<PAGE>
 
================================================================================

                      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 3, 1998 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                8,393,000
          ---------------------------            
                (Title of Class)        (Outstanding as of January 3, 1998)

================================================================================
<PAGE>
 
                              IKOS SYSTEMS, INC.
                                   FORM 10-Q
                         QUARTER ENDED January 3, 1998


                                     INDEX
                                     -----

Part I:  Financial Information

         Item 1:  Financial Statements
<TABLE> 
<CAPTION> 
                                                                        Page
<S>                                                                     <C> 
                  Consolidated Balance Sheets at
                    January 3, 1998 and September 27, 1997.............   3
 
                  Consolidated Statements of Income
                    for the three months ended
                    January 3, 1998 and December 28, 1996..............   4
 
                  Consolidated Statements of Cash Flows
                    for the three months ended
                    January 3, 1998 and December 28, 1996..............   5

                  Notes to Consolidated Financial Statements...........   6
 
         Item 2:  Management's Discussion and Analysis
                    of Financial Condition and Results of Operations...  11

Part II: Other Information

         Item 6:  Exhibits and Reports on Form 8-K.....................  17

         Signatures....................................................  20
</TABLE> 
<PAGE>
                              IKOS SYSTEMS, INC.
                          CONSOLIDATED BALANCE SHEETS
                   (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                      January 3,   September 27,
                                                         1998          1997
                                                      -----------  -------------
                                    ASSETS            (Unaudited)       (1)
<S>                                                   <C>          <C> 
Current assets:
  Cash and cash equivalents.........................   $ 15,316       $ 9,486
  Short-term investments............................      8,293        15,329
  Accounts receivable (net of allowances for                        
    doubtful accounts of $526 and $501,                             
    respectively)...................................     10,375        12,228
  Inventories.......................................      5,748         4,804
  Deferred tax assets...............................      3,450         3,450
  Prepaid expenses and other assets.................        621           659
                                                       --------       -------
     Total current assets...........................     43,803        45,956
                                                                    
  Equipment and leasehold improvements                              
    Office and evaluation equipment.................      3,979         3,684
    Machinery and equipment.........................      7,481         7,328
    Leasehold improvements..........................        441           337
                                                       --------       -------
                                                         11,901        11,349
     Less allowances for depreciation and                           
      amortization..................................     (7,536)       (7,080)
                                                       --------       -------
                                                          4,365         4,269 
 Intangible assets (net of amortization of                          
    $2,017 and $1,681, respectively)................      4,780         4,626
  Deferred tax assets...............................      1,127         1,127
  Other assets......................................        842           572
                                                       --------       -------
                                                       $ 54,917       $56,550
                                                       ========       =======
                                                                    
                     LIABILITIES AND STOCKHOLDERS' EQUITY           
                                                                    
Current liabilities:                                                
  Accounts payable..................................   $  2,580       $ 3,073
  Accrued payroll and related expenses..............      2,775         2,437
  Accrued commissions...............................        488           742
  Income taxes payable..............................      1,666         1,072
  Other accrued liabilities.........................      2,697         1,551
  Deferred maintenance revenues.....................      3,852         5,123
  Current portion of long-term debt.................        --            350
                                                       --------       -------
     Total current liabilities......................     14,058        14,348
Long-term debt, less current portion................        --            --
Accrued rent........................................        198           212
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, 8,393 and 8,579 shares                              
    issued and outstanding, respectively............         84            85
  Additional paid-in capital........................     55,647        57,442
  Accumulated deficit...............................    (15,070)      (15,537)
                                                       --------       -------
     Total stockholders' equity.....................     40,661        41,990
                                                       --------       -------
                                                       $ 54,917       $56,550
                                                       ========       =======
</TABLE> 

(1) Derived from audited financial statements

                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 3,  December 28,
                                                           1998         1996
                                                        ----------  ------------
<S>                                                     <C>         <C> 
Net revenues
  Product.............................................    $9,082       $11,852
  Maintenance.........................................     2,983         2,337
                                                          ------       -------
    Total net revenues................................    12,065        14,189

Cost of revenues
  Product.............................................     2,455         2,692
  Maintenance.........................................       558           421
                                                          ------       -------
    Total cost of revenues............................     3,013         3,113
                                                          ------       -------
    Gross profit......................................     9,052        11,076

Operating expenses:
  Research and development............................     2,849         2,351
  Sales and marketing.................................     4,464         4,200
  General and administration..........................       971         1,028
  Amortization of intangibles.........................       336           315
                                                          ------       -------
    Total operating expenses..........................     8,620         7,894
                                                          ------       -------
Income from operations................................       432         3,182

