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

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

                                   FORM 10-K

(Mark One)

[X]  Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
     Act of 1934 for the Fiscal Year Ended September 28, 1996 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                                 (IRS EMPLOYER
 INCORPORATION OR ORGANIZATION)                              IDENTIFICATION NO.)

 19050 PRUNERIDGE AVENUE, CUPERTINO, CA                               95014
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                           (ZIP CODE)

              REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
                                 (408) 255-4567

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
                                      NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                          COMMON STOCK $.01 PAR VALUE
                        PREFERRED STOCK PURCHASE RIGHTS
                                (TITLE OF CLASS)

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 such shorter period that the registrant was required
to file such report), and (2) has been subject to such filing requirements for
the past 90 days.  Yes  X     No 
                       ---       ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [_]

The approximate aggregate market value of the registrant's Common Stock held by
non-affiliates as of November 13, 1996, was approximately $160,416,000

As of November 13, 1996, approximately 8,226,000 shares of the registrant's
Common Stock were outstanding.


                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 1996 Annual Meeting of Stockholders are
incorporated by reference in Part III hereof.

This report (excluding exhibits) contains 48 pages.  The Index to Exhibits
begins on Page 26 of this report.
<PAGE>
 
FORWARD LOOKING STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K ARE MADE PURSUANT
TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995.  STOCKHOLDERS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS PERTAINING
TO THE COMPANY INVOLVE RISKS AND UNCERTAINTIES, INCLUDING, WITHOUT LIMITATION,
THOSE CONTAINED IN ITEM 7 OF THIS REPORT UNDER THE CAPTION ENTITLED,
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - 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 SECURITIES AND EXCHANGE COMMISSION.


                                     PART I

ITEM 1. BUSINESS

General

IKOS develops, manufactures, markets and supports hardware and software systems
for the verification of IC designs.  IKOS' mission is to help customers realize
their high complexity products through innovative design verification solutions.
The Company's products are designed to enable its customers to verify complex IC
designs more rapidly and accurately than existing software-based simulation
tools. The Company sells its products to a broad range of customers in the
communications, multimedia/graphics, semiconductor, computer, aerospace and
consumer electronics industries, such as Lucent Technologies, Motorola, NEC, S3,
Scientific Atlanta, SGS-Thomson Microelectronics, Siemens and Texas Instruments.
Headquartered in Cupertino, California, IKOS supports a direct sales operation
in North America, the United Kingdom, France, and Germany, and a distributor
network covering the remainder of Europe and in parts of Asia.  IKOS is publicly
traded on the Nasdaq National Market under the symbol IKOS.

In May 1996, the Company acquired Virtual Machine Works, Inc. ("VMW"), which was
founded in late 1993 to develop and market logic emulation systems for the
verification of complex ICs and IC-based systems. The Company believes that,
despite the potential of emulation to shorten IC and system development time,
the high cost and difficulty of use of existing emulation systems have impaired
broad acceptance of emulation. VirtualWires, a set of proprietary methods under
exclusive license from MIT, is being developed to address certain input/output
constraints and timing issues through two processes referred to as interconnect
resynthesis and timing resynthesis.  These processes are intended to allow the
development of easier to use and less costly emulation systems.  IKOS plans to
utilize these methods as it addresses the market for logic emulation.


Background

The EDA industry has provided technology and automation tools to the IC industry
which have enabled, to a significant degree, the advances in IC designs that
have occurred within the semiconductor industry over the last two decades.
However, while EDA design tools such as high level design languages and
synthesis have brought greater efficiency and productivity to the IC design
process, advances in EDA verification technology have not kept pace with the
requirements for verifying more complex IC

                                       2
<PAGE>
 
designs. A semiconductor industry consortium estimates that over the four
decades through 2010, IC complexity, measured in transistors per logic IC, will
grow at 58% compounded annually, while design engineer productivity will grow at
only 21% annually. IKOS believes that insufficient verification capability is a
significant contributor to this productivity gap.

As the density and complexity of electronic system designs increase, so does the
need for more thorough verification in the IC design process. Verification,
which is the assessment of the functionality and behavior of an IC design, is
used to test compliance with timing constraints, detect logic errors and predict
device speed, power consumption and a range of other characteristics. A number
of trends in the IC industry are currently in force which are causing
verification to receive greater attention in the design process. First, as
designers work at higher levels of abstraction and design more gates, the task
of directly evaluating the entire design is becoming extremely difficult. This
causes designers to seek tools which perform verification for them. Second, as
IC process geometries grow finer and device speeds increase, the margin for
error grows smaller, thus placing a premium on verification capability. Finally,
as system designers develop a broader range of systems for a wider range of
applications, they have become concerned with not just functionality, but also
IC speed and power dissipation.

Design verification includes modeling of a circuit in software (simulation), and
modeling of a circuit in hardware (emulation). Simulation utilizes computer
models of circuit logic and test programs to evaluate the functionality and
performance of the designed electronic circuits before committing to prototyping
or production of the actual design. In the simulation environment, the
individual components of an IC may be represented at different levels of detail
or hierarchy, ranging from transistors or gates (typically groups of four
transistors) to functional or behavioral blocks, which are commonly comprised of
a large number of gates. Before the advent of language-based design, the
traditional approach to simulation was at the gate level. However, language-
based or functional simulation creates an opportunity to simulate designs
earlier in the design cycle, at the functional or behavioral block level, before
the gate level structure of a design is known. Software simulators operating on
general purpose workstations are customarily used to verify the high level
specifications and detect design inconsistencies. The Company believes that the
need for accurate and timely simulation and verification of complex IC designs
cannot be satisfied by existing software simulators operating on general purpose
workstations. Due to lack of simulation capacity, software simulation of complex
IC designs at the lower, or gate, level of abstraction can take multiple hours
or days to be completed. Software simulators can verify more complex designs by
simulating at a higher, or behavioral, level of abstraction but without the
ability to accurately model timing information required for the interconnection
of gates and transistors of the IC. The Company believes that this high level
simulation is not sufficiently comprehensive because timing problems inherent in
complex ICs have not been effectively addressed at the behavioral level.

Logic emulation is the process of utilizing reprogrammable ICs, typically field
programmable gate arrays ("FPGAs"), as a hardware model of an IC prior to its
silicon fabrication. This model runs orders of magnitude faster than a software-
based simulation model and permits the verification of the design more quickly
and comprehensively. This virtual silicon prototype can be plugged into the
system for which the IC is designed, and

                                       3
<PAGE>
 
the system can then be tested using software to verify functionality. Logic
emulation can shorten IC and system development by allowing developers to engage
in concurrent design and verification of both the software and hardware
components of the designed system. The Company believes that, despite the
potential of emulation to shorten IC and system development time, the high cost
and difficulty of use of existing emulation systems have impeded their
widespread adoption.

The verification of a complex IC is an extremely time-consuming process, and
inadequate verification can result in lost market opportunity or significant
costs. Complicating the problem is the inability to determine when an IC design
has been sufficiently verified. Due to competitive market pressures, IC
designers are investing in a greater number and wider range of verification
tools.

Company Solutions

IC designs with 100,000 or more gates, which are referred to as complex ICs, are
becoming a larger part of the custom and semi-custom IC market. According to an
industry source, complex designs for ASICs will grow to a majority of the ASIC
designs within the next four years. The Company believes that rapid,
comprehensive and predictable verification of complex ICs can best be achieved
by simulation systems incorporating hardware and software and easy-to-use, cost-
effective emulation systems.

The Company currently provides dedicated hardware and software simulation
systems that enable iterative, mixed-level simulation. Under the IKOS design
approach, simulation begins at the behavioral level so that architectural
problems can be identified before the time and effort is expended to implement
the gate level design. Simulation is then performed at the gate level to address
timing problems. The designer may then iteratively simulate at the behavioral
level and the gate level to ensure that the design is correct. In addition, this
IKOS approach enables mixed-level simulation, or the ability to perform
behavioral level simulation in tandem with gate level simulation. Mixed-level
simulation allows an IC designer to insert newly developed gate level details
into the behavioral level design and simulate at both levels of abstraction
simultaneously, thereby reducing the time required to simulate a complex IC
design.

IKOS designs and markets systems which include software and hardware based
simulation algorithms. The hardware algorithm is implemented in a proprietary
processor used to form a massively parallel simulation engine. The IKOS
simulation systems reduce the time-consuming process of simulation of an IC
design, thereby potentially improving time-to-market of the final product and
the productivity of the IC designer. The software components of the IKOS
simulation systems run on Sun Microsystems, Inc. and Hewlett-Packard Company
workstations.

In order to broaden the Company's verification product offering to extend from
design concept stage to prototype stage, the Company is finalizing its
development of an emulation system that incorporates VirtualWires technology
acquired from VMW.  VirtualWires, a set of proprietary emulation methods under
exclusive license from MIT, is being developed to address certain input/output
constraints and timing issues through two processes referred to as interconnect
resynthesis and timing resynthesis. Interconnect resynthesis is intended to
overcome FPGA pin limitations by sharing or multiplexing each physical
input/output wire to carry more than one signal. This approach is intended

                                       4
<PAGE>
 
to allow for more automated and efficient compilation of the design on fewer
FPGAs, potentially lowering the cost of the emulation system and enhancing its
ease of use. Timing resynthesis can compensate for FPGA timing variations by
converting a user's design that may incorporate multiple synchronous or
asynchronous clocks into a high frequency single-clock synchronous design with
identical functionality. This approach is intended to address timing issues by
transforming a user's design into one that is predictable and easy to implement.

The Company is developing a modular, scaleable system for emulation of one or
more complex ICs. This system is being developed to include three principal
components: compiler software, a reconfigurable logic emulator, and a third-
party logic analyzer. The compiler software, executing on an engineering
workstation from either Sun or Hewlett-Packard, is expected to accept a netlist
description of the user's design and generate from it the programming data which
controls the behavior of the logic emulator. The logic emulator is expected to
be connected to the user's target system via cables and, once programmed,
operate as a surrogate for the IC being emulated. The emulator's internal
operation is being designed to be viewed with the aid of a commercial logic
analyzer available from Hewlett-Packard.

The Company seeks to use this technology, when fully developed, to provide cost-
effective emulation systems that are easy to use and utilize standard off-the-
shelf FPGA components which automate and simplify certain expensive and time
consuming steps in the emulation of an IC design.

Maintenance and Support

The Company provides hardware and software maintenance and support on a
contractual basis after the initial product warranty has expired.  Annual
maintenance revenues approximate 12% of the purchase price.  Hardware
maintenance is provided on an on-site or on a return and repair basis.  The
Company also provides application support via a toll-free telephone line.
Customers with software maintenance coverage also receive software releases, if
any, from the Company.  Foreign distributors generally provide customer
training, service and support for the products they sell.  For the three years
ended September 28, 1996, maintenance revenues, as a percentage of total
revenues, represented 17% in each of 1996, 1995 and 1994.

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 hardware-assisted simulation-based
systems sold by Zycad and traditional software verification methodologies from
vendors, such as Mentor Graphics, Cadence, Viewlogic and Synopsis. The Company
also competes in the market for emulation products, where its main competition
for emulation systems are those sold by Quickturn, Synopsis and other EDA
companies. 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

                                       5
<PAGE>
 
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.

The Company competes on the basis of certain factors, including product
performance, price, support of industry standards, technical support and
customer service, timely introduction of new products, ease of use and
reputation. The Company believes that it currently competes favorably overall
with respect to these factors.

