increase in inventories was due to the
continuing manufacturing delays in Apex and inventory management problems. The
increase in inventories has been partially offset by an increase in accounts
payable as certain vendors agreed to temporarily extend payment terms.

         The Company's announced restructuring in 1996 caused accrued expenses
and other liabilities to increase at year-end 1996 as most restructuring costs
will be paid or incurred throughout 1997 and 1998. The $1,740,000 and $1,361,000
increases in accounts receivable during 1996 and 1995, respectively, were
primarily due to the timing of sales in 1996 and the increase in sales in 1995.
The Company's investing activities during this period included capital
expenditures for computers, furniture and equipment and represented $904,000,
$1,841,000 and $840,000 for 1996, 1995 and 1994, respectively. The increase in
1995 capital expenditures resulted from the Company's development of its
internal manufacturing capabilities and enhancement of its information systems.

         As of December 28, 1996, the Company has an income tax receivable of
$1,984,000. This amount should be refunded from the U.S. Government as tax
losses for 1996 and 1995 are carried back to prior years. A valuation allowance
is provided when it is more likely than not that some portion or all of the
deferred tax assets will not be realized. As a result of the Company's
significant losses in 1996 and uncertainties surrounding the realization of the
net operating loss carryforward which was generated during 1996, management has
determined that the realization of the deferred tax assets is not more likely
than not. Accordingly, a 100% valuation allowance has been recorded. (See Note 8
of Notes to Financial Statements).

         The Company currently has a revolving line of credit agreement with a
lender which is collateralized by substantially all assets of the Company and
which expires on September 30, 1998. The Company has a maximum availability of
$10,000,000 under the line of credit based on a percentage of eligible accounts
receivables and inventories. Interest is payable monthly at the lender's
reference rate (8.25% at December 28, 1996) plus 1.75%. As of December 28, 1996
and March 17, 1997, the Company was in compliance with all covenants under the
line of credit. While the Company had no borrowings under its previous line of
credit agreement at December 30, 1995, its borrowings under the current line of
credit totaled $3,276,000 at December 28, 1996 and $6,044,000 at March 17, 1997.
(See Note 4 of Notes to Financial Statements).

         The Company's financing activities provided cash and cash equivalents
of $17,548,000 and $1,517,000 in 1996 and 1994, respectively, and used $964,000
in 1995. The significant cash provided in 1996 resulted from the issuance of
$15,000,000 of convertible debentures and net borrowings of $3,276,000 on its
line of credit. These significant borrowings were necessary to fund the
continuing net losses of the Company which were $20,833,000 in 1996 and
$2,459,000 in 1995. (See Notes 4 and 5 of Notes to Financial Statements).

         The Company believes that its existing cash balances, anticipated cash
flows from operating activities and borrowings under its line of credit will be
sufficient to support its working capital needs, capital expenditures
requirements, 


                                       14
<PAGE>   15
minimum lease payments and restructuring costs for the next twelve months.
However, the Company has recently experienced significant losses from
operations. The Company is taking the steps it believes necessary to bring its
inventory to appropriate levels which will provide cash flows from operating
activities. As part of its relocation to new facilities, the Company will have
capital expenditure requirements of approximately $1,000,000 in the first
quarter of 1997. The Company's ability to meet its future liquidity requirements
is dependent upon its ability to operate profitably or, in the absence thereof,
continued availability under its line of credit and to arrange additional
financing.

         The Company's line of credit expires on September 30, 1998 and there
can be no assurances the credit facility will be extended beyond such date. In
an effort to address its working capital needs, the Company has taken or intends
to take a number of actions including (i) a combination and consolidation of its
manufacturing facilities in a single facility located in Colorado Springs,
Colorado; (ii) seeking subtenants for the Company's former Colorado Springs
facility and the Company's Irvine facility; (iii) hiring a new Vice President of
Operations whose responsibilities include inventory management; and (iv)
increased efforts to develop markets for the Company's core Apex technology and
Apex-related products. No assurances can be given that such efforts will
significantly improve the Company's working capital situation.

         Because of the Company's present financial condition, normal sources of
external financing may not be available to the Company in the future, including
a replacement line of credit. The Company has not identified as of this filing
any additional financing and is unable to indicate at this time whether any
additional financing will be available to the Company in the future.


                                       15
<PAGE>   16
QUARTERLY RESULTS OF OPERATIONS

         The following table sets forth certain quarterly financial data for the
Company's operations during the eight quarters ended December 28, 1996, and such
data as a percentage of net sales. This quarterly information is unaudited and
has been prepared on the same basis as the annual financial statements and, in
management's opinion, reflects all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the information set forth
therein. The operating results for any quarter are not necessarily indicative of
results for any future period.


<TABLE>
<CAPTION>
                                                                          QUARTER ENDED
                                --------------------------------------------------------------------------------------------
                                APRIL 1,    JULY 1,    SEPT. 30,   DEC. 30,    MAR. 30,    JUN. 29,    SEPT. 28,    DEC. 28,
                                  1995       1995        1995        1995        1996        1996        1996        1996
                                -------     -------     -------     -------     -------     -------     -------     -------
                                                          (1)                                             (2)
                                                              (in thousands, except per share data)
<S>                             <C>         <C>         <C>         <C>         <C>         <C>         <C>         <C>
STATEMENT OF OPERATIONS DATA:
Net sales:
   Optical storage devices .... $20,185     $20,600     $20,980     $19,544     $17,434     $12,333     $14,259     $15,895
   Components .................      --          --         421         114          --          --          --          --
                                -------     -------     -------     -------     -------     -------     -------     -------
     Total net sales ..........  20,185      20,600      21,401      19,658      17,434      12,333      14,259      15,895
                                -------     -------     -------     -------     -------     -------     -------     -------
Cost of sales:
   Optical storage devices ....  14,501      15,201      15,142      14,593      14,306      10,180      11,646      11,960
   Components .................      --          --         348         107          --          --          --          --
                                -------     -------     -------     -------     -------     -------     -------     -------
     Total cost of sales ......  14,501      15,201      15,490      14,700      14,306      10,180      11,646      11,960
                                -------     -------     -------     -------     -------     -------     -------     -------
   Gross profit ...............   5,684       5,399       5,911       4,958       3,128       2,153       2,613       3,935
Operating expenses:
   Selling, general and
     administrative ...........   4,692       4,106       4,325       4,993       5,252       4,429       4,451       5,433
   Research and development....     789         891       1,378       1,920       1,592       1,436       1,494       1,484
   Nonrecurring charges .......     225         183         198       1,526         164          87       4,333         137
                                -------     -------     -------     -------     -------     -------     -------     -------
     Total operating expenses..   5,706       5,180       5,901       8,439       7,008       5,952      10,278       7,054
                                -------     -------     -------     -------     -------     -------     -------     -------
Operating income (loss) .......     (22)        219          10      (3,481)     (3,880)     (3,799)     (7,665)     (3,119)
Interest income ...............      50          55          41          41           4          --          59          21
Interest expense ..............      (9)        (10)        (12)         (4)        (36)       (114)       (201)       (198)
Non-cash interest expense .....      --          --          --          --          --          --      (1,286)       (435)
                                -------     -------     -------     -------     -------     -------     -------     -------
Income (loss) before income
  taxes .......................      19         264          39      (3,444)     (3,912)     (3,913)     (9,093)     (3,731)
Income tax expense (benefit)...       7         102          15        (787)          3          --          --         181
                                -------     -------     -------     -------     -------     -------     -------     -------
Net income (loss) ............. $    12     $   162     $    24     $(2,657)    $(3,915)    $(3,913)    $(9,093)    $(3,912)
                                =======     =======     =======     =======     =======     =======     =======     =======
Net income (loss) per share.... $  0.00     $  0.02     $  0.00     $ (0.34)    $ (0.50)    $ (0.49)    $ (1.15)    $ (0.42)
                                =======     =======     =======     =======     =======     =======     =======     =======


PERCENTAGE OF NET SALES:
   Net sales:
     Optical storage devices      100.0%      100.0%       98.0%       99.4%      100.0%      100.0%      100.0%      100.0%
     Components ...............      --          --         2.0         0.6          --          --          --          --
                                -------     -------     -------     -------     -------     -------     -------     -------
       Total net sales ........   100.0       100.0       100.0       100.0       100.0       100.0       100.0       100.0
                                -------     -------     -------     -------     -------     -------     -------     -------
       Cost of sales:
     Optical storage devices...    71.8        73.8        70.8        74.2        82.1        82.5        81.7        75.2
     Components ...............      --          --         1.6         0.6          --          --          --          --
                                -------     -------     -------     -------     -------     -------     -------     -------
     Total cost of sales ......    71.8        73.8        72.4        74.8        82.1        82.5        81.7        75.2
                                -------     -------     -------     -------     -------     -------     -------     -------
   Gross profit ...............    28.2        26.2        27.6        25.2        17.9        17.5        18.3        24.8
Operating expenses:
   Selling, general and
     administrative ...........    23.3        19.9        20.2        25.4        30.2        35.9        31.2        34.2
   Research and development....     3.9         4.3         6.4         9.7         9.1        11.7        10.5         9.3
   Nonrecurring charges .......     1.1         0.9         0.9         7.8         0.9         0.7        30.4         0.9
                                -------     -------     -------     -------     -------     -------     -------     -------
     Total operating expenses..    28.3        25.1        27.5        42.9        40.2        48.3        72.1        44.4
                                -------     -------     -------     -------     -------     -------     -------     -------
Operating income (loss) .......    (0.1)        1.1         0.1       (17.7)      (22.3)      (30.8)      (53.8)      (19.6)
Interest income ...............     0.2         0.2         0.2         0.2          --          --         0.4         0.1
Interest expense ..............      --          --        (0.1)         --        (0.2)       (0.9)       (1.4)       (1.3)
Non-cash interest expense .....      --          --          --          --          --          --        (9.0)       (2.7)
                                -------     -------     -------     -------     -------     -------     -------     -------
Income (loss) before income
  taxes .......................     0.1         1.3         0.2       (17.5)      (22.5)      (31.7)      (63.8)      (23.5)
Income tax expense (benefit)         --         0.5         0.1        (4.0)         --          --          --         1.1
                                -------     -------     -------     -------     -------     -------     -------     -------
   Net income (loss) ..........     0.1%        0.8%        0.1%      (13.5)%     (22.5)%     (31.7)%     (63.8)%     (24.6)%
                                =======     =======     =======     =======     =======     =======     =======     =======
</TABLE>

(1) Balances are as reflected in Form 10-Q/A filed with the SEC on April 12,
    1996.
(2) Balances are as reflected in Form 10-Q/A filed with the SEC on March 25,
    1997. (See Note 12 of Notes to Financial Statements).

