<PAGE>
 
================================================================================
                                        
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                                        
                             Washington, D.C. 20549

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

                                   FORM 10-Q
                                        

                                        
(Mark One)

[X]  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarter ended January 2, 1999 or
[ ]  Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from __________ to __________

Commission File Number 0-18623


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


                               IKOS SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)


                                        
               Delaware                                   77-0100318
    (State or other jurisdiction of                   (I.R.S. Employer
     incorporation or organization)                  Identification No.)

  19050 Pruneridge Ave., Cupertino, CA                       95014
(Address of principal executive offices)                  (zip code)


              Registrant's telephone number, including area code:
                                 (408) 255-4567
                                        


                                        
   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes  X    No 
                                               ---      ---  
   Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

         Common Stock $.01 Par Value                 8,231,000
         ---------------------------            
               (Title of Class)        (Outstanding as of January 2, 1999)

================================================================================

                                                                             

                                       1
<PAGE>
 
                               IKOS SYSTEMS, INC.
                                   FORM 10-Q
                         QUARTER ENDED January 2, 1999


                                     INDEX
                                     -----


                                        
Part I:  Financial Information


         Item I:  Financial Statements
<TABLE>
<CAPTION>
 
                                                                          Page
<S>               <C>                                                     <C>
 
                  Consolidated Balance Sheets at
                    January 2, 1999 and October 3, 1998................      3
 
                  Consolidated Statements of Income
                    for the three months ended January 2, 1999
                    and January 3, 1998................................      4
 
                  Consolidated Statements of Cash Flows
                    for the three months ended January 2, 1999
                    and January 3, 1998................................      5
 
                  Notes to Consolidated Financial Statements...........      6
 
         Item 2:  Management's Discussion and Analysis
                    of Financial Condition and Results of Operations...      8
 
Part II: Other Information
 
         Item 6:  Exhibits and Reports on Form 8-K.....................     16
 
     Signatures........................................................     20
 
</TABLE>

                                       2
<PAGE>
 
                               IKOS SYSTEMS, INC.
                           CONSOLIDATED BALANCE SHEETS
                    (in thousands, except per share amounts)
<TABLE>
<CAPTION>
 
                                                              January 2,   October 3,
                                                                1999         1998
                                                             -----------  -----------
          ASSETS                                             (unaudited)
<S>                                                          <C>          <C>
Current assets:
 Cash and cash equivalents.................................    $  7,668     $  8,165
 Short-term investments....................................       5,252        7,517
 Accounts receivable (net of allowances for
  doubtful accounts of $801 and $801, respectively)........       8,466        6,033
 Inventories...............................................       5,565        3,816
 Prepaid expenses and other assets.........................         610          536
                                                               --------     --------
    Total current assets...................................      27,561       26,067
 
 Equipment and leasehold improvements
  Office and evaluation equipment..........................       4,978        4,876
  Machinery and equipment..................................       9,529        9,201
  Leasehold improvements...................................         688          587
                                                               --------     --------
                                                                 15,195       14,664
    Less allowances for depreciation and amortization......      (9,931)      (9,342)
                                                               --------     --------
                                                                  5,264        5,322
 Intangible assets (net of amortization of
  $406 and $303, respectively).............................       1,456        1,559
 Other assets..............................................         362          396
                                                               --------     --------
                                                                $34,643     $ 33,344
                                                               ========     ======== 

                      LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current liabilities:
 Accounts payable..........................................    $  4,999     $  4,789
 Accrued payroll and related expenses......................       2,410        1,854
 Accrued commissions.......................................         907          801
 Income taxes payable......................................       1,184        1,185
 Other accrued liabilities.................................       3,260        4,350
 Deferred revenues.........................................       9,431        7,596
                                                               --------     --------
    Total current liabilities..............................      22,191       20,575
 
Accrued rent...............................................         134          156
Commitments
Stockholders' equity:
 Preferred stock, $.01 par value; 10,000 shares
  authorized, none issued and outstanding..................          --           --
 Common stock, $.01 par value; 50,000 shares
   authorized, 8,797 and 8,797 shares issued and
   8,231 and 8,361 outstanding, respectively...............          87           87
 Additional paid-in capital................................      58,751       58,775
 Treasury stock, at cost, 566 shares in 1999 and
  436 in 1998..............................................      (3,551)      (3,144)
 Accumulated translation adjustment........................        (230)        (314)
 Accumulated deficit.......................................     (42,739)     (42,791)
                                                               --------     --------
    Total stockholders' equity.............................      12,318       12,613
                                                               ========     ========
                                                                $34,643      $33,344
</TABLE>

                 See notes to consolidated financial statements.

                                       3
<PAGE>

                               IKOS SYSTEMS INC.
                       CONSOLIDATED STATEMENTS OF INCOME
                   (in thousands, except per share amounts)
                                  (Unaudited)

 
 
<TABLE>
<CAPTION>
                                                                     Three Months Ended
                                                                 ------------- ------------
                                                                  January 2,    January 3,
                                                                     1999          1998
                                                                 ------------- ------------
<S>                                                              <C>            <C>
Net revenues
    Product....................................................       $7,613        $9,082
    Maintenance................................................        3,731         2,983
                                                                 ------------- ------------
        Total net revenues.....................................       11,344        12,065

Cost of revenues
    Product....................................................        1,969         2,455
    Maintenance................................................          846           558
                                                                 ------------- ------------
        Total cost of revenues.................................        2,815         3,013
                                                                 ------------- ------------
        Gross profit...........................................        8,529         9,052

