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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 June 30, 2009

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 August 5,
2009, 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 JUNE 30, 2009

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 |  | 10
|                                                                                                 | 
|ITEM 4    CONTROLS AND PROCEDURES                                                                |  | 17
|                                                                                                 | 
|PART II  OTHER INFORMATION                                                                      |  | 18
|                                                                                                 | 
|ITEM 4    
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   |  | 18
|                                                                                                 | 
|ITEM 6    EXHIBITS                                                                               |  | 18
|                                                                                                 | 
|SIGNATURES                                                                                       |  | 19
|                                                                                                 | 
|CERTIFICATIONS                                                                                   |  |   



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##### Table of Contents

PART I  FINANCIAL INFORMATION



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

PINNACLE DATA SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)



|                                                                                           |  |              |        |   |                  |   |        |  
|------------------------------------------------------------------------------------------ |  | ------------ | ------ | - | ---------------- | - | ------ | -
|                                                                                           |  | June 30,2009 |        |   | December 31,2008 |  
|                                                                                           |  | (Unaudited)  |        |   |                  |  
|ASSETS                                                                                     |  |              |        |   |                  |   |        |  
|                                                                                           |  |             
|CURRENT ASSETS                                                                             |  |              |        |   |                  |   |        |  
|Cash                                                                                       |  | $            | 94     |   |                  | $ | 282    |  
|Accounts receivable, net of allowance for doubtful accounts of $245 and $135, respectively |  |              | 7,532  |   |                  |   | 11,550 |  
|Inventory, net                                                                             |  |              | 4,951  |   |                  |   | 5,445  |  
|Prepaid expenses and other current assets                                                  |  |              | 1,817  |   |                  |   | 1,793  |  
|                                                                                           |  |              |        |   |                  |   |        |  
|Total current assets                                                                       |  |              | 14,394 |   |                  |   | 19,070 |  
|                                                                                           |  |              |        |   |                  |   |        |  
|                                                                                           |  |             
|PROPERTY AND EQUIPMENT                                                                     |  |              |        |   |                  |   |        |  
|Property and equipment, cost                                                               |  |              | 5,907  |   |                  |   | 5,776  |  
|Less accumulated depreciation and amortization                                             |  |              | (4,963 | ) |                  |   | (4,717 | )
|                                                                                           |  |              |        |   |                  |   |        |  
|Total property and equipment, net                                                          |  |              | 944    |   |                  |   | 1,059  |  
|                                                                                           |  |              |        |   |                  |   |        |  
|                                                                                           |  |             
|OTHER ASSETS                                                                               |  |              |        |   |                  |   |        |  
|Goodwill                                                                                   |  |              | 809    |   |                  |   | 797    |  
|Other assets                                                                               |  |              | 476    |   |                  |   | 367    |  
|                                                                                           |  |              |        |   |                  |   |        |  
|Total other assets                                                                         |  |              | 1,285  |   |                  |   | 1,164  |  
|                                                                                           |  |              |        |   |                  |   |        |  
|                                                                                           |  |             
|TOTAL ASSETS                                                                               |  | $            | 16,623 |   |                  | $ | 21,293 |  
|                                                                                           |  |              |        |   |                  |   |        |  
|                                                                                           |  |             
|LIABILITIES AND STOCKHOLDERS EQUITY                                                       |  |              |        |   |                  |   |        |  
|                                                                                           |  |             
|CURRENT LIABILITIES                                                                        |  |              |        |   |                  |   |        |  
|Line of credit                                                                             |  | $            | 2,977  |   |                  | $ | 5,408  |  
|Accounts payable                                                                           |  |              | 3,789  |   |                  |   | 5,156  |  
|Unearned revenue                                                                           |  |              | 634    |   |                  |   | 138    |  
|Other current liabilities                                                                  |  |              | 981    |   |                  |   | 1,475  |  
|                                                                                           |  |              |        |   |                  |   |        |  
|Total current liabilities                                                                  |  |              | 8,381  |   |                  |   | 12,177 |  
|                                                                                           |  |             
|LONG-TERM LIABILITIES                                                                      |  |              |        |   |                  |   |        |  
|Accrued other                                                                              |  |              | 224    |   |                  |   | 221    |  
|                                                                                           |  |              |        |   |                  |   |        |  
|                                                                                           |  |             
|TOTAL LIABILITIES                                                                          |  |              | 8,605  |   |                  |   | 12,398 |  
|                                                                                           |  |              |        |   |                  |   |        |  
|                                                                                           |  |             
|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                                                                 |  |              | 1,880  |   |                  |   | 1,797  |  
|Accumulated other comprehensive income (loss)                                              |  |              | (46    | ) |                  |   | (57    | )
|Retained earnings                                                                          |  |              | 415    |   |                  |   | 1,386  |  
|                                                                                           |  |              |        |   |                  |   |        |  
|Total stockholders equity                                                                 |  |              | 8,018  |   |                  |   | 8,895  |  
|                                                                                           |  |              |        |   |                  |   |        |  
|                                                                                           |  |             
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                 |  | $            | 16,623 |   |                  | $ | 21,293 |  
|                                                                                           |  |              |        |   |                  |   |        |  

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)



|                                                             |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------ |  | -------------------------- | ----- | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                             |  | Three MonthsEnded June 30, |       |   | Six Months EndedJune 30, |  
|                                                             |  | 2009                       |       |   | 2008                     |   |        | 2009 |  |   | 2008   |  
|Sales                                                        |  | $                          | 9,038 |   |                          | $ | 14,265 |      |  | $ | 19,925 |   |  | $ | 31,458 |  
|Cost of sales                                                |  |                            | 7,054 |   |                          |   | 12,621 |      |  |   | 15,907 |   |  |   | 26,083 |  
|                                                             |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Gross profit                                                 |  |                            | 1,984 |   |                          |   | 1,644  |      |  |   | 4,018  |   |  |   | 5,375  |  
|Operating expenses                                           |  |                            | 2,272 |   |                          |   | 3,133  |      |  |   | 5,250  |   |  |   | 6,354  |  
|                                                             |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) from operations                                |  |                            | (288  | ) |                          |   | (1,489 | )    |  |   | (1,232 | ) |  |   | (979   | )
|Other expense                                                |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Interest expense                                             |  |                            | 49    |   |                          |   | 100    |      |  |   | 102    |   |  |   | 191    |  
|                                                             |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) before income taxes                            |  |                            | (337  | ) |                          |   | (1,589 | )    |  |   | (1,334 | ) |  |   | (1,170 | )
|Income tax expense (benefit)                                 |  |                            | (67   | ) |                          |   | (617   | )    |  |   | (363   | ) |  |   | (462   | )
|                                                             |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                                            |  | $                          | (270  | ) |                          | $ | (972   | )    |  | $ | (971   | ) |  | $ | (708   | )
|                                                             |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|                                                             |  |                            |       |  
|Basic and diluted earnings (loss) per common share           |  | $                          | (0.03 | ) |                          | $ | (0.12  | )    |  | $ | (0.12  | ) |  | $ | (0.09  | )
|                                                             |  |                            |       |  
|Basic and diluted weighted average common shares outstanding |  |                            | 7,825 |   |                          |   | 7,814  |      |  |   | 7,825  |   |  |   | 7,781  |  

