<PAGE>

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--------------------------------------------------------------------------------

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                               ----------------

                                   FORM 10-Q

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

                               ----------------

                      For the Quarter Ended March 31, 2000
                        Commission File Number 333-48817

                               ----------------

                              PHASE METRICS, INC.
                                  (registrant)

                               ----------------

                     Incorporated in the State of Delaware
                I.R.S. Employer Identification Number 33-0328048
            10260 Sorrento Valley Road, San Diego, California 92121
                                 (858) 646-4800

                               ----------------

  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 [_]

  The number of shares outstanding of the Registrant's securities as of March
31, 2000 are as follows:

<TABLE>
      <S>                                                       <C>
      Common Stock............................................. 5,609,839 shares
      Series A Preferred Stock................................. 8,250,000 shares
      Series B Preferred Stock................................. 3,857,280 shares
      Series C Preferred Stock................................. 7,610,000 shares
</TABLE>

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>

                              PHASE METRICS, INC.

                                   FORM 10-Q
                      FOR THE QUARTER ENDED MARCH 31, 2000

                                     INDEX

PART I. FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
 <C>     <S>                                                               <C>
 ITEM 1. Financial Statements (unaudited)

         Condensed Consolidated Balance Sheets as of December 31, 1999
         and March 31, 2000.............................................     3

         Condensed Consolidated Statements of Operations for the three
         months ended March 31, 1999 and 2000...........................     4

         Condensed Consolidated Statements of Cash Flows for the three
         months ended March 31, 1999 and 2000...........................     5

         Notes to Condensed Consolidated Financial Statements...........     6

         Management's Discussion and Analysis of Financial Condition and
 ITEM 2. Results of Operations..........................................     8

 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk.....    22


PART II. OTHER INFORMATION


 ITEM 1. Legal Proceedings..............................................    22
 ITEM 2. Changes in Securities..........................................    22
 ITEM 3. Defaults Upon Senior Securities................................    22
 ITEM 4. Submission of Matters to a Vote of Security Holders............    22
 ITEM 5  Other Information..............................................    22
 ITEM 6. Exhibits and Reports on Form 8-K...............................    22
</TABLE>

<TABLE>
<S>                                                                                    <C>
Signatures...........................................................................   23
</TABLE>

                                       2
<PAGE>

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                              PHASE METRICS, INC.

                     CONDENSED CONSOLIDATED BALANCE SHEETS

                                 (In thousands)

<TABLE>
<CAPTION>
                                                      December 31,  March 31,
                                                          1999        2000
                                                      ------------ -----------
                                                                   (Unaudited)
<S>                                                   <C>          <C>
                       ASSETS

Current assets:
  Cash and cash equivalents..........................  $   8,942    $   5,271
  Accounts receivable, net...........................      7,044        4,589
  Inventories........................................     14,500       15,271
  Prepaid expenses and other.........................      1,225        2,005
                                                       ---------    ---------
    Total current assets.............................     31,711       27,136
Property, plant and equipment, net...................     10,494        8,448
Intangible and other assets..........................      4,446        4,261
                                                       ---------    ---------
    Total assets.....................................  $  46,651    $  39,845
                                                       =========    =========

     LIABILITIES, REDEEMABLE PREFERRED STOCK AND
                STOCKHOLDERS' DEFICIT

Current liabilities:
  Accounts payable...................................  $   2,397    $   1,352
  Accrued expenses and other liabilities.............     19,895       18,963
  Current portion of debt............................      1,205        1,123
                                                       ---------    ---------
    Total current liabilities........................     23,497       21,438

Long-term liabilities:
  Long-term debt.....................................    114,531      114,487
  Accrued expenses and interest......................     10,236       10,314
Series B redeemable preferred stock..................     12,081       12,265
Series C redeemable preferred stock..................     34,184       34,966

Commitments and contingencies

Stockholders' deficit:
  Series A preferred stock...........................          3            3
  Common stock.......................................      6,892        6,992
  Retained deficit...................................   (154,222)    (159,607)
  Accumulated other comprehensive loss...............       (551)      (1,013)
                                                       ---------    ---------
    Total stockholders' deficit......................   (147,878)    (153,625)
                                                       ---------    ---------
Total liabilities, redeemable preferred stock and
 stockholders' deficit...............................  $  46,651    $  39,845
                                                       =========    =========
</TABLE>

See accompanying notes to unaudited condensed consolidated financial
statements.

                                       3
<PAGE>

                              PHASE METRICS, INC.

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

                           (In thousands, unaudited)

<TABLE>
<CAPTION>
                                                          Three Months Ended
                                                              March 31,
                                                          --------------------
                                                            1999       2000
                                                          ---------  ---------
<S>                                                       <C>        <C>
Net sales................................................ $  11,355  $ 11,156
Cost of sales............................................     9,582     6,150
                                                          ---------  --------
    Gross profit.........................................     1,773     5,006
Operating expenses:
  Research and development...............................     6,390     3,343
  Selling, general and administrative....................     3,002     2,756
  Amortization of intangible assets......................        93         9
                                                          ---------  --------
    Total operating expenses.............................     9,485     6,108
                                                          ---------  --------
Loss from operations.....................................    (7,712)   (1,102)
Interest expense.........................................     3,338     3,380
Other income, net........................................      (287)      (62)
                                                          ---------  --------
Net loss................................................. $ (10,763) $ (4,420)
                                                          =========  ========
Accretion for redemption value and dividends on Series B
 and C redeemable preferred stock........................      (894)     (965)
                                                          ---------  --------
Net loss attributable to common stockholders............. $ (11,657) $ (5,385)
                                                          =========  ========
Comprehensive loss:
  Net loss............................................... $ (10,763) $ (4,420)
  Other comprehensive loss--foreign currency translation
   adjustment............................................      (530)     (462)
                                                          ---------  --------
Comprehensive Loss....................................... $ (11,293) $ (4,882)
                                                          =========  ========
</TABLE>



See accompanying notes to unaudited condensed consolidated financial
statements.

                                       4
<PAGE>

                              PHASE METRICS, INC.

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                           (In thousands, unaudited)

<TABLE>
<CAPTION>
                                                         Three Months Ended
                                                              March 31,
                                                         --------------------
                                                           1999       2000
                                                         ---------  ---------
<S>                                                      <C>        <C>
OPERATING ACTIVITIES:
    Net cash used for operating activities.............. $  (6,289) $  (3,220)
                                                         ---------  ---------

INVESTING ACTIVITIES:
  Acquisition of property, plant and equipment..........      (703)      (119)
  Proceeds from sale of property, plant and equipment...       328        --
                                                         ---------  ---------
    Net cash used for investing activities..............      (375)      (119)
                                                         ---------  ---------

FINANCING ACTIVITIES:
  Payments on capital lease obligations.................      (351)      (309)
  Proceeds from issuance of common stock, net of
   repurchases..........................................         2        --
                                                         ---------  ---------
    Net cash used for financing activities..............      (349)      (309)
                                                         ---------  ---------
Effect of exchange rate changes on cash and cash
 equivalents............................................       (42)       (23)
                                                         ---------  ---------
Net decrease in cash and cash equivalents...............    (7,055)    (3,671)
Cash and cash equivalents, beginning of period..........    24,714      8,942
                                                         ---------  ---------
Cash and cash equivalents, end of period................ $  17,659  $   5,271
                                                         =========  =========
</TABLE>



See accompanying notes to unaudited condensed consolidated financial
statements.

