---




UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-QSB





|x |  | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
|- |  | -------------------------------------------------

| |  | SECURITIES EXCHANGE ACT OF 1934
| |  | -------------------------------




| |  | For the quarterly period ended September 28, 2002
| |  | -------------------------------------------------




| ̈ |  | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
|- |  | --------------------------------------------------

| |  | EXCHANGE ACT
| |  | ------------




| |  | For the transition period
from    to
| |  | ------------------------------------




Commission file number: 0-28483





---




PINNACLE DATA SYSTEMS,
INC.


(Exact name of small business issuer as specified in its charter)





Ohio

31-1263732(State or other jurisdiction of incorporation or organization)

(IRS Employer Identification
No.)





6600 Port Road, Groveport, Ohio 43125


(Address of principal executive offices)





(614) 748-1150


(Issuers Telephone Number)





---




APPLICABLE ONLY TO CORPORATE ISSUERS





State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date
                                 5,513,870 common shares, without par value, as of
October 31, 2002.





Transitional Small Business Disclosure Format (Check one): Yes  ̈ No  x





---



---




PINNACLE DATA SYSTEMS, INC.


(DBA PDSi)





BALANCE SHEETS





September 28, 2002

December 31, 2001(Unaudited)ASSETSCURRENT ASSETSCash

$
265,243

$
72,237Accounts receivable, net of allowance for doubtfulaccounts of $15,000


2,156,801


3,210,935Inventory


2,468,534


3,535,779Other prepaid expenses


306,626


135,987Refundable income taxes


68,993


372,687Deferred income taxes


448,000


448,0005,714,197


7,775,625PROPERTY AND EQUIPMENTLeasehold improvements


218,844


215,689Furniture and fixtures


329,921


316,106Computer equipment and related software


1,996,018


1,777,323Shop equipment


420,341


410,999Vehicle





21,8462,965,124


2,741,963Less accumulated depreciation and amortization


1,669,168


1,295,9751,295,956


1,445,988OTHER ASSETS


49,074


52,024$
7,059,227

$
9,273,637





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




-2-




---




PINNACLE DATA SYSTEMS, INC.


(DBA PDSi)





BALANCE SHEETS





September 28, 2002

December 31, 2001(Unaudited)LIABILITIES AND STOCKHOLDERS' EQUITYCURRENT LIABILITIESLine of credit

$
2,197,607

$
4,371,688Current portion of long-term debt


66,667


133,333Current portion of capital lease obligation


24,827


24,827Accounts payable


756,505


674,179Accrued expenses:Wages and payroll taxes


298,150


223,449Employee benefits


130,602


59,593Other


79,722


134,756Unearned revenue


8,120


7,9913,562,200


5,629,816LONG-TERM LIABILITIESLong-term debt, less current portion





33,334Capital lease obligation, less current portion


4,139


22,759Deferred income taxes


42,000


42,00046,139


98,0933,608,339


5,727,909COMMITMENTS AND CONTINGENCIES





STOCKHOLDERS' EQUITYPreferred stock; no par value; 4,000,000 shares authorized;no shares issued or outstanding





Common stock; no par value; 25,000,000 shares authorized;5,513,870 and 5,483,204 shares issued and outstanding, respectively


2,156,499


2,136,249Additional paid-in capital


501,506


501,506Retained earnings


792,883


907,9733,450,888


3,545,728$
7,059,227

$
9,273,637





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




-3-




---




PINNACLE DATA SYSTEMS, INC.


(DBA PDSi)





STATEMENTS OF OPERATIONS





For the Three Months Ended


For the Nine Months EndedSeptember 28, 2002


September 29, 2001


September 28, 2002


September 29, 2001(unaudited)