         The Company's quarterly operating results can fluctuate significantly
depending on factors such as timing of product introductions by the Company and
its competitors, market acceptance of new products and enhanced versions of the
Company's existing products, possible seasonality in the fourth quarter, changes
in pricing policies by the Company and its competitors, currency fluctuations
and the timing of expenditures on advertising, promotion and research and
development.


                                       16
<PAGE>   17
1997 TRENDS

         The Company's business changed so much in 1996 that prior periods
provide a limited basis for useful comparison. The Company is in its early
stages as an R&D and manufacturing company based upon the Apex technology. The
OEM reseller business must provide complementary product lines and necessary
revenue diversification. The Company's liquidity has deteriorated due to the
following recent trends:

         Apex Bookings. Apex bookings lag significantly below Apex shipments.
The long-standing order backlog for Apex was substantially shipped as of March
17, 1997 leaving minimal backlog. A critical task facing the Company in 1997 is
building demand for the Apex technology (and applications of that technology
such as optical libraries). In the past the Company committed significant
resources to mass market advertising of its products and of optical technology.
The Company is developing a new marketing approach with the aid of its new Vice
President of Marketing, internal and external market research and outside
consultants. The new marketing strategy is being tested and is not yet proven in
the market. The Company has limited time and resources to develop the markets
for its core Apex technology and products. If demand for Apex cannot be
developed to satisfactory levels and sustained the Company may have liquidity
constraints.

         Inventory. Inventory balances were higher at March 17, 1997, than at
year-end 1996. The higher inventory results from declining Apex bookings and the
long-lead nature of many Apex components. If Apex demand can not be increased,
the Company's liquidity will further deteriorate as inventory balances remain at
these high levels. Additionally, the Company's exposure to obsolete inventory
increases.

         Cash and Liquidity. From year-end 1996 to March 17, 1997, the Company's
cash balance decreased from $5,455,000 to less than $1,000,000 and borrowings on
the Company's line of credit increased from $3,276,000 to $6,044,000. The
build-up of inventory balances, continuing operating losses and costs to
relocate and consolidate operations are largely responsible for the use of cash
and increased borrowings on the line of credit during this period. The Company
is taking the steps it believes necessary to bring its inventory and operating
expense to appropriate levels.

INFLATION AND FOREIGN CURRENCY EXCHANGE

         Inflation has not had a significant impact on the Company's operating
results. The Company has from time-to-time attempted to reduce its anticipated
exposure to currency fluctuations by negotiating price and other cost
concessions from its suppliers, and by entering hedging transactions, including
the purchase of forward contracts for foreign currencies. Although the Company
monitors the fluctuations in the value of the Japanese Yen and other relative
currencies and may engage in hedging transactions in the future, the Company
believes that such transactions may be too expensive to adopt as a general
strategy. There can be no assurance that the Company's results of operations
will not be adversely affected by currency fluctuations.

         THIS SECTION AND THIS ENTIRE REPORT ON FORM 10-K CONTAIN
         FORWARD-LOOKING STATEMENTS AND INCLUDE ASSUMPTIONS CONCERNING THE
         COMPANY'S OPERATIONS, FUTURE RESULTS AND PROSPECTS. THESE
         FORWARD-LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS AND ARE
         SUBJECT TO A NUMBER OF RISKS, UNCERTAINTIES AND OTHER FACTORS. IN
         CONNECTION WITH THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995,
         THE COMPANY PROVIDES THE FOLLOWING CAUTIONARY STATEMENTS IDENTIFYING
         IMPORTANT FACTORS WHICH, AMONG OTHER THINGS, COULD CAUSE THE ACTUAL
         RESULTS AND EVENTS TO DIFFER MATERIALLY FROM THOSE SET FORTH IN OR
         IMPLIED BY THE FORWARD-LOOKING STATEMENTS AND RELATED ASSUMPTIONS
         CONTAINED IN THIS SECTION AND IN THIS ENTIRE REPORT.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The financial statements and supplementary data of the Company required
by this item are set forth at the pages indicated at Item 14(a)(1).


                                       17
<PAGE>   18
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

COOPERS & LYBRAND L.L.P.

         As noted in the Company's Form 8-K dated February 20, 1996, the
engagement of Coopers & Lybrand L.L.P., the former independent accountants of
the Company, was terminated by the resignation of Coopers & Lybrand L.L.P. on
February 20, 1996.

ERNST & YOUNG LLP

         As noted in the Company's Form 8-K dated March 30, 1995, the engagement
of Ernst & Young LLP, the former independent accountants of the Company, was
terminated by the resignation of Ernst & Young LLP on March 30, 1995.


                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; ITEM 11. EXECUTIVE
COMPENSATION; ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT; AND ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS are
incorporated herein by reference to the information supplied pursuant to those
Items in the Company's Proxy Statement for the 1997 Annual Meeting of
shareholders which will be filed with the SEC no later than 120 days after the
close of the fiscal year ended December 28, 1996.


                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

         (a) The following documents are filed as a part of this Report:

         (1) Financial Statements.

                        Indexing to Financial Statements
                        --------------------------------
<TABLE>
<CAPTION>
                                                                                                     Page No.
                                                                                                     --------
<S>                                                                                                     <C>
         Report of Independent Certified Public Accountants - 1996 and 1995 Financial Statements        23
         Report of Independent Accountants - 1994 Financial Statements                                  24
         Balance Sheets - December 28, 1996 and December 30, 1995                                       25
         Statements of Operations - Years Ended December 28, 1996, December 30, 1995
              and December 31, 1994                                                                     26
         Statements of Stockholders' Equity - Years Ended December 28, 1996,
              December 30, 1995 and December 31, 1994                                                   27
         Statements of Cash Flows - Years Ended December 28, 1996,
              December 30, 1995 and December 31, 1994                                                   28
         Notes to Financial Statements                                                                  30
</TABLE>

         (2)      Financial Statement Schedule. The following financial
                  statement schedule of Pinnacle Micro, Inc., is filed as part
                  of this Report and should be read in conjunction with the
                  Financial Statements of Pinnacle Micro, Inc.:


                                       18
<PAGE>   19
                      Index to Financial Statement Schedule
<TABLE>
<CAPTION>
                                                                                                     Page No.
                                                                                                     --------
<S>                                                                                                     <C>
         Schedule II - Valuation and Qualifying Accounts                                                42
</TABLE>

         All other schedules are omitted because they are not required or the
required information is included in the financial statements or notes thereto.

         (3)      Exhibits:

<TABLE>
<CAPTION>
             Exhibit No.                           Description                                                      Location
             -----------                           -----------                                                      --------
<S>                          <C>                                                                                       <C>
                  3.1        Certificate of Incorporation of the Company.                                              (1)
                  3.2        Bylaws of the Company, as currently in effect.                                            (1)
                  4.1        Specimen Certificate of Common Stock.                                                     (1)
                 10.1*       Pinnacle Micro, Inc. Incentive Stock Option, Nonqualified Stock Option
                             and Restricted Stock Purchase Plan -- 1989 (the "1989 Plan").                             (1)
                 10.2*       Form of Incentive Stock Option Agreement pertaining to the 1989 Plan.                     (1)
                 10.3*       Pinnacle Micro, Inc. Incentive Stock Option, Nonqualified Stock Option
                             and Restricted Stock Purchase Plan -- 1993 (the "1993 Plan").                             (1)
                 10.4*       Form of Incentive Stock Option Agreement pertaining to the 1993 Plan.                     (1)
                 10.5*       Form of Nonqualified Stock Option Agreement pertaining to the 1993 Plan.                  (1)
                 10.6*       Form of Restricted Stock Purchase Agreement pertaining to the 1993 Plan.                  (1)
                 10.7        Pinnacle Micro, Inc. Employee Stock Purchase Plan.                                        (1)
                 10.8        Distributor Agreement, dated June 14, 1991, by and between the Company
                             and Merisel Inc., together with Amendment dated June 14, 1991
                             and Addendum dated February 11, 1993.                                                     (1)
                 10.9        Distributor Agreement, dated July 30, 1991, by and between the
                             Company and Tech Data Corporation, together with Addendum No. 1
                             to Distributor Agreement dated July 30, 1991.                                             (1)
                 10.10       Distributor Agreement, dated August 18, 1989, by and between the
                             Company and Ingram Micro D Inc., together with Addenda Nos. 1, 2, 3, 4 and 5.             (1)
                 10.11       Peripherals OEM Purchase Agreement, dated May 1, 1991, by and
                             between the Company and Hewlett-Packard Company, together with
                             Amendment to Peripherals OEM Agreement No. A509M, effective May 12, 1992.                 (1)
                 10.12       Computer Peripheral Products Company Peripheral Systems Products
                             Agreement, dated April 1, 1992, by and between the Company and
                             Computer Peripheral Products Company, Sony Corporation of America.                        (1)
                 10.13       Basic Agreement, dated April 1, 1992, by and between the Company
                             and Sony Corp. in Japan.                                                                  (1)
                 10.14       Agreement, effective October 28, 1991, by and between the Company
                             and Olympus Optical Co., Ltd., together with Memorandum dated 
                             February 19, 1992, Addendum dated August 1, 1992, Memorandum
                             dated September 9, 1992 and letter dated October 15, 1992.                                (1)
                 10.15+      OKI Semiconductor Standard Products Volume Purchase Agreement,
                             dated August 17, 1992, by and between the Company and OKI Semiconductor.                  (1)
                 10.16+      Nippon Pinnacle Micro, Pinnacle Micro and Ricoh Company Ltd.
                             Purchase Agreement, dated October 1, 1992, by and among the
                             Company, Nippon Pinnacle Micro and Ricoh Company Ltd.                                     (1)
                 10.17       Agreement on Sale and Purchase, dated January 1, 1993, by and
                             between the Company and Victor Company of Japan, Limited, together
                             with Addenda Nos. I, II and III.                                                          (1)
                 10.19       Lease, dated January 6, 1993, by and between the Company and
                             Webb/Colorado Ventures, Ltd.                                                              (1)
                 10.20       Lease, dated February 5, 1991, by and between the Company and
                             The Irvine Company, together with Amendment Nos. 1, 2, 3 and 4.                           (1)
</TABLE>