                                       5
<PAGE>

                              PHASE METRICS, INC.

             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

Note 1. Basis of Presentation

  The accompanying unaudited condensed consolidated financial statements of
Phase Metrics, Inc. (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments considered necessary for a fair
presentation (consisting of normal recurring accruals) have been included.
Operating results for the three months ended March 31, 2000 are not
necessarily indicative of the results that may be expected for the fiscal year
ending December 31, 2000. For further information, refer to the consolidated
financial statements and footnotes thereto for the year ended December 31,
1999 included in the Company's 1999 Annual Report on Form 10-K. The Company's
first, second and third fiscal quarters end on the Sunday closest to March 31,
June 30 and September 30, respectively. For ease of reference, such quarter
end dates are used herein.

Note 2. Balance Sheet Details

  Inventories

    Inventories consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                          December 31, March 31,
                                                              1999       2000
                                                          ------------ ---------
   <S>                                                    <C>          <C>
     Raw materials and components........................   $ 3,374     $ 2,024
     Work-in-process.....................................     4,403       6,312
     Finished goods......................................     6,723       6,935
                                                            -------     -------
                                                            $14,500     $15,271
                                                            =======     =======
</TABLE>

  Property, Plant and Equipment

    Property, plant and equipment consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                         December 31, March 31,
                                                             1999       2000
                                                         ------------ ---------
   <S>                                                   <C>          <C>
     Equipment and furniture............................   $ 30,742   $ 30,012
     Leasehold improvements.............................      5,462      5,535
                                                           --------   --------
                                                             36,204     35,547
   Accumulated depreciation and amortization............    (25,710)   (27,099)
                                                           --------   --------
                                                           $ 10,494   $  8,448
                                                           ========   ========
</TABLE>

  Customer Advance--The Company entered into an advance payment agreement with
one of its customers. The agreement provided for an initial advance of $8.0
million, to be offset by future purchases of the Company's equipment and
services through June 30, 2000, and is secured by certain inventory. In the
event the advance is not fully offset by June 30, 2000, the full amount will
become due with interest accruing at 7% per annum thereafter. As of December
31, 1999 and March 31, 2000, the customer advance balance was $5.4 million and
$0.9 million, respectively.

Note 3. Industry and Geographic Information

  The Company operates in one reportable segment. Sales to customers outside
the United States (primarily Asia) totaled 54% and 77% of net sales for the
three months ended March 31, 1999 and 2000, respectively. As

                                       6
<PAGE>

                              PHASE METRICS, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)

of December 31, 1999 and March 31, 2000, balances due from foreign customers
were $3.8 million and $2.6 million, respectively.

 The Company had sales to individual customers in excess of 10% of net sales,
as follows:

<TABLE>
<CAPTION>
                                                           Three Months Ended
                                                                March 31,
                                                           ------------------
                                                             1999        2000
                                                           ---------   ---------
   <S>                                                     <C>         <C>
   Customer:
     A ...................................................        33%        56%
     B....................................................        --%        12%
     C....................................................        13%        --
     D....................................................        12%        --
</TABLE>

  As of December 31, 1999 and March 31, 2000, accounts receivable from
individual customers with balances due in excess of 10% of total accounts
receivable totaled $3.4 million and $2.6 million, respectively.

  For the three months ended March 31, 2000, the Company recorded revenue from
customers in the United States and Asia. The following presents net sales for
the three months ended March 31, 1999 and 2000 and long-lived assets as of
December 31, 1999 and March 31, 2000 by geographic territory:

<TABLE>
<CAPTION>
                              Long-Lived Assets              Net Sales
                            ---------------------- -----------------------------
                                                   Three Months Ended March 31,
                            December 31, March 31, ----------------------------
                                1999       2000         1999           2000
                            ------------ --------- -------------- --------------
   <S>                      <C>          <C>       <C>            <C>
   United States
    operations:
     Domestic..............   $13,324     $11,912  $        5,223 $        2,576
     Foreign...............       --          --            4,841          5,465
   Asia operations.........     1,616         797           1,291          3,115
                              -------     -------  -------------- --------------
   Total...................   $14,940     $12,709  $       11,355 $       11,156
                              =======     =======  ============== ==============
</TABLE>

Note 4. Subsequent Event

  The Company was unable to make the interest payment on the $110 million
Senior Notes ("the Notes") due on February 1, 2000 and is not in compliance
with certain covenants of the Notes and the Indenture governing the Notes. On
April 26, 2000, the Company announced that it had entered into an agreement in
principle with an informal committee representing approximately 81% of holders
to restructure the Notes. Under the restructuring, the $110.0 million
principal amount of Notes, plus accrued interest, would be exchanged for New
Common Stock representing 97.5% of the Company's outstanding common stock
after the restructuring. Holders of the existing Senior Subordinated
Convertible Notes, existing Series A, B and C Preferred Stock and existing
Common Stock would receive the remaining 2.5% of New Common Stock, as well as
warrants to purchase additional shares representing up to 10% of the Company's
then outstanding New Common Stock upon certain circumstances. The
restructuring will not in any way affect the Company's obligation to pay its
trade creditors or other vendors. The agreement in principle is subject to a
number of customary conditions. In addition, holders of all or some of the
Notes will provide the Company with a $10.0 million New Credit Facility in
conjunction with the restructuring. The New Credit Facility will be secured by
a pledge of substantially all of the Company's assets other than certain
secured assets and customer deposits. The commitment to provide the New Credit
Facility is subject to a number of customary conditions. There is no assurance
that the proposed restructuring will be completed as described above or at
all.

  The accompanying unaudited condensed consolidated financial statements do
not purport to reflect or provide for the consequences of the proposed
restructuring.

                                       7
<PAGE>

                              PHASE METRICS, INC.

        MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                             RESULTS OF OPERATIONS

ITEM 2.

  Statements in this discussion and analysis and elsewhere in this report,
including, but not limited to, statements regarding our strategy, financial
performance and revenue sources, are forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, Section 21E
of the Securities Exchange Act of 1934, as amended, and Section 27A of the
Securities Act of 1933, as amended, and are subject to the safe harbors
created by those sections. These and any other forward-looking statements
contained in this report are based on current expectations and involve various
risks and uncertainties that could cause actual results to differ materially
from those expressed in such forward-looking statements. Our actual results
could differ materially from the results anticipated in these forward-looking
statements as a result of certain factors set forth under "Risk Factors" and
elsewhere in this report. Readers are also urged to carefully review and
consider the various risk factor disclosures made in our other reports and
filings with the SEC, including our 1999 Annual Report on Form 10-K. Readers
are cautioned not to place undue reliance on these forward-looking statements
to reflect events or circumstances occurring after the date of this filing.
The following discussion should be read in conjunction with our condensed
consolidated financial statements and notes thereto included elsewhere in this
report.