(unaudited)SALESProduct sales

$
2,839,846


$
3,456,665


$
7,894,723


$
14,188,248Service sales


1,673,546



908,142



4,473,685



3,352,1004,513,392



4,364,807



12,368,408



17,540,348COST OF SALESProduct sales


1,930,260



2,924,403



6,172,573



11,643,721Service sales


964,426



623,219



2,819,006



2,480,2912,894,686



3,547,622



8,991,579



14,124,012GROSS PROFIT


1,618,706



817,185



3,376,829



3,416,336OPERATING EXPENSESSelling, general and administrative


1,101,749



1,047,844



2,893,689



3,062,987Research and development


167,521



269,050



572,803



1,027,6801,269,270



1,316,894



3,466,492



4,090,667INCOME/(LOSS) FROM OPERATIONS


349,436



(499,709
)


(89,663
)


(674,331
)OTHER INCOME/(EXPENSE)Interest expense


(31,698
)


(81,074
)


(100,427
)


(299,423
)Other income


8,000







8,000



(23,698
)


(81,074
)


(92,427
)


(299,423
)INCOME/(LOSS) BEFORE INCOME TAXES


325,738



(580,783
)


(182,090
)


(973,754
)INCOME TAX EXPENSE/(BENEFIT) (Note 3)


131,000



(223,000
)


(67,000
)


(377,000
)NET INCOME/(LOSS)

$
194,738


$
(357,783
)

$
(115,090
)

$
(596,754
)BASIC EARNINGS (LOSS) PER SHARE

$
0.04


$
(0.07
)

$
(0.02
)

$
(0.11
)DILUTED EARNINGS (LOSS) PER SHARE

$
0.04


$
(0.07
)

$
(0.02
)

$
(0.11
)WEIGHTED AVERAGE COMMON SHARES OUTSTANDINGBasic


5,508,523



5,473,875



5,500,119



5,454,450Diluted


5,541,099



5,473,875



5,500,119



5,454,450





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




-4-




---

PINNACLE DATA SYSTEMS, INC.


(DBA PDSi)





STATEMENTS OF CASH FLOWS





Nine Months Ended September 28, 2002 and September 29, 2001





2002


2001(Unaudited)


(Unaudited)CASH FLOWS FROM OPERATING ACTIVITIESNet income (loss)

$
(115,090
)

$
(596,754
)Adjustments to reconcile net income to net cash provided by(used in) operating activities:Depreciation and amortization


405,188



293,704Provision for doubtful accounts






7,000Inventory reserves


510,789



247,453Provision for deferred taxes






(144,000
)Gain on disposal of assets


(8,000
)


(Increase) decrease in assets:Accounts receivable


1,054,134



2,409,931Inventory


421,016



3,118,233Prepaid expenses and other assets


(170,639
)


(536,063
)Refundable income taxes


303,694



Increase (decrease) in liabilities:Accounts payable


82,326



(4,167,731
)Accrued expenses and taxes


90,676



(119,409
)Unearned revenues


129



1,865Total adjustments


2,689,313



1,110,983Net cash provided by (used in) operating activities


2,574,223



514,229CASH FLOWS FROM INVESTING ACTIVITIESPurchases of property and equipment


(116,766
)


(140,419
)Proceeds from sale of property and equipment


8,000



Net cash used in investing activities


(108,766
)


(140,419
)CASH FLOWS FROM FINANCING ACTIVITIESNet change in line of credit


(2,174,081
)


(379,848
)Principal payments on long-term debt


(100,000
)


(105,126
)Principal payments on capital lease obligation


(18,620
)


Proceeds from stock options exercised


20,250



100,687Net cash provided by (used in) financing activities


(2,272,451
)


(384,287
)





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




-5-




---

PINNACLE DATA SYSTEMS, INC.


(DBA PDSi)





STATEMENTS OF CASH FLOWS (CONTINUED)





Nine Months Ended September 28, 2002 and September 29, 2001





2002

2001INCREASE/(DECREASE) IN CASH


193,006


(10,477
)CASHBeginning of period


72,237


35,873CASHEnd of period

$
265,243

$
25,396SUPPLEMENTAL DISCLOSURE OF CASH FLOWINFORMATIONInterest paid

$
93,087

$
288,653Income taxes paid, net of refunds

$


$
304,321SUPPLEMENTAL DISCLOSURE OF NONCASHINVESTING AND FINANCING TRANSACTIONSDuring 2002, the company capitalized $136,227 of inventory as computer equipment.








