QUALMARK CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES)

		September 30, 2007				December 31, 2006
		(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents		$	1,401			$	1,179
Available for sale securities			63				—
Trade accounts receivable, net of allowance for doubtful accounts of $50 for each period			2,328				3,420
Inventories, net			3,052				2,524
Current deferred tax assets, net			943				943
Other current assets			382				143
Total current assets			8,169				8,209
Property and equipment, net			722				787
Restricted cash			90				90
Goodwill			1,057				1,057
Intangible assets			1,002				1,012
Non-current deferred tax assets, net			508				430
Other assets			444				464
		$	11,992			$	12,049
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	810			$	719
Accrued expenses			736				682
Deferred revenue and customer deposits			220				18
Advance billings on contracts			246				—
Current portion of long-term debt			1,544				913
Revolving line of credit			788				1,100
Total current liabilities			4,344				3,432
Deferred revenue and other			16				29
Long-term debt, net of current portion			505				1,627
Total liabilities			4,865				5,088
Commitments and contingencies
Shareholders’ equity:
Common stock; no par value; 15,000,000 shares authorized; 8,825,288 shares (2007) and 8,779,362 shares (2006) issued and outstanding			10,653				10,409
Accumulated deficit			(3,526	)			(3,448	)
Total shareholders’ equity			7,127				6,961
		$	11,992			$	12,049

The accompanying notes are an integral part of the condensed consolidated financial statements.

QUALMARK CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY AND
COMPREHENSIVE LOSS
NINE MONTHS ENDED SEPTEMBER 30, 2007
(UNAUDITED, AMOUNTS IN THOUSANDS, EXCEPT FOR NUMBER OF SHARES)

														Accumulated
														Other
		Common Stock								Accumulated				Comprehensive
		Shares				Amount				Deficit				Income				Total
Balance January 1, 2007			8,779,362			$	10,409			$	(3,448	)		$	—			$	6,961
Common stock issued for interest on convertible debt			45,426				69				—				—				69
Options exercised			500				1				—				—				1
Beneficial conversion feature on convertible debt and interest			—				105				—				—				105
Stock-based compensation expense			—				69				—				—				69
Components of comprehensive income:
Unrealized holding gain arising from available for sale securities			—				—				—				*				*
Net loss			—				—				(78	)			—				(78	)
Total comprehensive loss																			(78	)
Balance September 30, 2007			8,825,288			$	10,653			$	(3,526	)		$	*			$	7,127

The accompanying notes are an integral part of the condensed consolidated financial statements.

QUALMARK CORPORATION AND SUSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, AMOUNTS IN THOUSANDS)

		For the nine				For the nine
		months ended				months ended
		September 30,				September 30,
		2007				2006
Cash Flows From Operating Activities:
Net (loss) income		$	(78	)		$	722
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Change in provision for inventory allowance			9				(11	)
Change in provision for accounts receivable allowance			—				(1	)
Depreciation and amortization			251				275
Stock-based compensation expense			69				86
Loss (gain) on sale of assets			1				(8	)
Amortization on debt discounts			26				—
Deferred tax (benefit) expense			(78	)			30
Paid in kind (common stock) interest expense			69				61
Change in operating assets and liabilities:
Trade accounts receivable			1,092				156
Inventories			(489	)			(99	)
Other assets			(258	)			(159	)
Accounts payable and accrued expenses			145				(381	)
Advance billings on contracts			246				—
Deferred revenue and other			189				(46	)
Net cash provided by operating activities			1,194				625
Cash Flows From Investing Activities:
Cash paid for investments			(63	)			—
Sale of property and equipment			—				27
Purchase of Derritron, Inc. assets			(69	)			—
Acquisition of property and equipment			(117	)			(182	)
Net cash used in investing activities			(249	)			(155	)
Cash Flows From Financing Activities:
Issuance of common stock upon exercise of options			1				30
Proceeds from borrowings			500				400
Repayments on borrowings			(1,224	)			(685	)
Net cash used in financing activities			(723	)			(255	)
Net increase in cash and cash equivalents			222				215
Cash and cash equivalents at beginning of period			1,179				529
Cash and cash equivalents at end of period		$	1,401			$	744
Supplemental Disclosure:
Interest paid		$	186			$	187
Income taxes paid		$	14			$	35
Non-Cash Investing and Financing Activities:
Beneficial conversion feature on convertible debt		$	105			$	3,132
Conversion of convertible debt to common stock		$	—			$	40
Transfer of equipment to inventory held for resale		$	48			$	40
Preferred stock dividends		$	—			$	156
Accretion of preferred stock		$	—			$	183