Overview

  We are facing severe liquidity problems. We were unable to make the interest
payment on the Notes due on February 1, 2000 and are not in compliance with
certain covenants of the Notes and the Indenture governing the Notes.

  On April 26, 2000, we announced that we had entered into an agreement in
principle with an informal committee of Noteholders to restructure the Notes.
Under the restructuring, the $110.0 million principal amount of Notes, plus
accrued interest, would be exchanged for New Common Stock representing 97.5%
of our outstanding common stock after the restructuring. Holders of the
existing Senior Subordinated Convertible Notes, existing Series A, B and C
Preferred Stock and existing Common Stock would receive the remaining 2.5% of
New Common Stock, as well as warrants to purchase additional shares
representing up to 10% of our then outstanding New Common Stock if we achieve
certain financial targets. The restructuring will not in any way affect our
obligation to pay our trade creditors or other vendors. The agreement in
principle is subject to a number of customary conditions.

  In addition, holders of all or some of the Notes will provide us with a
$10.0 million New Credit Facility in conjunction with the restructuring. The
New Credit Facility will be secured by a pledge of substantially all of our
assets. The commitment to provide the New Credit Facility is subject to a
number of customary conditions. There is no assurance that the proposed
restructuring will be completed as described above or at all.

  We anticipate that the restructuring will take three to five months to
complete. During that time, we will face a number of risks over which we may
have limited or no control, including the risk that trade creditors or vendors
may discontinue providing us with trade credit, the risk that customers may
decrease the amount of business that they do with us and the risk that, in
spite of not paying interest on the Notes, we will not be able to generate the
liquidity necessary to maintain operations. In addition, we face the risk that
holders of Notes or other interests in us will refuse to accept our
restructuring proposal when made to them. For these and other reasons, we may
be forced to file for protection under Chapter 11 without the benefit of an
agreement in principle with the Noteholders, our creditors may file an
involuntary Chapter 11 case against us or we may be forced to liquidate our
business without the benefit of a reorganization.

                                       8
<PAGE>

  The accompanying unaudited condensed consolidated financial statements do
not purport to reflect or provide for the consequences of the proposed
restructuring.

 Business

  We are a leading supplier of process and production-test equipment for the
data storage industry. Our systems are used primarily by manufacturers of disk
drives, thin-film disks and read/write heads to manage and improve their
respective product yields by analyzing product and process quality at critical
stages in their production processes. We were formed in 1989 as a single
product supplier to the data storage industry. Since 1993, we expanded our
product lines through the acquisition of seven specialized suppliers of
complementary systems for the disk drive and disk drive component industries.

  We believe that period-to-period comparisons of our results of operations
are not necessarily meaningful and should not be relied upon as indicators of
future performance. Quarterly results in the future may fluctuate due to the
factors discussed above or other factors.

 Customer Concentration

  There are a relatively small number of data storage manufacturers throughout
the world and we derive a significant portion of our net sales from a
relatively small number of customers. We expect that our dependence on
relatively few key customers will continue in the future. Approximately 75.1%
of our net sales were derived from sales to our three largest customers for
the three months ended March 31, 2000. Even though our customer mix will
likely change from period to period in the future, for the three months ended
March 31, 2000, Seagate Technology, Inc. ("Seagate"), Yamaha Corporation
("Yamaha") and Alps Electric Company, Ltd. ("Alps") accounted for 55.5%, 11.9%
and 7.7% of net sales, respectively. If net sales to these or any of our other
significant customers were to decrease in any material amount in the future,
our business, operating results and financial condition would be materially
adversely affected.

Results of Operations

 Net Sales

  Net sales consist primarily of revenue from sales of our process and
production-test equipment and related upgrades, and to a lesser extent, parts
and services. Net sales decreased from $11.4 million for the first quarter of
1999 to $11.2 million for the first quarter of 2000.

 Gross Profit

  Cost of sales includes material costs, direct labor and overhead costs
related to the production and installation of our products, including warranty
and other service costs. Gross profit increased from $1.8 million for the
first quarter of 1999 to $5.0 million for the first quarter of 2000. Gross
profit as a percentage of net sales ("gross margin") increased from 15.6% for
the first quarter of 1999 to 44.8% for the first quarter of 2000. The increase
was primarily due to (1) lower gross profit on products shipped in the first
quarter of 1999 in connection with the Settlement Agreement discussed below
(2) underutilization of manufacturing capacity in the first quarter of 1999
and (3) a customer cancellation fee in the first quarter of 2000.

  In April 1998, we entered into a settlement agreement to reimburse a major
customer for costs incurred in connection with the customer's cancellation of
a contract with a third party to purchase upgrades to certain production test
equipment originally purchased from us. We took this action to protect our
intellectual property and preserve a valued customer relationship. We
concluded that such action was necessary in order to discourage further
unauthorized use of our intellectual property in the future by this or other
third parties. We made the reimbursement provided for under the settlement
agreement by providing a credit to the customer for products purchased by the
customer. Products purchased under the settlement agreement were at favorable
pricing which negatively impacted our gross profit margin during the first
quarter of 1999.

  We are unable to control with any degree of certainty our product sales
volume, linearity or mix from period to period and therefore our gross margin
in future periods may fluctuate from those achieved in past periods. In

                                       9
<PAGE>

any period when we experience an unfavorable product sales volume, linearity
or mix and/or provide significant volume pricing discounts or provision for
warranty costs, our gross margin may decrease.

 Research and Development Expense

  Research and development expense consists primarily of salaries and related
costs of personnel and consultants, project materials and other costs
associated with our ongoing research and product development. Research and
development expense decreased from $6.4 million for the first quarter of 1999
to $3.3 million for the first quarter of 2000. Research and development
expense as a percentage of net sales decreased from 56.3% for the first
quarter of 1999 to 30.0% for the first quarter of 2000. This percentage
decrease was primarily due to a decrease in personnel costs as a result of
workforce reductions in July and October 1999, closure of our Concord facility
and a decrease in project material costs. We anticipate that we will continue
to devote a significant amount of financial resources to research and
development for the foreseeable future.

 Selling, General and Administrative Expense

  Selling, general and administrative expense consists primarily of salaries
and related costs of personnel and professional services, including certain
acquisition related earnout costs. Selling, general and administrative expense
decreased from $3.0 million for the first quarter of 1999 to $2.8 million for
the first quarter of 2000. Selling, general and administrative expense as a
percentage of net sales decreased from 26.4% for the first quarter of 1999 to
24.7% for the first quarter of 2000. This percentage decrease was primarily
due to a decrease in personnel costs as a result of workforce reductions in
July and October 1999.