Operating expenses:
    Research and development...................................        3,015         2,849
    Sales and marketing........................................        4,604         4,464
    General and administration.................................          903           971
    Amortization of intangibles................................          103           336
                                                                 ------------- ------------
        Total operating expenses...............................        8,625         8,620
                                                                 ------------- ------------
Income (loss) from operations..................................          (96)          432

Other income (expense):
    Interest income............................................          148           320
                                                                 ------------- ------------
Income before provision for income taxes.......................           52           752
Provision for income taxes.....................................           --           285
                                                                 ------------- ------------
        Net income.............................................          $52          $467
                                                                 ============= ============

Basic net income per share.....................................        $0.01         $0.05
                                                                 ============= ============

Weighted-average common shares used
    in computing basic per share amounts.......................        8,302         8,501
                                                                 ============= ============

Dilutive net income per share..................................        $0.01         $0.05
                                                                 ============= ============
Common and common equivalent shares used
    in computing dilutive per share amounts....................        8,644         8,713
                                                                 ============= ============
</TABLE>

                See notes to consolidated financial statements.


                                       4

<PAGE>
 
                               IKOS SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
          Increase (decrease) in cash and cash equivalents in thousands
                                  (Unaudited)
<TABLE>
<CAPTION>
                                                                                      Three Months Ended
                                                                                    -----------------------
                                                                                    January 2,   January 3,
                                                                                       1999         1998
                                                                                      -------      -------
Operating activities:
<S>                                                                                     <C>     <C>
 Net income................................................................           $    52      $   467
 Adjustments to reconcile net income to net
  cash provided by operating activities:
  Depreciation and amortization............................................               692          792
  Deferred rent............................................................               (22)         (14)
 
 Changes in operating assets and liabilities:
  Accounts receivable......................................................            (2,433)       1,853
  Inventories..............................................................            (1,749)        (944)
  Prepaid expenses and other current assets................................               (74)          38
  Other asset..............................................................                34         (270)
  Accounts payable.........................................................               210         (493)
  Accrued payroll and other expenses.......................................               556          338
  Accrued commissions......................................................               106         (254)
  Income taxes payable.....................................................                (1)         594
  Other accrued liabilities................................................            (1,006)       1,146
  Deferred revenues........................................................             1,835       (1,271)
                                                                                      -------      -------
   Net cash provided by (used in) operating activities.....................            (1,800)       1,982
 
Investing activities:
 Purchases of equipment and leasehold improvements.........................              (531)        (542)
 Purchase of Deerbrook Systems, Inc........................................                --         (500)
 Purchase of short-term investments........................................            (1,596)      (2,476)
 Maturities of short-term investments......................................             3,861        9,512
                                                                                      -------      -------
   Net cash provided by investment activities..............................             1,734        5,994
 
Financing activities:
 Principal payments on long-term borrowings................................                --         (350)
 Net repurchase of common stock............................................              (431)      (1,796)
                                                                                      -------      -------
   Net cash used in financing activities...................................              (431)      (2,146)
 
Increase (decrease) in cash and cash equivalents...........................              (497)       5,830
Cash and cash equivalents at beginning of period...........................             8,165        9,486
 
Cash and cash equivalents at end of period.................................           $ 7,668      $15,316
                                                                                      =======      =======
</TABLE>

                 See notes to consolidated financial statements.

                                       5
<PAGE>
 
                               IKOS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


1.       Basis of Presentation

         The accompanying unaudited consolidated financial statements at January
         2, 1999 and for the three month periods ended January 2, 1999 and
         January 3, 1998, have been prepared in conformity with generally
         accepted accounting principles, consistent with those applied in, and
         should be read in conjunction with, the audited consolidated financial
         statements for the year ended October 3, 1998 included in the Form 10-K
         as filed with the Securities and Exchange Commission on December 21,
         1998. The unaudited interim financial information reflects all normal
         recurring adjustments which are, in the opinion of management,
         necessary for a fair statement of results for the interim periods
         presented. The results for the three-month period ended January 2, 1999
         are not necessarily indicative of results expected for the full year.

2.       Fiscal Year

         The Company is on a 52-53 week fiscal year. Fiscal year 1998 was a
         53-week year and the three-month period ending January 3, 1998 included
         the additional week for the fiscal year.

3.       Inventories

         Inventories are stated at the lower of cost (first-in, first-out) or
         market and consisted of (in thousands):

                                                    January 2,     October 3,
                                                       1999           1998
                                                     -------        -------

                   Raw materials                      $1,241        $ 1,520
                   Work-in-process                     1,261          1,163
                   Finished goods                      3,063          1,133
                                                     -------        -------
                                                      $5,565        $ 3,816
                                                     =======        =======

                                       6
<PAGE>
 
                               IKOS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

4.       Net Income Per Share

         The computation of basic net income per share for the periods presented
         is derived from the information on the face of the income statement,
         and there are no reconciling items in either the numerator or
         denominator. Additionally, there are no reconciling items in the
         numerator used to compute dilutive net income per share. The total
         shares used in the denominator of the diluted net income per share
         calculation includes 342,000 and 212,000 incremental common shares
         attributable to outstanding options for the first quarter.

