<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 September 30, 1997  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              [I.R.S. Employer Identification No.]
of incorporation or organization]


    2801 Mission College Boulevard
           P.O. Box 58058
       Santa Clara, California                          95052-8058
---------------------------------------                 ----------
[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 October 31, 1997 was 50,288,975

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


<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
        September 30, 1997 and December 31, 1996                                  3

        Condensed Consolidated Statements of Operations
        Three months and nine months
        ended September 30, 1997 and 1996                                         4

        Condensed Consolidated Statements of Cash Flows
        Nine months ended September 30, 1997 and 1996                             5

        Notes to Unaudited Condensed Consolidated Financial Statements           6-8


Item 2.  Management's Discussion and Analysis of
         Financial Condition and Results of Operations                           9-22


PART II. OTHER INFORMATION

Item 1.  Legal Proceedings                                                       23

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               Not Applicable

Item 5.  Other Information                                                 Not Applicable

Item 6.  Exhibits and Reports on Form 8-K                                        23

Signatures                                                                       24
</TABLE>


                                  Page 2 of 24


<PAGE>   3
   PART I. FINANCIAL INFORMATION
   Item 1. Financial Statements

                                 S3 INCORPORATED
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                    (Dollars in thousands, except share data)


<TABLE>
<CAPTION>
                                                                                    December 31,
                                                                    September 30,       1996
                                                                        1997       (As Restated)
                                                                    ------------   -------------
                                                                     (Unaudited)    (Unaudited)
<S>                                                                 <C>            <C>
                                     ASSETS
Current assets:
   Cash and equivalents                                               $ 67,399       $ 94,616
   Short-term investments                                               44,692         62,768
   Accounts receivable (net of allowances of $3,340 in 1997
     and $2,648 in 1996)                                               117,458         76,120
   Inventories, net                                                     50,727         53,466
   Prepaid expenses and other                                           35,715         34,369
                                                                      --------       --------
               Total current assets                                    315,991        321,339

Property and equipment,  net                                            48,593         34,047
Production capacity rights                                              14,400         14,400
Investment in joint venture                                            112,108         93,430
Other assets                                                            44,542         17,246
                                                                      --------       --------
               Total                                                  $535,634       $480,462
                                                                      ========       ========

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable                                                   $ 66,039       $ 51,160
   Notes payable                                                        28,461         17,802
   Accrued liabilities                                                  14,896         12,063
   Deferred revenue                                                     21,760         12,113
   Income taxes payable                                                     --          2,651
                                                                      --------       --------  
               Total current liabilities                               131,156         95,789

Notes payable                                                            4,800         14,400
Other liabilities                                                        9,188          6,452
                                                                      --------       --------  
               Total liabilities                                       145,144        116,641
                                                                      --------       --------
Convertible Subordinated Notes                                         103,500        103,500
                                                                      --------       --------

Commitments and contingencies (Notes 5 and 6)

Stockholders' equity:
   Common Stock, $.0001 par value; 70,000,000 shares 
     authorized; 50,194,051 and 48,331,794 shares outstanding 
     in 1997 and 1996                                                  178,987         169,411
   Unrealized gain (loss) on short-term investments                         39             (54)
   Retained earnings                                                   107,964          90,964
                                                                      --------        --------
               Total stockholders' equity                              286,990         260,321
                                                                      --------        --------
               Total                                                  $535,634        $480,462
                                                                      ========        ========
</TABLE>


               See accompanying notes to the unaudited condensed
                       consolidated financial statements.


                                  Page 3 of 24


<PAGE>   4
                                              S3 INCORPORATED
                              CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (In thousands, except per share data)
                                                (Unaudited)

<TABLE>
<CAPTION>
                                                         Three Months Ended                    Nine Months Ended
                                                   --------------------------------      ------------------------------
                                                   September 30,      September 30,      September 30,    September 30,
                                                        1997              1996               1997               1996
                                                   -------------      -------------      -------------    -------------
                                                                       (As Restated)                       (As Restated)
<S>                                                  <C>                 <C>               <C>                 <C>     
Net sales                                            $ 119,604           $110,085          $ 334,448           $311,327

Cost of sales                                           78,791             68,079            207,039            191,391
                                                     ---------           --------          ---------           --------

Gross margin                                            40,813             42,006            127,409            119,936

Operating expenses:
   Research and development                             20,057             15,897             60,028             45,675
   Selling, marketing and administrative                13,763             12,858             39,895             35,359
                                                     ---------           --------          ---------           --------
        Total operating expenses                        33,820             28,755             99,923             81,034
                                                     ---------           --------          ---------           --------