 Amortization of Intangible Assets

  Amortization of intangible assets decreased from $0.1 million for the first
quarter of 1999 to $9,000 for the first quarter of 2000. This decrease was due
to intangible assets becoming fully amortized.

 Interest Expense

  Interest expense for the first quarter of 1999 and 2000 relates primarily to
interest incurred on the senior and subordinated notes.

 Other Income, Net

  Other income was $0.3 million for the first quarter of 1999 as compared to
$0.1 million for the first quarter of 2000. These amounts consisted primarily
of earnings on invested funds.

Liquidity and Capital Resources

  We have financed our capital requirements through sales of common and
preferred stock, borrowings under the senior notes and subordinated, term and
revolving credit facilities. Our principal requirements for cash are debt
service requirements, capital expenditures and working capital.

  As of March 31, 2000, our outstanding indebtedness included $106.4 million
of senior notes, net of $3.6 million of unamortized debt issuance costs, $8.0
million of convertible subordinated notes and $1.2 million of capital lease
obligations. At March 31, 2000, we had $7.9 million and $8.3 million of
accrued interest outstanding on the senior notes and convertible subordinated
notes, respectively. The convertible subordinated notes, including all accrued
interest, are convertible into 5,142,720 shares of common stock at the option
of the holders and will automatically convert upon a public equity offering.
As of the date of this filing, we do not have a working capital credit
facility in place.

                                      10
<PAGE>

  We were unable to make the interest payment on the Notes due on February 1,
2000 and are not in compliance with certain covenants of the Notes and the
Indenture governing the Notes. On April 26, 2000, we announced that we had
entered into an agreement in principle with an informal committee representing
approximately 81% of holders to restructure the Notes. Under the
restructuring, the $110.0 million principal amount of Notes, plus accrued
interest, would be exchanged for New Common Stock representing 97.5% of our
outstanding common stock after the restructuring. Holders of the existing
Senior Subordinated Convertible Notes, existing Series A, B and C Preferred
Stock and existing Common Stock would receive the remaining 2.5% of New Common
Stock, as well as warrants to purchase additional shares representing up to
10% of our then outstanding New Common Stock upon certain circumstances. The
restructuring will not in any way affect our obligation to pay our trade
creditors or other vendors. The agreement in principle is subject to a number
of customary conditions. In addition, holders of all or some of the Notes will
provide us with a $10.0 million New Credit Facility in conjunction with the
restructuring. The New Credit Facility will be secured by a pledge of
substantially all of our assets other than certain secured assets and customer
deposits. The commitment to provide the New Credit Facility is subject to a
number of customary conditions. There is no assurance that the proposed
restructuring will be completed as described above or at all.

  The accompanying unaudited condensed consolidated financial statements do
not purport to reflect or provide for the consequences of the proposed
restructuring.

  The senior notes and the related indenture do not contain ongoing quarterly
or annual financial covenant requirements but do contain customary covenants
restricting our ability to, among other things, incur additional indebtedness,
create liens or other encumbrances, pay dividends or make other restricted
payments, make investments, loans and guarantees or sell or otherwise dispose
of a substantial portion of assets to, or merge or consolidate with, another
entity.

  Cash used for operating activities was $6.3 million and $3.2 million for the
first quarter of 1999 and 2000, respectively. Period to period fluctuations in
operations impacting these amounts were a smaller net loss in 2000, a decrease
in depreciation and amortization, a decrease in accounts receivable, increases
in inventories and prepaid expenses and other assets and smaller decreases in
accounts payable and other accrued expenses and other liabilities.

  Cash used for investing activities was $0.4 million for the first quarter of
1999 and $0.1 million for the first quarter of 2000 and consisted of
acquisition of property, plant and equipment and net of proceeds from sale of
property, plant and equipment in 1999. Cash used for financing activities was
$0.3 million for the first quarter of 1999 and $0.3 million for the first
quarter of 2000. In the first quarter of 1999 and 2000, financing activities
consisted of payments on capital lease obligations.

  We believe that cash generated from operations, borrowings under the
proposed New Credit Facility and existing cash balances will be adequate to
fund our operations for at least the next 12 months. While operating
activities may provide cash in certain periods, we may require additional
sources of financing. We may also from time to time consider additional
acquisitions of complementary businesses, products or technologies, which may
require additional financing. Additional sources of funding could include
additional debt and/or equity financings. We will continue to have limited
capital resources and significant future obligations and expect that we will
require additional capital to support future growth, if any. There can be no
assurance that we will be able to obtain alternative sources of financing on
favorable terms, if at all, at such time or times as we may require such
capital. See "Risk Factors--As a Result of Adverse Industry Conditions, We Are
Experiencing Liquidity Problems and We Failed to Make the Last Interest
Payment on the Notes; Unless We Complete Our Proposed Restructuring, We May Be
Forced to Seek Protection Under the Bankruptcy Laws."

                                      11
<PAGE>

RISK FACTORS

  You should consider carefully the following risks in your evaluation of us.
The risks and uncertainties described below are not the only ones facing our
company. Additional risks and uncertainties may also adversely impact and
impair our business. If any of the following risks actually occurs, our
business, operating results or financial condition would likely suffer.

As a Result of Adverse Industry Conditions, We Are Experiencing Liquidity
Problems and We Failed to Make the Last Interest Payment on the Notes; Unless
We Complete Our Proposed Restructuring, We May Be Forced to Seek Protection
Under the Bankruptcy Laws

  The data storage industry has experienced prolonged and intense competition,
pricing erosion and overcapacity. Such adverse market conditions have
resulted, and may in the future result, in the delay, reschedule or
cancellation of orders and fluctuation in demand for our products. These
adverse market conditions have had a material adverse effect on our results of
operations and financial condition over the last several quarters and are
expected to continue through 2000. For the three months ended March 31, 2000
our earnings were inadequate to cover our fixed charges by $5.4 million.

  As a result of these losses and deficiencies, we were unable to make the
interest payment on the Notes due on February 1, 2000 and we are not in
compliance with certain covenants of the Notes and the Indenture governing the
Notes.

  On April 26, 2000, we announced that we had entered into an agreement in
principle with an informal committee representing approximately 81% of holders
(the "Noteholders") of the Notes to restructure the Notes. Under the
restructuring, the $110.0 million principal amount of Notes, plus accrued
interest, would be exchanged for new common stock ("New Common Stock")
representing 97.5% of our outstanding common stock after the restructuring.
Holders of our existing Senior Subordinated Convertible Notes, existing Series
A, B and C Preferred Stock and existing Common Stock would receive the
remaining 2.5% of New Common Stock, as well as warrants to purchase additional
shares representing up to 10% of our then outstanding New Common Stock upon
certain circumstances. The restructuring will not in any way affect our
obligation to pay our trade creditors or other vendors. The agreement in
principle is subject to a number of customary conditions.

