SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended March 31, 2004

Commission File No: 000-31225

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [   ]

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act.) Yes [   ] No [X]

As of April 30, 2004, there were 3,692,053 shares of common stock, $1.00 par value per share, issued and outstanding.

Pinnacle Financial Partners, Inc.
Report on Form 10-Q
March 31, 2004

TABLE OF CONTENTS

FORWARD-LOOKING STATEMENTS

Pinnacle Financial Partners, Inc. (“Pinnacle Financial”) may from time to time make written or oral statements, including statements contained in this report which may constitute forward-looking statements within the meaning of Section 21E of the Securities Act of 1934 (the “Exchange Act”). The words “expect”, “anticipate”, “intend”, “consider”, “plan”, “believe”, “seek”, “should”, “estimate”, and similar expressions are intended to identify such forward-looking statements, but other statements may constitute forward-looking statements. These statements should be considered subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Pinnacle Financial’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors. Such factors are described below and include, without limitation, (i) unanticipated deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses, (ii) increased competition with other financial institutions, (iii) lack of sustained growth in the economy in the Nashville, Tennessee area, (iv) rapid fluctuations or unanticipated changes in interest rates, (v) the inability of our bank subsidiary, Pinnacle National Bank (“Pinnacle National”) to satisfy regulatory requirements for its expansion plans, and (vi) changes in the legislative and regulatory environment. Many of such factors are beyond Pinnacle Financial’s ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. Pinnacle Financial does not intend to update or reissue any forward-looking statements contained in this report as a result of new information or other circumstances that may become known to Pinnacle Financial.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)

See accompanying notes to consolidated financial statements.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

See accompanying notes to consolidated financial statements.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)

For the three months ended March 31, 2004 and 2003

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to consolidated financial statements.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Summary of Significant Accounting Policies

     Nature of Business — Pinnacle Financial Partners, Inc. (Pinnacle Financial) was formed on February 28, 2000 (inception) and is a bank holding company whose business is conducted by its wholly-owned subsidiary, Pinnacle National Bank (Pinnacle National). Additionally, PFP Title Company is a wholly-owned subsidiary of Pinnacle National. Pinnacle National is a commercial bank located in Nashville, Tennessee. Pinnacle National provides a full range of banking services in its primary market area of Davidson County and the surrounding counties. Pinnacle National commenced its banking operations on October 27, 2000. PFP Title Company sells title insurance policies to Pinnacle National customers and others. PNFP Statutory Trust I, a wholly-owned subsidiary of Pinnacle Financial, was created for the exclusive purpose of issuing capital trust preferred securities.

     Basis of Presentation — These consolidated financial statements include the accounts of Pinnacle Financial. Significant intercompany transactions and accounts are eliminated in consolidation, other than the accounts of PNFP Statutory Trust I which are included in these consolidated financial statements pursuant to the equity method of accounting.

     The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto included in Pinnacle Financial’s Form 10-KSB for the fiscal year ended December 31, 2003 as filed with the Securities and Exchange Commission.

     Use of Estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses.

     Stock-Based Compensation — In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123”. This Statement amends Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2003 and are included below.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

     Pinnacle Financial applies APB Opinion 25 and related interpretations in accounting for the stock option plan. All option grants carry exercise prices equal to or above the fair value of the common stock on the date of grant. Accordingly, no compensation cost has been recognized. Had compensation cost for Pinnacle Financial’s stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method prescribed in SFAS No. 123, “Accounting for Stock-Based Compensation,” Pinnacle Financial’s net income per share would have been adjusted to the pro forma amounts indicated below for the three months ended March 31, 2004 and 2003:

     For purposes of these calculations, the fair value of options granted for the three months ended March 31, 2004 and 2003 was estimated using the Black-Scholes option pricing model and the following assumptions:

     Income Per Common Share — Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stock were exercised or converted. The difference between basic and diluted weighted average shares outstanding was attributable to common stock options and warrants.

