##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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

For the quarterly period ended September 30, 2007

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



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Pinnacle Data Systems, Inc.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Ohio                                                           |  | 31-1263732                          
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification Number)

6600 Port Road, Groveport, Ohio 43125

(Address of principal executive offices)

(614) 748-1150

(Registrants Telephone Number)

No change

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



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Indicate by
check mark whether the registrant (1) 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 is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).    Yes ̈No  x

APPLICABLE ONLY TO CORPORATE ISSUERS

On November 14, 2007, the registrant had outstanding 6,419,548 common shares without par value,
which is the registrants only class of common equity.



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##### Table of Contents

PINNACLE DATA SYSTEMS, INC.

TABLE OF CONTENTS



|               |  |                                                                                                                         |  |         
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------- |  | --------
|               |  |                                                                                                                         |  | Page No.
|PART I         |  | FINANCIAL INFORMATION                                                                                                   |  |         
|               |  |                                                                                                                        
|Item 1.        |  | Financial Statements                                                                                                    |  |         
|               |  |                                                                                                                        
|               |  | Condensed Balance Sheets as of September 30, 2007 and December 31, 2006                                                 |  | 3       
|               |  |                                                                                                                        
|               |  | Condensed Statements of Operations for the three and nine month periods ended September 30, 2007 and September 30, 2006 |  | 4       
|               |  |                                                                                                                        
|               |  | Condensed Statements of Cash Flows for the nine month periods ended September 30, 2007 and September 30, 2006           |  | 5       
|               |  |                                                                                                                        
|               |  | Notes to Condensed Financial Statements                                                                                 |  | 6       
|               |  |                                                                                                                        
|Item 2.        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                   |  | 12      
|               |  |                                                                                                                        
|Item 3.        |  | Quantitative and Qualitative Disclosures About Market Risk                                                              |  | 18      
|               |  |                                                                                                                        
|Item 4.        |  | Controls and Procedures                                                                                                 |  | 19      
|               |  |                                                                                                                        
|PART II        |  | OTHER INFORMATION                                                                                                       |  |         
|               |  |                                                                                                                        
|Item 1A.       |  | Risk Factors                                                                                                            |  | 19      
|               |  |                                                                                                                        
|Item 5.        |  | Other Information                                                                                                       |  | 19      
|               |  |                                                                                                                        
|Item 6.        |  | Exhibits                                                                                                                |  | 20      
|               | 
|SIGNATURES     |  | 21                                                                                                                     
|              
|CERTIFICATIONS



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##### Table of Contents

PINNACLE DATA SYSTEMS, INC.

CONDENSED BALANCE SHEETS



|                                                                                                                              |  |                   |            |   |                  |   |            |  
|----------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---------- | - | ---------------- | - | ---------- | -
|                                                                                                                              |  | September 30,2007 |            |   | December 31,2006 |  
|                                                                                                                              |  | (Unaudited)       |            |   |                  |  
|ASSETS                                                                                                                        |  |                   |            |   |                  |   |            |  
|CURRENT ASSETS                                                                                                                |  |                   |            |   |                  |   |            |  
|Cash                                                                                                                          |  | $                 | 67,000     |   |                  | $ | 42,000     |  
|Accounts receivable, net of allowance for doubtful accounts of $94,000 and $138,000, respectively                             |  |                   | 12,888,000 |   |                  |   | 17,718,000 |  
|Inventory, net                                                                                                                |  |                   | 8,519,000  |   |                  |   | 11,732,000 |  
|Prepaid expenses                                                                                                              |  |                   | 547,000    |   |                  |   | 499,000    |  
|Income taxes receivable                                                                                                       |  |                   | 42,000     |   |                  |   | 1,030,000  |  
|Deferred income taxes                                                                                                         |  |                   | 858,000    |   |                  |   | 858,000    |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|Total current assets                                                                                                          |  |                   | 22,921,000 |   |                  |   | 31,879,000 |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|PROPERTY AND EQUIPMENT                                                                                                        |  |                   |            |   |                  |   |            |  
|Leasehold improvements                                                                                                        |  |                   | 570,000    |   |                  |   | 511,000    |  
|Furniture and fixtures                                                                                                        |  |                   | 408,000    |   |                  |   | 408,000    |  
|Computer equipment and related software                                                                                       |  |                   | 3,574,000  |   |                  |   | 3,373,000  |  
|Shop equipment                                                                                                                |  |                   | 818,000    |   |                  |   | 619,000    |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|Total property and equipment, cost                                                                                            |  |                   | 5,370,000  |   |                  |   | 4,911,000  |  
|Less accumulated depreciation and amortization                                                                                |  |                   | (4,064,000 | ) |                  |   | (3,667,000 | )
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|Total property and equipment, net                                                                                             |  |                   | 1,306,000  |   |                  |   | 1,244,000  |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|OTHER ASSETS                                                                                                                  |  |                   |            |   |                  |   |            |  
|Deferred income taxes                                                                                                         |  |                   | 597,000    |   |                  |   | 597,000    |  
|Other assets                                                                                                                  |  |                   | 53,000     |   |                  |   | 138,000    |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|Total other assets                                                                                                            |  |                   | 650,000    |   |                  |   | 735,000    |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|TOTAL ASSETS                                                                                                                  |  | $                 | 24,877,000 |   |                  | $ | 33,858,000 |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|                                                                                                                              |  |                  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                          |  |                   |            |   |                  |   |            |  
|CURRENT LIABILITIES                                                                                                           |  |                   |            |   |                  |   |            |  
|Line of credit                                                                                                                |  | $                 | 4,101,000  |   |                  | $ | 9,109,000  |  
|Short-term note                                                                                                               |  |                   | 4,000,000  |   |                  |   | 4,000,000  |  
|Accounts payable                                                                                                              |  |                   | 7,858,000  |   |                  |   | 11,851,000 |  
|Accrued expenses:                                                                                                             |  |                   |            |   |                  |   |            |  
|Wages, payroll taxes and benefits                                                                                             |  |                   | 1,081,000  |   |                  |   | 1,053,000  |  
|Other                                                                                                                         |  |                   | 835,000    |   |                  |   | 947,000    |  
|Unearned revenue                                                                                                              |  |                   | 450,000    |   |                  |   | 204,000    |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|Total current liabilities                                                                                                     |  |                   | 18,325,000 |   |                  |   | 27,164,000 |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|LONG-TERM LIABILITIES                                                                                                         |  |                   |            |   |                  |   |            |  
|Accrued other                                                                                                                 |  |                   |           |   |                  |   | 675,000    |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|Total long-term liabilities                                                                                                   |  |                   |           |   |                  |   | 675,000    |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|TOTAL LIABILITIES                                                                                                             |  |                   | 18,325,000 |   |                  |   | 27,839,000 |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|COMMITMENTS AND CONTINGENCIES                                                                                                 |  |                   |           |   |                  |   |           |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|STOCKHOLDERS EQUITY                                                                                                          |  |                   |            |   |                  |   |            |  
|Preferred stock; no par value; 4,000,000 shares authorized; no shares issued or outstanding                                   |  |                   |           |   |                  |   |           |  
|Common stock; no par value; 25,000,000 shares authorized; 6,419,548 and 6,363,448 shares issued and outstanding, respectively |  |                   | 3,488,000  |   |                  |   | 3,435,000  |  
|Additional paid-in capital                                                                                                    |  |                   | 1,408,000  |   |                  |   | 1,263,000  |  
|Retained earnings                                                                                                             |  |                   | 1,656,000  |   |                  |   | 1,321,000  |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|Total stockholders equity                                                                                                    |  |                   | 6,552,000  |   |                  |   | 6,019,000  |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                    |  | $                 | 24,877,000 |   |                  | $ | 33,858,000 |  
|                                                                                                                              |  |                   |            |   |                  |   |            |  

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



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##### Table of Contents

PINNACLE DATA SYSTEMS, INC.

