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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-QSB



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



For the quarterly period ended June 26, 2004



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



For the transition period from  to



Commission file number: 1-16103



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PINNACLE DATA SYSTEMS, INC.

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



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|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|Ohio                                                           |  | 31-1263732                       
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification No.)



6600 Port Road,
Groveport, Ohio 43125

(Address of principal executive offices)



(614) 748-1150

(Issuers Telephone Number)



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Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 ̈



APPLICABLE ONLY TO CORPORATE ISSUERS



State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date 5,586,806
common shares, without par value, as of August 10, 2004.



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



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PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



BALANCE SHEETS



|                                                                                      |  |               |            |                  |   |          
|------------------------------------------------------------------------------------- |  | ------------- | ---------- | ---------------- | - | ---------
|                                                                                      |  | June 26, 2004 |            | December 31,2003
|                                                                                      |  | (Unaudited)   |            |                 
|ASSETS                                                                                |  |               |            |                  |   |          
|                                                                                      |  |              
|CURRENT ASSETS                                                                        |  |               |            |                  |   |          
|Cash                                                                                  |  | $             | 62,685     |                  | $ | 48,345   
|Accounts receivable, net of allowance for doubtful accounts of $20,000                |  |               | 5,905,791  |                  |   | 5,126,632
|Inventory                                                                             |  |               | 3,758,747  |                  |   | 2,023,434
|Other prepaid expenses                                                                |  |               | 77,785     |                  |   | 197,270  
|Deferred income taxes                                                                 |  |               | 428,000    |                  |   | 428,000  
|                                                                                      |  |               |            |                  |   |          
|                                                                                      |  |               | 10,233,008 |                  |   | 7,823,681
|                                                                                      |  |               |            |                  |   |          
|PROPERTY AND EQUIPMENT                                                                |  |               |            |                  |   |          
|Leasehold improvements                                                                |  |               | 241,933    |                  |   | 226,693  
|Furniture and fixtures                                                                |  |               | 350,141    |                  |   | 331,991  
|Computer equipment and related software                                               |  |               | 2,351,662  |                  |   | 2,264,719
|Shop equipment                                                                        |  |               | 498,008    |                  |   | 494,857  
|                                                                                      |  |               |            |                  |   |          
|                                                                                      |  |               | 3,441,744  |                  |   | 3,318,260
|Less accumulated depreciation and amortization                                        |  |               | 2,513,849  |                  |   | 2,232,379
|                                                                                      |  |               |            |                  |   |          
|                                                                                      |  |               | 927,895    |                  |   | 1,085,881
|                                                                                      |  |               |            |                  |   |          
|OTHER ASSETS                                                                          |  |               |            |                  |   |          
|Deposits                                                                              |  |               | 20,385     |                  |   | 20,385   
|License agreement, less accumulated amortization of $39,628 and $32,595, respectively |  |               | 2,572      |                  |   | 9,606    
|                                                                                      |  |               |            |                  |   |          
|                                                                                      |  |               | 22,957     |                  |   | 29,991   
|                                                                                      |  |               |            |                  |   |          
|                                                                                      |  | $             | 11,183,860 |                  | $ | 8,939,553
|                                                                                      |  |               |            |                  |   |          



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



2



---

PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



BALANCE SHEETS



|                                                                                                                              |  |               |            |                  |   |          
|----------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | ---------------- | - | ---------
|                                                                                                                              |  | June 26, 2004 |            | December 31,2003
|                                                                                                                              |  | (Unaudited)   |            |                 
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                          |  |               |            |                  |   |          
|                                                                                                                              |  |              
|CURRENT LIABILITIES                                                                                                           |  |               |            |                  |   |          
|Line of credit and short term note                                                                                            |  | $             | 2,938,634  |                  | $ | 2,486,566
|Accounts payable                                                                                                              |  |               | 2,255,484  |                  |   | 1,902,047
|Accrued expenses:                                                                                                             |  |               |            |                  |   |          
|Wages, payroll taxes and benefits                                                                                             |  |               | 737,049    |                  |   | 351,778  
|Income taxes                                                                                                                  |  |               | 55,802     |                  |   | 7,379    
|Other                                                                                                                         |  |               | 168,387    |                  |   | 100,953  
|Unearned revenue                                                                                                              |  |               | 15,657     |                  |   |         
|                                                                                                                              |  |               |            |                  |   |          
|                                                                                                                              |  |               | 6,171,013  |                  |   | 4,848,723
|                                                                                                                              |  |               |            |                  |   |          
|LONG-TERM LIABILITIES                                                                                                         |  |               |            |                  |   |          
|Deferred income taxes                                                                                                         |  |               | 55,000     |                  |   | 55,000   
|                                                                                                                              |  |               |            |                  |   |          
|                                                                                                                              |  |               | 55,000     |                  |   | 55,000   
|                                                                                                                              |  |               |            |                  |   |          
|                                                                                                                              |  |               | 6,226,013  |                  |   | 4,903,723
|                                                                                                                              |  |               |            |                  |   |          
|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; 5,586,806 and 5,539,796 shares issued and outstanding, respectively |  |               | 2,234,419  |                  |   | 2,172,281
|Additional paid-in capital                                                                                                    |  |               | 502,095    |                  |   | 502,095  
|Retained earnings                                                                                                             |  |               | 2,221,333  |                  |   | 1,361,454
|                                                                                                                              |  |               |            |                  |   |          
|                                                                                                                              |  |               | 4,957,847  |                  |   | 4,035,830
|                                                                                                                              |  |               |            |                  |   |          
|                                                                                                                              |  | $             | 11,183,860 |                  | $ | 8,939,553
|                                                                                                                              |  |               |            |                  |   |          



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



3



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PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