Income from operations                                   6,993             13,251             27,486             38,902
Other income (expense), net                               (737)               277             (1,008)             1,986
                                                     ---------           --------          ---------           --------

Income before income taxes                               6,256             13,528             26,478             40,888

Provision for income taxes                               1,872              4,600              9,478             13,869
                                                     ---------           --------          ---------           --------

Net income                                           $   4,384           $  8,928          $  17,000           $ 27,019
                                                     =========           ========          =========           ========


Net income per common and equivalent share:

     Primary                                         $    0.08           $   0.17          $    0.33           $   0.54
                                                     =========           ========          =========           ========

     Assuming full dilution                          $    0.08           $   0.17          $    0.33           $   0.53
                                                     =========           ========          =========           ========

Shares used in computing net income per
common and equivalent share:

     Primary                                            52,380             51,101             51,232             50,421
                                                     =========           ========          =========           ========

     Assuming full dilution                             52,380             52,932             53,020             51,031
                                                     =========           ========          =========           ========
</TABLE>


                See accompanying notes to the unaudited condensed
                       consolidated financial statements.


                                  Page 4 of 24

<PAGE>   5
                                            S3 INCORPORATED
                            CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                        (Dollars in thousands)
                                              (Unaudited)


<TABLE>
<CAPTION>
                                                                          Nine Months Ended
                                                                   ---------------------------------
                                                                   September 30,      September 30,
                                                                        1997              1996
                                                                   -------------      --------------
                                                                                      (As Restated)
<S>                                                                  <C>                <C>
Operating activities:
   Net income                                                        $ 17,000           $  27,019
   Adjustments to reconcile net income to net cash used for
   operating activities:
       Deferred income taxes                                            3,229                (994)
       Depreciation and amortization                                   13,203               7,717
       Equity in income from joint venture                            (18,678)                 --
       Changes in assets and liabilities:
             Accounts receivable                                      (41,338)            (20,621)
             Inventories                                                2,739              (9,572)
             Prepaid expenses and other                                (3,221)             (6,794)
             Production capacity rights                                    --              (7,200)
             Accounts payable                                          14,879             (26,073)
             Accrued liabilities                                        4,937               6,319
             Deferred revenue                                           9,647              10,201
             Income taxes payable                                      (2,651)             (1,477)
                                                                     --------           ---------
   Net cash used for operating activities                                (254)            (21,475)
                                                                     --------           ---------

Investing activities:
   Property and equipment purchases, net                              (25,435)            (12,515)
   Investment in real estate partnership                                   --              (2,100)
   Sales/maturities of short-term investments, net                     18,169              11,389
   Technology investments                                             (16,200)                 --
   Investment in joint venture                                             --             (26,921)
   Other assets                                                       (12,875)                 --
                                                                     --------           ---------
   Net cash used for investing activities                             (36,341)            (30,147)
                                                                     --------           ---------

Financing activities:
   Sale of common stock, net                                            9,576               3,391
   Sale of convertible subordinated notes                                  --             103,500
   Debt issuance costs                                                     --              (3,250)
   Net borrowings (repayments) of notes payable                        (9,600)                 --
   Borrowings on equipment financing                                    9,402               6,500
   Net borrowings of notes payable                                         --               3,000
                                                                     --------           ---------
   Net cash provided by financing activities                            9,378             113,141
                                                                     --------           ---------

Net increase (decrease) in cash and equivalents                       (27,217)             61,519
Cash and cash equivalents at beginning of period                       94,616              69,289
                                                                     --------           ---------
Cash and cash equivalents at end of period                           $ 67,399           $ 130,808
                                                                     ========           =========
</TABLE>

               See accompanying notes to the unaudited condensed
                       consolidated financial statements.


                                  Page 5 of 24
<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"). 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 rules and regulations. In the opinion of
the Company, the financial statements reflect all adjustments consisting only of
normal recurring adjustments except as discussed in note 2 below, necessary for
a fair presentation of the financial position at September 30, 1997, the
operating results for the three and nine months ended September 30, 1997 and
1996, and cash flows for the nine months ended September 30, 1997 and 1996.

        The results of operations for the three months and nine months ended
September 30, 1997 are not necessarily indicative of the results that may be
expected for the future quarters or the year ending December 31, 1997. Certain
reclassifications of 1996 amounts were made in order to conform to the 1997
presentation.