     As of March 31, 2004 and 2003, there were common stock options outstanding to purchase up to 505,245 and 404,100 common shares, respectively. Substantially all of these shares have exercise prices, which when considered in relation to the average market price of Pinnacle Financial’s common stock for the respective reporting period, are considered dilutive and are considered in Pinnacle Financial’s diluted income per share calculation for the three months ended March 31, 2004 and 2003. Also, at March 31, 2004, there were 198,420 options outstanding to purchase common stock which were exercisable by the option holder.

     Additionally, as of March 31, 2004, Pinnacle Financial had dilutive warrants outstanding to purchase 203,000 common shares which have also been considered in the calculation of Pinnacle Financial’s diluted income per share for the three months ended March 31, 2004 and 2003. At March 31, 2004, all of the outstanding warrants to purchase common stock were exercisable by the warrant holder.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

     The following is a summary of the basic and diluted earnings per share calculation for the three months ended March 31, 2004 and 2003:

     On April 20, 2004, the Board of Directors of Pinnacle Financial approved a two for one stock split of the Company’s common stock payable as a 100% stock dividend on May 10, 2004 to shareholders of record on April 30, 2004. Pinnacle Financial will retroactively apply the impact of this stock split in all financial statements published after May 10, 2004. The following is the pro forma impact of the stock split on Pinnacle Financial’s reported basic and diluted net income per common share for the three months ended March 31, 2004 and 2003.

     Business Segments — Pinnacle Financial operates in one business segment, commercial banking, and has no individually significant business segments.

     Comprehensive Income (Loss) —Other comprehensive income refers to revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Currently, Pinnacle Financial’s other comprehensive income (loss) consists of unrealized gains and losses, net of deferred income taxes, on available-for-sale securities.

     Recent Accounting Pronouncements — In March 2004, the SEC issued Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments. Current accounting guidance requires the commitment to originate mortgage loans to be held for sale be recognized on the balance sheet at fair value from inception through expiration or funding. SAB 105 requires that the fair-value measurement include only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected future cash flows related to the customer relationship or loan servicing. SAB 105 is effective for commitments to originate mortgage loans to be held for sale that are entered into after March 31, 2004. Its adoption is not expected to have a material impact on the consolidated financial position on results of operations of Pinnacle Financial.

     In March 2004, the FASB’s Emerging Issues Task Force reached a consensus on EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The guidance prescribes a three-step model for determining whether an investment is other-than-temporarily impaired and requires disclosures about unrealized losses on investments. The accounting guidance is effective for reporting periods beginning after June 15, 2004, while the disclosure requirements are effective for annual reporting periods ending after June 15, 2004. Pinnacle Financial has adopted the requirements of this EITF.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

     Reclassifications – Certain previous amounts have been reclassified to conform to the 2004 presentation. Such reclassifications had no impact on net income or loss during any period.

Note 2. Securities

     The amortized cost and fair value of securities at March 31, 2004 and December 31, 2003 are summarized as follows:

     On March 31, 2004, Pinnacle National transferred approximately $27,656,000 of available-for-sale securities to held-to-maturity at fair value. The transfer consisted of substantially all of Pinnacle National’s holdings of Tennessee municipal securities and several of its longer-term agency securities. The unrealized gain on such securities as of the date of transfer was approximately $325,000. This amount is reflected in the accumulated other comprehensive income, net of tax, and will be amortized over the remaining lives of the respective held-to-maturity securities.

     Pinnacle Financial realized approximately $248,000 in net gains from the sale of $21,877,000 of available-for-sale securities during the three months ended March 31, 2004 and $18,000 in net gains on the sale of $12,404,000 of available-for-sale securities during the three months ended March 31, 2003. Gross realized gains amounted to $312,000 on the sale of $10.9 million of available-for-sale securities while gross realized losses amounted to $64,000 on the sale of $11.0 million of available-for-sale securities during the three months ended March 31, 2004. Gross realized gains amounted to $32,000 on the sale of $14.4 million of available-for-sale securities while gross realized losses amounted to $14,000 on the sale of $2.0 million of available-for-sale securities during the three months ended March 31, 2003. At March 31, 2004, approximately $88,747,000 of Pinnacle Financial’s available-for-sale portfolio was pledged to secure public fund deposits and securities sold under agreements to repurchase.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 3. Loans and Allowance for Loan Losses