STATEMENTS OF INCOME



|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|--------------------------------- |  | --------------------- | ---------- | -------------------------- | - | ------------- |  | ------------ | ---------- |  | - | ---------
|                                  |  | For the Quarter Ended |            | For the Two Quarters Ended
|                                  |  | June 26, 2004         |            | June 28,2003               |   | June 26, 2004 |  | June 28,2003
|                                  |  | (unaudited)           |            | (unaudited)               
|SALES                             |  |                       |            |                            |   |               |  |              |            |  |   |          
|Product sales                     |  | $                     | 9,774,835  |                            | $ | 3,463,543     |  | $            | 15,204,297 |  | $ | 5,666,419
|Service sales                     |  |                       | 1,504,759  |                            |   | 2,307,789     |  |              | 3,122,969  |  |   | 4,264,070
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|                                  |  |                       | 11,279,594 |                            |   | 5,771,332     |  |              | 18,327,266 |  |   | 9,930,489
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|COST OF SALES                     |  |                       |            |                            |   |               |  |              |            |  |   |          
|Product sales                     |  |                       | 7,648,924  |                            |   | 2,643,902     |  |              | 11,495,666 |  |   | 4,403,591
|Service sales                     |  |                       | 954,935    |                            |   | 1,522,174     |  |              | 1,878,777  |  |   | 2,681,723
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|                                  |  |                       | 8,603,859  |                            |   | 4,166,076     |  |              | 13,374,443 |  |   | 7,085,314
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|GROSS PROFIT                      |  |                       | 2,675,735  |                            |   | 1,605,256     |  |              | 4,952,823  |  |   | 2,845,175
|                                  |  |                       |            |                           
|OPERATING EXPENSES                |  |                       | 1,798,808  |                            |   | 1,288,704     |  |              | 3,440,290  |  |   | 2,383,119
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|INCOME FROM OPERATIONS            |  |                       | 876,927    |                            |   | 316,552       |  |              | 1,512,533  |  |   | 462,056  
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|OTHER EXPENSE                     |  |                       |            |                            |   |               |  |              |            |  |   |          
|Interest expense                  |  |                       | 32,512     |                            |   | 22,468        |  |              | 54,654     |  |   | 44,869   
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|INCOME BEFORE INCOME TAXES        |  |                       | 844,415    |                            |   | 294,084       |  |              | 1,457,879  |  |   | 417,187  
|                                  |  |                       |            |                           
|INCOME TAX EXPENSE                |  |                       | 347,000    |                            |   | 115,000       |  |              | 598,000    |  |   | 163,000  
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|NET INCOME                        |  | $                     | 497,415    |                            | $ | 179,084       |  | $            | 859,879    |  | $ | 254,187  
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|BASIC EARNINGS PER COMMON SHARE   |  | $                     | 0.09       |                            | $ | 0.03          |  | $            | 0.16       |  | $ | 0.05     
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          
|DILUTED EARNINGS PER COMMON SHARE |  | $                     | 0.08       |                            | $ | 0.03          |  | $            | 0.14       |  | $ | 0.04     
|                                  |  |                       |            |                            |   |               |  |              |            |  |   |          



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



4



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PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



STATEMENTS OF CASH FLOWS



Two Quarters Ended June 26, 2004 and June 28, 2003



|                                                                                  |  |             |            |   |             |   |            |  
|--------------------------------------------------------------------------------- |  | ----------- | ---------- | - | ----------- | - | ---------- | -
|                                                                                  |  | 2004        |            |   | 2003        |  
|                                                                                  |  | (Unaudited) |            |   | (Unaudited) |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                              |  |             |            |   |             |   |            |  
|Net income                                                                        |  | $           | 859,879    |   |             | $ | 254,187    |  
|                                                                                  |  |             |            |   |             |   |            |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |             |            |   |             |   |            |  
|Depreciation and amortization                                                     |  |             | 289,982    |   |             |   | 279,538    |  
|Inventory reserves                                                                |  |             | 119,070    |   |             |   | 145,798    |  
|Loss on disposal of equipment                                                     |  |             | (87        | ) |             |   | 1,289      |  
|(Increase)/decrease in assets:                                                    |  |             |            |   |             |   |            |  
|Accounts receivable                                                               |  |             | (779,159   | ) |             |   | (1,404,971 | )
|Inventory                                                                         |  |             | (1,897,676 | ) |             |   | 70,546     |  
|Prepaid expenses and other assets                                                 |  |             | 119,485    |   |             |   | 116,916    |  
|Increase/(decrease) in liabilities:                                               |  |             |            |   |             |   |            |  
|Accounts payable                                                                  |  |             | 353,437    |   |             |   | 722,425    |  
|Accrued expenses and taxes                                                        |  |             | 501,128    |   |             |   | 51,547     |  
|Unearned revenues                                                                 |  |             | 15,657     |   |             |   | 27,700     |  
|                                                                                  |  |             |            |   |             |   |            |  
|Total adjustments                                                                 |  |             | (1,278,163 | ) |             |   | 10,788     |  
|                                                                                  |  |             |            |   |             |   |            |  
|Net cash provided by/(used in) operating activities                               |  |             | (418,284   | ) |             |   | 264,975    |  
|                                                                                  |  |             |            |   |             |   |            |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                              |  |             |            |   |             |   |            |  
|Purchases of property and equipment                                               |  |             | (81,747    | ) |             |   | (48,921    | )
|Proceeds from sale of property and equipment                                      |  |             | 165        |   |             |   |           |  
|                                                                                  |  |             |            |   |             |   |            |  
|Net cash used in investing activities                                             |  |             | (81,582    | ) |             |   | (48,921    | )
|                                                                                  |  |             |            |   |             |   |            |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                              |  |             |            |   |             |   |            |  
|Net change in line of credit                                                      |  |             | 452,068    |   |             |   | (136,601   | )
|Principal payments on long-term debt                                              |  |             |           |   |             |   | (33,333    | )
|Principal payments on capital lease obligation                                    |  |             |           |   |             |   | (12,415    | )
|Proceeds from stock options exercised                                             |  |             | 62,138     |   |             |   |           |  
|Other proceeds from shareholders                                                  |  |             |           |   |             |   | 589        |  
|                                                                                  |  |             |            |   |             |   |            |  
|Net cash provided by/(used in) financing activities                               |  |             | 514,206    |   |             |   | (181,760   | )
|                                                                                  |  |             |            |   |             |   |            |  



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



5



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PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



STATEMENTS OF CASH FLOWS (CONTINUED)



Two Quarters Ended June 26, 2004 and June 28, 2003



|                                                 |  |      |         |      |   |        
|------------------------------------------------ |  | ---- | ------- | ---- | - | -------
|                                                 |  | 2004 |         | 2003
|INCREASE IN CASH                                 |  |      | 14,340  |      |   | 34,294 
|                                                 |  |     
|CASH - Beginning of period                       |  |      | 48,345  |      |   | 35,705 
|                                                 |  |      |         |      |   |        
|                                                 |  |     
|CASH - End of period                             |  | $    | 62,685  |      | $ | 69,999 
|                                                 |  |      |         |      |   |        
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION |  |      |         |      |   |        
|Interest paid                                    |  | $    | 53,278  |      | $ | 44,479 
|                                                 |  |      |         |      |   |        
|Income taxes paid, net of refunds                |  | $    | 549,577 |      | $ | 131,500
|                                                 |  |      |         |      |   |        



|                                                                                 
|---------------------------------------------------------------------------------
|SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING TRANSACTIONS          
|                                                                                 
|During 2004, the company capitalized $43,293 of inventory as computer equipment. 
|                                                                                 
|During 2003, the company capitalized $136,719 of inventory as computer equipment.