2.      Restatement of Financial Statements for Previous Periods

        Subsequent to the filing of the Company's Form 10-Q for the quarter
ended June 30, 1997, the Company discovered that its accounting policies with
respect to revenue recognition for international sales had not been fully
followed. The Company's policy is to defer recognition of revenue on all sales
to distributors until the product is sold by each distributor to its customers.
Following a preliminary review, the Company believes that in certain instances,
revenue was recognized at the time of shipment of product to the Company's
distributors instead of at the time the distributor sold the product to its
customer. The Company's review of this matter is ongoing and is being conducted
by the Audit Committee of the Board of Directors. Although the review has not
been completed, the Company believes that it has quantified the revenue
misstatements related to its distributors and has reported the effects as
restatements in this quarterly report. The effects of such restatements are
summarized as follows in thousands except per share amount: 


<TABLE>
<CAPTION>
                                                                 Three Months Ended,     Nine Months Ended, 
                                                                 September 30, 1996      September 30, 1996
                                                                 -------------------     ------------------
<S>                                                              <C>                     <C>     
Net sales before restatement                                           $119,440                $333,337
Net sales after restatement                                            $110,085                $311,327
                                                                                          
Cost of sales before restatement                                       $ 72,824                $203,691
Cost of sales after restatement                                        $ 68,079                $191,391
                                                                                          
Net income before restatement                                          $ 11,788                $ 32,888
Net income after restatement                                           $  8,928                $ 27,019
                                                                                          
Net income per common and equivalent share before restatement          $   0.23                $   0.65
Net income per common and equivalent share after restatement           $   0.17                $   0.54
</TABLE>

<TABLE>
                                                                 At December 31, 1996
                                                                 --------------------
<S>                                                                   <C>
Deferred revenue before restatement                                   $    624
Deferred revenue after restatement                                    $ 12,113

Total liabilities before restatement                                  $109,862 
Total liabilities after restatement                                   $116,641

Total stockholder's equity before restatement                         $267,100
Total stockholder's equity after restatement                          $260,321
</TABLE>

After further review, the Company will reissue its annual financial statements
for the year ended December 31, 1996. Until that time, no reliance should be
placed on the 1996 financial statements or independent auditors' report thereon
included in the 1996 Annual Report on Form 10-K or on the financial statements
included in the quarterly reports on Form 10-Q previously filed in 1996 and
1997.


                                  Page 6 of 24
<PAGE>   7
3.      Inventories:

        Inventories consist of work in process and finished goods and are stated
at the lower of cost (first-in, first-out) or market.


<TABLE>
<CAPTION>
                                          September 30,    December 31,
         Inventories consist of:             1997             1996
                                          ------------     ------------
                                                 (in thousands)
<S>                                         <C>              <C>    
        Work in process                     $27,584          $22,556
        Finished goods                       23,143           30,910
                                            -------          -------
           Total                            $50,727          $53,466
                                            =======          =======
</TABLE>


4.      Net income per share:

        Primary per share data is computed based on the weighted average number
of common and dilutive common equivalent shares outstanding. Common equivalent
shares include stock options and shares subscribed under the employee stock
purchase plan (computed using the treasury stock method). Fully diluted per
share data is computed using the most dilutive assumptions and by adjusting the
primary per share data and net income for the effect of the conversion of the 5
3/4% Convertible Subordinated Notes outstanding during the period and the
elimination of the related interest and amortization of issue costs, net of
income taxes.


5.      Wafer supply agreements and commitments

        During 1995, the Company entered into two long-term manufacturing
capacity arrangements. The Company entered into an agreement with United
Microelectronics Corporation (UMC) and Alliance Semiconductor Corporation to
form United Semiconductor Corporation (USC), a separate Taiwanese company, for
the purpose of building and managing a semiconductor manufacturing facility in
Taiwan, Republic of China. The Company has invested a total of $89.4 million for
its equity interest of 23.75%. The Company has the right to purchase up to
31.25% of the output from the foundry.

        In addition, 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 years capacity. The Company has signed promissory notes to
secure these payments over the term of the agreement. At September 30, 1997, the
remaining advance payments (and corresponding promissory notes) totaled $31.2
million ($16.8 million in prepaid expenses and $14.4 million in production
capacity rights).

        In the ordinary course of business, the Company places purchase orders
with its wafer suppliers based on its existing and anticipated customer orders
for its products. Should the Company experience a substantial unanticipated
decline in the selling price of its products and/or demand thereof, it could
result in a material loss on such purchase commitments.


