<PAGE>   1


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

                                    FORM 10-Q

(Mark One)

[X]     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934

                     For the quarter ended June 30, 2000 or

[ ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934

             For the transition period from __________ to __________

                         Commission file number 0-21126

                                 S3 INCORPORATED
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                    DELAWARE                             77-0204341
        (State or other jurisdiction of              (I.R.S. Employer
         incorporation or organization)             Identification No.)

         2841 Mission College Boulevard
             Santa Clara, California                      95054
     (Address of principal executive offices)           (Zip Code)

       Registrant's telephone number, including area code: (408) 588-8000

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                              Yes [X]   No [ ]

The number of shares of the Registrant's Common Stock, $.0001 par value,
outstanding at July 24, 2000 was 92,004,387.


<PAGE>   2


                                 S3 INCORPORATED
                                    FORM 10-Q

                                      INDEX

<TABLE>
<CAPTION>
                                                                                                    PAGE
                                                                                                    ----
<S>                                                                                            <C>
PART I.    CONDENSED CONSOLIDATED FINANCIAL INFORMATION

Item 1.    Condensed Consolidated Financial Statements:

           Condensed Consolidated Balance Sheets June 30, 2000 and December 31, 1999                  3

           Condensed Consolidated Statements of Operations three months ended
           June 30, 2000 and 1999                                                                     4

           Condensed Consolidated Statements of Cash Flows three months ended
           June 30, 2000 and 1999                                                                     5

           Notes to Unaudited Condensed Consolidated Financial Statements                             6

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of                13
           Operations

Item 3.    Quantitative and Qualitative Disclosures About Market Risk                                31

PART II.   OTHER INFORMATION

Item 1.    Legal Proceedings                                                                         31

Item 2.    Changes in Securities                                                               Not Applicable

Item 3.    Defaults Upon Senior Securities                                                     Not Applicable

Item 4.    Submission of Matters to a Vote of Security Holders                                       33

Item 5.    Other Information                                                                   Not Applicable

Item 6.    Exhibits and Reports on Form 8-K                                                          33

Signatures                                                                                           34
</TABLE>


                                       2
<PAGE>   3

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

                                 S3 INCORPORATED
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                 (In thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                  JUNE 30,       DECEMBER 31,
                                                   2000              1999
                                                -----------      ------------
                                                (UNAUDITED)
                                     ASSETS
<S>                                             <C>               <C>
Current assets:
   Cash and cash equivalents                    $    24,288       $  45,825
   Investment - UMC                                 490,602              --
   Other short-term investments                      26,150          58,918
   Accounts receivable, (net of allowances
    of $7,860 in 2000 and $19,298 in 1999)           75,218          78,312
   Inventories, net                                 138,396          97,161
   Deferred income taxes                                 --          15,486
   Prepaid expenses and other                        25,305          28,951
                                                -----------       ---------
               Total current assets                 779,959         324,653

Property and equipment, net                          31,776          34,404
Investment - UMC                                    406,363              --
Other investments                                    24,246          92,763
Deferred taxes                                           --          56,458
Goodwill and intangible assets                      183,865         199,139
Other assets                                         14,185          15,230
                                                -----------       ---------
               Total                            $ 1,440,394       $ 722,647
                                                ===========       =========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Accounts payable                             $    82,928       $ 117,539
   Notes payable                                     14,074          51,261
   Accrued liabilities                               42,149          45,751
   Deferred taxes                                   120,585              --
   Deferred revenue                                  10,771           9,953
                                                -----------       ---------
               Total current liabilities            270,507         224,504

Long-term deferred taxes                            106,796              --
Other liabilities                                    11,567          12,010
Convertible subordinated debentures                 103,500         103,500
                                                -----------       ---------
               Total liabilities                    492,370         340,014

Stockholders' equity:
   Common stock, $.0001 par value;
    175,000,000 shares authorized;
    91,944,350 and 78,139,745 shares
    outstanding in 2000 and 1999                    592,207         434,338
   Accumulated other comprehensive loss             (56,025)         (7,563)
   Retained Earnings (Accumulated deficit)          411,842         (44,142)
                                                -----------       ---------
               Total stockholders' equity           948,024         382,633
                                                -----------       ---------
               Total                            $ 1,440,394       $ 722,647
                                                ===========       =========
</TABLE>

See accompanying notes to the unaudited condensed consolidated financial
statements.


                                       3
<PAGE>   4

                                 S3 INCORPORATED
                            STATEMENTS OF OPERATIONS
                    (In thousands, except per share amounts)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                THREE MONTHS ENDED              SIX MONTHS ENDED
                                                                      JUNE 30,                       JUNE 30,
                                                             ------------------------       -------------------------
                                                                2000           1999            2000            1999
                                                             ---------       --------       ---------       ---------
<S>                                                          <C>             <C>            <C>             <C>
Net sales                                                    $ 135,820       $ 57,253       $ 297,539       $ 101,553

Cost of sales                                                  130,816         40,716         279,131          74,749
                                                             ---------       --------       ---------       ---------
Gross margin                                                     5,004         16,537          18,408          26,804

Operating expenses:
    Research and development                                    21,274         17,450          42,031          35,487
    Selling, marketing and administrative                       27,462          8,543          57,074          16,331
    Amortization of goodwill and  intangibles                   11,083             --          21,559              --
                                                             ---------       --------       ---------       ---------
               Total operating expenses                         59,819         25,993         120,664          51,818
                                                             ---------       --------       ---------       ---------
Loss from operations                                           (54,815)        (9,456)       (102,256)        (25,014)
Gain on sale of manufacturing joint venture                      7,266          7,207          14,738           7,207
Gain on UMC investment                                              --             --         880,166              --
Gain on other investment                                         2,678             --           5,917              --
Other income (expense), net                                        849            283             672             440
                                                             ---------       --------       ---------       ---------
Income (loss) before income taxes and equity
     in income of manufacturing joint venture
     and minority interest in RioPort.com, Inc.                (44,022)        (1,966)        799,237         (17,367)
 Income taxes expense (benefit)                                (13,788)            --         336,871              --
                                                             ---------       --------       ---------       ---------
Income (loss) before equity in income
     of manufacturing joint venture and minority
     interest in RioPort.com, Inc.                             (30,234)        (1,966)        462,366         (17,367)
Equity in income from manufacturing joint venture                   --          3,066              --           4,588
Minority interest in RioPort.com, Inc.                          (6,024)            --          (6,381)             --
                                                             ---------       --------       ---------       ---------
Net income (loss)                                            $ (36,258)      $  1,100       $ 455,985       $ (12,779)
                                                             =========       ========       =========       =========
Per share amounts:
    Basic                                                    $   (0.40)      $  (0.02)      $    5.19       $   (0.24)
    Diluted                                                  $   (0.40)      $  (0.02)      $    4.55       $   (0.24)

Shares used in computing per share amounts:
    Basic                                                       91,402         53,164          87,837          52,510
    Diluted                                                     91,402         57,588         100,574          52,510

</TABLE>

See accompanying notes to the unaudited condensed consolidated financial
statements.


                                       4
<PAGE>   5

                                 S3 INCORPORATED
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                            SIX MONTHS ENDED
                                                                 JUNE 30,
                                                        ------------------------
                                                           2000           1999
                                                        ---------       --------
<S>                                                     <C>             <C>
Operating activities:
  Net income (loss)                                     $ 455,985       $(12,779)
  Adjustments to reconcile net income (loss) to net
    cash provided by (used for) operating activities:
    Deferred income taxes                                 303,496             81
    Depreciation                                           10,905          9,067
    Amortization                                           21,740             --
    Gain on sale of manufacturing joint venture           (14,738)        (7,207)
    Gain on UMC investment                               (880,166)            --
    Gain on other investments                              (5,917)            --
    Equity in income of joint venture                          --         (4,588)
    Other investments                                       6,381             --
  Changes in assets and liabilities:
            Accounts receivable                             3,094        (11,981)
            Inventories                                   (41,236)        (6,057)
            Prepaid expenses and other                       (526)        24,669
            Accounts payable                              (34,611)        24,154
            Accrued liabilities and other                  (9,883)        (1,000)
            liabilities
            Deferred revenue                                  818         (1,202)
                                                        ---------       --------
  Net cash provided by (used for) operating activities   (184,658)        13,157
                                                        ---------       --------
Investing activities:
  Property and equipment purchases, net                    (7,384)        (2,736)
  Sale (purchase) of short-term investments, net           64,472         (6,725)
  Sale of manufacturing joint venture                      14,738          7,207
  Gain on other investments                                 5,917             --
  Investment in technologies                              (36,098)            --
  Issuance of notes receivable                                 --        (10,000)
  Other assets                                                802         (1,394)
                                                        ---------       --------
  Net cash used for investing activities                   42,447        (13,648)
                                                        ---------       --------
Financing activities:
  Sale of common stock, net                               157,869          5,107
  Sale of warrant                                              --            990
  Repayments of notes payable                             (37,187)            --
                                                        ---------       --------
  Net cash provided by financing activities               120,682          6,097
                                                        ---------       --------
Effect of exchange rate changes                                (8)            --
                                                        ---------       --------
Net increase (decrease) in cash and equivalents           (21,537)         5,606
Cash and cash equivalents at beginning of period           45,825         31,022
                                                        ---------       --------
Cash and cash equivalents at end of period              $  24,288       $ 36,628
                                                        =========       ========
</TABLE>


See accompanying notes to the unaudited condensed consolidated financial
statements.


                                       5
<PAGE>   6

                                 S3 INCORPORATED
         NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.      Basis of Presentation

        The condensed consolidated financial statements have been prepared by S3
Incorporated, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission and include the accounts of S3 Incorporated
and its wholly-owned subsidiaries ("S3" or collectively the "Company"). All
significant inter-company balances and transactions have been eliminated.
Investments in entities in which the Company does not have control, but has the
ability to exercise significant influence over operating and financial policies,
are accounted for by the equity method. Certain information and footnote
disclosures, normally included in financial statements prepared in accordance
with generally accepted accounting principles, have been condensed or omitted
pursuant to such principles and the rules and regulations of the Securities and
Exchange Commission. In the opinion of the Company, the financial statements
reflect all adjustments, consisting only of normal recurring adjustments with
the exception of the in-process research and development charge discussed in
Note 2, necessary for a fair presentation of the financial position at June 30,
2000 and December 31, 1999, and the operating results and cash flows for the six
months ended June 30, 2000 and 1999. These financial statements and notes should
be read in conjunction with the Company's audited financial statements and notes
thereto for the year ended December 31, 1999, included in the Company's Form
10-K filed with the Securities and Exchange Commission.

        The results of operations for the six months ended June 30, 2000 are not
necessarily indicative of the results that may be expected for the future
quarters or the year ending December 31, 2000. Certain reclassifications of 1999
amounts were made in order to conform to the 2000 presentation.

        This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. In particular, the assumptions set forth
in Note 2 and the Management's Discussion and Analysis section of this Quarterly
Report on Form 10-Q regarding revenue growth, gross margin increases, cost
decreases and cost of capital which underlie the Company's calculation of the
in-process research and development expenses contain forward-looking statements
and are qualified by the risks detailed in "Factors That May Affect Our Results"
and other risks detailed in the Company's Annual Report on Form 10-K for the
year ended December 31, 1999 and other reports filed by S3 with the Securities
and Exchange Commission from time to time. Actual results could differ
materially from those projected in these forward-looking statements as a result
of the risks described above as well as other risks set forth in S3's periodic
reports both previously and hereafter filed with the Securities and Exchange
Commission.

2.      Business Combinations

        Merger with Diamond

        On September 24, 1999, the Company completed the acquisition of all of
the outstanding common stock of Diamond Multimedia Systems, Inc. ("Diamond").
Diamond designs, develops, manufactures and markets multimedia and connectivity
products for personal computers. The transaction was accounted for as a purchase
and, accordingly, the results of operations of Diamond and the estimated fair
value of assets acquired and liabilities assumed are included in the Company's
consolidated financial statements as of September 24, 1999, the effective date
of the purchase.

        Pursuant to the merger agreement between S3 and Diamond, each share of
Diamond common stock was converted into the right to receive 0.52 shares of the
Company's common stock. No fractional shares were issued. Stockholders otherwise
entitled to a fractional share received cash. In addition, each option and right
to acquire Diamond common stock granted under Diamond's stock-based incentive
plans was converted into an option to purchase Company common stock.
Approximately 18.7 million common shares of S3 stock were issued to Diamond
stockholders and approximately 1.3 million options were assumed.

        The purchase price of $218.3 million includes $172.2 million of stock
issued at fair value (fair value being determined as the average price of the S3
stock for a period three days before and after the announcement of the merger),
$11.7 million in Diamond stock option costs (being determined under both the
Black-Scholes formula and in accordance with the Merger Agreement), cash paid to
Diamond of $20.0 million and $14.4 million in estimated expenses of the
transaction. The purchase price was allocated as follows: $0.8 million to the
estimated fair value of Diamond net liabilities assumed (as of September 24,
1999), $6.7 million to purchased in-process research and development, $6.8
million to purchased existing technology, $11.4 million to tradenames, $5.5
million to workforce-in-place, $12.5 million to Diamond distribution channel
relationships and $174.6 million to goodwill. Goodwill is recorded as a result
of consideration paid in excess of the fair value of net tangible and intangible
assets acquired. Goodwill and identified


                                       6
<PAGE>   7

acquisition related intangible assets are amortized on a straight-line basis
over the periods indicated below. The allocation of the purchase price to
intangibles was based upon management's estimates. The purchase price and the
related allocation are subject to further refinement and change over the initial
year of combined operations.

        Management has completed its integration plans related to Diamond. The
integration plans included initiatives to combine the operations of Diamond and
S3 and consolidate duplicative operations. Areas where management estimates may
be revised primarily relate to employee severance and relocation costs and other
exit costs. Adjustments to accrued integration costs related to Diamond will be
recorded as adjustments to the fair value of net assets in the purchase price
allocation. Accrued integration charges included $3.8 million related to
involuntary employee separation and relocation benefits for employees and $2.2
million in other exit costs primarily relating to the closing or consolidation
of facilities and the termination of certain contractual relationships. The
accruals recorded related to the integration of Diamond are based upon
management's current estimate of integration costs.