Other income (expense):
  Interest income.....................................       320           277
  Interest expense....................................       --            --
  Other...............................................       --             31
                                                          ------       -------
    Total other income................................       320           308
                                                          ------       -------

Income before provision for income taxes..............       752         3,490
  Provision for income taxes..........................       285         1,315
                                                          ------       -------
    Net income........................................    $  467       $ 2,175
                                                          ======       =======

Basic net income per share............................    $ 0.05       $  0.26
                                                          ======       =======
Weighted-average common shares used
 in computing basic per share amounts.................     8,501         8,241
                                                          ======       =======

Dilutive net income per share.........................    $ 0.05       $  0.25
                                                          ======       =======
Weighted-average shares used
 in computing dilutive per share amounts..............     8,713         8,856
                                                          ======       =======
</TABLE> 

All share and per share data have been adjusted retroactively to comply with the
requirements of Financial Accounting Standards Board Statement No. 128 "Earnings
Per Share."

                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 3,   December 28,
                                                          1998          1996    
                                                       ----------   ------------
<S>                                                    <C>          <C>        
Operating activities:                                                          
  Net income..........................................   $   467        $ 2,175 
  Adjustments to reconcile net income to net cash                  
   provided by (used in) operating activities:                     
   Depreciation and amortization......................       792            557
   Deferred taxes.....................................        --             (2)
   Deferred rent......................................       (14)            (6)
                                                                   
  Changes in operating assets and liabilities:                     
   Accounts receivable................................     1,853         (1,619)
   Inventories........................................      (944)          (266)
   Prepaid expenses and other current assets..........        38            198
   Other assets.......................................      (270)             5
   Accounts payable...................................      (493)        (2,181)
   Accrued payroll and other expenses.................       338            259
   Accrued commissions................................      (254)          (396)
   Income taxes payable...............................       594          1,205
   Other accrued liabilities..........................     1,146            498
   Deferred maintenance revenues......................    (1,271)        (1,242)
                                                         -------        -------
    Net cash provided by (used in) operating 
     activities.......................................     1,982           (815)
                                                                   
Investing activities:                                              
  Purchases of equipment and leasehold improvements...      (542)          (324)
  Purchases of Deerbrook Systems, Inc.................      (500)            --
  Purchase of short-term investments..................    (2,476)        (5,816)
  Maturities of short-term investments................     9,512         10,113
                                                         -------        -------
   Net cash provided by investment activities.........     5,994          3,973
                                                                   
Financing activities:                                              
  Principal payments on long-term borrowings..........      (350)          (300)
  Net (repurchase) sale of common stock...............    (1,796)           404
                                                         -------        -------
   Net cash provided by (used in) financing 
    activities........................................    (2,146)           104
                                                                   
                                                         -------        -------
Increase in cash and cash equivalents.................     5,830          3,262
Cash and cash equivalents at beginning of period......     9,486         10,590

                                                         -------        -------
Cash and cash equivalents at end of period............   $15,316        $13,852
                                                         =======        =======
</TABLE> 

                See notes to consolidated financial statements.

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

1.   Basis of Presentation

     The accompanying consolidated financial statements at January 3, 1998 and
     for the three month period ended January 3, 1998 and December 28, 1996,
     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 September 27, 1997 included in the Form 10-K as filed with the
     Securities and Exchange Commission on December 19, 1997.  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 3, 1998 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 is a 53 week
     year and the three month period ending January 3, 1998 includes the
     additional week for the fiscal year.  The additional week in the quarter
     did not result in a material change in the results had the quarter been 13
     weeks.


3.   Inventories

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

<TABLE> 
<CAPTION> 
                                       September 27,   September 27,
                                           1997           1997
                                       -------------   -------------
           <S>                         <C>             <C>
           Raw materials                  $2,101           $1,979
           Work-in-process                 1,350            1,385
           Finished good                   2,297            1,440
                                          ------           ------
                                          $5,748           $4,804
                                          ======           ======
</TABLE> 

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

4.   Net Income Per Share and Restated Income Per Share

     In February 1997, the Financial Accounting Standards Board (FASB) issued
     Statement of Financial Accounting Standards No. 128, "Earnings Per Share
     (FAS No. 128)." The overall objective of the Statement No. 128 is to
     simplify the calculation of earnings per share by excluding the dilutive
     effect of stock options and warrants from the "basic" earnings per share
     calculation.  "Dilutive" earnings per share is based on the weighted-
     average number of common shares  and common stock equivalents shares (using
     the treasury stock method) outstanding during the period. For the three
     months ended January 3, 1998, the Company adopted the provisions of FAS No.
     128 and all share and per share data have been adjusted retroactively to
     comply with the requirements of the new FASB Statement.

