IKOS SYSTEMS INC, 424A, 1996-05-31

IKOS SYSTEMS INC
424A, 1996-05-31
COMPUTER INTEGRATED SYSTEMS DESIGN

Previous: IDS PRECIOUS METALS FUND INC, 497J, 1996-05-31

Next: KEMPER TAX EXEMPT INCOME TRUST MULTI STATE SERIES 13, 485BPOS, 1996-05-31

<PAGE>

FILED PURSUANT TO RULE 424(a)
REGISTRATION NO. 333-04543

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

PROSPECTUS SUBJECT TO COMPLETION, DATED MAY 31, 1996

1,122,078 Shares

[LOGO OF IKOS SYSTEMS(R)]

Common Stock

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

Of the 1,122,078 shares of Common Stock offered hereby, 1,000,000 shares are
being sold by IKOS Systems, Inc. ("IKOS" or the "Company") and 122,078 shares
are being sold by the Selling Stockholders. See "Selling Stockholders." The
Common Stock is quoted on the Nasdaq National Market under the symbol "IKOS."
On May 30, 1996, the last reported sale price for the Company's Common Stock
was $28.375 per share.

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

THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING ON PAGE 5.

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

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNDERWRITING
DISCOUNTS AND PROCEEDS TO
PRICE TO COMMISSIONS PROCEEDS TO SELLING
PUBLIC (1) COMPANY (2) STOCKHOLDERS
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share...................... $ $ $ $
- --------------------------------------------------------------------------------
Total (3)...................... $ $ $ $
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."
(2) Before deducting offering expenses payable by the Company, estimated at
$350,000.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
an additional 168,312 shares of Common Stock solely to cover over-
allotments, if any. If the Underwriters exercise this option in full, the
total Price to Public, Underwriting Discounts and Commissions and Proceeds
to Company will be $ , $ and $ , respectively. See
"Underwriting."

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

The shares of Common Stock offered by this Prospectus are offered by the
several Underwriters, subject to prior sale, when, as and if delivered to and
accepted by them, and subject to the right of the Underwriters to reject any
order in whole or in part. It is expected that certificates for the shares of
Common Stock will be available for delivery in New York, New York, on or about
, 1996.

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

Needham & Company, Inc.

SoundView Financial Group, Inc.

Unterberg Harris

The date of this Prospectus is , 1996.
<PAGE>

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.

IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET
MAKING TRANSACTIONS IN THE COMPANY'S COMMON STOCK ON THE NASDAQ NATIONAL
MARKET IN ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT OF
1934. SEE "UNDERWRITING."

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

AVAILABLE INFORMATION

IKOS has filed a Registration Statement on Form S-3 (together with all
amendments and exhibits thereto, the "Registration Statement") under the
Securities Act of 1933, as amended (the "Securities Act") with the Securities
and Exchange Commission (the "Commission"). This Prospectus does not contain
all of the information set forth in the Registration Statement, certain parts
of which are omitted in accordance with the rules and regulations of the
Commission. For further information, reference is hereby made to the
Registration Statement, copies of which may be obtained from the Public
Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C.
20549, upon payment of the fees prescribed by the Commission.

The Company is also subject to the informational reporting requirements of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith files reports, proxy statements and other information
with the Securities and Exchange Commission (the "Commission"). Such reports,
proxy statements and other information can be inspected and copied at the
Public Reference Room of the Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549 and at the Commission's regional offices at: Seven World Trade
Center, New York, New York 10048; and 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661; and copies of such material can be obtained from the
Public Reference Section of the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates.

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

INFORMATION INCORPORATED BY REFERENCE

There are hereby incorporated by reference in this Prospectus the following
documents and information heretofore filed with the Commission: (1) the
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
1995; (2) the Company's Quarterly Reports on Form 10-Q for the fiscal quarters
ended December 30, 1995 and March 30, 1996; and (3) the Description of the
Company's capital stock as set forth under the caption "Description of Capital
Stock" in its Registration Statement on Form S-2 (File No. 33-63525),
effective October 12, 1995.

All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or
15(d) of the Exchange Act after the date of this Prospectus and prior to the
termination of the offering of securities contemplated hereby shall be deemed
to be incorporated by reference in this Prospectus and to be a part hereof
from the date of filing of such documents. Any statement contained in a
document incorporated by reference or deemed to be incorporated by reference
in this Prospectus shall be deemed to be modified or superseded for all
purposes of this Prospectus and the Registration Statement to the extent that
a statement contained herein, therein or in any subsequently filed document
which also is incorporated or deemed to be incorporated by reference herein
modifies or supersedes such statement. Any such statement so modified or
superseded shall not be deemed, except as so modified or superseded, to
constitute a part of this Prospectus.

The Company will provide without charge to each person to whom a copy of
this Prospectus has been delivered, upon the written or oral request of such
person, a copy of any and all of the documents referred to above which have
been or may be incorporated in this Prospectus by reference (other than
exhibits to such documents, unless such exhibits are specifically incorporated
by reference therein). Requests for such copies should be directed to the
Company's principal executive offices located at 19050 Pruneridge Avenue,
Cupertino, CA 95014, Attention: Chief Financial Officer, telephone number
(408) 255-4567.

2
<PAGE>

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors" and the consolidated financial statements
and notes thereto, appearing elsewhere or incorporated by reference in this
Prospectus. Unless otherwise indicated, the information contained in this
Prospectus assumes no exercise of the Underwriters' over-allotment option.

THE COMPANY

IKOS develops, manufactures, markets and supports hardware and software
systems for the verification of integrated circuit designs. 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.

A semiconductor industry consortium estimates that IC complexity is growing
substantially faster than IC designer productivity, and IKOS believes that
insufficient verification capability is a significant contributor to this
productivity gap. Design verification is becoming increasingly complex and time
consuming as IC designs grow larger, geometries continue to shrink, and system
developers are forced to address speed, power, and other characteristics in
addition to functionality. The Company believes that these verification needs
increasingly cannot be satisfied by traditional methods, which consist
primarily of software simulators running on general purpose workstations.

IKOS' mission is to be the leading supplier of tools for the verification of
complex IC designs. To date, the Company has designed and marketed systems
which incorporate software and hardware based simulation algorithms. The
software components of IKOS' products consist of behavioral, gate and mixed-
level simulators, interfaces to other electronic design automation tools, cell
libraries and library development tools for modeling of ICs. IKOS' hardware
products include a family of special purpose, massively parallel computers
incorporating proprietary simulation algorithms. In support of its efforts to
broaden its spectrum of verification product offerings to include logic
emulation, the Company recently acquired Virtual Machine Works, Inc. (VMW),
which holds an exclusive license to emulation methods developed at
Massachusetts Institute of Technology.

IKOS markets its products and services primarily through its direct sales,
application engineering and service organization. IKOS' direct sales strategy
concentrates on those companies that IKOS believes are key users and designers
of large and high-performance ICs and IC-based systems. The Company assembles
and tests its products in its Cupertino, California facilities. The Company was
incorporated in California in September 1985 and was reincorporated in Delaware
in July 1990. The Company's principal executive offices are located at 19050
Pruneridge Avenue, Cupertino, California 95014. Its telephone number is (408)
255-4567.

RECENT ACQUISITION

In May 1996, the Company acquired Virtual Machine Works, Inc. for
approximately $15 million in cash, stock and stock options. VMW was founded in
late 1993 to develop and market logic emulation systems for the verification of
complex ICs and IC-based systems.

IKOS 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 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.
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.

3
<PAGE>

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered by the Company.......... 1,000,000 shares
Common Stock offered by the Selling
Stockholders................................. 122,078 shares
Common Stock outstanding after the offering.. 8,551,019 shares(1)
Nasdaq National Market symbol................ IKOS
Use of proceeds.............................. General corporate purposes, including
working capital and capital expenditures.
See "Use of Proceeds."
</TABLE>

SUMMARY CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)

<TABLE>
<CAPTION>
FISCAL YEARS ENDED SIX MONTHS ENDED
-------------------------- -----------------
OCT. 2, OCT. 1, SEPT. 30, APRIL 1, MAR. 30,
1993 1994 1995 1995 1996
------- ------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF
OPERATIONS DATA:
Net revenues...................... $16,528 $21,636 $28,600 $12,788 $20,431
Gross profit...................... 10,197 15,706 21,461 9,481 15,898
Income (loss) from operations..... (8,875) 802 3,398 1,225 3,996
Net income (loss)................. (8,750) 1,505 3,156 1,163 3,785
Net income (loss) per share (2)... $ (1.62) $ 0.27 $ 0.51 $ 0.20 $ 0.49
Number of shares used in per share
computation (2).................. 5,415 5,651 6,151 5,897 7,681
</TABLE>

<TABLE>
<CAPTION>
MARCH 30, 1996
----------------------------
PRO FORMA
SEPT. 30, PRO AS
1995 ACTUAL FORMA(3) ADJUSTED(4)
--------- ------- -------- -----------
<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Working capital.......................... $ 7,509 $19,844 $10,603 $36,962
Total assets............................. 17,152 32,834 28,514 54,873
Long term debt, less current portion..... 1,300 800 800 800
Total stockholders' equity............... 7,710 22,590 17,990 44,349
</TABLE>
- --------
(1) Based on the number of shares outstanding at May 22, 1996 and assuming
issuance of 112,946 shares of Common Stock pursuant to the acquisition of
VMW by the Company (the "Acquisition"). Includes 25,997 shares of Common
Stock that will be issued upon the exercise of stock options by a Selling
Stockholder. Excludes (i) an aggregate of approximately 1,082,826 shares of
Common Stock subject to outstanding options under the Company's 1988 Stock
Option Plan, the Company's 1995 Stock Option Plan and the Company's 1995
Outside Directors Stock Option Plan (collectively, the "Option Plans"),
(ii) approximately 70,850 shares of Common Stock subject to certain other
outstanding options, (iii) approximately 589,156 shares available for
future issuance pursuant to the Company's Option Plans and
(iv) approximately 58,003 shares of Common Stock subject to certain
outstanding options assumed pursuant to the Acquisition. See "Selling
Stockholders" and Notes 4 and 8 of Notes to Consolidated Financial
Statements of IKOS.
(2) For a description of the net income (loss) per share, see Note 1 of Notes
to Consolidated Financial Statements of IKOS.

(3) Reflects on a pro forma basis the effect of the Acquisition as if the
Acquisition had occurred on March 30, 1996. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and
Unaudited Pro Forma Condensed Combined Financial Statements.

(4) Adjusted to reflect the sale of the 1,000,000 shares of Common Stock
offered by the Company hereby at an assumed public offering price of
$28.375 per share and the exercise of options to purchase 25,997 shares to
be sold by a Selling Stockholder and the application of the estimated net
proceeds therefrom. See "Use of Proceeds" and "Capitalization."

IKOS, the Company's facing parrots logo and Voyager are registered trademarks
of the Company. Gemini and VirtualWires are trademarks of the Company. This
Prospectus also includes trade names and trademarks of companies other than
IKOS. Unless the context otherwise requires, references in this Prospectus to
the "Company" and "IKOS" refer to IKOS Systems, Inc. and its consolidated
subsidiaries.

4
<PAGE>

RISK FACTORS

The Common Stock offered hereby involves a high degree of risk. In addition
to the other information in this Prospectus, the following factors should be
considered carefully in evaluating an investment in the shares of Common Stock
offered by this Prospectus. This Prospectus contains forward-looking
statements, and actual results could differ materially from those projected in
the forward-looking statements as a result of numerous factors, including the
factors set forth below and elsewhere in this Prospectus.

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 until recently had resulted, and in the
future may result, from shipments during the last few weeks of the quarter
from orders generally received in the last month of the quarter. Any
concentration of sales at the end of the quarter may limit the Company's
ability to plan or adjust operating expenses and production and inventory
levels. Therefore, if anticipated shipments in any quarter do not occur or are
delayed, expenditure levels could be disproportionately high as a percentage
of revenue, and the Company's operating results for that quarter would be
adversely affected. In addition, sales of individual systems with high average
sales prices can constitute a significant percentage of the Company's
quarterly revenue. Operating results in any period should not be considered
indicative of the results to be expected for any future period, and there can
be no assurance that the Company's net revenues will 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.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Quarterly Results."

CONTINUED ACCEPTANCE OF THE COMPANY'S SIMULATION 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. See "Business--
Industry Background."

DEVELOPMENT AND ACCEPTANCE OF THE COMPANY'S EMULATION PRODUCTS

Prior to the Acquisition, the Company had limited in-house experience with
logic emulation, and the Company's initial emulation technology is currently
under development. There can be no assurance that

5
<PAGE>

development of this technology will be completed, or that any products
resulting from such 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, when
developed, will function and perform as planned or that the Company will not
experience other delays or difficulties in 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
emulations 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.
See "Business--Industry Background" and "--Emulation."

RISKS RELATING TO THE ACQUISITION OF VMW

Achieving the anticipated benefits of the Acquisition will depend in part
upon the Company's ability to achieve integration of the two companies'
businesses and operations in an efficient and effective manner, and there can
be no assurance that such integration will occur smoothly or successfully. The
successful combination of companies in the high technology industry may be
more difficult to accomplish than in other industries. The difficulties of
such integration may be increased by the necessity of coordinating
geographically separated organizations. The integration of certain operations
following the Acquisition will require the dedication of management resources
which may temporarily distract attention from the day-to-day business of the
combined company. The inability of management to successfully integrate the
operations of the two companies or to retain key personnel could have a
material adverse effect on the business and results of operations of IKOS.

IKOS expects to incur a charge to operations currently estimated to be
approximately $9.6 million in the quarter ending June 29, 1996, to reflect the
purchase of in-process research and development pursuant to the Acquisition.
In addition, the Company intends to amortize approximately $5.7 million of
costs relating to the Acquisition. The amortization period for such costs will
be over their useful lives, which are estimated to be three to five years.
These amounts are preliminary estimates and therefore subject to change.
Additional unanticipated expenses may be incurred relating to the integration
of the businesses of VMW and IKOS, including the integration of technologies
and research and development and administrative functions. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

COMPETITION

The electronic design automation ("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. To
the extent the Company competes in the market for emulation products in the
future, it will experience competition from emulation systems 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

6
<PAGE>

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. See "Business--
Competition."

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
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. See "Business--
Simulation" and "--Emulation."

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.
See "Business--Industry Background."

7
<PAGE>

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. See "Business--Manufacturing and Suppliers."

CUSTOMER CONCENTRATION

A relatively limited number of customers have historically accounted for a
substantial portion of the Company's net revenues. For the six months ended
March 30, 1996 and in fiscal 1995, sales to the Company's top ten customers
accounted for approximately 62.0% and 49.5%, 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. See "Business--Customers."

LENGTHY SALES CYCLE

Sales of the Company's products depend, in significant part, upon the
decisions of prospective customers to commence projects for the design and
development of complex ICs and systems. In view of the significant amount of
time and commitment of capital involved in that regard, the Company may
experience delays following initial qualification of the Company's systems as
a result of delays in commencement of the project by a customer. As a result,
the Company's systems typically have a lengthy sales cycle during which the
Company may expend substantial funds and management effort. Lengthy sales
cycles subject the Company to a number of significant risks, including
fluctuations in operating results, over which the Company has little or no
control.

PROPRIETARY RIGHTS

8
<PAGE>

or not challenged by applicable governmental patent examiners, will be issued
with the scope of the claims sought by the Company, if at all. Furthermore,
there can be no assurance that others will not develop technologies that are
similar or superior to the Company's technology, duplicate the Company's
technology or design around the patents owned by the Company. The Company
generally enters into confidentiality or license agreements with its
employees, distributors and customers, and limits access to and distribution
of its software, documentation and other proprietary information. Despite
these precautions, it may be possible for a third party to copy or otherwise
obtain and use the Company's products or technology without authorization, or
to develop similar technology independently. In addition, effective copyright
and trade secret protection may be unavailable or limited in certain foreign
countries. The Company has also granted to Racal-Redac, Inc. ("Racal") a
security interest in certain VHDL simulation software jointly developed by the
Company and Racal with respect to payment of a promissory note to Racal by the
Company with a current balance of $1.25 million. 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.

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 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 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's 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 relies on certain software and other technologies 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. There can be no assurance that these third party licenses will
continue to be available to the Company on commercially reasonable terms or
otherwise. The loss of or inability to maintain any of these licenses could
result in delays or reductions in product shipments until equivalent software
or technology could be identified, licensed and integrated, which would
adversely affect the Company's operating results. In particular, the Company
licenses certain VirtualWires emulation patent rights from Massachusetts
Institute of Technology ("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. Loss of this license could materially adversely affect
the Company's future operating results. See "Business--Proprietary Rights."

INTERNATIONAL SALES

International sales accounted for approximately 31.1% and 30.9% of the
Company's net revenues for the six month periods ended March 30, 1996 and
April 1, 1995, respectively, and 36.9%, 25.8% and 20.1% of the Company's net
revenues in fiscal 1995, 1994 and 1993, respectively. The Company expects that
international sales will continue to account for a significant portion of its
revenues, and plans to continue to expand its international sales and
distribution channels. Revenues derived from international sales involve a
number of inherent risks, including traditionally slower adoption of the
Company's products internationally, the impact of recessionary environments in
economies outside the United States, generally longer receivables collection
periods, unexpected changes in or impositions of legislative or regulatory
requirements, reduced protection for intellectual property rights in some
countries, potentially adverse taxes, delays resulting from difficulty in
obtaining export licenses for certain technology and other trade barriers.
There can be no assurance that such factors will not have a material adverse
effect on the Company's future international sales and, consequently, on

9
<PAGE>

the Company's results of operations. Although the Company has attempted to
reduce the risk of fluctuations in exchange rates associated with
international revenues by selling its systems for United States currency 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. Furthermore, there can be no assurance that the Company will be
able to continue to sell its systems internationally for United States
currency. See "Business--Sales and Marketing. "

DEPENDENCE UPON KEY PERSONNEL AND MANAGEMENT OF GROWTH

The Company's future performance depends in significant part upon attracting
and retaining key technical, sales and marketing personnel. Competition for
such personnel is intense, and the inability to retain its key personnel or to
attract, assimilate or retain other highly qualified personnel in the future
on a timely basis could have a material adverse effect on the Company's
results of operations. In particular, there are only a limited number of
qualified EDA engineers, and the competition for such individuals is
especially intense. In addition, the Company's ability to compete effectively
and to manage future growth, if any, will require the Company to continue to
train and manage its employee workforce. There can be no assurance that the
Company will be able to do so successfully. The Company's failure to do so
could have a material adverse effect upon the Company's results of operations.
See "Business--Employees."