        The intangible assets and goodwill acquired have estimated useful lives
and estimated first year amortization, as follows (dollars in thousands:

<TABLE>
<CAPTION>
                                                               CALCULATED
                                                 ESTIMATED     FIRST YEAR
                                    AMOUNT      USEFUL LIFE   AMORTIZATION
                                   --------     -----------   ------------
<S>                                <C>          <C>           <C>
Purchased existing technology      $  6,800      2-5 years      $ 2,708
Tradenames                           11,400      7 years          1,629
Workforce-in-place                    5,500      4 years          1,375
Diamond distribution channel         12,500      5 years          2,500
relationships
Goodwill                            174,563      5 years         34,913
</TABLE>

        The value assigned and written off as purchased in-process research and
development ("IPR&D") of $6.7 million was determined by identifying research
projects in areas for which technological feasibility had not been established.
The value was determined by estimating the expected cash flows from the projects
once commercially viable, discounting the net cash flows back to their present
value and then applying a percentage of completion to the calculated value.

        The discount rate used in discounting the net cash flows from IPR&D
ranged from 25% to 35%. Relatively high discount rates were used to reflect the
inherent uncertainties surrounding the successful development of the IPR&D,
market acceptance of the technology, the useful life of such technology and the
uncertainty of technological advances which could potentially impact the
estimates described above.

        The percentage of completion for each project was determined using costs
incurred to date on each project as compared to the remaining research and
development to be completed to bring each project to technological feasibility.
The percentage of completion varied by individual project ranging from 20% to
60%.

        If the projects discussed above are not successfully developed, the
sales and profitability of the combined company may be adversely affected in
future periods.

Purchase of Number Nine

        On February 1, 2000, the Company completed the acquisition of all of the
assets of Number Nine Visual Technology Corporation ("Number Nine"). The
purchase price of $5.3 million includes $5.1 million of cash and $0.2 million in
estimated expenses of the transaction. The purchase price was allocated as
follows: $0.7 million to the estimated fair value of Number Nine net assets (as
of February 1, 2000), $0.5 million to workforce-in-place and $4.1 million to
goodwill. Goodwill is recorded as a result of consideration paid in excess of
the fair value of net tangible and intangible assets acquired. Goodwill and
identified acquisition related intangible assets are amortized on a
straight-line basis over five years. The allocation of the purchase price to
intangibles was based upon management's estimates. The purchase price and the
related allocation are subject to further refinement and change over the initial
year of combined operations.

3.      Inventories

        Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market. Inventories consisted of:


                                       7
<PAGE>   8

<TABLE>
<CAPTION>
                     JUNE 30,   DECEMBER 31,
                       2000         1999
                     --------   ------------
                         (IN THOUSANDS)
<S>                  <C>           <C>
Raw materials        $ 86,810      $40,132
Work in process         1,559       10,418
Finished goods         50,027       46,611
                     --------      -------
   Total             $138,396      $97,161
                     ========      =======
</TABLE>

4.      Investments

Investment in USC

        In June of 1999, the Company announced that it would receive $42.0
million for a patent license and release associated with the sale of 80 million
shares its stock of United Semiconductor Corporation ("USC") in January 1998.
Payments will be received over five fiscal quarters beginning in the quarter
ended June 30, 1999. Under the terms of the agreement, S3 will license to United
Microelectronics Corporation ("UMC") 29 patents covering multimedia products and
integrated circuit manufacturing technology for use in products manufactured by
UMC.

        In June 1999, UMC announced a foundry consolidation plans whereby USC,
United Integrated Circuits Corporation, United Silicon Incorporated and UTEK
Semiconductor Corporation would be merged into UMC. Under the terms of the
consolidation play, each of the Company's shares in the USC joint venture would
be exchanged for one share of UMC. On January 4, 2000, the Company's 252 million
shares of USC were exchanged for 252 million UMC shares of stock. The Company
recorded a gain on the transfer of the shares of $880.2 million to recognize the
difference in the carrying value of its investment in USC and the fair market
value of the UMC shares on the date of the transfer. Approximately half of the
shares received are subject to sale restrictions and are carried at market value
as of January 4, 2000 as long-term assets in the accompanying balance sheet at
June 30, 2000. As the remaining shares are publicly traded, the investment is
adjusted to fair market value in accordance with SFAS 115 and classified as
short-term investments.

        The Company received a 20% stock dividend, or approximately 50.4 million
shares of UMC, in a transaction which was approved by the UMC's shareholders at
its Annual Shareholders Meeting on April 7, 2000. With the stock dividend, the
Company's investment holdings in UMC has increased to approximately 302 millions
shares. At June 30, 2000, approximately 176 million shares are classified as a
current asset with approximately 126 millions shares as a long-term asset.

Interest in Partnership

        In 1995, the Company entered into a limited partnership arrangement (the
"partnership") with a developer to obtain a ground lease and develop and operate
the Company's current Santa Clara facilities. The Company invested $2.1 million
for a 50% limited partnership interest. On June 29, 1999, the Company entered
into an agreement to assign to the general partner the Company's entire interest
in the partnership for $7.8 million. The gain on the assignment of the Company's
partnership interest is being recognized over the term of the facilities lease,
which expires in 2008.

Investment in OneStep, LLC and RioPort.com, Inc.

        In July 1999, the Company acquired OneStep, LLC, a software development
company that supplies the Rio Audio Manager to RioPort.com, Inc., ("RioPort")
for $10.9 million in cash. The Rio Audio Manager is designed to allow audio
enthusiasts to easily acquire, create, organize and playback music or spoken
audio programming in one simple application.

        In October 1999, S3 caused RioPort, which was a wholly owned subsidiary,
to sell shares of its preferred stock to third party investors. RioPort is
developing an integrated platform for acquiring, managing and experiencing music
and spoken audio programming from the Internet. As a result, the Company retains
a minority investment in RioPort and accounts for its investment using the
equity method of accounting. In addition, in November 1999, the Company received
$10.9 million for the sale of OneStep, LLC to RioPort.com, Inc.

        In June 2000, RioPort sold additional preferred stock to third party
investors. As part of this financing, the Company invested an additional $10.7
million in RioPort, maintaining its percentage ownership of RioPort.

Investment in S3-VIA, Inc.


                                       8
<PAGE>   9
        In November 1999, the Company established a joint venture with VIA
Technologies, Inc. to bring high-performance integrated graphics and core logic
chip sets to the volume OEM desktop and notebook PC markets. The newly formed
S3-VIA, Inc. will have joint funding, exclusive access to both companies'
technology and distribution rights for developed products between S3 and VIA.
The Company owns 50.1% of the voting common stock of the joint venture.
Accordingly, the Company consolidates the accounts of S3-VIA, Inc. in its
consolidated financial statements.

5.      Notes Payable

        In 1995 the Company expanded and formalized its relationship with Taiwan
Semiconductor Manufacturing Company ("TSMC") to provide additional capacity over
the 1996 to 2000 timeframe. The agreement with TSMC requires the Company to make
certain annual advance payments to be applied against the following year's
capacity. The Company has signed promissory notes to secure these payments over
the term of the agreement. The notes bear interest at 10% per annum commencing
on the individual note's maturity dates if such notes are not paid. At June 30,
2000, the remaining advance payments totaled $14.3 million and the corresponding
promissory notes totaled $9.6 million. During the second quarter of 1999, the
Company and TSMC agreed to extend the term of the agreement two years to 2002.
The corresponding notes payable were extended with the final payment due in
2001.

        At June 30, 2000, the Company had a $50.0 million domestic bank facility
permitting borrowings at the prime rate. This bank facility expires in January
2001. The covenants covering this debt agreement pertain to minimum levels of
collateral coverage and tangible net worth, quarterly profitability and minimum
levels of liquidity. As of June 30, 2000, the Company is in compliance with all
loan covenants. Additionally, the Company has credit facilities under foreign
lines of credit. The Company has a foreign line of credit of 10 million
DeutscheMarks (approximately $4.8 million at June 30, 2000). The Company also
has a foreign line of credit of 400,000 British Pounds (approximately $608,000
at June 30, 2000). There were no borrowings under these facilities at June 30,
2000.

        As of June 30, 2000, the Company's future payments on debt related to
notes payable, lines of credit and capital lease obligations are due in 2000,
therefore all amounts have been classified as current.

6.      Earnings (Loss) Per Share

        Basic earnings (loss) per share ("EPS") is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
would occur from any instrument or options which could result in additional
common shares being issued.

        When computing earnings (loss) per share, the Company includes only
potential common shares that are dilutive. Exercise of options and conversion of
convertible debt in the three months ended June 30, 2000 and six months ended
June 30, 1999 are not assumed because the result would have been anti-dilutive.

        The following table sets forth the computation of basic and diluted
earnings (loss) per share:

<TABLE>
<CAPTION>
                                            THREE MONTHS ENDED            SIX MONTHS ENDED
                                          ----------------------      ------------------------
                                          JUNE 30,      JUNE 30,      JUNE 30,        JUNE 30,
                                            2000          1999          2000            1999
                                          --------      --------      --------        --------
                                                (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<S>                                       <C>            <C>          <C>             <C>
NUMERATOR
   Net income (loss)
      Basic                               $(36,258)      $ 1,100      $ 455,985       $(12,779)
      Interest expense on                       --            --          1,932             --
        subordinated debt
                                          --------       -------      ---------       --------
      Diluted                             $(36,258)      $ 1,100      $ 454,053       $(12,779)
                                          ========       =======      =========       ========

DENOMINATOR
    Denominator for basic earnings          91,402        53,164         91,402         52,510
      (loss) per share
    Common stock equivalents                    --         4,424          6,496             --
    Subordinated debt                           --            --          5,385             --
                                          --------       -------      ---------       --------
    Denominator for diluted earnings        91,402        57,588         52,510         52,510
      (loss) per share
                                          ========       =======      =========       ========
Basic earnings (loss) per share           $  (0.40)      $  0.02      $   (5.19)      $  (0.24)
Diluted earnings (loss) per share         $  (0.40)      $  0.02      $   (4.55)      $  (0.24)
</TABLE>


                                       9
<PAGE>   10

7.      Comprehensive Income (Loss)

        The Company's available-for-sale securities and foreign currency
translation adjustments are included in other comprehensive income (loss).

        The following are the components of accumulated other comprehensive
loss, net of tax:

<TABLE>
<CAPTION>
                                              JUNE 30,    DECEMBER 31,
                                               2000           1999
                                             --------     ------------
                                                  (IN THOUSANDS)
<S>                                          <C>            <C>
Unrealized gain (loss) on investments        $(47,651)      $   803
Foreign currency translation                   (8,374)       (8,366)
adjustments                                  --------       -------
Accumulated other comprehensive loss         $(56,025)      $(7,563)
                                             ========       =======
</TABLE>


   The following schedule of other comprehensive loss shows the gross
current-period gain (loss) and the reclassification adjustment:

<TABLE>
<CAPTION>
                                                           THREE MONTHS ENDED           SIX MONTHS ENDED
                                                                JUNE 30,                    JUNE 30,
                                                       -----------------------      -----------------------
                                                         2000           1999         2000            1999
                                                       ---------      --------      -------        --------
                                                                          (IN THOUSANDS)
<S>                                                    <C>            <C>           <C>            <C>
Unrealized gain on investments:
  Unrealized loss)on available-for-sale securities     $(47,496)      $  (929)      $(46,458)      $  (550)
  Less: reclassification adjustment for (gain)
     loss realized in net income                             (2)           21         (1,996)           67
                                                       --------       -------       --------       -------
Net unrealized loss on investments                      (47,498)         (908)       (48,454)         (483)
Foreign currency translation adjustments                      1         1,126             (8)       (1,578)
                                                       --------       -------       --------       -------
Other comprehensive income (loss)                      $(47,497)      $   218       $(48,462)      $(2,061)
                                                       ========       =======       ========       =======
</TABLE>

8.      Contingencies

        The semiconductor and personal computing products industries are
characterized by frequent litigation, including litigation regarding patent and
other intellectual property rights. The Company is party to various legal
proceedings that arise in the ordinary course of business. Although the ultimate
outcome of these matters is not presently determinable, management believes that
the resolution of all such pending matters will not have a material adverse
effect on the Company's financial position or results of operations.

        Since November 1997, a number of complaints have been filed in federal
and state courts seeking unspecified damages on behalf of an alleged class of
persons who purchased shares of the Company's common stock at various times
between April 18, 1996 and November 3, 1997. The complaints name as defendants
the Company, certain of its officers and former officers, and certain directors
of the Company, asserting that they violated federal and state securities laws
by misrepresenting and failing to disclose certain information about the
Company's business. In addition, certain stockholders have filed derivative
actions in the state courts of California and Delaware seeking recovery on
behalf of the Company, alleging, among other things, breach of fiduciary duties
by such individual defendants. The plaintiffs in the derivative action in
Delaware have not taken any steps to pursue their case. The derivative cases in
California state court have been consolidated, and plaintiffs have filed a
consolidated amended complaint. The court has entered a stipulated order in
those derivative cases suspending court proceedings and coordinating discovery
in them with discovery in the class actions in California state courts. On
plaintiffs' motion, the federal court has dismissed the federal class actions
without prejudice. The class actions in California state court have been
consolidated, and plaintiffs have filed a consolidated amended complaint. The
Company has answered that complaint. Discovery is pending. While management
intends to defend the actions against the Company vigorously, there can be no
assurance that an adverse result or settlement with regard to these lawsuits
would not have a material adverse effect on the Company's financial condition or
results of operations.

        The Company has received from the Securities and Exchange Commission a
request for information relating to the Company's restatement announcement in
November 1997. The Company has responded and intends to continue to respond to
such requests.

        The Company is also defending several putative class action lawsuits
naming Diamond, which were filed in June and July 1996 and June 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain former executive officers and
directors of Diamond are also named as defendants. The plaintiffs purport to
represent a class of all persons who purchased Diamond's Common Stock between
October 18, 1995 and June 20, 1996 (the "Class


                                       10
<PAGE>   11
Period"). The complaints allege claims under the federal securities laws and
California law. The plaintiffs allege that Diamond and the other defendants made
various material misrepresentations and omissions during the Class Period. The
complaints do not specify the amount of damages sought. On March 24, 2000, the
District Court for the Northern District of California dismissed the federal
action without prejudice. The Company believes that it has good defenses to the
claims alleged in the California Superior Court lawsuit and will defend itself
vigorously against this action. No trial date has been set for this action.