  In addition, holders of all or some of the Notes will provide us with a
$10.0 million working capital credit facility (the "New Credit Facility") in
conjunction with the restructuring. The New Credit Facility will be secured by
a pledge of substantially all of our assets other than certain secured assets
and customer deposits. The commitment to provide the New Credit Facility is
subject to a number of customary conditions. There is no assurance that the
proposed restructuring will be completed as described above or at all.

  We anticipate that the restructuring will take three to five months to
complete. During that time, we will face a number of risks over which we may
have limited or no control, including the risk that trade creditors or vendors
may discontinue providing us with trade credit, the risk that our customers
may decrease the amount of business that they do with us and the risk that, in
spite of not paying interest on the Notes, we will not be able to generate the
liquidity necessary to maintain operations. In addition, we face the risk that
holders of Notes or other interests in us will refuse to accept our
restructuring proposal when made to them. For these and other reasons, we may
be forced to file for protection under Chapter 11 without the benefit of our
agreement in principle with the Noteholders, our creditors may file an
involuntary Chapter 11 case against us or we may be forced to liquidate our
business without the benefit of a reorganization.

  The accompanying unaudited condensed consolidated financial statements do
not purport to reflect or provide for the consequences of the proposed
restructuring.

  See "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Liquidity and Capital Resources."

                                      12
<PAGE>

Existing Financing Covenants Impose Restrictions on our Operations Which we
May Not Be Able to Comply with Due to Reasons Beyond our Control

  The Indenture related to the Notes contains a number of covenants that
significantly restrict our operations, such as our ability to:

  . incur indebtedness;

  . make prepayments of certain indebtedness;

  . pay dividends;

  . make investments;

  . engage in transactions with stockholders and affiliates;

  . create liens;

  . sell assets; and

  . engage in mergers and other consolidations.

Funds May Not Be Available to Make Payments to Holders of the Notes Due to
Senior Rights of Other Existing and Future Indebtedness

  As of March 31, 2000, the Notes and the Note Guarantees were effectively
subordinated to approximately $1.2 million of secured indebtedness under our
capital lease obligations.

  If we incur any additional senior indebtedness in the future that is not
subordinated to the indebtedness outstanding under the Notes, even if such
indebtedness were not secured, the holders of such debt would be entitled to
share ratably with the holders of the Notes in any proceeds distributed in
connection with any insolvency, liquidation, reorganization, dissolution or
other winding-up of our business. This may have the effect of reducing the
amount of proceeds available to pay to holders of the Notes upon the
occurrence of any such events.

We Have Experienced Significant Losses

  We incurred net losses of approximately $4.4 million for the three months
ended March 31, 2000. Such losses and accrual of certain preferred stock
dividends and accretion for the redemption value and dividends of such
preferred stock have contributed to a retained deficit of approximately $159.6
million as of March 31, 2000. In addition, we used cash for operating
activities of approximately $3.2 million for 2000. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

Our Operating Results are Subject to Wide Variations and Continued Losses

  In the past, we have experienced wide fluctuations in our quarterly and
annual operating results and have experienced net losses for the past several
quarters. We may continue to experience net losses and fluctuations in our
business due to a number of factors, not all of which are in our control.
These factors include, without limitation, the following:

  . the continuing adverse market conditions in the data storage industry;

  . the size, timing and rescheduling or cancellation of orders from, and
    shipments to, major customers;

  . the timing of introductions of our new products and product enhancements
    or our competitors' introduction of new products or product enhancements;

  . our ability to develop, introduce and market new, technologically
    advanced products;

  . the cyclicality of the data storage industry;

                                      13
<PAGE>

  . the rescheduling or cancellation of capital expenditures by our
    customers;

  . variations in our customer base and product mix;

  . the level of any of our significant volume pricing discounts;

  . the availability and cost of key production materials and components;

  . our ability to effectively manage our inventory and control costs;

  . the financial stability of our major customers;

  . personnel changes;

  . expenses associated with acquisitions;

  . restructurings;

  . fluctuations in amortization and write-downs of intangible assets; and

  . foreign currency exchange rate fluctuations and general economic factors
    in the United States and certain foreign countries, including Japan,
    South Korea, Singapore, Malaysia, Thailand and other parts of Southeast
    Asia.

  The data storage industry has experienced prolonged and intense competition,
pricing erosion and overcapacity. Such adverse market conditions have
resulted, and may in the future result, in the delay, reschedule or
cancellation of orders and fluctuation in demand for our products. These
adverse market conditions have had a material adverse effect on our results of
operations and financial condition over the last several quarters and are
expected to continue through 2000.

  Quarterly results in the future may fluctuate due to the factors discussed
above or other factors. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

Dependence on and Cyclicality of Data Storage Industry May Lead to Continued
Losses

  Our business depends almost entirely upon capital expenditures by our
customers, which in turn depend upon market demand for their products. Our
industry is cyclical and historically has experienced varying growth rates and
periods of oversupply causing higher than anticipated inventory levels and
intense price competition. The data storage industry is currently experiencing
intense competition, significant price erosion and overcapacity. As a result
of these adverse market conditions, there is significantly reduced demand for
our products. These adverse market conditions in the disk storage industry
generally, and the slowdown in our customers' orders in the last several
quarters has had a material adverse effect on our business, operating results
and financial condition. It is likely that these adverse market conditions
will continue for the foreseeable future and, as a result, our customers will
likely continue to delay or cancel orders for our products and our business,
operating results and financial condition will be materially adversely
affected. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

We Have Had to Restructure Operations and May Have to Again in the Future

  The data storage industry has experienced intense competition, pricing
erosion and overcapacity. Such adverse market conditions have resulted, and
may in the future result, in the delay, reschedule or cancellation of orders
and fluctuation in demand for our products. These adverse market conditions
have had a material adverse effect on the our results of operations and
financial condition over the last several quarters and are expected to
continue through 2000. In June 1998, we implemented a workforce reduction of
approximately 155 employees, relocated and consolidated much of our Concord,
California operations to our Fremont, California facility and consolidated our
San Diego facility. In November 1998, we reduced our workforce by
approximately 60 employees and consolidated our Fremont, California
facilities. In the second quarter of 1999 we further consolidated a
significant portion of our Fremont facilities, and in July 1999, implemented a
workforce reduction

                                      14
<PAGE>

of approximately 25 employees. Due to the continued effects of the weakness in
demand for data storage products, in the fourth quarter of 1999, we
consolidated our Fremont facilities and implemented a workforce reduction of
approximately 24 employees.

