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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q







|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended March 31, 2010

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 1-16103





LOGO

PINNACLE DATA SYSTEMS, INC.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Ohio                                                           |  | 31-1263732                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|6600 Port Road, Groveport, Ohio                                |  | 43125                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

Registrants telephone number: (614) 748-1150





No change

(Former name, former address, and former fiscal year, if changed since last reports)





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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files).    Yes   ̈    No   ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.

Large accelerated
filer   ̈        Accelerated
filer   ̈        Non-accelerated
filer   ̈        Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes   ̈    No  x

On April 28, 2010, the registrant had outstanding 7,825,099 common shares without par value, which is the registrants only
class of common equity.









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PINNACLE DATA SYSTEMS, INC.

FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2010

TABLE OF CONTENTS



|                                                                                                 |  |   
|------------------------------------------------------------------------------------------------ |  | --
|PART I  FINANCIAL INFORMATION                                                                   |  | 1 
|                                                                                                 | 
|ITEM 1    
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                           |  | 1 
|                                                                                                 | 
|ITEM 2    
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  | 9 
|                                                                                                 | 
|ITEM 4    CONTROLS AND
PROCEDURES                                                                |  | 13
|                                                                                                 | 
|PART II  OTHER INFORMATION                                                                      |  | 14
|                                                                                                 | 
|ITEM 6    EXHIBITS                                                                               |  | 14
|                                                                                                 | 
|SIGNATURES                                                                                       |  | 15
|                                                                                                 | 
|CERTIFICATIONS                                                                                   |  | 16



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PART I  FINANCIAL INFORMATION



|ITEM 1 | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|------ | -------------------------------------------

PINNACLE DATA SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)



|                                                                                           |  |               |        |   |                  |   |        |  
|------------------------------------------------------------------------------------------ |  | ------------- | ------ | - | ---------------- | - | ------ | -
|                                                                                           |  | March 31,2010 |        |   | December 31,2009 |  
|ASSETS                                                                                     |  | (Unaudited)   |        |   |                  |  
|                                                                                           |  |               |        |   |                  |   |        |  
|                                                                                           |  |              
|CURRENT ASSETS                                                                             |  |               |        |   |                  |   |        |  
|Cash                                                                                       |  | $             | 45     |   |                  | $ | 323    |  
|Accounts receivable, net of allowance for doubtful accounts of $242 and $232, respectively |  |               | 7,044  |   |                  |   | 5,932  |  
|Inventory, net                                                                             |  |               | 3,628  |   |                  |   | 3,754  |  
|Prepaid expenses and other current assets                                                  |  |               | 246    |   |                  |   | 525    |  
|                                                                                           |  |               |        |   |                  |   |        |  
|Total current assets                                                                       |  |               | 10,963 |   |                  |   | 10,534 |  
|                                                                                           |  |               |        |   |                  |   |        |  
|                                                                                           |  |              
|PROPERTY AND EQUIPMENT                                                                     |  |               |        |   |                  |   |        |  
|Property and equipment, cost                                                               |  |               | 5,924  |   |                  |   | 5,899  |  
|Less accumulated depreciation and amortization                                             |  |               | (5,120 | ) |                  |   | (5,038 | )
|                                                                                           |  |               |        |   |                  |   |        |  
|Total property and equipment, net                                                          |  |               | 804    |   |                  |   | 861    |  
|                                                                                           |  |               |        |   |                  |   |        |  
|                                                                                           |  |              
|OTHER ASSETS                                                                               |  |               |        |   |                  |   |        |  
|Goodwill                                                                                   |  |               | 774    |   |                  |   | 821    |  
|Other assets                                                                               |  |               | 358    |   |                  |   | 359    |  
|                                                                                           |  |               |        |   |                  |   |        |  
|Total other assets                                                                         |  |               | 1,132  |   |                  |   | 1,180  |  
|                                                                                           |  |               |        |   |                  |   |        |  
|TOTAL ASSETS                                                                               |  | $             | 12,899 |   |                  | $ | 12,575 |  
|                                                                                           |  |               |        |   |                  |   |        |  
|                                                                                           |  |              
|LIABILITIES AND STOCKHOLDERS EQUITY                                                       |  |               |        |   |                  |   |        |  
|                                                                                           |  |              
|CURRENT LIABILITIES                                                                        |  |               |        |   |                  |   |        |  
|Line of credit                                                                             |  | $             | 1,150  |   |                  | $ | 2,413  |  
|Accounts payable                                                                           |  |               | 3,694  |   |                  |   | 2,694  |  
|Accrued wages, payroll taxes and employee benefits                                         |  |               | 1,022  |   |                  |   | 1,014  |  
|Unearned revenue                                                                           |  |               | 381    |   |                  |   | 85     |  
|Other current liabilities                                                                  |  |               | 582    |   |                  |   | 555    |  
|                                                                                           |  |               |        |   |                  |   |        |  
|Total current liabilities                                                                  |  |               | 6,829  |   |                  |   | 6,761  |  
|                                                                                           |  |              
|LONG-TERM LIABILITIES                                                                      |  |               |        |   |                  |   |        |  
|Accrued other                                                                              |  |               | 213    |   |                  |   | 226    |  
|                                                                                           |  |               |        |   |                  |   |        |  
|                                                                                           |  |              
|TOTAL LIABILITIES                                                                          |  |               | 7,042  |   |                  |   | 6,987  |  
|                                                                                           |  |               |        |   |                  |   |        |  
|                                                                                           |  |              
|STOCKHOLDERS EQUITY                                                                       |  |               |        |   |                  |   |        |  
|Preferred stock; no par value; 4,000 shares authorized; no shares issued or outstanding    |  |               |       |   |                  |   |       |  
|Common stock; no par value; 25,000 shares authorized; 7,825 shares issued and outstanding  |  |               | 5,769  |   |                  |   | 5,769  |  
|Additional paid-in capital                                                                 |  |               | 1,926  |   |                  |   | 1,912  |  
|Accumulated other comprehensive income (loss)                                              |  |               | (83    | ) |                  |   | (29    | )
|Retained earnings (deficit)                                                                |  |               | (1,755 | ) |                  |   | (2,064 | )
|                                                                                           |  |               |        |   |                  |   |        |  
|Total stockholders equity                                                                 |  |               | 5,857  |   |                  |   | 5,588  |  
|                                                                                           |  |               |        |   |                  |   |        |  
|                                                                                           |  |              
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                 |  | $             | 12,899 |   |                  | $ | 12,575 |  
|                                                                                           |  |               |        |   |                  |   |        |  

See accompanying notes to condensed consolidated financial statements.