CONDENSED STATEMENTS OF OPERATIONS



|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|---------------------------------------- |  | --------------------------------- | ---------- | ------------------ | -------------------------------- | ---------- | ------------------ |  | ------------------ | ---------- |  | - | ---------- | -
|                                         |  | For the Three Month Periods Ended |            |                    | For the Nine Month Periods Ended |           
|                                         |  | September 30, 2007                |            | September 30, 2006 |                                  |            | September 30, 2007 |  | September 30, 2006 |           
|                                         |  | (Unaudited)                       |            |                    | (Unaudited)                      |           
|SALES                                    |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|Product sales                            |  | $                                 | 14,432,000 |                    | $                                | 12,521,000 |                    |  | $                  | 47,166,000 |  | $ | 41,769,000 |  
|Service sales                            |  |                                   | 2,974,000  |                    |                                  | 2,874,000  |                    |  |                    | 7,974,000  |  |   | 7,878,000  |  
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|Total sales                              |  |                                   | 17,406,000 |                    |                                  | 15,395,000 |                    |  |                    | 55,140,000 |  |   | 49,647,000 |  
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|COST OF SALES                            |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|Product sales                            |  |                                   | 10,519,000 |                    |                                  | 11,517,000 |                    |  |                    | 37,406,000 |  |   | 36,403,000 |  
|Service sales                            |  |                                   | 2,305,000  |                    |                                  | 1,477,000  |                    |  |                    | 6,041,000  |  |   | 3,588,000  |  
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|Total cost of sales                      |  |                                   | 12,824,000 |                    |                                  | 12,994,000 |                    |  |                    | 43,447,000 |  |   | 39,991,000 |  
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|GROSS PROFIT                             |  |                                   | 4,582,000  |                    |                                  | 2,401,000  |                    |  |                    | 11,693,000 |  |   | 9,656,000  |  
|OPERATING EXPENSES                       |  |                                   | 3,277,000  |                    |                                  | 4,802,000  |                    |  |                    | 10,367,000 |  |   | 12,504,000 |  
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|INCOME (LOSS) FROM OPERATIONS            |  |                                   | 1,305,000  |                    |                                  | (2,401,000 | )                  |  |                    | 1,326,000  |  |   | (2,848,000 | )
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|OTHER EXPENSE                            |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|Interest expense                         |  |                                   | 208,000    |                    |                                  | 221,000    |                    |  |                    | 719,000    |  |   | 551,000    |  
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|INCOME (LOSS) BEFORE INCOME TAXES        |  |                                   | 1,097,000  |                    |                                  | (2,622,000 | )                  |  |                    | 607,000    |  |   | (3,399,000 | )
|INCOME TAX EXPENSE (BENEFIT)             |  |                                   | 466,000    |                    |                                  | (1,224,000 | )                  |  |                    | 272,000    |  |   | (1,535,000 | )
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|NET INCOME (LOSS)                        |  | $                                 | 631,000    |                    | $                                | (1,398,000 | )                  |  | $                  | 335,000    |  | $ | (1,864,000 | )
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|BASIC EARNINGS (LOSS) PER COMMON SHARE   |  | $                                 | 0.10       |                    | $                                | (0.22      | )                  |  | $                  | 0.05       |  | $ | (0.30      | )
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  
|DILUTED EARNINGS (LOSS) PER COMMON SHARE |  | $                                 | 0.10       |                    | $                                | (0.22      | )                  |  | $                  | 0.05       |  | $ | (0.30      | )
|                                         |  |                                   |            |                    |                                  |            |                    |  |                    |            |  |   |            |  

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



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PINNACLE DATA SYSTEMS, INC.

CONDENSED STATEMENTS OF CASH FLOWS



|                                                                                                   |  |                           |            |   |                    |   |            |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------- | ---------- | - | ------------------ | - | ---------- | -
|                                                                                                   |  | For the Nine Months Ended |           
|                                                                                                   |  | September 30, 2007        |            |   | September 30, 2006 |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                                               |  |                           |            |   |                    |   |            |  
|Net income (loss)                                                                                  |  | $                         | 335,000    |   |                    | $ | (1,864,000 | )
|                                                                                                   |  |                           |            |   |                    |   |            |  
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |  |                           |            |   |                    |   |            |  
|Depreciation                                                                                       |  |                           | 397,000    |   |                    |   | 300,000    |  
|Stock-based compensation expense                                                                   |  |                           | 145,000    |   |                    |   | 122,000    |  
|Provision for doubtful accounts                                                                    |  |                           | 30,000     |   |                    |   | 248,000    |  
|Inventory reserves                                                                                 |  |                           | 358,000    |   |                    |   |           |  
|Decrease/(increase) in assets:                                                                     |  |                           |            |   |                    |   |            |  
|Accounts receivable                                                                                |  |                           | 4,800,000  |   |                    |   | 898,000    |  
|Inventory                                                                                          |  |                           | 2,855,000  |   |                    |   | (4,210,000 | )
|Prepaid expenses and other assets                                                                  |  |                           | 37,000     |   |                    |   | (206,000   | )
|Income taxes receivable                                                                            |  |                           | 988,000    |   |                    |   | (1,668,000 | )
|(Decrease)/increase in liabilities:                                                                |  |                           |            |   |                    |   |            |  
|Accounts payable                                                                                   |  |                           | (4,044,000 | ) |                    |   | 2,927,000  |  
|Accrued expenses and taxes                                                                         |  |                           | (759,000   | ) |                    |   | 825,000    |  
|Unearned revenue                                                                                   |  |                           | 246,000    |   |                    |   | 539,000    |  
|                                                                                                   |  |                           |            |   |                    |   |            |  
|Total adjustments                                                                                  |  |                           | 5,053,000  |   |                    |   | (225,000   | )
|                                                                                                   |  |                           |            |   |                    |   |            |  
|Net cash provided by (used in) operating activities                                                |  |                           | 5,388,000  |   |                    |   | (2,089,000 | )
|                                                                                                   |  |                           |            |   |                    |   |            |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                                               |  |                           |            |   |                    |   |            |  
|Purchases of property and equipment                                                                |  |                           | (459,000   | ) |                    |   | (568,000   | )
|                                                                                                   |  |                           |            |   |                    |   |            |  
|Net cash used in investing activities                                                              |  |                           | (459,000   | ) |                    |   | (568,000   | )
|                                                                                                   |  |                           |            |   |                    |   |            |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                                               |  |                           |            |   |                    |   |            |  
|Net payments on line of credit                                                                     |  |                           | (5,008,000 | ) |                    |   | (3,080,000 | )
|Proceeds from short-term note                                                                      |  |                           |           |   |                    |   | 4,000,000  |  
|Outstanding checks in excess of funds on deposit                                                   |  |                           | 51,000     |   |                    |   | 768,000    |  
|Proceeds from stock options exercised                                                              |  |                           | 53,000     |   |                    |   | 565,000    |  
|                                                                                                   |  |                           |            |   |                    |   |            |  
|Net cash (used in) provided by financing activities                                                |  |                           | (4,904,000 | ) |                    |   | 2,253,000  |  
|                                                                                                   |  |                           |            |   |                    |   |            |  
|INCREASE (DECREASE) IN CASH                                                                        |  |                           | 25,000     |   |                    |   | (404,000   | )
|Cash at beginning of period                                                                        |  |                           | 42,000     |   |                    |   | 486,000    |  
|                                                                                                   |  |                           |            |   |                    |   |            |  
|Cash at end of period                                                                              |  | $                         | 67,000     |   |                    | $ | 82,000     |  
|                                                                                                   |  |                           |            |   |                    |   |            |  

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



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##### Table of Contents

Pinnacle Data Systems, Inc.

Notes to Condensed Financial Statements

(Unaudited)

Note 1. Organization

Nature of BusinessPinnacle Data Systems, Inc. (the Company) is an embedded computing technology provider offering design,
development, production, and repair services to original equipment manufacturers (OEMs) and independent software vendors. Industries served currently include medical, telecommunications, industrial/automation, military/aerospace, and
imaging. The Company also helps major computer platform manufacturers respond to their customers requirements for customized solutions and extended service life. The Company specializes in solving the challenges associated with complex
technologies, multi-vendor integrations, low to medium volume production, and long-term service of third party products.

The Company is a
collaborative and flexible outsourcing partner who helps clients create cost-effective solutions, respond to unplanned demand changes, improve customer satisfaction, and aggressively adapt to new trends in the technology market place. Through its
innovative and proactive staff of engineering, design, manufacturing, program management and supply chain specialists, the Company tailors solutions that meet the particular business and operational needs of each OEM client.

Note 2. Summary of Significant Accounting Policies

The condensed balance sheet as of September 30, 2007 and the condensed statements of operations and cash flows for the three month and nine month periods ended September 30, 2007 and 2006 have been prepared by the Company without
audit. In the opinion of management, all adjustments, which consist solely of normal recurring adjustments, necessary to present fairly, in accordance with accounting principles generally accepted in the United States of America, the financial
position, condensed statements of operations and changes in cash flows for all periods presented have been made. Certain prior year amounts have been reclassified to conform to the current years presentation.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed and omitted. These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Companys Annual Report on Form 10-K
for the year ended December 31, 2006. The results of operations for the three month and nine month periods ended September 30, 2007 are not necessarily indicative of the results for the full year.

