form10-q.htm

10-Q 1 form10-q.htm PINNACLE FINANCIAL PARTNERS 10-Q 9-30-2007 form10-q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(mark one)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2007
	or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
	For the transition period from ____ to ____
	Commission File Number: 000-31225

	, Inc.
	(Exact name of registrant as specified in its charter)

Tennessee		62-1812853
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

211 Commerce Street, Suite 300, Nashville, Tennessee		37201
(Address of principal executive offices)		(Zip Code)

	(615) 744-3700
	(Registrant’s telephone number, including area code)

	Not Applicable
	(Former name, former address and former fiscal year, if changes since last report)

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 o

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

Large Accelerated Filer o

Accelerated Filer x

Non-accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o

No x

As of October 31, 2007 there were 15,553,537 shares of common stock, $1.00 par value per share, issued and outstanding.

Pinnacle Financial Partners, Inc.

Report on Form 10-Q

September 30, 2007

TABLE OF CONTENTS
	Page No.
PART I – Financial Information:
Item 1. Consolidated Financial Statements (Unaudited)	2
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3. Quantitative and Qualitative Disclosures about Market Risk	44
Item 4. Controls and Procedures	44

PART II – Other Information:
Item 1. Legal Proceedings	45
Item 1A. Risk Factors	45
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	46
Item 3. Defaults Upon Senior Securities	46
Item 4. Submission of Matters to a Vote of Security Holders	46
Item 5. Other Information	46
Item 6. Exhibits	46
Signatures	47

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 Exchange 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. All forward-looking statements are subject to risks, uncertainties and other facts that may cause the actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Such factors 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) the inability of Pinnacle Financial to continue to grow its loan portfolio at historic rates in the Nashville-Davidson-Murfreesboro-Franklin MSA or projected rates in the Knoxville MSA, (iii) increased competition with other financial institutions, (iv) lack of sustained growth in the economy in the Nashville-Davidson-Murfreesboro-Franklin MSA and the Knoxville MSA, (v) rapid fluctuations or unanticipated changes in interest rates, (vi) the inability of Pinnacle Financial to satisfy regulatory requirements for its expansion plans, (vii) the inability of Pinnacle Financial to execute its expansion plans and (viii) changes in the legislative and regulatory environment. Additionally, risk factors exist in connection with Pinnacle Financial's proposed merger with Mid-America Bancshares, Inc. (“Mid-America”) including among others, (1) the risk that the cost savings and any revenue synergies from the merger may not be realized or take longer than anticipated, (2) disruption from the merger with customers, suppliers or employee relationships, (3) the occurrence of any event, change or other circumstances that could give rise to the termination of the merger agreement, (4) the risk of successful integration of the two companies' businesses, (5) the failure of Mid-America's or Pinnacle Financial's shareholders to approve the merger, (6) the amount of the costs, fees, expenses and charges related to the merger, and (7) the ability to obtain required governmental approvals of the proposed terms of the merger and anticipated schedule. A more detailed description of these and other risks is contained in Pinnacle Financial's most recent annual report on Form 10-K and below in Item 1A of Part II. 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 disclaims any obligation to update or revise any forward-looking statements contained in this report, whether as a result of new information, future events or otherwise.

Page 1

Table of Contents

Item 1.

Part I. FINANCIAL INFORMATION

PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	September 30, 2007			December 31, 2006
*ASSETS*
Cash and noninterest-bearing due from banks	$	48,865,526		$	43,611,533
Interest-bearing due from banks		5,819,607			1,041,174
Federal funds sold		26,522,858			47,866,143
Cash and cash equivalents		81,207,991			92,518,850

Securities available-for-sale, at fair value		325,171,126			319,237,428
Securities held-to-maturity (fair value of $26,603,414 and $26,594,235 at September 30, 2007 and December 31, 2006, respectively)		27,050,937			27,256,876
Mortgage loans held-for-sale		5,685,674			5,654,381

Loans		1,731,245,280			1,497,734,824
Less allowance for loan losses		(17,978,429	)		(16,117,978	)
Loans, net		1,713,266,851			1,481,616,846

Premises and equipment, net		38,208,897			36,285,796
Investments in unconsolidated subsidiaries and other entities		17,424,718			16,200,684
Accrued interest receivable		12,056,089			11,019,173
Goodwill		114,287,640			114,287,640
Core deposit intangible, net		9,837,744			11,385,006
Other assets		23,881,242			26,724,183
Total assets	$	2,368,078,909		$	2,142,186,863

*LIABILITIES AND STOCKHOLDERS' EQUITY*
Deposits:
Noninterest-bearing demand	$	316,542,088		$	300,977,814
Interest-bearing demand		254,958,551			236,674,425
Savings and money market accounts		538,976,126			485,935,897
Time		716,407,184			598,823,167
Total deposits		1,826,883,949			1,622,411,303
Securities sold under agreements to repurchase		145,331,726			141,015,761
Federal Home Loan Bank advances		35,685,005			53,725,833
Federal funds purchased		19,986,000			-
Subordinated debt		51,548,000			51,548,000
Accrued interest payable		5,973,825			4,952,422
Other liabilities		8,033,974			12,516,523
Total liabilities		2,093,442,479			1,886,169,842
Stockholders’ equity:
Preferred stock, no par value; 10,000,000 shares authorized; no shares issued and outstanding		-			-
Common stock, par value $1.00; 90,000,000 shares authorized; 15,553,037 issued and outstanding at September 30, 2007 and 15,446,074 issued and outstanding at December 31, 2006		15,553,037			15,446,074
Additional paid-in capital		213,644,006			211,502,516
Retained earnings		47,908,839			31,109,324
Accumulated other comprehensive loss, net of deferred income taxes		(2,469,452	)		(2,040,893	)
Total stockholders’ equity		274,636,430			256,017,021
Total liabilities and stockholders’ equity	$	2,368,078,909		$	2,142,186,863

See accompanying notes to consolidated financial statements.