1



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PINNACLE DATA SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share)



|                                                             |  |                                    |       |      |   |        |  
|------------------------------------------------------------ |  | ---------------------------------- | ----- | ---- | - | ------ | -
|                                                             |  | For the ThreeMonths EndedMarch 31, |      
|                                                             |  | 2010                               |       | 2009 |  
|Sales                                                        |  | $                                  | 8,812 |      | $ | 10,887 |  
|Cost of sales                                                |  |                                    | 6,663 |      |   | 8,853  |  
|                                                             |  |                                    |       |      |   |        |  
|Gross profit                                                 |  |                                    | 2,149 |      |   | 2,034  |  
|Operating expenses                                           |  |                                    | 1,728 |      |   | 2,978  |  
|                                                             |  |                                    |       |      |   |        |  
|Income (loss) from operations                                |  |                                    | 421   |      |   | (944   | )
|Other expense                                                |  |                                    |       |      |   |        |  
|Interest expense                                             |  |                                    | 23    |      |   | 53     |  
|                                                             |  |                                    |       |      |   |        |  
|Income (loss) before income taxes                            |  |                                    | 398   |      |   | (997   | )
|Income tax expense (benefit)                                 |  |                                    | 89    |      |   | (296   | )
|                                                             |  |                                    |       |      |   |        |  
|Net income (loss)                                            |  | $                                  | 309   |      | $ | (701   | )
|                                                             |  |                                    |       |      |   |        |  
|                                                             |  |                                   
|Basic and diluted weighted average common shares outstanding |  |                                    | 7,825 |      |   | 7,825  |  
|                                                             |  |                                   
|Basic and diluted earnings (loss) per common share           |  | $                                  | 0.04  |      | $ | (0.09  | )

See accompanying notes to
condensed consolidated financial statements.



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PINNACLE DATA SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

(Unaudited)

(in thousands)



|                                    |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   |       |  
|----------------------------------- |  | ----------------- |  | ------------------------ | ----- | ------------------------------------------ | - | ----- | ------------------------- | - | ---- | ------------------------ |  | - | ------ | - | --- | - | ----- | -
|                                    |  | Common Stock      |  | AdditionalPaid-InCapital |       | AccumulatedOtherComprehensiveIncome (Loss) |   |       | RetainedEarnings(Deficit) |   |      | TotalStockholdersEquity | 
|                                    |  | OutstandingShares |  | Amount                   |       |                                            |   |      
|Balance  December 31, 2008         |  | 7,825             |  | $                        | 5,769 |                                            | $ | 1,797 |                           | $ | (57  | )                        |  | $ | 1,386  |   |     | $ | 8,895 |  
|Share-based payment expense         |  |                  |  |                          |      |                                            |   | 42    |                           |   |     |                          |  |   |       |   |     |   | 42    |  
|Comprehensive loss, net of taxes:   |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   |       |  
|Net loss                            |  |                  |  |                          |      |                                            |   |      |                           |   |     |                          |  |   | (701   | ) |     |   | (701  | )
|Foreign currency translation        |  |                  |  |                          |      |                                            |   |      |                           |   | (46  | )                        |  |   |       |   |     |   | (46   | )
|                                    |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   |       |  
|Total comprehensive loss            |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   | (747  | )
|                                    |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   |       |  
|Balance  March 31, 2009            |  | 7,825             |  | $                        | 5,769 |                                            | $ | 1,839 |                           | $ | (103 | )                        |  | $ | 685    |   |     | $ | 8,190 |  
|                                    |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   |       |  
|Balance  December 31, 2009         |  | 7,825             |  | $                        | 5,769 |                                            | $ | 1,912 |                           | $ | (29  | )                        |  | $ | (2,064 | ) |     | $ | 5,588 |  
|Share-based payment expense         |  |                  |  |                          |      |                                            |   | 14    |                           |   |     |                          |  |   |       |   |     |   | 14    |  
|Comprehensive income, net of taxes: |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   |       |  
|Net income                          |  |                  |  |                          |      |                                            |   |      |                           |   |     |                          |  |   | 309    |   |     |   | 309   |  
|Foreign currency translation        |  |                  |  |                          |      |                                            |   |      |                           |   | (54  | )                        |  |   |       |   |     |   | (54   | )
|                                    |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   |       |  
|Total comprehensive income          |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   | 255 |  
|                                    |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   |       |  
|BalanceMarch 31, 2010              |  | 7,825             |  | $                        | 5,769 |                                            | $ | 1,926 |                           | $ | (83  | )                        |  | $ | (1,755 | ) |     | $ | 5,857 |  
|                                    |  |                   |  |                          |       |                                            |   |       |                           |   |      |                          |  |   |        |   |     |   |       |  

See accompanying notes to condensed consolidated financial statements.