POSSIBLE VOLATILITY OF STOCK PRICE

The market price of the Company's Common Stock has been, and is likely to
continue to be, highly volatile. Future announcements concerning the Company
or its competitors, quarterly variations in operating results, announcements
of technological innovations, the introduction of new products or changes in
product pricing policies by the Company or its competitors, proprietary rights
or other litigation, changes in earnings estimates by analysts or other
factors could cause the market price of the Common Stock to fluctuate
substantially. In addition, the stock market has from time-to-time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the common stocks of technology companies and that have
often been unrelated to the operating performance of particular companies.
These broad market fluctuations may also adversely affect the market price of
the Company's Common Stock. In the past, following periods of volatility in
the market price of a company's securities, securities class action litigation
has occurred against the issuing company. There can be no assurance that such
litigation will not occur in the future with respect to the Company. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect on the
Company's business, financial condition and results of operations. Any adverse
determination in such litigation could also subject the Company to significant
liabilities.

CERTAIN ANTI-TAKEOVER PROVISIONS

Certain provisions of the Company's Certificate of Incorporation and Bylaws,
Delaware law and certain other contractual provisions could have the effect of
making it more difficult for a third party to acquire, or of discouraging a
third party from attempting to acquire control of the Company. Such provisions
could limit the price that certain investors might be willing to pay in the
future for shares of the Company's Common Stock. Certain of these provisions
allow the Company to issue Preferred Stock with rights senior to those of the
Common Stock without any further vote or action by the stockholders, eliminate
the right of stockholders to act by written consent, eliminate cumulative
voting and impose various procedural and other requirements which could make
it more difficult for stockholders to effect certain corporate actions. In
addition, the Company has adopted a preferred stock purchase plan. These
provisions could also have the effect of delaying or preventing a change in
control of the Company.

10
<PAGE>

USE OF PROCEEDS

The net proceeds to the Company from the sale of the 1,000,000 shares of
Common Stock offered by the Company hereby are estimated to be approximately
$26,337,000 ($30,828,000 if the Underwriters' over-allotment option is
exercised in full), assuming a public offering price of $28.375 per share and
after deducting estimated underwriting discounts and commissions and estimated
offering expenses. The Company will not receive any proceeds from the sale of
shares by the Selling Stockholders.

The Company expects to use the net proceeds from this offering for general
corporate purposes, including capital expenditures and working capital. A
portion of the proceeds may also be used to acquire or invest in complementary
businesses or products or to obtain the right to use complementary
technologies. However, the Company has no present understandings, commitments,
agreements or intentions with respect to any material acquisitions of other
businesses, products or technologies. Pending use of the net proceeds for the
above purposes, the Company intends to invest such funds in short-term,
interest-bearing, investment grade obligations.

PRICE RANGE OF COMMON STOCK

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
------- --------
<S> <C> <C>
FISCAL 1994
First Quarter............................................... $ 5.125 $ 2.875
Second Quarter.............................................. 5.000 3.125
Third Quarter............................................... 3.750 2.625
Fourth Quarter.............................................. 4.250 2.625
FISCAL 1995
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 9.500
Second Quarter.............................................. 19.250 8.625
Third Quarter (through May 30, 1996)........................ 30.000 17.188
</TABLE>

On May 30, 1996, the last reported sale price for the Common Stock, as
reported on the Nasdaq National Market, was $28.375 per share. The approximate
number of record holders of IKOS stock as of April 30, 1996 was 172. The
approximate number of beneficial holders is estimated to be 3,850 as of that
same date.

DIVIDEND POLICY

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.

11
<PAGE>

CAPITALIZATION

The following table sets forth the consolidated capitalization of the
Company at March 30, 1996, on a pro forma basis to give effect to the
Acquisition, and pro forma as adjusted to give effect to the Acquisition and
the issuance and sale of the 1,000,000 shares of Common Stock offered by the
Company hereby at an assumed public offering price of $28.375 per share and
the exercise of options to purchase 25,997 shares to be sold by a Selling
Stockholder and the application of the estimated net proceeds therefrom. The
financial data in the following table should be read in conjunction with the
Company's Consolidated Financial Statements and notes thereto and Unaudited
Pro Forma Condensed Combined Financial Statements contained elsewhere in this
Prospectus.

<TABLE>
<CAPTION>
MARCH 30, 1996
----------------------------
(IN THOUSANDS)
PRO
PRO FORMA AS
ACTUAL FORMA(1) ADJUSTED
-------- -------- --------
<S> <C> <C> <C>
Long-term debt, less current portion (2)......... $ 800 $ 800 $ 800
Stockholders' equity:
Preferred stock, $0.01 par value; 10,000,000
shares authorized; no shares issued and
outstanding actual, pro forma or pro forma as
adjusted...................................... -- -- --
Common stock, $0.01 par value; 25,000,000
shares authorized; 7,264,277 shares issued and
outstanding actual; 7,377,223 shares issued
and outstanding pro forma; 8,403,220 shares
issued and outstanding pro forma as adjusted
(3)........................................... 73 74 84
Additional paid-in capital..................... 38,115 43,114 69,463
Accumulated deficit............................ (15,598) (25,198) (25,198)
-------- -------- --------
Total stockholders' equity................... 22,590 17,990 44,349
-------- -------- --------
Total capitalization....................... $ 23,390 $ 18,790 $ 45,149
======== ======== ========
</TABLE>
- --------
(1) Reflects on a pro forma basis the effect of the Acquisition as if the
Acquisition had occurred on March 30, 1996. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and
Unaudited Pro Forma Condensed Combined Financial Statements.
(2) See Note 1 of Notes to Consolidated Financial Statements of IKOS.

(3) Excludes at March 30, 1996 (i) an aggregate of approximately 1,206,250
shares of Common Stock subject to outstanding options under the Company's
Option Plans, (ii) approximately 71,750 shares of Common Stock subject to
certain other outstanding options and (iii) approximately 612,631 shares
available for future issuance pursuant to the Company's Option Plans. Also
excludes approximately 58,003 shares of Common Stock subject to certain
outstanding options assumed pursuant to the Acquisition. See "Selling
Stockholders" and Notes 4 and 8 of Notes to Consolidated Financial
Statements of IKOS.

12
<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data set forth below with respect to the
Company's consolidated statement of operations data for each of the three
years in the period ended September 30, 1995 and with respect to the Company's
consolidated balance sheets at October 1, 1994 and September 30, 1995 are
derived from consolidated financial statements that have been audited by Ernst
& Young LLP, independent auditors, which are included herein. The selected
consolidated statement of operations data for the fiscal years ended September
28, 1991 and September 26, 1992 and the selected consolidated balance sheet
data at September 28, 1991, September 26, 1992 and October 2, 1993 are derived
from the Company's audited consolidated financial statements but not included
herein. The selected consolidated financial data at March 30, 1996 and for the
six months ended April 1, 1995 and March 30, 1996 are derived from unaudited
financial statements of the Company, which are included herein. In the opinion
of management, the unaudited financial statements have been prepared on the
same basis as the audited financial statements referred to above and include
all adjustments, consisting only of normal recurring accruals, necessary for a
fair presentation of the financial position of the Company and its results of
operations for the indicated periods. Operating results for the six months
ended March 30, 1996 are not necessarily indicative of results to be expected
for any future period. The data should be read in conjunction with the
consolidated financial statements included herein.

<TABLE>
<CAPTION>
FISCAL YEARS ENDED SIX MONTHS ENDED
----------------------------------------------- ------------------
SEPT. 28, SEPT. 26, OCT. 2, OCT. 1, SEPT. 30, APRIL 1, MAR. 30,
1991 1992 1993 1994 1995 1995 1996
--------- --------- ------- ------- --------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT
OF OPERATIONS DATA:
Net revenues............ $15,122 $13,942 $16,528 $21,636 $28,600 $12,788 $20,431
Cost of revenues........ 3,786 3,993 6,331 5,930 7,139 3,307 4,533
------- ------- ------- ------- ------- ------- -------
Gross profit........... 11,336 9,949 10,197 15,706 21,461 9,481 15,898
Operating expenses:
Research and
development........... 5,751 2,627 7,896 3,861 3,999 1,954 3,268
Sales and marketing.... 8,920 8,879 9,303 9,447 11,763 5,268 6,911
General and
administrative........ 1,570 1,807 1,873 1,596 2,301 1,034 1,723
------- ------- ------- ------- ------- ------- -------
Total operating
expenses............ 16,241 13,313 19,072 14,904 18,063 8,256 11,902
Income (loss) from
operations............. (4,905) (3,364) (8,875) 802 3,398 1,225 3,996
Other income (expense):
Interest income........ 784 329 130 69 159 49 482
Interest expense....... -- -- -- (75) (107) (63) (42)
Other.................. -- -- 48 140 117 58 59
------- ------- ------- ------- ------- ------- -------
Total other income... 784 329 178 134 169 44 499
------- ------- ------- ------- ------- ------- -------
Income (loss) before
provision for income
taxes and extraordinary
credit................. (4,121) (3,035) (8,697) 936 3,567 1,269 4,495
Provision for income
taxes.................. 58 72 53 95 411 106 710
------- ------- ------- ------- ------- ------- -------
Income (loss) before
extraordinary credit... (4,179) (3,107) (8,750) 841 3,156 1,163 3,785
Extraordinary credit--
forgiveness of debt.... -- -- -- 664 -- -- --
------- ------- ------- ------- ------- ------- -------
Net income (loss)...... $(4,179) $(3,107) $(8,750) $ 1,505 $ 3,156 $ 1,163 $ 3,785
======= ======= ======= ======= ======= ======= =======
Per share:
Income (loss) before
extraordinary credit.. $ (0.79) $ (0.58) $ (1.62) $ 0.15 $ 0.51 $ 0.20 $ 0.49
Extraordinary credit... -- -- -- 0.12 -- -- --
------- ------- ------- ------- ------- ------- -------
Net income (loss)...... $ (0.79) $ (0.58) $ (1.62) $ 0.27 $ 0.51 $ 0.20 $ 0.49
======= ======= ======= ======= ======= ======= =======
Common and common
equivalent shares used
in computing per share
amounts................ 5,273 5,379 5,415 5,651 6,151 5,897 7,681
======= ======= ======= ======= ======= ======= =======
CONSOLIDATED BALANCE
SHEET DATA:
Working capital......... $10,397 $ 6,830 $ 1,805 $ 3,850 $ 7,509 $19,844
Total assets............ 17,732 15,678 10,806 12,129 17,152 32,834
Long-term debt, less
current portion........ 504 344 2,779 2,151 1,300 800
Total stockholders'
equity................. 13,645 10,603 1,903 3,476 7,710 22,590
</TABLE>

13
<PAGE>

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

This Prospectus contains forward-looking statements, and actual results
could differ materially from those projected in the forward-looking statements
as a result of numerous factors, including the factors set forth below and
elsewhere in the Prospectus.

OVERVIEW

The Company develops, manufactures, markets and supports high-performance
hardware and software systems for verification of ICs and IC-based electronic
systems.

In May 1996, the Company acquired VMW, a development stage company founded
by certain individuals affiliated with MIT. VMW was founded in late 1993 to
develop and market logic emulation systems for system level verification of
designs of complex ICs and electronic systems. Pursuant to the Acquisition,
holders of VMW stock received an aggregate of approximately $10.0 million in
cash and 112,946 shares of IKOS Common Stock. In addition, all outstanding
options to acquire VMW Common Stock were converted into options to acquire an
aggregate of 84,000 shares of IKOS Common Stock. The Acquisition constituted a
taxable reorganization and was accounted for as a purchase. The Company
expects to take a one-time charge of approximately $9.6 million in the fiscal
quarter ending June 29, 1996 relating to the purchase of in-process research
and development of VMW. See Note 8 of Notes to Consolidated Financial
Statements of IKOS and Unaudited Pro Forma Condensed Combined Financial
Statements.

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. Historically, the majority of the
Company's net revenues have been derived from the sale of its hardware
simulators. Net revenues under maintenance contracts are recognized ratably
over the term of the related contract, generally twelve months. To date
substantially all of the Company's international sales have been billed and
collected in U.S. dollars.

14
<PAGE>

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated selected items of
the Company's consolidated statements of operations as a percentage of its net
revenues:

<TABLE>
<CAPTION>
FISCAL YEARS ENDED SIX MONTHS ENDED
-------------------------- -----------------
OCT. 2, OCT. 1, SEPT. 30, APRIL 1, MAR. 30,
1993 1994 1995 1995 1996
------- ------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
Net revenues...................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues.................. 38.3 27.4 25.0 25.9 22.2
----- ----- ----- ----- -----
Gross profit...................... 61.7 72.6 75.0 74.1 77.8
Operating expenses:
Research and development........ 47.8 17.8 14.0 15.3 16.0
Sales and marketing............. 56.3 43.7 41.1 41.2 33.8
General and administrative...... 11.3 7.4 8.0 8.1 8.4
----- ----- ----- ----- -----
Total operating expenses...... 115.4 68.9 63.1 64.6 58.2
----- ----- ----- ----- -----
Income (loss) from operations..... (53.7) 3.7 11.9 9.6 19.6
Other income (expense):
Interest income................. 0.8 0.3 0.6 0.3 2.4
Interest expense................ -- (0.3) (0.4) (0.5) (0.2)
Other........................... 0.3 0.6 0.4 0.5 0.3
----- ----- ----- ----- -----
Total other income............ 1.1 0.6 0.6 0.3 2.5
----- ----- ----- ----- -----
Income (loss) before provision for
income taxes and extraordinary
credit........................... (52.6) 4.3 12.5 9.9 22.0
Provision for income taxes........ 0.3 0.4 1.4 0.8 3.5
----- ----- ----- ----- -----
Income (loss) before extraordinary
credit........................... (52.9) 3.9 11.1 9.1 18.5
Extraordinary credit--forgiveness
of debt.......................... -- 3.1 -- -- --
----- ----- ----- ----- -----
Net income (loss)............... (52.9)% 7.0% 11.1% 9.1% 18.5%
===== ===== ===== ===== =====
</TABLE>

SIX MONTHS ENDED MARCH 30, 1996 AND APRIL 1, 1995

Net revenues. Net revenues increased 59.8% to $20.4 million in the six
months ended March 30, 1996 as compared to $12.8 million for the comparable
period of fiscal 1995. International revenues increased by 61.2% and domestic
revenues increased by 59.1% over this same period. The primary reason for the
increase was continued growth of unit sales of the Voyager and Gemini systems,
the latter of which was introduced in the second half of fiscal 1995.
Maintenance revenue was $3.5 million and $2.3 million for the first six months
of fiscal 1996 and 1995, respectively, which represents 16.9% and 17.6% of net
revenues. International sales (export sales and sales shipped by the Company's
European operation) were $6.4 million and $3.9 million for the first six
months of fiscal 1996 and 1995, respectively, which represents 31.1% and 30.9%
of net revenues.

Gross profit. Gross profit was $15.9 million and $9.5 million or 77.8% and
74.1% of total net revenue for the first six months of fiscal 1996 and 1995,
respectively. The increase in gross margin was primarily the result of
increased maintenance revenues without any significant increases in
maintenance costs as well as the positive margin impact from product revenue
mix generated in the second quarter.

Research and development. Research and development expenses were $3.3
million and $2.0 million for the first six months of fiscal 1996 and 1995,
respectively. As a percentage of net revenues, research and development
expenses increased to 16.0% for the first six months of fiscal 1996 as
compared to 15.3% for the first six months of fiscal 1995. Research and
development costs increased significantly during the six month period ended
March 30, 1996 as a result of increased personnel expenses and the expense of
approximately $250,000 in the first quarter of 1996 relating to certain
acquired technology that had not yet reached technological feasibility and did
not have alternative future uses. The Company expects research and

15
<PAGE>

development expenses to increase in absolute dollars over the remainder of the
year as the Company continues its product enhancement, new product development
and technology development programs. The Company also expects that it will
take a charge of approximately $9.6 million in the fiscal quarter ending June
29, 1996 relating to the purchase of in-process research and development of
VMW. The purchase price was allocated to the tangible and intangible assets of
VMW based on the fair market values of those assets using a risk adjusted
discounted cash flow approach. 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.

Sales and marketing. Sales and marketing expenses were $6.9 million and $5.3
million for the first six months of fiscal 1996 and 1995, respectively. As a
percentage of net revenues, sales and marketing expenses decreased to 33.8%
for the first six months of fiscal 1996 as compared to 41.2% for the first six
months of fiscal 1995. The increase in absolute dollars was primarily the
result of increased headcount, increased commissions as a result of higher
revenue levels and increased expenses for international operations. Sales and
marketing expenses are expected to continue to increase in absolute dollars
over the next two fiscal quarters reflecting increased headcount, commission
expense and marketing expenses.

General and administrative. General and administrative expenses were $1.7
million and $1.0 million for the first six months of fiscal 1996 and 1995,
respectively. As a percentage of net revenues, general and administrative
expenses increased to 8.4% for the first six months of fiscal 1996 as compared
to 8.1% for the first six months of fiscal 1995. This increase was primarily
due to additional headcount, increased investor relations expenses,
professional services and profit sharing expenses. General and administrative
expenses are expected to increase slightly in absolute dollars over the
remainder of fiscal 1996.