The accompanying notes are an integral part of the condensed consolidated financial statements.

QUALMARK CORPORATION AND SUDSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

QualMark Corporation (the “Company”) was founded in 1991 and is a manufacturer and distributor of physical stress systems, as well as a provider of physical stress testing services. Physical stress systems rapidly and efficiently expose product design and manufacturing related failures of customer products and components, thereby providing manufacturers necessary information to improve product design, quality and reliability. The Company also provides physical stress testing services through its network of test centers. The Company’s wholly-owned subsidiaries, Qualmark ACG Corporation (“Qualmark ACG”) and QualMark Ling Electronics Corporation (“QualMark Ling”) supply electrodynamic systems, components, and service to the worldwide vibration test equipment market.

NOTE 1 — Business and Summary of Significant Accounting Policies

Financial Presentation

These financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2006 and notes thereto as well as other information and analysis included in the Company’s Form 10-KSB for the year then ended.

The interim financial data for the three and nine months ended September 30, 2007 and 2006 is unaudited; however, in the opinion of the management of the Company, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods presented. Results for the nine months ended September 30, 2007 are not necessarily indicative of results for the remainder of 2007. Amounts at December 31, 2006 are derived from the Company’s audited consolidated financial statements.

Income Taxes

The Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) on January 1, 2007. The Company did not identify any controversial tax positions taken on open tax years and did not have any unrecognized tax benefits, and there was no effect on the Company’s financial condition or results of operations as a result of implementing FIN 48.

The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is no longer subject to U.S federal tax examinations for years before 2003. State jurisdictions that remain subject to examination range from 2002 to 2006. The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months.

The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, the Company did not have any accrued interest or penalties associated with any unrecognized tax benefits and no interest expense or penalties were recognized during the quarter.

Stock Based Compensation

In the three months ended September 30, 2007, the Company recorded compensation expense related to stock options that reduced income from operations by $21,000, incurred a tax benefit of $11,000, increased the net loss by $10,000, and basic net income per share less than $0.01 per share. In the three months ended September 30, 2006, the Company recorded compensation expense related to stock options that reduced income from operations by $28,000, reduced the provision for income taxes by $1,000, reduced net income by $27,000, and basic net income per share less than $0.01 per share. In the nine months ended September 30, 2007, the Company recorded compensation expense related to stock options that reduced income from operations by $69,000, incurred a tax benefit of $37,000, increased the net loss by $32,000, and basic net income per share less than $0.01 per share. In the nine months ended September 30, 2006, the Company recorded compensation expense related to stock options that reduced income from operations by $86,000, reduced the provision for income taxes by $3,000, reduced net income by $83,000, and basic net income per share less than $0.01 per share. The stock based-compensation

expense was included in selling, general and administrative expenses in the accompanying condensed consolidated statements of income.

The Company did not grant any options during the three or nine months ended September 30, 2007. For options granted subsequent to our adoption date of SFAS 123R on January 1, 2006, the fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option pricing model. The Company used the following assumptions to determine the fair value of stock option grants during the nine months ended June 30, 2006:

Expected life		3 years
Volatility			126	%
Risk-free interest rate			4.6	%
Dividend yield			0.0	%

The expected term of stock options represents the period of time that the stock options granted are expected to be outstanding based on historical exercise trends. The expected volatility is based on the historical price volatility of the Company’s common stock. The risk-free interest rate represents the U.S. Treasury bill rate for the expected life of the related stock options. The dividend yield represents the Company’s anticipated cash dividend over the expected life of the stock options.