  In the second quarter of 1998, we recorded $3.0 million of restructuring
charges. The significant components included $0.9 million for employee
severance costs, $2.0 million in asset impairment costs related to property,
plant and equipment obsoleted due to restructuring activities, and $0.1
million of other costs. In the fourth quarter of 1998, we recorded $1.1
million of restructuring charges. The significant components included
$0.3 million for employee severance costs, $0.6 million in asset impairment
costs related to property, plant and equipment obsoleted due to restructuring
activities and $0.2 million of other costs. In the second quarter of 1999, we
recorded $2.0 million of restructuring charges. The significant components
included $0.7 million for future lease costs of consolidated facilities and
$1.3 million in asset impairment costs related to facilities consolidation. In
the fourth quarter of 1999, we recorded a restructuring charge of $1.1
million. The significant components included $0.6 million for employee
severance costs, $0.4 million for future lease costs of consolidated
facilities and $0.1 million in asset impairment costs related to facilities
consolidation. While we believe our cost-cutting measures are appropriate
given our current and anticipated levels of net sales, there can be no
assurance that such measures will be sufficient and that additional cost-
cutting measures will not be necessary, or that the 1998 and 1999
restructuring activities or future cost-cutting measures will not have a
material adverse effect on our ability to increase our net sales.

If We Are Not Able to Adapt to Rapid Technological Change, We May Lose
Customers

  Rapid technological changes and evolving industry standards characterize the
data storage industry. Our customers frequently introduce new products and
enhancements, with relatively short product life cycles, typically between
nine and 18 months. In addition, our customers often develop multiple products
simultaneously, such that new products could be introduced as frequently as
every three months. Our customers' new product introductions typically result
in new technological challenges for us, both with respect to our installed
base and with respect to our next generation products. As a result, we must
continue to enhance our existing products and develop and manufacture new
products with improved capabilities. These technological changes require us to
make substantial investments in research and development. Although we
continually develop new products, there can be no assurance that we will be
able to accurately anticipate technological advances in the disk drive market
and develop products incorporating such advances in a timely manner or at all.
Our failure to develop, manufacture and market new or enhanced products, would
have a material adverse effect on our business, operating results and
financial condition. In addition, we are highly dependent on our close working
relationships with our key customers to advance our technologies. The
termination of any one of these key relationships could have a material
adverse effect on our ability to anticipate and develop necessary
technological changes to our products.

  Our customers are constantly striving to improve their production processes,
including improving the manufacturing of substrates, the deposition of
material on the substrate, the finish processing of magnetic media, and head
fabrication. If our customers modify their own design and internal production
processes without our products, demand for our equipment would likely decline.
Further, unless we are able to effectively respond to such changes,
manufacturing process changes for disk drives, disks and read/write heads
could also have a material adverse effect on our business, operating results
and financial condition.

  Future technological innovations may reduce demand for disk drives.
Competing technologies to disk drive based data storage exist, including solid
state memory (flash memory), tape memory and re-writable optical technology
(CD and DVD technology). Although the current core technology for rotating
magnetic disk drive data storage has been the predominant technology in the
industry for many years, it is likely that some day this technology will be
replaced by an alternate technology. Our products may not be adaptable to any
successor technology. Our business, operating results and financial condition
could be materially adversely affected by any significant migration toward
technology that would replace disk drives as a computer data storage medium.

                                      15
<PAGE>

Because We Depend on a Small Number of Customers, Any Decrease in Net Sales to
or a Loss of a Customer Will Have a Significant Negative Impact on Our
Business

  There are a relatively small number of data storage manufacturers throughout
the world and we derive a significant portion of our net sales from a
relatively small number of customers. We expect that our dependence on
relatively few key customers will continue in the future. Approximately 75.1%
of our net sales were derived from sales to our three largest customers for
the three months ended March 31, 2000. Even though our customer mix will
likely change from period to period in the future, Seagate, Yamaha and Alps
have accounted for 55.5%, 11.9%, and 7.7% of net sales, respectively. If net
sales to these or any of our other significant customers were to decrease in
any material amount in the future, our business, operating results and
financial condition would be materially adversely affected.

  In general, we do not enter into long-term purchase agreements with our
customers. If completed orders are not replaced on a timely basis by new
orders from the same or other customers, our net sales would be materially
adversely affected. In addition, the following could have a material adverse
effect on our business, operating results and financial condition:

  . the loss of a key customer;

  . any reduction, cancellation or rescheduling of an order from any key
    customer, including reductions, delays or cancellations due to customer
    departures from recent buying patterns; and

  . economic or competitive conditions in our industry.

  Any failure to collect payment or delay in collecting payment on accounts
receivable from customers could have a material adverse effect on our
business, operating results and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

  There has been a trend toward consolidation in the disk drive industry and
we expect this trend to continue. Some of our customers have been, and may
continue to be acquired by competitors, causing further consolidation.
Previous acquisitions in the disk drive industry have often caused the
purchasing departments of the combined companies to reevaluate their
purchasing decisions. Such acquisitions may result in a change in a current
customer's purchasing habits, including a loss of the customer, a decrease in
orders from that customer or a rescheduling or cancellation of orders
previously made by a customer. Moreover, acquisitions involving existing
customers may cause the concentration of our customer revenues to increase
thereby increasing our dependence on fewer customers.

We Have a High Risk of Inventory Obsolescence Which can Adversely Affect
Operating Results by Increasing Cost of Sales

  Due to the cyclical nature of and rapid technological change in our
industry, our inventory is subject to substantial risk of obsolescence. To
address these risks, we monitor our inventories on a periodic basis and
provide inventory write-downs intended to cover these risks. Despite our
precautions, we may be required to take significant inventory charges which,
in turn, could materially and adversely affect our business, operating results
and financial condition due to the following:

  . our dependence on a few customers and a limited number of product
    programs for each customer;

  . the magnitude of our commitment to support our customers' programs;

  . our limited remedies in the event a customer cancels or materially
    reduces one or more product orders; and

  . the possibility that a customer may experience financial difficulties.

                                      16
<PAGE>

  The significant downturn in the data storage industry negatively impacted
our operations, and for the years ended December 31, 1998 and 1999, the
Company recorded $19.8 million and $5.0 million, respectively in charges to
cost of sales to write down excess and obsolete inventory. We may be required
to take additional inventory write-downs in the future due to our inability to
obtain necessary product acceptance, or due to further cancellations by
customers.

Our Industry is Highly Competitive

  The disk drive process and production-test equipment industry is highly
competitive. In each of our product lines, we face substantial competition
from established merchant suppliers of process and production-test equipment,
some of which have greater financial, engineering, manufacturing, research and
development and marketing resources. For example, we face competition from
Zyratex, General Disk and Hitachi DECO for servowriters; Hitachi DECO and Sony
Techtronics for disk certifiers; Integral Solutions International and Veeco
for quasi-static MR head testers; Koyo Precision Instruments, Inc. and Zygo
Corporation for flying height testers, and Technistar for automation
technology. Historically, there has also been competition from entrepreneurs
with focused market knowledge and new technology. We experience intense
competition world-wide from Hitachi DECO, a large, full-line manufacturer of
process and production-test equipment. Hitachi DECO has substantially greater
financial, technical, marketing, manufacturing, research and development and
other resources. We also experience competition from other full-line and
partial-line manufacturers of process and production-test equipment. Our
competitors may develop enhancements to, or future generations of, competitive
products that will offer price or performance features superior to our
products, or new competitors may enter our markets. Finally, as many of our
competitors are based in foreign countries, they have cost structures and
equipment prices based on foreign currencies. Accordingly, currency
fluctuations could cause our dollar-priced products to be less competitive
than our competitors' products priced in other currencies.