Inventories  Inventories are valued at average cost, not in excess of market. Inventory at September 30, 2007 and
December 31, 2006 was comprised of the following (net of inventory reserves):



|                                |  |                   |           |                  |   |           
|------------------------------- |  | ----------------- | --------- | ---------------- | - | ----------
|                                |  | September 30,2007 |           | December 31,2006
|Component parts (raw materials) |  | $                 | 6,164,000 |                  | $ | 9,855,000 
|Work-in-process                 |  |                   | 1,757,000 |                  |   | 1,169,000 
|Finished goods                  |  |                   | 598,000   |                  |   | 708,000   
|                                |  |                   |           |                  |   |           
|                                |  | $                 | 8,519,000 |                  | $ | 11,732,000
|                                |  |                   |           |                  |   |           

The carrying values of component parts and finished goods represent average cost or
managements estimate of its net realizable value. Such value is based on forecasts of product orders and repair/trade-in activity in the ensuing years. Such forecasts are based on historical information, known contracts, and managements
expertise in computer hardware life cycles. If demand for the Companys products and repair/trade-in hardware prove to be significantly less than anticipated, the ultimate realizable value of such products could be substantially less than the
amount shown in the balance sheet. At September 30, 2007 and December 31, 2006, the Company provided reserves of approximately $2,289,000 and $1,996,000, respectively, to reduce the carrying value of inventory.

Allowance for Doubtful Accounts  Accounts receivable is stated in the financial statements at amounts due
from customers net of an allowance for doubtful accounts. Credit is extended based on evaluation of customers financial condition and, generally, collateral is not required. Accounts receivable payment terms vary. The Company determines its
allowance by considering a number



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##### Table of Contents

Pinnacle Data Systems, Inc.

Notes to Condensed Financial Statements

(Unaudited)



of factors, including the length of time trade accounts receivable are past due, the Companys previous loss history with each customer, the
customers current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes off accounts receivable when they become uncollectible, and payments subsequently received
on such receivables are credited to the allowance for doubtful accounts.

Plant Consolidation Costs The Company
recognizes costs associated with the plant consolidation as discussed in Note 3 in accordance with Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal
Activities (SFAS No. 146). The liability and expense for costs associated with the consolidation was recognized and measured at fair value in the period in which the liability was incurred. The one-time termination benefits
for the terminated associates were ratably expensed over the remaining service period of the associates. The estimated outstanding lease costs on the abandoned facility, which had no future economic benefit to the Company, was recognized and
measured at its fair value in the period the Company ceased to use the facility for its intended use. In periods subsequent to the initial estimate of the lease costs on the abandoned facility, changes in the assumptions used to calculate the
liability are evaluated, and adjustments to the liability are recognized in the period of change.

Income Taxes 
The Company adopted Financial Accounting Standard Board (FASB) Interpretation No. 48 Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 Accounting for Income
Taxes (FIN 48) effective January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements and prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The adoption of this pronouncement did not impact the Companys financial position and results of operations. The Company recognizes any
interest and penalties related to uncertain tax positions in income tax expense.

Recently Issued Accounting
Pronouncement  In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement, (SFAS No. 157) which establishes a single authoritative definition of fair value, sets out a framework for
measuring fair value and requires additional disclosures about fair-value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of its adoption on its
financial position and results of operations.

In February 2007, the FASB issued SFAS No. 159 (SFAS No. 159),
The Fair Value Option for Financial Assets and Financial Liabilities, effective for the Company beginning on January 1, 2008. SFAS No. 159 provides entities with an option to report selected financial assets and liabilities at
fair value, with the objective to reduce both the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The Company is currently assessing the impact of this
guidance on its financial statements.

Note 3. Consolidation of Facilities

During 2006, the Company upgraded its headquarters facility in Groveport, Ohio, opened a warehouse and logistics facility in Groveport, Ohio, and
consolidated the Companys Monrovia, California operations into the Groveport, Ohio facilities (the Plan). The Company incurred $1,635,000 during the fiscal year ended December 31, 2006 for costs associated with the Plan. The
amounts were recorded as a component of Operating Expenses within the Statements of Operations during second quarter 2006 and thereafter. The total costs recorded in 2006 included $242,000 for termination and severance benefits
for associates, $1,150,000 for the estimated outstanding lease costs for the facility in Monrovia, California that provides no future economic benefit to the Company, and $243,000 for other closure costs including travel, training, and
relocation of associates and production lines. The Company recorded $1,399,000 and $1,467,000 in the three month and nine month periods ended September 30, 2006, respectively, for costs associated with the Plan.

During the second quarter 2007, the Company completed amendments to the original Monrovia, California lease agreement, which will eliminate any future
obligations under the lease agreement after November 30, 2007. The remaining liability for the Plan as of September 30, 2007 was $39,000.



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##### Table of Contents

Pinnacle Data Systems, Inc.

Notes to Condensed Financial Statements

(Unaudited)



The following table summarizes the accrued liabilities associated with the Plan during the nine month
period ended September 30, 2007:



|                                 |  |                                    |         |   |                    |   |          |       |  |   |          |  
|-------------------------------- |  | ---------------------------------- | ------- | - | ------------------ | - | -------- | ----- |  | - | -------- | -
|                                 |  | Severance and Termination Benefits |         |   | Abandoned Facility |   |          | Total | 
|Accrual as of January 1, 2007    |  | $                                  | 35,000  |   |                    | $ | 868,000  |       |  | $ | 903,000  |  
|Payments or settlements          |  |                                    | (23,000 | ) |                    |   | (286,000 | )     |  |   | (309,000 | )
|                                 |  |                                    |         |   |                    |   |          |       |  |   |          |  
|Accrual as of March 31, 2007     |  |                                    | 12,000  |   |                    |   | 582,000  |       |  |   | 594,000  |  
|Payments or settlements          |  |                                    | (12,000 | ) |                    |   | (446,000 | )     |  |   | (458,000 | )
|Adjustment to liability          |  |                                    |        |   |                    |   | 63,000   |       |  |   | 63,000   |  
|                                 |  |                                    |         |   |                    |   |          |       |  |   |          |  
|Accrual as of June 30, 2007      |  |                                    |        |   |                    |   | 199,000  |       |  |   | 199,000  |  
|                                 |  |                                    |         |   |                    |   |          |       |  |   |          |  
|Payments or settlements          |  |                                    |        |   |                    |   | (160,000 | )     |  |   | (160,000 | )
|                                 |  |                                    |         |   |                    |   |          |       |  |   |          |  
|Accrual as of September 30, 2007 |  | $                                  |        |   |                    | $ | 39,000   |       |  | $ | 39,000   |  
|                                 |  |                                    |         |   |                    |   |          |       |  |   |          |  

Note 4. Debt

On August 13, 2007, the Company became a borrower under an asset-based revolving credit facility (the AB Line) as defined in the Seventh Amendment Agreement (the Seventh Amendment) by and
between the Company and KeyBank National Association (KeyBank). The AB Line modified the revolving credit promissory note (the Line) dated November 19, 2003, as amended. The AB Line provides a maximum line of credit of
$11,000,000, subject to borrowing base restrictions. The borrowing base under the AB Line is determined as the lesser of 1) $11,000,000 or 2) the sum of (a) 85% of the aggregate amount of eligible receivable accounts, plus (b) the greater
of (i) 25% of the lower of cost or market value of the aggregate amount of eligible inventory, or (ii) 85% of the appraised net orderly liquidation value of the aggregate amount of eligible inventory, not to exceed $6,000,000 and
(c) $2,000,000 for working capital needs, minus (d) the outstanding principal balance of the Term Loan, as defined below. In addition, the agreement restricts the payments of cash dividends that would cause violations of the loan
covenants. The maturity date of the AB Line is May 18, 2008.

The AB Line is payable on demand and is collateralized by a blanket lien
on all assets of the Company. In addition, the Seventh Amendment eliminated the financial covenants from the Line and implemented a monthly minimum earnings before interest, taxes, depreciation and amortization and restructuring costs (costs
incurred with the establishment of the new credit facility) (EBITDAR) financial covenant.

As of September 30, 2007, the
maximum available borrowing base, subject to the borrowing base restrictions, was $8,982,000. The outstanding balance on the AB Line was $4,101,000 as of September 30, 2007, and the outstanding balance on the Line was $9,109,000 as of
December 31, 2006.

The outstanding balance on the AB Line bears interest monthly at an annual rate equal to prime rate or the
overnight LIBOR plus 2.45%. Use of prime rate or the overnight LIBOR is at the discretion of the Company. The borrowing rate on the AB Line was 7.76% at September 30, 2007, and was 7.7625% on the Line at December 31, 2006. The weighted
average interest rate for the nine month periods ended September 30, 2007 and 2006 was 7.78% and 7.87%, respectively. In addition, the unused AB Line capacity is subject to a commitment fee of 1/8%, payable monthly in arrears.