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 |   |     | TotalStockholdersEquity | 
|                                  |  | OutstandingShares |  | Amount                   |       |                                            |   |      
|Balance  December 31, 2007       |  | 7,689             |  | $                        | 5,485 |                                            | $ | 1,676 |                  | $ |    |                          |  | $ | 1,747 |   |  | $ | 8,908 |  
|Stock options exercised           |  | 8                 |  |                          | 6     |                                            |   |      |                  |   |    |                          |  |   |      |   |  |   | 6     |  
|Stock issued                      |  | 120               |  |                          | 272   |                                            |   |      |                  |   |    |                          |  |   |      |   |  |   | 272   |  
|Share-based payment expense       |  |                  |  |                          |      |                                            |   | 24    |                  |   |    |                          |  |   |      |   |  |   | 24    |  
|Comprehensive loss, net of taxes: |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   |       |  
|Net loss                          |  |                  |  |                          |      |                                            |   |      |                  |   |    |                          |  |   | (708  | ) |  |   | (708  | )
|Foreign currency exchange gain    |  |                  |  |                          |      |                                            |   |      |                  |   | 74  |                          |  |   |      |   |  |   | 74    |  
|                                  |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   |       |  
|Total comprehensive loss          |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   | (634  | )
|                                  |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   |       |  
|Balance  June 30, 2008           |  | 7,817             |  | $                        | 5,763 |                                            | $ | 1,700 |                  | $ | 74  |                          |  | $ | 1,039 |   |  | $ | 8,576 |  
|                                  |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   |       |  
|                                  |  |                   |  |                          |       |                                           
|Balance  December 31, 2008       |  | 7,825             |  | $                        | 5,769 |                                            | $ | 1,797 |                  | $ | (57 | )                        |  | $ | 1,386 |   |  | $ | 8,895 |  
|Share-based payment expense       |  |                  |  |                          |      |                                            |   | 83    |                  |   |    |                          |  |   |      |   |  |   | 83    |  
|Comprehensive loss, net of taxes: |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   |       |  
|Net loss                          |  |                  |  |                          |      |                                            |   |      |                  |   |    |                          |  |   | (971  | ) |  |   | (971  | )
|Foreign currency exchange gain    |  |                  |  |                          |      |                                            |   |      |                  |   | 11  |                          |  |   |      |   |  |   | 11    |  
|                                  |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   |       |  
|Total comprehensive loss          |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   | (960  | )
|                                  |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   |       |  
|Balance  June 30, 2009           |  | 7,825             |  | $                        | 5,769 |                                            | $ | 1,880 |                  | $ | (46 | )                        |  | $ | 415   |   |  | $ | 8,018 |  
|                                  |  |                   |  |                          |       |                                            |   |       |                  |   |     |                          |  |   |       |   |  |   |       |  

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)



|                                                                                         |  |                          |        |   |      |   |        |  
|---------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                         |  | Six Months EndedJune 30, |       
|                                                                                         |  | 2009                     |        |   | 2008 |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                                     |  |                          |        |   |      |   |        |  
|Net income (loss)                                                                        |  | $                        | (971   | ) |      | $ | (708   | )
|                                                                                         |  |                          |        |   |      |   |        |  
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |                          |        |   |      |   |        |  
|Depreciation and amortization                                                            |  |                          | 291    |   |      |   | 313    |  
|Share-based payment expense                                                              |  |                          | 83     |   |      |   | 24     |  
|Allowance for doubtful accounts                                                          |  |                          | 109    |   |      |   | 32     |  
|Inventory reserves                                                                       |  |                          | 404    |   |      |   | 903    |  
|(Increase) decrease in assets:                                                           |  |                          |        |   |      |   |        |  
|Accounts receivable                                                                      |  |                          | 3,918  |   |      |   | 1,648  |  
|Inventory                                                                                |  |                          | 94     |   |      |   | 198    |  
|Prepaid expenses and other assets                                                        |  |                          | 110    |   |      |   | (52    | )
|Income taxes receivable                                                                  |  |                          | (79    | ) |      |   | (760   | )
|Increase (decrease) in liabilities:                                                      |  |                          |        |   |      |   |        |  
|Accounts payable                                                                         |  |                          | (1,082 | ) |      |   | (455   | )
|Unearned revenue                                                                         |  |                          | 496    |   |      |   | 447    |  
|Other current liabilities                                                                |  |                          | (533   | ) |      |   | (480   | )
|                                                                                         |  |                          |        |   |      |   |        |  
|Total adjustments                                                                        |  |                          | 3,811  |   |      |   | 1,818  |  
|                                                                                         |  |                          |        |   |      |   |        |  
|Net cash provided by operating activities                                                |  |                          | 2,840  |   |      |   | 1,110  |  
|                                                                                         |  |                          |        |   |      |   |        |  
|                                                                                         |  |                         
|CASH FLOWS FROM INVESTING ACTIVITIES                                                     |  |                          |        |   |      |   |        |  
|Purchases of property and equipment                                                      |  |                          | (155   | ) |      |   | (113   | )
|Acquisition, net of cash received                                                        |  |                          |       |   |      |   | (937   | )
|Restricted cash                                                                          |  |                          |       |   |      |   | 1,200  |  
|                                                                                         |  |                          |        |   |      |   |        |  
|Net cash provided by (used in) investing activities                                      |  |                          | (155   | ) |      |   | 150    |  
|                                                                                         |  |                          |        |   |      |   |        |  
|                                                                                         |  |                         
|CASH FLOWS FROM FINANCING ACTIVITIES                                                     |  |                          |        |   |      |   |        |  
|Net change in line of credit                                                             |  |                          | (2,431 | ) |      |   | 2,959  |  
|Payment on short-term note payable                                                       |  |                          |       |   |      |   | (4,000 | )
|Net change in outstanding checks                                                         |  |                          | (264   | ) |      |   | 2      |  
|Other                                                                                    |  |                          | (181   | ) |      |   | 7      |  
|                                                                                         |  |                          |        |   |      |   |        |  
|Net cash used in financing activities                                                    |  |                          | (2,876 | ) |      |   | (1,032 | )
|                                                                                         |  |                          |        |   |      |   |        |  
|                                                                                         |  |                         
|EFFECT OF EXCHANGE RATE ON CASH                                                          |  |                          | 3      |   |      |   | 8      |  
|                                                                                         |  |                          |        |   |      |   |        |  
|                                                                                         |  |                         
|INCREASE (DECREASE) IN CASH                                                              |  |                          | (188   | ) |      |   | 236    |  
|Cash at beginning of period                                                              |  |                          | 282    |   |      |   | 54     |  
|                                                                                         |  |                          |        |   |      |   |        |  
|Cash at end of period                                                                    |  | $                        | 94     |   |      | $ | 290    |  
|                                                                                         |  |                          |        |   |      |   |        |  
|                                                                                         |  |                         
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION                                         |  |                          |        |   |      |   |        |  
|Common stock issued for acquisition                                                      |  | $                        |       |   |      | $ | 271    |  
|                                                                                         |  |                          |        |   |      |   |        |  

See accompanying notes to condensed consolidated financial statements.