6.      Contingencies

        The semiconductor and software industries are characterized by frequent
litigation regarding patent and other intellectual property rights and other
contract disputes. The Company has been and can be in the future party to
various claims of this nature. Although the ultimate outcome of these matters is
not presently determinable, management believes that


                                  Page 7 of 24
<PAGE>   8
the resolution of all such matters will not have a material adverse
effect on the Company's financial position or results of operations. 
See Note 8 concerning litigation.


7.      Recently Issued Accounting Standards

        In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS
128). The Company is required to adopt SFAS 128 in the fourth quarter of fiscal
1997 and will restate at that time earnings per share (EPS) data for prior
periods to conform with SFAS 128. Earlier application is not permitted.

        SFAS 128 will replace current EPS reporting requirements and requires a
dual presentation of basic and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income available to common shareholders by the weighted
average of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock.

        If SFAS 128 had been in effect during the current and prior year
periods, basic EPS would have been $0.09 and $0.19 for the three months ended
September 30, 1997 and 1996 respectively. Basic EPS would have been $0.35 and
$0.57 for the nine months ended September 30, 1997 and 1996 respectively.
Diluted EPS under SFAS 128 would have been $0.08 and $0.17 for the three months
ended September 30, 1997 and 1996 respectively. Diluted EPS for the nine months
ended September 30, 1997 and 1996 would have been $0.33 and $0.54 respectively.

        In June 1997, the Financial Accounting Standards Board adopted
Statements of Financial Accounting Standards No. 130 (Reporting Comprehensive
Income), which requires that an enterprise report, by major components and as a
single total, the change in its net assets during the period from nonowner
sources; and No. 131 (Disclosures about Segments of an Enterprise and Related
Information), which establishes annual and interim reporting standards for an
enterprise's business segments and related disclosures about its products,
services, geographic areas, and major customers. Adoption of these statements
will not impact the Company's consolidated financial position, results of
operations or cash flows. Both statements are effective for fiscal years
beginning after December 15, 1997, with earlier application permitted.


8.      Subsequent Events

        In November 1997, several complaints were filed in federal and state
courts seeking an unspecified amount of damages on behalf of an alleged class of
persons who purchased shares of the Company's Common Stock at various times
between January 1, 1995 and November 3, 1997. The complaints name as defendants
the Company, certain of its officers and former officers and certain directors
of the Company and its outside auditors, asserting that they violated federal
and state securities laws by misrepresenting and failing to disclose certain
information about the Company's business. The Company has not formally responded
to the complaints. While management intends to defend the actions vigorously,
there can be no assurance that an adverse result or settlement with regards to
these lawsuits would not have a material adverse effect on the Company's
financial condition or results of operations.


                                  Page 8 of 24
<PAGE>   9
PART I. FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations

        When used in this discussion, 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 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 Results," 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

        The Company is a leading supplier of multimedia acceleration hardware
and its associated software for the PC market. The Company's accelerators are
designed to work cooperatively with a PC's central processing unit ("CPU"),
implementing functions best suited for a dedicated accelerator while allowing
the CPU to perform the more general purpose computing functions of today's
advanced graphical user interface ("GUI") environment and applications.

        Subsequent to the filing of the Company's Form 10-Q for the quarter
ended June 30, 1997, the Company discovered that its accounting policies with
respect to revenue recognition for international sales had not been fully
followed. The Company's policy is to defer recognition of revenue on all sales
to distributors until the product is sold by each distributor to its customers.
Following a preliminary review, the Company believes that in certain instances,
revenue was recognized at the time of shipment of product to the Company's
distributors instead of at the time the distributor sold the product to its
customer. The Company's review of this matter is ongoing and is being conducted
by the  Audit Committee of the Board of Directors. As a result, the Company's
quarterly financial statements have been restated from the amounts previously
reported to reflect the recognition of revenue at the time of sale by the
distributor to the customer. See note 2 of notes to unaudited condensed
consolidated financial statements.