Customers, Marketing and Sales

IKOS sells its products to a broad range of companies including those
in the communications, multimedia/graphics, semiconductor, computer, aerospace
and consumer electronics industries. The Company markets its products and
services primarily through its direct sales and service organization. The
Company employs a technically-oriented sales force and application engineering
team to serve the needs of existing and prospective customers. The Company
recently established  a consulting services organization to provide the
Company's customers with a comprehensive solution that is tailored specifically
to the needs of the design team.  These services will include education,
application services, interface software support, custom library development and
other on-site support through customized consulting partnerships to assist the
customer in accomplishing successful delivery of their products to market.

IKOS' direct sales strategy concentrates on those companies that it believes are
key users and designers of complex ICs and IC-based systems for high-performance
applications. For the fiscal year ended September 28, 1996, one distributor,
Itochu & Co., Ltd (Itochu) in Japan accounted for approximately 12% of net
revenues and one customer, S3 Inc., accounted for approximately 14% of net
revenues. In fiscal 1995, one distributor, Itochu accounted for approximately
15% of net revenues. In fiscal 1994, one customer, Motorola, Inc., and one
distributor, Itochu, accounted for approximately 18% and 10% of net revenues,
respectively.

Direct Sales -  IKOS currently maintains direct sales and support offices in the
------------                                                                    
following states: Arizona, California, Colorado, Florida, Massachusetts, New
Hampshire, New Jersey and Texas.  IKOS makes direct sales internationally in
Canada, in Japan through its wholly-owned subsidiary, IKOS K.K. and in central
Europe through its wholly-owned subsidiary, ICOS Systems GmbH, and through its
sales offices in France and England.  Direct sales, including maintenance fees,
accounted for 86% of the Company's net revenues in fiscal 1996.

                                       6
<PAGE>
 
Distributors -  IKOS believes that international markets are an important source
------------                                                                    
of the Company's revenues.  Accordingly, the Company has developed distributor
relationships in ten foreign countries in Europe and Asia.  Revenues to
distributors were approximately 14% of the Company's net revenues for the fiscal
year 1996.   Distributor revenues for fiscal 1995 and 1994 as a percentage of
net revenues were 21% and 15%, respectively.

International Sales - International sales accounted for approximately   33%, 37%
-------------------                                                             
and 26% of the Company's net revenues in fiscal 1996, 1995, and 1994,
respectively. Sales to a variety of customers in Japan, through the Company's
exclusive Japanese distributor, Itochu & Co., Ltd., constituted approximately
12% of total sales for fiscal 1996.  The Company's current agreement with Itochu
provides for discounts to Itochu that are similar to those offered by the
Company to its other foreign distributors.  Sales in all foreign countries are
denominated in U.S. dollars. Although the Company has attempted to reduce the
risk of fluctuations in exchange rates associated with international revenues by
selling its systems denominated in U.S. dollars only, the Company pays the
expenses of its international operations in local currencies and does not engage
in hedging transactions with respect to such obligations. Currency exchange
fluctuations in countries in which the Company sells its systems could have a
material adverse effect on the Company by resulting in pricing that is not
competitive with prices denominated in local currencies.

Conducting business in international markets requires compliance with applicable
laws and regulations, such as safety and telecommunication laws and regulations
of foreign jurisdictions and import duties and quotas.  To date, the Company has
not experienced any difficulty in obtaining export licenses from the U.S.
Department of Commerce for foreign sales; however, there can be no assurance
that the Company will not experience difficulties in the future.

Manufacturing and Suppliers

The Company performs final assembly and test of all its products in its
Cupertino, California facility. The Company utilizes third parties for all major
subassembly manufacturing, including printed circuit boards and custom ICs. The
Company has a testing and qualification program to ensure that all subassemblies
meet the Company's specifications before going into final assembly and test.
 
The capacity and speed of IKOS' hardware results from its basic design and
architecture, and includes certain proprietary components and components that
are required to perform near technological limits.  Certain key components used
in the Company's products are presently available from sole or limited sources.
The Company believes that it could obtain alternative sources in a short period
of time, although 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 simulation and emulation
systems use proprietary ASICs, FPGAs and certain subassemblies that are
currently available from single sources. 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 these source
suppliers that require the suppliers to provide components in guaranteed
quantities or at set prices. The Company endeavors to maintain an ample supply
of such components at all times through order generation based on tracking of
sales projections, production and inventories, and by ordering critical
components for delivery over an extended period.

                                       7
<PAGE>
 
Product Development

The Company's ongoing product development activities include the enhancement of
current products, such as the ability to simulate, emulate and verify the design
of higher gate count ICs and to offer a greater degree of integration with EDA
tools.  Furthermore these product development activities include the development
of new product options and features, such as new library tools and the research
and development of new technologies for use in future products.

The Company's research and product development organization included 59
engineers at September 28, 1996, of whom 13 were engaged principally in the
development of the new emulation product and 29 were engaged principally in
software development. During fiscal 1996, 1995 and 1994, the Company spent
approximately $8.1  million, $4.0 million and $3.9  million, respectively, on
research and development. In addition, the Company spent approximately $9.6
million related to purchased research and development in connection with the
acquisition of VMW. The Company's research and development costs, including
costs of software development before technological feasibility, are expensed as
incurred.

Proprietary Rights

Due to the rapid pace of technological advancement, the Company believes it is
less dependent on the protection of proprietary product information than on its
ability to develop and market new products.  The Company protects its
proprietary product information through the use of employee nondisclosure
agreements and by limiting access to confidential information.  The Company
presently has three United States patents, two of which expire on November 22,
2005, and the third expiring on June 30, 2009, that cover various aspects and
features of its products, including its overall system architecture and certain
features in the hardware.  The Company has licensed rights under certain patent
applications relating to VirtualWires and has filed additional patent
applications. The Company's license rights with respect to the VirtualWires
technology is from MIT.  This license is exclusive for a period ending on the
earlier of the expiration of eight years after the first commercial sale or use
of a licensed patent or process or December 22, 2004, and thereafter becomes
nonexclusive.  MIT may terminate this license if the Company fails to meet
certain minimum net sales milestones or upon certain other material breaches of
the license agreement that remain uncured after 90 days' notice of such breach.
Although the Company may file additional patent applications in the future, it
does not expect to rely extensively on patents to protect its products.

The Company also relies on certain software which it licenses from third
parties, including software which is integrated with internally developed
software and used in the Company's systems to perform key functions.

From time to time the Company has received, and may receive in the future,
notice of claims of infringement of other parties' proprietary rights.  Although
the Company does not believe that its products infringe upon the proprietary
rights of any third parties, there can be no assurance that infringement or
invalidity claims (or claims for indemnification resulting from infringement
claims)  will not be asserted against the Company or that any such assertions
will not materially adversely affect the Company's business, financial condition
or results of operations.  Irrespective of the validity or the successful
assertion of

                                       8
<PAGE>
 
such claims, the Company could incur significant costs and diversion of
management efforts with respect to the defense thereof which could have a
material adverse effect on the Company' business, financial condition or results
of operations.  If any claims or actions are asserted against the Company, the
Company may seek to obtain a license under a third party's intellectual property
rights.  There can be no assurance, however, that under such circumstances, a
license would be available under reasonable terms or at all.

The Company's tradename, "IKOS," its facing parrots logo and its product series
named "Voyager" are registered trademarks of the Company.

Employees

As of September 28, 1996 the Company employed a total of 184 persons, consisting
of 93 in marketing, sales and support, 11 in manufacturing, 59 in research,
development and engineering, and 21 in finance, administration and other
capacities. The Company has never had a work stoppage. None of its employees is
represented by a labor organization, and the Company considers its relations
with its employees to be good.


ITEM 2.  PROPERTIES

The Company's principal executive offices, as well as its principal
manufacturing, marketing, research and development, and engineering facility,
are located in approximately 57,000 square feet of leased office building space
in Cupertino, California. The lease on this facility expires September 2000,
with options to extend the lease for up to nine years. The Company subleases
9,000 square feet of its leased office building space in Cupertino, California.
In addition, the Company leases research and development and sales office space
domestically in Arizona, California, Colorado, Florida, Massachusetts, New
Hampshire, New Jersey and Texas and internationally in England, France, Germany
and Japan. The Company believes that its existing facilities are adequate for
its current needs and that additional space will be available as needed.


ITEM 3. LEGAL PROCEEDINGS

Not applicable.

ITEM 4.  Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.

                                       9
<PAGE>
 
                                    PART II

ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters

The Company's Common Stock is currently traded on the Nasdaq National Market
under the symbol IKOS. From March 1994 to May 1995, the Company's stock was
traded on The Nasdaq SmallCap Market. The following table sets forth, for the
fiscal period indicated, the high and low closing sales prices for the Common
Stock as reported by Nasdaq. The quotations for the Common Stock traded on The
Nasdaq SmallCap Market may reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.

                   <TABLE>                                 
                   <CAPTION>                               
                                                           
                                          HIGH       LOW   
                                         -------   ------- 
                                                           
                   FISCAL 1995                             
                   <S>                   <C>       <C>     
                     First Quarter....   $ 5.125   $ 3.250 
                     Second Quarter...     6.500     4.500 
                     Third Quarter....    10.125     4.750 
                     Fourth Quarter...    13.625     8.875 
                                                           
                   FISCAL 1996                             
                     First Quarter....    14.125     9.813 
                     Second Quarter...    18.625     9.125 
                     Third Quarter....    30.000    17.188 
                     Fourth Quarter...    22.375    14.500 
                   </TABLE>                                 

The approximate number of record holders of IKOS stock as of November 13, 1996
was 160. The approximate number of beneficial holders is estimated to be 4,000
as of that same date.

The Company has never declared or paid cash dividends on its stock. The Company
currently anticipates that it will retain all future earnings for use in the
operation and expansion of its business and does not anticipate paying any cash
dividends in the foreseeable future.