     The computation of earning per share for the three months ended January 3,
     1998 and December 28, 1996 is as follows:

<TABLE>
<CAPTION>
 
                                                          Three Months Ended
                                                       -------------------------
                                                       January 3,   December 28,
                                                          1998          1996
                                                       ----------   ------------
<S>                                                    <C>          <C>
Basic Earnings Per Share:

Net income                                               $  467        $2,175
                                                         ======        ======
Weighted average common shares outstanding                8,501         8,241 
                                                         ======        ======
Basic net income per share                               $ 0.05        $ 0.26
                                                         ======        ======

Dilutive Earnings Per Share:

Net income                                               $  467        $2,175
                                                         ======        ======
Number of shares used in computing per share amounts:
  Weighted average common shares outstanding              8,501         8,241
  Common equivalent shares attributable to stock
   options (treasury stock method)                          212           615
                                                         ------        ------
Total weighted average common shares outstanding          8,713         8,856
                                                         ======        ======
Dilutive net income per share                            $ 0.05        $ 0.25
                                                         ======        ======
</TABLE>

                                       7
<PAGE>
 
                              IKOS SYSTEMS, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


4.  Net Income Per Share and Restated Income Per Share (continued)

    Restated net income per share information is as follows:

Selected Financial Data (in thousands, except per share data)

<TABLE> 
<CAPTION> 
                                                Fiscal Years Ended
                                  ---------------------------------------------
                                  Sept. 27, Sept. 28, Sept. 30, Oct. 1, Oct. 2,
                                    1997      1996      1995     1994    1993
                                  --------  --------  --------  ------  -------
<S>                               <C>       <C>       <C>       <C>     <C>
Net income (loss)                  $1,395    $2,451    $3,156   $1,505  $(8,750)
                                   ======    ======    ======   ======  =======
Basic net income (loss) per share:
  Income (loss) before 
   extraordinary credit            $ 0.17     $ 0.33    $ 0.56  $ 0.16  $ (1.62)
  Extraordinary credit                 --         --        --    0.12       --
                                   ------     ------    ------  ------  -------
      Basic net income (loss)      $ 0.17     $ 0.33    $ 0.56  $ 0.28  $ (1.62)
                                   ======     ======    ======  ======  =======
Weighted-average common shares                                      
  used in computing basic per                                       
  share amounts                     8,408      7,383     5,611   5,455    5,415
                                   ======     ======    ======  ======  =======
Dilutive net income (loss) per                                      
 share:                                                             
  Income (loss) before                                              
   extraordinary credit            $ 0.16     $ 0.30    $ 0.51  $ 0.15  $ (1.62)
  Extraordinary credit                 --         --        --    0.12       --
                                   ------     ------    ------  ------  -------
      Dilutive net income (loss)   $ 0.16     $ 0.30    $ 0.51  $ 0.27  $ (1.62)
                                   ======     ======    ======  ======  =======
Weighted-average common shares                                      
  used in computing dilutive per
  share amounts                     8,927      8,114     6,151   5,651    5,415
                                   ======     ======    ======  ======  =======
</TABLE> 


                                       8

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


4.  Net Income Per Share and Restated Income Per Share (continued)

    Restated selected quarterly data (unaudited) is as follows:

<TABLE> 
<CAPTION> 
                                                  Fiscal Quarters Ended
                                        ----------------------------------------
                                        Dec. 28,  March 29,  June 28,  Sept. 27,
                                          1996      1997       1997      1997
                                        --------  ---------  --------  ---------
<S>                                     <C>       <C>        <C>       <C>
Net income (loss)                        $2,175     $2,515    $(2,344)   $ (951)
                                         ======     ======    =======    ======
                                                                    
Basic net income (loss) per share        $ 0.26     $ 0.30    $ (0.28)   $(0.11)
                                         ======     ======    =======    ======
Weighted-average common shares used                                    
 in computing basic per share amounts     8,241      8,378      8,457     8,553
                                         ======     ======    =======    ======
                                                                     