                                  Page 9 of 24
<PAGE>   10

RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
                                               Three Months Ended             Nine Months Ended
                                        September 30,    September 30,    September 30,   September 30,
                                             1997              1996           1997            1996
                                        ------------     -------------    ------------    -------------
                                                         (As Restated)                    (As Restated) 
<S>                                         <C>              <C>             <C>              <C>   
Net sales                                   100.0%           100.0%          100.0%           100.0%
Cost of sales                                65.9             61.8            61.9             61.5
                                            -----            -----           -----            ----- 
Gross margin                                 34.1             38.2            38.1             38.5
                                            -----            -----           -----            ----- 
Operating expenses:
   Research and development                  16.8             14.4            18.0             14.7
   Selling, marketing and
     administrative                          11.5             11.7            11.9             11.3
                                            -----            -----           -----            ----- 
        Total operating expenses             28.3             26.1            29.9             26.0
                                            -----            -----           -----            ----- 
Income from operations                        5.8             12.1             8.2             12.5
Other income (expense), net                  (0.6)             0.2            (0.3)             0.6
                                            -----            -----           -----            ----- 
Income before income taxes                    5.2             12.3             7.9             13.1
Provision for income taxes                    1.6              4.2             2.8              4.5
                                            -----            -----           -----            ----- 
Net income                                    3.6%             8.1%            5.1%             8.6%
                                            =====            =====           =====            ===== 
</TABLE>

        The Company's operating results have historically been, and will
continue to be, subject to quarterly and other fluctuations due to a variety of
factors, including changes in pricing policies by the Company, its competitors
or its suppliers, anticipated and unanticipated decreases in unit average
selling prices of the Company's products, availability and cost of products from
the Company's suppliers, changes in the mix of products sold and in the mix of
sales by distribution channels, the gain or loss of significant customers, new
product introductions by the Company or its competitors, marketing acceptance of
new or enhanced versions of the Company's products, seasonal customer demand,
and the timing of significant orders.

        The Company's operating results may fluctuate from those in prior
quarters or may be adversely affected in quarters in which it is undergoing a
product line transition in which production and sales of new products are
ramping up and in which existing products are under extreme price pressures due
to competitive factors. If new products are not brought to market in a timely
manner or do not address market needs or performance requirements, then the
Company's operating results will be adversely affected. As a result of the
foregoing, the Company's operating results and stock price may be subject to
significant volatility, particularly on a quarterly basis. Any shortfall in net
sales or net income from levels expected by securities analysts could have an
immediate and significant adverse effect on the trading price of the Company's
common stock.


                                  Page 10 of 24
<PAGE>   11
        NET SALES

        The Company's net sales to date have been generated from the sale of its
graphics and multimedia accelerators. The Company's products are used in, and
its business is dependent on, the personal computer industry with sales
primarily in Asia, the U.S., and Europe. Net sales were $119.6 million for the
three months ended September 30, 1997, a 9% increase above the $110.1 million of
net sales for the three months ended September 30, 1996. Net sales were $334.4
million for the nine months ended September 30, 1997 or 7% above the $311.3
million of net sales for the nine months ended September 30, 1996. Year to date
net sales increased primarily as a result of demand for the Company's ViRGE and
Trio families of integrated accelerators that resulted in increased unit
shipments. The increase in unit shipments was partially offset by lower overall
average selling prices.

        Due to competitive price pressures, the Company's products experience
declining unit average selling prices over time, which at times can be
substantial. The pricing environment for 2D graphics accelerators, which
accounted for a majority of the Company's net sales in 1996, has recently
experienced and is expected to continue to experience increasing pricing
pressures due to aggressive pricing from certain of the Company's competitors.
In particular, the Company's Trio family of integrated 2D accelerators
experienced significant decreases in average selling prices in 1996 which has
continued during the first nine months of 1997. The graphics accelerator market
is transitioning from 2D acceleration to 3D acceleration, and the Company
introduced its ViRGE family of 2D/3D accelerators in response to this
transition. As a result of the entry of competitors into the 3D acceleration
market, the Company has experienced and anticipates that it may continue to
experience increased pricing pressures on average selling prices for the ViRGE
family of 2D/3D accelerators. The Company experienced significant price
competition for its products in the three and nine months ended September 30,
1997. The Company currently anticipates sequential price declines in the fourth
quarter of 1997 and the first half of 1998. 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. If the
transition occurs slower than expected, if the Company's graphic products do not
achieve market acceptance, or if the pricing pressures increase or continue in
the manner experienced in the first nine months of 1997, then the Company's
operating results could be adversely affected.

        Export sales accounted for 76% and 57% of net sales for the three months
ended September 30, 1997 and 1996, respectively. Export sales accounted for 68%
and 76% of net sales for the nine months ended September 30, 1997 and 1996
respectively. Approximately 20% and 19% of export sales for the three and nine
months ended September 30, 1997 were to affiliates of United States customers.
The Company expects that export sales will continue to represent a significant
portion of net sales, although there can be no assurance that export sales as a
percentage of net sales will remain at current levels. All sales transactions
were denominated in U.S. dollars.