The Company entered into a term loan with KeyBank, in the principal amount of $4,000,000, as evidenced by a promissory note dated September 28, 2006
(the Term Note), as amended and extended. The principal amount of the Term Note will bear interest at an annual rate equal to the prime rate less 0.25%. The borrowing rate on the Term Note was 7.5% and 8.0% on September 30, 2007 and
December 31, 2006, respectively. The Term Note is secured by substantially all of the assets of the Company, as provided for in the Commercial Security Agreement entered into between the Company and KeyBank on September 29, 2006. The
maturity date of the Term Note is November 15, 2007.



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##### Table of Contents

Pinnacle Data Systems, Inc.

Notes to Condensed Financial Statements

(Unaudited)



The average debt balance, including the AB Line, the Line, and the Term Note, for the nine month
period ended September 30, 2007 and for twelve month period ended December 31, 2006 was $11,856,000 and $10,055,000, respectively.

On November 13, 2007, the Company entered into an extension of the Term Note, which extended the maturity date to February 15, 2008, and established EBITDAR financial covenants for the monthly periods from October 2007 through
December 2007. There were no additional changes to the terms of the Term Note.

Note 5. Income Taxes

Income taxes for interim periods were computed using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to
ongoing review and evaluation by management. During the first quarter of 2007, the Company adopted FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements and prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The adoption of FIN 48 had no material impact on the Companys financial position and did not result
in unrecognized tax benefits being recorded. Accordingly, no corresponding interest and penalties have been accrued. The Company files income tax returns in the U.S. federal jurisdiction and various states. There are currently no federal or state
income tax examinations underway for these jurisdictions. The Company expects the impact of foreign taxes not to be material to its financial position and results of operations.

Note 6. Stock-based compensation

Stock compensation expense for the three month periods ended
September 30, 2007 and 2006 was $54,000 and $71,000, respectively. Stock compensation expense for the nine month periods ended September 30, 2007 and 2006 was $145,000 and $122,000, respectively. Stock compensation expense is reported in
Operating Expenses within the Condensed Statements of Operations.

Under the 2005 Equity Incentive Plan, the stock option
activity and weighted average exercise prices for the nine month periods ended September 30, 2007 and 2006 were as follows:



|                                            |  |                  |   |                |                       |      |                  |           |   |                       |   |     
|------------------------------------------- |  | ---------------- | - | -------------- | --------------------- | ---- | ---------------- | --------- | - | --------------------- | - | ----
|                                            |  | 2007             |   | 2006          
|                                            |  | Number ofOptions |   |                | WeightedAverage Price |      | Number ofOptions |           |   | WeightedAverage Price
|Outstanding at December 31                  |  | 1,894,100        |   |                | $                     | 2.71 |                  | 2,118,900 |   |                       | $ | 2.54
|Granted                                     |  | 440,300          |   |                | $                     | 2.33 |                  | 684,000   |   |                       | $ | 3.08
|Exercised                                   |  | (56,100          | ) |                | $                     | 0.95 |                  | (372,950  | ) |                       | $ | 1.93
|Forfeited                                   |  | (732,100         | ) |                | $                     | 2.66 |                  | (149,350  | ) |                       | $ | 3.01
|                                            |  |                  |   |                |                       |      |                  |           |   |                       |   |     
|Outstanding at September 30                 |  | 1,546,200        |   |                | $                     | 2.68 |                  | 2,280,600 |   |                       | $ | 2.77
|                                            |  |                  |   |                |                       |      |                  |           |   |                       |   |     
|Exercise price range of options outstanding |  | $0.75 to $5.25   |   | $0.75 to $5.25

The fair value of the stock options granted was estimated on the grant date using the
Black-Scholes option-pricing model. The weighted-average assumptions used in this valuation for the three and nine month periods ended September 30, 2007 and 2006 were as follows:



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##### Table of Contents

Pinnacle Data Systems, Inc.

Notes to Condensed Financial Statements

(Unaudited)



|                                        |  |                           |   |  |                          |   |  |                   |   |  |                   |  
|--------------------------------------- |  | ------------------------- | - |  | ------------------------ | - |  | ----------------- | - |  | ----------------- | -
|                                        |  | Three Month Periods Ended |   |  | Nine Month Periods Ended |  
|                                        |  | September 30,2007         |   |  | September 30,2006        |   |  | September 30,2007 |   |  | September 30,2006 |  
|Risk-free interest rate                 |  | 4.2                       | % |  | 4.9                      | % |  | 4.4               | % |  | 5.0               | %
|Dividend yield                          |  | 0.0                       | % |  | 0.0                      | % |  | 0.0               | % |  | 0.0               | %
|Volatility factor                       |  | 65.6                      | % |  | 77.7                     | % |  | 67.4              | % |  | 77.8              | %
|Weighted average expected life in years |  | 6.4                       |   |  | 5.9                      |   |  | 6.4               |   |  | 6.4               |  

For purposes of determining the expected volatility factor, the Company used the historical price
volatility of the Companys stock price over the prior seven-year period. The approximate risk-free interest rate was based on the implied yield available on U.S. Treasury zero-coupon issues with remaining terms equivalent to the expected term
on the options granted. The Company does not expect to pay dividends on its common stock; therefore, a dividend yield of zero was used in the option-pricing model. The expected term of stock options granted is the period of time the options are
expected to remain outstanding. Due to limited historical exercise data, the Company used the simplified method as provided in Staff Accounting Bulletin (SAB) 107 to estimate the expected term. Using this method, the expected term is
calculated as the mid-point between the vesting date and the contractual term or expiration date. The weighted-average fair value of the options granted during the three and nine month periods ended September 30, 2007 were $1.40 and $1.54,
respectively. The weighted-average fair value of the options granted during the three and nine month periods ended September 30, 2006 were $2.00 and $2.23, respectively.

Note 7. Earnings (Loss) Per Common and Common Equivalent Share

Earnings (loss) per common and common
equivalent shares (EPS) were computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. For the three and nine month periods ended September 30, 2006, no conversion
of common stock equivalents has been assumed in the calculation since the effect would be anti-dilutive. As a result, the number of weighted average outstanding common shares and EPS are the same for basic and diluted EPS calculations for the
periods noted above.

The following table presents EPS for the three and nine month periods ended September 30, 2007 and 2006.



|                                             |  |                           |           |                   |                          |            |                   |  |                   |           |  |   |            |  
|-------------------------------------------- |  | ------------------------- | --------- | ----------------- | ------------------------ | ---------- | ----------------- |  | ----------------- | --------- |  | - | ---------- | -
|                                             |  | Three Month Periods Ended |           |                   | Nine Month Periods Ended |           
|                                             |  | September 30,2007         |           | September 30,2006 |                          |            | September 30,2007 |  | September 30,2006 |          
|Net income (loss)                            |  | $                         | 631,000   |                   | $                        | (1,398,000 | )                 |  | $                 | 335,000   |  | $ | (1,864,000 | )
|Determination of common shares:              |  |                           |           |                   |                          |            |                   |  |                   |           |  |   |            |  
|Average common shares outstanding            |  |                           | 6,393,637 |                   |                          | 6,297,108  |                   |  |                   | 6,377,559 |  |   | 6,199,777  |  
|Assumed converions of dilutive stock options |  |                           | 63,288    |                   |                          |           |                   |  |                   | 75,962    |  |   |           |  
|                                             |  |                           |           |                   |                          |            |                   |  |                   |           |  |   |            |  
|Diluted average common shares outstanding    |  |                           | 6,456,925 |                   |                          | 6,297,108  |                   |  |                   | 6,453,521 |  |   | 6,199,777  |  
|                                             |  |                           |           |                   |                          |            |                   |  |                   |           |  |   |            |  
|Basic earnings (loss) per common share:      |  | $                         | 0.10      |                   | $                        | (0.22      | )                 |  | $                 | 0.05      |  | $ | (0.30      | )
|Diluted earnings (loss) per common share:    |  | $                         | 0.10      |                   | $                        | (0.22      | )                 |  | $                 | 0.05      |  | $ | (0.30      | )

Note 8. Operating Segments

The Companys reportable segments are Product and Service. A description of the segments may be found in Item 1 of the Companys Annual Report on Form 10-K for December 31, 2006, which includes a
discussion of principal markets and distribution. The column noted as Other reflects the costs and assets of the functional and administrative groups of the Company that are not allocated to the reportable segments, and include
engineering, finance, human resources, quality systems, and executive management. The Company evaluates performance based on operating earnings of the Product and Service segments and the segments effectiveness to cover the other
administrative expenses of the Company.



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Pinnacle Data Systems, Inc.