Page 2

Table of Contents

PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Interest income:
Loans, including fees	$	32,750,403	$	26,771,110	$	92,283,516	$	64,195,835
Securities:
Taxable		3,387,464		3,240,878		10,127,943		9,250,455
Tax-exempt		743,921		521,240		2,106,857		1,416,862
Federal funds sold and other		1,464,795		806,829		3,075,372		1,591,941
Total interest income		38,346,583		31,340,057		107,593,688		76,455,093

Interest expense:
Deposits		16,043,425		11,800,394		44,037,317		27,213,738
Securities sold under agreements to repurchase		2,061,333		1,382,418		5,664,167		2,569,383
Federal funds purchased and other borrowings		1,282,159		997,899		4,189,055		3,110,660
Total interest expense		19,386,917		14,180,711		53,890,539		32,893,781
Net interest income		18,959,666		17,159,346		53,703,149		43,561,312
Provision for loan losses		772,064		586,589		2,460,028		2,680,638
Net interest income after provision for loan losses		18,187,602		16,572,757		51,243,121		40,880,674

Noninterest income:
Service charges on deposit accounts		1,965,965		1,357,280		5,683,199		3,151,664
Investment sales commissions		868,738		644,931		2,453,505		1,811,428
Insurance sales commissions		563,367		549,584		1,829,282		1,562,946
Gain on loans and loan participations sold, net		378,682		490,254		1,380,883		1,285,609
Trust fees		466,581		311,997		1,312,076		675,994
Other noninterest income		1,088,430		1,069,811		3,249,918		2,364,592
Total noninterest income		5,331,763		4,423,857		15,908,863		10,852,233

Noninterest expense:
Compensation and employee benefits		9,106,256		7,576,011		26,167,610		19,314,365
Equipment and occupancy		2,632,747		2,070,727		7,209,977		5,325,274
Marketing and other business development		375,066		351,432		1,057,092		899,807
Postage and supplies		474,083		487,689		1,453,197		1,118,308
Amortization of core deposit intangible		515,754		534,957		1,547,262		1,248,335
Other noninterest expense		2,005,752		1,815,392		5,282,516		3,999,832
Merger related expense		-		218,167		-		1,582,734
Total noninterest expense		15,109,658		13,054,375		42,717,654		33,488,655
Income before income taxes		8,409,707		7,942,239		24,434,330		18,244,252
Income tax expense		2,637,897		2,595,465		7,634,815		5,963,112
Net income	$	5,771,810	$	5,346,774	$	16,799,515	$	12,281,140

*Per share information:*
Basic net income per common share	$	0.37	$	0.35	$	1.09	$	0.91
Diluted net income per common share	$	0.35	$	0.32	$	1.01	$	0.84

Weighted average shares outstanding:
Basic		15,503,284		15,393,735		15,477,339		13,450,282
Diluted		16,609,328		16,655,349		16,630,311		14,649,418

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

(Unaudited)

For the nine months ended September 30, 2007 and 2006

	Common Stock
	Shares		Amount		Additional Paid-in Capital			Unearned Compensation			Retained Earnings			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity

Balances, December 31, 2005		8,426,551	$	8,426,551	$	44,890,912		$	(169,689	)	$	13,182,291		$	(2,893,640	)	$	63,436,425
Transfer of unearned compensation to additional paid-in capital upon adoption of SFAS No. 123(R)		-		-		(169,689	)		169,689			-			-			-
Exercise of employee common stock options and related tax benefits		93,435		93,435		964,582			-			-			-			1,058,017
Issuance of restricted common shares pursuant to 2004 Equity Incentive Plan		22,057		22,057		(22,057	)		-			-			-			-
Exercise of director common stock warrants		11,000		11,000		44,000			-			-			-			55,000
Stock based compensation expense		-		-		1,001,372			-			-			-			1,001,372
Dividends paid to minority interest shareholders of PNFP Properties, Inc.		-		-		-			-			(7,813	)		-			(7,813	)
Merger with Cavalry Bancorp, Inc.		6,856,298		6,856,298		164,231,274			-			-			-			171,087,572
Costs to register common stock issued in connection with the merger with Cavalry Bancorp, Inc.		-		-		(187,609	)		-			-			-			(187,609	)
Comprehensive income:
Net income		-		-		-			-			12,281,140			-			12,281,140
Net unrealized holding gains on available-for-sale securities, net of deferred tax expense of $205,497		-		-		-			-			-			335,284			335,284
Total comprehensive income																		12,616,424
Balances, September 30, 2006		15,409,341	$	15,409,341	$	210,752,785		$	-		$	25,455,618		$	(2,558,356	)	$	249,059,388

Balances, December 31, 2006		15,446,074	$	15,446,074	$	211,502,516		$	-		$	31,109,324		$	(2,040,893	)	$	256,017,021
Exercise of employee common stock options and related tax benefits		78,437		78,437		645,118			-			-			-			723,555
Issuance of restricted common shares pursuant to 2004 Equity Incentive Plan		28,526		28,526		(28,526	)		-			-			-			-
Stock based compensation expense		-		-		1,524,898			-			-			-			1,524,898
Comprehensive income:
Net income		-		-		-			-			16,799,515			-			16,799,515
Net unrealized holding losses on available-for-sale securities, net of deferred tax benefit of $262,665		-		-		-			-			-			(428,559	)		(428,559	)
Total comprehensive income																		16,370,956
Balances, September 30, 2007		15,553,037	$	15,553,037	$	213,644,006		$	-		$	47,908,839		$	(2,469,452	)	$	274,636,430