                                       19
<PAGE>   20
<TABLE>
<CAPTION>
             Exhibit No.                           Description                                                      Location
             -----------                           -----------                                                      --------
<S>                          <C>                                                                                       <C>
                 10.21       Form of Indemnification Agreement for officers and directors of the Company.              (1)
                 10.22*      Form of Nonqualified Stock Agreement pertaining to the 1989 Plan.                         (1)
                 10.23       Business Loan Agreement, dated August 4, 1994, by and between the
                             Company and Bank of America, together with Amendment No. One,
                             dated October 4, 1994 and Amendment No. Two, dated February 2, 1995.                      (2)
                 10.24(a)    Amendment No. Three, dated August 31, 1995, to Business Loan
                             Agreement, dated August 4, 1994, by and between the Company
                             and Bank of America.                                                                      (3)
                 10.24(b)    Amendment No. Four, dated October 10, 1995, to Business
                             Loan Agreement, dated August 4, 1994, by and between the
                             Company and Bank of America.                                                              (3)
                 10.24(c)    Amendment No. Five, dated January 24, 1996, to Business Loan
                             Agreement, dated August 4, 1994, by and between the Company
                             and Bank of America.                                                                      (3)
                 10.24(d)    Amendment No. Six, dated March 28, 1996, to Business Loan
                             Agreement, dated August 4, 1994, by and between the Company
                             and Bank of America.                                                                      (3)
                 10.25++     Development, Manufacturing and Purchasing Agreement dated
                             June 30, 1995, by and between the Company and Asahi Optical Co., LTD.                     (3)
                 10.26*      Employment Agreement dated December 15, 1995, by and
                             between the Company and James G. Hanley.                                                  (3)
                 10.27*      First Amendment to the 1993 Equity Incentive Plan of Pinnacle
                             Micro, Inc. (the "1993 Plan").                                                            (3)
                 10.28*      First Amendment to the 1989 Equity Incentive Plan of Pinnacle
                             Micro, Inc. (the "1989 Plan").                                                            (3)
                 10.29++     Development and Manufacturing Agreement dated October 6,
                             1994, by and between the Company and Advanced Hardware
                             Architectures, Inc.                                                                       (3)
                 10.30++     Computer 2000 Purchase Agreement dated September 13, 1995,
                             by and between the Company and Computer 2000.                                             (3)
                 10.31       Stipulation of settlement - Class action - Kurtz, et al. vs. Blum, et al.;
                             Case No. SAC-94-1043-GLT(EEx).                                                            (3)
                 10.32       Form of Offshore Subscription Agreement.                                                  (4)
                 10.33       Form of Convertible Debentures.                                                           (4)
                 10.34       Form of Registration Rights Agreement.                                                    (4)
                 10.35       Loan and Security Agreement with Coast Business Credit dated
                             September 18, 1996.                                                                       (5)
                 10.36*      1996 Long-Term Incentive Plan.                                                            46
                 10.37*      1996 Non-Employee Directors Stock Option Plan.                                            59
                 10.38*      Employment Agreement for Kenneth Campbell as of December 1, 1996.                         63
                 10.39*      Employment Agreement for Roger Hay as of December 1, 1996.                                69
                 10.40*      Employment Agreement for Jonathan B. Eddison as of December 1, 1996.                      75
                 10.41*      Employment Agreement for Kevin Lehnert as of December 1, 1996.                            81
                 10.42*      Employment Agreement for David Ooley as of December 1, 1996.                              87
                 10.43*      Stand-still and Voting Rights Agreement dated December 8, 1996.                           93
                 10.44*      Scott Blum - Severance Agreement and Release of February 13, 1997.                        96
                 23.1        Consent of BDO Seidman, LLP.
                 23.2        Consent of Coopers & Lybrand L.L.P.
                 24.1        Power of Attorney.
                 27.1        Financial Data Schedule.
</TABLE>

----------
(1)      Incorporated by reference to the referenced exhibit number to the
         Company's Registration Statement on Form S-1, Reg. No. 33-62614.
(2)      Incorporated by reference to exhibit filed with the Company's Report on
         Form 10-K for the fiscal year ended December 31, 1994.


                                       20
<PAGE>   21
(3)      Incorporated by reference to exhibit filed with the Company's Report on
         Form 10-K for the fiscal year ended December 30, 1995.
(4)      Incorporated by reference to the exhibit filed with the Company's
         Report on Form 10-Q for the period ended June 29, 1996.
(5)      Incorporated by reference to the exhibit filed with the Company's
         Report on Form 10-Q for the period ended September 28, 1996.


----------

*        Denotes applicable executive compensation plans and arrangements of the
         Company.
+        Confidential treatment has been granted by the Commission. The copy
         filed as an exhibit omits the information subject to the
         confidentiality grant.
++       Confidentiality treatment has been requested. The copy filed as an
         exhibit omits the information subject to the confidentiality request.

         (b) Reports on Form 8-K

         October 1, 1996      Scott Blum resignation
         December 6, 1996     Lawrence Goelman and Charles Laverty resignations;
                              Standstill and Voting Agreement
         December 20, 1996    Closing of Offshore Private Placement of 
                              Convertible Debentures for $5 million


                                       21
<PAGE>   22
SIGNATURES

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

                                    PINNACLE MICRO, INC.

March 31, 1997                      By:  /s/ Kenneth C. Campbell
                                         -------------------------------------
Date                                     Kenneth C. Campbell, President



March 31, 1997                      By:  /s/ Roger Hay
                                         -------------------------------------
Date                                     Roger Hay, Executive Vice President,
                                         Chief Financial Officer and Chief 
                                         Accounting Officer

         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.


March 31, 1997                      By:  /s/ Kenneth C. Campbell
                                         -------------------------------------
Date                                     Kenneth C. Campbell, President and 
                                         Director



March 31, 1997                      By:  /s/ Roger Hay
                                         -------------------------------------
Date                                     Roger Hay, Executive Vice President,
                                         Chief Financial Officer, Chief 
                                         Accounting Officer and Director


March 31, 1997                      By:  /s/ Roger Hay
                                         -------------------------------------
Date                                     Daryl White, Chairman of the Board of 
                                         Directors


March 31, 1997                      By:  /s/ Roger Hay
                                         -------------------------------------
Date                                     John E. Koehler, Director


March 31, 1997                      By:  /s/ Roger Hay
                                         -------------------------------------
Date                                     Hans Imhof, Director


March 31, 1997                      By:  /s/ Roger Hay
                                         -------------------------------------
Date                                     William F. Blum, Director


                                       22
<PAGE>   23
               Report of Independent Certified Public Accountants


The Board of Directors
Pinnacle Micro, Inc.

We have audited the accompanying balance sheets of Pinnacle Micro, Inc. as of
December 28, 1996 and December 30, 1995, and the related statements of
operations, stockholders' equity and cash flows for each of the two years in the
period ended December 28, 1996. We have also audited the information for the
years ended December 28, 1996 and December 30, 1995 in the financial statement
schedule listed in the Index at Item 14(a)2. These financial statements and the
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
the financial statement schedule 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 and the financial
statement schedule are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and the financial statement schedule. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall presentation of the financial
statements and the financial statement schedule. 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 Micro, Inc. as of
December 28, 1996 and December 30, 1995, and the results of its operations and
its cash flows for each of the two years in the period ended December 28, 1996
in conformity with generally accepted accounting principles.

Also, in our opinion, the financial statement schedule referred to above
presents fairly, in all material respects, the information set forth therein.





                                    BDO SEIDMAN, LLP

Costa Mesa, California
February 14, 1997


                                       23
<PAGE>   24
                        Report of Independent Accountants


The Board of Directors
Pinnacle Micro, Inc.


We have audited the accompanying statements of operations, stockholders' equity
and cash flows of Pinnacle Micro, Inc. for the year ended December 31, 1994. Our
audit also included the information for the year ended December 31, 1994 in the
financial statement schedule listed in the Index at Item 14(a)2. These financial
statements and the financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.