Notes to Condensed Financial Statements

(Unaudited)



Segment information for the three and nine month periods ended September 30, 2007 and 2006 was
as follows:



|                                    |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  
|----------------------------------- |  | ------------------------- | ---------- | - | ------------------------ | - | ---------- | ------------------ |  | - | ------------------ | - |  | - | ---------- | -
|                                    |  | Three Month Periods Ended |            |   | Nine Month Periods Ended |  
|                                    |  | September 30, 2007        |            |   | September 30, 2006       |   |            | September 30, 2007 |  |   | September 30, 2006 |  
|Sales                               |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  
|Product                             |  | $                         | 14,432,000 |   |                          | $ | 12,521,000 |                    |  | $ | 47,166,000         |   |  | $ | 41,769,000 |  
|Service                             |  |                           | 2,974,000  |   |                          |   | 2,874,000  |                    |  |   | 7,974,000          |   |  |   | 7,878,000  |  
|                                    |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  
|Total sales                         |  | $                         | 17,406,000 |   |                          | $ | 15,395,000 |                    |  | $ | 55,140,000         |   |  | $ | 49,647,000 |  
|                                    |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  
|Gross profit                        |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  
|Product                             |  | $                         | 3,913,000  |   |                          | $ | 1,004,000  |                    |  | $ | 9,760,000          |   |  | $ | 5,366,000  |  
|Service                             |  |                           | 669,000    |   |                          |   | 1,397,000  |                    |  |   | 1,933,000          |   |  |   | 4,290,000  |  
|                                    |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  
|Total gross profit                  |  | $                         | 4,582,000  |   |                          | $ | 2,401,000  |                    |  | $ | 11,693,000         |   |  | $ | 9,656,000  |  
|                                    |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  
|Income (loss) from operations       |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  
|Product                             |  | $                         | 2,970,000  |   |                          | $ | (314,000   | )                  |  | $ | 6,378,000          |   |  | $ | 1,545,000  |  
|Service                             |  |                           | 380,000    |   |                          |   | 1,031,000  |                    |  |   | 1,117,000          |   |  |   | 3,282,000  |  
|Other                               |  |                           | (2,045,000 | ) |                          |   | (3,118,000 | )                  |  |   | (6,169,000         | ) |  |   | (7,675,000 | )
|                                    |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  
|Total income (loss) from operations |  | $                         | 1,305,000  |   |                          | $ | (2,401,000 | )                  |  | $ | 1,326,000          |   |  | $ | (2,848,000 | )
|                                    |  |                           |            |   |                          |   |            |                    |  |   |                    |   |  |   |            |  

Segment information at September 30, 2007 and December 31, 2006 was as follows:



|             |  |                    |            |                   |   |           
|------------ |  | ------------------ | ---------- | ----------------- | - | ----------
|             |  | September 30, 2007 |            | December 31, 2006
|Total assets |  |                    |            |                   |   |           
|Product      |  | $                  | 15,362,000 |                   | $ | 23,939,000
|Service      |  |                    | 7,480,000  |                   |   | 7,411,000 
|Other        |  |                    | 2,035,000  |                   |   | 2,508,000 
|             |  |                    |            |                   |   |           
|Total assets |  | $                  | 24,877,000 |                   | $ | 33,858,000
|             |  |                    |            |                   |   |           



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##### Table of Contents

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

The following discussion should be read in conjunction with the Condensed Financial Statements and Notes contained herein. This quarterly report,
including the following sections, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The words believe,
expect, anticipate, may, plan, estimate, and similar expressions identify forward-looking statements that speak only as of the date thereof. Investors are cautioned that such statements
involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated results due to many factors. These factors include without limitation changes in general economic conditions, changes in the specific
markets for our products and services, adverse business conditions, changes in customer order patterns, increased competition, changes in our business or our relationship with major technology partners or significant customers, pricing pressures,
lack of adequate financing to take advantage of business opportunities that may arise, lack of success in technological advancements, risks associated with our new business practices, processes and information systems, and other factors, including
those discussed under Risk Factors disclosed in Item 1A of this Quarterly Report on Form 10-Q. For more details, please refer to the Companys Securities and Exchange Commission filings, including its most recent Annual Report
on Form 10-K for December 31, 2006.

EXECUTIVE OVERVIEW

Pinnacle Data Systems, Inc. (the Company) is an embedded computing technology provider offering design, development, production, and repair services to original equipment manufacturers (OEMs)
and independent software vendors (ISVs). Industries served currently include medical, telecommunications, industrial/automation, military/aerospace, and imaging. The Company also helps major computer platform manufacturers respond to
their customers requirements for customized solutions and extended service life. The Company specializes in solving the challenges associated with complex technologies, multi-vendor integrations, low to medium volume production, and long-term
service of third party products.

The Company is a collaborative and flexible outsourcing partner who helps clients create cost-effective
solutions, respond to unplanned demand changes, improve customer satisfaction, and aggressively adapt to new trends in the technology market place. Through its innovative and proactive staff of engineering, design, manufacturing, program management
and supply chain specialists, the Company tailors solutions that meet the particular business and operational needs of each OEM client.

During the first half of the 2007 fiscal year, the Company established a branch office in Hong Kong. Through its Hong Kong office, the Company has collaborated with partner, E.C. Fix Technology Limited, to provide management and delivery of
repair services for the Companys global OEM and ISV customer base in the Asia region. In addition, the Company has partnered with Aspan Computer Repair Laboratories B.V. (Aspan) to provide repair services in The Netherlands.
Management of the Company continues to actively negotiate terms for the acquisition of Aspan with the owner and plans to have a transaction completed by the end of 2007 upon obtaining the appropriate financing.

At the end of the second quarter 2007, the Company entered into a partnership with Israeli-based Startronics, a wholly owned subsidiary of STG
International, Ltd., to jointly market and support the Companys products and services in Israel. The Company anticipates continued growth in the Asian, European and other international markets.

During the second quarter 2007, the Company completed amendments to the original Monrovia, California lease agreement, which will eliminate any future
obligations under the lease agreement after November 30, 2007. The remaining liability for the Plan as of September 30, 2007 was less than $0.1 million.

During the third quarter, the Company obtained favorable operating results due to solid organic growth and benefits from the Operational Improvement Plan completed earlier in fiscal 2007 and its continuing effort to
improve operating leverage and margins. The Company continues to address its scalability needs to meet customer requirements and to achieve profitable sales growth. In addition, the Company continues to evaluate and challenge existing business that
consistently performs below expected results, and is seeking new opportunities that are more in line with the Companys performance goals. The Company is focused on opportunities where the customer recognizes and values the Company as a partner
and enabler to the customers specialized product and services needs. Since September 30, 2007, the Company entered into an independent manufacturers sales representative agreement with a company in the Northeast Region of the United
States. The strategic use of independent manufacturers sales representatives will improve the Companys market and geographical coverage of its products and services.



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##### Table of Contents

In addition, the Company continues to evaluate viable acquisition opportunities that meet the
Companys established criteria, which include strategic fit that is either complementary, additive, or synergistic to the Companys business, and will provide projected accretive performance within less than a year.

During 2006, the Company upgraded its headquarters facility in Groveport, Ohio, opened a warehouse and logistics facility in Groveport, Ohio, and
consolidated the Companys Monrovia, California operations into the Groveport, Ohio facilities (the Plan). The Company invested approximately $0.4 million in 2006 to increase and improve its production, warehouse, and logistics
capabilities in Ohio. In addition, the Company incurred $1.6 million in costs, which included $0.2 million for termination and severance benefits for associates, an accrual of $1.2 million for the estimated outstanding lease costs for the
facility in Monrovia, California that provides no future economic benefit to the Company, and $0.2 million for other closure costs including travel, training, and relocation of associates and production lines. The Company recorded $1.4 million and
$1.5 million in the three month and nine month periods ended September 30, 2006, respectively, for costs associated with the Plan.

DISCUSSION AND
ANALYSIS OF OPERATING RESULTS

The following is a discussion and analysis of the financial condition and results of operations of the
Company for the three and nine month periods ended September 30, 2007 and September 30, 2006. The discussion should be read in conjunction with the Condensed Financial Statements of the Company and the notes thereto included elsewhere in
this Quarterly Report on Form 10-Q.