Provision for income taxes. The provision for income taxes consists
primarily of federal alternative minimum tax, state and foreign taxes and
Japanese withholding taxes. The tax rate is substantially below the federal
statutory rate due to the utilization of net operating loss carryovers for
which no benefit has previously been taken.

FISCAL 1995, 1994 AND 1993

Net revenues. Net revenues for fiscal 1995 were $28.6 million as compared to
$21.6 million for fiscal 1994. The primary reason for this 32.2% increase was
continued growth in sales of Voyager systems and the introduction of Gemini
systems in the fourth quarter of fiscal 1995. These product lines contributed
to the majority of net product revenues for the year. Maintenance revenue was
$4.9 million and $3.8 million for fiscal 1995 and 1994, respectively,
representing 17.1% and 17.3% of net revenues. The increase in maintenance
revenue was a result of the continued acceptance of the new products by the
growing customer base. International sales increased by 89.1% and domestic
revenues increased by 12.4% over this same period. Net revenues for fiscal
1994 were $21.6 million as compared to net revenues in fiscal 1993 of $16.5
million. This 30.9% increase was the result of the broader acceptance of the
Voyager systems, partially offset by a decrease in revenues from aging
products. International sales (export sales and sales shipped by the Company's
European operation) were $10.6 million, $5.6 million and $3.3 million for
fiscal 1995, 1994 and 1993, respectively. These sales represented 36.9%, 25.8%
and 20.1% of net revenues. The increases in international sales were a result
of the increased customer acceptance of the new product offerings, improved
economic conditions, particularly in Europe, increased focus on the
international market and increased presence in the Far East marketplace as the
Company opened its subsidiary in Japan during fiscal 1995.

Gross profit. Gross profit was $21.5 million, $15.7 million and $10.2
million or 75.0%, 72.6% and 61.7% of net revenues for fiscal 1995, 1994 and
1993, respectively. The increases in gross margin were primarily the result of
a change in product mix to a greater percentage of higher margin newer product
offerings. The Voyager products and the Gemini products have a higher software
content than previously offered products, which contributed to the higher
margins. To a lesser extent, the absorption of fixed manufacturing costs over
a broader revenue base also contributed to higher overall margins.

16
<PAGE>

Research and development. Research and development expenses were $4.0
million, $3.9 million and $7.9 million for fiscal 1995, 1994 and 1993,
respectively. As a percentage of net revenues, research and development
expenses were 14.0%, 17.8% and 47.8% for fiscal 1995, 1994 and 1993,
respectively, as the Company had completed a build-up in staffing and expenses
to effect its major product development program that began in fiscal 1991.
Research and development expenses in fiscal 1993 were substantially higher
than either fiscal 1994 or 1995 because of a $3.6 million charge in fiscal
1993 to research and development resulting from in-process research and
development acquired under the amended joint development agreement with Racal.
In addition, the Company incurred a non-recurring engineering expense of
approximately $600,000 in connection with the development of its Nsim
simulator.

Sales and marketing. Sales and marketing expenses were $11.8 million, $9.4
million and $9.3 million in fiscal 1995, 1994 and 1993 or 41.1%, 43.7% and
56.3% of net revenues, respectively. The primary cause of the increase in
absolute dollars has been an increase in the amount of presale support and
benchmarking performed by field application engineers and increased commission
expenses. Spending has also increased in the foreign sales offices to support
the increased sales and marketing activity in both Europe and Asia.

General and administrative. General and administrative expenses were $2.3
million, $1.6 million and $1.9 million for fiscal 1995, 1994 and 1993, or
8.0%, 7.4% and 11.3% of net revenues, respectively. The increase in fiscal
1995 was primarily due to additional headcount, as the Company filled the
President and Chief Operating Officer positions that were vacant throughout
fiscal 1994.

Other income (expense). Net interest income in fiscal 1995 of $52,000 was
the result of interest income of $159,000 being earned on an increasing cash,
cash equivalents and short-term investments during the year, net of interest
paid on long-term debt borrowings of $107,000. Net interest expense in fiscal
1994 was the result of $75,000 of interest expense on the long-term debt. Net
interest income of $130,000 for fiscal 1993 represents interest income earned
on cash, cash equivalents and short-term investments with no related interest
expense. Other income in fiscal 1995, 1994 and 1993 was $117,000, $140,000 and
$48,000, respectively, and primarily relates to rental income from property
that the Company began leasing in 1993.

Provision for income taxes. The Company's tax provision for fiscal 1995,
1994 and 1993 consists primarily of federal alternative minimum tax, state
taxes and foreign withholding taxes. As of September 30, 1995, the Company had
federal and state net operating loss carryforwards of approximately $10.0
million and $400,000, respectively. The Company also had federal and
California research and development tax credit carryforwards of approximately
$1.0 million and $300,000, respectively. The net operating loss and credit
carryforwards will expire at various dates beginning in 1997 through 2009, if
not utilized.

Utilization of the net operating losses and credits is subject to a
substantial 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 may result in the expiration of net
operating losses and credits before utilization.

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 provided a full valuation
allowance against its net deferred tax assets due to uncertainties surrounding
their realization, primarily due to the Company having cumulative losses in
the last three years, which causes predictability of earnings in the early
future years to be uncertain.

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 IKOS 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. See Note 2 of Notes to Consolidated Financial Statements of IKOS.

17
<PAGE>

QUARTERLY RESULTS

The following table sets forth certain quarterly financial information for
fiscal 1995 and the first two quarters of fiscal 1996. This information is
derived from unaudited financial statements that include, in the opinion of
management, all normal recurring accruals necessary for a fair presentation of
the information set forth therein. The operating results for any quarter are
not necessarily indicative of results to be expected for any future period.

<TABLE>
<CAPTION>
FISCAL 1995 FISCAL 1996
------------------------------------ ------------------
QUARTERS ENDED
-------------------------------------------------------
DEC. 31, APR. 1, JULY 1, SEPT. 30, DEC. 30, MARCH 30,
1994 1995 1995 1995 1995 1996
-------- ------- ------- --------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Net revenues............. $6,108 $6,680 $7,395 $8,417 $9,277 $11,154
Cost of revenues......... 1,644 1,663 1,826 2,006 2,136 2,397
------ ------ ------ ------ ------ -------
Gross profit........... 4,464 5,017 5,569 6,411 7,141 8,757
Operating expenses:
Research and
development........... 919 1,035 1,012 1,033 1,541 1,727
Sales and marketing.... 2,582 2,686 3,085 3,410 3,494 3,417
General and
administrative........ 483 551 542 725 689 1,034
------ ------ ------ ------ ------ -------
Total operating
expenses............ 3,984 4,272 4,639 5,168 5,724 6,178
------ ------ ------ ------ ------ -------
Income from operations... 480 745 930 1,243 1,417 2,579
Other income (expense):
Interest income........ 23 26 42 68 197 285
Interest expense....... (38) (25) (23) (21) (18) (24)
Other.................. 29 29 29 30 29 30
------ ------ ------ ------ ------ -------
Total other income... 14 30 48 77 208 291
------ ------ ------ ------ ------ -------
Income before provision
for income taxes........ 494 775 978 1,320 1,625 2,870
Provision for income
taxes................... 46 60 90 215 250 460
------ ------ ------ ------ ------ -------
Net income............. $ 448 $ 715 $ 888 $1,105 $1,375 $ 2,410
====== ====== ====== ====== ====== =======
Earnings per share:...... $ 0.08 $ 0.12 $ 0.14 $ 0.17 $ 0.18 $ 0.31
====== ====== ====== ====== ====== =======
Common and common
equivalent shares used
in computing per share
amounts................. 5,783 6,011 6,281 6,531 7,519 7,843
====== ====== ====== ====== ====== =======
</TABLE>

18
<PAGE>

The following table presents certain operating statement items expressed as
a percentage of net revenues for each quarter of fiscal 1995 and for the first
two quarters of fiscal 1996.

<TABLE>
<CAPTION>
FISCAL 1995 FISCAL 1996
---------------------------------- ------------------
QUARTERS ENDED
-----------------------------------------------------
DEC. 31, APR. 1, JULY 1, SEPT. 30, DEC. 30, MARCH 30,
1994 1995 1995 1995 1995 1996
-------- ------- ------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net revenues............. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues......... 26.9 24.9 24.7 23.8 23.0 21.5
----- ----- ----- ----- ----- -----
Gross profit........... 73.1 75.1 75.3 76.2 77.0 78.5
Operating expenses:
Research and
development........... 15.0 15.5 13.7 12.3 16.6 15.4
Sales and marketing.... 42.3 40.2 41.7 40.5 37.7 30.6
General and
administrative........ 7.9 8.2 7.3 8.6 7.4 9.3
----- ----- ----- ----- ----- -----
Total operating
expenses............ 65.2 63.9 62.7 61.4 61.7 55.4
----- ----- ----- ----- ----- -----
Income from operations... 7.9 11.2 12.6 14.8 15.3 23.1
Other income (expense):
Interest income........ 0.4 0.4 0.6 0.8 2.1 2.5
Interest expense....... (0.6) (0.4) (0.3) (0.3) (0.2) (0.2)
Other.................. 0.5 0.4 0.3 0.4 0.3 0.3
----- ----- ----- ----- ----- -----
Total other income... 0.3 0.4 0.6 0.9 2.2 2.6
Income before provision
for income taxes........ 8.2 11.6 13.2 15.7 17.5 25.7
Provision for income
taxes................... 0.8 0.9 1.2 2.6 2.7 4.1
----- ----- ----- ----- ----- -----
Net income............. 7.4% 10.7% 12.0% 13.1% 14.8% 21.6%
===== ===== ===== ===== ===== =====
</TABLE>

QUARTERLY TRENDS

Gross profit generally increased from quarter to quarter as a percentage of
net revenues over the six quarter period primarily as a result of a shift in
product mix to higher margin products. Research and development expenses
increased in the first two fiscal quarters of 1996, primarily as a result of
increased headcount and associated personnel related costs. In addition, for
the first fiscal quarter of 1996, the Company incurred an expense of
approximately $250,000 for certain acquired technology that had not reached
technical feasibility and did not have alternative future uses. Sales and
marketing expenses increased in absolute dollars in the first two quarters of
fiscal 1996 as a result of the significant increase in revenues but decreased
as a percentage of revenues primarily due to the increased efficiency of the
sales force.

The Company expects to recognize a loss in the quarter ending June 29, 1996,
due to the approximately $9.6 million in-process research and development
write-off resulting from the Acquisition. In addition, the Company's operating
expenses are expected to increase due to the development of emulation systems
and the amortization of intangibles resulting from the Acquisition.

The Company's quarterly operating results have in the past and may in the
future vary significantly depending on factors such as the timing of customer
development projects and related purchase orders to purchase the Company's
hardware-assisted simulation systems, 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 in
anticipation of increased sales, 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 delivery 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.
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. See "Risk Factors--
Potential Fluctuations in Quarterly Results."

19
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

Since inception, the Company has financed its operations, including
increases in accounts receivable and inventory and capital equipment
acquisitions, primarily through private and public sales of equity securities
and a loan secured by capital equipment. In addition, the Company's operations
provided cash during the first six months of fiscal 1996 and during fiscal
1995 and fiscal 1994.

Operating activities. The Company's operating activities provided cash of
$7.1 million in the first six months of fiscal 1996, $4.5 million in fiscal
1995 and $1.4 million in fiscal 1994 and used cash of $686,000 in fiscal 1993.
For the six months ended March 30, 1996, net cash provided by operating
activities was primarily due to net income plus depreciation and amortization,
a reduction in outstanding accounts receivable, increased deferred maintenance
revenues and accounts payable partially offset by an increase in inventories
and a decrease in accrued commissions and other accrued liabilities. 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. In fiscal
1993, the net cash used in operating activities was primarily the result of
net losses.

Investing activities. For the six months ended March 30, 1996 net cash used
in investing activities was approximately $11.6 million due primarily to the
advance to VMW of approximately $1.3 million and the net purchases of
approximately $9.2 million of short-term investments and purchases of $1.2
million of equipment, primarily engineering workstations. Other than the
purchase and sales and maturities of short-term investments, investment
activities were comprised primarily of capital expenditures of $1.1 million,
$959,000 and $1.0 million for fiscal 1995, 1994 and 1993, respectively.
Capital expenditures were primarily for evaluation equipment, engineering
workstations and the Company's own hardware simulators which were used for
research and development and benchmarking purposes.

In accordance with Statement of Financial Accounting Standards No. 86, the
Company capitalizes eligible computer software costs upon achievement of
technological feasibility subject to net realizable value considerations. The
Company defines technological feasibility as completion of a working model.
For the six months ended March 30, 1996 and April 1, 1995, such capitalizable
costs were insignificant. Accordingly, the Company has charged all such costs
to research and development expenses for these periods. For fiscal 1995 and
1994, the Company did not capitalize any costs for software. For fiscal 1993,
the Company capitalized $513,000 for the development of the VHDL simulator and
other Voyager series products.

Financing activities. Net cash provided by financing activities for the six
months ended March 30, 1996 was $10.4 million which was a result of the
completion of the Company's public stock offering in October 1995 and the
exercise of options by Company employees. Proceeds from the sale of 1,150,000
shares of Common Stock, net of offering costs, were approximately $10.4
million. During the six months ended March 30, 1996, and during fiscal 1995,
1994 and 1993, the Company received cash of $664,000, $1.1 million, $68,000
and $50,000, respectively, upon the exercise of options to purchase Common
Stock. Offsetting the increases in cash provided by financing activities, were
principal payments of approximately $738,000, $754,000, $683,000 and $335,000
for the six months ended March 30, 1996 and fiscal years ending 1995, 1994 and
1993, respectively.

The Company's primary unused sources of funds at March 30, 1996 consisted of
$22.8 million of cash, cash equivalents, and short-term investments.
Subsequent to March 30, 1996, the Company paid approximately $10.0 million in
cash to the preferred stockholders of VMW pursuant to the Acquisition. The
Company expects to make capital expenditures throughout the remainder of
fiscal 1996, as expected headcount additions will require additional capital
expenditures. The Company believes that net proceeds from this offering,
together with cash and cash generated from operations, will be sufficient to
finance its operations through at least the end of fiscal 1996. 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 financings.
There can be no assurance that such financing can be obtained on favorable
terms, if at all. To the extent that additional capital is raised through the
sale of additional equity or convertible debt securities, the issuance of such
securities could result in dilution to the Company's stockholders.

20
<PAGE>

BUSINESS

THE COMPANY

IKOS develops, manufactures, markets and supports hardware and software
systems for the verification of IC designs. 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.

In May 1996, the Company acquired 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.

INDUSTRY 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 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

21
<PAGE>

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 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.

THE IKOS SOLUTION

The Company's mission is to be the leading supplier of tools for the
verification of IC designs with 100,000 or more gates, which are referred to
as complex ICs. Complex IC designs 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.

To date, the Company has concentrated on providing 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.

In order to broaden the Company's verification product offering to extend
from design concept stage to prototype stage, the Company is developing
emulation systems that incorporate technology under development acquired from
VMW. 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.

22
<PAGE>

IKOS STRATEGY

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 a
family of hardware and software simulation and emulation systems. The key
elements of this strategy are the following:

Maintain leadership in mixed-level, hardware-assisted simulation tools. The
Company intends to continue to invest significant resources to expand its set
of core technologies, including improvements in the Company's hardware and
software performance and greater IC modeling performance at the different
levels of design verification, and to enhance and support its products. The
Company also intends to continue to invest significant resources to enhance
its mixed level and co-simulation technology that provides for simultaneous
operation of software simulation at the behavioral level and hardware
acceleration at the gate level. In addition, the Company plans to develop new
products that will enable IC designers to simulate the higher density ICs
enabled by future generations of silicon process technology.

Broaden market for logic emulation. The Company will seek to broaden the
market for logic emulation by providing easier to use and less costly
emulation products. In addition, the Company intends to market its emulation
systems to ASIC designers that to date have not widely used emulation
products. The Company believes that its experience in developing and marketing
hardware-accelerated simulation systems will enhance its ability to develop
and market competitive emulation systems.

Conform to industry standards. The Company believes that its support of
industry standards allows system and IC designers to employ its products as an
integral part of the entire design process. The Company's simulation systems
accept designs created in VHDL and Verilog-XL, commonly used hardware
description languages. In addition, the Company's software utilizes the Motif
standard for graphical user interfaces and operates on the UNIX operating
system. In addition, the Company believes that its interface with commonly
used design environments facilitates the adoption and use of its products.
Furthermore, the Company intends to utilize standard off-the-shelf FPGAs in
its emulation systems.

Develop strategic relationships with key accounts. 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 employs a technically-oriented sales force
and applications engineering team to serve the needs of existing and
prospective customers. The Company focuses on demonstrating the value of its
hardware assisted solutions to key customers in each segment. These key
relationships serve as strong references for the Company's products and help
specify technical requirements for future generations of the Company's tools.
In addition, the Company believes that the success of its relationships with
these customers is evidenced by repeat orders from these key relationships.

Provide comprehensive cell libraries and library development tools. The
Company believes that its IC cell libraries for its simulation systems greatly
facilitate ease of use and accuracy of verification systems and that the
extensive libraries and library development tools provided by the Company are
a competitive advantage over other verification solutions. The Company has
fostered relationships with IC manufacturers such as American Microsystems,
Inc., LSI Logic Corporation, NEC Corporation, OKI Semiconductor, Toshiba,
Texas Instruments Incorporated and VLSI Technology, Inc. in order to obtain
the design specifications necessary for the development of cell libraries and
library development tools.