     A summary of stock option activity for the nine months ended September 30, 2007 is presented below:

										Weighed
						Weighted				Average
		Shares				Average				Remaining				Aggregate
		Under				Exercise				Contractual				Intrinsic
		Option				Price				Life				Value
Outstanding at January 1, 2007			861,360			$	1.86
Granted			—				—
Exercised			(500	)			0.60
Forfeited			(37,750	)			2.37
Outstanding at September 30, 2007			823,110			$	1.81			3.57 Years				$	—
Exercisable at September 30, 2007			668,490			$	1.82			3.53 Years				$	—

The total fair value of stock options that vested during the three months ended September 30, 2007 and 2006 was $8,000 and $12,000, respectively. The total fair value of stock options that vested during the nine months ended September 30, 2007 and 2006 was $64,000 and $31,000, respectively. The weighted average grant date fair value of options granted during the three and nine months ended September 30, 2006 was $11,000 and $294,000, respectively. As of September 30, 2007, the Company had approximately 49,000 options available for issuance.

A summary of the status of the Company’s nonvested options as of September 30, 2007, and changes during the nine months ended September 30, 2007 is presented below.

		Nonvested				Weighted
		Shares				Average
		Under				Grant Date
		Option				Fair Value
Nonvested at January 1, 2007			251,570			$	1.76
Granted			—				—
Vested			(89,980	)			0.71
Forfeited			(6,970	)			1.60
Nonvested at September 30, 2007			154,620			$	1.79

As of September 30, 2007, the Company had $110,000 of unrecognized compensation cost related to stock options that will be recognized over a weighted average period of approximately 2 years.

Revenue Recognition

During 2007, the Company entered into a long-term sales contract for an electrodynamic system that is to be delivered on/or about December 31, 2007. The Company has determined that in order to properly match revenue and expenses associated with this contract, it has adopted the percentage of completion method as defined by the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”). Under SOP 81-1, the Company, during the three and nine months ended September 30, 2007, has recognized $207,000 and $236,000, respectively of revenue. The Company recorded $246,000 of advance billings on contracts (current liability) for cash payments received on the contract in excess of recognized revenue for the nine months ended September 30, 2007.

Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income”, requires the reporting and display of comprehensive income and its components. SFAS No. 130 requires unrealized gains and losses on the Company’s available-for-sale securities to be included in comprehensive income (loss).

Available For Sale Securities

Available for sale securities are carried at the estimated fair value ($63,000 at September 30, 2007) based upon quoted market prices, and are classified as current assets in the Company’s September 30, 2007 consolidated balance sheet, as management reasonably expects the securities to be realized in cash within the next year. Unrealized gains and losses are computed on the basis of specific identification and are reported as a separate component on comprehensive income (loss), included as a separate item in shareholders’ equity. Realized gains, realized losses, and declines in value, judged to be other-than-temporary, are included in other income (expense). The unrealized gain during the three and nine months ended September 30, 2007, was less than $1,000.

NOTE 2 — Inventories

Inventories consist of the following (in thousands):

		September 30,				December 31,
		2007				2006
Raw materials		$	2,295			$	2,098
Work in process			258				250
Finished goods			702				370
Less: Allowance for obsolescence			(203	)			(194	)
		$	3,052			$	2,524

The Company monitors inventory for turnover and obsolescence, and records reserves for excess and obsolete inventory as appropriate.