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




-6-




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PINNACLE DATA SYSTEMS, INC.


(DBA PDSi)





NOTES TO FINANCIAL STATEMENTS


(UNAUDITED)





Note 1.    Organization





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





Note 2.    Summary of Significant
Accounting Policies





The balance sheet as of September 28, 2002, the statements of operations for the three
and nine months ended September 28, 2002 and September 29, 2001, and the statements of cash flows for the nine month periods then ended have been prepared by the Company, without audit. In the opinion of management, all adjustments, which consist
solely of normal recurring adjustments, necessary to present fairly, in accordance with accounting principles generally accepted in the United States of America, the financial position, results of operations and changes in cash flows for all periods
presented have been made.





Certain information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the United States of America have been condensed and omitted. These condensed financial statements should be read in conjunction with the financial statements and notes thereto
included in the Companys December 31, 2001 annual report on Form 10-KSB. The results of operations for the periods ended September 28, 2002 are not necessarily indicative of the results for the full year.





In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 142 changes the accounting for
goodwill and certain other intangible assets from an amortization method to an impairment only approach. The adoption of this statement did not have a material impact on the financial statements.




-7-




---




PINNACLE DATA SYSTEMS, INC.


(DBA PDSi)





NOTES TO FINANCIAL STATEMENTS


(UNAUDITED)





Note 2.    Summary of
Significant Accounting Policies (continued)





In August 2001, the FASB issued SFAS No. 144, Accounting
for Impairment or Disposal of Long-Lived Assets. While this statement supercedes SFAS No. 121, Accounting for Impairment of Long-Lived Assets to Be Disposed Of it retains the fundamental provisions of SFAS No. 121 for recognition
and impairments of assets to be held and used, and assets to be disposed of by sale. The adoption of this statement did not have a material impact on the financial statements.





SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, will be effective for fiscal years
beginning after May 15, 2002 (December 31, 2002 for the Company). The standard rescinds FASB Statements No. 4, and 64 that deal with issues relating to the extinguishments of debt. The standard also rescinds FASB Statement No. 44 that deals with
intangible assets of motor carriers. The standard modifies SFAS No. 13, Accounting for Leases, so that certain capital lease modifications must be accounted for by lessees as sale-leaseback transactions. Additionally, the standard
identifies amendments that should have been made to previously existing pronouncements and formally amends the appropriate pronouncements. The adoption of SFAS No. 145 will not have a significant effect on the Companys results of operations or
its financial position.





SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, will be effective for exit or disposal activities that are initiated after December 31, 2002. The statement nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), and requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred rather than
at the date of an entitys commitment to an exit plan. The adoption of SFAS No. 146 will not have a significant effect on the Companys results of operations or its financial position.







-8-




---




PINNACLE DATA SYSTEMS, INC.


(DBA PDSi)





NOTES TO FINANCIAL STATEMENTS





(UNAUDITED)





Note 3.    Income Taxes





Income taxes for interim periods were computed
using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to ongoing review and evaluation by management.





Note 4.    Operating Segments





The Other column listed
below reflects items that are not allocated to segments. These items primarily represent assets and expenses for various administrative functions within the Company. The Company evaluates performance based on operating earnings of the reportable
segments.





Nine Months Ended September 28, 2002Product Sales

Service Sales

Other


TotalSales

$
7,894,723

$
4,473,685




$
12,368,408Gross profit


1,722,150


1,654,679





3,376,829Operating earnings


343,693


1,039,925

(1,473,281
)


(89,663
)Depreciation and amortization


163,543


99,841

141,804



405,188Interest expense







100,427



100,427Total assets


3,038,456


2,202,837

1,817,934



7,059,227Capital expenditures


12,060


46,753

57,953



116,766




-9-




---




PINNACLE DATA SYSTEMS, INC.