Dilutive net income (loss) per share     $ 0.25     $ 0.28    $ (0.28)   $(0.11)
                                         ======     ======    =======    ======
Weighted-average common shares used in
 computing dilutive per share amounts     8,856      8,984      8,457     8,553
                                         ======     ======    =======    ======
                                     
<CAPTION>                            
                                                  Fiscal Quarters Ended
                                        ----------------------------------------
                                        Dec. 30,  March 30,  June 29,  Sept. 28,
                                          1995      1996       1996      1996
                                        --------  ---------  --------  ---------
<S>                                     <C>       <C>        <C>       <C>
Net income (loss)                        $1,375     $2,410    $(7,416)   $6,082
                                         ======     ======    =======    ======
                                                                    
Basic net income (loss) per share        $ 0.20     $ 0.34    $ (1.00)   $ 0.69
                                         ======     ======    =======    ======
Weighted-average common shares used                                    
 in computing basic per share amounts     6,886      7,154      7,407     8,086
                                         ======     ======    =======    ======
                                                                       
Dilutive net income (loss) per share     $ 0.18     $ 0.31    $ (1.00)   $ 0.69
                                         ======     ======    =======    ======
Weighted-average common shares used in
 computing dilutive per share amounts     7,519      7,843      7,407     8,817
                                         ======     ======    =======    ======
</TABLE> 

                                       9
<PAGE>
 
                              IKOS SYSTEMS, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

4.    Net Income Per Share and Restated Income Per Share (continued)

      Restated computation of earnings per share is as follows:

<TABLE> 
<CAPTION> 
                                                  Three Years Ended
                                     -------------------------------------------
                                     September 27,  September 28,  September 30,
                                         1997           1996           1995
                                     -------------  -------------  -------------
<S>                                  <C>            <C>            <C> 
Basic Earnings Per Share:

Net income                               $1,395         $2,451         $3,156
                                         ======         ======         ======
Weighted average common shares           
 outstanding                              8,408          7,383          5,611
                                         ======         ======         ======
Basic net income per share               $ 0.17         $ 0.33         $ 0.56
                                         ======         ======         ======
                                         
Dilutive Earnings Per Share:             
                                         
Net income                               $1,395         $2,451         $3,156
                                         ======         ======         ======
Number of shares used in computing       
 per share amounts:                      
  Weighted average common shares         
   outstanding                            8,408          7,383          5,611
  Common equivalent shares               
   attributable to stock options         
   (treasury stock method)                  532            771            592
                                         
                                         ------         ------         ------
Total weighted average common shares     
 outstanding                              8,940          8,154          6,203
                                         ======         ======         ======
Dilutive net income per share            $ 0.16         $ 0.30         $ 0.51
                                         ======         ======         ======
</TABLE> 

5.    Stock Repricing

      In December 1997, the Board of Directors authorized the Company to offer
      all employees the opportunity to cancel certain previously granted options
      in exchange for new options with new vesting and expiration terms at the
      then fair market value price of $5.75 per share. At January 3, 1998,
      options to purchase 900,327 shares of common stock with a weighted-average
      price of $15.64 were exchanged for new options.

6.    Subsequent Event

      In January 1998, the Company entered into a letter of intent to acquire
      certain technology and research and development expertise from Interra,
      Inc. and its affiliate Delsoft. The basis of the transaction provides the
      Company with engineering resources and technology for approximately
      $8,500,000 in cash and stock. In connection with the acquisition, the
      Company will be establishing a research and development facility in India.
      The deal is expected to be completed within three to six months and will
      be accounted for under the purchase method of accounting.

                                      10
<PAGE>
 
ITEM 2.   Management's Discussion and Analysis of Financial Condition and
          Results of Operations


Forward-looking statements in this Quarterly Report on Form 10-Q are made
pursuant to the safe harbor provisions of Section 21E of the Securities Exchange
Act of 1934, as amended.  Investors are cautioned that all forward-looking
statements involve risks and uncertainties, including, without limitation, those
contained under the section entitled "Factors That May Affect Future Results of
Operations" and other risks detailed from time to time in the Company's periodic
reports and other information filed with the Securities and Exchange Commission.
Actual events and results may differ materially from the Company's current
expectations and beliefs.