                                       10
<PAGE>
ITEM 6.  Selected Financial Data
<TABLE> 
<CAPTION> 

                                                                                        Fiscal Years Ended
                                                           -------------------------------------------------------------------------
                                                           Sept. 28,        Sept. 30,        Oct. 1,       Oct. 2,         Sept. 26,
                                                             1996             1995            1994          1993             1992
                                                             ----             ----            ----          ----             ----
CONSOLIDATED STATEMENT OF OPERATIONS DATA

<S>                                                        <C>              <C>              <C>           <C>             <C> 
Net revenues                                               $45,341          $28,600          $21,636       $16,528         $13,942 
Cost of revenues                                             9,852            7,139            5,930         6,331           3,993
                                                           -------          -------          -------       -------         -------
        Gross profit                                        35,489           21,461           15,706        10,197           9,949

Operating expenses:
   Research and development                                  8,146            3,999            3,861         7,896           2,627
   Sales and marketing                                      14,483           11,763            9,447         9,303           8,879
   General and administration                                3,420            2,301            1,596         1,873           1,807
   Write off of in-process research                     
     and development                                         9,600               --               --            --              --
   Amortization of goodwill                                    421               --               --            --              --
                                                           -------          -------          -------       -------         -------
        Total operating expenses                            36,070           18,063           14,904        19,072          13,313

                                                           -------          -------          -------       -------         -------
Income (loss) from operations                                 (581)           3,398              802        (8,875)         (3,364)

Other income (expense):
   Interest income                                           1,058              159               69           130             329
   Interest expense                                            (42)            (107)             (75)           --              --
   Other                                                       124              117              140            48              --
                                                           -------          -------          -------       -------         -------
        Total other income                                   1,140              169              134           178             329

                                                           -------          -------          -------       -------         -------
Income (loss) before provision for
   income taxes and extraordinary credit                       559            3,567              936        (8,697)         (3,035) 
Provision (benefit) for income taxes                        (1,892)             411               95            53              72

                                                           -------          -------          -------       -------         -------
Income (loss) before extraordinary credit                    2,451            3,156              841        (8,750)         (3,107)
Extraordinary credit - forgiveness of debt                                       --              664            --              --

                                                           -------          -------          -------       -------         -------
        Net income (loss)                                  $ 2,451          $ 3,156          $ 1,505      ($ 8,750)       ($ 3,107)
                                                           =======          =======          =======       =======         =======
Earnings (loss) per share:

   Income (loss) before extraordinary credit               $  0.30          $  0.51          $  0.15      ($  1.62)       ($  0.58)
   Extraordinary credit                                         --               --             0.12            --              --
                                                           -------          -------          -------       -------         -------
        Net income (loss)                                  $  0.30          $  0.51          $  0.27      ($  1.62)       ($  0.58)
                                                           =======          =======          =======       =======         =======

Common and common equivalent shares used
   in computing per share amounts                            8,114            6,151            5,651         5,415           5,379
                                                           =======          =======          =======       =======         =======

CONSOLIDATED BALANCE SHEET DATA:

   Working capital                                         $27,919          $ 7,509          $ 3,850       $ 1,805         $ 6,830
   Total assets                                             53,471           17,152           12,129        10,805          15,678
   Long-term, debt, less current portion                       350            1,300            2,151         2,779             344
   Total stockholders' equity                               38,144            7,710            3,476         1,903          10,603
</TABLE> 


                                      11
<PAGE>

ITEM 7. 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."

NATURE OF OPERATIONS

The Company develops, manufactures,markets and supports hardware and software 
systems for the verification of integrated circuit designs. IKOS' mission is to 
help customers realize their high complexity products through innovative design 
verification solutions. The Company's products are designed to enable its 
customers to verify their designs more rapidly and accurately than existing
software-based simulation tools. With the completion of its acquisition of VMW,
the Company broadened its spectrum of verification solutions to extend from the
design concept stage to the prototype stage as the Company is completing its
development of an emulation system. The Company sells its products to a broad
range of customers in the communications, multimedia/graphics, semiconductor,
computer, aerospace and consumer electronics industries. The Company markets its
products and services primarily through its direct sales and service
organization as the Company has direct sales operations throughout the United
States and in the United Kingdom, France and Germany. The Company also has a
distribution network covering the remainder of Europe and in parts of Asia.

NET REVENUES

Net revenues increased 59% to $45,341,000 for the fiscal year ended September 
28, 1996 as compared to $28,600,000 for fiscal 1995. The increase for the year 
was primarily the result of continued growth in unit sales of the Voyager 
systems (primarily NSIM product) and maintenance revenues. Voyager system sales 
contributed over 74% of the net revenues for the fiscal year ended September 28,
1996 and represented an increase of 59% over the previous year. Maintenance 
revenue for the year ended September 28, 1996, increased 58% to $7,722,000 from 
$4,887,000 for fiscal 1995 and represented 17% of net revenues for both 1996 and
1995. The increase in maintenance revenues was primarily a result of the growth 
in the installed customer base of the Company's systems. International revenues 
increased by 41% and domestic revenues increased by 69% over this same period.

Net revenues for fiscal 1995 were $28,600,000 for the fiscal year ended 
September 30, 1995 as compared to $21,636,000 for fiscal 1994. This 32% increase
was the result of the broader acceptance of the Voyager systems and increases in
maintenance revenues.
                                       12
<PAGE>
 
International sales (export sales and sales shipped by the Company's European
operation) were $14,890,000, $10,560,000 and $5,583,000 for the fiscal years
1996, 1995 and 1994, respectively.   These sales represents 33%, 37% and 26% of
net revenues. The increases in international sales were a result of the
increased customer acceptance of the new product offerings, increased economic
demand, particularly in Europe, increased focus on the international market and
increased presence in the Far East marketplace.  The Company opened its
subsidiary in Japan during fiscal 1995.  It is expected that international sales
should increase in absolute dollars in fiscal 1997.

The Company first released its Voyager Series product, the VHDL software
simulator (VS) in 1992 and has since released its mixed level simulator, its
next generation hardware accelerator and its software gate level simulator.  The
Company entered the Verilog market with its Gemini product during 1995 and in
early 1996 released its Voyager fault simulator (Voyager FS).  The Company
expects to begin commercial shipments of its new emulator product in the first
quarter of fiscal 1997.  Although the Company believes its product offerings
have been accepted very favorably, there can be no assurances that there will
not be any new product offerings by competitors or changes in the marketplace
that could adversely affect the Company's sales and profits.

Gross Profit

Gross profit was $35,489,000, $21,461,000 and $15,706,000 or 78%, 75% and 73% of
total net revenues for fiscal years 1996, 1995 and 1994, respectively. The
increase in fiscal 1996 is primarily a result of both higher product margins of
$29,197,000 or 78% and higher maintenance margins of $6,292,000 or 81%.  The
increase in product margins is a result of the increases in unit shipments of
higher margin products and to a lesser extent, the absorption of fixed
manufacturing costs over a broader revenue base.  The increased maintenance
margins are a result of the increased maintenance revenues from a larger
customer base without significant increases in related maintenance costs. The
Company expects margins to remain comparable with fiscal 1996 as the Company
believes it will continue to recognize manufacturing efficiencies and continued
sales of products with higher margins.

Research and Development Expenses

Research and development expenses were $8,146,000, $3,999,000 and $3,861,000 for
fiscal 1996, 1995 and 1994, respectively.  As a percent of net revenues,
research and development expenses were 18%, 14% and 18% for fiscal 1996, 1995
and 1994, respectively.  The increase in absolute dollars and as a percentage of
net revenues from fiscal 1995 to fiscal 1996 were primarily the result of the
Company's addition of the VMW operations, increased headcount and related
expenses.  In addition, the increase in research and development is a result of
the Company's acquisition of certain technology that had not yet reached
technological feasibility and did not have alternative future uses.  Research
and development expenses in fiscal 1995 and 1994 were comparable in terms of
absolute dollars but lower in fiscal 1995 as a percentage of revenue due to the
completion of its major product development program that began in fiscal 1991.
In fiscal 1996, the Company increased its hiring to address its on-going
research and development efforts for enhancing its current products and for new
product and technology development. Research and development expenses are
expected to increase in absolute dollars when compared to fiscal 1996 as the
Company continues its product enhancement, new product development and
technology development programs.

                                       13
<PAGE>
 
Sales and Marketing Expenses

Sales and marketing expenses were $14,483,000, $11,763,000 and $9,447,000 in
fiscal 1996, 1995 and 1994 or 32%, 41% and 44% of net revenues, respectively.
The primary causes of the increase in absolute dollars have been increases in
headcount, commissions and international operations.  The growth in headcount
due to the higher level of presale support and benchmarking performed by field
application engineers. Commissions have increased as a result of higher net
revenue levels, as well as the growth of international operations. Spending on
international operations have increased to support the increased activity in
both Europe and Asia.  Sales and marketing expenses are expected to increase in
absolute dollars in fiscal 1997.

General and Administrative Expenses

General and administrative expenses were $3,420,000, $2,301,000 and $1,596,000
for fiscal 1996, 1995 and 1994, or 8%, 8% and 7% of net revenues, respectively.
The increase in expenses in 1996 was primarily due to increases in headcount
with related expenses, increased investor relations expenses, and increases in
professional services and profit sharing expenses.  The increase in fiscal 1995
was primarily due to additional headcount, as the Company filled the President
and Chief Operating Officer positions which were vacant in fiscal 1994. General
and administrative expenses are expected to increase in absolute dollars in
fiscal 1997.

Other Income (Expense)

Net interest income in fiscal 1996 of $1,016,000 was the result of interest
income of $1,058,000 being earned on increased cash, cash equivalent and short-
term investment balances during the fiscal year, net of interest paid on long-
term debt borrowings of $42,000.  The increasing cash balances were the result
of the Company completing two stock offerings netting proceeds of approximately
$20,177,000.  Net interest income of $52,000 in fiscal 1995 consisted of
approximately $159,000 of interest income offset by approximately $107,000 of
interest expense on long-term borrowings.  Net interest expense in fiscal 1994
was the result of $75,000 of interest expense on the long-term debt partially
offset by approximately $69,000 of interest income earned.  Other income in
fiscal 1996, 1995 and 1994 was $124,000, $117,000 and $140,000, respectively,
and primarily relates to rental income from property that the Company began
leasing in 1993.

Provision for Income Taxes

The Company recorded a tax benefit of $1,892,000 for fiscal 1996 which was
primarily attributable to the recognition of deferred tax assets for which no
benefit was previously recognized, net operating losses utilized during fiscal
1996, and acquired research and development expenditures for which no tax
benefit is available. The Company's tax provision for fiscal 1995 and 1994
consists primarily of federal alternative minimum tax, state taxes and foreign
withholding taxes.

                                       14
<PAGE>
 
Under Statement of Financial Accounting Standards No. 109 (FAS 109), deferred
tax assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse.  The Company has established a valuation allowance covering
a portion of the gross deferred tax assets based on management's expectations of
future taxable income and the actual taxable income during the three years ended
September 28, 1996.  Approximately $2,350,000 of the valuation allowance at
September 28, 1996 is related to tax benefits of stock option deductions which
will be credited to paid in capital when realized.  The remaining valuation
allowance is attributable to VMW pre-acquisition deferred tax assets which will
be credited to goodwill when recognized.

Extraordinary Credit - Forgiveness of Debt

In April 1994, the Company and Racal re-negotiated the terms of the July 1, 1993
agreement regarding the transfer, joint development and joint ownership in
certain Racal technology. The new terms reduce overall payments to Racal from
the Company by $750,000 and extend the scheduled payments into fiscal 1998. This
resulted in an extraordinary credit of $664,000 after being offset by certain
related expenses.

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 does not engage in hedging
transactions with respect to such obligations.

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

                                       15
<PAGE>
 
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, that its recent rate of quarterly revenue and earnings
growth will be sustained, 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
integrated circuit ("IC") and system designs is expected to depend on the
continued increasing complexity of 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, and the Company's initial emulation technology is in the
final stages of development. There can be no assurance that with the final
development of this technology, any products resulting from this development
will adequately meet the requirements of the marketplace, be of acceptable
quality or achieve market acceptance. In addition, because the Company's
proposed emulation products are based on a new technology concept, there can be
no assurance that the products will function and perform as planned or that the
Company will not experience other delays or difficulties in finalizing the
development of these products. The success of the Company in developing,
introducing, selling and supporting emulation products will depend on a variety
of factors in addition to the timely and successful completion of product design
and development, including 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 being 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 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.

                                       16
<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 hardware-assisted simulation-
based systems sold by Zycad Corporation ("Zycad") and traditional software
verification methodologies. The Company also competes in the market for
emulation products where its main competition for emulation systems are those
sold by Quickturn Design Systems, Inc. ("Quickturn") and other EDA companies.
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 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 Design Systems, Inc. ("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

                                       17
<PAGE>
 
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.

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 application-specific
integrated circuits ("ASICs") that are currently manufactured solely by
American Microsystems, Inc. ("AMI") and subassemblies that are manufactured
solely by Micron Technology Inc. ("Micron").