NOTE 3 — Intangible Assets

Intangible assets consist of the following (in thousands):

		September 30, 2007				December 31, 2006
Ling Electronics trade name/symbol (indefinite life)		$	849			$	849
ACG Dynamics customer list (5 year life)			152				152
ACG Dynamics non-compete agreement (2 year life)			74				74
Derritron Inc. intangible assets (10 year life)			20				—
Copyright, patents, and trademarks (2 to 20 year life)			402				402
CE Certification (4 year life)			64				64
Other intangibles (3 to 5 year life)			80				61
			1,641				1,602
Less: Accumulated amortization			(639	)			(590	)
		$	1,002			$	1,012

During the nine months ended September 30, 2007, the Company purchased the assets of Derritron, Inc., which consisted of fixed assets and technical drawings for $69,000 cash. Management believes the purchase strengthens the Company’s product offerings and develops deeper customer relationships within the Company’s market. Amortization expense on all intangible assets was approximately $16,000 and $26,000 for the three months ended September 30, 2007 and 2006, respectively. Amortization expense on all intangible assets was approximately $49,000 and $73,000 for the nine months ended September 30, 2007 and 2006, respectively.

NOTE 4 — Borrowings

The Company’s commercial borrowings consist of a term loan with a revolving line of credit (“Credit Agreement”) and two convertible subordinated debt agreements (“Convertible Debt”).

Credit Agreement

On March 13, 2007, the Company entered into the Fifth Amendment to a Loan and Security Agreement (“Fifth Amendment’) with its commercial bank. Among other things, the Fifth Amendment waived all financial covenant violations through January 31, 2007, reduced the financial covenant requirements, restructured the current term loan to extend the amortization period over a term of 24 months and increased the per annum interest rate to 9.75%. On April 2, 2007, the Company entered into the Sixth Amendment to the Loan and Security Agreement (“Sixth Amendment”) with its commercial bank, which further reduced the financial covenant requirements through May 31, 2007. Effective June 1, 2007, the financial covenant requirements resumed as previously established by the Fifth Amendment. As of September 30, 2007, the principal balance of the term loan was $668,000.

Both the revolving credit line and term loan under the Credit Agreement are collateralized by substantially all the assets of the Company. Borrowings under the line of credit are subject to borrowing base limits. As of September 30, 2007, there was $788,000 outstanding in borrowings (classified as current) and $606,000 of availability on the line of credit.

As required by the Credit Agreement, the Company is to make total monthly principal payments of $36,000 on the term loan during 2007. The Company has also determined that, during 2007, draws and payments on the revolving line of credit are expected to be made based on operational cash flows.

Convertible Debt

On February 20, 2007, the Company entered into an additional convertible debt agreement (“Additional Convertible Debt”) with the existing debt holder (“Debt Holder”) of the Convertible Debt. The Additional Convertible Debt agreement provides for a term loan in the amount of $500,000, which was received on February 21, 2007. All of the proceeds were used to pay off a portion of the term loan within the Credit Agreement. The Additional Convertible Debt agreement is a thirty-three month, interest only, convertible subordinated debt agreement, subordinate to the claims of the commercial bank. The Additional Convertible Debt agreement bears interest at a rate of 8% per annum, which is payable in common stock. The conversion provisions of the Additional Convertible Debt agreement permit the Debt Holder to convert the Additional Convertible Debt into the common stock of the Company at a fixed price of $1.50 per share at any time prior to the maturity date. As of September 30, 2007, the principal balance (net of a debt discount of $79,000), of the Convertible Debt was $1,381,000. Under the terms of the Convertible Debt, the entire principal balance is due in November 2009.

The conversion terms included within the Additional Convertible Debt agreement resulted in a beneficial conversion feature of $100,000. This beneficial conversion feature resulted in an increase in equity and a debt discount. The Company is accreting this discount to interest expense over the term of the Additional Convertible Debt agreement. As a result of the beneficial conversion feature, the effective interest rate on the Additional Convertible Debt agreement is approximately 16.8%. The accretion recorded for the three and nine months ended September 30, 2007 was $9,000 and $21,000, respectively. The Company is also amortizing the effect of the applicable conversion terms included within the Additional Convertible Debt agreement on the interest payable in the Company’s common stock, which resulted in additional interest expense for the three and nine months ended September 30, 2007 of $2,000 and $5,000, respectively. This additional interest expense will be incurred through the term of the Additional Convertible Debt agreement.