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



6



---

PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



NOTES TO FINANCIAL STATEMENTS



(UNAUDITED)



|Note 1. | Organization
|------- | ------------



Nature of Business - Pinnacle Data Systems, Inc. (dba PDSi) (the Company) provides technical services, encompassing the development and production of
computer systems and components, and the testing and repair of computer systems, components and peripherals, to Original Equipment Manufacturers (OEMs) in, among others, the aerospace computer, computer peripheral, data storage, digital-imaging,
medical diagnostic, process-control, and telecommunications equipment industries. PDSi offers a full range of services to increase product speed to market and engineered product life, and to provide service and support to units in the field through
comprehensive product lifecycle management programs encompassing depot repair, advanced exchange, contact center support and end-of-life control.



|Note 2. | Summary of Significant Accounting Policies
|------- | ------------------------------------------



The Company divides its fiscal calendar into 4 periods or quarters. It is intended that each quarter consist of thirteen weeks. The first
quarter of each year begins on January 1 and the fourth quarter ends on December 31. Depending on what day of the week January 1 falls, the first quarter may contain a few days less than thirteen full weeks and the fourth quarter may contain a few
days more than thirteen full weeks. The second quarter of 2004 ended on June 26 and contained 91 days. The second quarter of 2003 ended on June 28 and also contained 91 days. The first two quarters of 2004 contained 178 days and the first two
quarters of 2003 contained 179 days.



The balance sheet as of
June 26, 2004, and the statements of income and cash flows for the two quarters ended June 26, 2004 and June 28, 2003 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, statements of income and changes in cash flows for all periods presented have
been made.



Certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed and omitted. These condensed financial statements should be read in conjunction with
the financial statements and notes thereto included in the Companys December 31, 2003 annual report on Form 10-KSB. The results of operations for the period ended June 26, 2004 are not necessarily indicative of the results for the full year.



7



---

PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



NOTES TO FINANCIAL STATEMENTS



(UNAUDITED)



|Note 2. | Summary of Significant Accounting Policies (continued)
|------- | ------------------------------------------------------



SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in some circumstances), many of which were previously classified as equity. SFAS No. 150 is effective for interim periods beginning after June 15, 2003. In its October 2003
meeting, the FASB decided to defer the effective date of certain provisions of SFAS No. 150. Management does not expect the adoption of this accounting pronouncement to have a material impact on the Companys consolidated financial statements.



In December 2003, the FASB issued FIN 46 (Revised),
Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 requires a variable interest entity to be consolidated by a company, if
that company is subject to a majority of the risk of loss from the variable interest entitys activities or entitled to receive a majority of the entitys residual returns or both. FIN 46 also requires disclosures about variable interest
entities that a company is not required to consolidate but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply in the first fiscal year or interim period ending after December 15, 2004. The adoption of FIN
46 is not expected to have a material impact on the Companys consolidated financial statements.



|Note 3. | Line of Credit
|------- | --------------



On May 7, 2004, the Company entered into an additional 120-day $2,000,000 term loan agreement with its bank. The intent and effect of the loan was to
temporarily increase the limit of the line of credit from $5,000,000 to $7,000,000. The $2,000,000 of proceeds from the term loan were applied to the outstanding line of credit balance, reducing its balance by $2,000,000. The incremental $2,000,000
loan has the same interest rate as the line of credit. For the duration of the term loan, the collateralization and covenants of the two loans are combined as if they are one loan facility. Consequently, the combined outstanding balance of the two
loan facilities is presented as one amount on the Companys balance sheet. The $2,500,000 inventory collateral sub-limit of the line of credit was increased to $3,500,000 for the duration of the term loan.



8



---

PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



NOTES TO FINANCIAL STATEMENTS



(UNAUDITED)



|Note 4 | Stock Options
|------ | -------------



During the two quarters ended June 26, 2004, the Companys stock option activities and weighted average exercise prices were as follows:



Shares


ExercisePriceOutstanding, December 31, 2003

1,460,500


$
1.91Granted

25,000



1.90Exercised

(51,000
)


1.57Forfeited

(60,050
)


2.07Outstanding, June 26, 2004

1,374,450


$
1.91




The Company
accounts for employee and director stock options using the intrinsic value method. Under this method, no compensation expense was recorded for the first two quarters of 2004 because all stock options were granted at an exercise price equal to or
greater than the fair market value of the Companys stock on the date of the grant. If compensation expense for the Companys stock option grants had been determined based on their estimated fair value at the grant dates, the
Companys net income and earnings per share for the two quarters ending June 26, 2004 and June 28, 2003 would have been as follows:



Second Quarter


Two Quarters2004


2003


2004


2003Net income, as reported

$
497,415


$
179,084


$
859,879


$
254,187Deduct: total stock-based compensation expense determined under the fair value method for all awards, net of related tax
benefits


(68,754
)


(23,632
)


(137,507
)


(52,853
)Net income, pro forma


428,661



155,452



722,372



201,334Earnings per common share, basic:As reported

$
0.09


$
0.03


$
0.16


$
0.05Pro forma

$
0.08


$
0.03


$
0.13


$
0.04Earnings per common share, diluted:As reported

$
0.08


$
0.03


$
0.14


$
0.04Pro forma

$
0.07


$
0.03


$
0.12


$
0.04




9



---

PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



NOTES TO FINANCIAL STATEMENTS



(UNAUDITED)



|Note 4 | Stock Options (continued)
|------ | -------------------------



The fair value of options granted was estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted average
assumptions for the two quarters ended June 26, 2004:



|                                        |  |       |  
|--------------------------------------- |  | ----- | -
|Risk-free interest rate                 |  | 4.41  | %
|Dividend yield                          |  | 0     | %
|Volatility factor                       |  | 84.05 | %
|Weighted average expected life in years |  | 9.0   |  



|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.



|Note 6. | Profit Sharing and 401(k) Savings Plan
|------- | --------------------------------------



The Company maintains a qualified cash or deferred compensation plan under section 401(k) of the Internal Revenue Code. The plan covers all employees age
21 or over with three months of service. Under the plan, employees may elect to defer a portion of their salary, subject to Internal Revenue Code limits.



The Company, at its discretion, may match up to 100% of employee contributions up to 6% of wages deferred with an annual maximum contribution of $4,500
per employee. The Company elected to make a 15% match of employee contributions in the first two quarters of 2004 in the amount of approximately $19,500. The Company elected not to make matching contributions for the first two quarters of 2003.



10



---

PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



NOTES TO FINANCIAL STATEMENTS



(UNAUDITED)



|Note 7. | Earnings Per Common and Common Equivalent Share
|------- | -----------------------------------------------



Earnings per common and common equivalent share were computed by dividing net earnings by the weighted average number of shares of common stock
outstanding during the quarter.



For the quarter ended 6/26/2004

For the two quarters ended 6/26/2004Income(Numerator)

Shares(Denominator)

Per-ShareAmount

Income(Numerator)

Shares(Denominator)

Per-ShareAmountBasic EPSIncome available to common shareholders

$
497,415

5,553,813

$
0.09

$
859,879

5,547,181

$
0.16Effect of Dilutive SecuritiesOptions




637,411







547,183Diluted EPSIncome available to common stockholders and assumed conversions

$
497,415

6,191,224

$
0.08

$
859,879

6,094,364

$
0.14For the quarter ended 6/28/2003

For the two quarters ended 6/28/2003Income(Numerator)

Shares(Denominator)

Per-ShareAmount

Income(Numerator)

Shares(Denominator)

Per-ShareAmountBasic EPSIncome available to common shareholders

$
179,084

5,518,870

$
0.03

$
254,187

5,518,870

$
0.05Effect of Dilutive SecuritiesOptions




157,908







190,846Diluted EPSIncome available to common stockholders and assumed conversions

$
179,084

5,676,778

$
0.03

$
254,187

5,709,716

$
0.04




11



---

PINNACLE DATA SYSTEMS, INC.