See accompanying notes to consolidated financial statements.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine months ended September 30,
	2007			2006
Operating activities:
Net income	$	16,799,515		$	12,281,140
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of premium on securities		376,450			591,794
Depreciation and net amortization		2,010,487			1,263,375
Provision for loan losses		2,460,028			2,680,638
Gains on loans and loan participations sold, net		(1,380,883	)		(1,285,609	)
Stock-based compensation expense		1,524,898			1,001,372
Deferred tax (benefit) expense		1,587,523			(1,110,490	)
Excess tax benefit from stock compensation		(128,678	)		(110,244	)
Mortgage loans held for sale:
Loans originated		(125,018,617	)		(104,455,073	)
Loans sold		126,137,833			102,030,399
(Increase) decrease in other assets		1,728,650			(3,580,936	)
Decrease in other liabilities		(3,461,145	)		(9,368,829	)
Net cash provided (used in) by operating activities		22,636,061			(62,463	)

Investing activities:
Activities in securities available-for-sale:
Purchases		(36,988,675	)		(38,573,610	)
Sales		-			-
Maturities, prepayments and calls		30,193,241			26,320,244
		(6,795,434	)		(12,253,366	)
Increase in loans, net		(232,911,778	)		(205,522,296	)
Purchases of premises and equipment and software		(5,097,092	)		(3,708,595	)
Cash and cash equivalents acquired in merger with Cavalry Bancorp, Inc., net of acquisition costs		-			37,420,210
Investments in unconsolidated subsidiaries and other entities		(1,222,570	)		(65,647	)
Purchases of other assets		-			(1,206,335	)
Net cash used in investing activities		(246,026,874	)		(185,336,029	)

Financing activities:
Net increase in deposits		205,095,262			192,206,552
Net increase in securities sold under agreements to repurchase		4,315,965			56,520,032
Net increase in Federal funds purchased		19,986,000			-
Advances from Federal Home Loan Bank:
Issuances		35,000,000			31,000,000
Payments		(53,040,828	)		(61,527,218	)
Proceeds from the issuance of subordinated debt		-			20,619,000
Exercise of common stock warrants		-			55,000
Exercise of common stock options		594,877			947,773
Excess tax benefit from stock compensation		128,678			110,244
Costs incurred in connection with registration of common stock issued in merger		-			(187,609	)
Net cash provided by financing activities		212,079,954			239,743,774
Net increase (decrease) in cash and cash equivalents		(11,310,859	)		54,345,282
Cash and cash equivalents, beginning of period		92,518,850			58,654,270
Cash and cash equivalents, end of period	$	81,207,991		$	112,999,552

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) is a bank holding company whose primary business is conducted by its wholly-owned subsidiary, Pinnacle National Bank (Pinnacle National). Pinnacle National is a commercial bank headquartered in Nashville, Tennessee with operations in Nashville and Knoxville, Tennessee. Pinnacle National provides a full range of financial services, including banking, investments, mortgages, and insurance.

Basis of Presentation — These consolidated financial statements include the accounts of Pinnacle Financial and its wholly-owned subsidiaries. PNFP Statutory Trust I, PNFP Statutory Trust II, PNFP Statutory Trust III and Collateral Plus, LLC, are affiliates of Pinnacle Financial and are included in these consolidated financial statements pursuant to the equity method of accounting. Significant intercompany transactions and accounts are eliminated in consolidation. The unaudited consolidated financial statements include, in the opinion of management, all adjustments necessary for a fair presentation of such financial statements for all periods presented. On the Consolidated Statements of Cash Flows for the nine months ended September 30, 2006, Pinnacle Financial reclassified $2.4 million of amortization of intangible assets arising from the acquisition of Cavalry Bancorp, Inc. ("Cavalry") to properly reflect the cash flow from operations for that period.

Use of Estimates — The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 include the determination of the allowance for loan losses.

Impairment— Long-lived assets, including purchased intangible assets subject to amortization, such as Pinnacle Financial’s core deposit intangible asset, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the excess of the carrying amount over the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated.

Goodwill and intangible assets that have indefinite useful lives are tested annually for impairment and more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. Pinnacle Financial’s annual assessment date is as of September 30 such that the assessment will be completed during the fourth quarter of each year. Should Pinnacle Financial determine in a future period that the goodwill recorded in connection with the acquisition of Cavalry has been impaired, then a charge to earnings will be recorded in the period such determination is made.

Cash and Cash Flows — Cash on hand, cash items in process of collection, amounts due from banks, Federal funds sold and securities purchased under agreements to resell, with original maturities within ninety days, are included in cash and cash equivalents. The following supplemental cash flow information addresses certain cash payments and noncash transactions for each of the nine months ended September 30, 2007 and 2006 as follows:

	*For the nine months ended September 30,*
	*2007*		*2006*
*Cash Payments:*
Interest	$	53,491,752	$	34,444,269
Income taxes		7,850,000		6,380,000
*Noncash Transactions:*
Loans charged-off to the allowance for loan losses		809,703		627,838
Loans foreclosed upon with repossessions transferred to other assets		240,878		-
Common stock and options issued to acquire Cavalry Bancorp, Inc		-		171,087,572

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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, warrants and restricted shares. The dilutive effect of outstanding options, warrants and restricted shares is reflected in diluted earnings per share by application of the treasury stock method.