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PINNACLE DATA SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)



|                                                                                         |  |                                     |        |   |      |   |        |  
|---------------------------------------------------------------------------------------- |  | ----------------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                         |  | For the Three Months EndedMarch 31, |       
|                                                                                         |  | 2010                                |        |   | 2009 |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                                     |  |                                     |        |   |      |   |        |  
|Net income (loss)                                                                        |  | $                                   | 309    |   |      | $ | (701   | )
|                                                                                         |  |                                     |        |   |      |   |        |  
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |                                     |        |   |      |   |        |  
|Bad debt expense                                                                         |  |                                     | 10     |   |      |   | 67     |  
|Inventory reserves                                                                       |  |                                     | 105    |   |      |   | (57    | )
|Depreciation and amortization                                                            |  |                                     | 102    |   |      |   | 147    |  
|Share-based payment expense                                                              |  |                                     | 14     |   |      |   | 42     |  
|(Increase) decrease in assets:                                                           |  |                                     |        |   |      |   |        |  
|Accounts receivable                                                                      |  |                                     | (1,150 | ) |      |   | 2,257  |  
|Inventory                                                                                |  |                                     | 10     |   |      |   | 249    |  
|Prepaid expenses and other assets                                                        |  |                                     | 256    |   |      |   | 173    |  
|Increase (decrease) in liabilities:                                                      |  |                                     |        |   |      |   |        |  
|Accounts payable                                                                         |  |                                     | 533    |   |      |   | (414   | )
|Unearned revenue                                                                         |  |                                     | 296    |   |      |   | 790    |  
|Other current liabilities                                                                |  |                                     | 44     |   |      |   | (178   | )
|                                                                                         |  |                                     |        |   |      |   |        |  
|Total adjustments                                                                        |  |                                     | 220    |   |      |   | 3,076  |  
|                                                                                         |  |                                     |        |   |      |   |        |  
|Net cash provided by operating activities                                                |  |                                     | 529    |   |      |   | 2,375  |  
|                                                                                         |  |                                     |        |   |      |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                                     |  |                                     |        |   |      |   |        |  
|Purchases of property and equipment                                                      |  |                                     | (55    | ) |      |   | (44    | )
|                                                                                         |  |                                     |        |   |      |   |        |  
|Net cash provided by investing activities                                                |  |                                     | (55    | ) |      |   | (44    | )
|                                                                                         |  |                                     |        |   |      |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                                     |  |                                     |        |   |      |   |        |  
|Net change in line of credit                                                             |  |                                     | (1,263 | ) |      |   | (1,831 | )
|Net change in outstanding checks                                                         |  |                                     | 498    |   |      |   | (635   | )
|Other                                                                                    |  |                                     | 17     |   |      |   |       |  
|                                                                                         |  |                                     |        |   |      |   |        |  
|Net cash used in financing activities                                                    |  |                                     | (748   | ) |      |   | (2,466 | )
|                                                                                         |  |                                     |        |   |      |   |        |  
|EFFECT OF EXCHANGE RATE ON CASH                                                          |  |                                     | (4     | ) |      |   | (5     | )
|                                                                                         |  |                                     |        |   |      |   |        |  
|INCREASE (DECREASE) IN CASH                                                              |  |                                     | (278   | ) |      |   | (140   | )
|Cash at beginning of period                                                              |  |                                     | 323    |   |      |   | 282    |  
|                                                                                         |  |                                     |        |   |      |   |        |  
|Cash at end of period                                                                    |  | $                                   | 45     |   |      | $ | 142    |  
|                                                                                         |  |                                     |        |   |      |   |        |  

See accompanying notes to condensed consolidated financial statements.



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PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

March 31, 2010 and 2009

1. Basis of Presentation

The accompanying condensed consolidated financial statements of Pinnacle Data Systems, Inc. (PDSi or the Company)
have been prepared in accordance with United States (U.S.) generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly,
they do not include all information and footnotes required by GAAP for complete financial statements. The financial information included herein reflects all adjustments (all of which are normal and recurring in nature) which are, in the opinion of
management, necessary for a fair presentation of financial position and results of operations. Operating results for all periods presented are not necessarily indicative of the results that may be expected for the full year.

The Companys condensed consolidated financial statements include the accounts of PDSi and PDSi B.V., a private limited liability
company located in Tiel, the Netherlands (PDSi Tiel). All significant intercompany balances and transactions have been eliminated.

The preparation of financial statements and related disclosures in conformity with GAAP requires management to make judgments,
assumptions and estimates that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ significantly from those estimates. Certain prior year amounts have been reclassified
to conform to the current presentation. The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes for the year ended December 31, 2009
included in the Companys 2009 Annual Report on Form 10-K.

2. Summary of Significant Accounting Policies

A complete summary of the Companys significant accounting policies is included in Note 2 to the audited consolidated financial
statements included in the Companys 2009 Annual Report on Form 10-K. There have been no material changes to these policies since December 31, 2009.

Inventory

The
following table summarizes the Companys inventory as of the dates indicated (net of reserves of $2,486,000 and $2,404,000, respectively, as of March 31, 2010 and December 31, 2009):



|                                |  |               |       |                  |   |      
|------------------------------- |  | ------------- | ----- | ---------------- | - | -----
|(in thousands)                  |  | March 31,2010 |       | December 31,2009
|Component parts (raw materials) |  | $             | 3,139 |                  | $ | 3,289
|Work-in-process                 |  |               | 20    |                  |   | 19   
|Finished goods                  |  |               | 469   |                  |   | 446  
|                                |  |               |       |                  |   |      
|Total inventory                 |  | $             | 3,628 |                  | $ | 3,754
|                                |  |               |       |                  |   |      

3. Recently Issued Accounting Standards

In June 2009, the Financial Accounting Standards Board (FASB) issued a new accounting standard that codified U.S. GAAP (the
FASB Codification). Effective for financial statements issued for interim and annual periods ending after September 15, 2009, the FASB Codification is the source of authoritative U.S. GAAP recognized by the FASB to be applied by
nongovernmental entities. Rules and interpretive releases of the United States Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the
effective date, the FASB Codification superseded all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the FASB Codification became nonauthoritative. The Companys
adoption of the FASB Codification did not result in a change in its accounting practices. In accordance with recent SEC guidance, the Company no longer makes specific references to accounting standards. Instead, the Company discloses the current or
potential future material impact of recently issued accounting standards as applicable. The Company does not expect the adoption of any recently issued accounting standards to have a material impact on its financial position, results of operations
or cash flows.