5.       Comprehensive Income

         The Company has adopted the Statement of Financial Accounting Standards
         No. 130 (FAS 130), "Reporting Comprehensive Income" in the first
         quarter of fiscal 1999. FAS 130 establishes standards for the reporting
         and disclosure of comprehensive income and its components; however, the
         disclosure has no impact on the Company's consolidated results of
         operations, financial position or cash flows. Comprehensive income is
         defined as the change in equity of a company during a period resulting
         from certain transactions and other events and circumstances, excluding
         transactions resulting from investments by owners and distributions to
         owners. The difference between net income and comprehensive income for
         the Company is from foreign currency translation adjustments.
         Comprehensive income for the first fiscal quarters ended January 2,
         1999 and January 3, 1998 was $136,000 and $277,000, respectively and
         included $84,000 and $190,000 of accumulated translation adjustments,
         respectively.

6.       Impact of Recently Issued Accounting Standards

         In June 1997, the Financial Accounting Standards Board also issued
         Statement of Financial Accounting Standards No. 131, "Disclosures about
         Segments of an Enterprise and Related Information" ("SFAS 131"), which
         established standards for the way public enterprises report information
         in annual statements and financial reports regarding operating
         segments, products, services, geographic areas, and major customers.
         SFAS 131 will be first reflected in the Company's 1999 Annual Report.
         The adoption of SFAS 131 is not expected to materially impact the
         Company's results of operation or financial position

         In March 1998, the American Institute of Certified Public Accounts
         issued Statement of Position 98-1, "Accounting for the Costs of
         Computer Software Developed for Obtained for Internal Use" ("SOP
         98-1"), which provides guidelines for accounting for costs of computer
         software developed for internal use. SOP 98-1 is effective for
         financial statements for fiscal years beginning after December 15,
         1998. The adoption of SO 98-1 is not expected to materially impact the
         Company's results of operation or financial position.

         In June 1998, the Financial Accounting Standards Board issued Statement
         of Financial Accounting Standards No. 133, "Accounting for Derivative
         Instruments and Hedging Activities" ("SFAS133"), which is required to
         be adopted in years beginning after June 15, 1999. The adoption of SFAS
         133 is not expected to materially impact the Company's results of
         operations or its financial position.

                                       7
<PAGE>
 
ITEM 2.   Management's Discussion and Analysis of Financial Condition and
          Results of Operations


Cautionary Statement

The statements in the Management's Discussion and Analysis of Financial
Condition and Results of Operations that are forward looking involve numerous
risks and uncertainties and are based on current expectations.  Actual results
may differ materially from those projected.  Such risks and uncertainties may be
more fully described in other reports and information filed by the Company with
the Securities and Exchange Commission. Certain of these risks and uncertainties
are discussed under the caption "Factors That May Affect Future Results of
Operations."

Net Revenues

Net revenues for the first quarter of fiscal 1999 totaled $11,344,000, a
decrease of approximately 6% from the same quarter in fiscal 1998.  The decrease
was primarily the result of a decline in the sales of the Company's Voyager
product line, which was partially offset due to, increases in revenues from
emulation products and increased maintenance revenues.  Fewer units of the
Voyager product were shipped during the quarter when compared to the same period
in fiscal 1998, however, shipment levels were comparable to the previous
quarter. The Company continued to increase its focus on its emulation product
line.  Emulation systems which were in an extended beta period through most of
the fourth quarter of fiscal 1998, began to ship at increased levels during the
first quarter of fiscal 1999 resulting in increased revenue levels when compared
to fiscal 1998 and the prior quarter.

Maintenance revenues for the first quarter of fiscal 1999 totaled $3,731,000, an
increase of 25% over the same period from a year ago. The increase is primarily
attributable to the current Voyager systems installed base and the increasing
base of its new emulation systems. In addition, the Company announced certain
new products for its simulation system business which are expected to extend the
life of current Voyager products, resulting in several customers who no longer
had maintenance contracts with the Company, to renew such maintenance
agreements.

International sales for the first quarter of fiscal 1999 totaled $4,462,000 and
represented an increase from the previous quarter and were comparable to the
same quarter from fiscal 1998.  The Company had stronger sales and bookings in
the quarter due to increased economic demand, particularly in Europe for its
Voyager products.  Japan while still lower than initial expectations also showed
improvement over the previous quarters and the remainder of the Asian
marketplace showed increasing demand as sales within this region increased from
the prior year quarter.


Gross Profit Margins

Gross profit margin for the first quarter of fiscal 1999 was approximately 75%
and is comparable to the margin for the same period in the prior year.  The
Company's product margins were slightly higher than the same quarter from the
previous year, while the margins on its maintenance products decreased.  The
decrease for the maintenance is a result of increased costs associated with new
products primarily emulation offset by the larger maintenance customer base.

                                       8
<PAGE>
 
Research and Development Expenses

Research and development for the first quarter of fiscal 1999 was approximately
$3,015,000 or 27% of net revenues as compared to $2,849,000 or 24% of net
revenues for the same period in fiscal 1998.  The increase is primarily due to
additional funds spent on increased headcount, consulting and prototypes, as the
company continued to focus on its new product offerings and emulation efforts.
These increases included the additional costs associated with the Company's new
research and development facility in India.  The Company expects research and
development spending to continue to increase as the Company continues to address
its on-going development efforts for new product technology development.

Sales and Marketing Expenses

Sales and marketing expenses increased from $4,464,000, or 37% of net revenues
in the first quarter of fiscal 1998 to $4,604,000, or 41% of net revenues for
the first quarter of fiscal 1999.  The increase in absolute dollars is primarily
due to commissions earned during the quarter for sales by sales agents in Asia
and increased advertising.  The increase as a percentage is due to the increased
costs being distributed over few revenue dollars.