As of September 30, 2007 and 2006, there were options outstanding to purchase 1,929,000 and 1,562,000 common shares, respectively. Most of these options have exercise prices, compensation costs attributable to future services and excess tax benefits, which when considered in relation to the average market price of Pinnacle Financial’s common stock, are considered dilutive and are considered in Pinnacle Financial’s diluted income per share calculation for the three and nine months ended September 30, 2007 and 2006. There were common stock options of 352,000, and 177,000 outstanding as of September 30, 2007 and 2006, respectively, which were considered anti-dilutive and thus have not been considered in the diluted earnings per share calculations below. Additionally, as of September 30, 2007 and 2006, Pinnacle Financial had outstanding warrants to purchase 395,000 of common shares which have been considered in the calculation of Pinnacle Financial’s diluted net income per share for three and nine months ended September 30, 2007 and 2006.

The following is a summary of the basic and diluted earnings per share calculation for the three and nine months ended September 30, 2007 and 2006:

	*For the three months ended September 30,*				*For the nine months ended September 30,*
	*2007*		*2006*		*2007*		*2006*
*Basic earnings per share calculation:*
Numerator - Net income	$	5,771,810	$	5,346,774	$	16,799,515	$	12,281,140

Denominator - Average common shares outstanding		15,503,284		15,393,735		15,477,339		13,450,282
Basic net income per share	$	0.37	$	0.35	$	1.09	$	0.91

*Diluted earnings per share calculation:*
Numerator - Net income	$	5,771,810	$	5,346,774	$	16,799,515	$	12,281,140

Denominator - Average common shares outstanding		15,503,284		15,393,735		15,477,339		13,450,282
Dilutive shares contingently issuable		1,106,044		1,261,614		1,152,972		1,199,136
Average diluted common shares outstanding		16,609,328		16,655,349		16,630,311		14,649,418
Diluted net income per share	$	0.35	$	0.32	$	1.01	$	0.84

Comprehensive Income — SFAS No. 130, “Reporting Comprehensive Income” describes comprehensive income as the total of all components of comprehensive income including net income. Other comprehensive income refers to revenues, expenses, gains and losses that under U.S. generally accepted accounting principles are included in comprehensive income but excluded from net income. Currently, Pinnacle Financial’s other comprehensive income consists of unrealized gains and losses, net of deferred income taxes, on securities available-for-sale. Pinnacle Financial’s total comprehensive income for the nine months ended September 30, 2007 and 2006 is included in the Consolidated Statements of Stockholders’ Equity and Comprehensive Income.

Note 2. Definitive Merger Agreement with Mid-America Bancshares, Inc.

On August 15, 2007, Pinnacle Financial announced that it had entered into a definitive merger agreement to acquire all of the outstanding common stock of Mid-America Bancshares, Inc. (“Mid-America”), a two-bank holding company located in Nashville, Tennessee with approximately $1.1 billion in assets as of September 30, 2007. Terms of the agreement call for each share of Mid-America to be exchanged for 0.4655 Pinnacle shares and $1.50 in cash, which results in the transaction approximating 90 percent paid in Pinnacle Financial shares and 10 percent paid in cash. As of the date the merger was announced, the transaction has an implied purchase price of $196.2 million. Additionally, all Mid-America stock options and stock appreciation rights will be converted to Pinnacle Financial stock options and stock appreciation rights upon the closing of the transaction. Mid-America was formed in 2006 for the purpose of combining two Nashville community banks: PrimeTrust Bank and Bank of the South, both founded in 2001. Subject to receipt of shareholder and regulatory approval and the satisfaction of customary closing conditions, the transaction is expected to close in the fourth quarter of 2007. At that time, Pinnacle Financial will have estimated assets of approximately $3.7 billion with 31 offices in nine counties, including several high-growth counties new to the Pinnacle footprint.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The aggregate consideration approximates 6.6 million shares of Pinnacle Financial common stock and $21.3 million in cash. As a result, Mid-America shareholders will own approximately 30 percent of the combined company. Including restricted shares, Mid-America had approximately 14.2 million common shares outstanding as of August 15, 2007. In order to finance the $21.3 million cash component of the aggregate consideration, on October 31, 2007, Pinnacle Financial issued approximately $30 million in trust preferred securities prior to the closing of the Mid-America transaction. The trust preferred securities will bear a floating interest rate based on a spread over 3-month LIBOR of approximately 2.85% which is set each quarter and mature in 2037. Distributions are payable quarterly. Subject to approval by the Federal Reserve Bank of Atlanta, the trust preferred securities may be redeemed prior to maturity at Pinnacle Financial’s option beginning in 2012.

Note 3. Merger with Cavalry Bancorp, Inc.

On March 15, 2006, Pinnacle Financial consummated its merger with Cavalry, a one-bank holding company located in Murfreesboro, Tennessee. Pursuant to the merger agreement, Pinnacle acquired all of the outstanding shares of Cavalry common stock via a tax-free exchange whereby Cavalry shareholders received a fixed exchange ratio of 0.95 shares of Pinnacle Financial common stock for each share of Cavalry common stock, or approximately 6.9 million Pinnacle Financial shares. The accompanying consolidated financial statements include the activities of the former Cavalry since March 15, 2006.