(DBA PDSi)





NOTES TO FINANCIAL STATEMENTS


(UNAUDITED)





Note 4.    Operating
Segments (continued)





Nine Months Ended September 29, 2001Product Sales

Service Sales

Other


TotalSales

14,188,248

$
3,352,100




$
17,540,348Gross profit

2,544,527


871,809





3,416,336Operating earnings

501,982


511,698

(1,688,011
)


(674,331
)Depreciation and amortization

141,349


93,936

58,419



293,704Interest expense






299,423



299,423Total assets

7,373,412


1,636,739

1,228,643



10,238,794Capital expenditures

13,680


75,442

51,297



140,419





Two segments were reported on form 10-QSB for Service in the first
three quarters of 2001, Repair and Other service. For this 10-QSB, for the nine months ended September 28, 2002, the two segments are combined, as in prior years, under Service. The Company does not believe the additional breakdown of the Service
segment provided significant additional insight into the Companys operations for the readers of these financial statements. Certain amounts for the year 2001 have been reclassified to conform with the 2002 presentation.





Item 2.    Managements Discussion and Analysis of Financial Condition and Results of Operations





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





This quarterly report, including the following sections contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of
1995. The words believe, expect, anticipate, estimate, project, and similar expressions identify forward-looking statements that speak only as of the date thereof. Investors are cautioned
that such statements involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated results due to many factors. Such factors include, but are not limited to, adverse changes in general economic
conditions, including adverse changes in the specific markets for our products and services, adverse business conditions, decreased or lack of growth in the computing industry, adverse changes in customer order patterns, increased competition, any
adverse change in Sun Microsystems business or our relationship with Sun, around whose computing platforms a large portion of our business is based, lack of acceptance of new products,




-10-




---




pricing pressures, lack of adequate financing to take advantage of business opportunities that may
arise, lack of success in technological advancements, risks associated with our new business practices, processes and information systems, and other factors.





The following discussions and analyses are for the quarter and nine months ended September 28, 2002 compared to the quarter and nine months ended September 29, 2001.





SALES





Sales for the third quarter and first nine
months of 2002 and 2001 were as follows:





($ thousands)

Third Quarter

%


Nine Months

%2002

2001

Change


2002

2001

ChangeTotal company

$
4,513

$
4,365

3
%

$
12,368

$
17,540

-29
%Product


2,840


3,457

-18
%


7,895


14,188

-44
%Service


1,673


908

84
%


4,473


3,352

33
%





Product sales for the third quarter and first nine months of 2002 were significantly lower
compared to the same periods of 2001. Our major product division customers continue to invest cautiously in inventory while they await an upturn in their markets. We see few signs of a recovery in our customers capital spending in the
near-term, and anticipate product sales in the fourth quarter of 2002 to be the lowest of any quarter of the year.





In the fourth quarter
of 2001, we began providing repair services to Hewlett-Packard (H-P) pursuant to a new agreement. The revenue in the first nine months of 2002 generated from the H-P agreement led to the increases in service revenue for both the third quarter and
first nine months of 2002 compared to 2001. Based on the success of the initial program begun with H-P in 2001, we were awarded additional world-wide repair programs from H-P. The new programs started ramping up in the third quarter of 2002 and are
expected to nearly double the annual revenue run rate of the initial H-P program.





For the first nine months of 2002, five of our
customers generated sales of approximately $9,924,000, or 80% of our total sales.





GROSS PROFIT





Gross profit for the third quarter and first nine months of 2002 and 2001 were as follows:





($ thousands)

Third Quarter

%


Nine Months

%2002

2001

Change


2002

2001

ChangeTotal company

$
1,619

$
817

98
%

$
3,377

$
3,416

-1
%Product


910


532

71
%


1,722


2,544

-32
%Service


709


285

149
%


1,655


872

90
%





The gross profit margin percentages for 2002 and 2001 were as follows:




-11-




---




($ thousands)

Third Quarter


Nine Months2002


2001


2002


2001Total company

36
%

19
%

27
%

19
%Product

32
%

15
%

22
%

18
%Service

42
%

31
%

37
%

26
%





Improvements in the gross profit margin of both product and service sales resulted in the
overall gross profit margin in the third quarter of 2002 nearly doubling the margin of the third quarter of 2001.





For the third quarter
and first nine months of 2002, the increase in gross profit margin percentages on product sales compared to 2001 were the result of a more favorable mix of product shipments, specific cost reduction efforts and some volume purchasing improvements,
which more than offset lost volume leverage resulting from the sales declines.