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PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

June 30,
2009 and 2008



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.

On February 20, 2008, the Company acquired all of the equity of Aspan B.V., a private limited liability company located in Tiel, the Netherlands
(now known as PDSi B.V., or PDSi Tiel). The acquisition was accounted for under the purchase method of accounting. Accordingly, PDSi Tiels financial position as of December 31, 2008 and results of operations subsequent to
February 16, 2008, the effective date of the transaction, were consolidated with the Companys financial statements. The Companys condensed consolidated financial statements include the accounts of PDSi and PDSi Tiel. All significant
intercompany balances and transactions have been eliminated.

The preparation of financial statements in conformity with 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. Certain items in the condensed
consolidated financial statements and related notes 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 related notes for the year ended December 31, 2008 included in the Companys 2008 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 2008 Annual Report on Form 10-K. There have been no material changes to these policies since December 31, 2008.

Inventory

The following table summarizes the
Companys inventory as of the dates indicated (net of reserves of $1,737,000 and $2,366,000, respectively, as of June 30, 2009 and December 31, 2008):



|                                |  |              |       |                  |   |      
|------------------------------- |  | ------------ | ----- | ---------------- | - | -----
|(in thousands)                  |  | June 30,2009 |       | December 31,2008
|Component parts (raw materials) |  | $            | 4,457 |                  | $ | 4,696
|Work-in-process                 |  |              | 277   |                  |   | 577  
|Finished goods                  |  |              | 217   |                  |   | 172  
|                                |  |              |       |                  |   |      
|Total inventory                 |  | $            | 4,951 |                  | $ | 5,445
|                                |  |              |       |                  |   |      

Goodwill

In connection with the acquisition of PDSi Tiel during 2008, the Company recognized the excess of the purchase price over the fair value of identifiable net assets acquired as goodwill. The Company assigned the
goodwill to a reporting unit in the Service business segment. Goodwill is not amortized, but is evaluated annually for impairment at the reporting unit level. Goodwill of a reporting unit also is tested for impairment on an interim basis in addition
to the annual evaluation if an event occurs or circumstances change which would more likely than not reduce the fair value of a reporting unit below its carrying amount.

The process of evaluating goodwill for impairment requires several judgments and assumptions to be made to determine the fair value of the reporting units, including the method used to determine fair value, discount
rates, and expected levels of revenues and earnings.

Due to the operating losses at the Company and reporting unit levels for the six
months ended June 30, 2009, the Company determined that a triggering event had occurred. Accordingly, the Company performed an interim goodwill impairment test during the second quarter of 2009. The Company estimated the implied fair value of
goodwill using a net present value methodology dependent on significant assumptions related to estimated future discounted cash flows, capitalization rates and tax rates. The estimated future discounted cash flows used in the Companys model
were based on planned growth with an assumed perpetual growth rate. The capitalization rates were based on the Companys current cost of debt and equity capital, and tax rates were maintained at current levels. Based on the results of the
testing, management determined that no impairment had occurred as of the interim test date.

The Company will perform its annual goodwill
impairment testing during the fourth quarter of 2009 based on third quarter 2009 financial information. The Company can provide no assurance that a material impairment charge to goodwill will not occur in a future period. The Company will continue
to monitor events and circumstances in future periods to determine whether additional interim impairment testing is warranted.

3. Recently Issued
Accounting Standards

In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 168, The FASB Accounting Standards CodificationTMand the Hierarchy of Generally Accepted Accounting Principles  a replacement of FASB Statement No. 162(Codification). The Codification will
become 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 Codification will supersede all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature
not included in the Codification will become nonauthoritative. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company does not expect the adoption of the
Codification to result in a change in its current practices.



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PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

June 30, 2009 and 2008



In June 2009, the FASB
issued SFAS No. 166, Accounting for Transfers of Financial Assets  an amendment of FASB Statement No. 140 (SFAS 166). SFAS 166 addresses: 1) practices that have developed since the issuance of SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140), that are not consistent with the original intent and key requirements of SFAS 140; and 2) concerns of financial statement
users that many of the financial assets (and related obligations) that have been derecognized should continue to be reported in the financial statements of transferors. SFAS 166 must be applied as of the beginning of each reporting entitys
first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. SFAS 166 must be
applied to transfers occurring on or after the effective date. The Company currently is evaluating the requirements of SFAS 166 for future transactions.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS 165). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet
date but before financial statements are issued or are available to be issued. In particular, SFAS 165 sets forth: 1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that
may occur for potential recognition or disclosure in the financial statements; 2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and 3) the
disclosures that an entity should make about events or transactions that occurred after the balance sheet date. Entities should apply the requirements of SFAS 165 to interim or annual financial periods ending after June 15, 2009. The Company
adopted SFAS 165 during the quarter ended June 30, 2009. See Note 7 for a discussion of the Companys evaluation of subsequent event transactions.

In June 2008, the Emerging Issues Task Force (EITF) reached consensus on Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entitys Own Stock
(EITF 07-5). EITF 07-5 provides guidance for instruments (including options or warrants on a companys shares, forward contracts on a companys shares, and convertible debt instruments and convertible preferred stock) that may
contain contract terms that call into question whether the instrument or embedded feature is indexed to the entitys own stock. EITF 07-5 is effective for financial statements issued for fiscal years and interim periods beginning after
December 15, 2008. The application of EITF 07-5 effective January 1, 2009 did not impact the Companys financial position or results of operations.

In April 2008, the FASB issued Staff Position (FSP) FSP FAS 142-3, Determination of the Useful Life of Intangible Assets (FSP FAS 142-3). FSP FAS 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142). FSP FAS 142-3 is
effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. The amended factors that should be considered in developing renewal or extension assumptions used to determine the useful life of
a recognized intangible asset under SFAS 142 are to be applied prospectively to intangible assets acquired after the effective date. The Company does not expect the new factors to materially change the Companys current methodologies.