SALES

Sales for the three and nine month periods ended September 30, 2007 and 2006 were as follows:



|                 |  |                           |        |                   |                          |         |  |    |                   |  |                   |        |         |   |        |  |    |  
|---------------- |  | ------------------------- | ------ | ----------------- | ------------------------ | ------- |  | -- | ----------------- |  | ----------------- | ------ | ------- | - | ------ |  | -- | -
|                 |  | Three Month Periods Ended |        |                   | Nine Month Periods Ended |        
|($ in thousands) |  | September 30,2007         |        | September 30,2006 |                          | %Change |  |    | September 30,2007 |  | September 30,2006 |        | %Change |  
|Total sales      |  | $                         | 17,406 |                   | $                        | 15,395  |  | 13 | %                 |  | $                 | 55,140 |         | $ | 49,647 |  | 11 | %
|Product          |  | $                         | 14,432 |                   | $                        | 12,521  |  | 15 | %                 |  | $                 | 47,166 |         | $ | 41,769 |  | 13 | %
|Service          |  | $                         | 2,974  |                   | $                        | 2,874   |  | 3  | %                 |  | $                 | 7,974  |         | $ | 7,878  |  | 1  | %

Sales for the third quarter and year to date 2007 as compared to same respective periods in 2006
were higher primarily in product sales. The increase in product sales from year to date 2006 to year to date 2007 was primarily attributable to the initial set-up of a multi-program customer in the latter half of 2006 that has remained strong in
2007. The slight increase in service sales was due to the Companys ramp-up of new storage device repair programs in North America and the Europe, Middle East and Africa (EMEA) region, offset by lower billings on established
domestic accounts. The Companys results were affected by fluctuation in its customers product lines and programs, and the demands of their market.

For the nine month period ended September 30, 2007, the Company had two customers that generated sales of approximately $20.7 million and $6.3 million or 37% and 11% of total sales, respectively. In addition,
these customers represented 38% and less than 1%, respectively, of accounts receivable at September 30, 2007.

For the nine month
period ended September 30, 2006, the Company had three customers that generated sales of approximately $12.2 million, $5.2 million, and $4.3 million or 25%, 11%, and 9% of total sales, respectively. In addition, these customers represented 18%,
18%, and 7%, respectively, of accounts receivable at September 30, 2006.



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##### Table of Contents

GROSS PROFIT

Gross profit for the three and nine month periods ended September 30, 2007 and 2006 were as follows:



|                   |  |                           |       |                   |                          |         |  |     |                   |  |                   |        |         |   |       |  |     |   
|------------------ |  | ------------------------- | ----- | ----------------- | ------------------------ | ------- |  | --- | ----------------- |  | ----------------- | ------ | ------- | - | ----- |  | --- | --
|                   |  | Three Month Periods Ended |       |                   | Nine Month Periods Ended |        
|($ in thousands)   |  | September 30,2007         |       | September 30,2006 |                          | %Change |  |     | September 30,2007 |  | September 30,2006 |        | %Change |  
|Total gross profit |  | $                         | 4,582 |                   | $                        | 2,401   |  | 91  | %                 |  | $                 | 11,693 |         | $ | 9,656 |  | 21  | % 
|Product            |  | $                         | 3,913 |                   | $                        | 1,004   |  | 290 | %                 |  | $                 | 9,760  |         | $ | 5,366 |  | 82  | % 
|Service            |  | $                         | 669   |                   | $                        | 1,397   |  | (52 | )%                |  | $                 | 1,933  |         | $ | 4,290 |  | (55 | )%

The gross profit margin percentages for the three and nine month periods ended September 30,
2007 and 2006 were as follows:



|                   |  |                           |   |  |                          |   |  |                    |   |  |                    |  
|------------------ |  | ------------------------- | - |  | ------------------------ | - |  | ------------------ | - |  | ------------------ | -
|                   |  | Three Month Periods Ended |   |  | Nine Month Periods Ended |  
|                   |  | September 30, 2007        |   |  | September 30, 2006       |   |  | September 30, 2007 |   |  | September 30, 2006 |  
|Total gross profit |  | 26                        | % |  | 16                       | % |  | 21                 | % |  | 19                 | %
|Product            |  | 27                        | % |  | 8                        | % |  | 21                 | % |  | 13                 | %
|Service            |  | 22                        | % |  | 49                       | % |  | 24                 | % |  | 54                 | %

The increase in overall gross profit margin as a percentage of sales between each respective
comparable period was primarily attributable to the reduction of lower margin business and the increase in more profitable business including programs that supported customers last time buys of prior generation products. The Company continues
to focus on business with higher profitable returns. The decline in gross profit on service sales was caused by a higher percentage of sales recognized from service customers with lower gross profit margins, primarily from the ramp-up of a new
repair program in the EMEA region. The Company currently shares its profit on service sales generated in EMEA with Aspan. Once the Company is able to complete an acquisition transaction as contemplated with Aspan, the service sales and profit
margins are expected to benefit from full ownership.

The Company continues to believe that as sales revenues and gross profit margins
increase through the organic growth of existing customers and other additional global businesses, the results of operations will be positively affected. Gross margins will vary from program to program, and the mix of programs will vary from quarter
to quarter causing the gross margin percentages to vary from quarter to quarter. Consequently, it is difficult to predict gross margin results on future sales.

OPERATING EXPENSES AND INTEREST EXPENSES

Operating expenses, which include selling, general and administrative
(SG&A) expense, and interest expenses for the three and nine month periods ended September 30, 2007 and 2006 were as follows:



|                   |  |                           |       |                   |                          |         |  |     |                   |  |                   |        |         |   |        |  |     |   
|------------------ |  | ------------------------- | ----- | ----------------- | ------------------------ | ------- |  | --- | ----------------- |  | ----------------- | ------ | ------- | - | ------ |  | --- | --
|                   |  | Three Month Periods Ended |       |                   | Nine Month Periods Ended |        
|($ in thousands)   |  | September 30,2007         |       | September 30,2006 |                          | %Change |  |     | September 30,2007 |  | September 30,2006 |        | %Change |  
|Operating expenses |  | $                         | 3,277 |                   | $                        | 4,802   |  | (32 | )%                |  | $                 | 10,367 |         | $ | 12,504 |  | (17 | )%
|Interest expenses  |  |                           | 208   |                   |                          | 221     |  | (6  | )%                |  |                   | 719    |         |   | 551    |  | 30  | % 
|                   |  |                           |       |                   |                          |         |  |     |                   |  |                   |        |         |   |        |  |     |   
|Total expense      |  | $                         | 3,485 |                   | $                        | 5,023   |  | (31 | )%                |  | $                 | 11,086 |         | $ | 13,055 |  | (15 | )%
|                   |  |                           |       |                   |                          |         |  |     |                   |  |                   |        |         |   |        |  |     |   

The decrease in SG&A expenses for the three and nine month periods ended September 30,
2007 is primarily caused by the fact the SG&A expenses for the three and nine month periods ended September 30, 2006 included special one-time charges in the amount of $1.1 million and $2.1 million, respectively. The Company recorded $1.4
million and $1.5 million in the three month and nine month periods ended September 30, 2006, respectively, for costs associated with the Plan, as discussed in the Executive Overview. In addition, an allowance was established to cover the
outstanding receivable balance of one of the Companys customers, Silicon Graphics, Inc. (SGI), who filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code in May 2006. The Company settled this claim, and
SGI paid the Company 70% of the Companys pre-petition claims on outstanding receivables, or $437,000. The charge was reduced by $265,000 in the three month period ended September 30, 2006 for a total charge of



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##### Table of Contents

$200,000 for the nine month period ended September 30, 2006. For additional discussion, refer to Note 2 of the Financial Statements contained in the
Companys Annual Report on Form 10-K for the year ended December 31, 2006. In addition, the Company reduced the number of salaried personnel, as well as travel and outside professional services costs for the three and nine month periods
ended September 30, 2007 compared to the same periods a year ago.

The decrease in interest expense in the three month period ended
September 30, 2007 compared to the three month period ended September 30, 2006 was primarily due to lower borrowing requirements as the Company has improved performance over managing inventory levels and accounts receivable collections in
fiscal year 2007. The increase in interest expense for the nine month period ended September 30, 2007 compared to the nine month period ended September 30, 2006 was due to the higher average bank debt balance carried to support the working
capital requirements for the growth in the Companys business as well as higher average interest rates.

INCOME TAX EXPENSE (BENEFIT) AND NET
INCOME (LOSS)

Income tax expense (benefit) for the interim periods was computed using the effective tax rate estimated to be
applicable for the full fiscal year, and as adjusted for certain permanent book to tax differences as recorded in the prior year. The tax provision is subject to an on-going review and evaluation by management. The effective tax rate was 42% and 45%
for the three and nine month periods ended September 30, 2007, respectively.