(DBA PDSi)



NOTES TO FINANCIAL STATEMENTS



(UNAUDITED)



|Note 8. | Operating Segments
|------- | ------------------



The Other column listed below reflects items that are not allocated to segments. These items primarily represent assets and expenses for
various administrative functions within the Company.



Two Quarters Ended June 26, 2004Product Sales

Service Sales

Other


TotalSales

$
15,204,297

$
3,122,969

$



$
18,327,266Gross profit


3,708,631


1,244,192






4,952,823Income from operations


2,016,341


668,549


(1,172,357
)


1,512,533Depreciation and amortization


142,727


60,639


86,616



289,982Interest expense








54,654



54,654Total assets


8,540,631


701,298


1,941,931



11,183,860Capital expenditures


76,462


39,294


9,284



125,040Two Quarters Ended June 28, 2003Product Sales

Service Sales

Other


TotalSales

$
5,666,419

$
4,264,070

$



$
9,930,489Gross profit


1,262,828


1,582,347






2,845,175Income from operations


503,910


857,051


(898,905
)


462,056Depreciation and amortization


119,143


61,167


99,228



279,538Interest expense








44,869



44,869Total assets


3,351,423


3,046,467


1,564,416



7,962,306Capital expenditures


170,226


10,522


4,892



185,640




12



---

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



The following discussion should be read in conjunction with the Financial Statements and
Notes contained herein. This quarterly report, including the following sections, contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, including, but not limited to, statements regarding expected increases in sales of products and services, continued profitability, additional growth, increased Company visibility and lower overall product gross profit margins in 2004 and
statements regarding earnings, sales and inventory levels in the second half of 2004. The words believe, expect, anticipate, estimate, project, and similar expressions identify
forward-looking statements that speak only as of the date thereof. The Company undertakes no obligations to publicly update or revise such statements.



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 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, 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 adverse changes in customer order patterns, including any decline or change in product orders from large customers like the six customers that make up approximately 79% of our revenue during
the first two quarters of 2004, increased competition, and other risks described in this quarterly report and from time to time in the Companys periodic reports and filings with the Securities and Exchange Commission.



The following discussions and analyses are for the quarter ended June 26, 2004 compared to
the quarter ended June 28, 2003.



OVERVIEW



Pinnacle Data Systems, Inc. (PDSi or the Company) provides technical
services, encompassing the development and production of computer systems and components, and the testing and repair of computer systems, components and peripherals, to Original Equipment Manufacturers (OEMs) in, among others, the aerospace
computer, computer peripheral, data storage, digital-imaging, medical diagnostic, process-control, and telecommunications equipment industries. PDSi offers a full range of services to increase product speed to market and engineered product life, and
to provide service and support to units in the field through comprehensive product lifecycle management programs encompassing depot repair, advanced exchange, contact center support and end-of-life control. Our business model is a foundation of
electronics repair and logistics programs (Services) that provide resources for the development and sale of high-potential PDSi-engineered and manufactured hardware solutions for specific customers and niche-industry applications
(Products).



13



---

We entered 2004 with:



| |  | more large customers actively ordering products than at any other time in our history,
| | - | --------------------------------------------------------------------------------------



| |  | more direct referrals from Fortune Global 500 stalwarts in the computer industry than at any time in our history,
| | - | -----------------------------------------------------------------------------------------------------------------



| |  | more in-house experience selling and closing business through these kinds of partnerships, and
| | - | ----------------------------------------------------------------------------------------------



| |  | more award-winning technical capabilities than at any time in our history.
| | - | --------------------------------------------------------------------------



For the full year of 2004, we expect increased sales and continued profitability to result from our rather modest, but very effective, spending in marketing and sales of
the past few years. To fuel additional growth in 2004 and beyond, our 2004 plans include increasing our visibility in the marketplace by increasing the size of our marketing and sales team and making investments in our delivery infrastructure as
required. Our past efforts have only begun to tap into the large markets for our services and products.



Our marketing and sales efforts will continue to be on original equipment manufacturers (OEMs) in the aerospace, computer, computer peripheral, data storage, medical diagnostic, commercial imaging, process control and
telecommunications equipment industries-all very large markets that showed definite signs of recovery entering 2004.



SALES



Sales for the second quarter and the first two quarters of 2004 and 2003 were as follows:



|              |  |                |        |      |              |          |  |     |      |  |      |        |          |   |       |  |     |  
|------------- |  | -------------- | ------ | ---- | ------------ | -------- |  | --- | ---- |  | ---- | ------ | -------- | - | ----- |  | --- | -
|              |  | Second Quarter |        |      | Two Quarters |         
|($ thousands) |  | 2004           |        | 2003 |              | % Change |  |     | 2004 |  | 2003 |        | % Change |  
|Total company |  | $              | 11,280 |      | $            | 5,771    |  | 95  | %    |  | $    | 18,327 |          | $ | 9,930 |  | 85  | %
|Product       |  |                | 9,775  |      |              | 3,463    |  | 182 | %    |  |      | 15,204 |          |   | 5,666 |  | 168 | %
|Service       |  |                | 1,505  |      |              | 2,308    |  | -35 | %    |  |      | 3,123  |          |   | 4,264 |  | -27 | %



Product sales in the first two
quarters of 2004 were significantly impacted by the two largest orders in the companys history, a $3 million order for controller boards for medical diagnostic equipment announced in November of 2003 followed by a $4 million telecommunications
equipment order announced in April of 2004. About 25% of the $3 million order shipped in the fourth quarter of 2003 and both orders were completed in the first half of 2004. Without those two orders, total sales for the year to date would have been
20% greater than the same period of 2003.We expect product sales in the second half of 2004 to exceed the second half of 2003, but absent additional orders of the magnitude of the two aforementioned orders, to be lower than the first
half of 2004. Most of our customers continue to place orders or forecast requirements for only about three months at any given time, which continues to make it difficult to forecast product sales beyond one or two quarters.



Service sales in the first two quarters of 2004 declined 27% from the comparable period of
2003, when the overlapping of significant in-coming and out-going Hewlett-Packard Company repair programs were producing quarterly record service sales. However, in the second quarter of 2004, we won some significant new service opportunities that
we expect to result in higher service sales in the second half of 2004 than in the comparable period of 2003.



14



---

For the first two quarters of 2004, we had four customers that generated revenues of approximately $4,499,000,
$3,222,000, $2,002,000, and $1,969,000 or 25%, 18%, 11%, and 11% respectively, of total revenue. In the statements of income, approximately $11,532,000 of the revenues from these customers is included in product sales and $160,000 is included in
service sales. In addition, these customers represented 45%, 3%, 15%, and 17%, respectively, of accounts receivable at June 26, 2004.