General and Administrative Expenses

General and administrative costs were $903,000 or 8% of net revenues and were
comparable to the same period in fiscal 1998 when costs totaled $971,000 for the
quarter or 8% of net revenues.  General and administrative costs are expected to
remain flat over the remainder of fiscal 1999.

Income Taxes

The Company's effective tax rate on the consolidated pretax income for the three
month period ended January 2, 1999 is zero percent compared to an effective tax
rate of 38% on the consolidated pretax income for the three month period ended
January 3, 1998.  The Company's 1999 first quarter effective tax rate differs
from the federal statutory rate primarily due to benefits associated with its
net operating loss carryforward. The Company's 1998 first quarter effective tax
rate differs from the federal statutory rate primarily due to tax benefits
associated with its foreign sales corporation and research credits offset by
costs associated with the non-deductible goodwill amortization and state income
taxes.

Other

The Company has experienced minimal gains or losses on foreign currency
translation since substantially all of its international sales to date have been
billed and collected in U.S. dollars. The Company pays the expenses of its
international operations in local currencies and to date the Company has not
engaged in hedging transactions with respect to such hedging obligations.  The
Company has reorganized its operations at its Japan subsidiary and is engaging
in transactions in the Japanese local currency.  As such, the Company
periodically enters into foreign exchange contracts to minimize foreign exchange
risk relating to the Japanese subsidiary's sales that are denominated in yen.  A
forward exchange contract obligates the Company to exchange predetermined
amounts of a specified foreign currency at a specified exchange rate on a
specified date or to make an equivalent US dollar payment equal to the value of
such exchange.  These contracts are accounted for as hedges of identifiable
receivables denominated in Japanese yen.  Realized gains or losses are
recognized upon maturity of the contracts and offset the underlying asset or
liability. Through January 2, 1999, such hedging arrangements have been
immaterial to the Company operations.

                                       9
<PAGE>
 
Factors that May Affect Future Results of Operations

Potential Fluctuations in Quarterly Results - The Company's quarterly operating
-------------------------------------------                                    
results have in the past and may in the future vary significantly depending on
factors including the timing of customer development projects and purchase
orders, new product announcements and releases by the Company and other
companies, gain or loss of significant customers, price discounting of the
Company's products, the timing of expenditures, customer product delivery
requirements, availability and cost of components or labor and economic
conditions generally and in the electronics industry specifically. Any
unfavorable change in these or other factors could have a material adverse
effect on the Company's operating results for a particular quarter. Many of the
Company's customers order on an as-needed basis and often delay issuance of firm
purchase orders until their project commencement dates are determined. Quarterly
revenue and operating results will therefore depend on the volume and timing of
orders received during the quarter, which are difficult to forecast accurately.
Moreover, a significant portion of the Company's revenue may result from
shipments during the last few weeks of the quarter from orders generally
received in the last month of the quarter. Any concentration of sales at the end
of the quarter may limit the Company's ability to plan or adjust operating
expenses and production and inventory levels. Therefore, if anticipated
shipments in any quarter do not occur or are delayed, expenditure levels could
be disproportionately high as a percentage of revenue, and the Company's
operating results for that quarter would be adversely affected. In addition,
sales of individual systems with high average sales prices can constitute a
significant percentage of the Company's quarterly revenue. Operating results in
any period should not be considered indicative of the results to be expected for
any future period, and there can be no assurance that the Company's net revenues
will increase or that the Company will remain profitable in any future period.

Increased Sales and Development of the Company's Products - Substantially all of
---------------------------------------------------------                       
the Company's product revenues since fiscal 1993 have been derived from the sale
of its Voyager and Gemini simulation systems. The Company has seen a decline in
such revenues and there can be no assurance the decline in these product's
revenues will reverse. Increased sales of the Company's hardware-assisted
simulation products for the verification of IC and system designs are expected
to depend on the introduction of new simulation products and methodologies.
Furthermore, increased sales will also depend on an increasing number of complex
ICs designed for electronic systems, integration of the Company's products with
other tools for IC design and simulation, the ability of hardware-assisted
simulation systems to shorten the time of simulation of IC designs and continued
industry acceptance of mixed-level hardware-assisted simulation.  Because the
market for hardware-assisted simulation products is evolving, it is difficult to
predict with any assurance whether the market for hardware-assisted simulation
products will continue to expand. There can be no assurances that such market
will expand, or even if such market expands that the Company's products will
achieve the market acceptance required to maintain revenue growth and
profitability in the future.