Net Revenues

Net revenues for the first quarter of fiscal 1998 totaled $12,065,000, a
decrease of approximately 15% from the same quarter in fiscal 1997. The decrease
was primarily the result of a decline in the sales of the Company's Voyager
product line which was partially offset by increases in revenues from sales of
emulation systems, consulting services and maintenance contracts. Voyager
product revenues decreased as fewer units were shipped during the quarter due in
part to the Company's increased focus on the emulation and consulting businesses
as well as the Company's delay in introducing new simulation products.
Consulting revenues increased over 512% over the same period in the previous
year growing from $217,000 to over $1,327,000 during the quarter. The Company
expects to see growth when compared to the previous year in consulting revenues
throughout fiscal 1998. The Company's emulation revenue increased from
$1,594,000 during the first quarter fiscal of 1997 to $2,022,000 for the first
quarter of fiscal 1998. The Company has seen an increase in activity for its
emulation products and expects the revenues from systems to be a larger portion
of total revenues in fiscal 1998.

International sales for the first quarter of fiscal 1998 decreased approximately
29% over the same quarter in fiscal 1997 and accounted for over 37% of net
revenues for the quarter. The decrease is in part a result of the overall
decrease in revenues for the Company, primarily its Voyager product line and
also the result of the continued transition of the Company's Japan operations to
a direct sales channel, which began, in fiscal 1997. The Japan subsidiary has
shown increases over the prior three quarters.


Gross Profit Margins

Gross profit margin for the three-month period was approximately 75% of net
revenues, and is lower when compared to the 78% for the same period of fiscal
1997. The decrease in margins are a result of the lower than expected revenues
resulting in less coverage of fixed manufacturing costs and the increase in the
consulting services group which increased the level of fixed costs charged
against margins.


Research and Development Expenses

Research and development expenses in the first quarter of fiscal 1998 totaled
$2,849,000, representing an increase of 21% from $2,351,000 when compared to the
same period in fiscal 1997. The increase during the quarter is a result of
increased headcount, consulting services and certain non-recurring engineering
charges. The Company expects research and development expenses to increase over
the course of the year as the Company continues to address its on-going
development efforts for enhancing its current products and for new product
technology development.

                                       11
<PAGE>
 
Sales and Marketing Expenses

Sales and marketing expenses increased to $4,464,000 for the first quarter of
fiscal 1998 or 6% when compared to $4,200,000 for the same period in fiscal
1997. The slight increase is primarily the result of additional headcount offset
by decreased commissions as a result of lower revenue levels. Sales and
marketing expenses are expected to continue to increase in absolute dollars over
the remainder of the year reflecting increased headcount, commission expense and
marketing expenses.


General and Administrative Expenses

General and administrative expenses were $971,000 for the three month period
ended January 3, 1998 and were slightly lower when compared with the same three
month period in fiscal 1997. General and administrative expenses are expected to
remain relatively flat over the remainder of fiscal 1998.


Income Taxes

The Company's 1997 and 1998 first quarter provision for income taxes differs
from the federal statutory rate primarily due to benefits associated with its
foreign sales corporation, research credits and foreign taxes assessed at an
overall rate lower than the federal statutory rate and offset by costs
associated with the non deductible goodwill amortization and state income taxes.


Other

The Company has experienced virtually no 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 obligations. However, as
the Company has reorganized its operations at its Japan subsidiary, the Company
will be subject to engaging in transactions in the Japanese local currency. As
such, the Company may begin entering into hedging arrangements to mitigate the
currency risk with respect to such transactions. At January 3, 1998, the Company
had not entered into any such hedging arrangements.


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

                                       12
<PAGE>
 
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 continue to increase or that
the Company will remain profitable in any future period.


Continued Acceptance 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. There can be no assurance
that market acceptance of these products will continue. The continued adoption
of the Company's hardware-assisted simulation products for the verification of
IC and system designs is expected to 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, continued
industry acceptance of mixed-level hardware-assisted simulation, the development
and market acceptance of alternative simulation technologies such as cycle-based
software simulation, formal proof and hybrid timing verifiers, and modular
design techniques. 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 continued profitability in the future.

Prior to the acquisition of VMW, the Company had limited in-house experience
with logic emulation. The Company's initial emulation product was commercially
released in the first quarter of fiscal 1997. While the Company has released its
initial emulation product, there can be no assurance that the product will
adequately meet the requirements of the marketplace. In addition, there
continues to be further development of the emulation product. As the Company
continues to develop emulation products which are based on a new technology
concept, there can be no assurance that the enhancement of current 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, if successfully developed, 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.

                                       13
<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. To date, substantially all of the Company's
revenue has resulted from sales of hardware-assisted simulation products. The
Company currently experiences competition from traditional software verification
methodologies, including product offerings sold by Cadence, Synopsis and Mentor
Graphics. During the current year the Company commercially released its
emulation product. The Company's main competition for emulation systems are
those sold by 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. Those 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 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.