We conducted our audit 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 audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Pinnacle
Micro, Inc. for the year ended December 31, 1994, in conformity with generally
accepted accounting principles. Also, in our opinion, the financial statement
schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be included therein.

As a result of the accounting irregularities described in Note 9, the Company is
the subject of an investigation by the Securities and Exchange Commission and is
a defendant in a class action lawsuit alleging various violations of federal
securities laws. The ultimate outcome of these matters cannot presently be
determined and, accordingly, no provision for any liability that may result has
been made in the statement of operations for the year ended December 31, 1994.




                            COOPERS & LYBRAND L.L.P.

Newport Beach, California
May 15, 1995


                                       24
<PAGE>   25
                              PINNACLE MICRO, INC.

                                 BALANCE SHEETS

                                     ASSETS
<TABLE>
<CAPTION>
                                                            DECEMBER 28,     DECEMBER 30,
                                                                1996             1995
                                                            ------------     ------------
<S>                                                         <C>              <C>
Current assets:
   Cash and cash equivalents ...........................    $  5,455,000     $  3,606,000
   Accounts receivable, net of allowance
     of $748,000 at December 28, 1996
     and $1,178,000 at December 30, 1995 ...............      11,726,000       11,354,000
   Income taxes receivable .............................       1,984,000          999,000
   Inventories .........................................      17,714,000       11,413,000
   Prepaid expenses and other current assets ...........         215,000          961,000
   Deferred income taxes ...............................              --        1,058,000
                                                            ------------     ------------
Total current assets ...................................      37,094,000       29,391,000
Furniture and equipment, net ...........................       1,739,000        2,098,000
Deferred interest related to convertible debentures ....         786,000               --
Deferred income taxes ..................................              --          213,000
Other assets ...........................................         619,000          303,000
                                                            ------------     ------------
Total assets ...........................................    $ 40,238,000     $ 32,005,000
                                                            ============     ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Note payable ........................................    $  3,276,000     $         --
   Accounts payable ....................................      15,540,000       11,644,000
   Accrued expenses ....................................       2,922,000        1,264,000
   Accrued restructuring ...............................       1,421,000               --
   Payroll related liabilities .........................       1,225,000          956,000
                                                            ------------     ------------
Total current liabilities ..............................      24,384,000       13,864,000
Convertible debentures .................................       6,422,000               --
Other liabilities ......................................         929,000        1,400,000
Commitments and contingencies
Stockholders' equity:
   Preferred stock, $.001 par value:
     Authorized shares - 5,000,000
     Issued and outstanding - none .....................              --               --
   Common stock, $.001 par value:
     Authorized shares - 30,000,000
     Issued and outstanding shares -
       9,935,594 at December 28, 1996
       and 7,867,599 at December 30, 1995 ..............          10,000            8,000
   Additional paid-in capital ..........................      28,551,000       16,158,000
   Retained earnings (accumulated deficit) .............     (20,058,000)         775,000
   Foreign currency translation adjustment .............              --         (200,000)
                                                            ------------     ------------
Total stockholders' equity .............................       8,503,000       16,741,000
                                                            ------------     ------------
Total liabilities and stockholders' equity .............    $ 40,238,000     $ 32,005,000
                                                            ============     ============
</TABLE>

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


                                       25
<PAGE>   26
                              PINNACLE MICRO, INC.

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                               YEARS ENDED
                                              ----------------------------------------------
                                              DECEMBER 28,     DECEMBER 30,     DECEMBER 31,
                                                  1996             1995             1994
                                              ------------     ------------     ------------
<S>                                           <C>              <C>              <C>
Net sales:
   Optical storage devices ...............    $ 59,921,000     $ 81,309,000     $ 60,345,000
   Components ............................              --          535,000        5,037,000
                                              ------------     ------------     ------------
     Total net sales .....................      59,921,000       81,844,000       65,382,000
                                              ------------     ------------     ------------
Cost of sales:
   Optical storage devices ...............      48,092,000       59,437,000       41,044,000
   Components ............................              --          455,000        4,554,000
                                              ------------     ------------     ------------
     Total cost of sales .................      48,092,000       59,892,000       45,598,000
                                              ------------     ------------     ------------
Gross profit .............................      11,829,000       21,952,000       19,784,000
                                              ------------     ------------     ------------
Operating expenses:
   Selling, general and administrative ...      19,565,000       18,116,000       12,149,000
   Research and development ..............       6,006,000        4,978,000        2,708,000
   Nonrecurring charges ..................       4,721,000        2,132,000          696,000
                                              ------------     ------------     ------------
     Total operating expenses ............      30,292,000       25,226,000       15,553,000
                                              ------------     ------------     ------------
Operating income (loss) ..................     (18,463,000)      (3,274,000)       4,231,000
Interest income ..........................          84,000          187,000          237,000
Interest expense .........................        (549,000)         (35,000)         (19,000)
Non-cash interest expense related
   to convertible debentures .............      (1,721,000)              --               --
                                              ------------     ------------     ------------
Income (loss) before income taxes ........     (20,649,000)      (3,122,000)       4,449,000
Income tax expense (benefit) .............         184,000         (663,000)       1,713,000
                                              ------------     ------------     ------------
Net income (loss) ........................    $(20,833,000)    $ (2,459,000)    $  2,736,000
                                              ============     ============     ============
   Net income (loss) per share ...........    $      (2.52)    $      (0.31)    $       0.35
                                              ============     ============     ============

Weighted average common shares outstanding       8,272,000        7,842,000        7,849,000
                                              ============     ============     ============
</TABLE>

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


                                       26
<PAGE>   27
                              PINNACLE MICRO, INC.

                       STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                     RETAINED
                                                COMMON STOCK        ADDITIONAL       EARNINGS        FOREIGN
                                            --------------------     PAID-IN       (ACCUMULATED      CURRENCY
THREE YEARS ENDED DEC. 28, 1996              SHARES      AMOUNT      CAPITAL         DEFICIT)      TRANSLATION       TOTAL
                                            ---------    -------    -----------    ------------    -----------    ------------
<S>                                         <C>          <C>        <C>            <C>              <C>           <C>         
Balances at December 31, 1993 ..........    5,183,639    $ 5,000    $15,418,000    $    391,000     $      --     $ 15,814,000
   Exercise of stock options ...........       27,062         --        157,000              --            --          157,000
   Tax benefit of employee stock options           --         --        157,000              --            --          157,000
   Purchases through the employee
     stock purchase plan ...............        3,405         --         31,000              --            --           31,000
   Deferred compensation ...............           --         --             --          16,000            --           16,000
   Net income for the year ended
     December 31, 1994 .................           --         --             --       2,736,000            --        2,736,000
                                            ---------    -------    -----------    ------------     ---------     ------------
Balances at December 31, 1994 ..........    5,214,106      5,000     15,763,000       3,143,000            --       18,911,000
   Exercise of stock options ...........       16,037         --        191,000              --            --          191,000
   Tax benefit of employee stock options           --         --         70,000              --            --           70,000
   Purchases through the employee
     stock purchase plan ...............       14,938         --        134,000              --            --          134,000
   Shares issued in connection with
     50% stock dividend ................    2,622,518      3,000             --          (3,000)           --               --
   Repayment of dividends by
     S Corporation stockholders ........           --         --             --          80,000            --           80,000
   Deferred compensation ...............           --         --             --          14,000            --           14,000
   Foreign currency translation ........           --         --             --              --      (200,000)        (200,000)
   Net loss for the year ended
     December 30, 1995 .................           --         --             --      (2,459,000)           --       (2,459,000)
                                            ---------    -------    -----------    ------------     ---------     ------------
Balances at December 30, 1995 ..........    7,867,599      8,000     16,158,000         775,000      (200,000)      16,741,000
   Exercise of stock options ...........       15,010         --         63,000              --            --           63,000
   Tax benefit of employee stock options           --         --         11,000              --            --           11,000
   Purchases through the employee
     stock purchase plan ...............       19,737         --         98,000              --            --           98,000
   Shares issued for settlement of
     stockholder lawsuit ...............      190,084         --      1,400,000              --            --        1,400,000
   Shares issued upon conversion of
     convertible debentures ............    1,801,381      2,000      8,083,000              --            --        8,085,000
   Shares issued for interest on
     convertible debentures ............       41,783         --        191,000              --            --          191,000
   Additional paid-in capital related to
     debenture embedded interest .......           --         --      2,507,000              --            --        2,507,000
   Foreign currency translation ........           --         --             --              --       200,000          200,000
   Warrants issued in connection with
     convertible debentures ............           --         --         31,000              --            --           31,000
   Non-employee stock option
     compensation ......................           --         --          9,000              --            --            9,000
   Net loss for the year ended
     December 28, 1996 .................           --         --             --     (20,833,000)           --      (20,833,000)
                                            ---------    -------    -----------    ------------     ---------     ------------
Balances at December 28, 1996 ..........    9,935,594    $10,000    $28,551,000    $(20,058,000)    $      --     $  8,503,000
                                            =========    =======    ===========    ============     =========     ============
</TABLE>