GROSS PROFIT



Gross profit for the second quarter and the first two quarters of 2004 and 2003 was as follows:



|              |  |                |       |      |              |          |  |     |      |  |      |       |          |   |       |  |     |  
|------------- |  | -------------- | ----- | ---- | ------------ | -------- |  | --- | ---- |  | ---- | ----- | -------- | - | ----- |  | --- | -
|              |  | Second Quarter |       |      | Two Quarters |         
|($ thousands) |  | 2004           |       | 2003 |              | % Change |  |     | 2004 |  | 2003 |       | % Change |  
|Total company |  | $              | 2,676 |      | $            | 1,605    |  | 67  | %    |  | $    | 4,953 |          | $ | 2,845 |  | 74  | %
|Product       |  |                | 2,126 |      |              | 819      |  | 160 | %    |  |      | 3,709 |          |   | 1,263 |  | 194 | %
|Service       |  |                | 550   |      |              | 786      |  | -30 | %    |  |      | 1,244 |          |   | 1,582 |  | -21 | %



The gross profit margin percentages
for 2004 and 2003 were as follows:



|              |  |                |   |  |              |   |  |      |   |  |      |  
|------------- |  | -------------- | - |  | ------------ | - |  | ---- | - |  | ---- | -
|              |  | Second Quarter |   |  | Two Quarters |  
|              |  | 2004           |   |  | 2003         |   |  | 2004 |   |  | 2003 |  
|Total company |  | 24             | % |  | 28           | % |  | 27   | % |  | 29   | %
|Product       |  | 22             | % |  | 24           | % |  | 24   | % |  | 22   | %
|Service       |  | 37             | % |  | 34           | % |  | 40   | % |  | 37   | %



Gross profit margin percentages on
most product sales in the first half of 2004 were comparable to those in the first half of 2003. Many of the newer product programs may have lower margins than the older programs. Consequently, overall product gross profit margins may be somewhat
lower in the near term.



The improvement in the service sales gross profit
margin for the first half of 2004 reflects the fact that, while the overlapping of repair programs in the first half of 2003 resulted in higher sales volume, the beginning and ending of those programs resulted in incremental costs that reduced
margin percentages.



15



---

OPERATING EXPENSES AND INTEREST EXPENSES



Operating expenses, including selling, general and administrative (SG&A), research and development (R&D), and interest expenses for
the second quarter and the first two quarters of 2004 and 2003 were as follows:



|                   |  |                |       |      |              |          |  |    |      |  |      |       |          |   |       |  |    |  
|------------------ |  | -------------- | ----- | ---- | ------------ | -------- |  | -- | ---- |  | ---- | ----- | -------- | - | ----- |  | -- | -
|                   |  | Second Quarter |       |      | Two Quarters |         
|($ thousands)      |  | 2004           |       | 2003 |              | % Change |  |    | 2004 |  | 2003 |       | % Change |  
|Operating expenses |  | $              | 1,799 |      | $            | 1,289    |  | 40 | %    |  | $    | 3,440 |          | $ | 2,383 |  | 44 | %
|Interest expense   |  |                | 33    |      |              | 22       |  | 50 | %    |  |      | 55    |          |   | 45    |  | 22 | %
|                   |  |                |       |      |              |          |  |    |      |  |      |       |          |   |       |  |    |  
|Total expense      |  |                | 1,832 |      |              | 1,311    |  | 40 | %    |  |      | 3,495 |          |   | 2,428 |  | 44 | %
|                   |  |                |       |      |              |          |  |    |      |  |      |       |          |   |       |  |    |  



For the first half of 2004, operating
expenses, including selling, general and administrative (SG&A) expenses, increased due to costs directly tied to our increasing sales and profitability and our investment in the companys growth. In the first half of 2004, operating
expenses were 19% of sales generated compared to 24% in the first half of 2003. We expect to continue increasing our marketing and selling expenses in the near future in order to increase market share and achieve our long-term growth goals



INCOME TAXES AND NET INCOME



Income taxes for the interim periods were computed using the effective tax rate estimated to
be applicable for the full fiscal year, which is subject to ongoing review and evaluation by management. The effective tax rate for the first quarter of 2004 was 41%, compared to 39% in 2003.



Income before taxes, income taxes and net income for the second quarter and the first two
quarters of 2004 and 2003 were as follows:



|                    |  |                |     |      |              |          |  |     |      |  |      |       |          |   |     |  |     |  
|------------------- |  | -------------- | --- | ---- | ------------ | -------- |  | --- | ---- |  | ---- | ----- | -------- | - | --- |  | --- | -
|                    |  | Second Quarter |     |      | Two Quarters |         
|($ thousands)       |  | 2004           |     | 2003 |              | % Change |  |     | 2004 |  | 2003 |       | % Change |  
|Income before taxes |  | $              | 844 |      | $            | 294      |  | 187 | %    |  | $    | 1,458 |          | $ | 417 |  | 250 | %
|Income taxes        |  |                | 347 |      |              | 115      |  | 202 | %    |  |      | 598   |          |   | 163 |  | 267 | %
|                    |  |                |     |      |              |          |  |     |      |  |      |       |          |   |     |  |     |  
|Net income          |  |                | 497 |      |              | 179      |  | 178 | %    |  |      | 860   |          |   | 254 |  | 239 | %
|                    |  |                |     |      |              |          |  |     |      |  |      |       |          |   |     |  |     |  



Earnings per share for the second
quarter and the first two quarters of 2004 and 2003 were as follows:



|                                               |  |                |           |              |   |           |  |      |           |  |   |          
|---------------------------------------------- |  | -------------- | --------- | ------------ | - | --------- |  | ---- | --------- |  | - | ---------
|                                               |  | Second Quarter |           | Two Quarters
|                                               |  | 2004           |           | 2003         |   | 2004      |  | 2003
|Basic EPS                                      |  | $              | 0.09      |              | $ | 0.03      |  | $    | 0.16      |  | $ | 0.05     
|Fully diluted EPS                              |  | $              | 0.08      |              | $ | 0.03      |  | $    | 0.14      |  | $ | 0.04     
|                                               |  |                |           |             
|Weighted average number of shares outstanding: |  |                |           |              |   |           |  |      |           |  |   |          
|Basic                                          |  |                | 5,553,813 |              |   | 5,518,870 |  |      | 5,547,181 |  |   | 5,518,870
|Fully diluted                                  |  |                | 6,191,224 |              |   | 5,676,778 |  |      | 6,094,364 |  |   | 5,709,716



The improvement to date to net income
in 2004 resulted directly from increases in product sales and greater leverage on operating expenses. However, given our customers ordering patterns and our increasing investment in sales, marketing and infrastructure to fuel and support



16



---

continuing growth, we expect earnings in the second half of 2004 to be about the same as the second half of 2003, but
could be lower with the added expenses. Quarterly sales and earnings could vary either up or down from comparable prior year quarterly results.