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 these 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.

                                       18
<PAGE>
 
Customer Concentration - A relatively limited number of customers have
----------------------                                                
historically accounted for a substantial portion of the Company's net revenues.
During fiscal 1996 and 1995, sales to the Company's top ten customers accounted
for approximately 65% and 50%, 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.

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. At September 28,1996 the Company's cash, cash equivalents and
short-term investments increased to $25,228,000 from $7,755,000 at September 30,
1995.  The increase was a result of $10,445,000 cash provided by operating
activities and $20,882,000 provided by financing activities offset by
$28,042,000 for investment activities.

Operating Activities - The Company's operating activities provided cash of
--------------------                                                      
$10,445,000 during fiscal 1996, $4,502,000 in fiscal 1995 and $1,398,000 in
fiscal 1994. For fiscal 1996, net cash provided by operating activities resulted
primarily from net income adjusted for the purchase of in-process research and
development related to the purchase of VMW plus depreciation and amortization
partially offset by the adjustment for deferred tax assets.  In addition, the
increase was a result of increases in accounts payable, accrued payroll and
related expenses and deferred maintenance offset by increases in accounts
receivable and inventories.  For fiscal 1995 and 1994, net cash provided by
operating activities resulted primarily from net income adjusted for
depreciation and amortization, which was partially offset by increases in
accounts receivable, inventories and accounts payable associated with increases
in revenue activity.

Investing Activities - Net cash used in investing activities for fiscal 1996,
--------------------                                                         
1995 and 1994 were $28,042,000, $943,000 and $978,000, respectively.  A
significant use of cash for fiscal 1996 resulted from the acquisition of VMW
which totaled $10,712,000.  The purchases and maturities of short-term
investments resulted in a net use of cash in the amount $14,188,000 for
investment purposes in fiscal 1996.  Such investment activities in fiscal 1995
and 1994 were insignificant.  In addition to the short-term investments, the
Company's investment activities were comprised primarily of capital expenditures
of $3,142,000, $1,053,000 and $959,000 for fiscal 1996, 1995 and 1994,
respectively. Capital expenditures were primarily for evaluation equipment and
engineering workstations.  The Company expects continued capital expenditures
during fiscal 1997 as expected headcount additions will require additional
computers and engineering workstations.

                                       19
<PAGE>
 
Financing Activities - During fiscal 1996, 1995 and 1994, the Company's
--------------------                                                   
financing activities provided cash of $20,882,000, $324,000 and $135,000,
respectively.  During fiscal 1996, the Company completed two public stock
offerings, issuing approximately 1,743,000 shares of common stock while
receiving net proceeds of approximately $20,177,000. In addition, during fiscal
1996, 1995, and 1994, the Company also received cash upon the exercise of
options to purchase Common Stock under the Company's stock option and purchase
plans. During these same periods, the Company's principal payments on long-term
borrowings were $888,000, $754,000 and $683,000, respectively.

The Company's primary unused sources of funds at September 28, 1996 consisted of
$10,590,000 of cash and cash equivalents, in addition to $14,638,000 of short-
term investments. The Company expects to make capital expenditures throughout
fiscal 1997. The Company expects that capital expenditures will increase as
compared to capital expenditures incurred in fiscal 1996.  The Company believes
that net proceeds from the public offerings, together with cash and cash
equivalents generated from operations, will be sufficient to finance its
operations through at least the end of fiscal 1997. To the extent necessary, the
Company may also use bank borrowings and capital leases depending on the terms
available. The Company's cash requirements in the future may also be financed
through additional equity or debt financing. There can be no assurance that such
financing can be obtained on favorable terms, if at all.
 
ITEM 8. Financial Statements and Supplementary Data

The Company's Financial Statements and Schedules, and the report of the
independent auditors appear on pages F-1 through F-15 and S-1 of this Form 10-K.

The Company's Supplementary Date - Unaudited Selected Quarterly Financial Data
appears on F-15 of this Form 10-K.


ITEM 9. Changes In and Disagreements with Accountants on Accounting and
        Financial Disclosure

Not applicable.

                                       20
<PAGE>
 
                                    PART III


ITEM 10.  Directors and Executive Officers of the Registrant


            The executive officers and directors of the Company are as follows:
<TABLE>
<CAPTION>
 
NAME                            AGE            POSITION WITH THE COMPANY
-----------------------------   ---   -------------------------------------------
<S>                             <C>   <C>
Gerald S. Casilli............    57   Chairman of the Board

Ramon A. Nunez...............    42   Chief Executive Officer, President
                                      and Director

Joseph W. Rockom.............    57   Chief Financial Officer, Vice President of
                                      Finance and Administration, and Secretary

Paul Offredi.................    51   Senior Vice President, Product Operations

Daniel R. Hafeman............    47   Vice President of Advanced Research and
                                      Chief Technical Officer

Stephen M. McLaughlin........    49   Vice President of Manufacturing

Lawrence A. Melling..........    39   Vice President of Marketing

John Stressing...............    52   Vice President of Worldwide Sales

Lutz P. Henckels (1).........    56   Director

James R. Oyler (1)...........    50   Director

Glenn E. Penisten (1)........    65   Director
--------------
</TABLE>
(1)  Member of the Audit Committee and Compensation Committee

Mr. Casilli has served as Chairman of the Board of Directors of the Company
since July 1989 and served as Chief Executive Officer from April 1989 to August
1995. He has served as a director since 1986. From January 1986 to December
1989, he was a general partner of Trinity Ventures, Ltd., a venture capital firm
that was a former investor in the Company. Mr. Casilli was a general partner of
Genesis Capital, a venture capital firm, from February 1982 to 1990. Mr. Casilli
founded Millennium Systems, a manufacturer of microprocessor development
systems, in 1973 and served as its President and Chief Executive Officer until
1982.

Mr. Nunez was appointed Chief Executive Officer in August 1995. Mr. Nunez had
been President, Chief Operating Officer and Director of the Company since
October 1994. He had served as Vice President of Worldwide Sales since July
1993. Mr. Nunez joined the Company in April 1990 as Vice President of North
American Sales after five years in sales management with Zycad Corporation.
Earlier he was branch sales manager for Cadnetix (now part of Intergraph) in
Southern California.

                                       21
<PAGE>
 
Mr. Rockom has served as Chief Financial Officer and Vice President of Finance
and Administration since September 1986.  Mr. Rockom has also served as the
Company's Secretary since April 1995. Before joining the Company, Mr. Rockom
spent seventeen years at American Microsystems, Inc. (AMI), a semiconductor
manufacturer, where he held a variety of administrative, operating and
management positions, including Vice President of Finance.

Mr. Offredi was appointed Senior Vice President of Product Operations in August
1995. From August 1992, Mr. Offredi provided management consulting to companies
in computer related fields. From 1991 until 1992, Mr. Offredi was the General
Manager of EDA West for Teradyne, a manufacture of electronic test equipment.
From 1987 until 1991, Mr. Offredi was the Senior Vice President of Operations
for Zycad Corporation.

Mr. Hafeman, a founder of the Company, has served Vice President of Advance
Research and Chief Technical Officer since March 1996.  Mr. Hafeman served as
Vice President of Engineering from August 1989 to March 1996. From December 1984
to August 1989, he served in various positions of engineering management with
the Company. Mr. Hafeman was an engineering manager at Scientific Micro Systems,
Inc. for eight years prior to his employment with the Company.

Mr. McLaughlin has served as Vice President of Manufacturing since November
1986. From July 1977 to November 1986, he served as Director of Manufacturing of
Scientific Micro Systems, Inc.

Mr. Melling has served as Vice President of Marketing since July 1993. From
August 1990 to July 1993, Mr. Melling was Vice President of Technical Support.
From 1983 until joining IKOS in 1985, Mr. Melling had been a system design
engineer at Corvus Systems, a manufacturer of computer networking equipment.
Prior to his relationship with Corvus Systems, he was a production and circuit
engineer with Hewlett-Packard for four years.

Mr. Stressing has served as Vice President of Worldwide Sales since August 1995.
From October 1993 to August 1995 he served as European Sales Director and Vice
President, International Sales. From January 1989 to November 1993, he was the
proprietor of Premier Consultants, a recruitment and sales agency for IKOS'
products in Scandinavia. Prior to founding Premier Consultants, Mr. Stressing
was employed in various sales capacities by Zycad Corporation for four years, by
Daisy Systems for one year, by Teradyne for four years, and by British Aerospace
for thirteen years.

Mr. Henckels has served as a member of the Board since February 1994. Mr.
Henckels has been President of LeCroy Corporation, a supplier of test and
measurement equipment, since 1993 and Chief Executive Officer since 1994.  Mr.
Henckels is also a director of LeCroy Corporation. Before joining LeCroy
Corporation he was President of U.S. Operations for Racal-Redac, Inc. from 1989
to 1993. From 1983 to 1989, Mr. Henckels was President and Founder of HHB
Systems, an EDA company. Before that he was President and founder of HHB
Softron, an engineering consulting firm.

                                       22
<PAGE>
 
Mr. Oyler has served as a member of the Board since October 1991. He is
presently President, Chief Executive Officer and Director of Evans & Sutherland
Computer Corporation. Evans & Sutherland develops, manufactures and markets high
performance systems for various applications with demanding graphics
requirements. Prior to his position with Evans and Sutherland, Mr. Oyler was
president of AMG, Inc., a process machine design company. From 1976 to 1990, Mr.
Oyler worked at Harris Corporation, most recently as Senior Vice President and
Sector Executive, where he was responsible for nine operating divisions. Prior
to that he held positions as consultant and associate with Booz, Allen &
Hamilton in New York, a consulting company.

Mr. Penisten has been a member of the Board of Directors since September 1985.
Since September 1985, he has been a general partner of Alpha Partners, a venture
capital firm and former  investor in the Company. From January 1985 to August
1985, he was a general partner of P & C Venture Partners, a venture capital
firm. From 1982 to 1985, he was a Senior Vice President at Gould/AMI. From 1976
to 1982, Mr. Penisten served as Chief Executive Officer of AMI, a semiconductor
manufacturer.   Mr. Penisten is also a director of Bell Micro-Products, Inc.,
Pinnacle Systems, Inc. and Superconductor Technologies and is Chairman of the
Board for Network Peripherals, Inc.

All directors hold office until the next annual meeting of stock holders or the
election and qualification of their successors. The Board of Directors elects
officers annually and such officers serve at the discretion of the Board.


ITEM 11.  Executive Compensation

The information required by this Item is incorporated by reference from the
section captioned "EXECUTIVE COMPENSATION AND OTHER MATTERS" contained in the
Company's Definitive Proxy Statement related to the Annual Meeting of
Stockholders to be held January 27, 1997, to be filed by the Company with the
Securities and Exchange Commission (the "Proxy Statement").


ITEM 12.  Security Ownership of Certain Beneficial Owners and Management

The information required by this Item is incorporated by reference from the
section captioned "GENERAL INFORMATION- Security Ownership of Certain Beneficial
Owners and Management" contained in the Proxy Statement.


ITEM 13.  Certain Relationships and Related Transactions

Not applicable.