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


                                       27
<PAGE>   28
                              PINNACLE MICRO, INC.
                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                            YEARS ENDED
                                                           --------------------------------------------
                                                           DECEMBER 28,     DECEMBER 30,    DECEMBER 31,
CASH FLOWS FROM OPERATING ACTIVITIES                           1996             1995           1994
                                                           ------------     -----------     -----------
<S>                                                        <C>              <C>             <C>        
Net income (loss) .....................................    $(20,833,000)    $(2,459,000)    $ 2,736,000
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
     Depreciation and amortization ....................       1,323,000         896,000         658,000
     Provision for doubtful accounts ..................         369,000         230,000          78,000
     Provision for product returns and price protection         999,000         128,000         240,000
     Provision for inventory obsolescence .............         866,000         871,000         476,000
     Provision for litigation settlement ..............              --       1,400,000              --
     Non-cash interest expense ........................       1,721,000              --              --
     Interest on debentures paid in common stock ......         191,000              --              --
     Compensation related to stock options and warrants          40,000              --              --
     Deferred compensation recognized .................              --          14,000          16,000
     Deferred income taxes ............................       1,271,000        (128,000)       (300,000)
     Loss on disposal of assets .......................              --          16,000              --
     Changes in operating assets and liabilities:
       Accounts receivable ............................      (1,740,000)     (1,361,000)     (5,879,000)
       Income taxes receivable ........................        (985,000)       (999,000)        202,000
       Inventories ....................................      (7,167,000)     (4,260,000)     (2,149,000)
       Prepaid expenses and other current assets ......         746,000        (423,000)        (66,000)
       Other assets ...................................          31,000          25,000        (250,000)
       Accounts payable and accrued expenses ..........       7,081,000       4,994,000       2,043,000
       Payroll related liabilities ....................         269,000         343,000         283,000
       Other liabilities ..............................         929,000              --              --
                                                           ------------     -----------     -----------
Net cash used in operating activities .................     (14,889,000)       (713,000)     (1,912,000)
                                                           ------------     -----------     -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of short-term investments ........................              --       2,436,000       2,485,000
Purchase of furniture and equipment ...................        (904,000)     (1,841,000)       (840,000)
                                                           ------------     -----------     -----------
Net cash provided by (used in) investing activities ...        (904,000)        595,000       1,645,000
                                                           ------------     -----------     -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from note payable ............................       8,276,000              --       1,400,000
Principal payments on note payable to bank ............      (5,000,000)     (1,400,000)             --
Proceeds from issuance of debentures ..................      15,000,000              --              --
Payment of debt issuance costs ........................        (900,000)             --              --
Principal payments on long-term debt and
   capital lease obligations ..........................              --         (39,000)        (16,000)
Dividends (paid to stockholders) repaid to Company ....              --          80,000        (212,000)
Proceeds from exercise of stock options ...............          63,000         191,000         157,000
Tax benefit from exercise of stock options ............          11,000          70,000         157,000
Proceeds from issuance of stock through the
   employee stock purchase plan .......................          98,000         134,000          31,000
                                                           ------------     -----------     -----------
Net cash provided by (used in) financing activities ...      17,548,000        (964,000)      1,517,000
                                                           ------------     -----------     -----------
Effect of exchange rate changes on cash ...............          94,000        (178,000)             --
                                                           ------------     -----------     -----------
Increase (decrease) in cash and cash equivalents ......       1,849,000      (1,260,000)      1,250,000
Cash and cash equivalents at beginning of year ........       3,606,000       4,866,000       3,616,000
                                                           ------------     -----------     -----------
Cash and cash equivalents at end of year ..............    $  5,455,000     $ 3,606,000     $ 4,866,000
                                                           ============     ===========     ===========
</TABLE>

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


                                       28
<PAGE>   29
                              PINNACLE MICRO, INC.

                      STATEMENTS OF CASH FLOWS (CONTINUED)


<TABLE>
<CAPTION>
                                                          YEARS ENDED
                                            ---------------------------------------
                                            DECEMBER 28,  DECEMBER 30,  DECEMBER 31,
                                                1996          1995         1994
                                             ----------    ---------    ----------
<S>                                          <C>           <C>          <C>
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
   Interest .............................    $  306,000    $  45,000    $   19,000
                                             ==========    =========    ==========
   Income taxes .........................    $   15,000    $ 670,000    $1,381,000
                                             ==========    =========    ==========


SUPPLEMENTAL DISCLOSURE OF NON-CASH
   INVESTING AND FINANCING ACTIVITIES:
   Common stock issued upon conversion of
     debentures, net ....................    $8,085,000    $      --    $       --
                                             ==========    =========    ==========

   Common stock issued for settlement
     of stockholder lawsuit .............    $1,400,000    $      --    $       --
                                             ==========    =========    ==========

   Additional paid-in capital related to
     debenture embedded interest ........    $2,507,000    $      --    $       --
                                             ==========    =========    ==========
</TABLE>

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


                                       29
<PAGE>   30
                              PINNACLE MICRO, INC.

                          NOTES TO FINANCIAL STATEMENTS

                                DECEMBER 28, 1996


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION

Pinnacle Micro, Inc., (the "Company") develops, manufactures and markets optical
storage systems for data intensive applications for use both with stand-alone
and networked personal computers and workstations. The financial statements
include the accounts of Pinnacle Micro, Inc., and its foreign branches, Nippon
Pinnacle Micro and Euro Pinnacle Micro.
Nippon Pinnacle Micro was closed during 1996 (see Note 7).

FISCAL YEARS

Beginning with fiscal year 1995, the Company operates and reports financial
results on a fiscal year of 52 or 53 weeks ending on the Saturday closest to
December 31. Accordingly, fiscal 1996 ended on December 28, 1996 and fiscal 1995
ended on December 30, 1995. Prior to 1995 all fiscal years ended on December 31.
All references to years in these notes to financial statements represent fiscal
years unless otherwise noted.

REVENUE RECOGNITION

The Company recognizes product sales revenue at the time of shipment and records
a reserve for estimated sales returns and price adjustments. The Company has
agreements with its resellers which, under certain circumstances, provide for
stock rotation for slow-moving items and price protection for inventories held
by the resellers at the time of published price reductions.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist of all highly liquid investments with an
original maturity of three months or less when purchased.

INVENTORIES

Inventories are stated at the lower of cost (first-in, first-out method) or
market.

FURNITURE AND EQUIPMENT

Furniture and equipment is stated at cost, less accumulated depreciation and
amortization. Depreciation is determined using the straight-line method for all
assets based on the estimated useful lives of the assets, which range from one
to five years. Leasehold improvements are amortized using the straight-line
method over the shorter of their estimated useful lives or the term of the
related leases.

DEBT ISSUANCE COSTS

The costs related to the issuance of the convertible debentures are capitalized
and amortized over the terms of the related debt.


                                       30
<PAGE>   31
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

STOCK-BASED COMPENSATION

The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees,"
and related interpretations in accounting for its stock-based compensation
plans. Accordingly, no compensation cost is recognized for its employee stock
option plans, unless the exercise price of options granted is less than fair
market value on the date of grant. The Company has adopted the disclosure
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" (see Note 6).

FOREIGN CURRENCY TRANSACTIONS

On January 1, 1995, the Company changed the functional currency of its branch
located in Japan (Nippon Pinnacle Micro) to the local functional currency and,
accordingly, the foreign currency denominated assets and liabilities were
translated to U.S. dollars at the year-end exchange rate. The effects of
translation are recorded as a separate component of stockholders' equity through
the date that Nippon Pinnacle Micro was closed during 1996 (see Note 7).
Exchange gains and losses arising from transactions denominated in foreign
currencies are translated at average exchange rates. Net foreign currency
transaction gains of $478,000 and losses of $473,000 and $195,000 were realized
in 1996, 1995 and 1994, respectively, and are included in selling, general and
administrative expenses in the accompanying statements of operations.

Substantially all of the transactions of the Company's branch in the Netherlands
(Euro Pinnacle Micro) are denominated in U.S. dollars and accordingly no
remeasurement of foreign currency is necessary as the accounts are maintained in
U.S. dollars.

Foreign currency forward contracts are entered into from time to time to offset
the effects of exchange rate changes on transactions denominated in foreign
currencies. These contracts generally have maturity dates that do not exceed
three months. Gains and losses on contracts which effectively hedge foreign
currency transactions are deferred and included in income as part of those
transactions. The aggregate contract value of instruments used to buy U. S.
dollars in exchange for Japanese Yen was approximately $3,204,000 at December
30, 1995. There were no such contracts entered into at December 28, 1996. The
carrying value of the foreign currency contracts approximated their fair market
value. The counter parties to these transactions are major international
financial institutions; the Company does not anticipate nonperformance by the
counter parties.

SOFTWARE DEVELOPMENT COSTS

Research and development costs resulting from the design, development and
testing of new software for use in products are expensed as incurred until
technological feasibility has been established. Certain costs incurred
thereafter, such as coding and testing, are capitalized until the product is
available for general release to customers. Such amounts were not material for
the years presented.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amount of cash and cash equivalents, accounts receivable, accounts
payable and accrued expenses are reasonable estimates of their fair value
because of the short maturity of those items. The Company believes the carrying
amounts of the Company's notes payable and convertible debentures approximate
fair value because the interest rates on these instruments are subject to change
with, or approximate, market interest rates.


                                       31
<PAGE>   32
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

CONCENTRATION OF CREDIT RISK

Credit is extended for all customers based on financial condition and,
generally, collateral is not required. Credit losses are provided for in the
financial statements and consistently have been within management's
expectations.

The Company's financial instruments that are exposed to concentrations of credit
risk consist primarily of cash and cash equivalents. The Company places its cash
and temporary cash investments with high credit quality institutions. At times
such investments may be in excess of the FDIC insurance limit.

INCOME TAXES

The Company uses the liability method of accounting for income taxes in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
For Income Taxes." Deferred income taxes are recognized based on the differences
between financial statement and income tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse. Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. The provision for
income taxes represents the tax payable for the period and the change during the
period in deferred tax assets and liabilities.