        On August 4, 1999, two alleged stockholders of Diamond filed a lawsuit,
captioned Strum v. Schroeder, et al., in the Superior Court of the State of
California for the County of Santa Clara. Plaintiffs, on behalf of themselves
and a class of all former Diamond stockholders similarly situated whom they
purportedly represent, challenging the terms of the Company's merger with
Diamond. The complaint named Diamond, the former directors of Diamond and the
Company as defendants. The complaint alleged generally that Diamond's directors
breached their fiduciary duties to stockholders of Diamond and sought rescission
and the recovery of unspecified damages, fees and expenses. The case was
dismissed on May 25, 2000, with prejudice as to the named plaintiffs and
without prejudice as to the alleged class.

        Sega initiated a claim for arbitration in Tokyo, Japan against Diamond
in December 1998. The claim arises out of an agreement entered into between Sega
and Diamond in September 1995, in which Sega agreed to provide Diamond with Sega
game software that Diamond would bundle with its 3-D graphics board "The Edge."
Sega claims that Diamond breached the parties' agreement by failing to pay Sega
a contractual minimum royalty fee for the games as set forth in the agreement.
Sega claims as damages $3,800,000 in unpaid royalties and pre-judgment interest.
On May 28, 1999, Diamond responded to Sega's claims by filing an answer in which
it denied the material allegations of Sega's claims. The parties have filed
additional briefs in support of their claims and defenses. An evidentiary
hearing on this action has not yet been scheduled. The Company contests the
material allegations of Sega's claims. In addition, the Company has pleaded that
Sega's failure to provide it with 3-D optimized game software on a timely basis
adversely affected sales of The Edge. The Company claims that these lost sales
and profits should provide an offset to Sega's claims in the arbitration and
intends to defend the suit vigorously.

        C3 Sales, Inc. ("C3") filed suit against S3 on October 6, 1999 in the
Harris County (Houston), Texas District Court. The petition sought a judicial
declaration that a Sales Representative Agreement entered into between C3 and S3
on May 19, 1999 was a valid contract that governed the relationship between the
two parties. On November 8, 1999, S3 answered acknowledging that the May 19,
1999 agreement was a contract between the two parties. C3 failed to respond to
informal requests by S3 to dismiss the declaratory relief action on grounds that
no justiciable controversy existed between the parties. On December 3, 1999, S3
filed a summary judgment motion seeking judgment against C3 on the grounds that
no issues of material fact remain to be determined regarding the declaratory
judgment sought by C3. C3 responded by filing an amended petition raising new
matters. Specifically, C3's new claims allege that the Sales Representative
Agreement applies to Diamond products, and that certain commissions due under
the agreement have not been paid. S3 intends to defend this action vigorously.

        On January 6, 2000, PhoneTel Communications, Inc. ("PhoneTel") filed a
complaint for patent infringement against a group of defendants, including
Diamond, in the United States District Court for the Northern District of Texas.
PhoneTel generally alleges that Diamond and the other defendants are infringing
its two patents by making, using, selling, offering to sell and/or importing
digital synthesizers, personal computers, sound cards, or console game systems.
PhoneTel does not specify which Diamond products allegedly infringe its patents.
S3 filed Diamond's answer to the complaint on March 28, 2000. S3 believes that
the complaint is without merit and will vigorously defend itself against the
allegations made in the complaint.

        The ultimate outcome of these actions cannot be presently determined.
Accordingly, no provision for any liability or loss that may result from
adjudication or settlement of the lawsuits has been made in the accompanying
condensed consolidated financial statements.

9.      Proposed Joint Venture

        The Company, and VIA Technologies, Inc., a corporation organized under
the laws of Taiwan ("VIA"), entered into an Investment Agreement, dated as of
April 10, 2000 (the "Agreement"). Pursuant to the Agreement, the Company and VIA
will form a new joint venture (the "Joint Venture") for the purpose of
manufacturing and distributing graphics products and conducting related research
and development activities. At the closing of the transactions contemplated by
the Agreement, the Company will transfer to the Joint Venture its graphics chip
business in exchange for 100,000,000 shares of Class A common stock of the Joint
Venture. In addition, at the closing, VIA will deliver to the Joint Venture
$79.9 million in cash or a combination of cash and Via or S3 equity securities,
which in turn will be delivered by the Joint Venture to the Company (minus an
amount retained by the Joint Venture for the benefit of employees of the Joint
Venture), in exchange for 10,000,000 shares of Class B common stock of the Joint
Venture. The Joint Venture


                                       11
<PAGE>   12

will assume $38.5 million in debt from the Company. The Joint Venture will also
issue to the Company a promissory note with an aggregate principal amount of
$239.6 million, which will be payable in equal annual installments on each of
the first three anniversaries of the closing date of the formation of the Joint
Venture. The payments may be made, at the Joint Venture's option, in cash or a
combination of cash and Via or S3 equity securities. The note will be secured by
certain assets of the Joint Venture.

        In addition, the Company will receive additional payments from the Joint
Venture if certain specified financial milestones are achieved by the Joint
Venture.

        The closing of the transactions contemplated by the Agreement is
conditioned upon certain closing conditions, including the expiration or early
termination of the applicable waiting period under the Hart-Scott-Rodino
Antitrust Improvement Act and the approval of the government of the government
of Taiwan. In addition, the closing is conditioned upon the issuance by the
Company to VIA or an affiliate thereof of 3,000,000 shares of the Company's
common stock at a price per share of $17.875, and the election of a designee of
VIA to the Board of Directors of the Company. On July 1, 2000, the Investment
Commission of Ministry of Economic Affairs of the Taiwan Government informed VIA
that it would not approve the transaction as proposed, but that VIA could
reapply for approval. The Company and VIA are discussing additional efforts to
obtain the approval of the Taiwan Government, including a possible restructuring
of the proposed transaction's terms.

10.     Subsequent Events

        In July 2000, the Company terminated the "take and pay" contract with
Taiwan Semiconductor Manufacturing Company ("TSMC") and a foundry relationship
with United Microelectronics Corporation ("UMC"). The Company's agreement with
TSMC provided capacity through 2002 and requires us to make annual advance
payments to purchase specified capacity to be applied against the following
year's capacity or to forfeit advance payments against those amounts. The
Company received a refund of approximately $4.8 million and cancelled the notes
payable.

                                       12
<PAGE>   13

PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION

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

        When used in this Report, the words "expects," "anticipates,"
"estimates" and similar expressions are intended to identify forward-looking
statements. Such statements, which include statements concerning the timing of
availability and functionality of products under development, product mix,
trends in average selling prices, trends in the personal computer ("PC") market,
the percentage of export sales and sales to strategic customers and the
availability and cost of products from the Company's suppliers, are subject to
risks and uncertainties, including those set forth below under "Factors That May
Affect Our Results" and elsewhere in this report, that could cause actual
results to differ materially from those projected. These forward-looking
statements speak only as of the date hereof. The Company expressly disclaims any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any change in the
Company's expectations with regard thereto or any change in events, conditions
or circumstances on which any statement is based.

OVERVIEW

        S3(R) Incorporated ("S3" or the "Company") designs, develops,
manufactures and distributes multimedia, connectivity and Internet appliance
products for the PC and consumer appliance markets. The Company has been a
leading supplier of graphics and multimedia accelerator subsystems for PCs for
over ten years.

        In September 1999, S3 made a significant strategic shift by merging with
Diamond Multimedia Systems, Inc. ("Diamond"), an established original PC
equipment manufacturer ("OEM") and retail provider of communications and home
networking solutions, PC graphics and audio add-in boards, digital audio players
and Internet appliances. Diamond products include the Rio line of Internet music
players, the Stealth and Viper series of video accelerators, the Monster series
of gaming accelerators, the Fire series of NT workstation 3D graphics
accelerators, the Supra series of modems and the HomeFree line of home
networking products. The transaction was accounted for as a purchase and,
accordingly, the results of operations of Diamond and the estimated fair value
of assets acquired and liabilities assumed are included in the Company's
consolidated financial statements as of September 24, 1999, the effective date
of the purchase.

        In October 1999, S3 announced that it caused RioPort.com Inc., which was
a wholly owned subsidiary, to sell shares of its preferred stock to third party
venture capital and strategic investors. RioPort.com, Inc. is developing an
integrated platform for acquiring, managing and experiencing music and spoken
audio programming from the Internet. As a result of the preferred stock
financing, the Company retained a minority investment in RioPort.com, Inc. and
accounts for its investment using the equity method of accounting. In addition,
in November 1999, the Company received $10.9 million for the sale of OneStep,
LLC to RioPort.com, Inc. In June 2000, RioPort sold additional preferred stock
to third party investors. As part of this financing, the Company invested an
additional $10.7 million in RioPort, maintaining its percentage ownership of
RioPort.

        In November 1999, the Company established a joint venture with VIA
Technologies, Inc. to bring high-performance integrated graphics and core logic
chip sets to the volume OEM desktop and notebook PC markets. The newly formed
S3-VIA Inc. will have joint funding, exclusive access to both companies'
technology and distribution rights for developed products between S3 and VIA.
The Company owns 50.1% of the voting common stock of the joint venture.
Accordingly, the Company consolidates the accounts of S3-VIA Inc. in its
consolidated financial statements.

        The Company, and VIA Technologies, Inc., a corporation organized under
the laws of Taiwan ("VIA"), entered into an Investment Agreement, dated as of
April 10, 2000 (the "Agreement"). Pursuant to the Agreement, the Company and VIA
will form a new joint venture (the "Joint Venture") for the purposes of
manufacturing and distributing graphics products and conducting related research
and development activities. See "Recent Developments."

RESULTS OF OPERATIONS

        The following table sets forth certain financial data for the periods
indicated as a percentage of net sales:

<TABLE>
<CAPTION>
                                                     THREE MONTHS ENDED           SIX MONTHS ENDED
                                                          JUNE 30,                     JUNE 30,
                                                    --------------------        --------------------
                                                     2000          1999          2000          1999
                                                    ------        ------        ------        ------
<S>                                                 <C>           <C>           <C>           <C>
Net sales                                            100.0%        100.0%        100.0%        100.0%
Cost of sales                                         96.3          71.1          93.8          73.6
                                                    ------        ------        ------        ------
</TABLE>


                                       13
<PAGE>   14

<TABLE>
<S>                                                                   <C>          <C>            <C>          <C>
Gross margin                                                             3.7          28.9           6.2          26.4
Operating expenses:
   Research and development                                             15.7          30.5          14.1          34.9
   Selling, marketing and administrative                                20.2          14.9          19.2          16.1
   Amortization of goodwill and intangibles                              8.2            --           7.2            --
                                                                      ------        ------        ------        ------
           Total operating expenses                                     44.0          45.4          40.6          51.0
                                                                      ------        ------        ------        ------
Loss from operations                                                   (40.4)        (16.5)        (34.4)        (24.6)
Gain on sale of manufacturing joint venture                              5.3          12.6           5.0           7.1
Gain on UMC investment                                                    --            --         295.8            --
Gain on VIA investment                                                   2.0            --           2.0            --
Other income (expense), net                                              0.6           0.5           0.2           0.4
                                                                      ------        ------        ------        ------
Income (loss) before income taxes and equity
      in income of manufacturing joint venture
      and minority interest in RioPort.com, Inc.                       (32.4)         (3.4)        268.6         (17.1)
Provision for income taxes                                             (10.2)           --         113.2            --
                                                                      ------        ------        ------        ------
Income (loss) before equity in income of manufacturing
       joint venture and minority interest in RioPort.com, Inc.        (22.3)         (3.4)        155.4         (17.1)
Equity in income from manufacturing joint venture                         --           5.4            --           4.5

Minority interest in RioPort.com, Inc.                                  (4.4)           --          (2.1)           --
                                                                      ------        ------        ------        ------
Net income (loss)                                                      (26.7)%         1.9%        153.3%        (12.6)%
                                                                      ======        ======        ======        ======
</TABLE>

NET SALES

        The Company's net sales year to date have been generated from the sale
of its graphics and multimedia accelerators, connectivity products for the home
and products for acquiring, managing and experiencing music and spoken audio
programming from the Internet. The Company's products are used in, and its
business is dependent upon, the personal computer industry and growth of the
Internet with sales primarily in the U.S., Asia and Europe. Net sales were
$135.8 million for the three months ended June 30, 2000, a 137.0% increase from
the $57.3 million of net sales for the three months ended June 30, 1999. Net
sales were $297.5 million for the six months ended June 30, 2000, a 192.8%
increase from the $101.6 million of net sales for the six months ended June 30,
1999. Sales increased from 1999 to 2000 because of the acquisition of Diamond
and the inclusion of the revenue of Diamond products in the Company's financial
results of operations in the three months ended June 30, 2000 and six months
ended June 30, 2000. Net sales for the three months ended June 30, 2000 and six
months ended June 30, 2000 consisted primarily of the Company's graphics chips,
Diamond brand graphics add-in cards, modem and communication products and Rio
digital audio players while net sales for the three months ended June 30, 1999
and six months ended June 30, 1999 consisted primarily of the Company's graphics
chips. The net sales for the three months and six months ended June 30, 2000 for
the Company's graphics chips, excluding graphics chips integrated in the
Company's Diamond brand graphics add-in cards, were $21.4 million and $58.8
million respectively.

        The Company expects that the percentage of its net sales represented by
any one product or type of product may change significantly from period to
period as new products are introduced and existing products reach the end of
their product life cycles. Due to competitive price pressures, the Company's
products experience declining unit average selling prices over time, which at
times can be substantial.

        International sales accounted for 54% and 82% of net sales for the three
months ended June 30, 2000 and 1999, respectively. International sales accounted
for 54% and 90% of net sales for the six months ended June 30, 2000 and 1999,
respectively. Approximately 29% and 50% of international sales for the three
months ended June 30, 2000 and 1999, respectively, were to affiliates of United
States customers. Approximately 27% and 47% of international sales for the six
months ended June 30, 2000 and 1999, respectively, were to affiliates of United
States customers. The shift in international and domestic sales distribution in
2000 was primarily the result of the inclusion of the acquired multimedia and
communications products from the Diamond acquisition. The Company expects that
international sales will continue to represent a significant portion of net
sales, although there can be no assurance that international sales as a
percentage of net sales will remain at current levels. All sales transactions
were denominated in U.S. dollars.