                                       14
<PAGE>
 
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 hardware simulators, 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.

Customer Concentration - A relatively limited number of customers have
----------------------                                                
historically accounted for a substantial portion of the Company's net revenues.
During fiscal 1997 and 1996, sales to the Company's top ten customers accounted
for approximately 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.

                                       15
<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 $23,609,000 at January 3, 1998 from $24,815,000 at
September 27, 1997. The decrease was a result of $1,982,000 cash provided by
operating activities offset by $2,146,000 used in financing activities and
$1,042,000 of cash used in investment activities.

Operating Activities - The Company's operating activities provided cash of
--------------------                                                      
$1,982,000 during the first quarter of fiscal 1998. The $1,982,000 cash provided
by operations was primarily due to net income adjusted for depreciation and
amortization, a reduction of accounts receivable, accrued payroll and income
taxes payable offset by increases in inventory, other assets and the payment of
accounts payable and accrued commission balances.

Investing Activities - Net cash provided by investing activities for the three
--------------------                                                          
months ending January 3, 1998 was $5,994,000. The primary source of cash during
this period was the net maturities of short-term investments totaling
$7,036,000. The increase in cash equivalents from these maturities was the
result of the investment in higher yielding cash equivalent securities rather
than certain short-term investments. This source of cash from investment
activities was offset by approximately $542,000 in capital expenditures and
$500,000 related to the acquisition of Deerbrook Systems, Inc. For each period
presented, capital expenditures were primarily for evaluation equipment and
engineering workstations. The Company expects continued capital expenditures
during fiscal 1998 as expected headcount additions will require additional
computers and engineering workstations.

Financing Activities  Net cash used in financing activities for the three months
--------------------                                                            
ended January 3, 1998 was primarily related to the net purchases of stock during
the quarter. During the quarter, the Company announced its intention to
repurchase up to 1,000,000 shares of its outstanding common stock on the open
market. Through January 3, 1998, the Company had repurchased approximately
199,000 shares at a weighted-average per share price of $8.14. In addition, the
Company repaid its remaining principal debt obligations totaling $350,000.

The Company's primary unused sources of funds at January 3, 1998 consisted of
$15,316,000 of cash and cash equivalents, in addition to $8,293,000 of short-
term investments. The Company believes that 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.

                                       16
<PAGE>
 
                          PART II. OTHER INFORMATION


ITEMS 1-5    Not applicable

ITEM 6       Exhibits and Reports on Form 8-K


(a) INDEX TO EXHIBITS

<TABLE> 
<CAPTION> 

Exh. No.                Documentation Description                    Page
-------                 -------------------------                    ----

<C>          <S>                                                     <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).

 3.1         Certificate of Incorporation (Incorporation 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).

 4.1         Rights agreement dated as of January 27, 1992
             between the Company and Manufacturers Hanover Trust
             Company of California, Rights Agent. (Incorporated
             by reference to Exhibit (C)1, in the Company's
             report on Form 8-K filed February 10, 1992).

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).
</TABLE> 

                                       17
<PAGE>
 
<TABLE> 
<CAPTION> 

Exh. No.                Documentation Description                      Page
-------                 -------------------------                      ----

<C>          <S>                                                       <C> 
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).

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).
</TABLE> 

                                       18
<PAGE>
 
<TABLE> 
<CAPTION> 

Exh. No.                Documentation Description                   Page
-------                 -------------------------                   ----

<C>          <S>                                                    <C> 
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).

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.
</TABLE> 

                                       19
<PAGE>
 
<TABLE> 
<CAPTION> 


Exh. No.                Documentation Description                   Page
-------                 -------------------------                   ----

<C>          <S>                                                    <C> 
10.21        The Company's 1995 Stock Option Plan. (Incorporated
             by reference to Exhibit 10.21 of the Company's Annual
             Report on Form 10-K for the year ended September 28,
             1996).

10.22        The Company's 1996 Employee Stock Purchase Plan.
             (Incorporated by reference to Exhibit 10.21 of the
             Company's Annual Report on Form 10-K for the year
             ended September 28, 1996).

27.1         Financial Data Schedule
</TABLE> 

(b) REPORTS ON FORM 8-K


                                  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 13, 1998               /s/ Joseph W. Rockom
                                      ----------------------------        
                                      (JOSEPH W. ROCKOM CFO)
                                      Principal Financial Officer,
                                      Duly Authorized Officer

                                       20