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 and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

NET INCOME (LOSS) PER SHARE

Net income per share is based on the weighted average number of common and
common equivalent shares (stock options) outstanding during the period. Fully
diluted earnings per share approximates primary earnings per share.

Net loss per share is based on the weighted average number of common shares
outstanding during the period. Common equivalent shares are not included in the
computation because their effect would be antidilutive.

The weighted average common shares outstanding used in the computation of income
(loss) per share have been retroactively restated to reflect the 1995 stock
dividend (see Note 6).

RECLASSIFICATIONS

Certain reclassifications have been made to 1994 and 1995 financial statements
to be consistent with the 1996 presentation.


                                       32
<PAGE>   33
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


2. INVENTORIES

   Inventories consist of the following:

<TABLE>
<CAPTION>
                                                     1996               1995
                                                  -----------        -----------
<S>                                               <C>                <C>        
Components and work-in-process ...........        $13,991,000        $ 9,522,000
Finished goods ...........................          3,723,000          1,891,000
                                                  -----------        -----------
                                                  $17,714,000        $11,413,000
                                                  ===========        ===========
</TABLE>

From time-to-time certain vendors have established liens against inventory sold
to the Company. At December 30, 1995, inventory subject to vendor liens totaled
$634,000. There was no inventory subject to vendor liens at December 28, 1996.

3. FURNITURE AND EQUIPMENT

   Furniture and equipment consists of the following:

<TABLE>
<CAPTION>
                                                      1996              1995
                                                   -----------      -----------
<S>                                                <C>              <C>        
Furniture and equipment ......................     $ 2,587,000      $ 2,014,000
Computers ....................................       1,601,000        1,425,000
Tooling ......................................         757,000          757,000
Leasehold improvements .......................         270,000          202,000
                                                   -----------      -----------
                                                     5,215,000        4,398,000
Accumulated depreciation and amortization ....      (3,476,000)      (2,300,000)
                                                   -----------      -----------
                                                   $ 1,739,000      $ 2,098,000
                                                   ===========      ===========
</TABLE>

4. NOTE PAYABLE

The Company has a $10,000,000 revolving line of credit agreement with a lending
institution which is collateralized by substantially all assets of the Company
and which expires on September 30, 1998. Outstanding borrowings on this line of
credit at December 28, 1996 aggregated $3,276,000. The total unused amount
available at December 28, 1996 was $6,030,000. Borrowings on this line credit
are based on a percentage of eligible accounts receivable and inventories. The
Company can obtain up to $3,500,000 in letters of credit pursuant to this
agreement; there were no such obligations under standby letters of credit at
December 28, 1996. Interest is payable monthly at the institution's reference
rate (8.25% at December 28, 1996) plus 1.75%. At December 28, 1996, the Company
was in compliance with all convenants of the line of credit. The current line of
credit replaces a prior $5,000,000 line of credit with a different lending
institution which had no amounts outstanding at December 30, 1995.

The maximum amount outstanding under the Company's lines of credit at the end of
any month was $5,000,000 in 1996 and $1,200,000 in 1995. Average monthly
borrowings were $2,239,000 at a weighted average interest rate of 9.57% for 1996
and $261,000 at a weighted average interest rate of 8.81% for 1995.

5. CONVERTIBLE DEBENTURES

In July 1996, the Company completed its first offshore placement of $10,000,000
principal amount of convertible subordinated 8% debentures due July 2001. The
$10,000,000 placement yielded aggregate net proceeds of $9,400,000 after
commissions and fees to First Bermuda Securities Limited ("First Bermuda").
First Bermuda also received additional compensation in the form of 73,846
warrants exercisable for five years at a price of $8.125 which was 125% of the
closing


                                       33
<PAGE>   34
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


5. CONVERTIBLE DEBENTURES (CONTINUED)

bid price on the closing date. First Bermuda received customary piggyback
registration rights beginning 90 days from the closing date and demand rights
after two years. The debenture holders may convert the principal of the 8%
debentures in thirds, at discounts from the then market price of 15%, 17.5% and
20%, in intervals commencing 60, 90 and 120 days after the closing,
respectively.

In December 1996, the Company completed a second offshore placement of
$5,000,000 principal amount of convertible subordinated 6% debentures due
December 2001. The $5,000,000 placement yielded aggregate net proceeds of
$4,700,000 after commission and fees to First Bermuda. First Bermuda also
received additional compensation in the form of 65,076 warrants exercisable for
five years at a price of $4.61 which was 125% of the closing bid price on the
closing date. First Bermuda received customary piggyback registration rights
beginning 90 days from the closing date and demand rights after two years. The
debenture holders received an aggregate of 32,538 of warrants with terms similar
to those of First Bermuda, except that such warrants are exercisable for one
year. The debenture holders may convert the principal of the 6% debentures as
follows: 30%, 40% and 30%, at discounts from the then market price of 15%, 17.5%
and 20%, in intervals commencing 50, 80 and 110 days after closing,
respectively.

According to the views of certain members of the Staff of the SEC, convertible
debt instruments which are convertible at a discount to market should be
accounted for by treating such discount as additional interest expense. The
Company has computed the amount of the discount based on the difference between
the conversion price and fair value of the underlying common stock on the date
the debentures were issued. The Company conformed to those views and recorded
$2,507,000 as additional paid-in capital for the discount related to the
embedded interest in the convertible debentures. Of this amount, $1,721,000 has
been amortized and is included in the caption "Non-cash interest expense related
to convertible debentures" in the accompanying 1996 statement of operations (see
Note 12). The unamortized balance of deferred interest related to convertible
debentures is $786,000 at December 28, 1996 and is being amortized to interest
expense over the period that the debentures are first convertible using the
effective interest rate method.

As of December 28, 1996, debentures aggregating $8,578,000 have been converted
into 1,801,381 shares of common stock at conversion prices ranging from $3.15 to
$6.44 per share. Stockholders' equity was increased by the full amount of the
debentures converted less the unamortized debt issuance costs. In addition,
41,783 shares of common stock were issued for $191,000 of interest payable on
the converted debentures.


6. STOCKHOLDERS' EQUITY

DIVIDENDS TO STOCKHOLDERS

Subsequent to the conversion from an S Corporation to a C Corporation, the
Company paid dividends for the previously taxed undistributed S Corporation
earnings as of June 30, 1993. As of December 31, 1994, these stockholders were
estimated to have been overpaid by $130,000, which was included as a receivable
in the 1994 balance sheet. This $130,000 overpayment plus an additional $80,000,
which was also determined to be an overpayment, were repaid to the Company
during 1995.


                                       34
<PAGE>   35
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


6. STOCKHOLDERS' EQUITY (CONTINUED)

DIVIDENDS TO STOCKHOLDERS (CONTINUED)

The Company anticipates future earnings will be retained for use in the
business. The Company paid a 50% stock dividend on December 15, 1995, to
stockholders of record as of December 1, 1995. A total of 2,622,518 shares and
less than $1,000 of cash for fractional shares were distributed as part of this
stock dividend. All references in the financial statements to share amounts, per
share amounts and stock plan data have been restated to reflect this stock
dividend. The Company does not anticipate paying cash dividends on the common
stock in the foreseeable future. In addition, the Company's line of credit
agreement restricts the Company's ability to pay cash dividends on its capital
stock.

STOCK OPTIONS AND STOCK PURCHASE PLANS

Under terms of the Company's stock option plans (the "Plans"), 3,605,000 shares
of the Company's common stock are reserved for the granting of incentive stock
options and nonqualified stock options, and the sale of restricted common stock
to the Company's key employees and non-employee directors. Options may not be
granted at a price that is less than fair market value on the date of grant, as
determined by the Company's Board of Directors, while restricted common stock
may be sold at any price. Options generally vest over 36 months and must be
exercised within 10 years from the date of grant. During 1996, the Company
adopted the 1996 Non-Employee Directors Stock Option Plan under which eligible
directors will automatically receive initial option grants to purchase 25,000
shares upon joining the Company's board of directors and additional option
grants to purchase 10,000 shares after each subsequent annual meeting of the
Company's stockholders.

For financial reporting purposes, compensation expense, representing the excess
of the deemed value for accounting purposes of the stock issuable upon exercise
of the options over the aggregate exercise price of such options, amounting to
$50,000, was deferred in 1992 and was amortized over the vesting periods of the
respective option grants. This compensation expense was fully amortized at
December 30, 1995. During 1996, the Company recognized $9,000 of compensation
expense related to the issuance of stock options to non-employees.

The following is a summary of the activity under the Company's stock option
plans:

<TABLE>
<CAPTION>
                                              Number of Shares     Option Price
                                                Under Option         per Share
                                                -----------       --------------
<S>                                             <C>               <C>           
Options outstanding at December 31, 1993            204,579       $  .19 - 12.67
     Granted                                        192,750         7.17 - 12.33
     Exercised                                      (40,593)         .19 -  7.00
     Canceled                                       (67,920)        4.51 - 12.67
                                                -----------       --------------
Options outstanding at December 31, 1994            288,816          .33 - 12.00
     Granted                                        737,700         6.41 - 15.17
     Exercised                                      (24,055)         .87 -  8.83
     Canceled                                       (95,007)        6.41 - 11.17
                                                -----------       --------------
Options outstanding at December 30, 1995            907,454          .33 - 15.17
     Granted                                      1,841,175         3.69 - 15.00
     Exercised                                      (15,010)         .33 -  6.59
     Canceled                                    (1,080,886)         .33 - 15.17
                                                -----------       --------------
Options outstanding at December 28, 1996          1,652,733       $  .33 - 15.17
                                                ===========       ==============
</TABLE>

The weighted average option price per share was $6.40, $7.15 and $8.43 for
options outstanding at December 28, 1996, December 30, 1995 and December 31,
1994, respectively.