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PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

March 31, 2010 and 2009



4. Line of Credit

On April 3, 2009, the Company entered into a Credit and Security Agreement (the Credit Agreement) with Wells Fargo Bank,
National Association (Wells Fargo), providing for a revolving credit facility (the Line) with a maximum line of credit of $9.0 million, subject to borrowing base restrictions. The borrowing base is determined as follows:
(1) the sum of (a) 85% of the aggregate amount of eligible receivable accounts located within the United States, plus (b) 75% of the aggregate amount of eligible receivable accounts located outside of the United States, plus
(c) the lesser of 10% of the aggregate amount of eligible inventory or $500,000; less (2) the sum of a borrowing base reserve which may be established by Wells Fargo at its sole discretion, plus other indebtedness to Wells Fargo which may
occur outside of the Credit Agreement.

The Line is evidenced by a Revolving Note made by the Company in favor of Wells Fargo
and is secured by substantially all of the assets of the Company, as provided for in the Credit Agreement. The Line is subject to customary affirmative and negative covenants for credit facilities of this type, including limitations on the Company
with respect to liens, indebtedness, guaranties, investments, distributions, mergers and acquisitions, and dispositions of assets.

The Credit Agreement also contains certain financial covenants, including a minimum book net worth, minimum net income and maximum
capital expenditures. The Company obtained a waiver from Wells Fargo for violation of the minimum book net worth financial covenant as of June 30 and September 30, 2009, and for violation of the minimum net income financial covenant for
the three months ended June 30 and September 30, 2009. During the fourth quarter of 2009, the Credit Agreement was revised to adjust the financial covenants based on the Companys current financial projections and to include a
reduction and block of availability under the borrowing base of $250,000 until such time as the Company complies with each of the financial covenants described above for both of the fiscal quarters ending December 31, 2009 and March 31,
2010. Based on the Companys results of operations for the quarters ending December 31, 2009 and March 31, 2010, the Company expects the $250,000 reduction and block of availability under the borrowing base to be removed during the
second quarter of 2010.

The outstanding balance on the Line bears interest monthly at an annual rate, as elected by the
Company at the time of each credit advancement, of either: (1) a floating rate equal to the greater of 4% or the sum of (a) the Wells Fargo daily Base Rate, plus (b) 2.5%; or (2) a fixed rate of the London Interbank Offered Rate
plus 5.0%. The maturity date of the Line is April 3, 2012.

The Credit Agreement may be terminated by the Company upon 90
days written notice or by Wells Fargo immediately upon default. Upon any such termination, the Company is required to pay Wells Fargo a termination fee.

The Company may use borrowings under the Credit Agreement for working capital. Any unused portions of the maximum amount of the Line are
subject to unused Line fees.

5. Income Taxes

The Company reviewed its net deferred tax assets as of September 30, 2009 to assess the need to establish a valuation allowance due
to the continuing uncertain economic environment and the Companys pre-tax loss for the nine months ended September 30, 2009. The Companys net deferred tax assets primarily consist of temporary differences related to inventory
reserves and federal net operating loss carryforwards. Based on the Companys analysis and application of the required GAAP framework, management established a valuation allowance of $1,611,000 against its net deferred tax asset balance as of
September 30, 2009. The valuation allowance was adjusted to $1,571,000 during the fourth quarter of 2009 and to $1,510,000 during the first quarter of 2010 to reflect activity during those quarters.

The Company can provide no assurance that a change in the deferred tax asset valuation allowance will not be required in the future. The
Company will continue to monitor events and circumstances in future periods to determine whether a change in the valuation allowance is warranted, or if the valuation allowance should be released based on sustained future profitability. It is at
least reasonably possible that a material adjustment to the valuation allowance could occur within one year.



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PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

March 31, 2010 and 2009



6. Earnings (Loss) Per Share

Basic earnings (loss) per share (EPS) represents the amount of earnings (loss) available to each share of common stock outstanding during
the reporting period. Diluted EPS represents the amount of earnings (loss) available to each share of common stock outstanding during the reporting period adjusted for the potential issuance of common shares for stock options, if dilutive. For the
three months ended March 31, 2010 and 2009, the effect of potential common shares arising from share-based employee compensation plans would have been anti-dilutive. As a result, the number of weighted average outstanding common shares
outstanding was the same for the basic and diluted EPS calculations for the periods noted above.

7. Segment Information

The Companys reportable segments are Product and Service. The Companys Product segment offers a wide range of technology
platforms, including standard and custom-designed products for the telecommunications, imaging, defense/aerospace, medical, industrial automation and information technology markets. The Companys product capabilities range from board-level
designs to globally certified, fully integrated systems. PDSis specialties include long-life, embedded products and unique, customer-centric solutions. The Companys Service segment provides a variety of engineering and manufacturing
services for global OEMs requiring custom product design, system integration, repair programs, warranty management, and/or specialized production capabilities. With service centers in the United States, Europe and Asia, PDSi ensures seamless support
for solutions all around the world and also provides depot repair and reverse logistics programs for the OEMs of other types of computer equipment. The Other line item in the following tables reflects the costs and assets of the
functional and administrative groups of the Company that are not allocated to the reportable segments, including finance, information technology, human resources, engineering and executive management. The Company evaluates performance based on the
operating results of the Product and Service segments and based on their effectiveness in covering the other administrative expenses of the Company. The Company sells its products and services in the United States and internationally and attributes
sales based on shipping point.