23
<PAGE>

SIMULATION

To date, IKOS has marketed high performance IC design simulation systems
consisting of hardware and software. In the IKOS simulation system, certain
simulation algorithms are implemented in hardware to enhance performance. The
software components of the IKOS solution include behavioral-level simulation
software, interfaces with other EDA tools and cell libraries and library
development tools for modeling of ICs. IKOS simulation systems run on Sun
Microsystems, Inc. ("Sun") and Hewlett-Packard Company ("Hewlett-Packard")
workstations. The following is a description of the products offered by the
Company:

Voyager VS. Voyager VS is the Company's VHDL software simulator. It provides
the behavioral simulation kernel and the design data management framework for
the remainder of the Voyager product series. Voyager VS fully complies with
the IEEE-1076 VHDL Language Reference Manual, and has an easy-to-use graphical
user interface and a powerful early stage design and debug tool. Both third
party and user-developed behavioral models are supported through flexible
interfaces to the simulation kernel, and user-programmable output formatting
allows Voyager VS to integrate with the in-house tools of IC vendors and high-
end customers.

Voyager CS. Voyager CS is a mixed-level (behavioral and gate-level) software
simulator that combines the functional simulation capabilities of Voyager VS
with a gate-level software simulator. This software simulator provides the
same simulation as the Company's hardware simulator by using the same gate
level algorithms and IC libraries utilized by the IKOS Nsim hardware simulator
family. By using Voyager CS, simulation problems due to library errors and
mismatches between simulation algorithms can be avoided. Voyager CS is also
used by IC vendors for library development. Voyager CS is designed to enable
an IC designer to transition easily from software-based simulation to
hardware-assisted simulation.

Voyager CSX. Voyager CSX links the Nsim accelerator to Voyager CS to enable
an IC designer to perform functional, gate-level or mixed-level hardware-
assisted simulation. The key technology behind Voyager CSX is embedded in the
IKOS SimLink, which allows multiple simulation engines to share the work in a
single simulation. SimLink manages the design partitioning between the
software and the hardware algorithms, and provides efficient time
synchronization and fast event exchange.

Voyager FS. Voyager FS is a concurrent fault simulator that uses the same
libraries as Nsim and provides high-performance fault simulation, using
software. Fault simulation is used to verify the quality and completeness of
tests developed for the design once it is manufactured. The Company believes
that Voyager FS currently is the only product that allows the same VHDL test
patterns used by the design engineer for logic simulation to also be used by
the test engineer for fault simulation. Voyager FS runs on standard
workstations manufactured by Sun and Hewlett-Packard.

Gemini CSX. Gemini CSX links Cadence's Verilog-XL software simulator with
the IKOS Nsim simulator to provide a mixed-level Verilog simulation system.
Gemini CSX uses the IKOS SimLink together with SimMatrix, developed by
Precedence Incorporated ("Precedence"), to enable concurrent hardware-assisted
gate-level simulation by IKOS Nsim and software behavioral-level simulation by
Cadence Verilog-XL. The Company has been granted a license by Precedence to
use, market and distribute the SimMatrix interface in return for certain
development fees and royalties.

Nsim. This family of high performance special purpose computers is used with
Voyager CSX and Gemini CSX. Nsim computers incorporate proprietary algorithms
implemented in IKOS-designed ASICs under a massively parallel architecture to
accelerate gate-level simulation. The Nsim family of products supports
functional verification for IC designs with between 300,000 and four million
gates and full-timing simulation for deep sub-micron ICs with between 50,000
and four million gates of random logic.

24
<PAGE>

Cell Libraries and Library Development Tools. IKOS promotes the use of its
simulation systems by providing library development tools that permit IKOS,
manufacturers and end-users to create and maintain current libraries. These
libraries provide the required functional and timing specifications of a
particular manufacturer's technology. The architecture of IKOS simulators was
specifically designed to facilitate the development of libraries. IKOS works
with IC manufacturers such as American Microsystems, Inc., LSI Logic
Corporation, NEC Corporation, OKI Semiconductor, Toshiba, Texas Instruments
Incorporated and VLSI Technology, Inc. to enable customers to simulate complex
designs using IKOS systems prior to fabrication of the ICs by these
manufacturers.

U.S. list prices for the Company's software products currently range from
approximately $10,000 to $40,000 and for the Company's hardware family
currently range from approximately $80,000 to over $1.0 million.

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

EMULATION

The Company seeks to develop emulation products utilizing VirtualWires, a
set of proprietary emulation methods under exclusive license from MIT.
VirtualWires 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 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, scalable 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.

25
<PAGE>

CUSTOMERS

IKOS sells its products to a broad range of companies including those in the
communications, multimedia/graphics, semiconductor, computer, aerospace and
consumer electronics industries. One customer, Advanced Micro Devices, Inc.,
accounted for 16.2% of the Company's net revenues for the first six months of
fiscal 1996. One distributor, Itochu & Co., Ltd. in Japan, accounted for 14.0%
and 14.6%, respectively, of the Company's net revenues for the first six
months of fiscal 1996 and fiscal 1995. One customer, Motorola, Inc., and one
distributor, Itochu & Co., Ltd., accounted for 17.7% and 10.1%, respectively,
of the Company's net revenues in fiscal 1994. A number of the Company's
customers use IKOS products for multiple applications. Certain of the
Company's customers who have purchased at least $100,000 of products in the
fiscal 1995 are listed below based upon the major application for which the
Company believes the customer is using the IKOS system.

COMMUNICATIONS MULTIMEDIA/GRAPHICS ASIC MANUFACTURERS
. Alcatel Network . Chips & Technologies, . American Microsystems,
Systems, Inc. Inc. Inc.
. AT&T Corp. . MicroUnity Systems . LSI Logic Corp.
. Cabletron Systems, . S3 Incorporated . Mitsubishi Electronics
Inc. . Silicon Graphics, Inc. America, Inc.
. Motorola, Inc. . SGS-Thomson
. Siemens AG Microelectronics
. Tellabs Inc. . Texas Instruments
Incorporated

COMPUTERS/PERIPHERALS AEROSPACE CONSUMER ELECTRONICS
. Acer Incorporated . Allen-Bradley Co. . Fuji-Xerox
. Cyrix Corp. . Hughes Aircraft Co. . General Instrument
. Hewlett-Packard . Raytheon Co. Corp.
Company . Rockwell International . Scientific Atlanta,
. NEC Corporation Corp. Inc.
. Philips Semiconductor . Sony America Corp.
. Toshiba America Inc.

SALES AND MARKETING

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. IKOS' direct sales strategy concentrates on those
companies that it believes are key users and designers of ICs and IC-based
systems for high-performance applications. IKOS currently maintains direct
sales and support offices in the following states: Arizona, California, New
Hampshire, New Jersey and Texas. IKOS sells directly in Japan through a
wholly-owned subsidiary and in Europe through wholly-owned subsidiaries in
Germany and England and a sales office in France. In addition, the Company
sells and supports its products through distributors in Asia and certain
European regions. The sales process is supported with a broad range of
marketing programs which include trade shows, direct marketing, public
relations and advertising. From time to time the Company may enter into joint
marketing agreements with other EDA companies and technology partners to
increase market acceptance of the Company's verification systems.

International sales accounted for approximately 31.1% and 30.9%,
respectively, of the Company's net revenues for the six month periods ended
March 30, 1996 and April 1, 1995, respectively, and 36.9%, 25.8% and 20.1% of
the Company's net revenues in fiscal 1995, 1994 and 1993, respectively. In
addition to its direct sales activities in foreign countries, the Company has
developed distributor relationships in Europe and Asia. The Company expects
that international sales will continue to account for a significant portion of
its revenues, and plans to continue to expand its international sales and
distribution channels. Although the Company has attempted to reduce the risk
of fluctuations in exchange rates associated with international revenues by
selling its systems for United States currency 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

26
<PAGE>

Company by resulting in pricing that is not competitive with prices
denominated in local currencies. Furthermore, there can be no assurance that
the Company will be able to continue to sell its systems internationally for
United States currency. International sales are subject to a number of other
inherent risks. See "Risk Factors--International Sales."

The Company provides maintenance and support on a contractual basis after
the initial product warranty has expired. Maintenance and support are provided
on an on-site or on a return and repair basis. The Company also provides
maintenance and support via a toll-free telephone line, and customers with
maintenance coverage receive regular software releases from the Company.
Foreign distributors generally provide customer training, service and support
for the products they sell.

MANUFACTURING AND SUPPLIERS

The Company performs final assembly and test of all its simulation 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.

Certain key components used in the Company's simulation 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 simulation systems use proprietary ASICs that are
currently manufactured solely by AMI and subassemblies that are manufactured
solely by 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.
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. See
"Risk Factors--Dependence Upon Certain Suppliers."

RESEARCH AND DEVELOPMENT

The Company's research and development organization included 41 engineers at
March 30, 1996 of whom 27 were engaged principally in software development.
During the first six months of fiscal 1996, the Company spent approximately
$3.3 million on research and development and during fiscal 1995, 1994 and
1993, the Company spent approximately $4.0 million, $3.9 million and $7.9
million, respectively, on research and development. The Company's research and
development costs, including costs of software development before
technological feasibility, are expensed as incurred. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

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. To
the extent that the Company competes in the market for emulation products in
the future, it will experience competition from emulation systems sold by
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,

27
<PAGE>

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.

PROPRIETARY RIGHTS

The Company's success and ability to compete is dependent in part upon its
proprietary technology. The Company relies on patent, trademark, trade secret
and copyright law to protect its technology. The Company currently holds three
U.S. patents, has licensed rights under certain patent applications relating
to VirtualWires, and has filed additional patent applications. However, there
can be no assurance that any patent owned by the Company will not be
invalidated, circumvented or challenged, that the rights granted thereunder
will provide competitive advantages to the Company or that any of the
Company's patent applications, whether or not challenged by applicable
governmental patent examiners, will be issued with the scope of the claims
sought by the Company, if at all. Furthermore, there can be no assurance that
others will not develop technologies that are similar or superior to the
Company's technology, duplicate the Company's technology or design around the
patents owned by the Company. The Company generally enters into
confidentiality or license agreements with its employees, distributors and
customers, and limits access to and distribution of its software,
documentation and other proprietary information. Despite these precautions, it
may be possible for a third party to copy or otherwise obtain and use the
Company's products or technology without authorization, or to develop similar
technology independently. In addition, effective copyright and trade secret
protection may be unavailable or limited in certain foreign countries. The
Company has also granted Racal a security interest in certain VHDL simulation
software jointly developed by the Company and Racal with respect to payment of
a promissory note to Racal by the Company with a current balance of $1.25
million. 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.

28
<PAGE>

licenses could result in delays or reductions in product shipments until
equivalent software or technology could be identified, licensed and
integrated, which would adversely affect the Company's operating results. In
particular, the Company licenses certain VirtualWires emulation patent rights
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. Loss of
this license could materially adversely affect the Company's future operating
results. See "Risk Factors--Proprietary Rights."

EMPLOYEES

As of March 30, 1996, the Company employed a total of 144 persons,
consisting of 76 in marketing, sales and support, 9 in manufacturing, 41 in
research, development and engineering, and 18 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.

The Company's future performance depends in significant part upon attracting
and retaining key technical, sales, senior management and financial personnel.
Competition for such personnel is intense, and the inability to retain its key
personnel or to attract, assimilate or retain other highly qualified personnel
in the future on a timely basis could have a material adverse effect on the
Company's results of operations. See "Risk Factors-- Dependence Upon Key
Personnel and Management of Growth."

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. The Company also leases a development facility in Cambridge,
Massachusetts and a sales and development facility in Waldwick, New Jersey. In
addition, the Company leases sales office space domestically in Arizona,
California, New Hampshire 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.

29
<PAGE>

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The names, titles and ages of the executive officers and directors of the
Company are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
<C> <C> <S>
Gerald S. Casilli.......................... 57 Chairman of the Board
Ramon A. Nunez............................. 41 Chief Executive Officer,
President and Director
Daniel R. Hafeman.......................... 47 Chief Technical Officer
Joseph W. Rockom........................... 57 Chief Financial Officer, Vice
President of Finance and
Administration, and
Secretary
Paul Offredi............................... 51 Senior Vice President,
Product Operations
Stephen M. McLaughin....................... 48 Vice President of
Manufacturing
Lawrence A. Melling........................ 39 Vice President of Marketing
John Stressing............................. 52 Vice President of Worldwide
Sales
Lutz P. Henckels (1)....................... 55 Director
James R. Oyler (1)......................... 50 Director
Glenn E. Penisten (1)...................... 64 Director
</TABLE>
- --------
(1) Members of the Audit and Compensation Committees

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.

Mr. Hafeman, a founder of the Company, has served as 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. 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 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 manufacturer of electronic
test equipment. From 1987 until 1991, Mr. Offredi was the Senior Vice
President of Operations for Zycad Corporation.

Mr. McLaughin 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.

30
<PAGE>

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, Inc., a manufacturer of computer networking
equipment. Prior to his relationship with Corvus Systems, Inc., 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.

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 & 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 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
Microproducts, Inc. Pinnacle Systems, Inc. and Superconductor Technologies.

In March 1996, William B. Fazakerly resigned his position with the Company
as Chief Technical Officer to pursue new business opportunities.

31
<PAGE>

SELLING STOCKHOLDERS

The following table sets forth certain information regarding each Selling
Stockholder, each of whom is a former stockholder of VMW.

<TABLE>
<CAPTION>
SHARES TO
NAME OF SELLING SHARES BENEFICIALLY BE SOLD IN SHARES BENEFICIALLY
STOCKHOLDER OWNED PRIOR TO OFFERING OFFERING OWNED AFTER OFFERING
--------------- ----------------------- ---------- --------------------
<S> <C> <C> <C>
Melissa Barton.......... 59 59 0
Jonathan W. Babb........ 5,732 5,732 0
MIT..................... 14,020 14,020 0
Allen H. Michels(1)..... 25,997 25,997 0
Concord Partners II,
L.P.................... 65,851 65,851 0
Dillon, Read & Co. Inc.,
as agent............... 9,471 9,471 0
Lexington Partners IV,
L.P.................... 948 948 0
</TABLE>
--------
(1) Pursuant to the exercise of stock options.

32
<PAGE>

UNDERWRITING

Under the terms and subject to the conditions of the Underwriting Agreement,
the Underwriters named below, for whom Needham & Company, Inc. ("Needham &
Company"), SoundView Financial Group, Inc. and Unterberg Harris are acting as
representatives (the "Representatives"), have severally agreed to purchase
from the Company and the Selling Stockholders, and the Company and the Selling
Stockholders have agreed to sell to each Underwriter, the aggregate number of
shares of Common Stock set forth opposite their respective names on the table
below. The Underwriting Agreement provides that the obligations of the
Underwriters to pay for and accept delivery of the shares of Common Stock are
subject to certain conditions precedent, and that the Underwriters are
committed to purchase and pay for all shares if any shares are purchased.

<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
----------- ---------
<S> <C>
Needham & Company, Inc.........................................
SoundView Financial Group, Inc.................................
Unterberg Harris...............................................
---------
Total........................................................ 1,122,078
=========
</TABLE>

The Company and the Selling Stockholders have been advised by the
Representatives that the Underwriters propose to offer the shares of Common
Stock to the public at the public offering price per share set forth on the
cover page of this Prospectus and to certain dealers (who may include the
Underwriters) at such price less a concession not in excess of $ per share.
The Underwriters may allow, and such dealers may reallow, a concession to
certain other dealers (who may include the Underwriters) not in excess of $
per share. After the offering to the public, the offering price and other
selling terms may be changed by the Representatives.

The Company has granted an option to the Underwriters exercisable during the
30-day period after the date of this Prospectus, to purchase up to a maximum
of 168,312 shares of Common Stock at the public offering price per share, less
the underwriting discounts and commissions, set forth on the cover page of
this Prospectus. The Underwriters may exercise such option only to cover over-
allotments made in connection with the sale of

33
<PAGE>

the Common Stock offered hereby. To the extent the Underwriters exercise such
option, each of the Underwriters will be committed, subject to certain
conditions, to purchase approximately the same percentage of such additional
shares as the number of shares of Common Stock to be purchased by such
Underwriters, as shown in the above table, bears to the total shown.

In connection with this offering, certain underwriters and selling group
members (if any) or their respective affiliates may engage in passive market
making transactions in the Common Stock on the Nasdaq National Market
immediately prior to the commencement of sales in this offering, in accordance
with Rule 10b-6A under the Exchange Act. Passive market making consists of
displaying bids in the Nasdaq National market limited by the bid prices of
independent market makers and purchases limited by such prices and effected in
response to order flow. Net purchases by a passive market maker on each day are
generally limited to a specified percentage of the passive market maker's
average daily trading volume in the Common Stock during a specified prior
period and must be discontinued when such limit is reached. Passive market
making may stabilize the market price of the Common Stock at a level above that
which might otherwise prevail and, if commenced, may be discontinued at any
time.

In the Underwriting Agreement, the Company and the Selling Stockholders have
agreed to indemnify the Underwriters against certain liabilities that may be
incurred in connection with this offering, including liabilities under the
Securities Act, or to contribute payments that the Underwriters may be required
to make in respect thereof.

The Company and its directors and officers and the Selling Stockholders have
agreed, without the prior written consent of Needham & Company, not to,
directly or indirectly, sell, contract to sell, make any short sale, pledge, or
otherwise dispose of, any shares of Common Stock, options to acquire shares of
Common Stock or securities exchangeable for or convertible into shares of
Common Stock of the Company, for a period of 90 days after the effective date
of the Registration Statement to which this Prospectus relates, subject to
certain limited exceptions.

Needham & Company, one of the Representatives, acted as financial advisor to
the Company with respect to the Acquisition. In consideration of such services,
the Company has agreed to pay to Needham & Company a financial advisory fee and
has issued to Needham & Company a warrant to purchase 25,000 shares of Common
Stock.