                                       35
<PAGE>   36
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


6. STOCKHOLDERS' EQUITY (CONTINUED)

STOCK OPTIONS AND STOCK PURCHASE PLANS (CONTINUED)

Information relating to stock options at December 28, 1996 summarized by
exercise price are as follows:

                                                                       
<TABLE>
<CAPTION>
    Range of                            Options Outstanding              Options Exercisable
    --------                        ----------------------------     ----------------------------
 Exercise Prices                          Weighted Average                        Weighted Average
 ---------------                          ----------------                        ----------------
    Per Share            Shares     Life (Year)   Exercise Price     Shares        Exercise Price
    ---------            ------     -----------   --------------     ------        --------------
<S>                    <C>               <C>        <C>              <C>           <C>       
$ 0.33 to $ 5.50         125,140         8.73       $    3.67         35,140        $     2.34
$ 6.00 to $ 6.00       1,024,375         9.12            6.00         80,000              6.00
$ 6.25 to $ 6.25          25,000         9.76            6.25             --                --
$ 6.41 to $ 6.41         203,150         8.02            6.41        169,650              6.41
$ 6.59 to $ 8.33         174,226         8.29            7.57         73,951              7.66
$ 9.83 to $11.00          21,542         8.48           10.88          8,942             10.78
$11.17 to $11.17          52,500         6.95           11.17         52,500             11.17
$13.83 to $13.83           7,500         8.72           13.83          2,500             13.83
$14.25 to $14.25          11,800         9.10           14.25             --                --
$15.17 to $15.17           7,500         8.83           15.17          2,500             15.17
                       ---------    ---------                      ---------                      
                                                  
$ 0.33 to $15.17       1,652,733         8.80       $    6.40        425,183         $    6.98
                       =========                                   =========
</TABLE>
                                                    
In addition, the Company has an employee stock purchase plan which allows
employees to purchase directly from the Company shares of the Company's common
stock at a 15% discount from the market price, and to pay the purchase price in
installments by payroll deductions. The Company has reserved 150,000 shares for
granting under the employee stock purchase plan. During 1996, 19,737 shares of
common stock were purchased under this plan at an average price of $4.95. During
1995 and 1994, 14,938 and 3,405 shares were purchased at an average price of
$9.04 and $9.10, respectively, prior to considering the impact of the stock
dividend. As of December 28, 1996 and December 30, 1995, the Company's employee
stock purchase plan liability (included under the caption "Payroll Related
Liabilities" in the accompanying balance sheets) totaled $230,000 and $214,000,
respectively.

Statement of Financial Accounting Standards No. 123 ("FAS 123"), "Accounting for
Stock-Based Compensation," requires the Company to provide pro forma information
regarding net income and earnings per share as if such compensation cost for the
Company's stock option and purchase plans had been determined in accordance with
the fair value based method prescribed in FAS 123. The Company estimates the
fair value of each stock option at the grant date by using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants in 1996 and 1995, respectively: 0% dividend yield; expected volatility of
19%; risk free interest rates of 6.37% and 6.92%; and expected lives of 3 years.

Under the accounting provisions of FAS 123, the Company's net loss and net loss
per share would have been increased to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
Net loss:                                      1996                   1995
                                          --------------         --------------
<S>                                       <C>                    <C>            
     As reported ................         $  (20,833,000)        $   (2,459,000)
     Pro forma ..................         $  (21,187,000)        $   (2,788,000)
Net loss per share:
     As reported ................         $        (2.52)        $        (0.31)
     Pro forma ..................         $        (2.56)        $        (0.36)
</TABLE>


                                       36
<PAGE>   37
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


7. NONRECURRING CHARGES

Restructuring

During 1996, the Company recorded restructuring charges of $3,028,000 for costs
associated with the Company's planned consolidation and transfer of
manufacturing operations to Colorado Springs, Colorado and the closing of its
branch office in Japan. These restructuring charges principally reflect the
costs associated with early termination of existing leases, losses from the
disposal of assets and severance costs resulting from work force reductions.

During the fourth quarter, the Japanese branch office was closed and the Irvine,
California manufacturing facility was relocated to Colorado Springs, Colorado.
During 1996, charges totaling $678,000 were incurred in connection with this
restructuring, including: $421,000 for the write-off of the foreign currency
translation upon closing of the Japanese branch office; $107,000 for severance
related to the termination of 17 employees who worked in manufacturing and
marketing functions; $150,000 for facility and lease terminations. The remaining
balance of the restructuring liability as of December 28, 1996 was $2,350,000.
The majority of these liabilities should be paid or settled by the end of 1997,
except for amounts related to longer term lease and severance agreements, which
are included in other liabilities in the accompanying 1996 balance sheet.

Contract Termination

In 1996, the Company recorded $1,200,000 for estimated costs associated with
changes to a major component contract with a key supplier.

Litigation Settlement and Professional Fees

During 1996, 1995 and 1994 the Company incurred $493,000, $732,000 and $696,000,
respectively, for certain professional fees related to litigation and SEC
related matters. In addition, the Company incurred $1,400,000 for litigation
settlement expenses in 1995 (see Note 9).

8. INCOME TAXES

Income tax expense (benefit) consists of the following:

<TABLE>
<CAPTION>
                                 1996               1995               1994
                              -----------        -----------        -----------
<S>                           <C>                <C>                <C>
Current:
     Federal ..........       $(1,103,000)       $  (536,000)       $ 1,528,000
     State ............             1,000              1,000            482,000
     Foreign ..........            15,000                 --              3,000
                              -----------        -----------        -----------
                               (1,087,000)          (535,000)         2,013,000
                              -----------        -----------        -----------
Deferred:
     Federal ..........           971,000            (60,000)          (226,000)
     State ............           300,000            (68,000)           (74,000)
                              -----------        -----------        -----------
                                1,271,000           (128,000)          (300,000)
                              -----------        -----------        -----------
                              $   184,000        $  (663,000)       $ 1,713,000
                              ===========        ===========        ===========
</TABLE>


                                       37
<PAGE>   38
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


8. INCOME TAXES (CONTINUED)

Income tax expense (benefit) differs from the amount that would result from
applying the federal statutory rate as follows:

<TABLE>
<CAPTION>
                                                1996            1995            1994
                                             -----------     -----------     -----------
<S>                                          <C>             <C>             <C>        
Tax at U.S. Federal statutory rate ......    $(7,021,000)    $(1,061,000)    $ 1,513,000
State income taxes ......................          1,000           1,000         269,000
Nondeductible expenses ..................        595,000         495,000          13,000
Tax exempt income .......................         (1,000)        (45,000)        (71,000)
Adjustment to deferred tax asset
     valuation allowance ................      1,271,000              --              --
Net operating loss carryforward for which
     no tax benefit has been recognized .      5,396,000              --              --
Other ...................................        (57,000)        (53,000)        (11,000)
                                             -----------     -----------     -----------
                                             $   184,000     $  (663,000)    $ 1,713,000
                                             ===========     ===========     ===========
</TABLE>

The components of the deferred income tax assets are as follows:

<TABLE>
<CAPTION>
                                                                 1996            1995
                                                             -----------      ----------
<S>                                                          <C>              <C>
Deferred tax assets:
    Net operating loss carryforward ..................       $ 4,591,000      $   54,000
    Accrued restructuring costs and                                          
      other accruals not currently deductible ........           995,000         100,000
    Inventory obsolescence reserve ...................           430,000         327,000
    Furniture and equipment ..........................           353,000         274,000
    Sales returns and allowances for doubtful accounts           294,000         492,000
    Research and development credit carryforward .....           190,000              --
    Other ............................................           127,000          24,000
                                                             -----------      ----------
Total deferred tax assets ............................         6,980,000       1,271,000
Valuation allowance ..................................        (6,980,000)             --
                                                             -----------      ----------
Net deferred tax asset ...............................       $        --      $1,271,000
                                                             ===========      ==========
</TABLE>
                                                                            
A valuation allowance is provided when it is more likely than not that some
portion or all of the deferred tax assets will not be realized. As a result of
the Company's significant losses in 1996 and uncertainties surrounding the
realization of the net operating loss carryforward which was generated during
1996, management has determined that the realization of the deferred tax assets
is not more likely than not. Accordingly, a 100% valuation allowance has been
recorded. The net change in the total valuation allowance for the year ended
December 28, 1996 was an increase of $6,980,000. There was no change in the
valuation allowance during 1995.

At December 28, 1996, the Company has a federal tax net operating loss
carryforward of approximately $12,400,000, which expires in 2011 and a state net
operating loss carryforward of approximately $6,900,000 which expires through
2001.


                                       38
<PAGE>   39
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


9. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

In the fourth quarter of 1995, the Company reached a settlement agreement with
the plaintiffs who filed the November 20, 1994, class action complaint against
the Company, certain of its officers and directors and the Company's then
independent auditors, Ernst & Young LLP. This complaint resulted from the
Company's restatement of prior financial statements which, most significantly,
required approximately $2,400,000 of revenue, $1,400,000 of cost of good sold
and $70,000 of selling, general and administrative expenses previously reported
as earned or incurred in the quarter ended December 31, 1993 to be reported
instead as being earned or incurred in the quarter ended March 31, 1994. The
complaint alleged various violations of Federal Securities Laws and claimed
unspecified compensatory damages and related fees and costs. The complaint was
filed in the United States District Court for the Central District of California
under the case name of Kurtz, et al. v. Blum, et al., Case No. SACV94-1043-GLT.
The settlement agreement with the plaintiffs concerning this litigation required
a cash payment of $925,000 and the issuance of shares of the Company's common
stock with a value of $1,400,000. Pursuant to this settlement, the Company's
insurance carrier paid $925,000 in cash in December 1995, in connection with a
Directors and Officers liability policy purchased by the Company. The Company
issued 190,084 shares of common stock valued at $1,400,000 to the plaintiff
class and its attorneys during 1996. A provision for this $1,400,000 litigation
settlement was included as part of nonrecurring charges in the accompanying 1995
statement of operations (see Note 7).