The increase in the gross profit margin percentages on
service sales in the third quarter of 2002 was due to the mix of products being repaired and the increased leverage on fixed costs. For the first nine months of 2002, major factors in the increase of the gross profit margin percentage on service
sales were the replacement of low-margin fulfillment and logistics services in 2001 with higher-margin repair services in 2002 and increased efficiency.





SELLING, GENERAL AND ADMINISTRATIVE (SG&A), RESEARCH AND DEVELOPMENT (R&D) AND INTEREST EXPENSES





SG&A,
R&D and interest expenses for the third quarter and first nine months of 2002 and 2001 were as follows:





($ thousands)

Third Quarter

%


Nine Months

%2002

2001

Change


2002

2001

ChangeSG&A expense

$
1,102

$
1,048

5
%

$
2,894

$
3,063

-6
%R&D expense


167

$
269

-38
%


573


1,028

-44
%Interest expense


32

$
81

-60
%


100


299

-67
%Total expense

$
1,301

$
1,398

-7
%

$
3,567

$
4,390

-19
%





In the third quarter and first nine months of 2002, the decrease in the combination of
SG&A and R&D expenses resulted primarily from workforce reductions and the elimination of some discretionary expenses in a cost reduction program implemented in January, 2002. However, the decrease in the third quarter was slightly more than
offset by increases in business development efforts to penetrate additional large service customer prospects and a gain-sharing program implemented during the year that was designed to get us back to profitability on a consistent basis and reward
the contributions of our employees to help achieve and maintain profitability. R&D expenses also decreased as a result of the cost reduction program made in response to the downturn in product revenue. New product development continues, but at a
lower level, focusing on what are believed to be the highest potential opportunities with the highest probability of market success.





In
the third quarter and first nine months of 2002, lower interest rates and decreased use of the credit line due to lower levels of inventory and receivables resulted in lower interest expense compared to the same periods of 2001. Interest rates paid
on the line of credit ranged from 3.9% to 5.0% in 2002, and from 5.15% to 8.65% in 2001. The average daily balance on the line of credit declined to $2.5 million over the first nine months of 2002 from $6.9 million over the same period in 2001.




-12-




---




INCOME TAXES AND NET INCOME/(LOSS)





Income taxes for the interim periods were computed using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to ongoing review and evaluation by management. The
effective tax rate for the first nine months of 2002 and 2001 was 36.8% and 38.7%, respectively.





Income/(loss) before taxes, income tax
expense/(benefit) and net income/(loss) for the third quarter and first nine months of 2002 and 2001 were as follows:





($ thousands)

Third Quarter


Nine Months2002

2001


2002


2001Income/(loss) before income taxes

$
326

$
(581
)

$
(182
)

$
(974
)Income tax expense/(benefit)


131


(223
)


(67
)


(377
)Net income/(loss)

$
195

$
(358
)

$
(115
)

$
(597
)





Earnings/(loss) per share for the third quarter and first nine months of 2002 and 2001were
as follows:





Third Quarter


Nine Months2002

2001


2002


2001Basic EPS

$
0.04

$
(0.07
)

$
(0.02
)

$
(0.11
)Diluted EPS

$
0.04

$
(0.07
)

$
(0.02
)

$
(0.11
)Weighted average number of shares outstanding:Basic


5,508,523


5,473,875



5,500,119



5,454,450Diluted


5,541,099


5,473,875



5,500,119



5,454,450





The combination of higher service revenue, higher margins on the changing mix of products
and services and lower expenses resulted in a net profit for the third quarter of 2002 of $195,000 compared to a loss of $358,000 in 2001. The third quarter profit reduced the net loss for the year of 2002 to $115,000, compared to a loss for the
first nine months of 2001 of $597,000, despite the decline in revenue from 2001 to 2002.