LEGAL MATTERS

The validity of the shares offered hereby will be passed upon for the Company
and the Selling Stockholders by Gray Cary Ware & Freidenrich, A Professional
Corporation, Palo Alto, California. Pillsbury Madison & Sutro LLP, San
Francisco, California, is acting as counsel for the Underwriters in connection
with certain legal matters relating to the Common Stock offered hereby.

EXPERTS

The consolidated financial statements of IKOS Systems, Inc. at October 1,
1994 and September 30, 1995, and for each of the three years in the period
ended September 30, 1995, appearing in this Prospectus and Registration
Statement, and appearing in IKOS Systems, Inc.'s Annual Report on Form 10-K for
the year ended September 30, 1995 incorporated herein by reference, have been
audited by Ernst & Young LLP as set forth in their report thereon, appearing
elsewhere herein, and as set forth in their report thereon included in IKOS
Systems, Inc's. Annual Report on Form 10-K and incorporated herein by
reference. Such consolidated financial statements are included in reliance upon
such reports given upon the authority of such firm as experts in accounting and
auditing.

34
<PAGE>

The financial statements of VMW (a development stage enterprise) at December
31, 1994 and 1995, and for the years then ended and for the period from
October 6, 1993 (date of inception) to December 31, 1995 appearing in this
Prospectus and Registration Statement have been audited by Coopers & Lybrand
L.L.P., independent accountants, as set forth in their report dated April 12,
1996, except for Note 10, as to which the date is May 23, 1996, (which report
included an explanatory paragraph regarding the substantial doubt about the
entity's ability to continue as a going concern) accompanying such financial
statements appearing elsewhere herein and in the Registration Statement, in
reliance upon such reports of such firm which report is given upon their
authority as experts in accounting and auditing.

35
<PAGE>

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
IKOS SYSTEMS, INC.
Report of Ernst & Young LLP, Independent Auditors........................ F-2
Consolidated Balance Sheets.............................................. F-3
Consolidated Statements of Operations.................................... F-4
Consolidated Statements of Stockholders' Equity.......................... F-5
Consolidated Statements of Cash Flows.................................... F-6
Notes to Consolidated Financial Statements............................... F-7
VIRTUAL MACHINE WORKS, INC.
Report of Coopers & Lybrand L.L.P., Independent Accountants.............. F-16
Balance Sheets........................................................... F-17
Statements of Operations................................................. F-18
Statements of Stockholders' Deficit...................................... F-19
Statements of Cash Flows................................................. F-20
Notes to Financial Statements............................................ F-21
IKOS SYSTEMS, INC. AND VIRTUAL MACHINE WORKS, INC. UNAUDITED PRO FORMA
CONDENSED COMBINED FINANCIAL STATEMENTS
Unaudited Pro Forma Condensed Combined Financial Information............. F-29
Unaudited Pro Forma Condensed Combined Balance Sheet..................... F-30
Unaudited Pro Forma Condensed Combined Statement of Operations........... F-31
Notes to Unaudited Pro Forma Condensed Combined Financial Statements..... F-33
</TABLE>

F-1
<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 October 1, 1994 and September 30, 1995, and the related
consolidated statements of operations, stockholders' equity, and cash flows
for each of the three years in the period ended September 30, 1995. These
financial statements 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 October 1, 1994 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 30, 1995, in conformity with
generally accepted accounting principles.

ERNST & YOUNG LLP

San Jose, California
October 17, 1995

F-2
<PAGE>

IKOS SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30, MARCH 30,
1994 1995 1996
---------- ------------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............... $ 3,422 $ 7,305 $ 13,166
Short-term investments.................. 560 450 9,616
Accounts receivable (net of allowances
for doubtful accounts of $122, $171 and
$221, respectively).................... 4,884 6,046 3,857
Inventories............................. 1,050 1,328 2,121
Prepaid expenses and other assets....... 222 271 280
-------- -------- --------
Total current assets................ 10,138 15,400 29,040
Equipment and leasehold improvements
Office and evaluation equipment......... 2,576 2,730 3,197
Machinery and equipment................. 4,664 4,985 5,131
Leasehold improvements.................. 267 287 303
-------- -------- --------
7,507 8,002 8,631
Less allowances for depreciation and
amortization....................... (5,859) (6,363) (6,292)
-------- -------- --------
1,648 1,639 2,339
Advance and other assets.................. 343 113 1,455
-------- -------- --------
$ 12,129 $ 17,152 $ 32,834
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................ $ 1,909 $ 1,613 $ 2,719
Accrued payroll and related expenses.... 786 1,195 1,427
Accrued commissions..................... 650 697 186
Income taxes payable.................... 13 188 275
Other accrued liabilities............... 360 480 168
Deferred maintenance revenues........... 1,979 3,030 3,971
Current portion of long-term debt....... 591 688 450
-------- -------- --------
Total current liabilities........... 6,288 7,891 9,196
Long-term debt, less current portion...... 2,151 1,300 800
Accrued rent.............................. 214 251 248
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, 5,504, 5,886 and
7,264 shares issued and outstanding,
respectively........................... 55 59 73
Additional paid-in capital.............. 25,960 27,034 38,115
Accumulated deficit..................... (22,539) (19,383) (15,598)
-------- -------- --------
Total stockholders' equity.......... 3,476 7,710 22,590
-------- -------- --------
$ 12,129 $ 17,152 $ 32,834
======== ======== ========
</TABLE>

See notes to consolidated financial statements

F-3
<PAGE>

IKOS SYSTEMS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
FISCAL YEARS ENDED SIX MONTHS ENDED
----------------------------------- ------------------
APRIL
OCTOBER 2, OCTOBER 1, SEPTEMBER 30, 1, MARCH 30,
1993 1994 1995 1995 1996
---------- ---------- ------------- ------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues
Product............... $12,917 $17,886 $23,713 $10,534 $16,971
Maintenance........... 3,611 3,750 4,887 2,254 3,460
------- ------- ------- ------- -------
Total net revenues.. 16,528 21,636 28,600 12,788 20,431
Cost of revenues
Product............... 5,542 5,000 5,982 2,761 3,983
Maintenance........... 789 930 1,157 546 550
------- ------- ------- ------- -------
Total cost of
revenues........... 6,331 5,930 7,139 3,307 4,533
------- ------- ------- ------- -------
Gross profit........ 10,197 15,706 21,461 9,481 15,898
Operating expenses:
Research and
development.......... 7,896 3,861 3,999 1,954 3,268
Sales and marketing... 9,303 9,447 11,763 5,268 6,911
General and
administration....... 1,873 1,596 2,301 1,034 1,723
------- ------- ------- ------- -------
Total operating
expenses........... 19,072 14,904 18,063 8,256 11,902
------- ------- ------- ------- -------
Income (loss) from
operations............. (8,875) 802 3,398 1,225 3,996
Other income (expense):
Interest income....... 130 69 159 49 482
Interest expense...... -- (75) (107) (63) (42)
Other................. 48 140 117 58 59
------- ------- ------- ------- -------
Total other income.. 178 134 169 44 499
------- ------- ------- ------- -------
Income (loss) before
provision for income
taxes and extraordinary
credit................. (8,697) 936 3,567 1,269 4,495
Provision for income
taxes................... 53 95 411 106 710
------- ------- ------- ------- -------
Income (loss) before
extraordinary credit.... (8,750) 841 3,156 1,163 3,785
Extraordinary credit--
forgiveness of debt..... -- 664 -- -- --
------- ------- ------- ------- -------
Net income (loss)....... $(8,750) $ 1,505 $ 3,156 $ 1,163 $ 3,785
======= ======= ======= ======= =======
Earnings (loss) per
share:
Income (loss) before
extraordinary credit. $ (1.62) $ 0.15 $ 0.51 $ 0.20 $ 0.49
Extraordinary credit.. -- 0.12 -- -- --
------- ------- ------- ------- -------
Net income (loss)... $ (1.62) $ 0.27 $ 0.51 $ 0.20 $ 0.49
======= ======= ======= ======= =======
Common and common
equivalent shares used
in computing per share
amounts................ 5,415 5,651 6,151 5,897 7,681
======= ======= ======= ======= =======
</TABLE>

See notes to consolidated financial statements

F-4
<PAGE>

IKOS SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(IN THOUSANDS)

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL STOCKHOLDERS' TOTAL
------------ PAID-IN ACCUMULATED NOTES STOCKHOLDERS'
SHARE AMOUNT CAPITAL DEFICIT RECEIVABLE EQUITY
----- ------ ---------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at September 26,
1992................... 5,405 $54 $25,851 $(15,294) $(8) $10,603
Net issuance of stock
under employee benefit
plans.................. 26 -- 42 -- -- 42
Payments on
stockholder's note
receivable............. -- -- -- -- 8 8
Net loss................ -- -- -- (8,750) -- (8,750)
----- --- ------- -------- --- -------
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 (unaudited)...... 228 2 660 -- -- 662
Issuance of shares in
conjunction with public
offering (unaudited)... 1,150 12 10,421 -- -- 10,433
Net income (unaudited).. -- -- -- 3,785 -- 3,785
----- --- ------- -------- --- -------
Balance at March 30,
1996 (unaudited)....... 7,264 $73 $38,115 $(15,598) $-- $22,590
===== === ======= ======== === =======
</TABLE>

See notes to consolidated financial statements

F-5
<PAGE>

IKOS SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS IN THOUSANDS

<TABLE>
<CAPTION>
FISCAL YEARS ENDED SIX MONTHS ENDED
----------------------------------- -------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30, APRIL 1, MARCH 30,
1993 1994 1995 1995 1996
---------- ---------- ------------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating activities:
Net income (loss)....... $(8,750) $ 1,505 $ 3,156 $ 1,163 $ 3,785
Adjustments to
reconcile net income
to net cash provided
by (used in) operating
activities:
Depreciation and
amortization......... 2,628 2,024 1,259 684 493
Gain (loss) on
retirement of
equipment............ 6 (4) 16 2 19
Deferred rent......... 172 26 37 18 (3)
License delivery and
technology transfer
in exchange for debt. -- (344) -- -- --
Decrease of long-term
debt--forgiveness of
note................. 3,600 (750) -- -- --
Changes in operating
assets and liabilities
Accounts receivable... 1,756 (2,069) (1,162) (1,919) 2,189
Inventories........... (506) 415 (234) (65) (793)
Prepaid expenses and
other current assets. 20 (168) (49) (38) (9)
Other assets.......... (3) 12 (27) (12) (92)
Accounts payable...... 595 (169) (296) 283 1,106
Accrued payroll and
other expenses....... 80 128 409 13 232
Accrued commissions... (111) 357 47 (328) (511)
Income taxes payable.. (6) 4 175 (20) 87
Other accrued
liabilities.......... 23 (112) 120 (58) (312)
Deferred maintenance
revenues............. (190) 543 1,051 437 941
------- ------- ------- ------- --------
Net cash provided by
(used in) operating
activities......... (686) 1,398 4,502 160 7,132
Investing activities:
Purchases of equipment
and leasehold
improvements........... (1,037) (959) (1,053) (418) (1,212)
Capitalized software
development costs...... (513) -- -- -- --
Investment in Virtual
Machine Works, Inc. ... -- -- -- -- (1,250)
Purchase of short-term
investments............ (241) (400) (14) (14) (10,755)
Sales of short-term
investments............ 2,852 -- -- -- --
Maturities of short-
term investments....... 46 381 124 -- 1,589
------- ------- ------- ------- --------
Net cash provided by
(used in) investment
activities........... 1,107 (978) (943) (432) (11,628)
Financing activities:
Principal payments on
long-term borrowings... (335) (683) ( 754) (250) (738)
Borrowing under
promissory note........ -- 750 -- -- --
Sale of common stock.... 50 68 1,078 60 11,095
------- ------- ------- ------- --------
Net cash provided by
(used in) financing
activities........... (285) 135 324 (190) 10,357
------- ------- ------- ------- --------
Increase (decrease) in
cash and cash
equivalents............. 136 555 3,883 (462) 5,861
Cash and cash equivalents
at beginning of period.. 2,731 2,867 3,422 3,422 7,305
------- ------- ------- ------- --------
Cash and cash equivalents
at end of period........ $ 2,867 $ 3,422 $ 7,305 $ 2,960 $ 13,166
======= ======= ======= ======= ========
Supplemental disclosures
of cash flow
information:
Cash paid for income
taxes.................. $ 59 $ 91 $ 230 $ 126 $ 566
Cash paid for interest.. $ -- $ 75 $ 107 $ 63 $ 42
</TABLE>

See notes to consolidated financial statements

F-6
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 30, 1996 AND FOR THE SIX MONTHS ENDED APRIL 1, 1995
AND MARCH 30, 1996 IS UNAUDITED)
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 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 recently completed the acquisition of
Virtual Machine Works, Inc., a development stage company that is in the
process of developing a logic emulation system.

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.

On October 20, 1994, the Board of Directors approved a one-for-two reverse
stock split of the outstanding shares of common stock of the Company. The
reverse stock split was effected on April 24, 1995 and has been presented
retroactively within these financial statements.

Fiscal year: The Company is on a 52-53 week year. Accordingly, October 2,
1993, October 1, 1994 and September 30, 1995 are the fiscal year-ends for
1993, 1994 and 1995, respectively. Fiscal year ended October 2, 1993 was a 53-
week fiscal year.

Interim financial information: The financial statements and related notes as
of March 30, 1996 and for the six months ended April 1, 1995 and March 30,
1996 are unaudited and have been prepared on the same basis as the audited
financial statements. The unaudited financial statements include all
adjustments (consisting solely of normal recurring accruals) which are, in the
opinion of management, necessary for a fair presentation of the financial
position and results of operations for the interim period.

The results of operations for the six months ended March 30, 1996 are not
necessarily indicative of results for the full year.

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 30, 1995, cash equivalents consisted of money market
funds. At March 30, 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.

In May 1993, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 115 (FAS 115), "Accounting for Certain
Investments in Debt and Equity Securities," effective for fiscal years
beginning after December 15, 1993. Under the rules, 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.

F-7
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 30, 1996 AND FOR THE SIX MONTHS ENDED APRIL 1, 1995
AND MARCH 30, 1996 IS UNAUDITED)
The Company adopted FAS 115 on October 2, 1994 and all debt securities are
classified as held-to-maturity. The adoption of FAS 115 had no material impact
on the Company's financial position or its results of operations during fiscal
1995. The fair values for marketable debt and equity securities are based on
quoted market prices.

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

<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 30,
1995 1996
------------- ---------
<S> <C> <C>
U.S. Treasury Securities.......................... $ -- $ 1,987
U.S. Corporate Securities......................... 450 7,002
Mortgage-Backed Securities........................ -- 4,301
----- -------
$ 450 $13,290
===== =======
Amounts included in short-term investments........ $ 450 $ 9,616
Amounts included in cash and cash equivalents..... $ -- $ 3,674
</TABLE>

At September 30, 1995, the fair value of the held to maturity investment is
substantially equal to its fair value. At March 30, 1996, gross unrealized
gains approximated $89,000 and there were no gross unrealized losses resulting
in an estimated fair value of held-to maturity securities of approximately
$9,705,000.

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

<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30, MARCH 30,
1994 1995 1996
---------- ------------- ---------
<S> <C> <C> <C>
Raw materials.......................... $ 259 $ 347 $ 164
Work-in-process........................ 502 563 1,497
Finished goods......................... 289 418 460
------ ------ ------
$1,050 $1,328 $2,121
====== ====== ======
</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.

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.

Software development costs: 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 defines 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 fiscal 1993, the Company
capitalized approximately $513,000. For fiscal years 1994 and 1995, and for
the six months ended April 1, 1995 and March 30, 1996, such capitalized costs
were insignificant and thus charged to research and development expenses for
the respective periods in the accompanying financial statements. During the
fiscal 1993, 1994 and 1995 and for the six months ended April 1, 1995, the
Company

F-8
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 30, 1996 AND FOR THE SIX MONTHS ENDED APRIL 1, 1995
AND MARCH 30, 1996 IS UNAUDITED)
amortized $662,000, $864,000, $257,000 and $171,000, respectively, of
previously capitalized software development costs. As all capitalized costs
were fully amortized in fiscal 1995, no amounts were amortized during the six
months ended March 30, 1996.

Income taxes: The Company accounts for income taxes in accordance with the
provisions of Financial Accounting Standards Board Statement No. 109 (FAS 109)
"Accounting for Income Taxes". Under FAS 109, the liability method is used in
accounting for income taxes.

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.

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." SFAS 123 provides an alternative to APB 25 and is
effective for fiscal years beginning after December 15, 1995. The Company
expects to continue to account for its employee stock plans in accordance with
the provisions of APB 25. Accordingly, SFAS 123 is not expected to have any
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 due date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Such estimates relate to the useful lives of fixed assets,
allowances for doubtful accounts and customer returns, inventory reserves and
other reserves. Actual results inevitably will differ from those estimates,
and such differences may be material to the financial statements.

Net income (loss) per share: Net income (loss) per share is based on the
weighted average number of common shares outstanding during the period. Common
equivalent shares from dilutive options have been included in the computation
using the treasury stock method.

2. LONG-TERM DEBT

<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30, MARCH 30,
1994 1995 1996
---------- ------------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Debt obligation to Racal-Redac, Inc.
payable in sixteen quarterly payments
through 1998............................ $2,100 $1,550 $1,250
Line of credit arrangement with leasing
company paid over 36 months and bearing
interest at 1.45% per month............. 642 438 --
------ ------ ------
2,742 1,988 1,250
Less current portion..................... (591) (688) (450)
------ ------ ------
Long-term debt........................... $2,151 $1,300 $ 800
====== ====== ======
</TABLE>

F-9
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 30, 1996 AND FOR THE SIX MONTHS ENDED APRIL 1, 1995
AND MARCH 30, 1996 IS UNAUDITED)
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 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 March 30, 1996 all amounts
outstanding had been repaid.