     The composition of loans at March 31, 2004 and December 31, 2003 is summarized as follows:

     Using standard industry codes, Pinnacle Financial periodically analyzes its commercial loan portfolio to determine if a concentration of credit risk exists to any one or more industries. Pinnacle Financial has a meaningful credit exposure (loans outstanding plus unfunded lines of credit) to borrowers in the trucking industry and to operators of nonresidential buildings. Credit exposure to the trucking industry approximated $33.0 million and $35.0 million, while credit exposure to operators of nonresidential buildings approximated $16.8 million and $16.6 million at March 31, 2004 and December 31, 2003, respectively. Levels of exposure to these industry groups are periodically evaluated in order to determine if additional allowance allocations are warranted.

     At March 31, 2004 and 2003, Pinnacle Financial had certain impaired loans on nonaccruing interest status. The principal balance of these nonaccrual loans amounted to $86,000 and $1,095,000 at March 31, 2004 and 2003, respectively. In each case, at the date such loans were placed on nonaccrual, Pinnacle Financial reversed all previously accrued interest income against current year earnings. Had these loans been on accruing status, interest income would have been higher by $1,000 and $29,000 for the three months ended March 31, 2004 and 2003, respectively.

     Changes in the allowance for loan losses for the three months ended March 31, 2004 and for the year ended December 31, 2003 are as follows:

     At March 31, 2004, Pinnacle Financial has granted loans and other extensions of credit amounting to approximately $6,869,000 to certain directors, executive officers, and their related entities of which $3,867,000 had been drawn upon. The terms on these loans and extensions are on substantially the same terms customary for other persons for the type of loan involved.

     During the three months ended March 31, 2004 and 2003, Pinnacle Financial sold participations in certain loans to correspondent banks at an interest rate that was less than that of the borrower’s rate of interest. In accordance with generally accepted accounting principles, Pinnacle Financial has reflected a gain on the sale of these participated loans for the three months ended March 31, 2004 and 2003 of approximately $122,000 and $2,000, respectively, which is attributable to the present value of the future net cash flows of the difference between the interest payments the borrower is projected to pay Pinnacle Financial and the amount of interest that will be owed the correspondent based on their future participation in the loan.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 4. Income Taxes

     Income tax expense for the three months ended March 31, 2004 and 2003 consists of the following:

     Pinnacle Financial’s income tax expense differs from the amounts computed by applying the Federal income tax statutory rates of 34% in 2004 and 2003 to income before income taxes. A reconciliation of the differences for the three months ended March 31, 2004 and 2003 is as follows:

     In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that Pinnacle Financial will realize the benefit of these deductible differences. However, the amount of the deferred tax asset considered realizable could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. The components of deferred income taxes included in other assets in the accompanying consolidated balance sheets at March 31, 2004 and December 31, 2003 are as follows:

Note 5. Commitments and Contingent Liabilities

     In the normal course of business, Pinnacle Financial has entered into off-balance sheet financial instruments which include commitments to extend credit (i.e., including unfunded lines of credit) and standby letters of credit. Commitments to extend credit are usually the result of lines of credit granted to existing borrowers under agreements that the total outstanding indebtedness will not exceed a specific amount during the term of the indebtedness. Typical borrowers are commercial concerns that use lines of credit to supplement their treasury

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

management functions, thus their total outstanding indebtedness may fluctuate during any time period based on the seasonality of their business and the resultant timing of their cash flows. Other typical lines of credit are related to home equity loans granted to consumers. Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee.

     Standby letters of credit are generally issued on behalf of an applicant (our customer) to a specifically named beneficiary and are the result of a particular business arrangement that exists between the applicant and the beneficiary. Standby letters of credit have fixed expiration dates and are usually for terms of two years or less unless terminated beforehand due to criteria specified in the standby letter of credit. A typical arrangement involves the applicant routinely being indebted to the beneficiary for such items as inventory purchases, insurance, utilities, lease guarantees or other third party commercial transactions. The standby letter of credit would permit the beneficiary to obtain payment from Pinnacle Financial under certain prescribed circumstances. Subsequently, Pinnacle Financial would then seek reimbursement from the applicant pursuant to the terms of the standby letter of credit.