                                       23
<PAGE>
 
                                    PART IV


ITEM 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K

          (a) (1)    Financial Statements


                     The following financial statements of the Registrant are 
                     filed as part of this report:

                                                                          Page
                                                                          ---- 
          Report of Ernst & Young LLP, Independent Auditors.............  F - 1
 
          Consolidated Balance Sheets, September 28, 1996 and
               September 30, 1995.......................................  F - 2
 
          Consolidated Statements of Income for the fiscal years ended
               September 28, 1996, September 30, 1995 and 
               October 1, 1994..........................................  F - 3
 
          Consolidated Statements of Stockholders' Equity for the fiscal
               years ended September 28, 1996, September 30, 1995 and 
               October 1, 1994..........................................  F - 4
 
          Consolidated Statements of Cash Flows for the fiscal years 
              ended September 28, 1996, September 30, 1995 and 
              October 1, 1994...........................................  F - 5
 
          Notes to Consolidated Financial Statements....................  F - 6

          (a) (2) Financial Statement Schedule
 
                  The following financial statement schedule of the Registrant
                  are filed as part of this report:
 
                                                                          Page
                                                                          ----
 
          Schedule II -- Valuation and Qualifying Accounts.............   S - 1
 

                  All other schedules are omitted because they are not
                  applicable or the required information is shown in the 
                  Financial Statements or notes thereto.

          (a) (3) Exhibits

                  See Index to Exhibits beginning on Page 26 of this report.

          (b)     The Company filed no reports on Form 8-K during the fourth 
                  quarter ended September 28, 1996.

                                       24
<PAGE>
 
SIGNATURES


Pursuant to the requirements of Section 13 or 15(d) 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.



                                           /s/    Ramon Nunez
                                           ----------------------------
                                           Ramon Nunez, Chief Executive
                                           Officer, President and Director

POWER OF ATTORNEY

Each of the officers and directors of IKOS Systems, Inc. whose signature appears
below hereby constitutes and appoints Ramon A. Nunez and Joseph W. Rockom and
each of them, their true and lawful attorneys and agents, with full power of
substitution, each with power to act alone, to sign and execute on behalf of the
undersigned any amendment or amendments to this Report on Form 10-K and to
perform any acts necessary in order to file such amendment or amendments and
each of the undersigned does hereby ratify and confirm all that said attorneys
and agents or their or his substitutes, shall do or cause to be done by virtue
hereof.

Pursuant to requirements of the Securities Exchange Act of 1934, this report has
been signed on behalf of the Registrant and in the capacities and on the date
indicated.

<TABLE> 
<CAPTION> 
                                             Title                        Date
                                             -----                        ----
<S>                            <C>                                   <C> 
/s/  Ramon Nunez               Chief Executive Officer, President    December 16, 1996
----------------------------   and Director                                 
    (Ramon Nunez)              


/s/ Gerald S. Casilli          Chairman of the Board                 December 16, 1996
---------------------------- 
   (Gerald S. Casilli)
 

/s/ Joseph W. Rockom           Vice President of Finance and         December 16, 1996
----------------------------   Administration and Chief Finance
   (Joseph W. Rockom)          Officer (Principal Accounting and                                
                               Financial Officer) and Secretary
 

/s/ Lutz Henckels              Director                              December 16, 1996
----------------------------
   (Lutz Henckels)
 

/s/ James R. Oyler             Director                              December 16, 1996
----------------------------
   (James R. Oyler)
 

/s/ Glenn E. Penisten          Director                              December 16, 1996
----------------------------
   (Glenn E. Penisten)
</TABLE> 

                                       25
<PAGE>
 
                               INDEX TO EXHIBITS


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

  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       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).

  4.2       Registration rights agreement by and among the Company and 
            certain former stockholders of VMW (Incorporated by reference 
            to Exhibit 4.1 of the Company's registration statement on 
            Form S-3 effective July 26, 1996).

 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).

                                       26
<PAGE>
 
Exh. No.                     Documentation Description                     Page
-------                      -------------------------                     ----

 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).

 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).

                                       27
<PAGE>
 
Exh. No.                     Documentation Description                     Page
-------                      -------------------------                     ----

 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 been granted as to certain
            portions of this Exhibit.

 10.21      The Company's 1995 Stock Option Plan.

 10.22      The Company's 1996 Employee Stock Purchase Plan.

                                       28
<PAGE>
 
Exh. No.                     Documentation Description                     Page
-------                      -------------------------                     ----

 11.1       Statement of Computation of Earnings per Share.

 21.1       List of Subsidiaries.

 23.1       Consent of Ernst & Young LLP, Independent Auditors.

 24.1       Power of Attorney (Included on page 25 of this report).

 27.1       Financial Data Schedule

                                       29
<PAGE>
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS



Board of Directors and Stockholders
IKOS Systems, Inc.

We have audited the accompanying consolidated balance sheets of IKOS Systems,
Inc. as of September 28, 1996 and September 30, 1995 and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three fiscal years in the period ended September 28, 1996. Our audit also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of IKOS
Systems, Inc. at September 28, 1996 and September 30, 1995, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended September 28, 1996, in conformity with generally accepted
accounting principles. Also in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, present fairly in all material respects the information set forth
therein.



                                                  ERNST & YOUNG LLP

San Jose, California
October 17, 1996

                                      F-1
<PAGE>

                              IKOS SYSTEMS, INC.
                          CONSOLIDATED BALANCE SHEETS
                   (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                                       September 28,    September 30,
                                                                                           1996             1995
                                                                                       -------------    -------------

                                ASSETS
<S>                                                                                    <C>              <C>
Current assets:
        Cash and cash equivalents.....................................................   $  10,590        $  7,305
        Short-term investments........................................................      14,638             450
        Accounts receivable (net of allowances for
         doubtful accounts of $271 and $171, respectively)............................       9,193           6,046
        Inventories...................................................................       3,514           1,328
        Deferred tax assets ..........................................................       4,187              --
        Prepaid expenses and other assets.............................................         537             271
                                                                                         ---------        --------
                Total current assets..................................................      42,659          15,400
        Equipment and leasehold improvements
            Office and evaluation equipment...........................................       3,088           2,730
            Machinery and equipment...................................................       5,738           4,985
            Leasehold improvements....................................................         331             287
                                                                                         ---------        --------
                                                                                             9,157           8,002
                Less allowances for depreciation and amortization.....................      (5,565)         (6,363)
                                                                                         ---------        --------
                                                                                             3,592           1,639
        Goodwill (net of accumulated amortization of
         $421 at 1996 and none at 1995)...............................................       5,890              --
        Deferred tax assets ..........................................................       1,125              --
        Other assets..................................................................         205             113
                                                                                         ---------        --------
                                                                                         $  53,471        $ 17,152
                                                                                         =========        ========
                        LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
        Accounts payable..............................................................   $   4,775        $  1,613
        Accrued payroll and related expenses..........................................       2,406           1,195
        Accrued commissions...........................................................         725             697
        Income taxes payable..........................................................       1,745             188
        Other accrued liabilities.....................................................         496             480
        Deferred maintenance revenues.................................................       3,843           3,030
        Current portion of long-term debt.............................................         750             688
                                                                                         ---------        --------
                Total current liabilities.............................................      14,740           7,891
Long-term debt, less current portion..................................................         350           1,300
Accrued  rent.........................................................................         237             251
Commitments
Stockholders' equity:
        Preferred stock, $.01 par value; 10,000 shares
         authorized, none issued and outstanding......................................          --              --
        Common stock, $.01 par value; 25,000 shares
         authorized, 8,179 and 5,886 shares issued and outstanding,
         respectively.................................................................          82              59
        Additional paid-in capital....................................................      54,994          27,034
        Accumulated deficit...........................................................     (16,932)        (19,383)
                                                                                         ---------        --------
                Total stockholders' equity............................................      38,144           7,710
                                                                                         ---------        --------
                                                                                         $  53,471        $ 17,152
                                                                                         =========        ========
</TABLE>

                See notes to consolidated financial statements.

                                      F-2
<PAGE>
 
                              IKOS SYSTEMS, INC.
                       CONSOLIDATED STATEMENT OF INCOME
                   (in thousands, except per share amounts)
<TABLE>
<CAPTION>
                                                                                 Fiscal Years Ended
                                                                      -----------------------------------------
                                                                      September 28,   September 30,  October 1,
                                                                          1996           1995          1994
                                                                      -------------  -------------  -----------
<S>                                                                   <C>            <C>            <C> 
Net revenues
        Product.................................................         $37,619        $23,713       $17,886  
        Maintenance.............................................           7,722          4,887         3,750  
                                                                         -------        -------       -------
           Total net revenues...................................          45,341         28,600        21,636  
Cost of revenues                                                                                               
        Product.................................................           8,422          5,982         5,000  
        Maintenance.............................................           1,430          1,157           930
                                                                         -------        -------       -------  
           Total cost of revenues...............................           9,852          7,139         5,930

                                                                         -------        -------       -------  
           Gross profit.........................................          35,489         21,461        15,706  
Operating expenses:                                                                                            
        Research and development................................           8,146          3,999         3,861  
        Sales and marketing.....................................          14,483         11,763         9,447  
        General and administration..............................           3,420          2,301         1,596  
        Write-off of in-process  research and development.......           9,600             --            --  
        Amortization of goodwill................................             421             --            --
                                                                         -------        -------       -------  
           Total operating expenses.............................          36,070         18,063        14,904  

                                                                         -------        -------       -------
Income (loss) from  operations..................................            (581)         3,398           802
                                                                                                               
Other income (expense):                                                                                        
        Interest income.........................................           1,058            159            69  
        Interest expense........................................             (42)          (107)          (75) 
        Other...................................................             124            117           140
                                                                         -------        -------       -------  
           Total other income...................................           1,140            169           134

                                                                         -------        -------       -------  
Income before provision for income taxes and extraordinary                                                     
 credit.........................................................             559          3,567           936  
Provision (benefit) for income taxes............................          (1,892)           411            95
                                                                         -------        -------       -------  
Income before extraordinary credit..............................           2,451          3,156           841  
Extraordinary credit - forgiveness of debt......................              --             --           664
                                                                         -------        -------       -------  
           Net income...........................................         $ 2,451        $ 3,156       $ 1,505 
Earnings per share:                                                                                            
        Income before extraordinary credit......................         $  0.30        $  0.51       $  0.15 
        Extraordinary credit....................................              --             --          0.12 
                                                                         -------        -------       -------
           Net income...........................................         $  0.30        $  0.51       $  0.27 
                                                                         =======        =======       =======
Common and common equivalent shares used in computing per                                                      
 share amounts..................................................           8,114          6,151         5,651 
                                                                         =======        =======       ======= 

</TABLE>

                See notes to consolidated financial statements.

                                      F-3
<PAGE>
 
<TABLE>
<CAPTION>
                                                        IKOS SYSTEMS, INC.
                                          CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                                          (in thousands)

                                                      Common Stock            Additional                    Total
                                                  ---------------------        Paid-in     Accumulated   Stockholders'
                                                   Shares        Amount        Capital       Deficit        Equity
                                                  --------      -------       ----------   -----------   -------------
<S>                                               <C>           <C>           <C>          <C>           <C>
Balance at October 2, 1993...................       5,431        $    54        $ 25,893     $ (24,044)     $ 1,903

Net issuance of stock under
 employee benefit plans......................          73              1              67            --           68

Net income...................................          --             --              --         1,505        1,505
                                                 --------        -------        --------     ---------      -------
Balance at October 1, 1994...................       5,504             55          25,960       (22,539)       3,476

Net issuance of stock under employee
 benefit plans...............................         382              4           1,074            --        1,078

Net income...................................          --             --              --         3,156        3,156
                                                 --------        -------        --------     ---------      -------
Balance at September 30, 1995................       5,886             59          27,034       (19,383)       7,710

Net issuance of stock under employee
 benefit plans...............................         437              4           1,589            --        1,593
Net issuance of stock in connection
 with stock offerings........................       1,743             18          20,159            --       20,177
Net issuance of stock and warrants
 in connection with the acquisition
 of VMW......................................         113              1           5,198            --        5,199
Income tax benefit from stock
  options exercised..........................          --             --           1,014            --        1,014
Net income...................................          --             --              --         2,451        2,451
                                                 --------        -------        --------     ---------      -------
Balance at September 28, 1996................       8,179        $    82        $ 54,994     $ (16,932)     $38,144
                                                 ========        =======        ========     =========      =======
</TABLE>

                See notes to consolidated financial statements.