On December 12, 2005, the Company entered into a Loan Modification Agreement (“Loan Modification Agreement”) with the Debt Holder, to modify certain existing loan documents. The Loan Modification Agreement allowed the Company to take on additional senior debt to complete the asset acquisition of Ling Electronics (refer to the 2006 10KSB, Financial Statement Note 15). This Loan Modification Agreement, among other things, required the Company to provide a cash deposit of $350,000 as additional security for the obligations outstanding with the Debt Holder. This additional cash security deposit was recorded as an other long-term asset. The deposit does not bear interest and at the maturity date of the Debt Holder obligations will be applied to the outstanding amounts or will be returned to the Company.

The Company must maintain certain financial and other covenants to be in compliance with the Credit Agreement and the Convertible Debt. The Company is not now, nor has it ever been in arrears on any payment pursuant to the Credit Agreement or the Convertible Debt. As of September 30, 2007, the Company was not in compliance with certain financial covenants pertaining to the Credit Agreement and Convertible Debt. As a result, all amounts due under the Credit Agreement are callable by the lender. Therefore, the Company has classified the Credit Agreement term loan balance ($668,000) to current liabilities based on the covenant violations, as they have not yet been cured, and the debt is now callable. The Company has also classified a portion of the Convertible Debt balance ($876,000) as a current liability based on the covenant violations, as they have not yet been cured. The reclassification on the balance sheet was made because the Convertible Debt is now amortizable over a 30 month period, rather than due in full in November 2009. On November 6, 2007, the Company elected to accelerate its Convertible Debt, based on previous financial covenant defaults. The Convertible Debt agreements call for an equal 30 month amortization of the outstanding balance, which was $1,460,000 before any amortization payments, as cure for the financial covenant defaults. The Company has been in default of certain financial covenants of the Convertible Debt since June 30, 2007, however, since that time, the Debt Holder and the Company have been in discussion regarding alternative cures for the financial covenant default. Based on the analysis of the alternative cures, the Company began amortizing the Convertible Debt as originally stated in the Convertible Debt agreements. Therefore, on November 6, 2007, the Company paid the Debt Holder $292,000 to cure defaults from June 30, 2007 through September 30, 2007 and have begun making monthly amortization payments of $49,000.

The weighted average interest rate on all outstanding debt for the nine months ended September 30, 2007 and 2006 was 10.86% and 8.46%, respectively.

NOTE 5 —Income Per Share

Basic income per share is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding during the period. Diluted income per share is computed using the weighted average number of shares determined for the basic computations plus the number of shares of common stock that would be issued assuming all contingently issuable shares having a dilutive effect on earnings per share were outstanding for the period, using the if-converted or treasury-stock methods.

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2007				2006				2007				2006
BASIC:
Net (loss) income		$	(189	)		$	192			$	(78	)		$	722
Accretion of redeemable preferred stock			—				(109	)			—				(183	)
Preferred stock dividends			—				(34	)			—				(156	)
Net (loss) income available to common shareholders — basic		$	(189	)		$	49			$	(78	)		$	383
Weighted average shares outstanding — basic			8,825				6,240				8,805				5,050
Net (loss) income per share — basic		$	(0.02	)		$	0.01			$	(0.01	)		$	0.08
DILUTED:
Net (loss) income		$	(189	)		$	192			$	(78	)		$	722
Accretion of redeemable preferred stock and preferred stock dividends			—				(143	)			—				(339	)
Interest expense from convertible debt			—				19				—				55
Net (loss) income available to common shareholders — diluted		$	(189	)		$	68			$	(78	)		$	438
Weighted average shares outstanding — basic			8,825				6,240				8,805				5,050
Dilutive stock options and warrants			—				113				—				146
Convertible securities			—