Income (loss) before taxes, income tax expense (benefit)
and net income (loss) for the three and nine month periods ended September 30, 2007 and 2006 were as follows:



|                             |  |                           |       |                   |                          |        |         |  |     |                   |  |                   |     |  |         |        |   |  |     |  
|---------------------------- |  | ------------------------- | ----- | ----------------- | ------------------------ | ------ | ------- |  | --- | ----------------- |  | ----------------- | --- |  | ------- | ------ | - |  | --- | -
|                             |  | Three Month Periods Ended |       |                   | Nine Month Periods Ended |       
|($ in thousands)             |  | September 30,2007         |       | September 30,2006 |                          |        | %Change |  |     | September 30,2007 |  | September 30,2006 |     |  | %Change |       
|Income (loss) before taxes   |  | $                         | 1,097 |                   | $                        | (2,622 | )       |  | 142 | %                 |  | $                 | 607 |  | $       | (3,399 | ) |  | 118 | %
|Income tax expense (benefit) |  |                           | 466   |                   |                          | (1,224 | )       |  | 138 | %                 |  |                   | 272 |  |         | (1,535 | ) |  | 118 | %
|                             |  |                           |       |                   |                          |        |         |  |     |                   |  |                   |     |  |         |        |   |  |     |  
|Net income (loss)            |  | $                         | 631   |                   | $                        | (1,398 | )       |  | 145 | %                 |  | $                 | 335 |  | $       | (1,864 | ) |  | 118 | %
|                             |  |                           |       |                   |                          |        |         |  |     |                   |  |                   |     |  |         |        |   |  |     |  

EARNINGS (LOSS) PER SHARE

Earnings (loss) per share (EPS) for the three month periods ended September 30, 2007 and 2006 were as follows:



|                                               |  |                           |           |                   |                          |           |                   |  |                   |           |  |   |           |  
|---------------------------------------------- |  | ------------------------- | --------- | ----------------- | ------------------------ | --------- | ----------------- |  | ----------------- | --------- |  | - | --------- | -
|                                               |  | Three Month Periods Ended |           |                   | Nine Month Periods Ended |          
|                                               |  | September 30,2007         |           | September 30,2006 |                          |           | September 30,2007 |  | September 30,2006 |          
|Basic earnings (loss) per common share:        |  | $                         | 0.10      |                   | $                        | (0.22     | )                 |  | $                 | 0.05      |  | $ | (0.30     | )
|Diluted earnings (loss) per common share:      |  | $                         | 0.10      |                   | $                        | (0.22     | )                 |  | $                 | 0.05      |  | $ | (0.30     | )
|                                               |  |                           |           |                  
|Weighted average number of shares outstanding: |  |                           |           |                   |                          |           |                   |  |                   |           |  |   |           |  
|Basic average common shares outstanding        |  |                           | 6,393,637 |                   |                          | 6,297,108 |                   |  |                   | 6,377,559 |  |   | 6,199,777 |  
|Diluted average common shares outstanding      |  |                           | 6,456,925 |                   |                          | 6,297,108 |                   |  |                   | 6,453,521 |  |   | 6,199,777 |  

For the three and nine month periods ended September 30, 2006, no conversion of common stock
equivalents has been assumed in the calculation of loss per share, as the effect would be anti-dilutive. As a result, the number of weighted average outstanding common shares and EPS are the same for basic and diluted EPS calculations for the three
and nine month periods noted above.



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##### Table of Contents

LIQUIDITY AND CAPITAL RESOURCES

A summary of changes in current assets for the periods ended September 30, 2007 and December 31, 2006 were as follows:



|                     |  |                    |        |                   |   |          |  |     |   
|-------------------- |  | ------------------ | ------ | ----------------- | - | -------- |  | --- | --
|($ in thousands)     |  | September 30, 2007 |        | December 31, 2006 |   | % Change | 
|Accounts receivable  |  | $                  | 12,888 |                   | $ | 17,718   |  | (27 | )%
|Inventory            |  |                    | 8,519  |                   |   | 11,732   |  | (27 | )%
|Other current assets |  |                    | 1,514  |                   |   | 2,429    |  | (38 | )%
|                     |  |                    |        |                   |   |          |  |     |   
|Total current assets |  | $                  | 22,921 |                   | $ | 31,879   |  | (28 | )%
|                     |  |                    |        |                   |   |          |  |     |   

A summary of changes in current liabilities for the periods ended September 30, 2007 and
December 31, 2006 were as follows:



|                          |  |                    |        |                   |   |          |  |     |   
|------------------------- |  | ------------------ | ------ | ----------------- | - | -------- |  | --- | --
|($ in thousands)          |  | September 30, 2007 |        | December 31, 2006 |   | % Change | 
|Line of credit            |  | $                  | 4,101  |                   | $ | 9,109    |  | (55 | )%
|Short-term note           |  |                    | 4,000  |                   |   | 4,000    |  |    |   
|Accounts payable          |  |                    | 7,858  |                   |   | 11,851   |  | (34 | )%
|Other current liabilities |  |                    | 2,366  |                   |   | 2,204    |  | 7   | % 
|                          |  |                    |        |                   |   |          |  |     |   
|Total current liabilities |  | $                  | 18,325 |                   | $ | 27,164   |  | (33 | )%
|                          |  |                    |        |                   |   |          |  |     |   

During the nine month period ended September 30, 2007, the net cash provided by operating
activities was $5.4 million. During the nine month period ended September 30, 2006, the net cash used in operating activities was $2.1 million. Net income (loss) as adjusted for the effects of the non-cash items, which include depreciation
expense, stock-based compensation expense, accounts receivable reserves, and inventory reserves, if applicable, provided cash from operations of $1.3 million for the nine month period ended September 30, 2007 and used cash from operations of
$1.2 million for the nine month period ended September 30, 2006. Change in the working capital components provided a net cash inflow of $4.1 million for the nine month period ended September 30, 2007, and required a net cash outflow of
$0.9 million for the nine month period ended September 30, 2006. As of the end of the third quarter 2007, the Company has improved its performance over managing inventory levels and accounts receivable collections as compared to the prior year.

The net cash used in investing activities was $0.5 million and $0.6 million for the nine month periods ended September 30, 2007 and
2006, respectively. The Companys use of cash in investing activities was for the purchase of equipment, including computer equipment and leasehold improvements, in the nine month periods ended September 30, 2007 and 2006.

During the nine month period ended September 30, 2007, the net cash used in financing activities was $4.9 million. During the nine month period
ended September 30, 2006, the net cash provided by financing activities was $2.3 million. In the nine month period ended September 30, 2007, net cash was used in financing activities primarily for payments on the Line and AB Line (as
defined below) of $5.0 million. In the nine month period ended September 30, 2006, net cash provided by financing activities included the proceeds from the short term note of $4.0 million, $0.8 million of outstanding checks to be applied
against the Line, $0.6 million from the exercise of stock options, offset by $3.1 million of payments on the Line.

On August 13,
2007, the Company became a borrower under an asset-based revolving credit facility (the AB Line) as defined in the Seventh Amendment Agreement (the Seventh Amendment) by and between the Company and KeyBank National
Association (KeyBank). The AB Line modified the revolving credit promissory note (the Line) dated November 19, 2003, as amended. The AB Line provides a maximum line of credit of $11.0 million, subject to borrowing base
restrictions. The borrowing base under the AB Line is determined as the lesser of 1) $11.0 million or 2) the sum of (a) 85% of the aggregate amount of eligible receivable accounts, plus (b) the greater of (i) 25% of the lower of cost
or market value of the aggregate amount of eligible inventory, or (ii) 85% of the appraised net orderly liquidation value of the aggregate amount of eligible inventory, not to exceed $6.0 million and (c) $2.0 million for working capital
needs, minus (d) the outstanding principal balance of the Term Loan (as defined below). In addition, the agreement restricts the payments of cash dividends that would cause violations of the loan covenants. The maturity date of the AB Line is
May 18, 2008.



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##### Table of Contents

The AB Line, which is the Companys primary source of operational and non-operational funding, is
collateralized by a blanket lien on the Companys assets. The agreement restricts the payments of cash dividends that would cause violations of the loan covenants. In addition, the Seventh Amendment eliminated the financial covenants from the
Line and implemented a monthly minimum earnings before interest, taxes, depreciation and amortization and restructuring costs (costs incurred with the establishment of the new credit facility) (EBITDAR) financial covenant.

As of September 30, 2007, the maximum available borrowing base, subject to the borrowing base restrictions, was $9.0 million. The outstanding
balance on the AB Line was $4.1 million as of September 30, 2007, and the outstanding balance on the Line was $9.1 million as of December 31, 2006.

The outstanding balance on the AB Line bears interest monthly at an annual rate equal to prime rate or the overnight LIBOR plus 2.45%. Use of prime rate or the overnight LIBOR is at the discretion of the Company. The
borrowing rate on the AB Line was 7.76% at September 30, 2007, and was 7.7625% on the Line at December 31, 2006. The weighted average interest rate for the nine month periods ended September 30, 2007 and 2006 was 7.78% and 7.87%,
respectively. In addition, the unused AB Line capacity is subject to a commitment fee of 1/8%, payable monthly in arrears.