                                      F-4
<PAGE>

<TABLE>
<CAPTION>
                                                        IKOS SYSTEMS, INC.
                                               CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  Increase (decrease) in cash and cash equivalents (in thousands)


                                                                                    Fiscal years ended
                                                                          ---------------------------------------
                                                                          September 28,  September 30, October 1,
                                                                              1996          1995         1994
                                                                          ------------   ------------  ----------
<S>                                                                       <C>            <C>           <C>
Operating activities:
   Net income.........................................................     $  2,451       $ 3,156     $   1,505
   Adjustments to reconcile net income to net
     cash provided by operating activities:
   Depreciation and amortization......................................        1,583         1,259         2,024
   Gain (loss) on retirement of equipment.............................           27            16            (4)
   Deferred tax assets................................................       (5,312)           --            --
   Deferred rent......................................................          (14)           37            26
   Purchase of in-process research and development....................        9,600            --            --
   License delivery and technology transfer in exchange for
     debt.............................................................           --            --          (344)
Decrease of long-term debt - forgiveness of note......................           --            --          (750)
Changes in operating assets and liabilities
   Accounts receivable................................................       (3,147)       (1,162)       (2,069)
   Inventories........................................................       (2,186)         (234)          415
   Prepaid expenses and other current assets..........................         (266)          (49)         (168)
   Other assets.......................................................          (92)          (27)           12
   Accounts payable...................................................        3,162          (296)         (169)
   Accrued payroll and other expenses.................................        1,211           409           128
   Accrued commissions................................................           28            47           357
   Income taxes payable...............................................        2,571           175             4
   Other accrued liabilities..........................................           16           120          (112)
   Deferred maintenance revenues......................................          813         1,051           543
                                                                           --------       -------     ---------
     Net cash provided by operating activities........................       10,445         4,502         1,398

Investing activities:
   Purchases of equipment and leasehold improvements..................       (3,142)       (1,053)         (959)
   Acquisition of Virtual Machine Works, Inc..........................      (10,712)           --            --
   Purchases of  short-term investments...............................      (25,393)           --          (400)
   Maturities of short-term investments...............................       11,205           110           381
                                                                           --------       -------     ---------
     Net cash used in investment activities...........................      (28,042)         (943)         (978)

Financing activities:
   Principal payments on long-term borrowings.........................         (888)         (754)         (683)
   Borrowing under promissory note....................................           --            --           750
   Sale of common stock...............................................       21,770         1,078            68
                                                                           --------       -------     ---------
     Net cash provided by financing activities........................       20,882           324           135
                                                                           --------       -------     ---------
Increase in cash and cash equivalents.................................        3,285         3,883           555
Cash and cash equivalents at beginning of period......................        7,305         3,422         2,867
                                                                           --------       -------     ---------
Cash and cash equivalents at end of period............................     $ 10,590       $ 7,305     $   3,422
                                                                           ========       =======     =========
Supplemental disclosures of cash flow information:
   Cash paid for income taxes.........................................     $    704       $   230     $      91
   Cash paid for interest.............................................     $     42       $   107     $      75
Non cash transactions:
   In connection with the acquisition of VMW, the Company paid approximately $5,199,000 in
   IKOS common stock, options and warrants.

</TABLE>

                See notes to consolidated financial statements.

                                      F-5
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996


1. Nature of operations and summary of significant accounting policies
   --------------------------------------------------------------------

   Nature of operations:  The Company develops, manufactures, markets and
   -------------------- 
   supports hardware and software systems for the verification of integrated
   circuit designs. The Company's strategy is to serve the needs of a growing
   universe of IC designers for fast, accurate verification of complex IC
   designs through its family of hardware and software simulation and emulation
   systems. The Company performs final assembly and test of all of its products
   in its Cupertino, California facility and utilizes third parties for all
   major subassembly manufacturing. Certain key components used in the Company's
   products are presently available from sole or limited sources. The Company is
   dependent upon these suppliers to provide these components on a timely basis.
   The Company sells its products to a broad range of customers in the
   communications, multimedia/graphics, semiconductor, computer, aerospace and
   consumer electronics industries. Substantially all of the Company's product
   revenues since fiscal 1993 have been derived from the sale of Voyager and
   Gemini simulation systems.

   Basis of presentation: The accompanying consolidated financial statements
   --------------------- 
   include the Company and its wholly owned subsidiaries after elimination of
   all significant inter-company accounts and transactions.

   Fiscal year: The Company is on a 52-53 week year. Accordingly, September 28,
   ----------- 
   1996, September 30, 1995 and October 1, 1994 are the fiscal year-ends for
   1996, 1995 and 1994, respectively.

   Cash equivalents and short-term investments: All liquid investments with
   ------------------------------------------- 
   original maturities of three months or less when purchased are considered to
   be cash equivalents and are stated at cost, which approximates their fair
   value.  At September 28, 1996, cash equivalents consisted of money market
   funds, certificates of deposits and U.S. corporate overnight securities.
   Short-term investments are stated at cost, which approximates market, and
   consist primarily of U.S. Treasury securities, commercial paper and other
   corporate obligations. The Company is exposed to credit risks in the event of
   default by the financial institutions or issuers of investments to the extent
   of amounts recorded on the balance sheet.

   Under Statements of Financial Accounting Standards No. 115 (FAS 115),
   "Accounting for Certain Investments in Debt and Equity Securities," debt
   securities that the Company has both positive intent and ability to hold to
   maturity are carried at amortized cost. Debt securities that the Company does
   not have the positive intent and ability to hold to maturity and all
   marketable equity securities are classified as available-for-sale or trading
   and carried at fair value. Unrealized holding gains and losses on securities
   classified as available-for-sale are reported as part of equity while
   unrealized holding gains and losses on securities classified as trading are
   reported in earnings.

   The fair values for marketable debt securities are based on quoted market
   prices. The fair value of marketable securities is substantially equal to
   their carrying value as of September 28, 1996.

                                      F-6
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996



1.  Nature of operations and summary of significant accounting policies
    -------------------------------------------------------------------
   (continued):
   -------------

   The following is a summary of held-to-maturity securities at September 28,
   1996 and September 30, 1995 (in thousands):

    <TABLE>                                                                  
    <CAPTION>                                                                
                                                                             
                                               September 28,   September 30, 
                                                   1996            1995      
                                               -------------   ------------- 
    <S>                                        <C>             <C>           
    U.S. Treasury Securities................     $   125           $  -- 
    U.S. Corporate Securities...............      17,399             450 
    Mortgage-Backed Securities..............       2,216              -- 
                                                 -------           ----- 
                                                 $19,740           $ 450 
                                                 =======           ===== 
                                                                             
    Amounts included in short-term                                           
    investments.............................     $14,638           $ 450 
                                                                             
    Amounts included in cash and cash                                        
    equivalents.............................     $ 5,102           $  -- 
    </TABLE>                                                                  


   Inventories: Inventories are stated at the lower of cost (first-in, first-out
   ----------- 
   method) or market (estimated net realizable value). Inventories consist of
   the following (in thousands):

    <TABLE>                                                      
    <CAPTION>                                                    
                                                                 
                                  September 28,   September 30,  
                                      1996            1995       
                                  -------------   -------------  
                                                                 
    <S>                           <C>             <C>            
    Raw materials..........         $  631          $  347  
    Work-in-process............      2,245             563  
    Finished goods..........           638             418  
                                    ------          ------  
                                    $3,514          $1,328  
                                    ======          ======  
    </TABLE>                                                      

   Equipment and leasehold improvements: Equipment and leasehold improvements
   ------------------------------------ 
   are stated at cost and are depreciated or amortized using the straight-line
   method over the estimated useful life (generally two to five years) of the
   related asset, or in the case of leasehold improvements, the term of the
   lease, if shorter.

   Goodwill and software development costs: The goodwill presented in the
   --------------------------------------- 
   accompanying financial statements relate to the acquisition of VMW and is
   being amortized over five years.

   The Company capitalizes software development costs upon achievement of
   technological feasibility, subject to net realizable value considerations in
   accordance with Statement of Financial Accounting Standards No. 86. The
   Company has defined technological feasibility as completion of a working
   model. Such capitalized costs are amortized upon product release on a
   straight-line basis over the estimated useful life of two years or the ratio
   of current revenue to the total of current and anticipated future revenues,
   whichever is greater. For the three fiscal years ended September 28, 1996
   capitalizable costs were insignificant and thus charged to research and
   development expenses for the respective periods in the accompanying financial
   statements. During the fiscal 1995 and 1994, the Company amortized $257,000
   and $864,000, respectively, of previously capitalized software development
   costs. For 1996, all capitalized costs had previously been amortized.

   Revenue recognition: Product revenues, which include licensing and software
   -------------------
   revenues, are generally recognized on shipment provided that no significant
   vendor or post-contract support obligations remain outstanding and collection
   of the resulting receivable is deemed probable. Insignificant vendor and
   post-support obligations are accrued upon shipment. Revenue under maintenance
   contracts is recognized ratably over the term of the related contract,
   generally twelve months.

                                      F-7
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996


1. Nature of operations and summary of significant accounting policies
   -------------------------------------------------------------------
   (continued):
   -------------

   Warranty: The Company warrants products sold to customers for ninety days
   -------- 
   from shipment. A provision for the estimated future cost of warranty is
   recorded upon shipment.

   Employee stock plans:  The Company accounts for its stock option and employee
   -------------------- 
   stock purchase plans in accordance with provisions of the Accounting
   Principles Board's Opinion No. 25 (APB 25), "Accounting for Stock Issued to
   Employees." In 1995, the Financial Accounting Standards Board released the
   Statement of Financial Accounting Standard No. 123 (SFAS 123), "Accounting
   for Stock Based Compensation." The Company elected to adopt the disclosure
   requirements of FAS 123 rather than the accounting requirements of FAS 123.

   Long-lived assets:  In 1995, the Financial Accounting Standards Board
   ----------------- 
   released the Statement of Financial Accounting Standard No. 121 (SFAS 121),
   "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
   to be Disposed of." SFAS 121 requires recognition of impairment of long-lived
   assets in the event the net book value of such assets exceeds the future
   undiscounted cash flows attributable to such assets. SFAS 121 is effective
   for fiscal years beginning after December 15, 1995. Adoption of SFAS 121 is
   not expected to have a material impact on the Company's financial position or
   results of operations.

   Use of estimates:  The preparation of financial statements in conformity with
   ---------------- 
   generally accepted accounting principles requires management to make
   estimates and assumptions that affect the reported amounts of liabilities and
   disclosure of contingent assets and liabilities at the date of the financial
   statements and the reported amounts of revenues and expenses during the
   reporting period.  Such estimates related to the useful lives of fixed
   assets, allowances for doubtful accounts and customer returns, inventory
   reserves, other reserves and income tax valuation allowances.  Actual results
   inevitably will differ from those estimates, and such differences may be
   material to the financial statements.