The following table summarizes the Companys segment operating results for the three months ended
March 31:



|                              |  |      |       |   |      |   |        |  
|----------------------------- |  | ---- | ----- | - | ---- | - | ------ | -
|(in thousands)                |  | 2010 |       |   | 2009 |  
|Sales                         |  |      |       |   |      |   |        |  
|Product                       |  | $    | 5,927 |   |      | $ | 8,486  |  
|Service                       |  |      | 2,885 |   |      |   | 2,401  |  
|                              |  |      |       |   |      |   |        |  
|Total                         |  | $    | 8,812 |   |      | $ | 10,887 |  
|                              |  |      |       |   |      |   |        |  
|Gross profit                  |  |      |       |   |      |   |        |  
|Product                       |  | $    | 1,069 |   |      | $ | 1,222  |  
|Service                       |  |      | 1,080 |   |      |   | 812    |  
|                              |  |      |       |   |      |   |        |  
|Total                         |  | $    | 2,149 |   |      | $ | 2,034  |  
|                              |  |      |       |   |      |   |        |  
|Income (loss) from operations |  |      |       |   |      |   |        |  
|Product                       |  | $    | 704   |   |      | $ | 290    |  
|Service                       |  |      | 652   |   |      |   | 232    |  
|Other                         |  |      | (935  | ) |      |   | (1,466 | )
|                              |  |      |       |   |      |   |        |  
|Total                         |  | $    | 421   |   |      | $ | (944   | )
|                              |  |      |       |   |      |   |        |  



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##### Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

March 31, 2010 and 2009



The following table summarizes segment assets as of the dates indicated:



|               |  |               |        |                  |   |       
|-------------- |  | ------------- | ------ | ---------------- | - | ------
|(in thousands) |  | March 31,2010 |        | December 31,2009
|Product        |  | $             | 4,722  |                  | $ | 4,305 
|Service        |  |               | 6,780  |                  |   | 6,314 
|Other          |  |               | 1,397  |                  |   | 1,956 
|               |  |               |        |                  |   |       
|Total          |  | $             | 12,899 |                  | $ | 12,575
|               |  |               |        |                  |   |       

The following table summarizes sales by geographic
region for the three months ended March 31:



|               |  |      |       |      |   |       
|-------------- |  | ---- | ----- | ---- | - | ------
|(in thousands) |  | 2010 |       | 2009
|United States  |  | $    | 8,041 |      | $ | 10,036
|International  |  |      | 771   |      |   | 851   
|               |  |      |       |      |   |       
|Total          |  | $    | 8,812 |      | $ | 10,887
|               |  |      |       |      |   |       

The following table summarizes long-lived assets by
geographic region as of the dates indicated:



|               |  |               |       |                  |   |      
|-------------- |  | ------------- | ----- | ---------------- | - | -----
|(in thousands) |  | March 31,2010 |       | December 31,2009
|United States  |  | $             | 561   |                  | $ | 559  
|International  |  |               | 1,375 |                  |   | 1,482
|               |  |               |       |                  |   |      
|Total          |  | $             | 1,936 |                  | $ | 2,041
|               |  |               |       |                  |   |      

International long-lived assets include goodwill of
$774,000 and $821,000 as of March 31, 2010 and December 31, 2009, respectively.



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##### Table of Contents

|ITEM 2 | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------ | -------------------------------------------------------------------------------------

SAFE HARBOR STATEMENT

Portions of this Quarterly Report on Form 10-Q (including information incorporated by reference) include 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, including, but not limited to, statements regarding Pinnacle Data Systems, Inc. (PDSi or the
Company) achieving its financial growth and profitability goals, or its sales, earnings and profitability expectations for the fiscal year ending December 31, 2010. The words believe, expect,
anticipate, estimate, intend, seek, may and similar expressions identify forward-looking statements that speak only as of the date of this Quarterly Report on Form 10-Q. 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. These factors include, but are not limited to, the following:



| |  |  | changes in general economic conditions, including prolonged or substantial economic downturn, and any related financial difficulties experienced by
original equipment manufacturers, end users, customers, suppliers or others with whom the Company does business;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in customer order patterns;
| | - |  | -----------------------------------



| |  |  | changes in our business or our relationship with major technology partners or significant customers;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | failure to maintain adequate levels of inventory;
| | - |  | -------------------------------------------------



| |  |  | production components and service parts cease to be readily available in the marketplace;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | lack of adequate financing to meet working capital needs or to take advantage of business and future growth opportunities that may arise;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | inability of cost reduction initiatives to lead to a realization of savings in labor, facilities or other operational costs;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | deviation of actual results from estimates and/or assumptions used by the Company in the application of its significant accounting policies;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | lack of success in technological advancements;
| | - |  | ----------------------------------------------



| |  |  | inability to retain certifications, authorizations or licenses to provide certain products and/or services;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | risks associated with our new business practices, processes and information systems;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | impact of judicial rulings or government regulations, including related compliance costs;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | disruption in the business of suppliers, customers or service providers due to adverse weather, casualty events, technological difficulty, acts of
war or terror, or other causes;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | risks associated with doing business internationally, including economic, political and social instability and foreign currency exposure; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | other factors from time to time described in the Companys filings with the United States Securities and Exchange Commission (SEC).
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------

The Company undertakes no obligation to publicly update or revise any such statements, except as required
by applicable law.

The following is managements discussion and analysis of financial condition and results of
operations of the Company for the three months ended March 31, 2010 and 2009. This discussion should be read in conjunction with the Companys audited consolidated financial statements and related notes contained in its 2009 Annual Report
on Form 10-K.

Executive Overview

PDSi is a global provider of services and products for original equipment manufacturers (OEMs) of computer hardware products
or products that contain computer hardware. We provide a variety of engineering and manufacturing services for global OEMs requiring custom product design, system integration, repair programs, warranty management, and/or specialized production
capabilities. With service centers in the United States, Europe and Asia, we ensure seamless support for solutions all around the world and also provide depot repair and reverse logistics programs for the OEMs of other types of computer equipment.
We offer a wide range of technology platforms, including standard and custom-designed products for the telecommunications, imaging, defense/aerospace, medical, industrial automation and information technology markets. Our product capabilities range
from board-level designs to globally certified, fully integrated systems. Our specialties include long-life, embedded products and unique, customer-centric solutions. The common shares of PDSi are traded on NYSE Amex under the stock symbol
PNS.