        Two customers accounted for 23% and 14% of net sales, respectively, for
the three months ended June 30, 2000. Two customers and two distributors
accounted for 17%, 10%, 17% and 10% of net sales, respectively, for the three
months ended June 30, 1999. Two customers accounted for 18% and 10% of net
sales, respectively, for the six months ended June 30, 2000. One customer and
two distributors accounted for 25%, 21% and 12% of net sales, respectively, for
the six months ended June 30, 1999. The Company expects a significant portion of
its future sales to remain concentrated within a limited number of strategic
customers. There can be no assurance that the Company will be able to retain its
strategic customers or that such customers will not otherwise cancel or
reschedule orders, or in the event of canceled orders, that such orders will be
replaced by other sales. In addition, sales to any particular customer may
fluctuate significantly from quarter to quarter. The occurrence of any such
events or the loss of a strategic customer could have a material adverse effect
on the Company's operating results.


                                       14
<PAGE>   15

GROSS MARGIN

        Gross margin percentage decreased to 3.7% for the three months ended
June 30, 2000 from 28.9% for the three months ended June 30, 1999. Gross margin
percentage decreased to 6.2% for the six months ended June 30, 2000 from 26.4%
for the six months ended June 30, 1999. The decrease was primarily the result of
inclusion of manufacturing costs for the Diamond products. Another factor
resulting in the decreased gross margin is the highly competitive pricing
pressures in the market for mainstream and entertainment graphics accelerators.
This was partially offset by improving margins on the Company's desktop chips
and communications products.

        In the future, the Company's gross margin percentages may be affected by
increased competition and related decreases in the unit average selling prices
(particularly with respect to older generation products), timing of volume
shipments of new products, the availability and cost of products from the
Company's suppliers, changes in the mix of products sold, the extent to which
the Company forfeits or utilizes its production capacity rights with Taiwan
Semiconductor Manufacturing Company ("TSMC"), the extent to which the Company
will incur additional licensing fees and shifts in sales mix between add-in card
and motherboard manufacturers and systems OEMs.

RESEARCH AND DEVELOPMENT EXPENSES

        The Company has made and intends to continue to make significant
investments in research and development to remain competitive by developing new
and enhanced products. Research and development expenses were $21.3 million for
the three months ended June 30, 2000, an increase of $3.8 million from $17.5
million for the three months ended June 30, 1999. Research and development
expenses were $42.0 million for the six months ended June 30, 2000, an increase
of $6.5 million from $35.5 million for the six months ended June 30, 1999. This
increase was due primarily to inclusion of headcount and related expenses
associated with the Diamond acquisition savings partially offset by an increased
focus on core technology and products. Concentration of research and development
efforts resulted in lower overhead, headcount and related costs. Write-offs of
idle and excess capital equipment resulted in lower depreciation and maintenance
charges.

SELLING, MARKETING AND ADMINISTRATIVE EXPENSES

        Selling, marketing and administrative expenses consist primarily of
salaries, related benefits and fees for professional services, such as legal and
accounting services. Selling, marketing and administrative expenses were $27.5
million for the three months ended June 30, 2000, an increase of $19.0 million
from $8.5 million for the three months ended June 30, 1999. Selling, marketing
and administrative expenses were $57.1 million for the six months ended June 30,
2000, an increase of $40.8 million from $16.3 million for the six months ended
June 30, 1999. Selling, marketing and administrative expenses increased from the
prior year due primarily to the integration and combination of selling,
marketing and administrative headcount and related expenses due to the
acquisition of Diamond. As a percentage of revenue, selling, marketing and
administrative expenses increased from 16.1% in 1999 to 19.2% in 2000.

GAIN ON SALE OF MANUFACTURING JOINT VENTURE

        On December 31, 1997, the Company entered into an agreement to sell to
United Microelectronics Corporation ("UMC") 80 million shares of stock of United
Semiconductor Corporation ("USC") for a purchase price of 2.4 billion New Taiwan
dollars. The Company received the purchase price (approximately $68.0 million in
cash) in January 1998 upon closing. The gain on the sale of stock of USC was
$26.6 million.

        In June 1999, the Company amended its agreements with UMC. Under the
terms of the amended agreements, UMC has agreed to pay the Company, subject to
certain conditions, 1.4 billion New Taiwan dollars (approximately $43.3 million
in cash) and the Company has agreed to release UMC from contingencies associated
with the sale in January 1988 of 80 million shares of stock of USC and to grant
a license to patents covering multimedia products and integrated circuit
manufacturing technology for use in products manufactured by UMC. Payments are
being received over five fiscal quarters beginning in the quarter ended June 30,
1999.

OTHER INCOME (EXPENSE), NET

        Other income was $0.8 million for the three months ended June 30, 2000,
a increase of $0.6 million from other income of $0.3 million for the three
months ended June 30, 1999. Other income was $0.7 million for the six months
ended June 30, 2000, a increase of $0.2 million from other income of $0.4
million for the six months ended June 30, 1999. The increase was due primarily
to a


                                       15
<PAGE>   16

decrease in interest expense associated with repayment of a line of credit
assumed in the merger with Diamond, partially offset by foreign currency
translation gains.

INCOME TAXES

        The Company's effective tax rates for the three months and six months
ended June 30, 2000 and 1999 are 41.6% and 0%, respectively. The effective tax
rate for 2000 reflects expected tax payment on the adjusted taxable income at
the federal, state and international statutory rates. The effective tax rate for
1999 reflects net operating losses with no realized tax benefit.

LIQUIDITY AND CAPITAL RESOURCES

        Cash used for operating activities for the six months ended June 30,
2000 was $184.7 million, as compared to $13.2 million cash provided by operating
activities for the six months ended June 30, 1999. The Company's net income of
$456.0 million for the six months ended June 30, 2000 was partially offset by
depreciation and amortization expenses. Cash used for operations for the six
months ended June 30, 2000 was unfavorably impacted by increases in inventories
and decreases in accounts receivable, accounts payable and accrued liabilities
and other liabilities. In addition, cash used for operations for the six months
ended June 30, 2000 was favorably impacted by depreciation, amortization and
decreases in deferred revenue, prepaid expenses and other. The Company received
an income tax refund. The Company's net loss for the three months ended June 30,
1999 was offset by depreciation, decreases in accounts receivable, inventories
and prepaid expenses and other and increases in accounts payable, accrued
liabilities and other liabilities and deferred revenue.

        Investing activities provided cash of $42.4 million for the six months
ended June 30, 2000 and consisted primarily of purchases of short-term
investments, net, investments in KB Gear Interactive, Inc., RioPort and other
technology investments and purchases of property and equipment, partially offset
by cash received from sale of UMC related to the sale of USC shares, and the
increases in other assets. Investing activities used cash of $13.6 million for
the six months ended June 30, 1999 and consisted primarily of issuance's of
notes receivable to Diamond Multimedia Systems, Inc., cash received from UMC
related to the sale of shares, purchases of property and equipment, net and the
purchase of short term investments, net, offset by cash received from the sale
of USC shares.

        Financing activities provided cash of $120.7 million and $6.1 million
for the six months ended June 30, 2000 and 1999, respectively. Sales of common
stock, including $145.5 million received from the sale of stock to VIA, was the
financing activity generating cash during the six months ended June 30, 2000
which was offset partially by repayments of notes payable. Sales of common stock
and the sale of a warrant to Intel were the financing activities that provided
cash for the six months ended June 30, 1999.

        Working capital at June 30, 2000 and December 31, 1999 was $509.5
million and $100.1 million, respectively. At June 30, 2000, the Company's
principal sources of liquidity included cash and equivalents of $24.3 million
and $26.2 million in short-term investments. In addition, the company held
shares of UMC valued at $490.6 million at June 30, 2000 based upon then existing
New Taiwan dollar to U.S. dollar exchange rates and UMC's market prices on the
Taiwan Stock Exchange. The Company's principle sources of liquidity at December
31, 1999 included cash and equivalents of $45.8 million and $58.9 million of
short-term investments. As of June 30, 2000, the Company had short-term lines of
credit and bank credit facilities totaling $55.5 million, of which approximately
$18.0 million was unused and available. At December 31, 1999, the Company was in
default with its loan covenants regarding liquidity. The Company obtained a
waiver for this violation. The Company believes that its available funds will
satisfy the Company's projected working capital and capital expenditure
requirements for at least the next 12 months, other than expenditures for future
potential manufacturing agreements.

        The Company is currently a party to certain legal proceedings.
Litigation could result in substantial expense to the Company. See "Part II-
Item 1. Legal Proceedings."

RECENT DEVELOPMENTS

        In February 2000, the Company purchased substantially all of the assets
of Number Nine Visual Technology Corporation ("Number Nine"). Number Nine was a
supplier of graphics accelerator subsystems for PCs using S3 graphics chips. The
acquisition of the assets of Number Nine, a supplier to IBM, allows S3 to
consolidate its graphics business with IBM into a single source distribution
model and furthers S3's strategy of becoming a single graphics solution provider
to the PC graphics market. The acquisition also adds skilled hardware and
software engineering resources to S3's existing teams.


                                       16
<PAGE>   17

        In February 2000, VIA purchased from the Company 10,775,000 shares of
the Company's Common Stock for an aggregate purchase price of $145,462,500
pursuant to the terms of an agreement entered into December 1999.

        The Company, and VIA Technologies, Inc., a corporation organized under
the laws of Taiwan ("VIA"), entered into an Investment Agreement, dated as of
April 10, 2000 (the "Agreement"). Pursuant to the Agreement, the Company and VIA
will form a new joint venture (the "Joint Venture") for the purpose of
manufacturing and distributing graphics products and conducting related research
and development activities. At the closing of the transactions contemplated by
the Agreement, the Company will transfer to the Joint Venture its graphics chip
business in exchange for 100,000,000 shares of Class A common stock of the Joint
Venture. In addition, at the closing, VIA will deliver to the Joint Venture
$79.9 million in cash or a combination of cash and Via or S3 equity securities,
which in turn will be delivered by the Joint Venture to the Company (minus an
amount retained by the Joint Venture for the benefit of employees of the Joint
Venture), in exchange for 10,000,000 shares of Class B common stock of the Joint
Venture. The Joint Venture will assume $38.5 million in debt from the Company.
The Joint Venture will also issue to the Company a promissory note with an
aggregate principal amount of $239.6 million, which will be payable in equal
annual installments on each of the first three anniversaries of the closing date
of the formation of the Joint Venture. The payments may be made, at the Joint
Venture's option, in cash or a combination of cash and Via or S3 equity
securities. The note will be secured by certain assets of the Joint Venture.

        In addition, the Company will receive additional payments from the Joint
Venture if certain specified financial milestones are achieved by the Joint
Venture.

        The closing of the transactions contemplated by the Agreement is
conditioned upon certain closing conditions, including the expiration or early
termination of the applicable waiting period under the Hart-Scott-Rodino
Antitrust Improvement Act and the approval of the government of Taiwan. In
addition, the closing is conditioned upon the issuance by the Company to VIA or
an affiliate thereof of 3,000,000 shares of the Company's common stock at a
price per share of $17.875, and the election of a designee of VIA to the Board
of Directors of the Company. On July 1, 2000, the Investment Commission of
Ministry of Economic Affairs of the Taiwan Government informed VIA that it would
not approve the transaction as proposed, but that VIA could reapply for
approval. The Company and VIA are discussing additional efforts to obtain the
approval of the Taiwan Government, including a possible restructuring of the
terms of the proposed transaction.


                                       17
<PAGE>   18

YEAR 2000 COMPLIANCE

        The Company is not aware of any material problems resulting from Year
2000 issues, either with its products, its internal systems, or the products or
services of third parties. The Company will continue to monitor its critical
computer applications and those of its suppliers and vendors throughout the year
2000 to ensure that any latent Year 2000 issues that may arise are addressed
promptly.

FACTORS THAT MAY AFFECT OUR RESULTS

We have recently changed the focus of our business and may be unsuccessful or
experience difficulties in implementing this change. If this occurs, our net
losses could increase significantly.

        In April 2000, we announced that we agreed to transfer our PC graphics
semiconductor business to a newly formed joint venture with VIA Technologies and
have realigned our resources to focus on our Internet-related businesses. We
have a limited operating history with our Internet-related businesses and our
shift in focus may prove to be unsuccessful. Our Internet-related businesses
compete with larger, more established competitors, and we may be unable to
achieve market success.

If we cannot complete the formation of our new joint venture with VIA
Technologies, we could incur substantial losses.

        The formation of the VIA joint venture is subject to customary closing
conditions, including the receipt of antitrust and other regulatory approvals,
including the approval of the government of Taiwan. We cannot assure you that
these conditions will be satisfied. We may be required to pay substantial sums
to VIA if other conditions in the joint venture agreement are not satisfied. If
we are unable to complete the formation of the joint venture, our graphics chip
business could be severely harmed because, among other things, we would have to
bear the expenses of that business while we have refocused our sales and
marketing resources elsewhere. Also, we have retained our obligations under our
agreements with our semiconductor foundries, and we may be required to purchase
specified quantities of wafers or semiconductors, which could result in excess
inventory of those products and corresponding writeoffs.

Our quarterly and annual operating results are subject to fluctuations caused by
many factors, which could result in failing to achieve our revenue or
profitability expectations, resulting in a drop in the price of our common
stock.