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

<TABLE>
<CAPTION>
RACAL- EQUIPMENT
AS OF SEPTEMBER 30, 1995 REDAC LINE TOTAL
------------------------ ------ --------- ------
<S> <C> <C> <C>
1996.............................................. $ 450 $238 $ 688
1997.............................................. 750 200 950
1998.............................................. 350 -- 350
------ ---- ------
Total........................................... $1,550 $438 $1,988
====== ==== ======
</TABLE>

3. COMMITMENTS

Non cancelable operating leases include building leases which expire in
seven years. The Company has the option to renew its building lease at its
principal offices for up to an additional eight years, commencing in September
2000, at the fair market value at the time of renewal.

Rent expense approximated $750,000, $763,000 and $901,000, in fiscal 1993,
1994 and 1995, respectively, and approximately $381,000 and $458,000 and for
the six months ended April 1, 1995 and March 30, 1996, respectively. The
Company subleases certain facilities. This sublease expires in 1997. Sublease
rental income was approximately $48,000, $140,000 and $117,000 in fiscal 1993,
1994 and 1995, respectively and approximately $58,000 and $59,000 for six
months ended April 1, 1995 and March 30, 1996, respectively. Future minimum
rentals from subleases are approximately $123,000.

F-10
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 30, 1996 AND FOR THE SIX MONTHS ENDED APRIL 1, 1995
AND MARCH 30, 1996 IS UNAUDITED)

Future minimum payments under non-cancelable operating leases at September
30, 1995 are as follows (in thousands):

<TABLE>
<CAPTION>
SEPTEMBER 30, 1995 AMOUNT
------------------ ------
<S> <C>
1996.................................................................. $ 599
1997.................................................................. 629
1998.................................................................. 659
1999.................................................................. 694
and thereafter........................................................ 731
------
$3,312
======
</TABLE>

4. 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.

Stock option plans: In 1988, the Company established a Stock Option Plan
(the "1988 Plan" which provides for the granting of options to employees or
directors to purchase shares of the Company's common stock. In fiscal year
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 options plans (in
thousands, except per share data):

<TABLE>
<CAPTION>
OPTIONS AND RIGHTS OUTSTANDING
--------------------------------------
NUMBER AGGREGATE PRICE
OF SHARES EXERCISE PRICE PER SHARE
--------- -------------- -------------
<S> <C> <C> <C>
Balance at September 26, 1992........... 800 $2,314 $0.350-$5.250
Granted............................... 282 1,220 3.125-4.625
Exercised............................. (26) (42) 0.350-3.875
Forfeitures........................... (160) (548) 0.350-5.250
----- ------
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............................... 354 3,388 9.125-16.00
Exercised............................. (228) (662) 0.350-10.250
Forfeitures........................... (54) (324) 3.00-11.125
----- ------
Balance at March 30, 1996............... 1,278 $7,788 $ 3.00-16.00
===== ======
</TABLE>

F-11
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 30, 1996 AND FOR THE SIX MONTHS ENDED APRIL 1, 1995
AND MARCH 30, 1996 IS UNAUDITED)
Exercisable options were approximately 514,000, 651,000 and 785,000 for
fiscal years ending 1993, 1994 and 1995 and approximately 507,000 at March 30,
1996.

Vesting provisions with respect to the Stock Option Plans 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.

Included in the table are options to purchase approximately 72,000 shares of
common stock granted outside of the 1988 Stock Plan. These options were
granted to various employees and have rights and vesting provisions which are
the same as those granted pursuant to the plan.

Total shares reserved for grant under the plans total 2,893,000 of which
approximately 2,343,000 shares were granted leaving approximately 550,000
shares available for grant at March 30, 1996.

The Company has reserved approximately 1,719,000 shares of common stock for
future issuance under the stock option plans for option outstanding and
available for grant at March 30, 1996 and approximately 72,000 shares of
common stock for future issuance of shares granted outside of the option plan.

1995 Outside Directors Stock Plan: The Company's 1995 Outside 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 March 30, 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 March 30, 1996, no 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 stockholders
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 interest of
the stockholders. The Board of Directors of the Company has designated 500,000
share of Series G Preferred Stock, $0.01 par value per share, and has reserved
for such shares for issuance pursuant to the Company's Rights Plan.

5. EMPLOYEE SAVINGS AND INVESTMENT PLAN

During the first six months of 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 March 30, 1996,
the matching contributions were approximately $69,000.

F-12
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 30, 1996 AND FOR THE SIX MONTHS ENDED APRIL 1, 1995
AND MARCH 30, 1996 IS UNAUDITED)

6. INCOME TAXES

The tax provision for continuing operations consists of the following (in
thousands):

<TABLE>
<CAPTION>
FISCAL YEARS ENDED
----------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30
1993 1994 1995
---------- ---------- ------------
<S> <C> <C> <C>
Current:
Federal.............................. $-- $ 7 $ 90
State................................ 7 3 112
Foreign.............................. 46 85 209
--- --- ----
$53 $95 $411
=== === ====
</TABLE>

A reconciliation between the Company's effective tax rate and the U.S.
statutory rate (34% in 1993; 35% in 1994 and 1995) follows (in thousands):

<TABLE>
<CAPTION>
FISCAL YEARS ENDED
----------------------------------
OCTOBER 2, OCTOBER 1, SEPTEMBER 30
1993 1994 1995
---------- ---------- ------------
<S> <C> <C> <C>
Tax provision (benefit) at U.S.
statutory rate...................... $(2,957) $ 328 $ 1,249
Operating losses (utilized), not
utilized............................ 2,957 (328) (1,170)
Alternative minimum tax.............. -- 7 90
Foreign withholding tax.............. 46 85 130
State taxes.......................... 7 3 112
------- ----- -------
$ 53 $ 95 $ 411
======= ===== =======
</TABLE>

For the six month periods ended April 1, 1995 and March 30, 1996, income
taxes have been provided based upon estimated annualized effective tax rates
of 8.3% and 15.8%, respectively, applied to the earnings for the period. The
provisions for income taxes reflect the tax benefits of utilizing net
operating loss and tax credit carryovers.

As of September 30, 1995, the Company had federal and state net operating
loss carryforwards of approximately $10,000,000 and $400,000, respectively.
The Company also had federal and California research and development tax
credit carryforwards of approximately $1,000,000 and $300,000, respectively.
The net operating loss and credit carryforwards will expire at various dates
beginning in 1997 through 2009, if not utilized.

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 1996, as amended, an similar state provisions. The
annual limitation could result in the expiration of net operating losses and
credits before utilization.

F-13
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 30, 1996 AND FOR THE SIX MONTHS ENDED APRIL 1, 1995
AND MARCH 30, 1996 IS UNAUDITED)

Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes as of October 1, 1994 and September 30,
1995, are as follows (in thousands):

<TABLE>
<CAPTION>
OCTOBER 1, SEPTEMBER 30,
1994 1995
---------- -------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.................. $ 5,000 $ 3,500
Research credits.................................. 1,200 1,200
Capitalized software.............................. 2,800 1,600
Deferred revenue.................................. 733 1,200
Accrued expenses and reserves..................... (233) 700
------- -------
Total deferred tax assets......................... 9,500 8,200
Valuation allowance for deferred tax assets....... (9,500) (8,200)
------- -------
Net deferred tax assets........................... $ -- $ --
------- -------
</TABLE>

The net valuation allowance decreased by $800,000 and $1,300,000 during the
twelve months ended October 1, 1994 and September 30, 1995.

7. 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.

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

<TABLE>
<CAPTION>
FISCAL YEARS ENDED SIX MONTHS
----------------------------------- ENDED
OCTOBER 2, OCTOBER 1, SEPTEMBER 30, MARCH 30,
1993 1994 1995 1996
---------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
Far East...................... $1,276 $2,511 $ 4,841 $3,244
Europe........................ 1,801 3,008 5,613 3,120
Other......................... 253 64 106 --
------ ------ ------- ------
$3,330 $5,583 $10,560 $6,364
====== ====== ======= ======
</TABLE>

F-14
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 30, 1996 AND FOR THE SIX MONTHS ENDED APRIL 1, 1995
AND MARCH 30, 1996 IS UNAUDITED)

In fiscal 1993, no customer accounted for more than 10% of net revenues. In
fiscal 1994, one customer and one distributor accounted for approximately 18%
and 10% of net revenues, respectively. In fiscal 1995, one distributor
accounted for approximately 15% of net revenues. For the six months ended
March 30, 1996, one customer and one distributor accounted for approximately
16% and 14% of net revenues.

Certain key components used in the Company's products are presently
available from sole or limited sources. The Company is dependent upon these
sources to deliver key components on a timely basis.

8. SUBSEQUENT EVENT

In May 1996, the Company completed the acquisition of Virtual Machine Works,
Inc. (VMW), a development stage company, The acquired company is a developer
of logic emulation systems. Under the purchase agreement, the Company will pay
approximately $10.0 million in cash and issue approximately 113,000 shares of
IKOS common stock to the VMW stockholders, options to purchase VMW stock will
be converted in options to purchase approximately 84,000 shares of IKOS common
stock, and the Company will pay acquisition costs of approximately $500,000.
In connection with the acquisition, the Company advanced VMW approximately
$1,250,000 in exchange for a note. The advance is included in other assets in
the accompanying financial statements. In connection with the acquisition, the
Company expects to take a charge of approximately $9.6 million for the
acquisition of in-process research and development being acquired.

The purchase price was allocated to the tangible and intangible assets of
VMW based on the fair market values of those assets using a risk adjusted
discounted cash flows approach. 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.

During April 1996, in connection with the acquisition, the Company issued
warrants to purchase 25,000 shares of common stock at $23.50 per share in
return for professional services rendered. These warrants expire on April 19,
2001.

F-15
<PAGE>

REPORT OF COOPERS & LYBRAND L.L.P., INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Virtual Machine Works, Inc.

We have audited the accompanying balance sheets of Virtual Machine Works,
Inc. (a Development Stage Enterprise) as of December 31, 1994 and 1995, and
the related statements of operations, stockholders' deficit, and cash flows
for the years then ended and for the period from October 6, 1993 (date of
inception) to December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Virtual Machine Works,
Inc. (a Development Stage Enterprise) as of December 31, 1994 and 1995, and
the results of its operations and its cash flows for the years then ended and
for the period from October 6, 1993 (date of inception) to December 31, 1995
in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from
operations that raise substantial doubt about its ability to continue as a
going concern. Management's plans in regard to these matters are also
described in Note 1. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.

Coopers & Lybrand L.L.P.

Boston, Massachusetts
April 12, 1996, except for Note 10, as to which the date is May 23, 1996

F-16
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- MARCH 31,
1994 1995 1996
--------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............... $ 487,772 $ 46,752 $ 1,140,423
Research contract:
Billed................................ 43,323 342,324 325,003
Unbilled.............................. 56,332 113,473 37,785
Receivable from lender.................. -- 420,000 --
Prepaid expenses and other assets....... 1,749 6,962 31,841
--------- ----------- -----------
Total current assets................ 589,176 929,511 1,535,052
Property and equipment..................
Machinery and equipment............... 136,934 232,275 250,536
Furniture and fixture................. 11,954 15,920 24,060
Purchase software..................... 7,563 10,799 10,798
--------- ----------- -----------
156,451 258,994 285,394
Less allowances for depreciation and
amortization........................ (30,019) (109,271) (132,631)
--------- ----------- -----------
Property and equipment, net........ 126,432 149,723 152,763
--------- ----------- -----------
Total assets...................... $ 715,608 $ 1,079,234 $ 1,687,815
========= =========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable........................ $ 24,852 $ 174,844 $ 176,130
Accrued payroll and related expenses.... 19,610 47,697 56,001
Accrued expenses........................ -- 46,425 43,919
Convertible demand note................. -- 420,000 497,884
--------- ----------- -----------
Total current liabilities........... 44,462 688,966 773,934
Notes payable........................... -- -- 1,250,000
Other noncurrent liabilities............ -- 4,304 3,591
Mandatorily redeemable preferred stock:
Redeemable preferred stock, Series A
($.001 par value); authorized, issued
and outstanding 600,000 shares in 1994,
1995 and 1996.......................... 647,180 695,180 707,180
Redeemable preferred stock, Series B
($.001 par value);
authorized 1,052,632 shares, issued and
outstanding 421,053 shares in 1994 and
1,052,632 shares in 1995 and 1996 ..... 825,095 2,173,170 2,212,644
Commitments (Note 7)
Stockholders' deficit:
Common stock, ($.001 par value);
authorized 4,200,000 shares, issued and
outstanding 786,964 shares in 1994 and
862,464 shares (after deduction of
reacquired shares at cost) in 1995 and
1996 .................................. 787 862 862
Deficit accumulated during the
development stage...................... (801,916) (2,483,248) (3,260,396)
--------- ----------- -----------
Total stockholders' deficit......... (801,129) (2,482,386) (3,259,534)
--------- ----------- -----------
Total liabilities and
stockholders' deficit............ $ 715,608 $ 1,079,234 $ 1,687,815
========= =========== ===========
</TABLE>

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

F-17
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
OCTOBER 6, 1993 OCTOBER 6, 1993
FOR THE YEARS ENDED (DATE OF SIX MONTHS ENDED (DATE OF
DECEMBER 31, INCEPTION) MARCH 31, INCEPTION)
---------------------- TO DECEMBER 31, ---------------------- TO MARCH 31,
1994 1995 1995 1995 1996 1996
--------- ----------- --------------- --------- ----------- ---------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Operating expenses:
Research and
development.......... $ 517,432 $ 668,570 $ 1,186,002 $ 152,279 $ 572,570 $ 1,758,572
Sales and marketing... 66,967 289,249 356,216 95,085 181,177 537,393
General and
administration....... 121,070 557,273 719,358 224,973 435,544 1,154,902
--------- ----------- ----------- --------- ----------- -----------
Loss from
operations......... (705,469) (1,515,092) (2,261,576) (472,337) (1,189,291) (3,450,867)
Interest income......... 16,577 22,360 38,937 11,464 10,271 49,208
--------- ----------- ----------- --------- ----------- -----------
Net loss................ (688,892) (1,492,732) (2,222,639) (460,873) (1,179,020) (3,401,659)
Accretion on preferred
stock.................. 71,293 188,600 260,609 69,630 102,948 363,557
--------- ----------- ----------- --------- ----------- -----------
Net loss applicable to
common stockholders.... $(760,185) $(1,681,332) $(2,483,248) $(530,503) $(1,281,968) $(3,765,216)
========= =========== =========== ========= =========== ===========
Net loss per share
applicable to common
stockholders........... $ (0.81) $ (2.08) $ (0.58) $ (1.49)
========= =========== ========= ===========
Common and common
equivalent shares used
in computing per share
amounts................ 937,865 806,468 907,079 862,464
========= =========== ========= ===========
</TABLE>

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

F-18
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF STOCKHOLDERS' DEFICIT

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
---------------- PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT DEFICIT
-------- ------ ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
December 1, 1993:
Issuance of common
stock at $.001 per
share................ 933,564 $ 934 $ -- $ -- $ 934
December 22, 1993:
Reverse stock split on
existing shares...... (83,564) (84) 84 -- --
Issuance of common
stock for patent
license.............. 118,651 119 -- -- 119
Accrued dividends on
redeemable preferred
stock.................. -- -- (84) (716) (800)
Net loss................ -- -- -- (41,015) (41,015)
-------- ----- ------- ----------- -----------
Balance at December 31,
1993................... 968,651 969 -- (41,731) (40,762)
October 31, 1994:
Forfeitures of common
stock................ (181,687) (182) 182 -- --
Accrued dividends on
redeemable preferred
stock.................. (182) (71,293) (71,475)
Net loss................ -- -- -- (688,892) (688,892)
-------- ----- ------- ----------- -----------
Balance at December 31,
1994................... 786,964 787 -- (801,916) (801,129)
September 29, 1995
Issuance of common
stock upon exercise
of stock options..... 75,500 75 7,475 -- 7,550
Accrued dividends on
redeemable preferred
stock.................. (7,475) (188,600) (196,075)
Net loss................ -- -- -- (1,492,732) (1,492,732)
-------- ----- ------- ----------- -----------
Balance at December 31,
1995................... 862,464 862 -- (2,483,248) (2,482,386)
Accrued dividends on
redeemable preferred
stock (unaudited)...... -- -- -- (51,474) (51,474)
Net loss (unaudited).... -- -- -- (725,674) (725,674)
-------- ----- ------- ----------- -----------
Balance at March 31,
1996 (unaudited)....... 862,464 $ 862 $ -- $(3,260,396) $(3,259,534)
======== ===== ======= =========== ===========
</TABLE>