9



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##### Table of Contents

During the fourth quarter of 2009, we announced the implementation of a plan to return to
profitability in 2010 by focusing on our core Service segment business and current Product segment offerings, and by focusing on customer-funded development of new embedded products. We are fully supporting our current products and customer
programs, as well as maintaining the ability to upgrade these products. We will focus our sales and marketing efforts in the Service segment and on specialized product integration programs where our highly valued engineering and operational
expertise give us distinct competitive advantages. This plan aligned PDSis operations with this focused growth strategy, and included reductions and changes in senior and mid-level management to flatten the organizational structure and reduce
overhead costs. While these actions resulted in a profitable first quarter of 2010, difficult worldwide economic conditions that have persisted since mid-2008, and which have negatively affected our existing multi-national OEM customers and the
industries in which they participate, may continue to materially adversely affect the Companys results of operations, financial condition and cash flows.

During the three months ended March 31, 2010, the Company reported net income of $309,000, or $0.04 per diluted share, versus a net
loss of $701,000, or $0.09 per diluted share, for the prior year quarter. See below for further discussion of consolidated and reportable segment results of operations for the three months ended March 31, 2010 and 2009.

We believe our operating results will continue to improve as gross profit and operating profit increase due to several factors. First, as
mentioned above, we have reduced the Companys overhead cost structure to focus resources and investment on developing our core services and current product businesses. In addition, we anticipate organic growth through our existing global
service offerings and computer products, and specialized product integration programs sold to current and new customers in markets in which higher value is rewarded with higher margins. Gross margins will vary from program to program, and the mix of
programs will vary each quarter, resulting in quarterly gross margin percentage fluctuations. Consequently, it is difficult to predict quarterly gross margins on future sales. However, we believe gross margins should continue to trend higher over
the next few years.

Results of Operations

Consolidated Operations

First Quarter  2010 Compared to 2009

The following table summarizes the Companys consolidated results of operations for the three months ended March 31:



|                                  |  |      |       |           |       |   |      |   |        |           |  |       |         |  |     |  
|--------------------------------- |  | ---- | ----- | --------- | ----- | - | ---- | - | ------ | --------- |  | ----- | ------- |  | --- | -
|(dollars in thousands)            |  | 2010 |       | % ofSales |       |   | 2009 |   |        | % ofSales |  |       | %Change | 
|Sales                             |  | $    | 8,812 |           | 100.0 | % |      | $ | 10,887 |           |  | 100.0 | %       |  | -19 | %
|Cost of sales                     |  |      | 6,663 |           | 75.6  | % |      |   | 8,853  |           |  | 81.3  | %       |  | -25 | %
|                                  |  |      |       |           |       |   |      |   |        |           |  |       |         |  |     |  
|Gross profit                      |  |      | 2,149 |           | 24.4  | % |      |   | 2,034  |           |  | 18.7  | %       |  | 6   | %
|Operating expenses                |  |      | 1,728 |           | 19.6  | % |      |   | 2,978  |           |  | 27.4  | %       |  | -42 | %
|                                  |  |      |       |           |       |   |      |   |        |           |  |       |         |  |     |  
|Income (loss) from operations     |  |      | 421   |           | 4.8   | % |      |   | (944   | )         |  | -8.7  | %       |  | NM  |  
|Other expense                     |  |      |       |           |       |   |      |   |        |           |  |       |         |  |     |  
|Interest expense                  |  |      | 23    |           | 0.3   | % |      |   | 53     |           |  | 0.5   | %       |  | -57 | %
|                                  |  |      |       |           |       |   |      |   |        |           |  |       |         |  |     |  
|Income (loss) before income taxes |  |      | 398   |           | 4.5   | % |      |   | (997   | )         |  | -9.2  | %       |  | NM  |  
|Income tax expense (benefit)      |  |      | 89    |           | 1.0   | % |      |   | (296   | )         |  | -2.7  | %       |  | NM  |  
|                                  |  |      |       |           |       |   |      |   |        |           |  |       |         |  |     |  
|Net income (loss)                 |  | $    | 309   |           | 3.5   | % |      | $ | (701   | )         |  | -6.4  | %       |  | NM  |  
|                                  |  |      |       |           |       |   |      |   |        |           |  |       |         |  |     |  

The Company recorded net income for the three months ended March 31, 2010 compared to a net
loss in the prior year period primarily due to a reduction in operating expenses and manufacturing overheads. This reduction in expenses reflects the aforementioned actions taken throughout 2009 to reduce the Companys overhead cost structure,
including employee costs and facilities expenses, to a level commensurate with current sales levels. Service segment gross profit increased 31% due to a 20% increase in Service sales driven by growth in new programs in both the United States and the
Europe, Middle East and Africa (EMEA) region. Lastly, interest expense declined 57% due to lower average debt balances. The improvement in results of operations was partially mitigated by lower Product segment gross profit due to a 29%
decline in Product sales.

For the first quarter of 2010, the Company had three customers that generated $2.5 million, $1.5
million and $1.4 million, or 28%, 17% and 16%, respectively, of total sales. Of the revenues from these customers, 86% and 14% were included in Product and Service segment sales, respectively. For the first quarter of 2009, the Company had two
customers that generated $4.1 million and $1.6 million, or 38% and 15%, respectively, of total sales. Of the revenues from these customers, 88% and 12% were included in Product and Service segment sales, respectively.



10



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##### Table of Contents

Segment Operations

Product

The
following table summarizes the Companys gross profit for the Product segment for the three months ended March 31:



|                       |  |      |       |           |       |   |      |   |           |  |       |         |  |     |  
|---------------------- |  | ---- | ----- | --------- | ----- | - | ---- | - | --------- |  | ----- | ------- |  | --- | -
|(dollars in thousands) |  | 2010 |       | % ofSales |       |   | 2009 |   | % ofSales |  |       | %Change | 
|Sales                  |  | $    | 5,927 |           | 100.0 | % |      | $ | 8,486     |  | 100.0 | %       |  | -30 | %
|Cost of sales          |  |      | 4,858 |           | 82.0  | % |      |   | 7,264     |  | 85.6  | %       |  | -33 | %
|                       |  |      |       |           |       |   |      |   |           |  |       |         |  |     |  
|Gross profit           |  | $    | 1,069 |           | 18.0  | % |      | $ | 1,222     |  | 14.4  | %       |  | -13 | %
|                       |  |      |       |           |       |   |      |   |           |  |       |         |  |     |  

Lower Product segment gross profit primarily was due to a 30% decrease in Product sales, including
a $3.0 million decline in sales to large OEMs in the imaging and medical industries. Strong growth in the telecommunications sector, which increased $0.9 million, partially offset the overall decline in Product sales. The improvement in gross profit
as a percentage of sales from 14% in 2009 to 18% in 2010 reflects a shift in sales mix to higher margin products.