In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement No. 157 (FSP FAS 157-2). This
FSP delays the effective date of SFAS No. 157, Fair Value Measurements (SFAS 157), for nonfinancial assets and liabilities until fiscal years beginning after November 15, 2008. FSP FAS 157-2 applies to nonfinancial assets and
liabilities, except for items that are recognized or disclosed at fair value in the Companys financial statements on a recurring basis (at least annually), and is effective upon issuance. The application of the provisions of SFAS 157 to the
nonfinancial assets and liabilities within the scope of FSP FAS 157-2 effective January 1, 2009 did not have a material impact on the Companys financial position or results of operations.



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PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

June 30, 2009 and 2008



In December 2007, the
FASB issued SFAS No. 141 (revised 2007), Business Combinations(SFAS 141R), which replaces SFAS No. 141, Business Combinations(SFAS 141). SFAS 141R establishes principles and requirements for
how an acquiring entity: 1) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; 2) recognizes and measures the goodwill acquired in the
business combination or a gain from a bargain purchase; and 3) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R applies to all
transactions or other events in which an entity obtains control of one or more businesses and retains the fundamental requirements in SFAS 141 that the acquisition method of accounting be used for all business combinations and for an acquirer to be
identified for each business combination. SFAS 141R defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control.
SFAS 141R is applicable prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier application is prohibited. The
Company currently is evaluating the requirements of SFAS 141R for future business combinations.

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 in its sole discretion, plus other indebtedness to Wells Fargo which may occur outside of the
Credit Agreement.

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% and 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 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, a 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, 2009, and for violation of
the minimum net income financial covenant for the three months ended June 30, 2009. 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 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.

On April 3, 2009, in connection with entering into the Credit Agreement described above, the Company terminated the Amended and Restated Loan Agreement by and between the Company and KeyBank National Association (KeyBank)
dated September 30, 2008 (the Amended and Restated Loan Agreement), and as amended by the First Amendment to Amended and Restated Loan Agreement dated December 24, 2008 (the First Amendment), and the Second
Amendment to Amended and Restated Loan Agreement dated March 26, 2009 (together with the Amended and Restated Loan Agreement and the First Amendment, the Loan Agreement).

The Loan Agreement provided for a demand line credit facility in the principal amount of $5.5 million (the Loan), subject to borrowing base restrictions. The borrowing base was
determined as the sum of: (a) 85% of eligible receivable accounts plus (b) 30% of eligible inventory, but not to exceed $2.5 million. The Loan was evidenced by a Cognovit Promissory Note, and secured by substantially all of the assets of
the Company, as provided for in the Security Agreement entered into between the Company and KeyBank on April 8, 2008.

On the date of
the termination, the Company made a final payment of all borrowings outstanding under the Loan Agreement. The Company did not incur any early termination penalties in connection with the termination of the Loan Agreement.



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##### Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

June 30, 2009 and 2008



5. 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. As a
result of the Companys net losses for the three-month and six-month periods ended June 30, 2009 and 2008, the effect of potential common shares arising from share-based employee compensation plans would have been anti-dilutive and thus
were excluded from the computation of diluted EPS for all periods presented.

6. Segment Information

The Companys reportable segments are Product and Service. The Product segment includes embedded computing hardware products, ranging from
board-level products to fully integrated systems. The Service segment includes service programs provided to global original equipment manufacturers, including depot repair, warranty management, screening and testing, and remanufacturing. 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 engineering, finance, human resources, quality
systems and executive management. The Company evaluates Product and Service segment performance based on (1) operating results; (2) effectiveness in covering the other administrative expenses of the Company; and (3) contribution to
earnings per share. The Company sells its products and services in the U.S. and internationally and attributes sales based on shipping point.

The following table summarizes the Companys segment operating results for the periods indicated:



|                                    |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|----------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                    |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|(in thousands)                      |  | 2009                       |        |   | 2008                     |   |        | 2009 |  |   | 2008   |  
|Sales                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Product                             |  | $                          | 6,599  |   |                          | $ | 11,493 |      |  | $ | 15,085 |   |  | $ | 25,802 |  
|Service                             |  |                            | 2,439  |   |                          |   | 2,772  |      |  |   | 4,840  |   |  |   | 5,656  |  
|                                    |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total sales                         |  | $                          | 9,038  |   |                          | $ | 14,265 |      |  | $ | 19,925 |   |  | $ | 31,458 |  
|                                    |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Gross profit                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Product                             |  | $                          | 1,211  |   |                          | $ | 1,041  |      |  | $ | 2,433  |   |  | $ | 4,100  |  
|Service                             |  |                            | 773    |   |                          |   | 603    |      |  |   | 1,585  |   |  |   | 1,275  |  
|                                    |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total gross profit                  |  | $                          | 1,984  |   |                          | $ | 1,644  |      |  | $ | 4,018  |   |  | $ | 5,375  |  
|                                    |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) from operations       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Product                             |  | $                          | 660    |   |                          | $ | 50     |      |  | $ | 950    |   |  | $ | 2,010  |  
|Service                             |  |                            | 278    |   |                          |   | 184    |      |  |   | 510    |   |  |   | 312    |  
|Other                               |  |                            | (1,226 | ) |                          |   | (1,723 | )    |  |   | (2,692 | ) |  |   | (3,301 | )
|                                    |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total income (loss) from operations |  | $                          | (288   | ) |                          | $ | (1,489 | )    |  | $ | (1,232 | ) |  | $ | (979   | )
|                                    |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  

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



|               |  |              |        |                  |   |       
|-------------- |  | ------------ | ------ | ---------------- | - | ------
|(in thousands) |  | June 30,2009 |        | December 31,2008
|Product        |  | $            | 7,991  |                  | $ | 9,780 
|Service        |  |              | 5,488  |                  |   | 8,477 
|Other          |  |              | 3,144  |                  |   | 3,036 
|               |  |              |        |                  |   |       
|Total          |  | $            | 16,623 |                  | $ | 21,293
|               |  |              |        |                  |   |       



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PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

June 30, 2009 and 2008



The following table summarizes sales by
geographic region for the periods indicated:



|               |  |                            |       |                          |   |        |  |      |        |  |   |       
|-------------- |  | -------------------------- | ----- | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|               |  | Three MonthsEnded June 30, |       | Six Months EndedJune 30,
|(in thousands) |  | 2009                       |       | 2008                     |   | 2009   |  | 2008
|United States  |  | $                          | 8,252 |                          | $ | 12,927 |  | $    | 18,288 |  | $ | 29,047
|International  |  |                            | 786   |                          |   | 1,338  |  |      | 1,637  |  |   | 2,411 
|               |  |                            |       |                          |   |        |  |      |        |  |   |       
|Total          |  | $                          | 9,038 |                          | $ | 14,265 |  | $    | 19,925 |  | $ | 31,458
|               |  |                            |       |                          |   |        |  |      |        |  |   |       

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



|               |  |          |       |              |   |      
|-------------- |  | -------- | ----- | ------------ | - | -----
|               |  | June 30, |       | December 31,
|(in thousands) |  | 2009     |       | 2008        
|United States  |  | $        | 681   |              | $ | 665  
|International  |  |          | 1,548 |              |   | 1,558
|               |  |          |       |              |   |      
|Total          |  | $        | 2,229 |              | $ | 2,223
|               |  |          |       |              |   |      

International long-lived assets include goodwill of $809,000 and $797,000 as of June 30, 2009
and December 31, 2008, respectively.