                                       10
<PAGE>
 
In addition to the Company's simulation product line, the Company has focused
certain of its resources on its emulation product line.  The Company's initial
emulation product was commercially released in the first quarter of fiscal 1997.
The Company encountered several hardware and software design issues with its
initial emulation product, and in addition, the EDA marketplace for emulation
products continued to evolve, impacting the original design.  During 1998, the
Company addressed its hardware and software design issues by completely
redesigning the emulation product and has recently commercially released its
second-generation emulation product.  While the Company has seen favorable
results with its latest release, particularly in the first quarter of fiscal
1999, there can be no assurance that the product will adequately meet the
requirements of the marketplace.  There continues to be further development of
the emulation product, and as the Company continues to develop emulation
products which are based on the new technology concept, there can be no
assurance that the enhanced products or other developed products resulting from
this development will provide the necessary solutions to customer design
verification needs, be of acceptable quality or achieve further market
acceptance. The success of the Company in developing, introducing, selling and
supporting emulation products will depend on a variety of factors, including but
not limited to, the timely and successful enhancement of current products,
completion of product design and development of future products, the timely and
efficient implementation of manufacturing processes, effective sales, marketing
and customer service, and the absence of performance problems or other
difficulties that may require design modifications and related expenses and may
hinder or damage market acceptance of the products. While the Company's
emulation systems are designed to provide cost and ease of use advantages
intended to broaden the market for logic emulation, there can be no assurance
that its products will be able to achieve such goals. Moreover, there can be no
assurance that the market for logic emulation will broaden beyond the current
set of emulation systems users. The adoption of any emulation products the
Company has or may develop will also depend on the continued increasing
complexity of ICs designed for electronic systems, integration of such products
with other tools for IC design and verification, importance of the time to
market benefits of emulation systems and industry acceptance of the need to
close the gap between high level design and silicon production. Because the
market for emulation products is new and evolving, it is difficult to predict
with any assurance whether the market for emulation products will continue to
expand, or even if such market expands, that the Company's products will achieve
the market acceptance required to maintain revenue growth and continued
profitability.

In May 1998, the Company completed its acquisition of certain technology and
research and development expertise from Interra, Inc., and its affiliate,
Delsoft India Pvt. Limited.  While the Company expects that the technology
acquired and the resources obtained in this transaction will assist the Company
in meeting its new product introduction goals and deadlines, the Company has
significant development risk with respect to incorporating the acquired
technology into current products or generating new products from such
technology.  Such effort will result in increased spending on research and
development as the Company attempts to meet these goals and deadlines.  There
can be no assurances that such goals or deadlines will be achieved in a timely
manner.  Furthermore, should such goals and deadlines for the introduction of
new products be attained, there can be no assurances that the resulting new
products will adequately meet the requirements of the marketplace.

                                       11
<PAGE>
 
Competition - The EDA industry is highly competitive and rapidly changing. The
-----------                                                                   
Company's products are specifically targeted at the emerging portion of the
industry relating to complex designs that the Company believes benefit from
simulation and emulation products.  The Company currently competes with
traditional software verification methodologies, including product offerings
sold by Cadence, Synopsis and Mentor Graphics. The Company's main competition
for the sale of emulation systems is Quickturn. The Company expects competition
in the market for verification tools to increase as other companies attempt to
introduce new products, such as cycle-based software simulation products and
product enhancements. Moreover, the Company competes, and expects that it will
continue to compete, with established EDA companies. A number of these companies
have longer operating histories, significantly greater financial, technical and
marketing resources, greater name recognition and larger installed customer
bases than the Company. In addition, many of these competitors and potential
competitors have established relationships with current and potential customers
of the Company and offer a broader and more comprehensive product line.
Increased competition could result in price reductions, reduced margins and loss
of market share, all of which could materially adversely affect the Company. In
addition, current competitors or other entities may develop other products that
have significant advantages over the Company's products. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors or that competitive pressures faced by the Company will
not materially adversely affect its operating results.

New Products and Technological Change - The EDA industry is characterized by
-------------------------------------                                       
extremely rapid technological change in both hardware and software development,
frequent new product introductions, evolving industry standards and changing
customer requirements. The introduction of products embodying new technologies
and the emergence of new industry standards can render existing products
obsolete and unmarketable. The Company's future success will depend upon its
ability to enhance its current series of simulation and emulation systems and to
design, develop and support its future simulation and emulation products on a
timely basis. These efforts require a high level of expenditures for research
and development by the Company to address the increasingly sophisticated needs
of the customers. For example, all of the Company's current products operate in,
and planned future products will operate in, the Unix operating environment, an
industry standard in the EDA market. In the event that another operating system,
such as Windows NT, becomes an industry standard, the Company may be required to
port its products to such new standard. In addition, the Company's simulation
systems generally accept designs in the broadly accepted hardware description
language, Verilog-XL, which Cadence has developed and made available to the
Company. In the event Cadence adopts a less cooperative stance toward the
Company in the future, the Company's systems may not be able to accept designs
based on Verilog-XL and the Company may be required to develop software to
accept designs of other hardware description languages. The inability to accept
designs in Verilog-XL may materially adversely affect the Company's results of
operations. There can be no assurance that the Company will be successful in
developing and marketing product enhancements or new products

                                       12
<PAGE>
 
that respond to technological change or evolving industry standards or changing
customer requirements, that the Company will not experience difficulties that
could delay or prevent the successful development, introduction and marketing of
these products, or that its new products and product enhancements will
adequately meet the requirements of the marketplace, will be of acceptable
quality or will achieve market acceptance. If the Company is unable, for
technological or other reasons, to develop and introduce  products in a  timely
manner in response to changing market conditions or customer requirements, the
Company's business, operating results and financial condition will be materially
and adversely affected. Moreover, from time to time, the Company may announce
new products or technologies that have the potential to replace the Company's
existing product offerings. There can be no assurance that the announcement of
new product offerings will not cause customers to defer purchases of existing
Company products, which could adversely affect the Company's results of
operations for any particular quarter.

Dependence on Electronics Industry - The Company is dependent upon the
----------------------------------                                    
electronics industry and, in particular, new system and IC design projects. The
electronics industry is characterized by rapid technological change, short
product life cycles, fluctuations in manufacturing capacity and pricing and
margin pressures, all of which cause it to be volatile. As a result, the
electronics industry has historically experienced sudden and unexpected
downturns, at which time the number of new system and IC design projects
decrease. Because most of the Company's sales occur upon the commencement of new
projects for system and IC products, the Company is dependent upon the rate of
commencement of new system and IC design projects. Accordingly, negative factors
affecting the electronics industry could have a material adverse effect on the
Company's results of operations.