     Pinnacle Financial follows the same credit policies and underwriting practices when making these commitments as it does for on-balance sheet instruments. Each customer’s creditworthiness is evaluated on a case-by-case basis and the amount of collateral obtained, if any, is based on management’s credit evaluation of the customer. Collateral held varies but may include cash, real estate and improvements, marketable securities, accounts receivable, inventory, equipment, and personal property.

     The contractual amounts of these commitments are not reflected in the consolidated financial statements and would only be reflected if drawn upon. Since many of the commitments are expected to expire without being drawn upon, the contractual amounts do not necessarily represent future cash requirements. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, Pinnacle Financial’s maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments.

     A summary of Pinnacle Financial’s total contractual amount for all off-balance sheet commitments at March 31, 2004 is as follows:

     At March 31, 2004, the fair value of Pinnacle Financial’s standby letters of credit was $146,000. This amount represents the unamortized fee associated with these standby letters of credit and is included in the consolidated balance sheet of Pinnacle Financial. This fair value will decrease over time as the existing standby letters of credit approach their expiration dates.

     In the normal course of business, Pinnacle Financial may become involved in various legal proceedings. As of March 31, 2004, the management of Pinnacle Financial is not aware of any such proceedings against Pinnacle Financial.

Note 6. Stock Option Plan

     Pinnacle Financial has a stock option plan under which it has granted options to its employees to purchase common stock at or above the fair market value on the date of grant. All of the options are intended to be incentive stock options qualifying under Section 422 of the Internal Revenue Code for favorable tax treatment. Options under the plan vest in varying increments over five years beginning one year after the date of the grant and are exercisable over a period of ten years from the date of grant. The shareholders of Pinnacle Financial have already approved an allocation of 520,000 common shares toward this plan.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

     A summary of the plan changes for the three-month period ended March 31, 2004 is as follows:

     The following table summarizes information about Pinnacle Financial’s stock option plan at March 31, 2004:

Note 7. Regulatory Matters

     Pinnacle National is subject to certain restrictions on the amount of dividends that may be declared without prior regulatory approval. Pinnacle Financial and Pinnacle National are subject to various other regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Pinnacle Financial and Pinnacle National must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Pinnacle Financial’s and Pinnacle National’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

     Quantitative measures established by regulation to ensure capital adequacy require Pinnacle Financial and Pinnacle National to maintain minimum amounts and ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of March 31, 2004 and December 31, 2003, Pinnacle Financial and Pinnacle National meet all capital adequacy requirements to which they are subject. To be categorized as well-capitalized, Pinnacle National must maintain minimum Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. Pinnacle Financial and Pinnacle National’s actual capital amounts and ratios are presented in the following table (dollars in thousands):

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

     In connection with approving Pinnacle Financial’s issuance of Trust Preferred Securities, the Federal Reserve Bank of Atlanta (“FRB-Atlanta”) required Pinnacle Financial to maintain a Total capital to risk-weighted assets ratio of 10%, a Tier 1 capital to risk-weighted assets ratio of 6% and a Tier 1 capital to average-assets ratio of 5% during the year ended December 31, 2004. Furthermore, and in order to provide additional assurance to the FRB-Atlanta as to the maintenance of these ratios, Pinnacle Financial’s President and Chief Executive Officer, Chairman and Chief Administrative Officer agreed to exercise their common stock warrant agreements should it become apparent that maintenance of the ratios at the required levels would not occur otherwise during the year ended December 31, 2004.

Note 8. Subsequent Events

     On April 20, 2004, the shareholders of Pinnacle Financial approved an increase in the number of authorized shares of capital stock from 20,000,000 shares to 30,000,000 shares. With the increase, the number of authorized shares of common stock was increased from 10,000,000 shares to 20,000,000 shares and the number of authorized shares of preferred stock remained at 10,000,000 shares.