   Net income per share: Net income per share is computed using the weighted
   -------------------- 
   average number of shares of common stock and common equivalent shares, when
   dilutive, from stock options (using the treasury stock method).

2. Acquisition of Virtual Machine Works, Inc.
   ------------------------------------------
 
   In May 1996, the Company completed the acquisition of Virtual Machine Works,
   Inc. (VMW), a development stage company and a developer of logic emulation
   systems. Under the terms of the acquisition, the Company paid approximately
   $10,712,000 in cash and issued approximately 113,000 shares of common stock
   to the former stockholders of VMW. In addition, the options to purchase VMW
   stock were converted into options to purchase approximately 84,000 shares of
   IKOS common stock. The transaction was treated as a purchase; accordingly the
   purchase price has been allocated to tangible assets acquired, goodwill and
   liabilities assumed at their fair market values using a risk adjusted
   discounted cash flows approach. In connection, with the acquisition, the
   Company recorded a charge of approximately $9,600,000 for the acquisition of
   in-process research and development during the third quarter of fiscal 1996.
   In fiscal 1996, the Company recorded amortization of $421,000 relating to the
   capitalized intangible assets.

                                      F-8
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996

 
2. Acquisition of Virtual Machine Works, Inc. (continued)
   ------------------------------------------------------

   The evaluation of the underlying technology and patent rights acquired
   considered the inherent difficulties and uncertainties in completing the
   development, and thereby achieving technological feasibility, and the risks
   related to the viability of and potential changes in future target markets.
   The underlying technology and patent rights had no alternative use (in other
   research and development projects or otherwise) since the technology was
   acquired for the sole purpose of developing emulation products.
 
   The following pro forma information reflects the statements of income for the
   years ended September 28, 1996 and September 30, 1995 as if the acquisition
   had occurred at the beginning of fiscal 1995, and includes certain
   adjustments for amortization of intangible assets, reduced interest income
   and the related tax impact.  The pro forma information excludes the
   $9,600,000 write off of purchased research and development as it represents a
   non recurring item.  This pro forma information may not be indicative of the
   results that actually would have occurred if the combination had been in
   effect on the dates indicated or which may be realized in the future.
   
   <TABLE>                                                             
   <CAPTION>                                                           
                                                                       
                                                                       
                              September 28, 1996    September 30, 1995 
                              ------------------    ------------------
                              (in thousands, except per share amounts) 
   <S>                        <C>                   <C>                
   Net revenues...............     $45,341              $28,600        
                                   =======              =======        
   Net income.................     $ 9,897              $  (498)       
                                   =======              =======        
   Net income per share.......     $  1.21              $ (0.09)       
                                   =======              =======        
                                                                       
   </TABLE>                                                             

3. Long-term debt
   --------------
    <TABLE>                                                                    
    <CAPTION>                                                                  
                                                                               
                                               September 28,    September 30,  
                                                    1996             1995      
                                               --------------   -------------- 
                                                      (in thousands)           
    <S>                                        <C>              <C>            
    Debt obligation to Racal-Redac, Inc.                                       
    payable in sixteen quarterly payments                                      
    through 1998............................          $1,100           $1,550  
                                                                               
                                                                               
    Line of credit arrangement with leasing                                    
    company paid over 36 months and bearing                                    
    interest at 1.45% per month.............              --              438  
                                                      ------           ------  
                                                       1,100            1,988  
    Less current portion....................            (750)            (688) 
                                                      ------           ------  
    Long-term debt..........................          $  350           $1,300  
                                                      ======           ======  
    </TABLE>                                                                    


   Racal-Redac Agreement - In July 1993, the Company and Racal-Redac, Inc.
   --------------------- 
   ("Racal") amended the May 1991 Technology Transfer and Joint Development
   Agreement which provided for the exchange of certain VHDL technologies and
   for the joint ownership in certain Racal technology for cash, common stock
   and future payments based on future sales. Under the terms of the July
   agreement the original agreement was amended to require payments of
   $3,600,000 (payable over four years) in lieu of the future payments based on
   product sales. In April 1994, the Company and Racal re-negotiated the terms
   of the July 1993 agreement. The new terms reduced overall payments to Racal
   from the Company by $750,000 and extended the scheduled payments into fiscal
   1998. This resulted in an

                                      F-9
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996



3. Long-term debt (continued)
   --------------------------

   extraordinary credit of $664,000, after being offset by certain related
   expenses. The Company has also granted Racal a security interest in certain
   VHDL software developed by the Company with respect to the promissory note to
   Racal by the Company. In the event that the Company defaults in the payment
   of the promissory note, Racal may obtain all rights to the software,
   including access to the source code of the software.

   Equipment Line - In June 1993, the Company entered into a $2,000,000
   equipment financing credit agreement with Phoenix Leasing, Incorporated. The
   Company drew down $750,000 in March 1994 and at September 28, 1996 all
   amounts outstanding had been repaid.

   Total payments for all debt over the next two fiscal years are as follows (in
   thousands):

   <TABLE>                                                   
   <CAPTION>                                                 
                                                             
     Fiscal Year                                             
                                              Racal-Redac    
                                              -----------    
                                                             
   <S>                                        <C>            
     1997...............................           $  750    
     1998...............................              350    
                                                   ------    
        Total...........................           $1,100    
                                                   ======    
   </TABLE>                                                   

4. Commitments
   ------------

   Non cancelable operating leases include building leases which expire in
   September 2000. The Company has the option to renew its building lease at its
   principal offices for up to an additional nine years, commencing in September
   2000, at the fair market value at the time of renewal. The Company subleases
   certain facilities. This sublease expires in 1997. Sublease rental income was
   approximately $122,000, $117,000 and $140,000, in fiscal 1996, 1995 and 1994,
   respectively. Future minimum rentals from subleases are approximately
   $61,000.

   Rent expense approximated $975,000, $901,000 and $763,000 in fiscal 1996,
   1995 and 1994, respectively.

   Future minimum payments under non cancelable operating leases at September
   28, 1996 are as follows (in thousands):

   <TABLE>                                        
   <CAPTION>                                      
                                                  
                Fiscal Year                      Amount    
                -----------                      -------   
                <S>                               <C>       
                                                  
                1997.........................    $  629      
                1998.........................       659      
                1999.........................       694      
                2000.........................       731      
                                                 ------      
          Total..............................    $2,713      
                                                 ======      
   </TABLE>                                        

5.  Stockholders' equity
    ---------------------

   Common stock:  In October 1995, the Company sold 1,150,000 shares of common
   ------------ 
   stock in a public offering resulting in net proceeds to the Company of
   approximately $10,450,000. In July 1996, the Company completed a second
   offering of common stock whereby approximately 593,000 shares of common stock
   were sold resulting in net proceeds to the Company of approximately
   $9,727,000.

                                      F-10
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996


 
5. Stockholders' equity (continued)
   ---------------------------------

   VMW Acquisition:  In connection with the acquisition of VMW (see Note 1), the
   ---------------
   Company issued approximately 113,000 shares of common stock in exchange for
   VMW shares. In addition, the Company granted options to purchase
   approximately 84,000 shares of common stock in exchange for VMW options.
   The option prices range from $0.85 - $2.54 and are included in the grants
   in the table below. In connection with the acquisition, the Company also
   issued warrants to purchase 25,000 shares of common stock at $23.50 per
   share in return for professional services rendered. These warrants, which
   were valued at approximately $200,000, are included as consideration in
   connection with the acquisition. These warrants expire on April 19, 2001.
   At September 28, 1996, options to purchase approximately 56,000 shares of
   common stock and warrants to purchase 25,000 shares of common stock remain
   outstanding. The Company has reserved approximately 81,000 shares of common
   stock for issuance in connection with these options and warrants.

   Stock option plans:  In 1988, the Company established a Stock Option Plan
   ------------------
   (the Plan) which provides for the granting of options to employees or
   directors to purchase shares of the Company's common stock.   During fiscal
   1996, the Company replaced the 1988 Stock Option Plan by establishing the
   1995 Stock Option Plan (the "1995 Plan"). The terms of the 1995 Plan are
   similar to the 1988 Plan.  Any shares remaining available for grant under the
   1988 Plan were converted to the 1995 Plan and an additional 750,000 shares
   were reserved for future grants under the 1995 Plan.

   The following table summarizes the activity for the stock option plans (in
   thousands, except per share data):

     <TABLE>                 
     <CAPTION>          
                                                       Options and Rights Outstanding         
                                                    (in thousands, except per share data)     
                                                --------------------------------------------- 
                                                  Number        Aggregate          Price      
                                                of Shares    Exercise Price      Per Share    
                                                ----------   ---------------   -------------- 
     <S>                                        <C>          <C>               <C>            
     Balance at October 2, 1993..............         896           $ 2,944   $ 0.350 - $ 5.250 
       Granted  .............................         635             2,296     3.375 -   4.750 
       Exercised.............................         (73)              (68)    0.350 -   4.000 
       Forfeitures...........................        (185)             (721)    0.350 -   5.000 
                                                    -----           -------                   
     Balance at October 1, 1994                     1,273             4,451     0.350 -   5.250 
       Granted  .............................         391             2,526     3.500 -  13.250 
       Exercised.............................        (410)           (1,356)    0.350 -   6.000 
       Forfeitures...........................         (48)             (235)    3.000 -   9.250 
                                                    -----           -------                   
     Balance at September 30, 1995...........       1,206             5,386     0.350 -  13.250 
       Granted  .............................         863            11,115     0.850 -  28.375 
       Exercised.............................        (419)           (1,424)    0.350 -  11.125 
       Forfeitures...........................         (85)             (580)    0.850 -  18.500
                                                    -----           -------                   
     Balance at September 28, 1996...........       1,565           $14,497   $ 0.850 - $28.375 
                                                    =====           =======                   
     </TABLE>        

   Exercisable options were approximately 544,000, 785,000 and 651,000 at fiscal
   year end for 1996, 1995 and 1994, respectively.  At September 28, 1996, there
   were no shares that were exercised and subject to repurchase.

                                      F-11
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996



5. Stockholders equity (continued)
   -------------------------------

   Vesting provisions with respect to the 1988 Stock Option Plan are determined
   by the Board of Directors at the date of grant. Generally, shares issued
   pursuant to the Plan vest at 12 1/2% upon an employee's six-month employment
   date and ratably thereafter in monthly installments over three and one-half
   years.  At September 28, 1996, options to purchase approximately 544,000
   shares of common stock were vested.
 
   Included in the table above are options to purchase approximately 73,000
   shares of common stock which were granted outside of the 1988 Plan during
   fiscal 1995. These options were granted to various employees and have
   rights and vesting provisions which are the same as those granted pursuant
   to the plan. At September 28, 1996, options to purchase approximately
   62,000 shares of common stock remain outstanding.

   Total shares reserved for grant under option plans total 2,893,000 (excluding
   options subject to grant  under the Outside Directors Stock Option Plan), of
   which approximately 2,736,000 shares were granted, leaving approximately
   157,000 shares available for grant at September 28, 1996.

   The Company has reserved 1,565,000 shares of common stock for future issuance
   under the  stock option plans for outstanding options and options available
   for grant at September 28, 1996 and 62,000 shares of common stock for future
   issuance of shares granted outside of the option plan.