-13-




---




LIQUIDITY AND CAPITAL RESOURCES





A summary of changes in current assets for the third quarter and nine months is as follows:





($ thousands)

9/28/02

6/30/02

% Change


9/28/02

12/31/01

% ChangeAccounts receivable

$
2,157

$
3,052

-29
%

$
2,157

$
3,211

-33
%Inventory


2,469


2,905

-15
%


2,469


3,536

-30
%Other current assets


1,088


1,004

8
%


1,088


1,029

6
%Total

$
5,714

$
6,961

-18
%

$
5,714

$
7,776

-27
%





A summary of changes in current liabilities for the third quarter and nine months is as
follows:





($ thousands)

9/28/02

6/30/02

% Change


9/28/02

12/31/01

% ChangeLine of credit

$
2,198

$
3,228

-32
%

$
2,198

$
4,372

-50
%Accounts payable


757


1,228

-38
%


757


674

12
%Other current liab.


607


523

16
%


607


584

4
%Total

$
3,562

$
4,979

-28
%

$
3,562

$
5,630

-37
%





During the first nine months of 2002, $2,574,000 of cash was generated by operating
activities. Net income before depreciation, inventory reserves increases and other non-cash transactions, was $793,000. Additional cash was generated by reductions in accounts receivable of $1,054,000, in inventory of $421,000, and other current
assets of $133,000, and by increases in current liabilities of $173,000.





For the first nine months of 2002, we used $117,000 of cash
generated by operating activities to purchase equipment, including computers and software.





The remainder of the cash generated by
operating activities was used to reduce debt, primarily the line of credit. We paid down our bank line of credit by $2,174,000. We also made scheduled payments on our bank term loan and capital lease of $119,000. The line of credit is the primary
source of operational and non-operational funding. An additional $20,000 was generated by the exercise of employee stock options.





The
company maintains a bank line of credit with KeyBank National Association (KeyBank). The line is payable on demand and is collateralized by a Blanket Lien on all of our assets. The amount available under the line of credit is subject to
borrowing base restrictions and other financial covenants as outlined in the agreement. In addition, the agreement restricts the payment of cash dividends.





On July 31, 2002, the bank line of credit was renewed until May 15, 2003 with new terms and new financial covenants. Positive cash flow from the first quarter, approaching profitability in the second quarter and reduced
capital needs on the product side of the business until the economy improves have reduced our need for a $6 million line through at least the end of 2002. The maximum amount available under the line was therefore reduced from $6,000,000 to
$4,000,000. The interest rate was increased from the prime rate to the prime rate plus 0.25%. Should our working capital needs change significantly in the near future, short term notes may be used to finance those needs or the line may be
renegotiated and increased by the bank.





The aforementioned borrowing base on the line of credit is calculated as 85% of eligible
accounts receivable and 50% of inventory value, net of reserves. That calculation represents the maximum amount that can be drawn on the line of credit. In the near term, that number is not expected to exceed $4,000,000. The unused capacity on the
line (the excess of the borrowing base calculation over the




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amount drawn) was approximately $830,000 at September 28, 2002. This was the highest level of availability on the line in over a year. We were
in compliance with all covenants of the line for the quarter ended September 28, 2002.





As the line of credit is our primary source of
financing, it is critical to our short-term liquidity. To maintain a sufficient borrowing base to meet our needs and meet the covenant requirements of the line, we must maintain sales and gross profit levels with minimum inventory on hand, and
effectively manage cash flow from collections to payments. Significant delays or loss of customer orders, or delayed customer payments, could severely impact our ability to meet our short-term financial obligations. Inventory reductions also reduce
our borrowing base, thereby limiting our capacity for short-term borrowing. This would include reductions in inventory due to changes in the valuation of our inventory and the setting of appropriate inventory reserves to reflect changes in
technology or reduced customer requirements.





We lease our operating facility under an operating lease in which we have an obligation to
pay rent through 2009. See Note 6 to the financial statements contained in our Form 10-KSB for the year ended December 31, 2001. Except for that operating lease, we have not entered into any off-balance sheet transactions in 2002 and 2001.