In accordance with SFAS No. 141, “Accounting for Business Combinations” (“SFAS No. 141”), SFAS No. 142, “Goodwill and Intangible Assets” (“SFAS No. 142”) and SFAS No. 147, “Acquisition of Certain Financial Institutions” (“SFAS No. 147”), Pinnacle Financial recorded at fair value the following assets and liabilities of Cavalry as of March 15, 2006:

Cash and cash equivalents	$	37,420,210
Investment securities – available-for-sale		39,476,178
Loans, net of an allowance for loan losses of $5,102,296		545,598,367
Goodwill		114,287,640
Core deposit intangible		13,168,236
Other assets		42,936,956
Total assets acquired		792,887,587

Deposits		583,992,422
Federal Home Loan Bank advances		17,766,661
Other liabilities		18,851,261
Total liabilities assumed		620,610,344
Total consideration paid for Cavalry	$	172,277,243

As shown in the table above, total consideration for Cavalry approximates $172.3 million of which $171.1 million was in the form of Pinnacle Financial common shares and options to acquire Pinnacle Financial common shares and $1.2 million in investment banking fees, attorney’s fees and other costs related to the acquisition which have been accounted for as a component of the purchase price. Pinnacle Financial issued 6,856,298 shares of Pinnacle Financial common stock to the former Cavalry shareholders. In accordance with EITF No. 99-12, “Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination,” the consideration shares were valued at $24.53 per common share which represents the average closing price of Pinnacle Financial common stock from the two days prior to the merger announcement on September 30, 2005 through the two days after the merger announcement. Aggregate consideration for the common stock issued was approximately $168.2 million. Additionally, Pinnacle Financial also has assumed the Cavalry Bancorp, Inc. 1999 Stock Incentive Plan (the “Cavalry Plan”) pursuant to which Pinnacle is obligated to issue 195,551 shares of Pinnacle Financial common stock upon exercise of stock options awarded to certain former Cavalry employees who held outstanding options as of March 15, 2006. All of these options were fully vested prior to the merger announcement date and expire at various dates between 2011 and 2012. The exercise prices for these stock options range between $10.26 per share and $13.68 per share. In accordance with SFAS No. 141, Pinnacle Financial has considered the fair value of these options in determining the acquisition cost of Cavalry. The fair value of these vested options approximated $2.9 million which has been included as a component of the aggregate purchase price.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

In accordance with SFAS Nos. 141 and 142, Pinnacle Financial recognized $13.2 million as a core deposit intangible in connection with its merger with Cavalry. This identified intangible is being amortized over seven years using an accelerated method which anticipates the life of the underlying deposits to which the intangible is attributable. For the nine months ended September 30, 2007 and 2006, $1,547,000 and $1,248,000 of amortization, respectively, was recognized in the accompanying statement of income. Amortization expense associated with this identified intangible will approximate $1.8 million to $2.1 million per year for the next four years with lesser amounts for the remaining two years.

Pinnacle Financial also recorded other adjustments to the carrying value of Cavalry’s assets and liabilities in order to reflect the fair value of those net assets in accordance with U.S. generally accepted accounting principles, including a $4.8 million discount associated with the loan portfolio, a $2.9 million premium for Cavalry’s certificates of deposit and a $4.6 million premium for Cavalry’s land and buildings. Pinnacle Financial also recorded the corresponding deferred tax assets or liabilities associated with these adjustments. The discounts and premiums related to financial assets and liabilities are being amortized into the statements of income using a method that approximates the level yield method over the anticipated lives of the underlying financial assets or liabilities. For the nine months ended September 30, 2007 and 2006, the accretion of the fair value discounts related to the acquired loans and certificates of deposit increased net interest income by approximately $2,061,000 and $2,382,000, respectively. Based on the estimated useful lives of the acquired loans and deposits, Pinnacle Financial expects to recognize increases in net interest income related to accretion of these purchase accounting adjustments of $1.9 million for the remainder of 2007 and in subsequent years.

Statement of Position 03-03, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-03”) addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans acquired in purchase business combinations and applies to all nongovernmental entities, including not-for-profit organizations. The SOP does not apply to loans originated by the entity. At March 15, 2006, Pinnacle Financial identified $3.9 million in loans to which the application of the provisions of SOP 03-03 was required. The purchase accounting adjustments reflect a reduction in loans and the allowance for loan losses of $1.0 million related to Cavalry’s impaired loans, thus reducing the carrying value of these loans to $2.9 million as of March 15, 2006. At September 30, 2007, the carrying value of these loans had been reduced to $756,000 due to cash payments received from the borrowers.

The following pro forma income statements assume the merger was consummated on January 1, 2006 and purchase accounting adjustments began to be recorded at that time. The pro forma information does not reflect Pinnacle Financial’s results of operations that would have actually occurred had the merger been consummated on such date (dollars in thousands, except per share information).

	Nine months ended September 30, 2006 (1)
*Pro Forma Income Statements:*
Net interest income	$	49,855
Provision for loan losses		3,662
Noninterest income		13,249
Noninterest expense:
Compensation		22,095
Other noninterest expense		15,140
Net income before taxes		22,207
Income tax expense		7,867
Net income	$	14,340

*Pro Forma Per Share Information:*
Basic net income per common share	$	0.97
Diluted net income per common share	$	0.89

Weighted average shares outstanding:
Basic		14,840,326
Diluted		16,039,462

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

______________

(1)

In preparation and as a result of the merger during 2006, Cavalry and Pinnacle Financial incurred significant merger related charges of approximately $10.6 million in the aggregate, primarily for severance benefits, accelerated vesting of defined compensation agreements, investment banker fees, etc. Including these charges would have decreased pro forma net income for the nine months ended September 30, 2006 by $7.5 million resulting in net income of $6,841,000 and a basic and fully diluted net income per share of $0.46 and $0.43, respectively.