LIQUIDITY AND CAPITAL RESOURCES



A summary of changes in current assets for the first two quarters is as follows:



|                     |  |         |        |          |   |          |  |     |  
|-------------------- |  | ------- | ------ | -------- | - | -------- |  | --- | -
|($ thousands)        |  | 6/26/04 |        | 12/31/03 |   | % Change | 
|Accounts receivable  |  | $       | 5,906  |          | $ | 5,127    |  | 15  | %
|Inventory            |  |         | 3,759  |          |   | 2,023    |  | 86  | %
|Other current assets |  |         | 568    |          |   | 674      |  | -16 | %
|                     |  |         |        |          |   |          |  |     |  
|Total                |  | $       | 10,233 |          | $ | 7,824    |  | 31  | %
|                     |  |         |        |          |   |          |  |     |  



A summary of changes in current
liabilities for the first two quarters is as follows:



|                          |  |         |       |          |   |          |  |     |  
|------------------------- |  | ------- | ----- | -------- | - | -------- |  | --- | -
|($ thousands)             |  | 6/26/04 |       | 12/31/03 |   | % Change | 
|Line of credit            |  | $       | 2,939 |          | $ | 2,487    |  | 18  | %
|Accounts payable          |  |         | 2,255 |          |   | 1,902    |  | 19  | %
|Other current liabilities |  |         | 977   |          |   | 460      |  | 112 | %
|                          |  |         |       |          |   |          |  |     |  
|Total                     |  | $       | 6,171 |          | $ | 4,849    |  | 27  | %
|                          |  |         |       |          |   |          |  |     |  



During the first two quarters of 2004,
$418,000 of cash was used by operating activities. Net income before depreciation, and inventory reserve increases was $1,269,000. Additional cash was also used by an increase in accounts receivable of $779,000 and an increase in inventory of $1.9
million. Additional cash was generated by a decrease in prepaid expenses and other current assets of $119,000 and increases in accounts payable of $353,000, and other current liabilities of $517,000. The increase in accounts receivable reflects the
higher revenue level of the second quarter of 2004 compared to the fourth quarter of 2003. The increased inventory total reflects the higher number of ongoing customer programs at June 26, 2004 compared to December 31, 2003. In contrast to the two
large orders shipped in the first half, the new product and service programs require relatively more inventory to support those programs or an ongoing basis. We expect inventory levels in the second half of 2004 to be generally higher than in the
first half of 2004.



For the first two quarters of 2004, we used $82,000 of
cash generated by operating activities to purchase equipment, including computers and software. We also transferred $43,000 of equipment to fixed assets from inventory.



We drew a net additional $452,000 on our line of credit to provide the cash used by operations and fixed asset purchases.



The line of credit, which is our primary source of operational and non-operational funding,
is maintained with KeyBank National Association (KeyBank) and is payable on demand and collateralized by substantially all of our assets. The amount available under the line of credit is subject to borrowing base restrictions and other financial
covenants as outlined in the agreement. In addition, the agreement restricts the payment of cash dividends.



17



---

The aforementioned borrowing base on the line of credit is calculated as 85% of eligible accounts receivable and 50% of
inventory value, net of reserves. The line has an overall limit of $5,000,000 as well as a sub-limit of $2,500,000 that can be collateralized by inventory. That calculation represents the maximum amount that can be drawn on the line of credit.



In order to fund working capital to fulfill the second quarter customer
product orders referenced above, on May 7, 2004, we entered into an additional 120-day $2,000,000 term loan agreement with the bank. The intent and effect of the loan was to temporarily increase the limit of the line of credit from $5,000,000 to
$7,000,000. The $2,000,000 of proceeds from the term loan were applied to the outstanding line of credit balance, reducing its balance by $2,000,000. The incremental $2,000,000 loan has the same interest rate as the line of credit. For the duration
of the term loan, the collateralization and covenants of the two loans are combined as if they are one loan facility. Consequently, the combined outstanding balance of the two loan facilities is presented as one amount on our balance sheet. The
$2,500,000 inventory collateral sub-limit of the line of credit was increased to $3,500,000 for the duration of the term loan. The combined outstanding balance exceeded $5,000,000 briefly during the middle of the second quarter of 2004. The balance
at June 26, 2004 was $2,939,000. The borrowing base on that date was $6,877,000, resulting in an unused capacity (the excess of the borrowing base calculation over the amount drawn) of $3,938,000. We were in compliance with all covenants of the line
for the quarter ended June 26, 2004.



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



Additional financing may be
needed to support the future growth plans of the company. We are evaluating an acquisition strategy that may be financed by the issuance of additional common or preferred stock that has already been authorized by the shareholders. Those shares may
be issued by approval of the Board of Directors. Acquisitions being evaluated provide services similar to those of the Company that are, or can be made, accretive in a short period of time; that bring large OEM customer relationships with potential
additional business for the combined company (that neither company would get on their own); and that bring resources, in terms of people, processes and systems, that increase the scalability of the combined businesses.



OFF-BALANCE SHEET ARRANGEMENTS



We have 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.



18



---

At any given point in time in the normal course of business, we have numerous outstanding purchase orders with our
vendors to purchase inventory for use in the products that we sell to our customers or to use in performing repair services for our customers. Such orders are not recorded as liabilities in our balance sheet until the material is physically received
from the vendors. We have no minimum purchase quantity requirements with any of our vendors.



CRITICAL ACCOUNTING POLICIES



The preparation
of financial statements and related disclosures in conformity with accounting principles generally accepted 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 1 to the Financial Statements in the Annual Report on our Form 10-KSB for the year ended December 31, 2003 describes 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 and inventory reserves. Actual results could differ from these estimates. The following critical accounting policies are impacted
significantly by judgments, assumptions and estimates used in the preparation of the Financial Statements.



For product sales, we recognize revenue upon transference of the title to the products to the customer. For repair sales, we recognize revenue upon completion of the repair work and either shipment of the item back to
the customer or, in the programs in which we also manage the customers inventory on our site, when we return the repaired item to the customers finished goods inventory. For some repair and maintenance programs, the customer pays a flat
fee that covers multiple fiscal periods. In those instances, we recognize revenue over the fiscal periods covered by the billing on a pro-rata basis. Our inventory and logistics management programs are billed monthly, with revenue recognized upon
billing. For non-recurring engineering projects, we recognize revenue on a percentage-of-completion basis.



The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts and the aging of the accounts receivable. If there is a deterioration of a major customers
credit worthiness or actual defaults are higher than our historical experience, our estimates of the recoverability of amounts due to us could be adversely affected.



Inventory purchases and commitments are based upon future demand forecasts. If there is a sudden and significant decrease in demand for our
products or there is a higher risk of inventory obsolescence because of rapidly changing technology and customer requirements, we may be required to increase our inventory allowances and our gross margin would be adversely affected.



RISK FACTORS



Investors should carefully consider the risks described below before making an investment decision. The risks and uncertainties described
below are not the only ones facing the Company. Additional risks not presently known to us or that we currently believe are immaterial may also impair our business operations. If any of the following risks actually occurs, our business, financial
condition or operating results could be seriously impaired. This section should be read in conjunction with the Financial Statements and Notes thereto, and Managements Discussion and Analysis of Financial Condition and Results of Operations
contained in this quarterly report.