7. Subsequent Events

The Company evaluated subsequent events through August 7, 2009, the date these condensed consolidated financial statements were filed with the SEC, and determined that none required disclosure.



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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,
2009. 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 and six months ended June 30, 2009 and 2008. This discussion should be read in conjunction with the Companys audited consolidated financial statements and related notes contained in its 2008 Annual Report on Form 10-K.

Executive Overview

PDSi is a global provider of
specialized embedded computing products and manufacturing services for original equipment manufacturers (OEMs) of computer hardware products and products that contain computer hardware. The common shares of PDSi are traded on NYSE Amex
under the stock symbol PNS. We offer a wide range of technology platforms, including standard and custom-designed products for the defense/aerospace, telecommunications, 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. We also provide a variety of engineering,
manufacturing and reverse logistics services for our global product customers, including custom product design, system integration, repair programs, warranty management and specialized production capabilities. With service centers in the United
States, Europe and Asia, PDSi ensures seamless support for the Companys solutions all around the world, as well as depot repair and reverse logistics programs for the OEMs of other types of computer equipment.



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##### Table of Contents

During the first six months of 2009, ongoing U.S. and global economic conditions continued to negatively
affect our existing multi-national OEM customers, and therefore, our business and operating results. As a result, we expect continued lower sales during 2009 compared to 2008, and have adjusted our cost structure accordingly. We expect to mitigate
the impact of lower sales by continuing to focus on higher margin embedded products sold into the defense industry and service business, both of which are less affected by these economic conditions, as well as through labor and facilities cost
reduction initiatives. However, difficult economic conditions may continue to materially adversely affect the Companys results of operations, financial condition and cash flows.

The Company reported a net loss of $270,000, or $0.03 per diluted share, during the quarter ended June 30, 2009 compared to a net loss of $972,000, or $0.12 per diluted share, for the prior
year quarter. The Company reported a net loss of $971,000, or $0.12 per diluted share, during the six months ended June 30, 2009 versus a net loss of $708,000, or $0.09 per diluted share, for the prior year period. See below for further
discussion of consolidated and reportable segment results of operations for the three-month and six-month periods ended June 30, 2009 and 2008.

The Company is continuing to take actions to improve operating efficiencies and future results of operations. During the first quarter of 2009, we divided our business development and engineering organizations into
two primary groups  the Embedded Products Group and the Services Group. This strategy allows us to vertically align our resources, with each group targeting specific industries and customers with a defined set of products and services. In
addition, we believe our alignment of sales and technical resources provides more focus on development of new business opportunities, while providing our customers with better service and responsiveness. This realignment of resources did not change
the Companys reportable segments.

We believe our operating results will improve as gross profit margins increase due to several
factors. First, we expect the continued decline of lower margin integration business. In addition, we anticipate organic growth through new embedded product and related service offerings sold to current and new customers in markets in which higher
value is rewarded with higher margins. Lastly, we expect our global service business to continue to grow. Gross margins will vary from program to program, and the mix of programs will vary each quarter, driving 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 up over the next few years.

Consistent with the Companys goals of developing new business and providing more cost effective in-region services, we successfully completed the acquisition of all of the equity of Aspan
B.V., a private limited liability company located in Tiel, the Netherlands (now known as PDSi B.V., or PDSi Tiel), during the first quarter of 2008. See Note 4 and Note 10 to the consolidated financial statements included in the
Companys 2008 Annual Report on Form 10-K for additional information related to the acquisition of PDSi Tiel and the related private equity financing, respectively.

While the Company continues to evaluate viable acquisition opportunities, currently we do not anticipate any acquisitions in 2009.



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##### Table of Contents

Results of Operations

Consolidated Operations

Second Quarter  2009 Compared to 2008

The following table summarizes the Companys consolidated results of operations for the periods indicated:



|                                  |  |                             |       |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|--------------------------------- |  | --------------------------- | ----- | - | --------- | ----- | - | ---- | - | ------ | --------- |  | ----- | - |  | --- | -
|                                  |  | Three Months Ended June 30, |       |   | %Change   |      
|                                  |  | 2009                        |       |   | % ofSales |       |   | 2008 |   |        | % ofSales |  |      
|Sales                             |  | $                           | 9,038 |   |           | 100.0 | % |      | $ | 14,265 |           |  | 100.0 | % |  | -37 | %
|Cost of sales                     |  |                             | 7,054 |   |           | 78.0  | % |      |   | 12,621 |           |  | 88.5  | % |  | -44 | %
|                                  |  |                             |       |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Gross profit                      |  |                             | 1,984 |   |           | 22.0  | % |      |   | 1,644  |           |  | 11.5  | % |  | 21  | %
|Operating expenses                |  |                             | 2,272 |   |           | 25.1  | % |      |   | 3,133  |           |  | 22.0  | % |  | -27 | %
|                                  |  |                             |       |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Income (loss) from operations     |  |                             | (288  | ) |           | -3.2  | % |      |   | (1,489 | )         |  | -10.4 | % |  | NM  |  
|Other expense                     |  |                             |       |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Interest expense                  |  |                             | 49    |   |           | 0.5   | % |      |   | 100    |           |  | 0.7   | % |  | -51 | %
|                                  |  |                             |       |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Income (loss) before income taxes |  |                             | (337  | ) |           | -3.7  | % |      |   | (1,589 | )         |  | -11.1 | % |  | NM  |  
|Income tax expense (benefit)      |  |                             | (67   | ) |           | -0.7  | % |      |   | (617   | )         |  | -4.3  | % |  | NM  |  
|                                  |  |                             |       |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Net income (loss)                 |  | $                           | (270  | ) |           | -3.0  | % |      | $ | (972   | )         |  | -6.8  | % |  | NM  |  
|                                  |  |                             |       |   |           |       |   |      |   |        |           |  |       |   |  |     |  

The lower net loss for the quarter ended June 30, 2009 compared to the prior year quarter was
largely due to the impact on gross profit in the second quarter of 2008 of a one-time non-cash inventory valuation adjustment totaling $720,000 pre-tax. In addition, operating expenses during the prior year quarter included $115,000 of expenses
associated with the termination of a facility lease in Monrovia, California. Excluding the inventory valuation adjustment mentioned above, gross profit declined 16% primarily due to lower Product segment sales. However, Product segment gross profit
as a percentage of sales improved, reflecting an improved mix of business toward higher margin products, reductions in overhead expenses in response to reduced sales levels, and margin improvements on existing products. The decline in Product
segment performance during the second quarter of 2009 was more than offset by a 27% decrease in operating expenses reflecting cost reduction actions taken over the last several quarters, a 28% increase in Service segment gross profit and lower
interest expense.