        Our quarterly and annual results of operations have varied significantly
in the past and are likely to continue to vary in the future due to a number of
factors, many of which are beyond our control. Any one or more of the factors
listed below or other factors could cause us to fail to achieve our revenue or
profitability expectations. The failure to meet market expectations could cause
a drop in our stock price. These factors include:

-       our ability to develop, introduce and market successfully new or
        enhanced products;

-       our ability to introduce and market products in accordance with
        specialized customer design requirements and short design cycles;

-       changes in the relative volume of sales of various products with
        sometimes significantly different margins;

-       changes in demand for our products and our customers' products;

-       rapid changes in electronic commerce on which we or our customers may
        not capitalize or which erode our traditional business base;

-       frequent gains or losses of significant customers or strategic
        relationships;

-       unpredictable volume and timing of customer orders;

-       the availability, pricing and timeliness of delivery of components for
        our products;

-       the availability of manufacturing capacity, including wafer capacity
        using advanced process technologies;

-       the timing of new product announcements or introductions by us or by our
        competitors;


                                       18
<PAGE>   19

-       product obsolescence and the management of product transitions;

-       production delays;

-       decreases in the average selling prices of products;

-       seasonal fluctuations in sales; and

-       general economic conditions, including economic conditions in Asia and
        Europe in particular, that could affect the timing of customer orders
        and capital spending and result in order cancellations or rescheduling.

Some or all of these factors could adversely affect demand for our products and
our future operating results.

        Most of our operating expenses are relatively fixed in the short term.
We may be unable to rapidly adjust spending to compensate for any unexpected
sales shortfall, which could harm our quarterly operating results. Because the
lead times of firm orders are typically short in the graphics industry, we do
not have the ability to predict future operating results with any certainty.
Therefore, sudden changes that are outside our control, such as general economic
conditions, the actions or inaction of competitors, customers, third-party
vendors of operating systems software, and independent software application
vendors, may materially and adversely affect our performance.

        We generally ship more products in the third month of each quarter than
in either of the first two months of the quarter, with levels of shipment in the
third month higher towards the end of the month. This pattern, which is common
in the semiconductor and multimedia communication industries, is likely to
continue and makes future quarterly operating results less predictable.

        Because of the above factors, you should not rely on period-to-period
comparisons of results of operations as an indication of future performance.

We experienced a net loss for the last two years and we may continue to
experience net losses in the future.

        We had a net loss of $30.8 million for 1999 and a net loss of $113.2
million for 1998. These results occurred primarily because we did not offer
competitive products in the high end of the graphics and multimedia accelerator
market. As a result, our sales consisted of primarily older generation and lower
price products that were sold into markets that had significant price
competition. Our ability to achieve profitability depends on our success in
refocusing our business resources and in executing our business plan for our
refocused business. We cannot assure you that we will be able to achieve or
maintain profitability.

If we do not continue to develop and market new and enhanced products, we will
not be able to compete successfully in our markets.

        The markets for which our products are designed are intensely
competitive and are characterized by short product life cycles, rapidly changing
technology, evolving industry standards and declining average selling prices. As
a result, we cannot succeed unless we consistently develop and market new
products. We believe this will require expenditures for research and development
in the future consistent with our historical research and development
expenditures. To succeed in this environment, we must anticipate the features
and functionality that customers will demand. We must then incorporate those
features and functionality into products that meet the design, performance,
quality and pricing requirements of the personal computer market and the timing
requirements of PC OEMs and retail selling seasons. For example, we have a joint
venture with VIA Technologies to bring integrated graphics and core logic chip
sets to the OEM desktop and notebook PC markets. There can be no assurance that
the joint venture will be successful or that our existing products will be
compatible with new products. We have in the past experienced delays in
completing the development and introduction of new products, as well as
compatibility issues with integrated products and we cannot assure you that we
will not experience similar delays in the future. In the past, our business has
been seriously harmed when we developed products that failed to achieve
significant market acceptance and therefore were unable to compete successfully
in our markets. Such a failure could occur again in the future.

The demand for our products has historically been weaker in certain quarters.


                                       19
<PAGE>   20

        Due to industry seasonality, demand for PCs and PC related products is
strongest during the fourth quarter of each year and is generally slower in the
period from April through August. This seasonality may become more pronounced
and material in the future to the extent that:

-       a greater proportion of our sales consist of sales into the retail/mass
        merchant channel;

-       PCs become more consumer-oriented or entertainment-driven products; or

-       our net revenue becomes increasingly based on entertainment-related
        products, including our Internet-related products such as our Rio
        digital music players.

Also, to the extent we expand our European sales, we may experience relatively
weak demand in third calendar quarters due to historically weak summer sales in
Europe.

We operate in markets that are intensely and increasingly competitive.

        The consumer Internet device, personal computer multimedia and
communications markets in which we compete are intensely competitive and are
likely to become more competitive in the future. Because of this competition, we
face a constant and increasing risk of losing customers to our competitors. The
competitive environment also creates downward pressure on prices and requires
higher spending to address the competition, both of which tend to keep profit
margins lower. We believe that the principal competitive factors for our
products are:

-       performance and quality;

-       conformity to industry standard application programming interfaces, or
        APIs;

-       access to customers and distribution channels;

-       reputation for quality and strength of brand;

-       manufacturing capabilities and cost of manufacturing;

-       price;

-       product support; and

-       ability to bring new products to the market in a timely manner.

        Historically, the gross profit margins on Diamond's products have been
lower than the margins on our products. As a result of the Diamond merger, our
average gross margins will likely be lower than they were prior to the merger,
thereby decreasing our average gross margins.

        Many of our current and potential competitors have substantially greater
financial, technical, manufacturing, marketing, distribution and other
resources. These competitors may also have greater name recognition and market
presence, longer operating histories, greater market power and product breadth,
lower cost structures and larger customer bases. As a result, these competitors
may be able to adapt more quickly to new or emerging technologies and changes in
customer requirements. In addition, some of our principal competitors offer a
single vendor solution because they maintain their own semiconductor foundries
and may therefore benefit from certain capacity, cost and technical advantages.
In some markets where we are a relatively new entrant, such as modems, home
networking, sound cards and consumer electronics, including Internet music
players, we face dominant competitors that include 3Com (home networking and
modems), Creative Technologies (sound cards, modems and Internet music players),
Intel (home networking) and Sony (consumer electronic music players). In
addition, the markets in which we compete are expected to become increasingly
competitive as PC products support increasingly more robust multimedia functions
and companies that previously supplied products providing distinct functions
(for example, companies today primarily in the sound, modem, microprocessor or
motherboard markets) emerge as competitors across broader or more integrated
product categories.


                                       20
<PAGE>   21

        In addition to graphics board manufacturers, our competitors include
OEMs that internally produce graphics chips or integrate graphics chips on the
main computer processing board of their personal computers, commonly known as
the motherboard, and makers of other personal computer components and software
that are increasingly providing graphics or video processing capabilities.

We operate in markets that are rapidly changing, highly cyclical and vulnerable
to sharp declines in demand and average selling prices.

        We operate in the personal computer, graphics/video chip, Internet
appliance, and home networking markets. These markets are constantly and rapidly
changing and have in the past, and may in the future, experience significant
downturns. These downturns are characterized by lower product demand and
accelerated product price reductions. In the event of a downturn, we would
likely experience significantly reduced demand for our products. Although are
changing our focus to concentrate on our Internet-related businesses,
substantially all of our revenues are currently derived from products sold for
use in or with personal computers. In the near term, we expect to continue to
derive almost all of our revenues from the sale of products for use in or with
personal computers. Changes in demand in the personal computer and
graphics/video chip markets could be large and sudden. Since graphics board and
personal computer manufacturers often build inventories during periods of
anticipated growth, they may be left with excess inventories if growth slows or
if they have incorrectly forecasted product transitions. In such cases, the
manufacturers may abruptly stop purchasing additional inventory from suppliers
like us until the excess inventory has been used. This suspension of purchases
or any reduction in demand for personal computers generally, or for particular
products that incorporate our products, would negatively impact our revenues and
financial results. We may experience substantial period-to-period fluctuations
in results of operations due to these general semiconductor industry conditions.

If we are unable to continue to develop and market new and enhanced products,
our average selling prices and gross profits will likely decline.

        We must continue to develop new products in order to maintain average
selling prices and gross margins. As the markets for our products continue to
develop and competition increases, we anticipate that product life cycles will
shorten and average selling prices will decline. In particular, average selling
prices and, in some cases, gross margins, for each of our products will decline
as products mature. A decline in selling prices may cause the net sales in a
quarter to be lower than those of a preceding quarter or corresponding quarter
in a prior year, even if more units were sold during that quarter than in the
preceding or corresponding quarter of a prior year. To avoid that, we must
successfully identify new product opportunities and develop and bring new
higher-end and higher-margin products to market in time to meet market demand.
The availability of new products is typically restricted in volume early in a
product's life cycle. If customers choose to wait for the new version of a
product instead of purchasing the current version, our ability to procure
sufficient volumes of these new products to meet higher customer demand will be
limited. If this happens, our revenues and operating margins could be harmed.

Our products have short product life cycles, requiring us to manage product
transitions successfully in order to remain competitive.

        Our products have short product life cycles. For example, the life
cycles of Diamond's graphics boards typically range from six to twelve months
and the life cycles of our graphic chips typically range from twelve to eighteen
months. If we fail to introduce new products successfully within a given time
frame, our competitors could gain market share, which could cause us to lose
revenue. Further, continued failure to introduce competitive new products on
time could also damage our brand name, reputation and relationships with our
customers and cause longer-term harm to our financial condition. Our major OEM
customers typically introduce new computer system configurations as often as
twice a year. Short product life cycles are the result of frequent transitions
in the computer market and in the consumer market in which products rapidly
incorporate new features and performance standards on an industry-wide basis.
Our graphics products must be able to support the new features and performance
levels being required by personal computer manufacturers at the beginning of
these transitions. Otherwise, we would likely lose business as well as the
opportunity to compete for new design contracts until the next product
transition. Failing to develop products with required features and performance
levels or a delay as short as a few months in bringing a new product to market
could significantly reduce our revenues for a substantial period.

We may face inventory risks that are increased by a combination of short product
life cycles and long component lead times.

        The short product life cycles of our board-based products also give rise
to a number of risks involving product and component inventories. These risks
are heightened by the long lead times that are necessary to acquire some
components of our products. We may not be able to reduce our production or
inventory levels quickly in response to unexpected shortfalls in sales. This
could leave us with significant and costly obsolete inventory. Long component
lead times could cause these inventory levels to be higher than they


                                       21
<PAGE>   22

otherwise would be and may also prevent us from quickly taking advantage of an
unexpected new product cycle. This can lead to costly lost sales opportunities
and loss of market share, which could result in a loss of revenues. For example,
the timing and speed of the PCI-to-AGP bus transition and the SGRAM-to-SDRAM
memory transition led to an excess inventory of PCI and SGRAM-based products at
Diamond and in its distribution channel, which in turn resulted in lower average
selling prices, lower gross margins, end-of-life inventory write-offs, and
higher price protection charges during the second and third quarters of 1998.
Further, declining demand for an excess supply of Monster 3D II and competitive
3D gaming products in the channel during the third quarter of 1998 resulted in
rapidly declining revenue and prices vis-a-vis the second quarter of 1998, and
resulted in price protection charges for this class of product in the third
quarter of 1998. Our Internet-related device sales could be affected in the
future by the availability of flash memory, which is a key component of our Rio
digital music players and is currently subject to high market demand and
allocations from suppliers. We estimate and accrue for potential inventory
write-offs and price protection charges, but we cannot assure you that these
estimates and accruals will be sufficient in future periods, or that additional
inventory write-offs and price protection charges will not be required. The
impact of these charges on Diamond's operating results in 1998 and the first
quarter of 1999 was material. Any similar occurrence in the future could
materially and adversely affect our operating results because as our subsidiary,
Diamond's charges will be included in our operating results on a going forward
basis.

We have only recently started to offer products intended to address all
performance segments of the commercial and consumer PC market.

        We recently commenced shipments of our Savage2000 product, which is
designed to compete in multiple performance segments of the commercial and
consumer PC markets and to satisfy multiple-function market needs, such as
graphics, video and DVD support. We do not know whether Savage2000 or future
products will be able to compete successfully in those segments. If we are not
able to introduce and successfully market higher performance products, our gross
margin and profitability could be negatively affected.

Demand for our products may decrease if the same capabilities provided by our
products become available in operating systems or embedded in other personal
computer components.

        A majority of our net sales are derived from the sale of graphics boards
and multimedia accelerators for PC subsystems. However, there is a trend within
the industry for lower performance graphics and video functionality to migrate
from the graphics board to other personal computer components or into operating
systems. We expect that additional specialized graphics processing and general
purpose computing capabilities will be integrated into future versions of Intel
and other Pentium-based microprocessors and that standard multimedia
accelerators in the future will likely integrate memory, system logic, audio,
communications or other additional functions. In particular, Intel and others
have announced plans to develop chips that integrate graphics and processor
functions to serve the lower-cost PC market. These could significantly reduce
the demand for our products. Graphics boards are usually used in higher-end
personal computers offering the latest technology and performance features.
However, as graphics functionality becomes technologically stable and widely
accepted by personal computer users, it typically migrates to the personal
computer motherboard. We expect this trend to continue, especially with respect
to low-end graphics boards. In this regard, the MMX instruction set from Intel
and the expanded capabilities provided by the DirectX applications programming
interface from Microsoft have increased the capability of Microsoft's operating
systems to control display features that have traditionally been performed by
graphics boards. As a result of these trends of technology migration, our
success largely depends on our ability to continue to develop products that
incorporate new and rapidly evolving technologies that manufacturers have not
yet fully incorporated onto personal computer motherboards or into operating
systems.

        Although our joint venture with VIA is intended to produce integrated
graphics/core logic accelerator products that provide these functions, we have
traditionally offered only single function graphics accelerator chips or
chipsets. We have and intend to continue to expand the scope of our research and
development efforts to provide integrated graphics/core logic accelerator
products, which will require that we hire engineers skilled in these areas and
promote additional coordination among our design and engineering groups.
Alternatively, we may find it necessary or desirable to license or acquire
technology to enable us to provide these functions, and we cannot assure you
that any such technology will be available for license or purchase on terms
acceptable to us.

        We believe that a large portion of the growth in the sales of personal
computers may be in sealed systems that contain most functionality on a single
systems board and are not upgradeable in the same manner as are most personal
computers. These sealed computers would contain a systems board that could
include CPU, system memory, graphics, audio and Internet or network connectivity
functionality on a single board. Although Diamond acquired Micronics Computers
in 1998 for the purposes of obtaining technical and marketing expertise and
brand acceptance in CPU motherboard design and developing integrated multimedia
system board products, we cannot assure you that a significant market will exist
for low-cost fixed system boards or that the acquisition of Micronics will
enable us to compete successfully in this emerging market or in the current
motherboard market.