Dependence Upon Certain Suppliers - Certain key components used in the Company's
---------------------------------                                               
products are presently available from sole or limited sources. The inability to
develop alternative sources for these sole or limited source components or to
obtain sufficient quantities of these components could result in delays or
reductions in product shipments which could adversely affect the Company's
operating results. The Company's systems use proprietary ASICs and FPGAs that
are currently manufactured solely by American Microsystems, Inc. (''AMI'') and
Xilinx, Inc. ("Xilinx"), respectively.

The Company generally purchases these components, including semiconductor
memories used in the Company's simulator and emulator hardware, pursuant to
purchase orders placed from time to time in the ordinary course of business and
has no supply arrangements with any of its source suppliers that require the
suppliers to provide components in guaranteed quantities or at set prices.
Moreover, the manufacture of these components can be extremely complex, and the
Company's reliance on the suppliers of these components exposes the Company to
production difficulties and quality variations that may be experienced by these
suppliers. Therefore, the Company's reliance on its sole and limited source
suppliers involves several risks, including a potential inability to obtain an
adequate supply of required components, reduced control over pricing and timely
delivery and quality of acceptable components. While the timeliness and quality
of deliveries to date from such suppliers have been acceptable, there can be no
assurance that problems will not occur in the future. Any prolonged inability to
obtain components or subassemblies in sufficient quantities or quality or on
favorable pricing or delivery terms, or any other circumstances that would
require the Company to seek alternative sources of supply, could have a material
adverse effect on the Company's operating results and could damage the Company's
relationships with its customers.

                                       13
<PAGE>
 
Customer Concentration - A relatively limited number of customers have
----------------------                                                
historically accounted for a substantial portion of the Company's net revenues.
During fiscal 1998, 1997 and 1996, sales to the Company's top ten customers
accounted for approximately 45%, 52% and 65%, respectively, of the Company's net
revenues. The Company expects that sales of its products to a limited number of
customers will continue to account for a high percentage of net revenues for the
foreseeable future. The loss of a major customer or any reduction in orders by
such customers, including reductions due to market or competitive conditions in
the electronics or EDA industries, would have an adverse effect on the Company's
results of operations. Moreover, the Company's ability to increase its sales
will depend in part upon its ability to obtain orders from new customers, as
well as the financial condition and success of its existing customers and the
general economy. There can be no assurance that such increases will occur.

Year 2000 Considerations  The Year 2000 issue is the result of computer programs
------------------------                                                        
being written using two digits rather than four to define the applicable year.
As such there is the risk that computer programs or hardware that have date-
sensitive software or embedded chips may recognize a date using "00" as the year
1900 rather than the year 2000. Such recognition, could result in
miscalculations, classifications errors or system failures.  The Company has
taken steps to review, update or confirm such update of all of the systems (IT
and Non IT) which use date-sensitive computerized information used in its
operations, including its current products, vendor and customer systems.  The
Company has completed its assessment and testing for Year 2000 compliance within
its current product lines and all future products are being designed and tested
to be Year 2000 compliant.  The costs associated with this assessment and
testing have been immaterial and have not materially impacted other non-Year
2000 IT projects.  The Company has completed its assessments of its significant
third party systems, including its IT systems and other vendor systems and
believe such systems are in compliance. The Company is currently in the process
of performing its testing of such systems to confirm compliance.  The Company
does not believe that the costs incurred to date or expected to be incurred in
the future in addressing this matter are material to the Company's operating
results. However, if the Company has failed to adequately address any of its
systems or if its vendor or customer systems fail to adequately address this
risk, the Company's financial condition and results of operations could be
adversely affected.  The Company currently does not have a contingency plan
completed and is currently reviewing initial drafts of such plans. Accordingly,
the Company will continue to devote the necessary resources to the issue.

Euro Currency  Effective January 1999, 11 members of the countries of the
-------------                                                            
European Union established a fixed conversion rate between their existing
sovereign currencies and the Euro and adopted the Euro as their common legal
currency.  During a three year transition, the Euro will be available for non-
cash transactions and legal currencies will remain the legal tender.  The
Company is assessing the Euro impact on its business including the ability to
handle the conversion in the accounting system and other information systems,
ability of foreign banks to report on dual currencies, the legal and contractual
implications of contracts, and reviewing pricing strategies.  The Company
expects that modifications to its operations and systems will be completed on a
timely basis, and does not believe the conversion will have a material adverse
impact on the Company's operations.  However, there can be no assurance that the
Company will be able to successfully modify all systems and contracts to comply
with Euro requirements on a timely basis.

                                       14
<PAGE>
 
Liquidity and Capital Resources

Since inception, the Company has financed its operations, including increases in
accounts receivable and inventory and capital equipment acquisitions, primarily
through private and public sales of equity securities and a loan secured by
capital equipment. The Company's cash, cash equivalents and short-term
investments decreased to $12,920,000 at January 2, 1999 from $15,682,000 at
October 3, 1998.  The decrease was a result of $1,800,000 cash used in operating
activities, $531,000 of cash used in investing activities (excluding short-term
investment activities) and $431,000 of cash used in financing activities.