     On April 20, 2004, the shareholders also approved the 2004 Equity Incentive Plan which would set aside for issuance up to 264,755 shares of Pinnacle Financial common stock. This includes a new allocation of 250,000 shares plus 14,755 shares from the previous stock option plan.

     On April 20, 2004, the Board of Directors of Pinnacle Financial approved a two for one stock split of the Company’s common stock payable as a 100% stock dividend on May 10, 2004 to shareholders of record on April 30, 2004. Pinnacle Financial will retroactively apply the impact of this stock split in all financial statements published after May 10, 2004.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion of our financial condition at March 31, 2004 and December 31, 2003 and our results of operations for the three months ended March 31, 2004 and 2003. The purpose of this discussion is to focus on information about our financial condition and results of operations which is not otherwise apparent from the consolidated financial statements. You should read the following discussion and analysis along with our consolidated financial statements and the related notes included elsewhere herein.

Overview

General. Pinnacle Financial’s rapid growth from its inception through the first quarter of 2004 continues to have a material impact on Pinnacle Financial’s financial condition and results of operations. This rapid growth resulted in net income for the three months ended March 31, 2004 of $0.26 per diluted share as compared to $0.10 per diluted share for the three months ended March 31, 2003. At March 31, 2004, loans totaled $323 million, as compared to $297 million at December 31, 2003, while total deposits were $438 million at March 31, 2004 compared to $391 million at December 31, 2003.

Financial Condition. The $26 million increase in loans for 2004 contributed to the increase in Pinnacle Financial’s net income for the three months ended March 31, 2004 when compared to an increase of $19 million for the similar period in 2003. This increase in volume offset the decrease in average yields on loans between 2003 and 2002. As Pinnacle Financial seeks to increase its loan portfolio it must also continue to monitor the risks inherent in its lending operations. If Pinnacle Financial’s allowance for loan losses is not sufficient to cover loan losses in Pinnacle Financial’s loan portfolio, increases to the allowance for loan losses would be required which would decrease Pinnacle Financial’s earnings.

Pinnacle Financial has successfully grown its total deposits to $438 million at March 31, 2004. This growth in deposits has allowed Pinnacle Financial to fund its asset growth at a lower cost than in 2003. While rates paid on deposits decreased during the first quarter of 2004 compared to the same quarter in 2003, Pinnacle Financial, for competitive reasons, has typically adjusted its deposit rates more slowly than its loan yields during a period of declining interest rates. As such, Pinnacle Financial’s deposit funding costs do not decrease as quickly as do revenues from interest income on earning assets, thus reducing Pinnacle Financial’s net interest margin. In addition, Pinnacle Financial believes that in certain cases rates paid on deposits have decreased to such levels that further reductions could put Pinnacle Financial at a competitive disadvantage as customers seek higher returns on their balances. The reverse impact would likely result in a scenario of rising interest rates.

Results of Operations. Pinnacle Financial’s net interest income increased from $2.6 million in the first quarter of 2003 to $4.2 million in 2004. The net interest margin (the ratio of net interest income to average earning assets for the period) was approximately 3.5% for both periods.

The increase in loan volumes for the three months ended March 31, 2004 was also the primary cause for the $66,000 increase in Pinnacle Financial’s provision for loan losses when compared to the same period in 2003. As Pinnacle Financial’s loan portfolio continues to grow, Pinnacle Financial expects that it will continue to record a provision for loan losses consistent with the growth in the loan portfolio.

Noninterest income for Pinnacle Financial also increased by 166% from 2003 to 2004. Much of the increase was due to Pinnacle Financial initiating a mortgage origination unit during the first quarter of 2003, which contributed $146,000 in increased fees during the three months ended March 31, 2004 when compared to the three months ended March 31, 2003 and a $234,000 increase in investment services revenues during the first quarter of 2004 compared to the same period in 2003. We also recorded $248,000 in gains on the sales of securities available-for-sale and $122,000 in gains on the sale of loans.