                                       22
<PAGE>   23

We depend on third parties for the manufacture of our products.

        We currently rely on two independent foundries to manufacture all of our
products either in finished form or wafer form. We have a "take or pay" contract
with Taiwan Semiconductor Manufacturing Company ("TSMC") and a foundry
relationship with United Microelectronics Corporation ("UMC"). Our agreement
with TSMC provides capacity through 2002 and requires us to make annual advance
payments to purchase specified capacity to be applied against the following
year's capacity or to forfeit advance payments against those amounts. For
example, in the fourth quarter of 1998, we wrote off approximately $4.0 million
of the 1998 prepaid production capacity because it did not fully utilize the
capacity related to the advance payment. As of June 30, 1999, our note payable
to TSMC was $9.6 million. If we purchase excess inventories of particular
products or choose to forfeit advance payments, our operating results could be
harmed. In July 2000, the Company terminated the "take and pay" contract,
received a refund of approximately $4.8 million and cancelled the notes payable.

        In 1999, UMC, the majority owner of our United Semiconductor Corporation
("USC") foundry joint venture, merged USC with UMC. As a result, we lost our
ability to influence the USC board and any veto power we had over actions to be
taken by USC. Our relationship with UMC is therefore based on a foundry capacity
agreement rather than a joint venture. Although we are currently unaware of any
changes that UMC may propose in the future to the foundry relationship, we will
have less ability to influence this relationship if changes adverse to us are
made in the future.

        We conduct business with one of our current foundries by delivering
written purchase orders specifying the particular product ordered, quantity,
price, delivery date and shipping terms. This foundry is therefore not obligated
to supply products to us for any specific period, in any specific quantity or at
any specific price, except as may be provided in a particular purchase order. To
the extent a foundry terminates its relationship with us or our supply from a
foundry is interrupted or terminated for any other reason, such as a natural
disaster or an injunction arising from alleged violations of third party
intellectual property rights, we may not have a sufficient amount of time to
replace the supply of products manufactured by that foundry. We may be unable to
obtain sufficient advanced process technology foundry capacity to meet customer
demand in the future. From time to time, we may evaluate potential new sources
of supply. However, the qualification process and the production ramp-up for
additional foundries has in the past taken, and could in the future take, longer
than anticipated. Accordingly, there can be no assurance that such sources will
be able or willing to satisfy our requirements on a timely basis or at
acceptable quality or per unit prices.

        TSMC and UMC are both located in the Science-Based Industrial Park in
Hsin Chu City, Taiwan. We currently expect these foundries to supply the
substantial portion of our graphics accelerator chips and S3-VIA joint venture
products in 2000 and 2001. Disruption of operations at these foundries for any
reason, including work stoppages, political or military conflicts, earthquakes
or other natural disasters, could cause delays in shipments of our products
which could have a material adverse effect on our operating results. For
example, in September 1999, Taiwan experienced a major earthquake. The
earthquake and its resulting aftershocks caused power outages and significant
damage to Taiwan's infrastructure. The result was delays of shipments of our
products from the TSMC and UMC foundries in Taiwan. Any such future delays could
have a material adverse effect on our operating results.

        In addition, as a result of the rapid growth of the semiconductor
industry based in the Science-Based Industrial Park, severe constraints have
been placed on the water and electricity supply in that region. Any shortages of
water or electricity could adversely affect our foundries' ability to supply our
products, which could have a material adverse effect on operating results.

        We rely on independent subcontractors to manufacture, assemble and/or
test certain of our products. We procure our components, assembly and test
services and assembled products through purchase orders and we do not have
specific volume purchase agreements with each of our subcontractors. Most of our
subcontractors could cease supplying the services, products or components at any
time with limited or no penalty. If we need to replace a key subcontractor, we
could incur significant manufacturing set-up costs and delays. Also, we may be
unable to find suitable replacement subcontractors. Our emphasis on maintaining
low internal and channel inventory levels may exacerbate the effects of any
shortage that may result from the use of sole-source subcontractors during
periods of tight supply or rapid order growth. Further, some of our
subcontractors are located outside the United States, which may present
heightened process control, quality control, political, infrastructure,
transportation, tariff, regulatory, legal, import, export, economic or supply
chain management risks.

We historically have had significant product concentration and significantly
depend on the health of the graphics and multimedia accelerator market, which
means that a decline in demand for a single product, or in the graphics and
multimedia accelerator market in general, could severely impact overall revenues
and financial results.


                                       23
<PAGE>   24

        Our revenues are dependent on the markets for graphics/video chips for
PCs and on our ability to compete in those markets. Our business would be
materially harmed if we are unsuccessful in selling these graphic chips. We have
agreed to transfer our PC graphics semiconductor business to a newly formed
joint venture with VIA Technologies but our remaining business will continue to
have significant product concentration after the transfer. Historically, over
75% of the net sales of our subsidiary, Diamond, have come from sales of
graphics and video accelerator subsystems. Diamond has introduced audio
subsystems, has entered the PC modem and home networking markets, and has
entered into the PC consumer electronics market with the Rio digital audio
player, but graphics and video accelerator subsystems are expected to continue
to account for a significant portion of our sales for the foreseeable future. A
decline in demand or average selling prices for graphics and video accelerator
subsystems, digital audio players, PC modem and home networking markets, whether
as a result of new competitive product introductions, price competition, excess
supply, widespread cost reduction, technological change, incorporation of the
products' functionality onto personal computer motherboards or otherwise, would
have a material adverse effect on our sales and operating results.

We may not be able to successfully manage the growth and expansion of our
business.

        In the past year, and particularly following the merger with Diamond,
the Company has experienced a significant expansion in the overall level of its
business and the scope of its operations, including manufacturing, research and
development, marketing, technical support, customer service, sales and
logistics. This expansion in scope has resulted in a need for significant
investment in infrastructure, process development and information systems. This
requirement includes, without limitation: securing adequate financial resources
to successfully integrate and manage the growing businesses and acquired
companies; retention of key employees; integration of management information,
product data management, control, accounting, telecommunications and networking
systems; establishment of a significant worldwide web and e-commerce presence;
consolidation of geographically dispersed manufacturing and distribution
facilities; coordination of suppliers; rationalization of distribution channels;
establishment and documentation of business processes and procedures; and
integration of various functions and groups of employees. Each of these
requirements poses significant, material challenges.

        The Company's future operating results will depend in large measure on
its success in implementing operating, manufacturing and financial procedures
and controls, improving communication and coordination among the different
operating functions, integrating certain functions such as sales, procurement
and operations, strengthening management information and telecommunications
systems, and continuing to hire additional qualified personnel in certain areas.
There can be no assurance that the Company will be able to manage these
activities and implement these additional systems, procedures and controls
successfully, and any failure to do so could have a material adverse effect upon
the Company's short-term and long-term operating results.

A significant portion of our sales are concentrated within a limited number of
customers.

        We expect a significant portion of our future sales to remain
concentrated within a limited number of strategic customers. If we lose one or
more of these customers, our operating results would be harmed.

        Two customers accounted for 23% and 14% of net sales, respectively, for
the three months ended June 30, 2000. Two customers and two distributors
accounted for 17%, 10%, 17% and 10% of net sales, respectively, for the three
months ended June 30, 1999. Two customers accounted for 18% and 10% of net
sales, respectively, for the six months ended June 30, 2000. One customer and
two distributors accounted for 25%, 21% and 12% of net sales, respectively, for
the six months ended June 30, 1999. The Company expects a significant portion of
its future sales to remain concentrated within a limited number of strategic
customers. There can be no assurance that the Company will be able to retain its
strategic customers or that such customers will not otherwise cancel or
reschedule orders, or in the event of canceled orders, that such orders will be
replaced by other sales. In addition, sales to any particular customer may
fluctuate significantly from quarter to quarter. The occurrence of any such
events or the loss of a strategic customer could have a material adverse effect
on the Company's operating results.

The manufacturers on which we depend may experience manufacturing yield problems
that could increase our per unit costs and otherwise jeopardize the success of
our products.

        Our primary products, graphics chips, are difficult to manufacture. The
production of graphic chips requires a complex and precise process that often
presents problems that are difficult to diagnose and time-consuming or expensive
to solve. As a result, companies like us often experience problems in achieving
acceptable wafer manufacturing yields. Our chips are manufactured from round
wafers made of silicon. During manufacturing, each wafer is processed to contain
numerous individual integrated circuits, or chips. We may reject or be unable to
sell a percentage of wafers or chips on a given wafer because of:


                                       24
<PAGE>   25

-       minute impurities,

-       difficulties in the fabrication process,

-       defects in the masks used to print circuits on a wafer,

-       electrical performance,

-       wafer breakage, or

-       other factors.

        We refer to the proportion of final good chips that have been processed,
assembled and tested relative to the gross number of chips that could be
constructed from the raw materials as our manufacturing yields. These yields
reflect the quality of a particular wafer. Depending on the specific product, in
the past, we negotiated with our manufacturers to pay either an agreed upon
price for all wafers or a price that is typically higher for only wafers of
acceptable quality. If the payment terms for a specific product require us to
pay for all wafers, and if yields associated with that product are poor, we bear
the risk of those poor manufacturing yields.

Our products could have design defects.

        Product components may contain undetected errors or "bugs" when first
supplied to the Company that, despite testing by the Company, are discovered
only after certain of the Company's products have been installed and used by
customers. There can be no assurance that errors will not be found in the
Company's products due to errors in such products' components, or that any such
errors will not impair the market acceptance of these products or require
significant product recalls. Problems encountered by customers or product
recalls could materially adversely affect the Company's business, financial
condition and results of operations. Further, the Company continues to upgrade
the firmware, software drivers and software utilities that are incorporated into
or included with its hardware products. The Company's software products, and its
hardware products incorporating such software, are extremely complex due to a
number of factors, including the products' advanced functionality, the diverse
operating environments in which the products may be deployed, the rapid pace of
technology development and change in the Company's target product categories,
the need for interoperability, and the multiple versions of such products that
must be supported for diverse operating platforms, languages and standards.
These products may contain undetected errors or failures when first introduced
or as new versions are released. The Company's return policies for its graphics
chips and boards may permit OEMs to return these products for full credit within
thirty days after receipt of products that do not meet product specifications.
In addition, the Company generally provides warranties for its retail products
allowing the return or repair of defective products. There can be no assurance
that, despite testing by the Company, by its suppliers and by current or
potential customers, errors will not be found in new products after commencement
of commercial shipments, resulting in loss of or delay in market acceptance or
product acceptance or in warranty returns. Such loss or delay would likely have
a material adverse effect on the Company's business, financial condition and
results of operations.

        Additionally, new versions or upgrades to operating systems, independent
software vendor titles or applications may require upgrades to the Company's
software products to maintain compatibility with such new versions or upgrades.
There can be no assurance that the Company will be successful in developing new
versions or enhancements to its software or that the Company will not experience
delays in the upgrade of its software products. In the event that the Company
experiences delays or is unable to maintain compatibility with operating systems
and independent software vendor titles or applications, the Company's business,
financial condition and results of operations could be materially adversely
affected.

We are subject to risks relating to product returns and price protection.

        We often grant limited rights to customers to return unsold inventories
of our products in exchange for new purchases, also known as "stock rotation."
We also often grant price protection on unsold inventory, which allows customers
to receive a price adjustment on existing inventory when our published price is
reduced. Also, some of our retail customers will readily accept returned
products from their own retail customers. These returned products are then
returned to us for credit. We estimate returns and potential price protection on
unsold inventory in our distribution channel. We accrue reserves for estimated
returns, including warranty returns and price protection, and since the fourth
quarter of 1998, we reserve the gross margin associated with channel inventory
levels that exceed four weeks of demand. We may be faced with further
significant price protection charges as our competitors move to reduce channel
inventory levels of current products, such as our Monster Fusion, as new product
introductions are made.


                                       25
<PAGE>   26

We depend on sales through distributors. If relationships with or sales through
distributors decline, our operating results will be harmed.

        We sell our products through a network of domestic and international
distributors, and directly to major retailers/mass merchants, value-added
resellers and OEM customers. Our future success is dependent on the continued
viability and financial stability of our customer base. Computer distribution
and retail channels historically have been characterized by rapid change,
including periods of widespread financial difficulties and consolidation and the
emergence of alternative sales channels, such as direct mail order, telephone
sales by PC manufacturers and electronic commerce on the worldwide web. The loss
of, or a reduction in, sales to certain of our key distribution customers as a
result of changing market conditions, competition or customer credit problems
could materially and adversely affect our operating results. Likewise, changes
in distribution channel patterns, such as:

-       increased electronic commerce via the Internet,

-       increased use of mail-order catalogues,

-       increased use of consumer-electronics channels for personal computer
        sales, or

-       increased use of channel assembly to configure PC systems to fit
        customers' requirements

could affect us in ways not yet known. For example, the rapid emergence of
Internet-based e-commerce, in which products are sold directly to consumers at
low prices, is putting substantial strain on some of our traditional
distribution channels.

        Inventory levels of our products in the two-tier distribution channels
generally are maintained in a range of one to two months of customer demand.
These channel inventory levels tend toward the low end of the months-of-supply
range when demand is stronger, sales are higher and products are in short
supply. Conversely, during periods when demand is slower, sales are lower and
products are abundant, channel inventory levels tend toward the high end of the
months-of-supply range. Frequently, in these situations, we attempt to ensure
that distributors devote a greater degree of their working capital, sales and
logistics resources to our products instead of to our competitors. Similarly,
our competitors attempt to ensure that their own products are receiving a
disproportionately higher share of the distributors' working capital and
logistics resources. In an environment of slower demand and abundant supply of
products, price declines and channel promotional expenses are more likely to
occur and, should they occur, are more likely to have a significant impact on
our operating results. Further, in an event like this, high channel inventory
levels may result in substantial price protection charges. These price
protection charges have the effect of reducing net sales and gross profit.
Consequently, in taking steps to bring our channel inventory levels down to a
more desirable level, we may cause a shortfall in net sales during one or more
accounting periods. These efforts to reduce channel inventory might also result
in price protection charges if prices are decreased to move product out to final
consumers, having a further adverse impact on operating results. We accrue for
potential price protection charges on unsold channel inventory. We cannot assure
you, however, that any estimates, reserves or accruals will be sufficient or
that any future price reductions will not seriously harm our operating results.