For the second quarter of 2009, the Company had two customers that generated $2.4 million and $2.1 million, or 26% and
23%, respectively, of total sales. Of the revenues from these customers, 85% and 15% were included in Product and Service segment sales, respectively. For the second quarter of 2008, the Company had two customers that generated $7.0 million and $1.5
million, or 49% and 10%, respectively, of total sales. Of the revenues from these customers, 90% and 10% were included in Product and Service segment sales, respectively.



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##### Table of Contents

Year-to-Date  2009 Compared to 2008

The following table summarizes the Companys consolidated results of operations for the periods indicated:



|                                  |  |                           |        |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|--------------------------------- |  | ------------------------- | ------ | - | --------- | ----- | - | ---- | - | ------ | --------- |  | ----- | - |  | --- | -
|                                  |  | Six Months Ended June 30, |        |   | %Change   |      
|                                  |  | 2009                      |        |   | % ofSales |       |   | 2008 |   |        | % ofSales |  |      
|Sales                             |  | $                         | 19,925 |   |           | 100.0 | % |      | $ | 31,458 |           |  | 100.0 | % |  | -37 | %
|Cost of sales                     |  |                           | 15,907 |   |           | 79.8  | % |      |   | 26,083 |           |  | 82.9  | % |  | -39 | %
|                                  |  |                           |        |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Gross profit                      |  |                           | 4,018  |   |           | 20.2  | % |      |   | 5,375  |           |  | 17.1  | % |  | -25 | %
|Operating expenses                |  |                           | 5,250  |   |           | 26.3  | % |      |   | 6,354  |           |  | 20.2  | % |  | -17 | %
|                                  |  |                           |        |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Income (loss) from operations     |  |                           | (1,232 | ) |           | -6.2  | % |      |   | (979   | )         |  | -3.1  | % |  | NM  |  
|Other expense                     |  |                           |        |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Interest expense                  |  |                           | 102    |   |           | 0.5   | % |      |   | 191    |           |  | 0.6   | % |  | -47 | %
|                                  |  |                           |        |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Income (loss) before income taxes |  |                           | (1,334 | ) |           | -6.7  | % |      |   | (1,170 | )         |  | -3.7  | % |  | NM  |  
|Income tax expense (benefit)      |  |                           | (363   | ) |           | -1.8  | % |      |   | (462   | )         |  | -1.5  | % |  | NM  |  
|                                  |  |                           |        |   |           |       |   |      |   |        |           |  |       |   |  |     |  
|Net income (loss)                 |  | $                         | (971   | ) |           | -4.9  | % |      | $ | (708   | )         |  | -2.3  | % |  | NM  |  
|                                  |  |                           |        |   |           |       |   |      |   |        |           |  |       |   |  |     |  

The higher net loss for the six months ended June 30, 2009 compared to the prior year period
was driven by a 41% decline in Product segment gross profit due to a comparable drop in sales. The prior year period also includes the impact of the inventory valuation adjustment in the second quarter of 2008 described previously. Reduced operating
expenses, a 24% increase in Service segment gross profit and lower interest expense partially offset the decline in Product segment performance during the first six months of 2009.

For the first six months of 2009, the Company had two customers that generated $6.5 million and $3.8 million, or 33% and 19%, 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 six months of 2008, the Company had two customers that generated $13.1 million and $5.0 million, or 42% and 16%, respectively, of total sales. Of the
revenues from these customers, 91% and 9% were included in Product and Service segment sales, respectively.

Segment Operations

Product

Second Quarter  2009 Compared to 2008

The following table summarizes the Companys gross profit for the Product segment for the periods indicated:



|              |  |                             |       |           |         |   |      |   |           |  |       |   |  |     |  
|------------- |  | --------------------------- | ----- | --------- | ------- | - | ---- | - | --------- |  | ----- | - |  | --- | -
|              |  | Three Months Ended June 30, |       |           | %Change |  
|              |  | 2009                        |       | % ofSales |         |   | 2008 |   | % ofSales |  |      
|Sales         |  | $                           | 6,599 |           | 100.0   | % |      | $ | 11,493    |  | 100.0 | % |  | -43 | %
|Cost of sales |  |                             | 5,388 |           | 81.6    | % |      |   | 10,452    |  | 90.9  | % |  | -48 | %
|              |  |                             |       |           |         |   |      |   |           |  |       |   |  |     |  
|Gross profit  |  | $                           | 1,211 |           | 18.4    | % |      | $ | 1,041     |  | 9.1   | % |  | 16  | %
|              |  |                             |       |           |         |   |      |   |           |  |       |   |  |     |  

Product segment gross profit increased due to the aforementioned $720,000 inventory valuation
adjustment in the second quarter of 2008. Excluding this adjustment, gross profit fell 32% due to lower sales driven by softening demand from existing large accounts and our reduced focus on lower margin business. These factors accounted for
approximately $4.5 million of the decline in Product sales. However, excluding the inventory valuation adjustment mentioned above, and despite lower fixed cost coverage, gross profit as a percentage of sales improved to 18% in 2009 from an adjusted
15% in 2008, reflecting an improved mix of business toward higher margin products, reductions in overhead expenses in response to reduced sales levels, and margin improvements on existing products.