Operating Activities - The Company's operating activities used cash of
--------------------                                                  
$1,800,000 during the first quarter of fiscal 1999.  The 1,800,000 cash used by
operations was primarily due to increases in accounts receivable, inventories
and decreases in other accrued liabilities offset by net income adjusted for
depreciation and amortization, and increases in accounts payable, accrued
payroll and related expenses and deferred revenues.

Investing Activities - Net cash provided by investing activities for first
--------------------                                                      
fiscal quarter of 1999 was $1,734,000.  The $1,734,000 of cash provided was
primarily the result of $3,861,000 obtained from maturities of short-term
investment offset by purchases of short-term investments of $1,596,000 and
acquisition of capital equipment of $531,000. For each period presented, capital
expenditures were primarily for evaluation equipment and engineering
workstations.

Financing Activities  Net cash used in financing activities for the first
--------------------                                                     
quarter ended January 2, 1999, was $431,000 and was primarily related to the net
purchases of stock during the quarter. During fiscal 1998, the Company announced
its intention to repurchase up to 1,000,000 shares of its outstanding common
stock on the open market.  During the quarter the Company repurchased
approximately 130,000 shares of common stock.  Through January 2, 1999, the
Company had repurchased approximately 516,500 shares at a weighted-average per
share price of $5.96.

The Company's primary unused sources of funds at January 2, 1999 consisted of
$7,668,000 of cash and cash equivalents, in addition to $5,252,000 of short-term
investments. The Company believes that its current cash, cash equivalents and
short-term investments, together with cash and cash equivalents generated from
operations will be sufficient to finance its operations for at least the next
twelve months. Should the Company require other financing arrangements, there
can be no assurances that such financing will be available on terms favorable or
acceptable to the Company.

 

                                       15
<PAGE>
 
                           PART II. OTHER INFORMATION


ITEMS 1-5         Not applicable

ITEM 6            Exhibits and Reports on Form 8-K


(a) INDEX TO EXHIBITS
                                INDEX TO EXHIBITS
<TABLE> 
<CAPTION> 
Exh. No.                        Documentation Description                                Page
<S>               <C>                                                                    <C> 
  2.1             Agreement and Plan of Reorganization among the Company, VMW
                  Acquisition Corporation and VMW dated May 14, 1996
                  (Incorporated by reference to Exhibit 2.1 of the Company's
                  registration statement on Form S-3 effective June 26, 1996).

  2.2             Technology Purchase Agreement dated May 12, 1998 by and
                  between the Company and Interra, Inc. (Incorporated by
                  reference to Exhibit 2.1 of the Company's Current Report on
                  Form 8-K filed May 20, 1998).

  3.1             Certificate of Incorporation (Incorporated by reference to
                  Exhibit 3.1 of the Company's registration statement on Form
                  S-1 effective July 25, 1990).

  3.2             Certificate of Amendment of Certificate of Incorporation filed
                  May 5, 1994 (Incorporated by reference to Exhibit 4.1 of the
                  Company's registration statement on Form S-2 effective October
                  12, 1995).

  3.3             Certificate of Amendment of Certificate of Incorporation filed
                  April 24, 1995 (Incorporated by reference to Exhibit 4.2 of
                  the Company's registration statement on Form S-2 effective
                  October 12, 1995).

  3.4             Certificate of Amendment of Certificate of Incorporation filed
                  February 3. 1997 (Incorporated by reference to Exhibit 3.4 of
                  the Company's quarterly report on Form 10-Q for the quarter
                  ending March 29, 1997).

  3.5             By laws (Incorporated by reference to Exhibit 3.2 of the
                  Company's registration statement on Form S-1 effective July
                  25, 1990).

  3.6             Certificate of Amendment to Bylaws (Incorporated by reference
                  to Exhibit to Exhibit 7 of the Company's registration
                  statement on Form 8-A/A filed February 3, 1999)
</TABLE> 

                                       16
<PAGE>
 
<TABLE> 
<CAPTION> 
Exh. No.                        Documentation Description                                Page
--------                        -------------------------                                ---- 
<S>               <C>                                                                    <C> 
  10.1            Lease Agreement for the Company's principal facility dated
                  March 20, 1992, between Ames Avenue Associates and the
                  Company, as amended. (Incorporated by reference to Exhibit
                  10.1 of the Company's annual report on 10-K for the year
                  ending September 26, 1992).

  10.2            Form of Director and Officer Indemnity Agreement.
                  (Incorporated by reference to Exhibit 10.6 of the Company's
                  registration statement on Form S-1 effective July 25, 1990).

  10.3            1988 Stock Option Plan. (Incorporated by reference to Exhibit
                  10.14 of the Company's registration statement on Form S-1
                  effective July 25, 1990).

  10.4            Patent Cross License Agreement dated May 17, 1989 with Zycad
                  Corporation (Incorporated by reference to Exhibit 10.20 of the
                  Company's registration statement on Form S-1 effective July
                  25, 1990).

  10.5            International Distributorship Agreement dated April 11, 1988,
                  with C. Itoh & Co., Ltd. (Incorporated by reference to Exhibit
                  10.24 of the Company's registration statement on Form S-1
                  effective July 25, 1990). Confidential Treatment has been
                  granted as to certain portions of this Exhibit.

  10.6            OEM Software License Agreement between CAD Language Systems,
                  Inc. and IKOS Systems, Inc. dated June 22, 1989 and amendment
                  dated September 1991 (Incorporated by reference to Exhibit
                  10.18 of the Company's Annual Report for the year ended
                  September 28, 1991).