We rely on intellectual property and other proprietary information that may not
be adequately protected and that may be expensive to protect.

        The industry in which we compete is characterized by vigorous protection
and pursuit of intellectual property rights. We rely heavily on a combination of
patent, trademark, copyright, and trade secret laws, employee and third-party
nondisclosure agreements and licensing arrangements to protect our intellectual
property. If we are unable to adequately protect our intellectual property, our
business may suffer from the piracy of our technology and the associated loss of
sales. Also, the protection provided to our proprietary technology by the laws
of foreign jurisdictions, many of which offer less protection than the United
States, may not be sufficient to protect our technology. It is common in the
personal computer industry for companies to assert intellectual property
infringement claims against other companies. Therefore, our products may also
become the target of infringement claims. These infringement claims or any
future claims could cause us to spend significant time and money to defend our
products, redesign our products or develop or license a substitute technology.
We may be unsuccessful in acquiring or developing substitute technology and any
required license may be unavailable on commercially reasonable terms, if at all.
In addition, an adverse result in litigation could require us to pay substantial
damages, cease the manufacture, use, sale, offer for sale and importation of
infringing products, or discontinue the use of certain processes. Any of those
events could materially harm our business. Litigation by or against us could
result in significant expense to us and could divert the efforts of our
technical and management personnel, regardless of the outcome of such
litigation. However, even if claims do not have merit, we may be required to
dedicate significant management time and expense to defending ourselves if we
are directly sued, or assisting our OEM customers in their defense of these or
other infringement claims pursuant to


                                       26
<PAGE>   27

indemnity agreements. This could have a negative effect on our financial
results. For example, Intel Corporation is currently in litigation with VIA,
with whom we recently entered into a joint venture to bring high-performance
integrated graphics and core logic chip sets to the volume OEM desktop and
notebook PC markets and with whom we recently agreed to form a new joint venture
into which our graphics chip business would be transferred. The result of such
litigation could have an adverse effect on us.

Our products depend upon third-party certifications, which may not be granted
for future products, resulting in product shipment delays and lost sales.

        We submit most of our products for compatibility and performance testing
to the Microsoft Windows Hardware Quality Lab because our OEM customers
typically require our products to have this certification prior to making volume
purchases. This certification typically requires up to several weeks to complete
and entitles us to claim that a particular product is "Designed for Microsoft
Windows." We may not receive this certification for future products in a timely
fashion, or at all, which could result in product shipment delays and lost
sales.

We may not be able to retain or integrate key personnel, which may prevent us
from succeeding.

        We may not be able to retain our key personnel or attract other
qualified personnel in the future. Our success will depend upon the continued
service of key management personnel. The loss of services of any of the key
members of our management team or our failure to attract and retain other key
personnel could disrupt our operations and have a negative effect on employee
productivity and morale, decreasing production and harming our financial
results. In addition, the competition to attract, retain and motivate qualified
technical, sales and operations personnel is intense. We have at times
experienced, and continue to experience, difficulty recruiting qualified
software and hardware development engineers.

We depend on a limited number of third party developers and publishers that
develop graphics software products that will operate with and fully utilize the
capabilities of our products to generate demand for our products.

        Only a limited number of software developers are capable of creating
high quality entertainment software. Because competition for these resources is
intense and is expected to increase, a sufficient number of high quality,
commercially successful software titles compatible with our products may not be
developed. We believe that the availability of numerous high quality,
commercially successful software entertainment titles and applications
significantly affects sales of multimedia hardware to the PC-based interactive
3D entertainment market. We depend on third party software developers and
publishers to create, produce and market software titles that will operate with
our 3D graphics accelerators. If a sufficient number of successful software
titles are not developed, our product sales and revenues could be negatively
impacted. In addition, the development and marketing of game titles that do not
fully demonstrate the technical capabilities of our products could create the
impression that our technology offers only marginal or no performance
improvements over competing products. Either of these effects could have an
adverse effect on our product sales and financial results.

We depend on a limited number of suppliers from whom we do not have a guarantee
of adequate supplies, increasing the risk that a loss of or problems with a
single supplier could result in impaired margins, reduced production volumes,
strained customer relations and loss of business.

        We obtain several of the components used in our products from single or
limited sources. If component manufacturers do not allocate a sufficient supply
of components to meet our needs or if current suppliers do not provide
components of adequate quality or compatibility, we may have to obtain these
components from distributors or on the spot market at a higher cost. We rarely
have guaranteed supply arrangements with our suppliers, and suppliers may not be
able to meet our current or future component requirements. If we are forced to
use alternative suppliers of components, we may have to alter our product
designs to accommodate these components. Alteration of product designs to use
alternative components could cause significant delays and could require product
recertification by our OEM customers or reduce our production of the related
products. In addition, from time to time we have experienced difficulty meeting
certain product shipment dates to customers for various reasons. These reasons
include component delivery delays, component shortages, system compatibility
difficulties and component quality deficiencies. Delays in the delivery of
components, component shortages, system compatibility difficulties and supplier
product quality deficiencies will continue to occur in the future. These delays
or problems have in the past and could in the future result in impaired margins,
reduced production volumes, strained customer relations and loss of business.
For example, DRAM and flash memory components, which are used in our graphics
boards and Rio digital audio players, significantly increased in price in
September 1999 due in part to supply interruptions arising from the earthquake
in Taiwan. In addition, industry-wide demand for flash memory components has
increased dramatically, causing increases in price and shortages in supply.
These price increases may have an adverse impact on our gross margin in future
periods.


                                       27
<PAGE>   28

Also, in an effort to avoid actual or perceived component shortages, we may
purchase more of certain components than we otherwise require. Excess inventory
resulting from such over-purchases, obsolescence or a decline in the market
value of such inventory could result in inventory write-offs, which would have a
negative effect on our financial results as happened in the first and second
quarters of 1998. Similarly, Diamond's perception of component shortages caused
Diamond to over-purchase certain components and pay surcharges for components
that subsequently declined in value in the second, third and fourth quarters of
1998. In addition, our inventory sell-offs or sell-offs by our competitors could
trigger channel price protection charges, further reducing our gross margins and
profitability, as occurred with the Monster 3D II product line in the third and
fourth quarters of 1998.

We may experience product delivery delays due to the inadequacy or
incompatibility of software drivers. Such delays could hurt our sales.

        Some components of our products require software drivers in order for
those components to work properly in a PC. These software drivers are essential
to the performance of nearly all of our products and must be compatible with the
other components of the graphics board and PC in order for the product to work.
Some of these products that include software drivers are among those products
based on components, including software drivers, that are supplied by a limited
number of suppliers. From time to time, we have experienced product delivery
delays due to inadequacy or incompatibility of software drivers either provided
by component suppliers or developed internally by them. These delays could cause
us to lose sales, revenues and customers. Software driver problems will continue
to occur in the future, and those problems could negatively affect our operating
results.

We have significant exposure to international markets.

        International sales accounted for 54% and 82% of net sales for the three
months ended June 30, 2000 and 1999, respectively. International sales accounted
for 54% and 90% of net sales for the six months ended June 30, 2000 and 1999,
respectively. Approximately 29% and 50% of international sales for the three
months ended June 30, 2000 and 1999, respectively, were to affiliates of United
States customers. Approximately 27% and 47% of international sales for the six
months ended June 30, 2000 and 1999, respectively, were to affiliates of United
States customers. In addition, a substantial proportion of our products are
manufactured, assembled and tested by independent third parties in Asia. As a
result, we are subject to the risks of conducting business internationally,
including:

-       unexpected changes in, or impositions of, legislative or regulatory
        requirements;

-       fluctuations in the U.S. dollar, which could increase the price in local
        currencies of our products in foreign markets or increase the cost of
        wafers and components purchased by us;

-       delays resulting from difficulty in obtaining export licenses for
        certain technology;

-       tariffs and other trade barriers and restrictions;

-       potentially longer payment cycles;

-       greater difficulty in accounts receivable collection;

-       potentially adverse tax treatment; and

-       the burdens of complying with a variety of foreign laws.

        In the past, we have experienced an adverse impact associated with the
economic downturn in Asia that contributed to decreases in net sales. In
addition, our international operations are subject to general geopolitical
risks, such as political and economic instability and changes in diplomatic and
trade relationships. The People's Republic of China and Taiwan have in the past
experienced and are currently experiencing strained relations, and a worsening
of relations or the development of hostilities between them could disrupt
operations at our foundries and affect our Taiwanese customers.

As a result of the merger with Diamond, we expect that some of our suppliers may
not do business with us, which could cause a decline in our sales.


                                       28
<PAGE>   29

        The consummation of the merger is expected to cause some of our add-in
card and motherboard customers to end or curtail their relationships with us.
The loss of these customers could cause a decline in our sales unless new sales
resulting from the integration of Diamond have an offsetting effect. For
example, Creative Technology Ltd., a competitor of Diamond and previously an S3
customer, has discontinued its relationship with us. Additional customers may
discontinue their relationships with us in the future. This may occur because
our products comprise both graphics chips and graphics boards. Thus, as a result
of the merger, we are competing with some of our current customers, which are
graphics board manufacturers. As a result, we expect that sales to some of our
existing customers will be reduced significantly from prior levels and that
these customers will no longer continue to be significant customers. Unless we
are able to offset the loss of these sales with new customers or sales of
alternative products, our revenues may decline.

We are dependent on a limited source of graphics chips and graphics boards
because S3 and Diamond are each suppliers to each other, resulting in heightened
risks because one company's suppliers may not meet the other company's
requirements.

        As a result of the merger with Diamond, we have become significantly
dependent on our graphics chip design and development capabilities and
significantly dependent on Diamond's graphics board design, manufacturing and
marketing capabilities. This occurred because we are now more restricted in our
ability to select and use products produced by our competitors prior to the
merger. If either our graphics chips or Diamond's graphics boards fail to meet
the requirements of the market and our customers, our relationship with those
customers could be hurt, negatively affecting our financial performance. In
addition, we will be highly dependent on our ability to provide graphics chips
on a timely basis meeting the rigid scheduling and product specification
requirements of OEMs. If our graphics chips are not competitive or not provided
on a timely basis, we will most likely not be able to readily obtain suitable
alternative graphics chips, which would result in our loss of revenue and
customers.

We have a significant level of debt.

        At June 30, 2000, we had total debt and other long-term liabilities
outstanding of $221.7 million. The degree to which we are leveraged could
adversely affect our ability to obtain additional financing for working capital
or other purposes and could make us more vulnerable to economic downturns and
competitive pressures. Our significant leverage could also adversely affect our
liquidity, as a substantial portion of available cash from operations may have
to be applied to meet debt service requirements. In the event of a cash
shortfall, we could be forced to reduce other expenditures to be able to meet
such debt service requirements.

Our stock price is highly volatile and we expect that our stock price will
continue to be highly volatile.

        The market price of our common stock has been highly volatile, like that
of the common stock of many other semiconductor companies. We expect our common
stock to remain volatile. This volatility may result from:

-       general market conditions and market conditions affecting technology and
        semiconductor stocks generally;

-       actual or anticipated fluctuations in our quarterly operating results;

-       announcements of design wins, technological innovations, acquisitions,
        investments or business alliances, by us or our competitors; and

-       the commencement of, developments in or outcome of litigation.

        The market price of our common stock also has been and is likely to
continue to be significantly affected by expectations of analysts and investors,
especially if our operating results do not meet those expectations. Reports and
statements of analysts do not necessarily reflect our views. The fact that we
have in the past met or exceeded analyst or investor expectations does not
necessarily mean that we will do so in the future.

        In the past, following periods of volatility in the market price of a
particular company's securities, securities class action litigation has often
been brought. This litigation could result in substantial costs and a diversion
of our management's attention and resources. We are currently involved in
securities class action litigation and Diamond is also involved in similar
proceedings.

We are a party to legal proceedings alleging securities violations that could
have a negative financial impact on us.

        Since November 1997, a number of complaints have been filed in federal
and state courts seeking an unspecified amount of damages on behalf of an
alleged class of persons who purchased shares of our common stock at various
times between April 18, 1996


                                       29
<PAGE>   30

and November 3, 1997. The complaints name us as defendants as well as certain of
our officers and former officers and certain of our directors, asserting that we
and they violated federal and state securities laws by misrepresenting and
failing to disclose certain information about our business. In addition, certain
shareholders have filed derivative actions in the state courts of California and
Delaware seeking recovery on our behalf, alleging, among other things, breach of
fiduciary duties by such individual defendants. The plaintiffs in the derivative
action in Delaware have not taken any steps to pursue their case. The derivative
cases in California state court have been consolidated, and plaintiffs have
filed a consolidated amended complaint. The court has entered a stipulated order
in those derivative cases suspending court proceedings and coordinating
discovery in them with discovery in the class actions in California state
courts. On plaintiffs' motion, the federal court has dismissed the federal class
actions without prejudice. The class actions in California state court have been
consolidated, and plaintiffs have filed a consolidated amended complaint. The
Company has answered that complaint. Discovery is pending. While our management
intends to defend the actions against us vigorously, there can be no assurance
that an adverse result or settlement with regard to these lawsuits would not
have a material adverse effect on our financial condition or results of
operations.

        We are also defending several putative class action lawsuits naming
Diamond which were filed in June and July 1996 and June 1997 in the California
Superior Court for Santa Clara County and the U.S. District Court for the
Northern District of California. Certain former executive officers and directors
of Diamond are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased Diamond's Common Stock between October 18,
1995 and June 20, 1996 (the "Class Period"). The complaints allege claims under
the federal securities laws and California law. The plaintiffs allege that
Diamond and the other defendants made various material misrepresentations and
omissions during the Class Period. The complaints do not specify the amount of
damages sought. On March 24, 2000, the District Court for the Northern District
of California dismissed the federal action without prejudice. We believe that we
have good defenses to the claims alleged in the California Superior Court
lawsuit and will defend ourselves vigorously against this action. No trial date
has been set for this action. The ultimate outcome of this action cannot be
presently determined. Accordingly, no provision for any liability or loss that
may result from adjudication or settlement thereof has been made in the
accompanying consolidated financial statements.