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

F-19
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE YEARS ENDED OCTOBER 6, 1993 SIX MONTHS ENDED OCTOBER 6, 1993
DECEMBER 31, (DATE OF INCEPTION) MARCH 31, (DATE OF INCEPTION)
---------------------- TO DECEMBER 31, ---------------------- TO MARCH 31,
1994 1995 1995 1995 1996 1996
--------- ----------- ------------------- --------- ----------- -------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss............... $(688,892) $(1,492,732) $(2,222,639) $(460,874) $(1,179,020) $(2,948,313)
Adjustments to
reconcile net loss to
net cash used in
operating activities:
Depreciation......... 30,019 79,252 109,271 10,277 66,076 138,631
Non cash charge of
acquired technology. -- -- 119 -- -- 119
Changes in operating
assets and liabilities
Increase in research
contract--billed...... (43,323) (299,001) (342,324) (109,382) (215,621) (325,003)
Increase in research
contract--unbilled.... (56,332) (57,141) (113,473) (56,332) 18,547 (37,785)
Increase (decrease) in
prepaid expenses and
other current assets.. (1,749) (5,213) (6,962) 5,923 185,692 (31,841)
Increase in accounts
payable............... 8,840 149,992 174,844 22,485 79,052 176,130
Increase (decrease) in
payroll and related
expenses.............. 19,610 28,087 47,697 18,698 37,303 56,001
Increase (decrease) in
accrued expenses...... (40,519) 46,425 46,425 68,862 40,483 43,919
Increase (decrease) in
other non current
liabilities........... -- 4,304 4,304 -- (1,087) 3,591
--------- ----------- ----------- --------- ----------- -----------
Net cash used in
operating
activities........ (772,346) (1,546,027) (2,302,738) (500,343) (968,575) (2,930,551)
Investing activities:
Purchases of property
and equipment......... (140,816) (102,543) (258,994) (93,462) (6,847) (285,394)
--------- ----------- ----------- --------- ----------- -----------
Net cash used in
investment activi-
ties.............. (140,816) (102,543) (258,994) (93,462) (6,847) (285,394)
Financing activities:
Proceeds from debt
issuance.............. -- -- -- -- 1,250,000 1,250,000
Proceeds from demand
note issuance......... -- -- -- -- 497,884 497,884
Issuance of redeemable
preferred stock....... 900,000 1,200,000 2,600,000 832,101 -- 2,600,000
Issuance (repurchase)
of common stock....... -- 7,550 8,484 (182) 26 8,484
--------- ----------- ----------- --------- ----------- -----------
Net cash provided
by financing
activities........ 900,000 1,207,550 2,608,484 831,919 1,747,910 4,356,368
--------- ----------- ----------- --------- ----------- -----------
Increase (decrease) in
cash and cash
equivalents............ (13,162) (441,020) 46,752 238,114 772,488 1,140,423
Cash and cash
equivalents at
beginning of period.... 500,934 487,772 -- 728,352 367,935 --
--------- ----------- ----------- --------- ----------- -----------
Cash and cash
equivalents at end of
period................. $ 487,772 $ 46,752 $ 46,752 $ 966,466 $ 1,140,423 1,140,423
========= =========== =========== ========= =========== ===========
Supplemental disclosures
of noncash
transactions:
Issuance of common
stock for acquired
technology............ $ -- $ -- $ 119 $ -- $ -- $ 119
Receivable for
convertible demand
note.................. $ -- $ 420,000 $ -- $ -- $ -- $ --
</TABLE>

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

F-20
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS

(INFORMATION AS OF MARCH 31, 1996 AND FOR THE SIX MONTHS ENDED MARCH 31, 1995
AND 1996 IS UNAUDITED)

1. NATURE OF BUSINESS:

Virtual Machine Works, Inc. (the "Company") was incorporated in Delaware on
October 6, 1993. The Company was founded to develop and market advanced, low
cost, easy to use logic emulation systems to the EDA industry. Logic emulation
is the practice of using reprogrammable hardware as a physical prototype of
custom and semi-custom integrated circuits prior to their silicon fabrication.
VirtualWires, the Company's core technology, originated at the Massachusetts
Institute of Technology, and has been made available to the Company under a
long-term exclusive license (Note 8).

Since inception, the Company has devoted substantially all of its efforts to
research and development, raising capital, developing products, and recruiting
new employees. Accordingly, the Company is considered a development stage
enterprise as defined in Statement of Financial Accounting Standards No. 7 and
the accompanying financial statements represent those of a development stage
enterprise.

For the period from inception (October 6, 1993) through December 31, 1995
and for the six months ended March 31, 1996, the Company has incurred losses
from operations. The Company anticipates that it will require additional
financing to fund the completion of its products. Management's plan in
continuing their operations include raising additional funds from new
investors, generating revenues from product sales and utilizing funding from
the federal government (see Note 3). There can be no assurance that the
Company will obtain additional financing or product revenue necessary to
continue operations. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty. (See also Note 10 for
subsequent event discussing the acquisition of the Company).

2. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES:

ORGANIZATIONAL COSTS

All start-up costs of the Company are charged to expense as incurred due to
risk of recoverability.

CASH EQUIVALENTS

The Company considers all highly liquid investments with a maturity of three
months or less from purchase date to be cash equivalents include shares in a
money market mutual fund at December 31, 1994 and 1995 and March 31, 1996.

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets as
follows:

<TABLE>
<S> <C>
Machinery and equipment........................ 3 years
Furniture and fixtures......................... 5 years
Purchased software............................. 3 years
</TABLE>

Upon retirement or sale, the cost of the assets disposed of and related
accumulated depreciation are removed from the accounts and any resulting gain
or loss is included in the determination of net income or loss.

F-21
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 31, 1996 AND FOR THE SIX MONTHS ENDED MARCH 31, 1995
AND 1996 IS UNAUDITED)
RESEARCH AND DEVELOPMENT

Research and development costs are expensed as incurred. Recoverable costs
from government research and development reimbursement contracts are
recognized as the costs are incurred and offset directly against research and
development costs.

INCOME TAXES

The Company accounts for income taxes under the liability method. Under this
method, deferred tax liabilities and assets are recognized for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax basis of assets and liabilities. A valuation allowance is required
to offset any net deferred tax assets if, based upon the available evidence,
it is more likely than not that some or all of the deferred tax assets will
not be realized.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates
and assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of expenses during the reported period.
Actual results could differ from those estimates.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying value of financial instruments including cash and cash
equivalents, recoverable costs owed from research and development cost sharing
agreements, accounts payable and short-term debt approximate fair value as of
December 31, 1994 and 1995 and March 31, 1996 because of the relatively short
maturities of the instruments.

INTERIM FINANCIAL INFORMATION

The financial statements and related notes as of March 31, 1996 and for the
six months ended March 31, 1995 and 1996 are unaudited and have been prepared
on the same basis as the audited financial statements. The unaudited financial
statements include all adjustments (consisting solely of normal recurring
accruals) which are, in the opinion of management, necessary for a fair
presentation of the financial position and results of operations for the
interim period.

The results of operations for the six months ended March 31, 1996 are not
necessarily indicative of results for the the full year.

NET LOSS PER COMMON SHARE

Net loss per common share is based upon the weighted average number of
common and common equivalent shares (when dilutive) outstanding each year.
Common equivalent shares result from the assumed exercise of outstanding stock
options, the proceeds of which are then assumed to have been used to
repurchase outstanding common stock using the treasury stock method. Primary
and fully diluted earnings per share are equal for all periods presented.

CONCENTRATION OF CREDIT RISK

Financial instruments which potentially subject the Company to
concentrations of credit risk consist of temporary cash investments in money
market mutual funds and recoverable costs owed from research and development
cost sharing arrangements.

STOCK-BASED COMPENSATION

In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123), which is effective for 1996. SFAS 123 established a
fair value based method of accounting for stock-based compensation plans. The

F-22
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 31, 1996 AND FOR THE SIX MONTHS ENDED MARCH 31, 1995
AND 1996 IS UNAUDITED)
Company intends to adopt the disclosure only alternative under SFAS 123, and,
accordingly, the Company will be required to disclose the pro forma effect on
net income or loss in the notes to the financial statements using the fair
value method in 1996. The Company has not yet determined the impact of these
pro forma adjustments.

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 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 undisclosed 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.

3. GOVERNMENT RESEARCH AND DEVELOPMENT CONTRACT:

In 1994, the Company was awarded a cost-without-fee research and product
development contract from the federal government. Under the terms of the
contract the Company is to perform "best efforts" research and development
aimed at developing among other things; a low cost, easy to use logic
emulation system prototype using VirtualWires technology, algorithms and
software packages for VirtualWires systems, and software compilation
technology which will allow high level designs for rapid prototyping,
simulation and emulation.

The contract commenced in September 1994 and is expected to run
approximately 36 months (but not to exceed 10 years). Costs incurred by the
Company on the contract plus applicable overhead are billed monthly to the
federal government. The total contract upper limit is $3,846,387 ($2,008,712
authorized at December 31, 1995 and at March 31, 1996). Amounts included in
these financial statements relating to the contract are as follows:
<TABLE>
<CAPTION>
OCTOBER 6,
1993 (DATE
OF SIX
INCEPTION) MONTHS
DECEMBER 31, TO ENDED
------------------- DECEMBER 31, MARCH
1994 1995 1995 31, 1996
-------- ---------- ------------ --------
<S> <C> <C> <C> <C>
Total costs billed and recovered..... $ 66,059 $ 948,458 $1,014,517 $423,698
Total costs billed but not yet
received............................ 43,323 342,324 342,324 325,004
Total costs incurred but not yet
billed.............................. 56,332 113,473 113,473 37,785
Total costs incurred under contract
and netted against research and
development expense................. $165,714 $1,404,255 $1,470,314 $786,487
</TABLE>

There is no allowance for uncollectible costs under the contract.

4. INCOME TAXES

No income tax provision or benefit has been provided for federal income tax
purposes as the Company has incurred losses since inception.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of deferred income taxes were as follows:
<TABLE>
<CAPTION>
1994 1995
--------- ---------
<S> <C> <C>
Gross deferred tax assets:
Net operating losses.................................... $ 256,000 $ 788,000
Research and development credits........................ 34,000 94,000
Start-up costs.......................................... 26,000 79,000
Other................................................... 11,000 20,000
--------- ---------
Total................................................. 327,000 981,000
Valuation allowance..................................... (327,000) (981,000)
--------- ---------
Net deferred tax asset.................................. $ -- $ --
========= =========
</TABLE>

F-23
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 31, 1996 AND FOR THE SIX MONTHS ENDED MARCH 31, 1995
AND 1996 IS UNAUDITED)
Management of the Company has evaluated the positive and negative evidence
impacting the realizability of its deferred tax assets, and has determined
that based on the weight of the available evidence, it is more likely than not
that all of the deferred tax assets will not be realized, accordingly, the
deferred tax assets have been fully reserved. If the Company achieves
profitability, the net deferred tax asset would be available to offset future
income tax expense.

At December 31, 1994 and 1995, the Company had net operating loss
carryforwards of approximately $640,000 and $1,970,000, respectively, which
begin to expire in the year 2008.

At December 31, 1994 and 1995, the Company also had approximately $34,000
and $94,000, respectively, of research and experimentation credit
carryforwards (which begin to expire in 2008) for tax purposes that are
available to offset federal income taxes.

5. STOCKHOLDERS' DEFICIT AND MANDATORILY REDEEMABLE PREFERRED STOCK:

COMMON STOCK

Common Stock has full voting rights. Dividend and liquidation rights of
common stock are subordinated to those of all series of preferred stock.

On December 1, 1993, the founders of the Company purchased 933,564 shares of
common stock (the "Founders' Shares") at par value. Twenty percent of the
Founders' Shares immediately vested upon issuance. Thereafter, the shares
continue to vest ratably at the rate of 5% per quarter. On December 23, 1993
the Company effectuated a reverse stock split resulting in the reduction in
the number of shares of Founders' Shares from 933,564 to 850,000 shares.
Subsequently, on that same day, the Company issued 118,651 shares of common
stock to the Massachusetts Institute of Technology in accordance with the
Patent License agreement dated December 22, 1993 (Note 8).

On October 1, 1994, the Company and one of the founders entered into a
severance agreement. Under the terms of the employment agreement, the
founders' vesting schedule for his portion of the Founders' Shares (403,750)
automatically accelerate such that he will be treated as if his employment
terminated on November 1, 1995. As a result, the founder became vested in
222,063 shares of common stock. The remaining unvested stock was forfeited.
The forfeited common shares of 181,687 for financial reporting purposes are
treated as treasury stock.

MANDATORILY REDEEMABLE PREFERRED STOCK

The Company has authorized two series of $.001 par value preferred stock as
of December 31, 1995 and March 31, 1996; 600,000 shares of Series A redeemable
preferred stock and 1,052,632 shares of Series B redeemable preferred stock.
As of December 31, 1995 and March 31, 1996, 600,000 shares of Series A
redeemable preferred stock and 1,052,632 shares of Series B redeemable
preferred stock were outstanding.

DIVIDENDS

The holders of the Series A and Series B redeemable preferred stock are
entitled to receive cumulative dividends out of legally available assets of
the Company, as declared by the Board of Directors prior, and in preference
to, payment of dividends to common stockholders. Dividends accrue at $.08 and
$.15 per share, per annum, on Series A and Series B redeemable preferred
stock, respectively.

F-24
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 31, 1996 AND FOR THE SIX MONTHS ENDED MARCH 31, 1995
AND 1996 IS UNAUDITED)
VOTING RIGHTS

Series A and Series B redeemable preferred stockholders are entitled to
voting rights equivalent to those of common stockholders on most matters voted
on by holders of common stock. Certain exceptions include the election of
directors, where under different scenarios, different classes of stock are
individually responsible for electing individual directors.

LIQUIDATION

In the event of liquidation of the Company and before any distribution to
common stockholders, the Series A and B preferred stockholders are entitled to
receive an amount per share equal to the original issue price ($1.00 for
Series A and $1.90 for Series B), plus all accrued but unpaid dividends. At
December 31, 1995, the aggregate liquidation preference for both classes of
redeemable preferred stock was $2,868,350 ($2,919,824 at March 31, 1996).

Upon the merger or consolidation of the Company, or any sale or transfer of
substantially all the assets of the Company, the preferred stockholders may
elect to receive their liquidation preference immediately prior to the
transaction or, share equally in the treatment received by common stockholders
as if the preferred shares were converted at their applicable conversion
price.

REDEMPTION

The Company is required to redeem Series A and Series B redeemable preferred
stock at a price per share equal to the original issue price ($1.00 for Series
A and $1.90 for Series B), plus all accrued but unpaid dividends.

Redemption is at the option of the stockholder, however, the Company is not
required to redeem prior to 60 days after the first quarterly accounting
period in which the Company has minimum net worth in excess of $10,000,000 and
working capital in excess of $6,000,000. Additionally, the Company is not
required to redeem prior to the sixth anniversary of the preferred stock issue
date and redemption may be declined by the Company to the extent that there
are insufficient legally available funds for the purchase.

The maximum number of shares which the Company will be required to redeem in
any year shall equal (A) the total number of Series A and Series B redeemable
preferred stock shares issued by the Company (whether or not then outstanding)
multiplied by the Purchase Percentage set forth below, less (B) the number of
redeemable preferred shares previously redeemend by the Company:

<TABLE>
<CAPTION>
YEAR PURCHASE PERCENTAGE
---- -------------------
<S> <C>
Year in which redemption is requested................. 34%
First following year.................................. 67%
Second following year................................. 100%
</TABLE>

CONVERSION

Each share of Series A redeemable and Series B redeemable preferred stock is
convertible into one share of common stock, adjustable for certain dilutive
events. Conversion is at the option of the holder, but becomes automatic upon
the closing of an initial public offering in which not less than $10,000,000
of gross proceeds shall be received by the Company, at a price per share of at
least 300% of the applicable conversion price in

F-25
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 31, 1996 AND FOR THE SIX MONTHS ENDED MARCH 31, 1995
AND 1996 IS UNAUDITED)
effect for such preferred share immediately prior to the public distribution.
Applicable conversion price at December 31, 1995 and March 31, 1996 is $1.00
and $1.90 for Series A and B redeemable preferred stock, respectively. At
December 31, 1995 and March 31, 1996, 1,652,632 shares of common stock were
reserved for conversion.

PREEMPTIVE RIGHTS

Until the occurrence of certain events, holders of Series A and Series B
redeemable preferred stock have the preemptive right of subscription on a pro
rata basis, to all shares of additional preferred stock. Additionally, until
the occurrence of certain events, the holders of common stock, Series A and
Series B redeemable preferred stock have the preemptive right of subscription
to all additional shares of common stock.

1994 STOCK OPTION PLAN

The Company has adopted the 1994 Stock Option Plan (the "Plan") for
directors, officers, employees and consultants of the Company. The Plan, which
is administered by the Board of Directors, permits the Company to grant
options for the purchase of common stock, up to a maximum of 1,000,000 shares.
The Company has reserved 1,000,000 shares of common stock for issuance under
the Plan.

The Plan provides for the granting of Incentive Stock Options (ISOs) and
nonqualified stock options. The ISOs exercise price may not be less than 100%
(110% in certain cases) of the fair market value of the common stock, as
determined by the Board of Directors, on the date of the grant. The options
granted vest over a period determined by the Board of Directors upon issuance
and expire not more than ten years (five years in certain cases) from the date
of grant.

Nonqualified options grant recipients the right to purchase a specified
number of common stock shares at a purchase price of at least $.001 (par
value), as determined by the Board of Directors. The options become
exercisable over a period determined by the Board of Directors and in most
cases expire ten years from the date of grant, however, no expiration date is
required under the Plan.

In 1995, the Company granted nonqualified options to consultants for the
purchase of 50,000 shares of common stock at an exercise price of $0.30 per
share. The options were granted under similar terms as incentive stock options
from the same period and the Company has not recorded any charge for such
grants as their effect on the computation of net loss in these financial
statements is not material.

Information with respect to the options granted, exercised, and canceled is
set forth below:

<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED
-------------------- MARCH 31,
1994 1995 1996
-------- ---------- ----------
<S> <C> <C> <C>
Shares under option at beginning of peri-
od....................................... -- 430,500 705,500
Options granted........................... 460,500 387,000 67,000
Options exercised......................... -- (75,500) --
Options canceled.......................... (30,000) (1,500) (62,500)
-------- ---------- -------
Shares under option at the end of period.. 430,500 740,500 710,000
======== ========== =======
Options exercisable at end of period...... 83,906 163,721 205,895
Price per share of options granted and ex-
ercised.................................. $0.10 $0.10-0.30 $0.30
</TABLE>

F-26
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 31, 1996 AND FOR THE SIX MONTHS ENDED MARCH 31, 1995
AND 1996 IS UNAUDITED)

During 1995, 75,500 options were exercised at an option price of $0.10 per
share. During the period ended December 31, 1993, no options were granted.