  Many of our competitors are investing heavily in the development of new and
enhanced products aimed at applications currently addressed by our products.
We expect our competitors to continue to improve the design and performance of
their products and to introduce new products with competitive
price/performance characteristics. Competitive pressures often necessitate
price reductions which can adversely affect operating results. We will be
required to make significant investments in product development and research,
sales and marketing and ongoing customer service and support to remain
competitive. We cannot be certain that we will have sufficient resources to
continue to make such investments or that we will be able to achieve the
technological advances necessary to maintain our competitive position.

  We believe that our future success will be dependent, in part, upon our
ability to compete successfully in the Japanese, South Korean and Southeast
Asian markets. Our largest competitor, Hitachi DECO, is headquartered in Japan
which gives it a competitive advantage in that market to the extent buying
decisions are influenced by Hitachi DECO's local presence. In addition, our
ability to compete in Japan, South Korea and Southeast Asia in the future is
dependent upon continuing free trade between these countries and the
United States, our continuing ability to develop in a timely manner products
that meet the technical requirements of our foreign customers and our
continuing ability to develop and maintain satisfactory relationships with
leading companies in our industry in these areas. Moreover, our sales in these
areas will be affected by the overall economies of Japan, South Korea and
Southeast Asia. To the extent that recent economic troubles in Asian markets
have negatively impacted the capacity expansion and upgrade plans of our
customers or potential customers in affected regions, then such economic
troubles have also negatively impacted our operations. With respect to
existing customers, we do not believe that such Asian economic troubles have
had a significant impact on our operations. With respect to potential
customers, we are unable to quantify the impact that such Asian economic
troubles will have on our operations.

  In addition to the competition from our competitors, most of our customers
develop at least a portion of their own process and production-test equipment
needs internally, especially servowriters and read/write head test equipment.
Accordingly, we must compete against the internal development efforts of this
captive market.

                                      17
<PAGE>

Manufacturers within this captive market are often reluctant to change their
production lines to incorporate merchant-supplied process and production-test
technology. Moreover, rapid changes in data storage technology, and the
development of new process and production-test equipment may be so closely
linked to our customers' product development cycles that certain customers and
potential customers will find it more efficient to develop their own process
and production-testing equipment needs internally, thereby placing us at a
competitive disadvantage.

  Because of the foregoing competitive factors, we may not be able to compete
successfully in the future. Increased competitive pressure could cause us to
lower our prices which would have an adverse effect on our business, financial
condition and results of operations.

Because We Sell a Small Number of Products, A Reduction in Demand For Any One
of These Products May Have a Significant Negative Effect on Our Business

  We derive revenues primarily from sales of our process and production-test
systems and parts for such systems. Our products can generally be categorized
into four principal areas:

  . disk (media) testing and processing;

  . read/write head testing;

  . disk drive processing; and

  . automation.

  We derive a significant portion of our net sales from a relatively small
number of products. For the three months ended March 31, 2000, we derived
approximately 53.3% of our net sales, from sales of our media certifier
products (excluding parts and service). Although we expect that net sales from
our media certifier products, including our MG series and our MC series, will
continue to account for a substantial portion of our total net sales in the
foreseeable future, we realize that the downturn in the data storage industry
is caused, in part, by the overcapacity of media certifiers in the market
today. Any material reduction in demand for our media certifier products would
have a material adverse effect on our business, operating results and
financial condition.

We May Not Be Able to Adequately Protect Our Proprietary Technology or May Be
Subject to Claims of Infringement

  Our success is heavily dependent upon the establishment and maintenance of
proprietary technologies. We currently attempt to protect our intellectual
property rights through patents, copyrights, trade secrets and other measures.
These efforts may not be adequate to prevent misappropriation by third parties
and may not be adequate under the laws of some foreign countries which may not
protect our proprietary rights to the same extent as do laws of the United
States. Our competitors may be able to independently develop products that are
substantially equivalent or superior to our products, or design around our
patents. Any such adverse circumstances could have a material adverse effect
on our business, operating results and financial condition.

  Although we do not believe any of our products or proprietary rights
infringe the rights of third parties, infringement claims may be asserted
against us in the future. Any such claims, with or without merit, could divert
the attention of management, result in costly litigation, cause product
shipment delays or require us to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on
acceptable terms, or at all. If infringement were established, we could be
required to pay damages or be enjoined from making, using or selling the
infringing product. Likewise, a third party's product, if infringing on our
proprietary rights, may not be prevented from doing so without litigation. Any
of the foregoing could have a material adverse effect on our business,
operating results and financial condition.

  We cannot be certain that the claims allowed on any of our patents will be
sufficiently broad to protect our technology. Moreover, any patent we own
could be invalidated, deemed unenforceable, circumvented or challenged. Also,
we cannot be certain that our patent rights will provide us competitive
advantages or that any

                                      18
<PAGE>

of our pending or future patent applications will be issued with claims of the
scope that we desire, if at all. Furthermore, others may develop similar
products, duplicate our products or design around the patents we own. In
addition, foreign intellectual property laws or our agreements may not protect
our intellectual property rights in any foreign country. Any failure to
protect our intellectual property rights could have a material adverse effect
on our business, operating results and financial condition.

  We require each of our employees to enter into a proprietary rights and non-
disclosure agreement in which the employee agrees to maintain the
confidentiality of all of our proprietary information and, subject to certain
exceptions, to assign to us all rights in any proprietary information or
technology made or contributed by the employee during his or her employment.
In addition, we regularly enter into non-disclosure agreements with third
parties, such as consultants, potential joint venture partners and customers.
In spite of these precautions, it may be possible for third parties to copy,
develop or otherwise obtain and use our proprietary technology without
authorization or to develop similar technology independently.

The Complexity and Customization of our Products May Lead to Technical
Difficulties and Unanticipated Costs

  Our products have a large number of components and are highly complex. We
have experienced and may continue to experience manufacturing delays due to
technical difficulties. In addition, many of our products must be semi-
customized to meet individual product specification requirements. The
customization of a customer order may require new technical capabilities not
previously incorporated successfully into our products. As a result, we may be
unable to complete our customers' customized development or technical
specifications in a timely manner. Any significant failure in this regard
would have a material adverse effect on our business, operating results and
financial condition as well as our customer relationships. In addition, due to
the semi-customized nature of many of our products, we have incurred and may
continue to incur substantial unanticipated costs in a product's development
and production which cannot be passed on to the customer. Such unanticipated
costs include the increased cost of components due to expediting charges,
other purchasing inefficiencies and greater than expected engineering, quality
control, installation, upgrade, post-installation service and support and
warranty costs. The occurrence of any of these events could materially
adversely affect our business, operating results and financial condition.