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Pinnacle Financial’s continued growth in 2004 when compared to 2003 resulted in an increase of approximately $1.2 million in noninterest expense related to salaries and employee benefits, equipment and occupancy expenses and other operating expenses. As Pinnacle Financial increased its number of full-time equivalent employees from 65.5 at March 31, 2003 to 95.0 at March 31, 2004, Pinnacle Financial experienced an approximately $833,000 increase in compensation and employee benefit expense. Pinnacle Financial expects to add additional employees throughout 2004 which will cause Pinnacle Financial’s compensation and employee benefit expense to increase in future periods. Pinnacle Financial’s branch expansion efforts in 2003 also resulted in increased noninterest expense for 2003 and the first quarter of 2004. The increased operational expenses for the branches opened in 2003 and the expected opening of two additional branches in 2004 will continue to result in increased noninterest expense in future periods. Although Pinnacle Financial’s expenses increased in 2004 when compared to 2003, Pinnacle Financial’s efficiency ratio, the ratio of noninterest expense to the sum of net interest income and noninterest income, decreased from 72.4% for the three months ended March 31, 2003 compared to 63.5% for the three months ended March 31, 2004.

Furthermore, we believe that a rising interest rate environment will result in increased earnings for us over that of a falling rate environment. Currently, approximately 52% of our loan volumes are floating rate loans that reprice with adjustments to our prime lending rate or other similarly published overnite interest rate indices. We also believe we will continue to grow our balance sheet with continued emphasis on floating rate lending. The additional revenues provided by these two items should be sufficient to overcome any immediate increases in funding costs which would also be incurred in rising rate environment.

Conversely, a falling rate environment would serve to have the opposite effect on our earnings. Additionally, in a falling rate environment, we may not be able to reduce our deposit funding costs by any meaningful amount due to market pressures, while our interest income would decrease at a more rapid pace, as we do not believe interest rate “floors” which are included in many of our floating rate loan documents could be practically enforced.

Capital and Liquidity. On December 30, 2003, Pinnacle Financial issued $10 million in trust preferred securities which bear interest at a floating rate based on a spread over 3-month LIBOR, which is set each quarter, and mature on December 30, 2033. Pinnacle Financial believes that the proceeds from this offering should provide, under current regulatory guidelines, the regulatory capital Pinnacle Financial needs to support its anticipated growth in 2004. At March 31, 2004, Pinnacle Financial’s capital ratios, including Pinnacle National’s capital ratios, met regulatory minimum capital requirements. Additionally, at March 31, 2004, Pinnacle National would be considered to be “well-capitalized” pursuant to banking regulations.

Critical Accounting Estimates

The accounting principles we follow and our methods of applying these principles conform with accounting principles generally accepted in the United States and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses (ALL), have been critical to the determination of our financial position and results of operations.

Allowance for Loan Losses (ALL). Our management assesses the adequacy of the ALL prior to the end of each calendar quarter. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The ALL consists of two portions (1) an allocated amount representative of specifically identified credit exposure and exposures readily predictable by historical or comparative experience; and (2) an unallocated amount representative of inherent loss which is not readily identifiable. Even though the ALL is composed of two components, the entire ALL is available to absorb any credit losses.

We establish the allocated amount separately for two different risk groups (1) unique loans (commercial loans, including those loans considered impaired); and (2) homogeneous loans (generally consumer loans). We base the allocation for unique loans primarily on risk rating grades assigned to each of these loans as a result of our loan management and review processes. We then assign each risk-rating grade a loss ratio, which is determined based on

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the experience of management, discussions with banking regulators and our independent loan review process. We estimate losses on impaired loans based on estimated cash flows discounted at the loan’s original effective interest rate or based on the underlying collateral value. Based on management’s experience, we also assign loss ratios to our consumer portfolio. These loss ratios are assigned to the various homogenous categories of the consumer portfolio (e.g., automobile, residential mortgage, home equity).