A portion of the options exercised during 1995 were for common stock which
is subject to restriction. This restriction provides that the common stock may
be repurchased by the Company (at the option price paid by the employee), if
the conditions under which the options would have become exercisable cease to
exist. At December 31, 1995, 75,000 of these shares were subject to repurchase
by the Company (56,250 shares were subject to repurchase at March 31, 1996).

6. CONVERTIBLE DEMAND NOTE:

In December 1995, the Company entered into a Convertible Demand Note
Agreement (the "Note") with a face value of $420,000. The Note is payable upon
written demand of the holder and bears interest at 9% per annum. Upon the
occurrence of certain events, the Note may be converted into convertible
securities (i.e. convertible preferred stock) at the option of the holder.

Additionally, in connection with the Note, the holder received a warrant to
purchase common stock. The holder is entitled to warrant shares equal to 10%
of the principal amount of the Note divided by the eventual exercise price,
plus an additional 10% of the principal amount of the Note for each full month
the Note remains outstanding divided by the eventual exercise price. The
exercise price for warrant shares is set upon exercise at the most recent
price offered for similar shares, or, if after June 30, 1996 at $1.90 per
share (either is defined as the "Purchase Price"). In lieu of exercising the
warrants for cash, the holder may elect to receive a number of shares equal to
the value of the warrants as calculated based on the appreciation in fair
value over the Purchase Price at the date of such exercise. The warrant
terminates on December 31, 2005 or, if earlier, immediately prior to: the
closing of an initial public offering of the Company's common stock which
meets certain criteria, the closing of the sale of all or substantially all of
the Company's assets, or upon the acquisition of the Company by merger. The
Company has not recorded a charge for this warrant as the effect of this
warrant on the computation of net loss in these financial statements is not
material.

In February 1996, the Company entered into an additional Convertible Demand
Note Agreement under the same terms as the first Note with a face value of
$77,884.

All amounts outstanding at March 31, 1996 were repaid in connection with the
sale of the Company (see Note 10).

7. COMMITMENTS:

On July 24, 1995, the Company entered into a lease to rent space for its
primary office and development facilities which commenced on August 1, 1995
and expires on July 31, 1998. In February 1996, the Company also entered into
a lease to rent space for one of its sales offices which commenced on March 1,
1996 and expires on February 28, 1998. Under these agreements, minimum lease
commitments are approximately as follows:

<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1995
- -----------------------
<S> <C>
1996.................... $116,236
1997.................... 126,324
1998.................... 73,689
--------
$316,249
========
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31, 1996
- --------------------
<S> <C>
1996 (remaining nine
months)................ $116,711
1997.................... 155,124
1998.................... 78,489
--------
$350,324
========
</TABLE>

Rent expense was approximately $34,000, $88,000, $123,000 , $31,477 and
$64,000 for the years ended December 31, 1994 and 1995, for the period from
October 6, 1993 (date of inception) to December 31, 1995 and for the six
months ended March 31, 1995 and 1996, respectively.

F-27
<PAGE>

VIRTUAL MACHINE WORKS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION AS OF MARCH 31, 1996 AND FOR THE SIX MONTHS ENDED MARCH 31, 1995
AND 1996 IS UNAUDITED)

8. PATENT LICENSE AGREEMENT:

On December 22, 1993, the Company entered into an agreement with the
Massachusetts Institute of Technology ("MIT") where MIT granted a license for
the use of its VirtualWires technology to the Company for commercial product
development. In consideration for the license, the Company agreed to: pay MIT
running royalties at 1.5% of net sales from the eventual licensed products,
pay MIT running royalties at 50% of any sublicense fees received by the
Company for the eventual licensed products and processes, and issue 118,651
shares of common stock in the Company to MIT. In addition, among other things,
the Company agreed to the following minimum net sales milestones as a covenant
to the agreement. If the Company fails to meet these milestones, MIT has the
right to terminate the license agreement with 90 days notice.

<TABLE>
<S> <C>
1995................................................................ $125,000
1996................................................................ 250,000
1997 and each year thereafter....................................... 500,000
</TABLE>

For the year ended December 31, 1995, the Company failed to meet the
established milestone. The Company has received a waiver from MIT and paid MIT
1.5% of the established minimum milestone. Through March 31, 1996, the Company
has not achieved the 1996 milestone. Should the Company not meet future
milestones, the Company will need to obtain future waivers which are subject
to MIT's approval.

9. EMPLOYEE BENEFIT PLAN:

The Company has adopted a salary deferral plan (the "Plan") covering
substantially all of its employees. The Company has made no contributions to
the Plan as of December 31, 1995 or March 31, 1996.

10. SUBSEQUENT EVENT:

As of May 23, 1996, the Company was acquired by IKOS Systems, Inc. (IKOS), a
developer, manufacturer and marketer of high-performance hardware-assisted
systems for simulation of integrated circuits (IC) and IC-based electronic
systems. Under the terms of the purchase agreement, the stockholders of the
Company will receive approximately $10.0 million in cash and approximately
$5.0 million in IKOS common stock and options. Prior to March 31, 1996 and in
connection with the acquisition, the Company was advanced $1,250,000 in
exchange for a note. At March 31, 1996, the note is included in long-term debt
in the accompanying financial statements.

F-28
<PAGE>

IKOS SYSTEMS, INC. AND VIRTUAL MACHINE WORKS, INC.

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

In May 1996, IKOS Systems, Inc. (IKOS) completed the acquisition of Virtual
Machine Works, Inc. (VMW), a development stage company. The acquired company
is currently developing logic emulation systems. Under the purchase agreement,
the Company will pay approximately $10.0 million in cash and issue
approximately 113,000 shares in stock to the VMW Stockholders, options to
purchase VMW stock will be converted in options to purchase approximately
84,000 shares of IKOS Common Stock, and the Company will pay acquisition costs
of approximately $500,000. In March 1996 the Company advanced VMW
approximately $1,250,000 in exchange for a note. The purchase price allocation
is based on a preliminary appraisal received by IKOS, and will be finalized
upon closing to reflect the final balance sheet of VMW.

The following unaudited pro forma condensed combined financial statements
give effect to the acquisition of Virtual Machine Works, Inc. under the
purchase method of accounting at the date and for the period shown. Under the
purchase method of accounting, the amount relating to acquired in-process
research and development will be charged to operations as of the purchase
date. The Company presently expects to record a charge of approximately $9.6
million relating to the acquisition of in-process technology in the quarter
ending June 29, 1996.

The pro forma condensed combined balance sheet assumes the acquisition
occurred as of March 31, 1996 (the date of the balance sheet) and presents the
combined financial position of IKOS and VMW. Such unaudited pro forma
information is based on the historical balance sheets for IKOS and VMW and
gives effect for the pro forma adjustments described in the notes accompanying
the pro forma condensed combined financial statements. The charge relating to
the acquisition of in-process technology described above is included in the
pro forma condensed combined balance sheet as a charge to retained earnings.

The pro forma condensed combined statements of operations assume the
acquisition took place on October 2, 1994 and October 1, 1995 and present the
combined operating results of IKOS and VMW. Such unaudited pro forma
information is based on the historical statements of operations for IKOS and
VMW and give effect for the pro forma adjustments described in the notes
accompanying the pro forma condensed combined financial statements. The charge
relating to the acquisition of in-process technology described above is
excluded from the pro forma statements of operations as it represents a
nonrecurring item directly related to the transaction. The pro forma condensed
combined statement of operations for the year ended September 30, 1995
combines the historical statement of operations information for IKOS for the
fiscal year ended September 30, 1995 with the historical statement of
operations for VMW for the fiscal year ended December 31, 1995. The pro forma
condensed combined statement of operations for the six months ended March 30,
1996 combines the historical statement of operations information for IKOS for
the six months ended March 30, 1996 with the historical statement of
operations for VMW for the six months ended March 31, 1996. For presentation
of comparative operating periods, the results of operations of VMW for the
three months ended December 31, 1995 has been included in both the annual and
the six month interim period. The net loss for VMW for the three months ended
December 31, 1995 was approximately $453,000.

These pro forma statements 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.

F-29
<PAGE>

IKOS SYSTEMS, INC.

UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET

(IN THOUSANDS)

<TABLE>
<CAPTION>
VIRTUAL MACHINE
IKOS SYSTEMS, INC. WORKS, INC.
HISTORICAL HISTORICAL PRO FORMA PRO FORMA
MARCH 30, 1996 MARCH 31, 1996 ADJUSTMENTS MARCH 30, 1996
------------------ --------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets.......... $29,040 $ 1,535 $(10,500)(B) $20,075
Property and equipment.. 2,339 153 2,492
Other assets............ 1,455 -- 430 (C) 5,947
5,312 (C)
(1,250)(J)
------- ------- -------- -------
$32,834 $ 1,688 $ (6,008) $28,514
======= ======= ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICIENCY)
Current liabilities..... $ 9,196 $ 774 $ (498)(A) $ 9,472
Long term debt.......... 800 1,250 (1,250)(J) 800
Other liabilities....... 248 4 252
Mandatory redeemable
preferred stock........ -- 2,920 (2,920)(A) --
Commitments
Stockholders' equity:
Common stock and paid-
in capital........... 38,188 1 (1)(G) 43,188
5,000 (B)
Accumulated deficit... (15,598) (3,261) 3,261 (G) (25,198)
(9,600)(C)(H)
------- ------- -------- -------
Total stockholders'
equity (net capital
deficiency)........ 22,590 (3,260) (1,340) 17,990
------- ------- -------- -------
$32,834 $ 1,688 $ (6,008) $28,514
======= ======= ======== =======
</TABLE>

See accompanying notes to the Unaudited Pro Forma Condensed Consolidated
Financial Statements.

F-30
<PAGE>

IKOS SYSTEMS, INC.

UNAUDITED PRO FORMA
CONDENSED COMBINED STATEMENT OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
HISTORICAL
----------------------------------
VIRTUAL MACHINE
IKOS SYSTEMS, INC. WORKS, INC.
------------------ ---------------
PRO FORMA
SIX MONTHS ENDED SIX MONTHS
---------------------------------- PRO FORMA ENDED
MARCH 30, 1996 MARCH 31, 1996 ADJUSTMENTS MARCH 30, 1996
------------------ --------------- ----------- --------------
<S> <C> <C> <C> <C>
Net revenues............ $20,431 $ -- $ -- $20,431
Cost of revenues........ 4,533 -- -- 4,533
------- ------- ----- -------
Gross margin............ 15,898 -- -- 15,898
Operating expenses:
Research and
development.......... 3,268 573 -- 3,841
Sales and marketing... 6,911 181 -- 7,092
General and
administration....... 1,723 435 -- 2,158
Amortization of
acquired intangibles. -- -- 603 (D) 603
------- ------- ----- -------
Total operating
expenses........... 11,902 1,189 603 13,694
------- ------- ----- -------
Income (loss) from
operations............. 3,996 (1,189) (603) 2,204
Other income (expense).. 499 10 (294)(F) 215
------- ------- ----- -------
Income (loss) before
income taxes........... 4,495 (1,179) (897) 2,419
Provision (benefit) for
income taxes........... 710 -- (103)(I) 607
------- ------- ----- -------
Net income (loss)....... $ 3,785 $(1,179) $(794) $ 1,812
======= ======= ===== =======
Net income (loss) per
share................ $0.49 $ (1.37) $ 0.23
======= ======= =======
Shares used in computing
net income (loss)
per share.............. 7,681 862 7,878(K)
======= ======= =======
</TABLE>

See accompanying notes to the Unaudited Pro Forma Condensed Consolidated
Financial Statements.

F-31
<PAGE>

IKOS SYSTEMS, INC.

UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
HISTORICAL
------------------------------------
VIRTUAL MACHINE
IKOS SYSTEMS, INC. WORKS, INC.
------------------ -----------------
YEARS ENDED PRO FORMA
------------------------------------ PRO FORMA YEAR ENDED
SEPTEMBER 30, 1995 DECEMBER 31, 1995 ADJUSTMENTS SEPTEMBER 30, 1995
------------------ ----------------- ----------- ------------------
<S> <C> <C> <C> <C>
Net revenues............ $28,600 $ -- $ -- $28,600
Cost of revenues........ 7,139 -- -- 7,139
------- ------- ------- -------
Gross margin............ 21,461 -- -- 21,461
Operating expenses:
Research and
development.......... 3,999 669 -- 4,668
Sales and marketing... 11,763 289 -- 12,052
General and
administration....... 2,301 557 -- 2,858
Charge for acquired
in-process
technology........... -- -- -- --
Amortization of
goodwill............. -- -- 1,205 (D) 1,205
------- ------- ------- -------
Total operating
expenses........... 18,063 1,515 1,205 20,783
------- ------- ------- -------
Income (loss) from
operations............. 3,398 (1,515) (1,205) 678
Other income (expense).. 169 22 (1,058)(E) (867)
------- ------- ------- -------
Income (loss) before
income taxes........... 3,567 (1,493) (2,263) (189)
Provision (benefit) for
income taxes........... 411 -- (102)(I) 309
------- ------- ------- -------
Net income (loss)....... $ 3,156 $(1,493) $(2,161) $ (498)
======= ======= ======= =======
Net income (loss) per
share................ $ 0.51 $ (1.85) $ (0.09)
======= ======= =======
Shares used in computing
net income (loss) per
share.................. 6,151 806 5,724 (K)
======= ======= =======
</TABLE>

See accompanying notes to the Unaudited Pro Forma Condensed Consolidated
Financial Statements.

F-32
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The pro forma information presented is theoretical in nature and not
necessarily indicative of the future consolidated results of operations of the
Company or the consolidated results of operations which would have resulted
had the Company purchased Virtual Machine Works, Inc. (VMW) during the periods
presented. The pro forma condensed consolidated financial statements reflect
the effects of the acquisition, assuming the acquisition and related events
occurred as of March 30, 1996 for the purposes of the pro forma condensed
combined balance sheet and as of October 2, 1994 and October 1, 1995 for the
purposes of the pro forma condensed combined statements of operations.

2. PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENT ADJUSTMENTS:

(A) To eliminate bridge financing from redeemable preferred stockholders
and investors who were repaid with cash tendered by IKOS.

(B) The purchase price for the completion of the VMW acquisition was
determined as follows (in thousands):

<TABLE>
<S> <C>
Cash.............................................................. $10,000
IKOS common stock and stock options............................... 5,000
Estimated transaction costs, including financing warrants......... 500
-------
Consideration to stockholders and optionholders of VMW............ 15,500
Previously advanced funds to VMW.................................. 1,250
-------
$16,750
=======
</TABLE>

<TABLE>
<S> <C>
Current assets at March 31, 1996................................. $ 1,535
Property and equipment at March 31, 1996......................... 153
Acquired workforce intangible.................................... 430
Goodwill......................................................... 5,312
Assumption of VMW current and other liabilities at March 31,
1996............................................................ (280)
Acquired in-process technology................................... 9,600
-------
$16,750
=======
</TABLE>

(D) Amortization of the acquired workforce and excess purchase price
(goodwill) will be over the estimated useful lives of three years and
five years, respectively.

(E) Adjustment to interest expense to reflect the increased debt that would
have been required had the transaction occurred on October 2, 1994.

(F) To reduce interest income earned on the cash payment and cash advance
to VMW of $11,750,000 for the purchase price and related acquisition
costs.

(G) Elimination of VMW stockholders' equity amounts.

F-33
<PAGE>

IKOS SYSTEMS, INC.

NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

(H) The pro forma statement of operations exclude the charge of $9.6
million for purchased in-process research and development which arose
from the acquisition. These charges will be included in the Company's
consolidated financial statements for the year ending September 28,
1996.

The purchase price was allocated to the tangible and intangible assets
of VMW based on the fair market values of those assets using a risk
adjusted discounted cash flows approach. 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.

(I) The pro forma provision for income taxes represents the hypothetical
amount that would have resulted had the Company and VMW filed
consolidated income tax returns during the period presented. The
Company will not receive any tax benefits for either the amounts
expensed as in-process research and development costs or the expenses
related to the amortization of acquired intangible assets.

(J) To eliminate advance made by the Company to VMW prior to March 30,
1996.

(K) Shares used in net income (loss) per share computation have been
adjusted to reflect the issuance of approximately 112,946 shares of
IKOS common stock and options to purchase VMW stock will be converted
in options to purchase approximately 84,000 shares of IKOS common stock
as if the transaction had occurred on October 2, 1994 or October 1,
1995. Common equivalent shares are excluded from the computation of net
loss per share as their effect is antidilutive.

F-34
<PAGE>

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

NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING MADE BY THIS PROSPECTUS. IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES OTHER THAN THE SHARES OF COMMON STOCK TO WHICH THIS PROSPECTUS
RELATES, OR AN OFFER IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION
IS NOT AUTHORIZED, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE
HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT
THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE
DATE HEREOF.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information...................................................... 2
Information Incorporated by Reference...................................... 2
Prospectus Summary......................................................... 3
Risk Factors............................................................... 5
Use of Proceeds............................................................ 11
Price Range of Common Stock................................................ 11
Dividend Policy............................................................ 11
Capitalization............................................................. 12
Selected Consolidated Financial Data....................................... 13
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................................................ 14
Business................................................................... 21
Management................................................................. 30
Selling Stockholders....................................................... 32
Underwriting............................................................... 33
Legal Matters.............................................................. 34
Experts.................................................................... 34
Index to Financial Statements.............................................. F-1
</TABLE>

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

1,122,078 Shares

[LOGO OF IKOS SYSTEMS]

Common Stock
-----------------

PROSPECTUS

-----------------
Needham & Company, Inc.
SoundView Financial Group, Inc.
Unterberg Harris
-----------------

, 1996

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