  10.7            Technology Transfer and Joint Development Agreement with
                  Racal-Redac, Inc. dated July 1, 1993 (Incorporated by
                  reference to Exhibit 10.19 of the Company's quarterly report
                  on Form 10-Q for the quarter ended July 3, 1993). Confidential
                  Treatment has been granted as to certain portions of this
                  Exhibit.

  10.8            Settlement Agreement and Release dated March 31, 1994 between
                  Racal Redac, Inc. and the Company (Incorporated by reference
                  to Exhibit 10.13 of the Company's registration statement on
                  Form S-2 effective October 12, 1995).

  10.9            Software License Agreement with Compass Design Automation
                  dated December 31, 1993 (Incorporated by reference to Exhibit
                  10.17 of the Company's quarterly report on Form 10-Q for the
                  quarter ended January 1, 1994).

  10.10           Agreement dated June 2, 1994, by and between the Company and
                  Gerald S. Casilli (Incorporated by reference to Exhibit 10.18
                  of the Company's quarterly report on Form 10-Q for the quarter
                  ended July 2, 1994). 
</TABLE> 

                                       17
<PAGE>
 
<TABLE> 
<CAPTION> 
Exh. No.                        Documentation Description                                Page
--------                        -------------------------                                ---- 
<S>               <C>                                                                    <C> 
  10.11           Agreement dated June 2, 1994, by and between the Company and
                  Daniel R. Hafeman (Incorporated by reference to Exhibit 10.18
                  of the Company's quarterly report on Form 10-Q for the quarter
                  ended July 2, 1994).

  10.12           Agreement dated June 2, 1994, by and between the Company and
                  Stephen McLaughlin. (Incorporated by reference to Exhibit
                  10.18 of the Company's quarterly report on Form 10-Q for the
                  quarter ended July 2, 1994).

  10.13           Agreement dated June 2, 1994, by and between the Company and
                  Larry A. Melling (Incorporated by reference to Exhibit 10.18
                  of the Company's quarterly report on Form 10-Q for the quarter
                  ended July 2, 1994).

  10.14           Agreement dated June 2, 1994, by and between the Company and
                  Ramon A. Nunez (Incorporated by reference to Exhibit 10.18 of
                  the Company's quarterly report on Form 10-Q for the quarter
                  ended July 2, 1994).

  10.15           Agreement dated June 2, 1994, by and between the Company and
                  Joseph W. Rockom (Incorporated by reference to Exhibit 10.18
                  of the Company's quarterly report on Form 10-Q for the quarter
                  ended July 2, 1994).

  10.16           The Company's 1995 Outside Directors Stock Option Plan
                  (Incorporated by reference to Exhibit 10.22 of the Company's
                  registration statement on Form S-2 effective October 12,
                  1995).

  10.17           Development and OEM Agreement for Verilog/IKOS Co-simulation
                  Interface dated August 26, 1994 by and between the Company and
                  Precedence Incorporated (Incorporated by reference to Exhibit
                  10.24 of the Company's registration statement on Form S-2
                  effective October 12, 1995).

  10.18           Amendment to OEM Agreement for the acquisition of certain
                  software technology, by and between Compass Design Automation,
                  Inc. and the Company dated December 27, 1995 (Incorporated by
                  reference to Exhibit 10.20 of the Company's quarterly report
                  on Form 10-Q for the quarter ended December 30, 1995).

  10.19           Amended and Restated Employment Agreement dated August 1, 1995
                  by and between the Company and Ramon Nunez (Incorporated by
                  reference to Exhibit 10.21 of the Company's quarterly report
                  on Form 10-Q for the quarter ended December 30, 1995).
</TABLE> 

                                       18
<PAGE>
 
<TABLE> 
<CAPTION> 
Exh. No.                        Documentation Description                                Page
--------                        -------------------------                                ---- 
<S>               <C>                                                                    <C> 
  10.20           Patent License Agreement dated December 22, 1993 between
                  Massachusetts Institute of Technology and the Company
                  (Incorporated by reference to Exhibit 10.20 of the Company's
                  quarterly report on Form 10-Q for the quarter ended June 29,
                  1996). Confidential treatment has be granted as to certain
                  portions of this Exhibit.

  10.21           The Company's 1995 Stock Option Plan, as amended (Incorporated
                  by reference to Exhibit 10.21 of the Company's Quarterly
                  Report on Form 10-Q for the quarter ended April 4, 1998).

  10.22           The Company's 1996 Employee Stock Purchase Plan, as amended
                  (Incorporated by reference to Exhibit 10.22 of the Company's
                  Quarterly Report on Form 10-Q for the quarter ended April 4,
                  1998).

  17.1            Amended and restated Rights Agreement dated January 22, 1999
                  between IKOS Systems, Inc. and BankBoston N.A., as Rights
                  Agent, including the Certificates of Designation, the form of
                  Rights Certificate and the Summary of Terms attached thereto
                  as Exhibit A, B and C, respectively (Incorporated by reference
                  to Exhibit 1 to the Company's Registration Statement on Form
                  8-A /A filed on February 3, 1999.

  27.1            Financial Data Schedule

</TABLE> 

(b) REPORTS ON FORM 8-K

         NONE

                                   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.

                                      IKOS SYSTEMS, INC.
                                      ------------------
                                      Registrant


Date: February 8, 1999                /s/ Joseph W. Rockom
                                      ---------------------
                                      (JOSEPH W. ROCKOM CFO)
                                      Principal Financial Officer,
                                      Duly Authorized Officer

                                       19