The unallocated amount is particularly subjective and does not lend itself to exact mathematical calculation. The unallocated amount represents estimated inherent credit losses which may exist, but have not yet been identified, as of the balance sheet date. In estimating the unallocated amount, such matters as changes in the local or national economy, the depth or experience in the lending staff, any concentrations of credit in any particular industry group, and new banking laws or regulations. After we assess applicable factors, we evaluate the aggregate unallocated amount based on our management’s experience.

We then test the resulting ALL balance by comparing the balance in the ALL to historical trends and peer information. Our management then evaluates the result of the procedures performed, including the result of our testing, and concludes on the appropriateness of the balance of the ALL in its entirety. The audit committee of our board of directors reviews the assessment prior to the filing of quarterly and annual financial information.

In assessing the adequacy of the ALL, we also rely on an ongoing independent loan review process. We undertake this process both to ascertain whether there are loans in the portfolio whose credit quality has weakened over time and to assist in our overall evaluation of the risk characteristics of the entire loan portfolio. Our loan review process includes the judgment of management, the input from our independent loan reviewer, who is not an employee of Pinnacle National, and reviews that may have been conducted by bank regulatory agencies as part of their usual examination process.

Results of Operations

Our results for the three months ended March 31, 2004 and 2003 were highlighted by the continued growth in loans and other earning assets and deposits, which resulted in increased revenues and expenses. The net income for the three months ended March 31, 2004 and 2003 was $1,071,000 and $373,000, respectively. The following is a more detailed discussion of results of our operations.

Net Interest Income. Net interest income represents the amount by which interest earned on various earning assets exceeds interest paid on deposits and other interest bearing liabilities and is the most significant component of our earnings. For the three months ended March 31, 2004, we recorded net interest income of $4,152,000, which resulted in a net interest margin of 3.49% for the period. For the three months ended March 31, 2003, we recorded net interest income of $2,636,000 which resulted in a net interest margin of 3.46% for the period. During the first quarter of 2002, the Federal funds rate was 1.25% compared to 1.00% for the first quarter of 2003. Our management believes this historically low interest rate environment continues to have a negative impact on our net interest income as a significant number of our customers are adjustable rate borrowers with their lines of credit tied primarily to our prime lending rate which declined in lock-step with the Federal funds rate declines.

The following table sets forth the amount of our average balances, interest income or interest expense for each category of interest-earning assets and interest-bearing liabilities and the average interest rate for total interest-earning assets and total interest-bearing liabilities, net interest spread and net yield on average interest-earning assets for the three months ended March 31, 2004 and 2003 (dollars in thousands):

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As noted above, the net interest margin for the first quarter of 2004 was 3.49% compared to a net interest margin of 3.46% for the same period in 2003, an increase of 0.03%. The net change in the net interest margin was relatively small because the net decrease in the yield on interest-earning assets between the two periods of 41 basis points approximated the net decrease in the rate paid on interest-bearing liabilities between the two periods of 53 basis points. Other matters related to the changes in net interest income, net interest yields and rates, and net interest margin are presented below:

•

Our loan yields decreased from 5.52% for 2003 to 5.14% for 2004, a decrease of 38 basis points. Approximately 53% of our loans are floating rate loans whereby the interest rate charged the borrower is tied, in substantially all cases, to our prime rate. During the first quarter of 2003, our prime rate was 4.25% compared to a prime rate of 4% for the first quarter of 2004.

•

During 2004, we were able to grow our funding base significantly. For asset/liability management purposes in 2004, we elected to allocate a greater proportion of such funds to our securities portfolio versus our loan portfolio than in 2003. Our securities portfolio generally has lower yields than do loans.

•

During 2004, overall deposit rates were less than those rates for the comparable period in 2003. In some cases, rates for 2004 have decreased to such levels that further decreases in deposit rates approach what we

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term “embedded floors” or rates that it is not reasonable or practical to go below, such that further decreases in deposit rates could place us in a competitive disadvantage as customers seek higher returns on their balances. Changes in interest rates paid on such products as interest checking, savings and money market, securities sold under agreements to repurchase and Federal funds purchased will increase or decrease in a manner that is consistent with changes in the short-term rate environment. During 2004, and as was the case with our prime lending rate, short-term rates were less in 2004 than in 2003. We also monitor the pricing of similar products by our primary competitors. The changes in the short-term rate environment and the information we obtained from price shopping our primary competitors allowed us to reduce these rates in 2004 compared to the same period in 2003.