Additional financing will be needed to support the future growth plans of the company. The search for financing continues. However,
economic factors have greatly decreased the availability and increased the cost of financing for our industry and hampered our progress in this area. The slowdown in product sales and our recent losses have shifted our focus to attaining additional
service business and returning to profitability. As we make progress in these areas, and/or the demand for products returns, we expect to increase our efforts to obtain further financing. However, there is no assurance that there will be financing
available at terms that are acceptable to us.





ACCOUNTING POLICIES





Our 10-KSB for the year ended December 31, 2001 included a discussion of our critical accounting policies which should be read in conjunction with the quarterly discussions contained in this Form
10-QSB.





Item 3.    Controls and Procedures





Based on the evaluation of the Companys disclosure controls and procedures as of a date within 90 days of the filing date of this quarterly report, each of John D. Bair, the Chief Executive
Officer of the Company, and Michael R. Sayre, the Chief Financial Officer of the Company, have concluded that the Companys disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in
the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commissions rules and forms.





There were no significant changes in the Companys internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.




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PART II  OTHER INFORMATION





Item 6.    Exhibits and Reports on Form 8-K.





(A)    Listing of Exhibits.  The following is a listing of Exhibits either filed with this report or incorporated by reference:





Exhibit No.

Description of Exhibit

If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC3(a)

Amended and restated articles of incorporation

Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.3(b)

Amendments to Amended and Restated Articles of Incorporation, adopted June 26, 2000

Form SB-2 filed with the Securities and Exchange Commission September 21, 2000.3(c)

Amendment to the Companys Amended and Restated Articles of Incorporation adopted May 23, 2001

Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on August 13, 2001.3(d)

Amended and Restated Code of Regulations

Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.3(e)

Amendment to Amended and Restated Code of Regulations

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2000.3(f)

Amendments to Amended and Restated Code of Regulations, adopted June 26, 2000

Form SB-2 filed with the Securities and Exchange Commission September 21, 2000.4

Instruments defining the rights of security holders, including indentures

Form SB-2 filed with the Securities and Exchange Commission September 21, 2000.10(a)

Technology license agreement between Pinnacle Data Systems, Inc. and Sun Microsystems, Inc. dated May 12, 1994

Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 199910(b)

Pinnacle Data Systems, Inc. 1995 Stock Option Plan dated December 19, 1995

Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.




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Exhibit No.

Description of Exhibit

If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC10(c)

Development and manufacturing license agreement between Pinnacle Data Systems, Inc. and Sun Microsystems, Inc. dated October 27, 1997

Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.10(d)

Lease agreement between Pinnacle Data Systems, Inc. and Duke Realty Limited Partnership dated March 9, 1999

Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.10(e)

Repair services agreement between Pinnacle Data Systems, Inc. and Sun Microsystems, Inc. dated March 29, 1999

Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.10(f)

Reference Design License Agreement between Pinnacle Data Systems, Inc. and Sun Microsystems, Inc. dated May 11, 1999

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002.10(g)

First Lease Amendment between Pinnacle Data Systems, Inc. and Duke Realty Limited Partnership dated January 5, 2000

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2000.10(h)

Amendment No. 1 to Pinnacle Data Systems, Inc. 1995 Stock Option Plan dated February 16, 2000

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2000.10(i)

Pinnacle Data Systems, Inc. 2000 Directors Stock Option Plan dated March 22, 2000

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2000.10(j)

Business Loan Agreement between Pinnacle Data Systems, Inc. and Key Bank National Association dated August 10, 2000

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2001.




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Exhibit No.

Description of Exhibit

If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC10(k)

Employment agreement between Pinnacle Data Systems, Inc. and John D. Bair dated January 1, 2001

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2001.10(l)

O.E.M. Supply Agreement between Pinnacle Data Systems, Inc. and Alcatel USA Sourcing L.P. dated February 12, 2001

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 200210(m)

Divisional Service Agreement between Pinnacle Data Systems, Inc. and Hewlett-Packard Company dated September 1, 2001

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 200210(n)

Direct Connect VS Supplier Services Agreement between Pinnacle Data Systems, Inc. and Hewlett-Packard Company dated September 1, 2001

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 200210(o)

Employment agreement between Pinnacle Data Systems, Inc. and C. Robert Hahn dated September 1, 2001

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 200210(p)

Employment agreement between Pinnacle Data Systems, Inc. and Michael R. Sayre dated September 1, 2001

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 200210(q)

Employment agreement between Pinnacle Data Systems, Inc. and Christopher L. Winslow dated September 1, 2001

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 200210(r)

Amendment to Promissory Note between Pinnacle Data Systems, Inc. and Key Bank National Association dated February 21, 2002

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002




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Exhibit No.