During the three and nine months ended September 30, 2006, Pinnacle Financial incurred merger integration expense related to the merger with Cavalry of $218,000 and $1,583,000, respectively. These expenses were directly related to the merger, recognized as incurred and reflected on the accompanying consolidated statement of income as merger related expense.

Note 4. Securities

The amortized cost and fair value of securities available-for-sale and held-to-maturity at September 30, 2007 and December 31, 2006 are summarized as follows:

	September 30, 2007
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Securities available-for-sale:
U.S. Treasury securities	$	-	$	-	$	-	$	-
U.S. government agency securities		37,094,336		39,148		171,478		36,962,006
Mortgage-backed securities		216,191,499		309,176		3,523,811		212,976,864
State and municipal securities		74,509,398		51,644		768,496		73,792,546
Corporate notes and other		1,487,539		-		47,829		1,439,710
	$	329,282,772	$	399,968	$	4,511,614	$	325,171,126
Securities held-to-maturity:
U.S. government agency securities	$	17,747,473	$	-	$	185,173	$	17,562,300
State and municipal securities		9,303,464		-		262,350		9,041,114
	$	27,050,937	$	-	$	447,523	$	26,603,414

	December 31, 2006
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Securities available-for-sale:
U.S. Treasury securities	$	-	$	-	$	-	$	-
U.S. Government agency securities		38,076,428		9,739		457,321		37,628,846
Mortgage-backed securities		220,397,093		455,203		3,028,241		217,824,055
State and municipal securities		62,215,952		131,412		388,124		61,959,240
Corporate notes and other		1,887,475		-		62,188		1,825,287
	$	322,576,948	$	596,354	$	3,935,874	$	319,237,428
Securities held-to-maturity:
U.S. government agency securities	$	17,747,228	$	-	$	378,528	$	17,368,700
State and municipal securities		9,509,648		-		284,113		9,225,535
	$	27,256,876	$	-	$	662,641	$	26,594,235

At September 30, 2007, approximately $176,081,000 of Pinnacle Financial’s investment portfolio was pledged to secure public funds and other deposits and securities sold under agreements to repurchase.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

At September 30, 2007 and December 31, 2006, included in securities were the following investments with unrealized losses. The information below classifies these investments according to the term of the unrealized loss of less than twelve months or twelve months or longer:

	Investments with an Unrealized Loss of less than 12 months				Investments with an Unrealized Loss of 12 months or longer				Total Investments with an Unrealized Loss
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
At September 30, 2007:

U.S. government agency securities	$	-	$	-	$	42,161,570	$	356,651	$	42,161,570	$	356,651
Mortgage-backed securities		35,898,115		258,967		127,576,903		3,264,844		163,475,018		3,523,811
State and municipal securities		33,377,347		254,388		35,579,684		776,458		68,957,031		1,030,846
Corporate notes and other		-		-		1,439,710		47,829		1,439,710		47,829
Total temporarily-impaired securities	$	69,275,462	$	513,355	$	206,757,867	$	4,445,782	$	276,033,329	$	4,959,137

At December 31, 2006:

U.S. government agency securities	$	-	$	-	$	47,988,246	$	835,849	$	47,988,246	$	835,849
Mortgage-backed securities		13,959,080		68,965		149,496,521		2,959,276		163,455,601		3,028,241
State and municipal securities		13,975,595		47,071		35,660,379		625,166		49,635,974		672,237
Corporate notes and other		-		-		1,825,286		62,188		1,825,286		62,188
Total temporarily-impaired securities	$	27,934,675	$	116,036	$	234,970,432	$	4,482,479	$	262,905,107	$	4,598,515

Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of Pinnacle Financial to retain its investment in the issue for a period of time sufficient to allow for any anticipated recovery in fair value. Because the declines in fair value noted above were attributable to increases in interest rates and not attributable to credit quality and because Pinnacle Financial has the ability and intent to hold all of these investments until a market price recovery or maturity, the impairment of these investments is not deemed to be other-than-temporary.

Note 5. Loans and Allowance for Loan Losses

The composition of loans at September 30, 2007 and December 31, 2006 is summarized as follows:

	*At September 30,*			*At December 31,*
	*2007*			*2006*

Commercial real estate – Mortgage	$	315,340,104		$	284,301,650
Commercial real estate – Construction		176,130,568			161,903,496
Commercial – Other		780,340,943			608,529,830
Total Commercial		1,271,811,615			1,054,734,976
Consumer real estate – Mortgage		297,360,456			299,626,769
Consumer real estate – Construction		112,889,641			91,193,738
Consumer – Other		49,183,568			52,179,341
Total Consumer		459,433,665			442,999,848
Total Loans		1,731,245,280			1,497,734,824
Allowance for loan losses		(17,978,429	)		(16,117,978	)
Loans, net	$	1,713,266,851		$	1,481,616,846

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Changes in the allowance for loan losses for the nine months ended September 30, 2007 and for the year ended December 31, 2006 are as follows:

	September 30, 2007			December 31, 2006

Balance at beginning of period	$	16,117,978		$	7,857,774
Charged-off loans		(809,704	)		(818,467	)
Recovery of previously charged-off loans		210,127			244,343
Allowance acquired in acquisition of Cavalry (see note 2)		-			5,102,296
Provision for loan losses		2,460,028			3,732,032
Balance at end of period	$	17,978,429		$	16,117,978

At September 30, 2007 and at December 31, 2006, Pinnacle Financial had certain impaired loans on nonaccruing interest status. The principal balance of these nonaccrual loans amounted to $2,364,000 and $7,070,000 at September 30, 2007 and December 31, 2006, 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 nonaccruing loans been on accruing status, interest income would have been higher by $108,000 and $202,000 for the nine months ended September 30, 2007 and 2006, respectively.