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##### Table of Contents

Year-to-Date  2009 Compared to 2008

The following table summarizes the Companys gross profit for the Product segment for the periods indicated:



|              |  |                           |        |           |         |   |      |   |           |  |       |   |  |     |  
|------------- |  | ------------------------- | ------ | --------- | ------- | - | ---- | - | --------- |  | ----- | - |  | --- | -
|              |  | Six Months Ended June 30, |        |           | %Change |  
|              |  | 2009                      |        | % ofSales |         |   | 2008 |   | % ofSales |  |      
|Sales         |  | $                         | 15,085 |           | 100.0   | % |      | $ | 25,802    |  | 100.0 | % |  | -42 | %
|Cost of sales |  |                           | 12,652 |           | 83.9    | % |      |   | 21,702    |  | 84.1  | % |  | -42 | %
|              |  |                           |        |           |         |   |      |   |           |  |       |   |  |     |  
|Gross profit  |  | $                         | 2,433  |           | 16.1    | % |      | $ | 4,100     |  | 15.9  | % |  | -41 | %
|              |  |                           |        |           |         |   |      |   |           |  |       |   |  |     |  

Product segment gross profit declined primarily due to lower sales attributable to softening
demand from existing large accounts and our reduced focus on lower margin business, which drove approximately $9.2 million of the decrease in Product sales. Lower telecommunications sector demand accounted for most of the remaining shortfall. The
prior year period also includes the impact of the inventory valuation adjustment in the second quarter of 2008 described previously. Excluding this adjustment, gross profit as a percentage of sales declined to 16% in 2009 from an adjusted 19% in
2008, reflecting the timing of overhead cost reductions in the current year in response to lower overall sales levels, as well as a favorable product mix in the first quarter of 2008 that included a high-margin end-of-life sale to a large OEM.

Service

Second Quarter  2009
Compared to 2008

The following table summarizes the Companys gross profit for the Service segment for the periods indicated:



|              |  |                             |       |           |         |   |      |   |           |  |       |   |  |     |  
|------------- |  | --------------------------- | ----- | --------- | ------- | - | ---- | - | --------- |  | ----- | - |  | --- | -
|              |  | Three Months Ended June 30, |       |           | %Change |  
|              |  | 2009                        |       | % ofSales |         |   | 2008 |   | % ofSales |  |      
|Sales         |  | $                           | 2,439 |           | 100.0   | % |      | $ | 2,772     |  | 100.0 | % |  | -12 | %
|Cost of sales |  |                             | 1,666 |           | 68.3    | % |      |   | 2,169     |  | 78.2  | % |  | -23 | %
|              |  |                             |       |           |         |   |      |   |           |  |       |   |  |     |  
|Gross profit  |  | $                           | 773   |           | 31.7    | % |      | $ | 603       |  | 21.8  | % |  | 28  | %
|              |  |                             |       |           |         |   |      |   |           |  |       |   |  |     |  

The increase in Service segment gross profit was driven by ongoing operational efficiency gains in
this segment, our continued shift toward higher margin sales, and improved margins on existing business. Lower Service sales reflect the impact of customers working off service spares inventories during the second quarter of 2009 in response to
slower global economic activity.

Year-to-Date  2009 Compared to 2008

The following table summarizes the Companys gross profit for the Service segment for the periods indicated:



|              |  |                           |       |           |         |   |      |   |           |  |       |   |  |     |  
|------------- |  | ------------------------- | ----- | --------- | ------- | - | ---- | - | --------- |  | ----- | - |  | --- | -
|              |  | Six Months Ended June 30, |       |           | %Change |  
|              |  | 2009                      |       | % ofSales |         |   | 2008 |   | % ofSales |  |      
|Sales         |  | $                         | 4,840 |           | 100.0   | % |      | $ | 5,656     |  | 100.0 | % |  | -14 | %
|Cost of sales |  |                           | 3,255 |           | 67.3    | % |      |   | 4,381     |  | 77.5  | % |  | -26 | %
|              |  |                           |       |           |         |   |      |   |           |  |       |   |  |     |  
|Gross profit  |  | $                         | 1,585 |           | 32.7    | % |      | $ | 1,275     |  | 22.5  | % |  | 24  | %
|              |  |                           |       |           |         |   |      |   |           |  |       |   |  |     |  

Higher Service segment gross profit primarily was due to ongoing improvements in the operational
efficiency of this segment, combined with our continued shift toward higher margin sales and improved margins on existing business. The decline in Service sales was driven by customers working off service spares inventories in the first half of 2009
in response to slower global economic activity.



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##### Table of Contents

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)                                                                |  | June 30,2009 |        |   | December 31,2008 |  
|Line of credit                                                                |  | $            | 2,977  |   |                  | $ | 5,408  |  
|                                                                              |  |              |        |   |                  |   |        |  
|                                                                              |  |             
|Stockholders equity, excluding accumulated other comprehensive income (loss) |  |              | 8,064  |   |                  |   | 8,952  |  
|Accumulated other comprehensive income (loss)                                 |  |              | (46    | ) |                  |   | (57    | )
|                                                                              |  |              |        |   |                  |   |        |  
|Total stockholders equity                                                    |  |              | 8,018  |   |                  |   | 8,895  |  
|                                                                              |  |              |        |   |                  |   |        |  
|Total capital                                                                 |  | $            | 10,995 |   |                  | $ | 14,303 |  
|                                                                              |  |              |        |   |                  |   |        |  

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.

The following tables summarize the Companys condensed consolidated cash flows for the six months ended June 30:



|                                                    |  |      |        |   |      |   |        |  
|--------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|(in thousands)                                      |  | 2009 |        |   | 2008 |  
|Net cash provided by operating activities           |  | $    | 2,840  |   |      | $ | 1,110  |  
|Net cash provided by (used in) investing activities |  |      | (155   | ) |      |   | 150    |  
|Net cash provided by (used in) financing activities |  |      | (2,876 | ) |      |   | (1,032 | )
|Effect of exchange rate on cash                     |  |      | 3      |   |      |   | 8      |  
|                                                    |  |      |        |   |      |   |        |  
|Increase (decrease) in cash                         |  |      | (188   | ) |      |   | 236    |  
|Cash at beginning of period                         |  |      | 282    |   |      |   | 54     |  
|                                                    |  |      |        |   |      |   |        |  
|Cash at end of period                               |  | $    | 94     |   |      | $ | 290    |  
|                                                    |  |      |        |   |      |   |        |  

Operating Activities

Net cash provided by operating activities was $2.8 million for the first six months of 2009 compared to $1.1 million for the comparable period of 2008. Net income (loss) adjusted for the effects of non-cash items,
which primarily include depreciation expense and inventory reserves, totaled ($0.1) million and $0.6 million in the first six months of 2009 and 2008, respectively. Changes in working capital provided net cash of $2.9 million for the first six
months of 2009 compared to $0.5 million for the comparable period of 2008. Lower accounts receivable, inventory and accounts payable in 2009 reflect declining sales volumes and overall business activity compared to the prior year period.

Investing Activities

Net cash used in
investing activities was $0.2 million for the first six months of 2009 compared to net cash provided by investing activities of $0.2 million for the comparable period of 2008. The Company used $1.2 million in proceeds from a private equity
transaction to acquire PDSi Tiel in February 2008. The private equity funds were placed in escrow in December 2007 and classified as restricted cash. During the first quarter of 2008 the restricted cash was released, and $0.9 million was paid to
acquire PDSi Tiel.