19



---

If we are unable to compete effectively with existing or new competitors, the loss of our competitive position could
result in price reductions, fewer customer orders, reduced revenues, reduced margins, reduced levels of profitability, and loss of market share. If we are unable to manage our inventory, will not be able to satisfy customer demand. Our reliance on
one or a few suppliers for inventory components could delay shipments and increase our costs. Our future operating results depend on our ability to purchase a sufficient amount of components to meet the demands of our customers. Since we may order
components from suppliers in advance of receipt of customer orders for our products that include these components, we could face a material inventory risk. Our products may have quality issues that could adversely affect our sales and reputation. We
are dependent on significant customers, as noted in the SALES section above.



We depend on key employees and face competition in hiring and retaining qualified employees. Recent and proposed regulations related to equity compensation could adversely affect our ability to attract and retain key
personnel.



We expect our quarterly revenues, cash flows and operating results
to fluctuate due to the fact that our quarterly sales have historically reflected a pattern in which a disproportionate percentage of such quarters total sales occur in the last month and weeks and days of the quarter. This pattern makes
prediction of revenues, earnings and working capital for each financial period especially difficult and uncertain and increases the risk of unanticipated variations in quarterly results and financial condition.



Business interruptions could adversely affect our business. Environmental regulations and
costs could result in significant liabilities for us. Our credit rating is subject to downgrade. Our business may suffer if it is alleged or found that we have infringed the intellectual property rights of others.



Our stock price, like that of other technology companies, can be volatile. Our stock price
can be affected by many factors such as quarterly increases or decreases in our earnings, speculation in the investment community about our financial condition or results of operations, technological developments, or the loss of key management or
technical personnel. In addition, general macroeconomic and market conditions unrelated to our financial performance may also affect our stock price.



20



---

Item 3. 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, each of John D. Bair, the Chief Executive Officer of the Company, and Michael R. Sayre, the Chief Financial Officer of the Company, have concluded that the Companys disclosure controls and procedures are effective in ensuring that
information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified by the Securities
and Exchange Commissions rules and forms.



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



21



---

PART II  OTHER INFORMATION



Item 4. Submission of matters to a vote of security holders.



The annual meeting of shareholders was held on April 28, 2003. Of the 5,540,796 shares entitled to vote at the meeting,
5,293,964 shares were voted. The results were as follows:



Proposal number 1  Election of Directors



(Term
expiring in the year 2006):



|                  |  |           |  |         
|----------------- |  | --------- |  | --------
|                  |  | FOR       |  | WITHHOLD
|John D. Bair      |  | 5,127,094 |  | 166,870 
|C. Robert Hahn    |  | 5,127,594 |  | 166,370 
|Thomas M. OLeary |  | 5,128,094 |  | 165,870 
|Michael R. Sayre  |  | 5,126,694 |  | 167,270 



Proposal number 2
 Amendment to the Companys Amended and Restated Code of Regulations to delete Article Nine consistent with the Companys Articles of Incorporation:



|          |  |         |  |          |  |          
|--------- |  | ------- |  | -------- |  | ---------
|FOR       |  | AGAINST |  | WITHHOLD |  | NON-VOTES
|2,575,183 |  | 176,650 |  | 17,960   |  | 2,524,171



Proposal number 3
 Amendment to the Companys Amended and Restated Code of Regulations to delete Article Eleven:



|          |  |         |  |          |  |          
|--------- |  | ------- |  | -------- |  | ---------
|FOR       |  | AGAINST |  | WITHHOLD |  | NON-VOTES
|2,581,383 |  | 169,550 |  | 18,860   |  | 2,524,171



Broker non-votes
submitted at the annual meeting were counted as votes against Proposals 2 and 3. Consequently, Proposals 2 and 3 did not pass. Management intends to re-submit both proposals for consideration at next years annual meeting.



The following directors continued in office with terms ending in 2005:



Hugh C. Cathey

Paul H. Lambert

Robert V. R. Ostrander



Item 5. Other information.



None.



22



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



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



|            |  |                                                                                                                |  |                                                                                                             
|----------- |  | -------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                         |  | If Incorporated by Reference, Document with which Exhibit was Previously Filed with the 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                                                                       |  | Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.
|            |  |                                                                                                               
|3(e)        |  | Amendment to Amended and Restated Code of Regulations                                                          |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2000.           
|            |  |                                                                                                               
|3(f)        |  | Amendments to Amended and Restated Code of Regulations, adopted June 26, 2000                                  |  | Form SB-2 filed with the Securities and Exchange Commission September 21, 2000.                             
|            |  |                                                                                                               
|4           |  | Instruments defining the rights of security holders, including indentures                                      |  | Form SB-2 filed with the Securities and Exchange Commission September 21, 2000.                             
|            |  |                                                                                                               
|10(a)       |  | Technology license agreement between Pinnacle Data Systems, Inc. and Sun Microsystems, Inc. dated May 12, 1994 |  | Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.



23



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|            |  |                                                                                                                                       |  |                                                                                                             
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                |  | If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC                 
|10(b)*      |  | Pinnacle Data Systems, Inc. 1995 Stock Option Plan dated December 19, 1995                                                            |  | Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.
|            |  |                                                                                                                                      
|10(c)       |  | Development and manufacturing license agreement between Pinnacle Data Systems, Inc. and Sun Microsystems, Inc. dated October 27, 1997 |  | Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.
|            |  |                                                                                                                                      
|10(d)       |  | Lease agreement between Pinnacle Data Systems, Inc. and Duke Realty Limited Partnership dated March 9, 1999                           |  | Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.
|            |  |                                                                                                                                      
|10(e)       |  | Repair services agreement between Pinnacle Data Systems, Inc. and Sun Microsystems, Inc. dated March 29, 1999                         |  | Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on December 13, 1999.
|            |  |                                                                                                                                      
|10(f)       |  | Reference Design License Agreement between Pinnacle Data Systems, Inc. and Sun Microsystems, Inc. dated May 11, 1999                  |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002.           
|            |  |                                                                                                                                      
|10(g)       |  | First Lease Amendment between Pinnacle Data Systems, Inc. and Duke Realty Limited Partnership dated January 5, 2000                   |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2000.           
|            |  |                                                                                                                                      
|10(h)*      |  | Amendment No. 1 to Pinnacle Data Systems, Inc. 1995 stock option plan dated February 16, 2000                                         |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2000.           