The Company and certain members or former members of its senior management have
been the subject of an investigation by the Securities and Exchange Commission
(the "SEC") relating principally to the restatement of the Company's
previously-reported financial results. The Company and its management have been
cooperating fully with the investigation.

The resignation of the Company's prior independent public accountants on
February 20, 1996, led to additional inquiries by the SEC. These inquiries
relate principally to the 1995 accounting adjustment matters discussed in Note
12. The Company and its management continue to cooperate fully with the SEC.

On March 15, 1996, a complaint was filed against the Company and certain of its
officers and directors in a securities class action lawsuit which alleges that
Company management engaged in improper accounting practices and made certain
false and misleading statements. The complaint was filed in the United States
District Court for the Central District of California under the case name Wills,
Cohen, et al. v. William Blum et al., Case No. SACV96-261GLT. The Company denies
all allegations and intends to vigorously contest the suit. The ultimate outcome
of this matter cannot presently be determined. Accordingly, no provision for any
liability that may result has been made in the accompanying financial
statements. However, any adverse determination with respect to the pending
lawsuit could have a material adverse effect on the Company's financial
statements. The Company may incur significant legal costs relating to this suit
in 1997.

The Company is also subject to other legal proceedings and claims which arise in
the normal course of business. While the outcome of these proceedings cannot be
predicted with certainty, the Company does not believe that the outcome of these
other legal matters will have a material adverse effect on the Company's
financial statements.


                                       39
<PAGE>   40
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

9. COMMITMENTS AND CONTINGENCIES (CONTINUED)

Operating Leases

The Company leases its facilities and equipment under various noncancellable
operating leases for terms of up to five years. Future minimum lease payments
under these leases as of December 28, 1996 are as follows:

<TABLE>
<S>                                                     <C>        
            1997                                        $ 1,629,000
            1998                                            954,000
            1999                                            392,000
            2000                                            133,000
                                                        -----------
                                                        $ 3,108,000
                                                        ===========
</TABLE>

Rent expense was approximately $1,650,000, $1,531,000 and $801,000 for 1996,
1995 and 1994, respectively.

10. EMPLOYEE BENEFITS

The Company maintains an elective retirement savings plan which is intended to
qualify under Section 401(k) of the Internal Revenue Code. Participating
employees are allowed to contribute up to 15% of their cash compensation. The
Company can make contributions to the plan at the discretion of management.
There were no contributions to the plan in 1996, which was the first year of the
plan.

11. MAJOR CUSTOMERS, EXPORT SALES AND GEOGRAPHIC SEGMENT INFORMATION

For 1996, 1995 and 1994, the Company had product sales to one distributor of
approximately $10,847,000, $11,965,000 and $9,900,000 or 18%, 15% and 15%,
respectively, of the Company's net sales. The accounts receivable balance from
this distributor was $2,820,000 and $2,645,000 or 24% and 23% of total accounts
receivable at December 28, 1996 and December 30, 1995, respectively.

The Company's United States operations include export sales of $6,568,000,
$10,589,000 and $6,857,000 for 1996, 1995 and 1994, respectively. Foreign
operations are comprised of sales offices in the Netherlands and Japan which are
branches of the Company. Inventory is transferred to each of these sales offices
at the Company's manufacturing cost. A summary of the Company's operations by
geographic region is as follows:

<TABLE>
<CAPTION>
                                     1996             1995             1994
                                 ------------     ------------     ------------
<S>                              <C>              <C>              <C>
Net sales:
United States ...............    $ 48,489,000     $ 64,142,000     $ 53,127,000
Europe ......................       9,838,000       15,543,000        8,488,000
Japan .......................       1,594,000        2,159,000        3,767,000
                                 ------------     ------------     ------------
                                 $ 59,921,000     $ 81,844,000     $ 65,382,000
                                 ------------     ------------     ------------

Operating income (loss):
United States ...............    $(17,571,000)    $ (3,761,000)    $  2,751,000
Europe ......................        (221,000)       1,096,000        1,537,000
Japan .......................        (671,000)        (609,000)         (57,000)
                                 ------------     ------------     ------------
                                 $(18,463,000)    $ (3,274,000)    $  4,231,000
                                 ------------     ------------     ------------

Identifiable assets:
United States ...............    $ 37,990,000     $ 26,912,000     $ 25,429,000
Europe ......................       1,955,000        3,062,000        1,631,000
Japan .......................         293,000        2,031,000        1,795,000
                                 ------------     ------------     ------------
Total assets ................    $ 40,238,000     $ 32,005,000     $ 28,855,000
                                 ------------     ------------     ------------
</TABLE>


                                       40
<PAGE>   41
                              PINNACLE MICRO, INC.

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


12. FOURTH QUARTER ADJUSTMENTS

1996 Adjustments

The Company originally accounted for its convertible debentures (see Note 5) in
accordance with APB 14, "Accounting for Convertible Debentures and Debt Issued
with Stock Purchase Warrants." According to the views of certain members of the
Staff of the SEC, which the Company learned in December 1996, convertible debt
instruments which are convertible at a discount to market should be accounted
for by treating such discount as additional interest expense. The Company
conformed to those views and computed the amount of the discount based on the
difference between the conversion price and fair value of the underlying common
stock on the date the debentures were issued. In the fourth quarter of 1996, the
Company recorded $1,721,000 of non-cash interest expense related to the embedded
interest in the convertible debentures. Of this amount, $1,286,000 should have
been recorded as interest expense in the third quarter. If this amount had been
properly recorded, net loss would have increased by $1,286,000 ($0.16 per share)
in the third quarter and decreased by $1,286,000 ($0.14 per share) in the fourth
quarter. The Company considers these amounts to be material and therefore has
restated its financial statements for the quarterly period ended September 28,
1996 on Form 10-Q/A for that period.

1995 Adjustments

The Company previously capitalized certain non-recurring engineering
expenditures for 1994 and the quarters ended April 1, July 1 and September 30,
1995, which expenditures primarily related to design and development of
components incorporated into certain of the Company's products. The Company
since determined the capitalization of these amounts was not appropriate. The
amounts should have been accounted for as research and development and expensed
as incurred. The aggregate amount of capitalized expenditures for 1994 and 1995
were $138,000 and $429,000, respectively.

The amounts capitalized in 1995 and the aggregate effect of such amounts if they
had been properly expensed are as follows:

<TABLE>
<CAPTION>
   Quarter            Amount                      Aggregate Effect on
    Ended           Capitalized            Net Income       Net Income Per Share
    -----           -----------            ----------       --------------------
<S>                <C>                     <C>                  <C>
   April 1         $   38,000              $  (23,000)          $     -
   July 1              69,000                 (42,000)                -
September 30          322,000                (198,000)              (.03)
                   ----------
    Total          $  429,000
                   ==========
</TABLE>

The Company considers the $322,000 for the quarter ended September 30, 1995 to
be material and restated the financial statements in the Form 10-Q/A for that
period. The Company considers the $38,000 for the quarter ended April 1, 1995,
the $69,000 for the quarter ended July 1, 1995 and the $138,000 for 1994 to be
immaterial and therefore has not restated the financial statements for those
periods. For the aforementioned periods which have not been restated, the total
amount of $245,000 was charged to research and development expense for the
quarter ended December 30, 1995. The aggregate effect of such adjustments in the
quarter ended December 30, 1995 was to increase the net loss by $151,000 or $.02
per share.


                                       41
<PAGE>   42
                                                                     SCHEDULE II


                              PINNACLE MICRO, INC.

                        VALUATION AND QUALIFYING ACCOUNTS

                                DECEMBER 28, 1996


<TABLE>
<CAPTION>
                                                             Balance at   Charged to                     Balance at
        DESCRIPTION                                           Beginning   Costs and                        End of
        -----------                                           of Period    Expenses     Deductions         Period
                                                              ---------    --------    --------------    ----------
<S>                                                           <C>          <C>         <C>               <C> 
Year ended December 28, 1996: 
     Deducted from asset accounts:
       Allowance for doubtful accounts ....................    $350,000    $369,000    $  (383,000)*     $  336,000
       Allowance for product returns and price protection..     828,000     999,000     (1,415,000)         412,000
       Inventory obsolescence reserve .....................     783,000     866,000       (554,000)**     1,095,000


Year ended December 30, 1995: 
     Deducted from asset accounts:
       Allowance for doubtful accounts ....................    $287,000    $230,000    $  (167,000)*     $  350,000
       Allowance for product returns and price protection..     700,000     128,000             --          828,000
       Inventory obsolescence reserve .....................     683,000     871,000       (771,000)**       783,000


Year ended December 31, 1994: 
     Deducted from asset accounts:
       Allowance for doubtful accounts ....................    $250,000    $ 78,000    $   (41,000)*     $  287,000
       Allowance for product returns and price protection..     460,000     240,000             --          700,000
       Inventory obsolescence reserve .....................     207,000     476,000             --          683,000
</TABLE>
----------
*    Doubtful accounts written off.
**   Disposal of obsolete inventory.


                                       42