Service

The following table summarizes the Companys gross profit for the Service segment for the three months ended
March 31:



|                       |  |      |       |           |       |   |      |   |           |  |       |         |  |    |  
|---------------------- |  | ---- | ----- | --------- | ----- | - | ---- | - | --------- |  | ----- | ------- |  | -- | -
|(dollars in thousands) |  | 2010 |       | % ofSales |       |   | 2009 |   | % ofSales |  |       | %Change | 
|Sales                  |  | $    | 2,885 |           | 100.0 | % |      | $ | 2,401     |  | 100.0 | %       |  | 20 | %
|Cost of sales          |  |      | 1,805 |           | 62.6  | % |      |   | 1,589     |  | 66.2  | %       |  | 14 | %
|                       |  |      |       |           |       |   |      |   |           |  |       |         |  |    |  
|Gross profit           |  | $    | 1,080 |           | 37.4  | % |      | $ | 812       |  | 33.8  | %       |  | 33 | %
|                       |  |      |       |           |       |   |      |   |           |  |       |         |  |    |  

Higher Service segment gross profit was due to a 20% increase in Service sales driven by growth in
new programs in both the U.S. and EMEA. Gross profit as a percentage of sales increased from 34% in 2009 to 37% in 2010 due to improved operating efficiency.

Liquidity and Capital Resources

Liquidity and capital resources demonstrate the overall financial strength of the Company and its ability to generate cash flows from
operations and borrow funds at competitive rates to meet operating and growth needs.

The Companys current capital
structure consists of a line of credit and stockholders equity. The following table summarizes the Companys capital structure as of the dates indicated:



|                                                                              |  |               |       |   |                  |   |       |  
|----------------------------------------------------------------------------- |  | ------------- | ----- | - | ---------------- | - | ----- | -
|(in thousands)                                                                |  | March 31,2010 |       |   | December 31,2009 |  
|Line of credit                                                                |  | $             | 1,150 |   |                  | $ | 2,413 |  
|                                                                              |  |               |       |   |                  |   |       |  
|Stockholders equity, excluding accumulated other comprehensive income (loss) |  |               | 5,940 |   |                  |   | 5,617 |  
|Accumulated other comprehensive income (loss)                                 |  |               | (83   | ) |                  |   | (29   | )
|                                                                              |  |               |       |   |                  |   |       |  
|Total stockholders equity                                                    |  |               | 5,857 |   |                  |   | 5,588 |  
|                                                                              |  |               |       |   |                  |   |       |  
|Total capital                                                                 |  | $             | 7,007 |   |                  | $ | 8,001 |  
|                                                                              |  |               |       |   |                  |   |       |  

Based on the Companys historical cash flow, current financial results and unused capacity on the line
of credit, we believe we have access to adequate resources to provide sufficient liquidity for the operations of the Company over the next year. See further discussion in Financing Activities below.



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##### Table of Contents

The following tables summarize the Companys condensed consolidated cash flows for the
three months ended March 31:



|                                          |  |      |      |   |      |   |        |  
|----------------------------------------- |  | ---- | ---- | - | ---- | - | ------ | -
|(in thousands)                            |  | 2010 |      |   | 2009 |  
|Net cash provided by operating activities |  | $    | 529  |   |      | $ | 2,375  |  
|Net cash used in investing activities     |  |      | (55  | ) |      |   | (44    | )
|Net cash used in financing activities     |  |      | (748 | ) |      |   | (2,466 | )
|Effect of exchange rate on cash           |  |      | (4   | ) |      |   | (5     | )
|                                          |  |      |      |   |      |   |        |  
|Increase (decrease) in cash               |  |      | (278 | ) |      |   | (140   | )
|Cash at beginning of period               |  |      | 323  |   |      |   | 282    |  
|                                          |  |      |      |   |      |   |        |  
|Cash at end of period                     |  | $    | 45   |   |      | $ | 142    |  
|                                          |  |      |      |   |      |   |        |  

Operating Activities

Net cash provided by operating activities was $0.5 million and $2.4 million for the three months ended March 31, 2010 and 2009,
respectively. Net income (loss) adjusted for the effects of non-cash items, which primarily include inventory reserves and depreciation expense, resulted in cash inflows of $0.5 million and cash outflows of $0.5 million in the first three months of
2010 and 2009, respectively. Changes in working capital resulted in no net cash activity for the first three months of 2010 compared to $2.9 million in cash provided for the comparable period of 2009. Lower cash provided by operating activities in
the current year period was driven by the reduction in working capital in 2009 attributable to declining sales volumes, as well as increased 2010 accounts receivable due to significant shipments late in the quarter.

Investing Activities

Net cash used in investing activities represents purchases of property and equipment and was not significant for the three months ended
March 31, 2010 and 2009.

Financing Activities

Net cash used in financing activities was $0.7 million and $2.5 million for the first three months of 2010 and 2009, respectively.
Financing activity in both periods reflects net repayments on the Companys line of credit. All cash generated by operations after funding investing activities is applied to the line of credit.

On April 3, 2009, the Company entered into a Credit and Security Agreement (the Credit Agreement) with Wells Fargo Bank,
National Association (Wells Fargo), providing for a revolving credit facility (the Line) with a maximum line of credit of $9.0 million, subject to borrowing base restrictions. The borrowing base is determined as follows:
(1) the sum of (a) 85% of the aggregate amount of eligible receivable accounts located within the United States, plus (b) 75% of the aggregate amount of eligible receivable accounts located outside of the United States, plus
(c) the lesser of 10% of the aggregate amount of eligible inventory or $500,000; less (2) the sum of a borrowing base reserve which may be established by Wells Fargo at its sole discretion, plus other indebtedness to Wells Fargo which may
occur outside of the Credit Agreement.