24



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|            |  |                                                                                                                                       |  |                                                                                                  
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                |  | If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC      
|10(i)*      |  | Pinnacle Data Systems, Inc. 2000 Directors Stock Option Plan dated March 22, 2000                                                     |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2000.
|            |  |                                                                                                                                      
|10(j)       |  | Business Loan Agreement between Pinnacle Data Systems, Inc. and Key Bank National Association dated August 10, 2000                   |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2001.
|            |  |                                                                                                                                      
|10(k)*      |  | Employment agreement between Pinnacle Data Systems, Inc. and John D. Bair dated January 1, 2001                                       |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2001.
|            |  |                                                                                                                                      
|10(l)       |  | O.E.M. Supply Agreement between Pinnacle Data Systems, Inc. and Alcatel USA Sourcing L.P. dated February 12, 2001                     |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002.
|            |  |                                                                                                                                      
|10(m)       |  | Divisional Service Agreement between Pinnacle Data Systems, Inc. and Hewlett-Packard Company dated September 1, 2001                  |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002.
|            |  |                                                                                                                                      
|10(n)       |  | Direct Connect VS Supplier Services Agreement between Pinnacle Data Systems, Inc. and Hewlett-Packard Company dated September 1, 2001 |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002.
|            |  |                                                                                                                                      
|10(o)*      |  | Employment agreement between Pinnacle Data Systems, Inc. and C. Robert Hahn dated September 1, 2001                                   |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002.
|            |  |                                                                                                                                      
|10(p)*      |  | Employment agreement between Pinnacle Data Systems, Inc. and Michael R. Sayre dated September 1, 2001                                 |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002.



25



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|            |  |                                                                                                                                           |  |                                                                                                   
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                    |  | If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC       
|10(q)*      |  | Employment agreement between Pinnacle Data Systems, Inc. and Christopher L. Winslow dated September 1, 2001                               |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002. 
|            |  |                                                                                                                                          
|10(r)       |  | Amendment to Promissory Note between Pinnacle Data Systems, Inc. and Key Bank National Association dated February 21, 2002                |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002. 
|            |  |                                                                                                                                          
|10(s)       |  | First Amendment Agreement to Loan Agreement between Pinnacle Data Systems, Inc. and Key Bank National Association dated February 21, 2002 |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002. 
|            |  |                                                                                                                                          
|10(t)       |  | Second Amendment Agreement to Loan Agreement between Pinnacle Data Systems, Inc. and Key Bank National Association dated March 7, 2002    |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 20, 2002. 
|            |  |                                                                                                                                          
|10(u)       |  | Renewal of Loan Agreement between Pinnacle Data Systems, Inc. and Key Bank National Association dated April 1, 2003                       |  | Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on May 14, 2003.
|            |  |                                                                                                                                          
|10(v)       |  | Fifth Amendment Agreement to Loan Agreement between Pinnacle Data Systems, Inc. and Key Bank National Association dated May 12, 2003      |  | Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on May 14, 2003.
|            |  |                                                                                                                                          
|10(w)       |  | OEM Technology Partner agreement between Pinnacle Data Systems, Inc. and Sun Microsystems, Inc. dated August 1, 2002                      |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 28, 2003. 



26



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|            |  |                                                                                                                                       |  |                                                                                                   
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                |  | If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC       
|10(x)       |  | Amendment to Supplier Services Agreement between Pinnacle Data Systems, Inc. and Hewlett-Packard Company dated November 5, 2002       |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 28, 2003. 
|            |  |                                                                                                                                      
|10(y)       |  | Renewal of Loan Agreement between Pinnacle Data Systems, Inc, and Key Bank National Association dated April 1, 2003                   |  | Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on May 14, 2003.
|            |  |                                                                                                                                      
|10(z)       |  | Fifth Amendment Agreement to Loan Agreement between Pinnacle Data Systems, Inc. and Key Bank National Association dated May 12, 2003. |  | Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on May 14, 2003.
|            |  |                                                                                                                                      
|10(aa)      |  | Business Loan Agreement between Pinnacle Data Systems, Inc. and KeyBank National Association dated November 26, 2003.                 |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 24, 2004. 
|            |  |                                                                                                                                      
|10(ab)      |  | Promissory Note between Pinnacle Data Systems, Inc. and KeyBank National Association dated November 26, 2003.                         |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 24, 2004. 
|            |  |                                                                                                                                      
|10(ac)      |  | Commercial Security Agreement between Pinnacle Data Systems, Inc. and KeyBank National Association dated November 26, 2003.           |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 24, 2004. 
|            |  |                                                                                                                                      
|10(ad)      |  | Libor 1 Month Exhibit between Pinnacle Data Systems, Inc. and KeyBank National Association dated November 26, 2003.                   |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 24, 2004. 



27



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|            |  |                                                                                                                                                                                |  |                                                                                                   
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | --------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                                                         |  | If Incorporated by Reference, Document with which Exhibit was Previously Filed with the SEC       
|10(ae)      |  | Amendment to Loan Agreement and Allonge to Variable Rate Promissory Note between Pinnacle Data Systems, Inc. and KeyBank National Association dated November 26, 2003.         |  | Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 24, 2004. 
|            |  |                                                                                                                                                                               
|10(af)      |  | Promissory Note between Pinnacle Data Systems, Inc. and KeyBank National Association dated May 7, 2004.                                                                        |  | Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on May 17, 2004.
|            |  |                                                                                                                                                                               
|31(a)       |  | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-QSB of Pinnacle Data Systems, Inc. for the quarter ended June 26, 2004. |  | Contained herein.                                                                                 
|            |  |                                                                                                                                                                               
|31(b)       |  | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-QSB of Pinnacle Data Systems, Inc. for the quarter ended June 26, 2004. |  | Contained herein.                                                                                 
|            |  |                                                                                                                                                                               
|32(a)       |  | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-QSB of Pinnacle Data Systems, Inc. for the quarter ended June 26, 2004. |  | Contained herein.                                                                                 
|            |  |                                                                                                                                                                               
|32(b)       |  | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-QSB of Pinnacle Data Systems, Inc. for the quarter ended June 26, 2004. |  | Contained herein.                                                                                 



28



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



On April 16, 2004, Pinnacle Data Systems, Inc. furnished a current report on Form 8-K under Item 6 of Form 8-K reporting the resignation of director
David C. Swaddling on April 9, 2004, effective April 7, 2004.



April 21, 2004, Pinnacle Data Systems, Inc. furnished a current report on Form 8-K under Item 12 of Form 8-K reporting the issuance of a news release on February 21, 2004 announcing its earnings for the three-month period ending March 27,
2004.



On June 8, 2004, Pinnacle Data Systems, Inc. furnished
a current report on Form 8-K under Item 10 of Form 8-K reporting the approval by the Companys Board of Directors of an amendment to the Companys Code of Conduct and Ethics and Conflict of Interest Policy, making it applicable to all
directors, officers, and employees of the Company, in accordance with recently effective corporate governance rules of the American Stock Exchange.



29



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SIGNATURES



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



|                      |  |                                        
|--------------------- |  | ---------------------------------------
|                      |  | PINNACLE DATA SYSTEMS, INC.            
|                      | 
|Date: August 13, 2004 |  | /s/ Michael R. Sayre                   
|                      |  | Michael Sayre, Executive Vice President
|                      |  | and Chief Financial Officer            
|                      | 
|Date: August 13, 2004 |  | /s/ Thomas J. Carr                     
|                      |  | Thomas J. Carr, Controller             



30