Description of Exhibit

If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC10(s)

First Amendment Agreement to Loan Agreement between Pinnacle Data Systems, Inc. and Key Bank National Association dated February 21, 2002

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 200210(t)

Second Amendment Agreement to Loan Agreement between Pinnacle Data Systems, Inc. and Key Bank National Association dated March 7, 2002

Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002





| | (B)    Reports |  | on Form 8-K.
| | -------------- |  | ------------




None.




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SIGNATURES





In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.





PINNACLE DATA SYSTEMS, INC.  /s/    Michael R. SayreDate:    November 12, 2002



Michael R. Sayre, Executive Vice President
and Chief Financial OfficerDate:    November 12, 2002



/s/    Thomas J. CarrThomas J. Carr, Controller





CERTIFICATIONS





I, John D. Bair, certify that:





1.  I have reviewed this quarterly
report on Form 10-QSB of Pinnacle Data Systems, Inc.;





2.  Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly
report;





3.  Based on my knowledge, the financial statements, and other financial information included in this quarterly
report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;





4.  The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and have:





a)  designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;





b)  evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and





c)  presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;





5.  The
registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent
functions):





a)  all significant deficiencies in the design or operation of internal controls which could adversely affect the
registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and




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b) any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrants internal controls; and





6. The registrants other certifying officers and I have indicated
in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.





Date:    November 12, 2002





/s/    John D. BairChief Executive Officer








I, Michael R. Sayre, certify that:





1.  I have reviewed this quarterly report on Form 10-QSB of Pinnacle Data Systems, Inc.;





2.  Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;





3.  Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;





4.  The
registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:





a)  designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;





b)  evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and





c)  presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;





5.  The registrants other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent functions):





a)  all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial
data and have identified for the registrants auditors any material weaknesses in internal controls; and





b)  any fraud,
whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and




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6.    The registrants other certifying officers and I have indicated in this quarterly report whether or not there
were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and
material weaknesses.





Date:    November 12, 2002





/s/    Michael R. SayreChief Financial Officer





CERTIFICATION PURSUANT TO


SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


OF QUARTERLY REPORT ON FORM 10-QSB


OF PINNACLE DATA
SYSTEMS, INC.


FOR THE QUARTER ENDED SEPTEMBER 28, 2002





The undersigned is the Chief Executive Officer of Pinnacle Data Systems, Inc. (the Issuer). This Certification is made pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This
Certification accompanies the Quarterly Report on Form 10-QSB of the Issuer for the quarterly period ended September 28, 2002.





I, John
D. Bair, certify that the Quarterly Report on Form 10-QSB for the period ended September 28, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) and that information
contained in the Quarterly Report on Form 10-QSB fairly presents, in all material respects, the financial condition and results of operations of the Issuer.





This certification is executed as of November 12, 2002.





/s/    John D. BairChief Executive Officer





CERTIFICATION PURSUANT TO


SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


OF QUARTERLY REPORT ON FORM 10-QSB


OF PINNACLE DATA
SYSTEMS, INC.


FOR THE QUARTER ENDED SEPTEMBER 28, 2002




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The undersigned is the Chief Financial Officer of Pinnacle Data Systems, Inc. (the Issuer).
This Certification is made pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This Certification accompanies the Quarterly Report on Form 10-QSB of the Issuer for the quarterly period ended September 28, 2002.





I, Michael R. Sayre, certify that the Quarterly Report on Form 10-QSB for the period ended September 28, 2002 fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) and that information contained in the Quarterly Report on Form 10-QSB fairly presents, in all material respects, the financial condition and results of operations of the
Issuer.





This certification is executed as of November 12, 2002.





/s/ Michael R. SayreChief Financial Officer




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