   1995 Outside Directors Stock Plan:  The Company's 1995 Directors Stock Option
   --------------------------------- 
   Plan (the "Directors Plan") was adopted by the Company's Board of Directors
   in June 1995 and approved in February 1996. A total of 100,000 shares of
   Common Stock has been reserved for issuance under the Directors Plan. As of
   September 28, 1996, 37,500 shares had been granted to Directors under the
   plan and are included in the table presented above.

   1996 Stock Purchase Plan:  In fiscal 1996, the 1996 Employee Stock Purchase
   ------------------------ 
   Plan (ESPP) was approved and 100,000 shares of common stock was reserved for
   issuance under this plan.  The ESPP provides that substantially all employees
   may purchase stock at 85% of its fair value on certain specified dates via a
   payroll deduction plan.  Through September 28, 1996, approximately 18,000
   shares have been issued under this plan.

   Preferred Stock Purchase Rights Plan:  The Company has a Preferred Stock
   ------------------------------------ 
   Purchase Rights Plan (the "Rights Plan") which provides existing
   shareholders with the right to purchase 1/100 preferred share for each common
   share held in the event of certain changes in the Company's ownership. The
   Rights Plan may serve as a deterrent to takeover tactics which are not in the
   best interests of shareholders. The Board of Directors of the Company has
   designated 500,000 shares of Series G Preferred Stock, $0.01 par value per
   share, and has reserved such shares for issuance pursuant to the Company's
   Rights Plan.

6. Employee savings and investment plan
   ------------------------------------

   During fiscal 1996, the Company amended its 401(k) savings and investment
   plan in which all employees, at least 21 years of age, are eligible to
   participate.  The amended plan allows for the Company to make matching
   contributions based on an employee's elective deferrals.  The matching
   contributions may not exceed $1,500 per employee, and through September 28,
   1996, the matching contributions were approximately $62,000

                                      F-12
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996

7. Income taxes
   -------------

   The provision (benefit) for income taxes consists of the following (in
   thousands):

    <TABLE>                                                           
    <CAPTION>                                                         
                                     Fiscal Year Ended                
                       ---------------------------------------------  
                       September 28,    September 30,    October 1,   
                            1996             1995           1994      
                       --------------   --------------   -----------  
    <S>                <C>              <C>              <C>          
    Federal:                                                          
      Current            $ 2,591          $    90         $   7 
      Deferred            (4,326)              --            -- 
                         -------          -------         ----- 
                          (1,735)              90         $   7 
    State:                                                            
      Current                273              112             3 
      Deferred              (987)              --            -- 
                         -------          -------         ----- 
                            (714)             112             3 
    Foreign:                                                          
      Current                557              209            85 
                         -------          -------         ----- 
                                                                      
                         $(1,892)         $   411         $  95 
                         =======          =======         =====  
   
    </TABLE> 
 
Pretax income (loss) from foreign operations was $680,000 in 1996, $30,000 in 
1995 and ($300,000) in 1994.
 
A reconciliation between the Company's effective tax rate and the U.S.
statutory rate of 35% follows (in thousands):

     <TABLE>                                    
     <CAPTION>                                 
                                                             Fiscal Year Ended               
                                                -------------------------------------------- 
                                                September 28,    September 30,    October 1, 
                                                     1996             1995          1994     
                                                ------------     ------------     ---------- 
     <S>                                        <C>              <C>              <C> 
     Tax provision at U.S. statutory rate....       $   196          $ 1,249         $ 328   
     Operating losses utilized...............        (2,871)          (1,170)         (328)  
     Valuation of temporary differences......        (3,148)              --            --   
     In process research and development.....         3,264               --            --   
     Goodwill amortization...................           143               --            --   
     Foreign taxes in excess of U.S. rate....           137               --            --   
     Alternative minimum tax.................            --               90             7   
     Foreign withholding tax.................           124              130            85   
     Other individually immaterial items.....            83               --            --   
     State taxes.............................           180              112             3   
                                                    -------          -------         -----   
                                                    $(1,892)         $   411         $  95   
                                                    =======          =======         =====   
     </TABLE>                                   

   As of September 28, 1996, the Company had federal and state net operating
   loss carryforwards of approximately $10,400,000 and $8,300,000, respectively.
   The Company also had federal and California research and development tax
   credit carryforwards and alternative minimum tax credit carryforwards of
   approximately $630,000 and $260,000, respectively. The net operating loss and
   research credit carryforwards will expire at various dates beginning in 2001
   through 2011, if not utilized.  The alternative minimum tax credit
   carryforwards have no expiration date.

                                      F-13
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996


7. Income taxes (continued):
   -------------------------

   Utilization of the net operating losses and credits may be subject to an
   annual limitation due to the ownership change limitations provided by the
   Internal Revenue Code of 1986, as amended, and similar state provisions. The
   annual limitation could result in the expiration of net operating losses and
   credits before utilization.

   Significant components of the Company's deferred tax assets and liabilities
   are as follows (in thousands):

    <TABLE>                                                                   
    <CAPTION>                                                                 
                                                                              
                                               September 28,    September 30, 
                                                    1996             1995     
                                               --------------   --------------
    <S>                                        <C>              <C>           
    Deferred tax assets:                                                      
       Net operating loss carryforwards........    $ 4,059          $ 3,500   
       Research credits and alternative 
        minimum tax credits....................        892            1,200   
       Capitalized software....................      1,028            1,600   
       Deferred revenue........................      1,770            1,200   
      Accrued expenses and reserves............      1,093              700
                                                   -------          -------
         Total deferred tax assets.............      8,842            8,200   
    Valuation allowance for deferred tax                                      
      assets...................................     (3,530)          (8,200)  
                                                   -------          -------   
    Net deferred tax assets.................       $ 5,312          $    --   
                                                   =======          =======   
    </TABLE>                                                                   

   Management has established a valuation allowance covering a portion of the
   gross deferred tax assets based on management's expectations of future
   taxable income and the actual taxable income during the three years ended
   September 28, 1996. Approximately $2,350,000 of the valuation allowance at
   September 28, 1996 is related to tax benefits of stock option deductions
   which will be credited to paid in capital when realized. The remaining
   valuation allowance is attributable to VMW pre-acquisition deferred tax
   assets which will be credited to goodwill when recognized.

8. Geographic, major customers and concentration of credit risks
   --------------------------------------------------------------

   The Company and its subsidiaries operate in one segment, principally the
   development, manufacture, sale and service of high performance hardware-
   assisted systems for simulation of integrated circuits (ICs) and IC-based
   electronic systems. The Company sells its products to a broad range of
   customers in the communications, multimedia/graphics, semiconductor,
   computer, aerospace and consumer electronics industries. The Company performs
   ongoing credit evaluations of its customers and generally does not require
   collateral. The Company maintains reserves for potential credit losses and
   such losses have been within management's expectations.

                                      F-14
<PAGE>
 
                              IKOS SYSTEMS, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              September 28, 1996


8. Geographic, major customers and concentration of credit risks (continued):
   -------------------------------------------------------------------------

   Total international sales by geographic region, including export sales and
   foreign operation net revenues, are as follows (in thousands):

    <TABLE>                                                      
    <CAPTION>                                                    
                                                                 
                                 Fiscal Year Ended               
                    ------------------------------------------   
                    September 28,   September 30,   October 1,   
                         1996            1995          1994     
                    -------------   -------------   ----------   
    <S>             <C>             <C>             <C>          
                                                                 
      Far East            $ 7,012         $ 4,841       $2,511   
      Europe                7,878           5,613        3,008   
      Other                    --             106           64   
                          -------         -------       ------   
                          $14,890         $10,560       $5,583   
                          =======         =======       ======   
    </TABLE>                                                      

   In fiscal 1996, one customer, S3, Inc., and one distributor, Itochu,
   accounted for 14% and 12% of net revenues, respectively. For the fiscal year
   ended September 30, 1995, one distributor, Itochu, accounted for
   approximately 15% of net revenues. In fiscal 1994, one customer, Motorola,
   Inc., and one distributor, Itochu, accounted for approximately 18% and 10% of
   net revenues, respectively.
 
9. Unaudited Quarterly Consolidated Financial Data
   -----------------------------------------------

    <TABLE>                                      
    <CAPTION>                                     
                                                                            Fiscal Quarters Ended                            
                                                  -------------------------------------------------------------------------- 
                                                   Dec. 30,             March 30,             June 29,             Sept. 28, 
                                                     1995                  1996                 1996                 1996    
                                                  ---------             ----------           ----------           ---------- 
    <S>                                           <C>                   <C>                  <C>                  <C>        
    Net revenues                                     $9,277                $11,154              $11,850              $13,060 
    Gross profit                                      7,141                  8,757                9,340               10,251 
    Total operating expenses                          5,724                  6,178               16,636                7,532 
    Income (loss) from operations                     1,417                  2,579               (7,296)               2,719 
    Net income (loss)                                 1,375                  2,410               (7,416)               6,082 
                                                                                                                             
    Net income (loss) per share                       $0.18                  $0.31               $(1.00)               $0.69 
                                                  =========             ==========           ==========           ========== 
                                                                                                                             
    Common and common equivalent shares                                                                                      
      used in computing per share amounts             7,519                  7,843                7,407                8,817 
                                                  =========             ==========           ==========           ========== 
    </TABLE>                                                

    <TABLE>                                                  
    <CAPTION>                                                   
                                                            
                                                                             Fiscal Quarters Ended                         
                                                -------------------------------------------------------------------------- 
                                                 Dec. 31,              April 1,             July 1,             Sept. 30,  
                                                   1994                  1995                 1995                 1995    
                                                ---------             ----------           ----------           ---------- 
    <S>                                         <C>                   <C>                  <C>                  <C>        
    Net revenues                                   $6,108                $ 6,680              $ 7,395              $ 8,417 
    Gross profit                                    4,464                  5,017                5,569                6,411 
    Total operating expenses                        3,984                  4,272                4,639                5,168 
    Income from operations                            480                    745                  930                1,243 
    Net income                                        448                    715                  888                1,105 
                                                                                                                           
    Net income per share                            $0.08                  $0.12                $0.14                $0.17 
                                                =========             ==========           ==========           ========== 
                                                                                                                           
    Common and common equivalent shares                                                                                    
       used in computing per share amounts          5,783                  6,011                6,281                6,531 
                                                =========             ==========           ==========           ========== 
    </TABLE>                                          
 
 

                                      F-15
<PAGE>
 
                                                                     SCHEDULE II

                              IKOS SYSTEMS, INC.
                       VALUATION AND QUALIFYING ACCOUNTS
                                (In Thousands)

<TABLE> 
<CAPTION> 
                                          Balance at                 Charged to                                 Balance at
                                          Beginning                  Costs and             Deductions               End
                                          of Period                  Expenses              Write-offs            of Period
                                          ---------                  ----------            -----------          ---------- 
<S>                                      <C>                         <C>                   <C>                  <C> 
Allowance for doubtful accounts:
 
  Year ended October 2, 1993                $122                         $ --                  $ --              $  122
                                            ====                         ====                  ====              ======  
                                                               
  Year ended October 1, 1994                $122                         $ --                  $ --              $  122
                                            ====                         ====                  ====              ======  
                                                               
  Year ended September 30, 1995             $122                         $ 49                  $ --              $  171
                                            ====                         ====                  ====              ======  
                                                               
  Year ended September 28, 1996             $171                         $100                  $ --              $  271
                                            ====                         ====                  ====              ======   
 
</TABLE> 

                                      S-1
<PAGE>
 
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