Financing Activities

Net cash used in financing activities was $2.9 million for the first six months of 2009 compared to $1.0 million for the comparable period of 2008. Financing activity in the current year period primarily related to net repayments on the
Companys lines of credit. In the prior year period, the net $1.0 million in cash used in financing activities included the Companys repayment of a $4.0 million short-term note and $3.0 million in net borrowings on its line of credit to
support the Companys working capital requirements.



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##### Table of Contents

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 in its sole discretion, plus other
indebtedness to Wells Fargo which may occur outside of the Credit Agreement.

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% and 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 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, a 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, 2009, and for violation of the minimum net income financial covenant for the three months ended June 30, 2009. 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 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.

On April 3, 2009, in connection with entering into the Credit Agreement described above, the Company terminated the Amended and Restated Loan
Agreement by and between the Company and KeyBank National Association (KeyBank) dated September 30, 2008 (the Amended and Restated Loan Agreement), and as amended by the First Amendment to Amended and Restated Loan
Agreement dated December 24, 2008 (the First Amendment), and the Second Amendment to Amended and Restated Loan Agreement dated March 26, 2009 (together with the Amended and Restated Loan Agreement and the First Amendment, the
Loan Agreement).

The Loan Agreement provided for a demand line credit facility in the principal amount of $5.5 million (the
Loan), subject to borrowing base restrictions. The borrowing base was determined as the sum of: (a) 85% of eligible receivable accounts plus (b) 30% of eligible inventory, but not to exceed $2.5 million. The Loan was evidenced
by a Cognovit Promissory Note, and secured by substantially all of the assets of the Company, as provided for in the Security Agreement entered into between the Company and KeyBank on April 8, 2008.

On the date of the termination, the Company made a final payment of all borrowings outstanding under the Loan Agreement. The Company did not incur any
early termination penalties in connection with the termination of the Loan Agreement.

Additional financing also may be required to support
the future growth plans of the Company, which may include an acquisition strategy of acquiring companies that are similar to or that complement the Company. The Companys acquisition strategy may be financed by the issuance of additional common
or preferred stock that has been previously authorized by shareholders. The issuance of these shares requires approval of the Companys Board of Directors. The Company evaluates acquisition targets based on similar or complementary services as
currently provided by the Company that will be accretive within one year thereafter. Acquisition targets may provide large OEM customer relationships that have a potential for additional business through the product synergies of the combined company
(which may not be attainable by either company on their own) and/or bring resources, in terms of people, processes and/or systems, that increase the scalability of the combined businesses. The Company currently does not anticipate any acquisitions
in 2009.

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.



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##### Table of Contents

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 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 2008 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 a summary of recently issued accounting standards. The Companys critical
accounting policies have not changed materially from those disclosed in the Companys 2008 Annual Report on Form 10-K. However, disclosed below are the results of the Companys interim goodwill impairment test performed as of June 30,
2009.

Goodwill

In connection
with the acquisition of PDSi Tiel during 2008, the Company recognized the excess of the purchase price over the fair value of identifiable net assets acquired as goodwill. The Company assigned the goodwill to a reporting unit in the Service business
segment. Goodwill is not amortized, but is evaluated annually for impairment at the reporting unit level. Goodwill of a reporting unit also is tested for impairment on an interim basis in addition to the annual evaluation if an event occurs or
circumstances change which would more likely than not reduce the fair value of a reporting unit below its carrying amount.

The process of
evaluating goodwill for impairment requires several judgments and assumptions to be made to determine the fair value of the reporting units, including the method used to determine fair value, discount rates, and expected levels of revenues and
earnings.

Due to the operating losses at the Company and reporting unit levels for the six months ended June 30, 2009, the Company
determined that a triggering event had occurred. Accordingly, the Company performed an interim goodwill impairment test during the second quarter of 2009. The Company estimated the implied fair value of goodwill using a net present value methodology
dependent on significant assumptions related to estimated future discounted cash flows, capitalization rates and tax rates. The estimated future discounted cash flows used in the Companys model were based on planned growth with an assumed
perpetual growth rate. The capitalization rates were based on the Companys current cost of debt and equity capital, and tax rates were maintained at current levels. Based on the results of the testing, management determined that no impairment
had occurred as of the interim test date.

The Company will perform its annual goodwill impairment testing during the fourth quarter of
2009 based on third quarter 2009 financial information. The Company can provide no assurance that a material impairment charge to goodwill will not occur in a future period. The Company will continue to monitor events and circumstances in future
periods to determine whether additional interim impairment testing is warranted.



|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 second fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Companys internal
control over financial reporting.



17



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##### Table of Contents

PART II  OTHER INFORMATION



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

The Company held its Annual Meeting of Shareholders on May 12, 2009. At that meeting, shareholders voted on the following proposal:



|                                                                                    |  |           |  |         
|----------------------------------------------------------------------------------- |  | --------- |  | --------
|                                                                                    |  | For       |  | Withheld
|Election of Class I Directors to serve a two-year term expiring in 2011 as follows: |  |           |  |         
|Carl J. Aschinger, Jr.                                                              |  | 6,106,264 |  | 102,536 
|Hugh C. Cathey                                                                      |  | 6,082,095 |  | 126,705 
|Benjamin Brussell                                                                   |  | 6,082,095 |  | 126,705 

The terms of office of the following Class II Directors continued after the
meeting (expiring in 2010): John D. Bair, Thomas M. OLeary, Ralph V. Roberts and Michael R. Sayre.



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



|            |  |                                                                                                                                                                                                        |  |                                                                                           
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                                                                                 |  | If incorporated by reference, document with which Exhibit waspreviously filed with
the SEC
|4           |  | Instruments defining the rights of security holders, including indentures                                                                                                                              |  | Registration Statement on Form 10-SB filed with the SEC on December 13, 1999              
|            |  |                                                                                                                                                                                                       
|10.1        |  | Credit and Security Agreement between Pinnacle Data Systems, Inc. and Wells Fargo Bank, National Association dated April 3, 2009                                                                       |  | Current Report on Form 8-K filed with the SEC on April 9, 2009                            
|            |  |                                                                                                                                                                                                       
|10.2        |  | Revolving Note between Pinnacle Data Systems, Inc. and Wells Fargo Bank, National Association dated April 3, 2009                                                                                      |  | Current Report on Form 8-K filed with the SEC on April 9, 2009                            
|            |  |                                                                                                                                                                                                       
|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 June 30, 2009 |  | 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 June 30, 2009 |  | 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 June 30, 2009 |  | 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 June 30, 2009 |  | 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: August 7, 2009 |  | /s/    Michael R. Sayre              
|                     |  | Michael R. Sayre                     
|                     |  | President and Chief Executive Officer
|                     | 
|Date: August 7, 2009 |  | /s/    Nicholas J. Tomashot          
|                     |  | Nicholas J. Tomashot                 
|                     |  | Chief Financial Officer              



19