The Line is evidenced by a Revolving Note made by the Company in favor of Wells Fargo
and is secured by substantially all of the assets of the Company, as provided for in the Credit Agreement. The Line is subject to customary affirmative and negative covenants for credit facilities of this type, including limitations on the Company
with respect to liens, indebtedness, guaranties, investments, distributions, mergers and acquisitions, and dispositions of assets.

The Credit Agreement also contains certain financial covenants, including a minimum book net worth, minimum net income and maximum
capital expenditures. The Company obtained a waiver from Wells Fargo for violation of the minimum book net worth financial covenant as of June 30 and September 30, 2009, and for violation of the minimum net income financial covenant for
the three months ended June 30 and September 30, 2009. During the fourth quarter of 2009, the Credit Agreement was revised to adjust the financial covenants based on the Companys current financial projections and to include a
reduction and block of availability under the borrowing base of $250,000 until such time as the Company complies with each of the financial covenants described above for both of the fiscal quarters ending December 31, 2009 and March 31,
2010. Based on the Companys results of operations for the quarters ending December 31, 2009 and March 31, 2010, the Company expects the $250,000 reduction and block of availability under the borrowing base to be removed during the
second quarter of 2010.

The outstanding balance on the Line bears interest monthly at an annual rate, as elected by the
Company at the time of each credit advancement, of either: (1) a floating rate equal to the greater of 4% or the sum of (a) the Wells Fargo daily Base Rate, plus (b) 2.5%; or (2) a fixed rate of the London Interbank Offered Rate
plus 5.0%. The maturity date of the Line is April 3, 2012.



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##### Table of Contents

The Credit Agreement may be terminated by the Company upon 90 days written notice or by
Wells Fargo immediately upon default. Upon any such termination, the Company is required to pay Wells Fargo a termination fee.

The Company may use borrowings under the Credit Agreement for working capital. Any unused portions of the maximum amount of the Line are
subject to unused Line fees.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements with (1) any obligation under a guarantee contract; (2) a retained or
contingent interest in assets or similar arrangement that serves as credit, liquidity or market risk support for such assets; or (3) any other obligation, including a contingent obligation, under a contract that would be accounted for as a
derivative instrument or arising out of a variable interest.

During the normal course of business, the Company may have
numerous outstanding purchase orders with vendors to purchase inventory for use in products that are sold to the Companys customers or are used in performing repair services for the Companys customers. The Company does not record such
orders as liabilities on the consolidated balance sheets until the material is placed on a common carrier or delivered to the Companys facilities, depending on terms of the arrangement. The Company has no minimum purchase quantity requirements
with any of its vendors.

Critical Accounting Policies and Recently Issued Accounting Standards

The preparation of financial statements and related disclosures in conformity with United States generally accepted accounting principles
(GAAP) requires management to make judgments, assumptions and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ significantly from those estimates. The
Companys most critical estimates include those related to revenue recognition, accounts receivable, inventory, goodwill and income taxes. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP,
with no need for judgment in application. In addition, there are areas in which managements judgment in selecting an available alternative would not produce a materially different result. Note 2 to the audited consolidated financial statements
included in the Companys 2009 Annual Report on Form 10-K describes the significant accounting policies and methods used by the Company. See Part I  Financial Information, Item 1  Condensed Consolidated Financial Statements,
Note 3  Recently Issued Accounting Standards for information regarding recently issued accounting standards. The Companys critical accounting policies have not changed materially from those disclosed in the Companys 2009 Annual
Report on Form 10-K.



|ITEM 4 | CONTROLS AND PROCEDURES
|------ | -----------------------

Evaluation of
Disclosure Controls and Procedures

The Companys management, with the participation of the Chief Executive Officer
and Chief Financial Officer, have evaluated the effectiveness of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this
quarterly report (the Evaluation Date). The disclosure controls and procedures are to ensure 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 SECs rules and forms, and to ensure that information required to be disclosed by the Company in the reports it files or submits under the
Securities Exchange Act of 1934 is accumulated and communicated to the Companys management, including the Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, as appropriate, to allow timely decisions
regarding required disclosure. Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

No change was made in the Companys internal control over financial reporting during the Companys first fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



13



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##### Table of Contents

PART II  OTHER INFORMATION



|ITEM 6. | EXHIBITS
|------- | --------



|            |  |                                                                                                                                                                                                         |  |                                                                                            
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                                                                                  |  | If incorporated by reference, document with which
Exhibit was previously filed with the SEC
|31.1        |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-Q of Pinnacle Data Systems,
Inc. for the quarter ended March 31, 2010 |  | Contained herein                                                                           
|            |  |                                                                                                                                                                                                        
|31.2        |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-Q of Pinnacle Data Systems,
Inc. for the quarter ended March 31, 2010 |  | Contained herein                                                                           
|            |  |                                                                                                                                                                                                        
|32.1        |  | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-Q of Pinnacle Data Systems,
Inc. for the quarter ended March 31, 2010 |  | Contained herein                                                                           
|            |  |                                                                                                                                                                                                        
|32.2        |  | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-Q of Pinnacle Data Systems,
Inc. for the quarter ended March 31, 2010 |  | Contained herein                                                                           



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##### Table of Contents

SIGNATURES

Pursuant to the requirements 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 DATA SYSTEMS, INC.                 
|                     |  | 
|Date: April 30, 2010 |  |  |  | /s/    John D. Bair                         
|                     |  |  |  | John D. Bair
Chief Executive Officer        
|                     |  | 
|Date: April 30, 2010 |  |  |  | /s/    Nicholas J. Tomashot                 
|                     |  |  |  | Nicholas J. Tomashot Chief
Financial Officer



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