        We have also received from the SEC a request for information relating to
our financial restatement announcement in November 1997. We have responded and
intend to continue to respond to the SEC requests.

        Sega initiated a claim for arbitration in Tokyo, Japan against Diamond
in December 1998. The claim arises out of an agreement entered into between Sega
and Diamond in September 1995, in which Sega agreed to provide Diamond with Sega
game software that Diamond would bundle with its 3-D graphics board "The Edge."
Sega claims that Diamond breached the parties' agreement by failing to pay Sega
a contractual minimum royalty fee for the games as set forth in the agreement.
Sega claims as damages $3,800,000 in unpaid royalties and pre-judgment interest.
On May 28, 1999, Diamond responded to Sega's claims by filing an answer in which
it denied the material allegations of Sega's claims. The parties have filed
additional briefs in support of their claims and defenses. An evidentiary
hearing on this action has not yet been scheduled. The Company contests the
material allegations of Sega's claims. In addition, the Company has pleaded that
Sega's failure to provide it with 3-D optimized game software on a timely basis
adversely affected sales of The Edge. The Company claims that these lost sales
and profits should provide an offset to Sega's claims in the arbitration and
intends to defend the suit vigorously.

        C3 Sales, Inc. ("C3") filed suit against S3 on October 6, 1999 in the
Harris County (Houston), Texas District Court. The petition sought a judicial
declaration that a Sales Representative Agreement entered into between C3 and S3
on May 19, 1999 was a valid contract that governed the relationship between the
two parties. On November 8, 1999, S3 answered acknowledging that the May 19,
1999 agreement was a contract between the two parties. C3 failed to respond to
informal requests by S3 to dismiss the declaratory relief action on grounds that
no justiciable controversy existed between the parties. On December 3, 1999, S3
filed a summary judgment motion seeking judgment against C3 on the grounds that
no issues of material fact remain to be determined regarding the declaratory
judgment sought by C3. C3 responded by filing an amended petition raising new
matters. Specifically, C3's new claims allege that the Sales Representative
Agreement applies to Diamond products, and that certain commissions due under
the agreement have not been paid. S3 intends to defend this action vigorously.

        On January 6, 2000, PhoneTel Communications, Inc. ("PhoneTel") filed a
complaint for patent infringement against a group of defendants, including
Diamond, in the United States District Court for the Northern District of Texas.
PhoneTel generally alleges that Diamond and the other defendants are infringing
its two patents by making, using, selling, offering to sell and/or importing
digital synthesizers, personal computers, sound cards, or console game systems.
PhoneTel does not specify which Diamond products allegedly infringe its patents.
S3 filed Diamond's answer to the complaint on March 28, 2000. S3 believes that
the complaint is without merit and will vigorously defend itself against the
allegations made in the complaint.


                                       30
<PAGE>   31

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

INVESTMENT PORTFOLIO

        The Company does not use derivative financial instruments in its
investment portfolio. The Company places its investments in instruments that
meet high credit quality standards, as specified in the Company's investment
policy. The Company also limits the amount of credit exposure to any one issue,
issuer or type of investment. The Company does not expect any material loss with
respect to its investment portfolio.

        The table below summarizes the Company's investment portfolio. The table
represents principal cash flows and related average fixed interest rates by
expected maturity date. The Company's policy requires that all investments
mature within twenty months.

        Principal (Notional) Amounts Maturing in 2000 in U.S. Dollars:

<TABLE>
<CAPTION>
                                         FAIR VALUE AT
                                         JUNE 30, 2000
                                    ----------------------
                                        (IN THOUSANDS,
                                    EXCEPT INTEREST RATES)
<S>                                 <C>
Cash and cash equivalents                  $24,288
Weighted average interest rate                5.01%
Other short-term investments               $26,150
Weighted average interest rate                6.48%
Total portfolio                            $52,438
Weighted average interest rate                5.38%
</TABLE>

CONVERTIBLE SUBORDINATED NOTES

        In September 1996, the Company completed a private placement of $103.5
million aggregate principal amount of convertible subordinated notes. The notes
mature in 2003. Interest is payable semi-annually at 5 3/4% per annum. The notes
are convertible at the option of the note holders into the Company's common
stock at an initial conversion price of $19.22 per share, subject to adjustment.
Beginning in October 1999, the notes are redeemable at the option of the Company
at an initial redemption price of 102% of the principal amount. The fair value
of the convertible subordinated notes at June 30, 2000 was approximately $ 117.1
million.

IMPACT OF FOREIGN CURRENCY RATE CHANGES

        The Company invoices its customers in US dollars for all products. The
Company is exposed to foreign exchange rate fluctuations as the financial
results of its foreign subsidiaries are translated into US dollars in
consolidation. The foreign subsidiaries maintain their accounts in the local
currency of the foreign location in order to centralize the foreign exchange
risk with the parent company. To date this risk has not been material.

        The effect of foreign exchange rate fluctuations on the Company's
financial statements for the three months ended June 30, 2000 and 1999 was not
material. Since foreign currency exposure increases as intercompany receivables
grow, from time to time the Company uses foreign exchange forward contracts as a
means for hedging these balances. As of June 30, 2000, the Company held the
following forward exchange contracts:

<TABLE>
<CAPTION>
                                         MATURITY DATE   NOTIONAL    FAIR VALUE
                                         -------------   --------    ----------
                                                     (IN THOUSANDS)
<S>                                      <C>            <C>          <C>
 Foreign Currency Forward Exchange
Contracts:
    275,905,000 New Taiwan Dollars        July 5, 2000    $8,466       $(489)
</TABLE>

PART II. OTHER INFORMATION

Item 1.  Legal Proceedings

        The semiconductor and personal computing products industries are
characterized by frequent litigation, including litigation regarding patent and
other intellectual property rights. The Company is party to various legal
proceedings that arise in the ordinary course of business. Although the ultimate
outcome of these matters is not presently determinable, management believes that
the resolution of all such pending matters will not have a material adverse
effect on the Company's financial position or results of operations.


                                       31
<PAGE>   32

        Since November 1997, a number of complaints have been filed in federal
and state courts seeking unspecified damages on behalf of an alleged class of
persons who purchased shares of the Company's common stock at various times
between April 18, 1996 and November 3, 1997. The complaints name as defendants
the Company, certain of its officers and former officers, and certain directors
of the Company, asserting that they violated federal and state securities laws
by misrepresenting and failing to disclose certain information about the
Company's business. In addition, certain stockholders have filed derivative
actions in the state courts of California and Delaware seeking recovery on
behalf of the Company, alleging, among other things, breach of fiduciary duties
by such individual defendants. The plaintiffs in the derivative action in
Delaware have not taken any steps to pursue their case. The derivative cases in
California state court have been consolidated, and plaintiffs have filed a
consolidated amended complaint. The court has entered a stipulated order in
those derivative cases suspending court proceedings and coordinating discovery
in them with discovery in the class actions in California state courts. On
plaintiffs' motion, the federal court has dismissed the federal class actions
without prejudice. The class actions in California state court have been
consolidated, and plaintiffs have filed a consolidated amended complaint. The
Company has answered that complaint. Discovery is pending. While management
intends to defend the actions against the Company vigorously, there can be no
assurance that an adverse result or settlement with regard to these lawsuits
would not have a material adverse effect on the Company's financial condition or
results of operations.

        The Company has received from the Securities and Exchange Commission a
request for information relating to the Company's restatement announcement in
November 1997. The Company has responded and intends to continue to respond to
such requests.

        The Company is also defending several putative class action lawsuits
naming Diamond, which were filed in June and July 1996 and June 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain former executive officers and
directors of Diamond are also named as defendants. The plaintiffs purport to
represent a class of all persons who purchased Diamond's Common Stock between
October 18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege
claims under the federal securities laws and California law. The plaintiffs
allege that Diamond and the other defendants made various material
misrepresentations and omissions during the Class Period. The complaints do not
specify the amount of damages sought. On March 24, 2000, the District Court for
the Northern District of California dismissed the federal action without
prejudice. The Company believes that it has good defenses to the claims alleged
in the California Superior Court lawsuit and will defend itself vigorously
against this action. No trial date has been set for this action.

        On August 4, 1999, two alleged stockholders of Diamond filed a lawsuit,
captioned Strum v. Schroeder, et al., in the Superior Court of the State of
California for the County of Santa Clara. Plaintiffs, on behalf of themselves
and a class of all former Diamond stockholders similarly situated whom they
purportedly represent, challenging the terms of the Company's merger with
Diamond. The complaint named Diamond, the former directors of Diamond and the
Company as defendants. The complaint alleged generally that Diamond's directors
breached their fiduciary duties to stockholders of Diamond and sought rescission
and the recovery of unspecified damages, fees and expenses. The case was
dismissed on May 25, 2000, with prejudice as to the named plaintiffs and
without prejudice as to the alleged class.

        Sega initiated a claim for arbitration in Tokyo, Japan against Diamond
in December 1998. The claim arises out of an agreement entered into between Sega
and Diamond in September 1995, in which Sega agreed to provide Diamond with Sega
game software that Diamond would bundle with its 3-D graphics board "The Edge."
Sega claims that Diamond breached the parties' agreement by failing to pay Sega
a contractual minimum royalty fee for the games as set forth in the agreement.
Sega claims as damages $3,800,000 in unpaid royalties and pre-judgment interest.
On May 28, 1999, Diamond responded to Sega's claims by filing an answer in which
it denied the material allegations of Sega's claims. The parties have filed
additional briefs in support of their claims and defenses. An evidentiary
hearing on this action has not yet been scheduled. The Company contests the
material allegations of Sega's claims. In addition, the Company has pleaded that
Sega's failure to provide it with 3-D optimized game software on a timely basis
adversely affected sales of The Edge. The Company claims that these lost sales
and profits should provide an offset to Sega's claims in the arbitration and
intends to defend the suit vigorously.

        C3 Sales, Inc. ("C3") filed suit against S3 on October 6, 1999 in the
Harris County (Houston), Texas District Court. The petition sought a judicial
declaration that a Sales Representative Agreement entered into between C3 and S3
on May 19, 1999 was a valid contract that governed the relationship between the
two parties. On November 8, 1999, S3 answered acknowledging that the May 19,
1999 agreement was a contract between the two parties. C3 failed to respond to
informal requests by S3 to dismiss the declaratory relief action on grounds that
no justiciable controversy existed between the parties. On December 3, 1999, S3
filed a summary judgment motion seeking judgment against C3 on the grounds that
no issues of material fact remain to be determined regarding the declaratory
judgment sought by C3. C3 responded by filing an amended petition raising new
matters. Specifically, C3's new claims


                                       32
<PAGE>   33

allege that the Sales Representative Agreement applies to Diamond products, and
that certain commissions due under the agreement have not been paid. S3 intends
to defend this action vigorously.

        On January 6, 2000, PhoneTel Communications, Inc. ("PhoneTel") filed a
complaint for patent infringement against a group of defendants, including
Diamond, in the United States District Court for the Northern District of Texas.
PhoneTel generally alleges that Diamond and the other defendants are infringing
its two patents by making, using, selling, offering to sell and/or importing
digital synthesizers, personal computers, sound cards, or console game systems.
PhoneTel does not specify which Diamond products allegedly infringe its patents.
S3 filed Diamond's answer to the complaint on March 28, 2000. S3 believes that
the complaint is without merit and will vigorously defend itself against the
allegations made in the complaint.

        The ultimate outcome of these actions cannot be presently determined.
Accordingly, no provision for any liability or loss that may result from
adjudication or settlement of the lawsuits has been made in the accompanying
condensed consolidated financial statements.

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

(a)     The Company's Annual Meeting of Stockholders was held on May 26, 2000.

(b)     The matters voted upon at the Annual Meeting of Stockholders and results
        of the voting with respect to those matters were as follows:

(1)     Election of Five Directors:

<TABLE>
<CAPTION>
                         Votes For      Withheld
                         ----------     --------
<S>                      <C>            <C>
Kenneth F. Potashner     69,525,704     678,116
Terry N. Holdt           69,472,794     731,026
Robert P. Lee            69,536,515     665,305
Carmelo J. Santoro       69,537,369     666,451
James T. Schraith        69,535,539     668,281
</TABLE>

(2) Amendment to the Company's 1993 Employee Stock Purchase Plan increasing the
number of shares available for sale to from 2.8 million to 4.8 million:

<TABLE>
<CAPTION>
Votes For     Against       Abstain
---------     -------       -------
<S>           <C>           <C>
54,319,236    5,525,331     262,546
</TABLE>

(3) Confirmation of Ernst & Young LLP as the Company's independent auditors:

<TABLE>
<CAPTION>
Votes For     Against       Abstain
---------     -------       -------
<S>           <C>           <C>
59,848,599    155,030       103,384
</TABLE>

Item 6. Exhibits and Reports on Form 8-K

(a)     Exhibits

<TABLE>
<CAPTION>
 EXHIBIT
  NUMBER     NOTES   DESCRIPTION OF DOCUMENT
  ------     -----   -----------------------

<S>                  <C>
   27.1              Financial Data Schedule (filed only with the electronic
                     submission of Form 10-Q in accordance with the EDGAR
                     requirements)
</TABLE>

(b)     Reports on Form 8-K:

        No reports on Form 8-K were filed during the quarter for which this
report is filed.


                                       33
<PAGE>   34

                                   SIGNATURES

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


                                  S3 INCORPORATED
                                  (Registrant)


Date: August 14, 2000                        /s/ WILLIAM F. MCFARLAND
                                  ----------------------------------------------
                                                WILLIAM F. MCFARLAND
                                  Controller and Interim Chief Financial Officer
                                   (Principal Financial and Accounting Officer)

                                       34

<PAGE>   35

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
 EXHIBIT
  NUMBER     NOTES   DESCRIPTION OF DOCUMENT
  ------     -----   -----------------------

<S>                  <C>
   27.1              Financial Data Schedule (filed only with the electronic
                     submission of Form 10-Q in accordance with the EDGAR
                     requirements)
</TABLE>