  In certain instances we rely on a single source or a limited group of
suppliers for certain components and subassemblies used in our products. The
partial or complete loss of these sources could have at least a temporary
material adverse effect on our results of operations and damage customer
relationships due to the complexity of the products they supply and the
significant amount of time required to qualify new suppliers. In addition,
long lead times are often required to obtain critical components and
subassemblies used in certain of our products from these and other suppliers
which could impede our ability to quickly respond to changes in demand and
product specifications.

  Shortages of critical components and subassemblies used in our products have
occurred in the past and may occur in the future. Also, the availability of
materials may have longer lead times. In addition, our manufacture and timely
delivery of products is often dependent on the ability of certain suppliers to
deliver subassemblies and other components in a timely manner. The failure of
such suppliers to deliver these components in a timely manner may delay our
product delivery until alternative sourcing may be developed. Alternative
sources may not be located in time to avoid penalties or cancellation of our
product orders. If a significant order or orders were cancelled for this
reason it could have a material adverse effect on our business, operating
results and financial condition. Further, a significant increase in the price
of one or more components used to produce our products would increase our
production costs.

Risks Associated with Acquisitions

  While we currently have no commitments, agreements or understandings with
respect to any future acquisitions, our business strategy includes the
expansion of our business, products lines and technology through

                                      19
<PAGE>

acquisitions. We regularly review various acquisition prospects, including
companies, technologies or products complementary to our business and
periodically engage in discussions regarding such possible acquisitions.
Acquisitions involve numerous risks, including:

  . evaluating new technologies;

  . difficulties in the assimilation of the operations, products, personnel
    and cultures of the acquired companies;

  . the ability to manage geographically remote units;

  . the diversion of management's attention from other day-to-day business
    concerns;

  . the risks of entering markets in which we have limited or no direct
    experience;

  . the potential loss of key employees of the acquired companies;

  . dilutive issuances of equity securities;

  . the incurrence of additional debt;

  . reduction of existing cash balances; and

  . amortization expenses related to goodwill and other intangible assets and
    other charges to operations that may materially adversely affect our
    results of operations.

  Moreover, any equity or debt financings proposed in connection with any
acquisition may not be available to us on acceptable terms or at all, when,
and if, suitable strategic acquisition opportunities arise. Although
management expects to carefully analyze any opportunity before committing our
resources, there can be no assurance that any completed acquisition will
result in long-term benefits or that our management will be able to manage
effectively the resulting business.

Any Future Inability to Obtain Additional Financing Will Have a Significant
Negative Effect on Our Business

  To achieve our long-term strategic objectives and maintain our competitive
position, we will need additional financial resources over the next several
years to fund acquisitions, service debt, make capital expenditures, fund
working capital and pay for research and development. We are continually
investing in new technologies and our international infrastructure and, as a
result, our fixed costs may increase in the foreseeable future, depending on
the timing of any recovery in demand for our products. Our fixed costs may
also increase if we expand our infrastructure in South Korea, Japan, other
parts of Asia, or other locations. Any liquidity deficiency in the future
could delay or change our future plans, including curtailing potential
acquisitions, capital expenditures, facilities expansion and research and
development expenditures, which could materially adversely affect our ability
to pay our debts (including indebtedness and interest under the Notes) and our
business, operating results and financial condition.

  We continue to have limited cash resources and significant future
obligations. The precise amount and timing of our capital needs will depend
upon a number of factors, including:

  . the market demand for our products;

  . the availability of strategic opportunities;

  . the progress of our product development efforts;

  . technological challenges in connection with existing and future products;
    and

  . the success of our working capital and inventory management.

  We may not be able to obtain additional financing as needed on acceptable
terms or at all. If we are unable to obtain sufficient capital, potential
acquisitions, capital expenditures, facilities expansion and research and

                                      20
<PAGE>

development expenditures would be materially and adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

  In August 1998, we issued and sold an aggregate of 6,360,000 shares of our
Series C Preferred Stock in our Series C Financing for $25.4 million in gross
proceeds. Immediately following the consummation of the Series C Financing, we
used $7.1 million of the proceeds from the offering to repay all outstanding
indebtedness under the credit facility that we entered into in January 1998
and subsequently terminated such facility. As of the date of this filing, we
have no revolving or other type of credit facility for working capital. In
September 1998, one of the investors in the Series C Financing purchased an
additional 1,250,000 shares of Series C Preferred Stock for an aggregate of
$5.0 million.

  We believe that cash generated from operations, borrowings under the
proposed New Credit Facility and existing cash balances will be adequate to
fund our operations for at least the next 12 months. While operating
activities may provide cash in certain periods, we may require additional
sources of financing. We may also from time to time consider additional
acquisitions of complementary businesses, products or technologies, which may
require additional financing. Additional sources of funding could include
additional debt and/or equity financings. We will continue to have limited
capital resources and significant future obligations and expect that we will
require additional capital to support future growth, if any. There can be no
assurance that we will be able to obtain alternative sources of financing on
favorable terms, if at all, at such time or times as we may require such
capital. See "Risk Factors--As a Result of Adverse Industry Conditions, We Are
Experiencing Liquidity Problems and We Failed to Make the Last Interest
Payment on the Notes; Unless We Complete Our Proposed Restructuring, We May Be
Forced to Seek Protection Under the Bankruptcy Laws."

Because We are Subject to Many Environmental Regulations, Any Violation will
Subject us To Significant Liabilities

  We are subject to a variety of governmental regulations relating to the use,
storage, discharge, handling, emission, generation, manufacture, treatment and
disposal of toxic or other hazardous substances, chemicals, materials or
waste. We believe that we are in compliance, in all material respects, with
such regulations. Any failure to comply with current or future regulations
could result in civil penalties or criminal fines being imposed upon us, or
our officers, directors or employees, suspension of production, alteration of
our manufacturing process or cessation of operations. Such regulations could
require expensive remediation or abatement actions to comply with
environmental regulations. Any failure to properly manage the use, disposal or
storage of, or adequately restrict the release of, hazardous or toxic
substances could subject us to significant liabilities.


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<PAGE>

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

  There have been no material changes during the three months ended March 31,
2000.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

  Phase Metrics is subject to various legal matters in the normal course of
its business. While the results of litigation and claims cannot be predicted
with certainty, Phase Metrics believes that the final outcome of these other
matters will not have a material adverse effect on its business, operating
results or financial condition.

ITEM 2. CHANGES IN SECURITIES

  None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

  Not Applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

  None.

ITEM 5. OTHER INFORMATION

  Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

  (a) Exhibits.

      Financial Data Schedule.

  (b) Reports on Form 8-K.

      Not applicable.


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<PAGE>

                              PHASE METRICS, INC.

                                   SIGNATURES

  Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                          PHASE METRICS, INC.
                                          (Registrant)

                                                   /s/ Dewey Hockemeyer
                                          By: _________________________________
                                                      Dewey Hockemeyer
                                                  Vice President, Finance,
                                                  Chief Financial Officer
                                                  and Assistant Secretary

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