The Company
entered into a term loan with KeyBank, in the principal amount of $4.0 million, as evidenced by a promissory note dated September 28, 2006 (the Term Note), as amended and extended. The principal amount of the Term Note will bear
interest at an annual rate equal to the prime rate less 0.25%. The borrowing rate on the Term Note was 7.5% and 8.0% on September 30, 2007 and December 31, 2006, respectively. The Term Note is secured by substantially all of the assets of
the Company, as provided for in the Commercial Security Agreement entered into between the Company and KeyBank on September 29, 2006. The maturity date of the Term Note is November 15, 2007.

The average debt balance, including the AB Line, the Line, and the Term Note, for the nine month period ended September 30, 2007 and for twelve
month period ended December 31, 2006 was $11.9 million and $10.0 million, respectively.

On November 13, 2007, the Company
entered into an extension of the Term Note, which extended the maturity date to February 15, 2008, and established EBITDAR financial covenants for the monthly periods from October 2007 through December 2007. There were no additional changes to
the terms of the Term Note.

The Companys ability to meet the terms and covenants of the AB Line and Term Note will be dependent upon
the Companys future performance, which will be subject to general economic conditions and financial operations. There can be no assurance that the Companys future performance will not be affected negatively by changes in the above
factors to such a degree that it affects the Companys ability to meet the terms and covenants of the AB Line and Term Note.

Additional financing may be required to support the future growth plans of the Company. The future growth plans of the Company include an acquisition strategy that may include acquiring companies that are in a similar or complementary
business as 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 the shareholders. The issuance of these noted shares require the approval
of the Board of Directors. The Company is evaluating acquisition targets based on similar or complementary services as currently provided by the Company that will be accretive within one year thereafter. The 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.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no off-balance sheet arrangements with any obligation under a guarantee contract, or a retained or contingent interest in assets or
similar arrangement that serves as credit, liquidity or market risk support for such assets, or 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.

At any given point in time in the normal course of business, the Company has numerous outstanding purchase orders with
vendors to purchase inventory for use in the products that are sold to the Companys customers or are used in performing repair



17



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##### Table of Contents

services for the Companys customers. Such orders are not recorded as liabilities in the balance sheet 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.

RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standard Board
(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurement, (SFAS No. 157) which establishes a single authoritative definition of fair value, sets out a
framework for measuring fair value and requires additional disclosures about fair-value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.

In February 2007, the FASB issued SFAS No. 159 (SFAS No. 159), The Fair Value Option for Financial Assets and Financial
Liabilities, effective for the Company beginning on January 1, 2008. SFAS No. 159 provides entities with an option to report selected financial assets and liabilities at fair value, with the objective to reduce both the complexity in
accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The Company is currently assessing the impact of this guidance on its financial statements.

CRITICAL ACCOUNTING POLICIES

The preparation
of financial statements and related disclosures in conformity with generally accepted accounting principles in the United States requires management to make judgments, assumptions, and estimates that affect the amounts reported in the Financial
Statements and accompanying Notes. Note 2 to the Financial Statements contained in the Companys Annual Report on Form 10-K for the year ended December 31, 2006 and Note 2 to this Quarterly Report on Form 10-Q describe the significant
accounting policies and methods used in the preparation of the Financial Statements. Estimates are used for, but not limited to, the accounting for allowance for doubtful accounts, inventory reserves, taxes and lease termination costs. Actual
results could differ from these estimates.

The Company adopted FASB Interpretation No. 48 Accounting for Uncertainty in
Income Taxes, an interpretation of FASB Statement No. 109 Accounting for Income Taxes (FIN 48) effective January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in
financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The adoption of FIN 48 had no material
impact on the Companys financial position and did not result in unrecognized tax benefits being recorded. Accordingly, no corresponding interest and penalties have been accrued. The Company files income tax returns in the U.S. federal
jurisdiction and various states. There are currently no federal or state income tax examinations underway for these jurisdictions.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk.
|------- | -----------------------------------------------------------

The Company does not engage in commodity trading activities and does not enter into derivative financial instruments for speculative trading purposes. In the normal course of business, the Companys operations are exposed to interest
rate risk. The primary interest rate risk exposure relates to (i) the ability to refinance the line of credit and short-term note at market rates, and (ii) the impact of interest rate movements on the ability to meet interest expense
requirements and financial covenants under the Companys debt instruments.

As a borrower under the AB Line, effective August 13,
2007, and Term Note, the Company is exposed to changes in interest rates. The outstanding balance on the AB Line bears interest at an annual rate equal to prime rate or the overnight LIBOR plus 2.45%. The borrowing rate on the AB Line was 7.76% at
September 30, 2007. A 1% increase in the interest rate may cause an additional $0.1 million in annual expense on the total available AB Line of $11.0 million. The principal amount on the Term Note of $4.0 million bears interest at an annual
rate equal to the prime rate less 0.25%. A 1% increase in interest rate may cause less than $0.1 million in annual expense on the Term Note. The Company believes that the effect of changes in interest rates will not adversely affect the
Companys financial position, results of operations and cash flows.

Although the Company has transactions that were denominated in
currencies other than the United States dollar, the Companys market risk associated with foreign currency rates is not considered material.



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##### Table of Contents

|Item 4. | Controls and Procedures.
|------- | ------------------------

Based on the evaluation
of the Companys disclosure controls and procedures as of the end of the period covered by this quarterly report (the Evaluation Date), the Companys Chief Executive Officer and Chief Financial Officer as of the Evaluation
Date, have concluded that the Companys disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commissions rules and forms.

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

Part II OTHER INFORMATION



|Item 1A. | Risk Factors.
|-------- | -------------

Since December 31, 2006, there
have been no material changes to the significant risk factors and uncertainties known to the Company that, if they were to occur, could materially adversely affect the Companys business, financial condition, operating results, and cash flow.
For a discussion of the Companys risk factors, refer to Item 1A Risk Factors, contained in the Companys Annual Report on Form 10-K for the year ended December 31, 2006.



|Item 5. | Other Information.
|------- | ------------------

As discussed above in
Item 2, Managements Discussion and Analysis of Financial Condition and Results of Operations, on November 13, 2007, the Company entered into an Eighth Amendment to Loan Agreement (the Amendment) with
KeyBank. The Amendment extended the maturity date of the Companys Term Note to February 15, 2008 (previously such maturity date was November 15, 2007) and established EBITDAR financial covenants for the monthly
periods from October 2007 through December 2007.

The foregoing description of the Amendment does not purport to be complete and is
qualified in its entirety by reference to the Amendment, which is filed as Exhibit 10 and is incorporated herein by reference.



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##### Table of Contents

|Item 6. | Exhibits.
|------- | ---------

The following is a listing of Exhibits
either filed with this report or incorporated by reference:



|            |  |                                                                                                                                                                                  |  |                                                                                                             
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                                                           |  | If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC                 
|3(a)        |  | Amended and Restated Articles of Incorporation                                                                                                                                   |  | Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.
|            |  |                                                                                                                                                                                 
|3(b)        |  | Amendments to Amended and Restated Articles of Incorporation, adopted June 26, 2000                                                                                              |  | Form SB-2 filed with the Securities and Exchange Commission September 21, 2000.                             
|            |  |                                                                                                                                                                                 
|3(c)        |  | Amendment to the Companys Amended and Restated Articles of Incorporation adopted May 23, 2001                                                                                   |  | Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on August 13, 2001.       
|            |  |                                                                                                                                                                                 
|3(d)        |  | Amended and Restated Code of Regulations                                                                                                                                         |  | Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2006.                            
|            |  |                                                                                                                                                                                 
|4           |  | Instruments defining the rights of security holders, including indentures                                                                                                        |  | Form SB-2 filed with the Securities and Exchange Commission on September 21, 2000.                          
|            |  |                                                                                                                                                                                 
|10          |  | Eighth Amendment Agreement between Pinnacle Data Systems, Inc. and KeyBank National Association dated November 13, 2007.                                                         |  | Contained herein.                                                                                           
|            |  |                                                                                                                                                                                 
|31(a)       |  | Certification 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 September 30, 2007 |  | Contained herein.                                                                                           
|            |  |                                                                                                                                                                                 
|31(b)       |  | Certification 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 September 30, 2007 |  | Contained herein.                                                                                           
|            |  |                                                                                                                                                                                 
|32(a)       |  | Certification 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 September 30, 2007 |  | Contained herein.                                                                                           
|            |  |                                                                                                                                                                                 
|32(b)       |  | Certification 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 September 30, 2007 |  | Contained herein.                                                                                           



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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: November 14, 2007 |  | /s/ Michael R. Sayre                       
|                        |  | Michael R. Sayre, Chief Executive Officer  
|                        | 
|Date: November 14, 2007 |  | /s/ George A. Troutman                     
|                        |  | George A. Troutman, Chief Financial Officer



21