At September 30, 2007, Pinnacle Financial had granted loans and other extensions of credit amounting to approximately $24,095,000 to certain directors, executive officers, and their related entities, of which $14,676,000 had been drawn upon. During the nine months ended September 30, 2007, $20,000 of new loans to certain directors, executive officers, and their related entities were made and repayments totaled $2,085,000. At December 31, 2006, Pinnacle Financial had granted loans and other extensions of credit amounting to approximately $29,942,000 to certain directors, executive officers, and their related entities, of which approximately $17,461,000 had been drawn upon. The terms of these loans and extensions are substantially the same terms customary for other persons for the type of loan involved. None of these loans to certain directors, executive officers, and their related entities, were impaired at September 30, 2007.

During the three and nine months ended September 30, 2007 and 2006, 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 U.S. generally accepted accounting principles, Pinnacle Financial recognized a net gain on the sale of these participated loans for the nine months ended September 30, 2007 and 2006 of approximately $230,000 and $224,000, 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 bank based on their participation in the loans. At September 30, 2007, Pinnacle Financial was servicing $132 million of loans for correspondent banks and other entities, of which $125 million was commercial loans.

SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140”.(“SFAS No. 156”) requires an entity to recognize a servicing asset or servicing liability each time it undertakes a contractual obligation to service a financial asset in certain circumstances. All separately recognized servicing assets and servicing liabilities are required to be initially measured at fair value. Subsequent measurement methods include the amortization method, whereby servicing assets or servicing liabilities are amortized in proportion to and over the period of estimated net servicing income or net servicing loss, or the fair value method, whereby servicing assets or servicing liabilities are measured at fair value at each reporting date and changes in fair value are reported in earnings in the period in which they occur. If the amortization method is used, an entity must assess servicing assets or servicing liabilities for impairment or increased obligation based on the fair value at each reporting date. SFAS No. 156 is effective for fiscal years beginning after December 15, 2006. As a result of the adoption of SFAS 156, Pinnacle Financial has approximately $55,000 recorded as a servicing liability as of September 30, 2007.

Note 6. Income Taxes

FASB Interpretation 48, “Accounting for Income Tax Uncertainties” (“FIN 48”) was issued in June 2006 and defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. FIN 48 also provides guidance on the derecognition, measurement and classification of income tax uncertainties, along with any related interest and penalties and includes guidance concerning accounting for income tax uncertainties in interim periods. Pinnacle Financial adopted the provisions of FIN 48, on January 1, 2007, and determined there was no need to make an adjustment to retained earnings upon adoption of this Interpretation.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

As of January 1, 2007, Pinnacle Financial has accrued no interest and no penalties related to uncertain tax positions. It is Pinnacle Financial’s policy to recognize interest and/or penalties related to income tax matters in income tax expense.

Pinnacle Financial and its subsidiaries file a consolidated U.S. Federal income tax return. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2005 through 2006. Pinnacle Financial and its subsidiaries’ state income tax returns are open to audit under the statute of limitations for the years ended December 31, 2002 through 2006.

Income tax expense attributable to income from continuing operations for the three and nine months ended September 30, 2007 and 2006 consists of the following:

	Three Months Ended September 30,					Nine months Ended September 30,
	2007			2006		2007		2006
Current tax expense (benefit):
Federal	$	762,232		$	2,404,721	$	5,894,231	$	6,644,857
State		(40,480	)		118,652		153,061		428,745
Total current tax expense (benefit)		721,752			2,523,373		6,047,292		7,073,602
Deferred tax expense (benefit):
Federal		1,805,893			57,292		1,531,720		(949,171	)
State		110,252			14,800		55,803		(161,319	)
Total deferred tax expense (benefit)		1,916,145			72,092		1,587,523		(1,110,490	)
	$	2,637,897		$	2,595,465	$	7,634,815	$	5,963,112

Pinnacle Financial's income tax expense (benefit) differs from the amounts computed by applying the Federal income tax statutory rates of 35% in 2007 and 2006 to income before income taxes. A reconciliation of the differences for the three and nine months ended September 30, 2007 and 2006 is as follows:

	Three Months Ended September 30,						Nine months Ended September 30,
	2007			2006			2007			2006

Income taxes at statutory rate	$	2,943,397		$	2,779,782		$	8,552,015		$	6,385,488
State tax expense, net of federal tax effect		45,352			86,743			135,762			173,827
Federal tax credits		(90,000	)		(75,000	)		(270,000	)		(225,000	)
Tax-exempt securities		(217,167	)		(155,154	)		(615,896	)		(425,766	)
Other items		(43,685	)		(40,906	)		(167,066	)		54,563
Income tax expense	$	2,637,897		$	2,595,465		$	7,634,815		$	5,963,112

The effective tax rate for 2007 and 2006 is impacted by Federal tax credits related to the New Markets Tax Credit program whereby a subsidiary of Pinnacle National has been awarded approximately $2.3 million in future Federal tax credits which are available thru 2010. Tax benefits related to these credits will be recognized for financial reporting purposes in the same periods that the credits are recognized in the Company’s income tax returns. The credit that is available for the year ended December 31, 2007 is $360,000 and for the year ended December 31, 2006 is $300,000. Pinnacle Financial believes that it will comply with the various regulatory provisions of the New Markets Tax Credit program, and therefore has reflected the impact of the credits in its estimated annual effective tax rate for 2007 and 2006.