•

The short- and long-term rate environment also impacts rates paid on certificates of deposit and advances from the FHLB, however, these items are also impacted by our decisions to alter the mix of maturities of the underlying accounts within these items. Furthermore, the timing of the initial sale of the certificate of deposit or the funding of the FHLB advance also impacts the rates paid on these items. The results for the first three months of 2003 were impacted by certificates of deposit and advances from the FHLB that had been acquired during periods of higher interest rates. Such items matured during the interim period between the three months ended March 31, 2004 and 2003, and were replaced by certificates of deposit and advances from the FHLB which had lower interest rates. These matters contributed to the reduction in the rates paid on certificates of deposit and advances from the FHLB between the two periods.

•

Also impacting the net interest margin during the first three months of 2004 was the issuance of subordinated indebtedness. This indebtedness was issued at the end of 2003, thus it did not impact the prior period’s results.

Rate and Volume Analysis. As noted above, net interest income increased by $1,516,000 between the three months ended March 31, 2004 and 2003. The following is an analysis of the changes in our net interest income comparing the changes attributable to rates and those attributable to volumes (dollars in thousands):

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In December 2003, Pinnacle National acquired for $500,000 a $1,500,000 loan which it had previously sold to another financial institution. At March 31, 2004, the net book value of such loan is $86,000 and the loan is on nonaccrual status. Pinnacle Financial is currently accounting for the discount under the cost-recovery method pursuant to Practice Bulletin Number 6, Amortization of Discounts on Certain Acquired Loans, issued by the Accounting Standards Executive Committee (AcSEC). Under the cost-recovery method of accounting, cash collections are first applied against the recorded amount of the loan; when the loan has been reduced to zero, any additional amounts received are recognized as income. The cost-recovery method will continue to be used by Pinnacle until such time that management determines that collection of the discount is probable and the timing of collection can be reasonably estimated. At the time when management can make such determination with respect to the discount, or some portion thereof, Pinnacle will begin amortizing to interest income such amount over the time period that the payments are probable of collection.

Provision for Loan Losses. The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in our management’s evaluation, should be adequate to provide coverage for the inherent losses on outstanding loans. The provision for loan losses amounted to $354,000 and $288,000 for the three months ended March 31, 2004 and 2003, respectively.

Based upon our management’s evaluation of the loan portfolio, our management believes the allowance for loan losses to be adequate to absorb our estimate of probable losses existing in the loan portfolio at the balance sheet date. The increase in the provision for loan losses for the three months ended March 31, 2004 when compared to the three months ended March 31, 2003 was primarily due to the increase in loans throughout 2004 when compared to 2003 offset by lower net charge-off’s for 2004 compared to 2003.

Based upon our management’s assessment of the loan portfolio, we adjust our ALL to an amount deemed appropriate to adequately cover inherent risks in the loan portfolio. While our policies and procedures used to estimate the ALL, as well as the resultant provision for loan losses charged to operations, are considered adequate by our management and are reviewed from time to time by Pinnacle National’s regulators, they are necessarily approximate and imprecise. There exist factors beyond our control, such as general economic conditions both locally and nationally, which may negatively impact, materially, the adequacy of our ALL and, thus, the resulting provision for loan losses.

Noninterest Income. Pinnacle Financial’s noninterest income is composed of several components, some of which vary significantly between quarterly periods. Service charges on deposit accounts and other noninterest income generally reflect Pinnacle Financial’s growth, while investment services and fees from the origination of mortgage loans will often reflect market conditions and fluctuate from period to period. The opportunities for recognition of gains on loan participations sold and gain on sales of investment securities may also vary widely from quarter to quarter.

The following is the makeup of our noninterest income for the three months ended March 31, 2004 and 2003 (dollars in thousands):