The components of deferred income taxes included in other assets in the accompanying consolidated balance sheets at September 30, 2007 and December 31, 2006 are as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	2007		2006
Deferred tax assets:
Allowance for loan losses	$	7,049,011	$	6,654,334
Loans		1,018,955		1,337,983
Securities		1,514,302		1,251,636
Accrued liability for supplemental retirement agreements		1,599,756		1,535,688
Deposits		342,186		585,568
Other deferred tax assets		424,155		340,296
		11,948,365		11,705,505
Deferred tax liabilities:
Depreciation and amortization		2,280,204		1,563,078
Core deposit intangible asset		3,866,162		4,473,076
REIT dividends		1,250,732		-
FHLB dividends		855,833		770,156
Other deferred tax liabilities		561,738		440,642
		8,814,669		7,246,952
Net deferred tax assets	$	3,133,696	$	4,458,553

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.

Note 7. 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 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

A summary of Pinnacle Financial's total contractual amount for all off-balance sheet commitments at September 30, 2007 is as follows:

Commitments to extend credit		$	592,441,536
Standby letters of credit			63,642,493

At September 30, 2007, the fair value of Pinnacle Financial’s standby letters of credit was $211,000. 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.

Various legal claims also arise from time to time in the normal course of business. As of September 30, 2007, management is not aware of any such proceedings against Pinnacle Financial.

Note 8. Stock Option Plan and Restricted Shares

Pinnacle Financial has two equity incentive plans under which it has granted stock options to its employees to purchase common stock at or above the fair market value on the date of grant and granted restricted share awards to employees and directors. During the first quarter of 2006 and in connection with its merger with Cavalry, Pinnacle Financial assumed a third equity incentive plan, the 1999 Cavalry Bancorp, Inc. Stock Option Plan (the “Cavalry Plan”). All options granted under the Cavalry Plan were fully vested prior to Pinnacle Financial’s merger with Cavalry and expire at various dates between January 2011 and June 2012.

As of September 30, 2007, of the approximately 1,929,000 stock options outstanding, 1,213,000 of those options were granted with the intention to be incentive stock options qualifying under Section 422 of the Internal Revenue Code for favorable tax treatment to the option holder while 716,000 options would be deemed non-qualified stock options and thus not subject to favorable tax treatment to the option holder. All stock options under the plans vest in equal increments over five years from the date of grant and are exercisable over a period of ten years from the date of grant.

A summary of the activity within the three equity incentive plans during the nine months ended September 30, 2007 and information regarding expected vesting, contractual terms remaining, intrinsic values and other matters was as follows:

Number

Weighted- Average

Exercise Price

Weighted- Average

Contractual

Remaining

Term (in years)

Aggregate

Intrinsic Value

(1) (000’s)

Outstanding at December 31, 2006

1,658,459

12.93

6.4

31,848

Granted

371,843

30.69

Exercised

(78,437

)

7.58

Forfeited

(22,608

)

27.79

Outstanding at September 30, 2007

1,929,257

17.36

6.4

23,334

Outstanding and expected to vest as of September 30, 2007

1,887,595

17.16

6.4

23,192

Options exercisable at September 30, 2007

1,047,280

9.24

4.7

20,564

_______________

(1)

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of Pinnacle Financial common stock of $28.82 and $33.18 per common share for the approximately 1.6 million options that were in-the-money at September 30, 2007 and December 31, 2006.

During the nine months ended September 30, 2007, 200,000 option awards vested at an average exercise price of $16.84 and an intrinsic value of approximately $2.4 million.

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PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

During the nine months ended September 30, 2007, the aggregate intrinsic value of options exercised under the equity incentive plans was $1.79 million determined as of the date of option exercise. As of September 30, 2007, there was approximately $6.75 million of total unrecognized compensation cost related to unvested stock options granted under the equity incentive plans. That cost is expected to be recognized over a weighted-average period of 4.0 years.

During the three and nine months ended September 30, 2007 and 2006, Pinnacle Financial recorded stock-based compensation expense using the Black-Scholes valuation model for awards granted prior to, but not yet vested, as of January 1, 2006 and for stock-based awards granted after January 1, 2006. For these awards, Pinnacle Financial has recognized compensation expense using a straight-line amortization method. Stock-based compensation expense has been reduced for estimated forfeitures. The impact on the Company’s results of operations (compensation and employee benefits expense) and earnings per share of recording stock-based compensation in accordance with SFAS No. 123(R) “Share Based Payments” (related to stock option awards) for the three and nine months ended September 30, 2007 and 2006 was as follows:

	Three months ended September 30, 2007
	Awards granted with the intention to be classified as incentive stock options		Non-qualified stock option awards		Total		Three months ended September 30, 2006

Stock-based compensation expense	$	113,000	$	339,000	$	452,000	$	285,000
Deferred income tax benefit		-		133,000		133,000		57,000
Impact of stock-based compensation expense after deferred income tax benefit	$	113,000	$	206,000	$	319,000	$	228,000
Impact on earnings per share:
Basic	$	0.01	$	0.01	$	0.02	$	0.01
Fully diluted	$	0.01	$	0.01	$	0.02	$	0.01

	Nine months ended September 30, 2007
	Awards granted with the intention to be classified as incentive stock options		Non-qualified stock option awards		Total		Nine months ended September 30, 2006

Stock-based compensation expense	$	344,000	$	909,000	$	1,253,000	$	690,000