        Four customers accounted for 24%, 17%, 15% and 11% of net sales for the
three months ended September 30, 1997, and three customer accounted for 24%,
15%, and 11% of net sales for the nine months ended September 30, 1997.
Comparatively, three customers accounted for 22%, 14% and 10% of net sales for
the three months ended September 30, 1996, and two customer accounted for 16%
and 14% of net sales for the nine months ended September 30, 1996. 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 cancel or reschedule orders or, in the event orders are canceled, 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 occurrence of any supply problems for the Company's products may
adversely affect the rate of growth in net sales. Net sales may also be
adversely affected by delays in the production ramp of customers' new programs
and systems which incorporate the Company's products. In addition, the Company
ships more product


                                  Page 11 of 24
<PAGE>   12
in the third month of each quarter than in either of the first two months of the
quarter, with shipments in the third month higher at the end of the month. This
pattern, which is common in the semiconductor industry, is likely to continue.
The concentration of sales in the last month of the quarter may cause the
Company's quarterly results of operations to be more difficult to predict.
Moreover, a disruption in the Company's production or shipping near the end of a
quarter could materially reduce the Company's net sales for that quarter. The
Company's reliance on outside foundries and independent assembly and testing
houses reduces the Company's ability to control, among other things, delivery
schedules.

        GROSS MARGIN

        Gross margin percentage decreased to 34% for the three months ended
September 30, 1997 from 38% for the three months ended September 30, 1996. The
decrease was due to decreases in overall average selling prices coupled with the
Company's mix of product sold. Gross margin percentage decreased to 38% for the
nine months ended September 30, 1997 from 39% for the nine months ended
September 30, 1996. The Company currently expects its gross margin percentage
for the three months ending December 31, 1997 to approximate current levels or
decrease as a percentage of revenue.

        In the future, the Company's gross margin percentages may be affected by
increased competition and related decreases in 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 profitability of
the USC joint venture (the Company recognizes its proportionate share of USC
profits and losses), the extent to which the Company forfeits or utilizes its
production capacity rights with TSMC, the extent to which the Company will incur
additional licensing fees and shifts in sales mix between add-in card and
motherboard manufacturers to 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 $20.1 million for
the three months ended September 30, 1997, an increase of $4.2 million from
$15.9 million for the three months ended September 30, 1996. Research and
development expenses were $60.0 million for the nine months ended September 30,
1997, an increase of $14.3 million from $45.7 million for the nine months ended
September 30, 1996. Research and development spending increases reflect
additions to the Company's engineering staff and nonrecurring engineering and
initial product verification expenses related to the expected introduction of
new products. Research and development spending is expected to increase in
absolute dollars in 1997 as a result of the product development activities
currently underway for the desktop, mobile and home PC markets with a focus on
full motion video, 3D, and audio.

        Products in the Company's market typically have a life cycle of 12 to 24
months. The successful development and commercialization of new products
required to replace or supplement existing products involve many risks,
including the identification of new product opportunities, the successful and
timely completion of the development process, and the selection of the Company's
products by leading systems suppliers and board manufacturers for design into
their products. The Company currently lacks product offerings addressing the
high end of the desktop graphics market. These products are currently expected
to be announced in the first half of 1998. There can be no assurance that these
products will achieve market acceptance or that the Company will successfully
identify new product opportunities and develop and bring to the market in a
timely manner successful new products, that products or technologies developed
by others will not render the Company's products noncompetitive, or that the
Company's products will be selected for design into its customers' products. In
addition, it is possible that the Company's products may be found defective
after the Company has already shipped significant volume production. There can
be no assurance that the Company would be able to successfully correct such
problems or that such corrections would be acceptable to customers. The
occurrence of any such events would have a material adverse effect on the
Company's operating results.


                                  Page 12 of 24
<PAGE>   13
        SELLING, MARKETING AND ADMINISTRATIVE EXPENSES

        Selling, marketing and administrative expenses were $13.8 million for
the three months ended September 30, 1997, an increase of $0.9 million from
$12.9 million for the three months ended September 30, 1996. Selling, marketing
and administrative expenses were $39.9 million for the nine months ended
September 30, 1997 an increase of $4.5 million from $35.4 million in the nine
months ended September 30, 1996. Selling and marketing costs increased as a
result of additional personnel, increased commissions and increased marketing
costs associated with the expected introduction of new products. Administrative
costs have increased due to the hiring of additional personnel necessary to
support the increased level of operations. The Company anticipates that selling,
marketing and administrative expenses will increase in absolute dollars for the
three months ended December 31, 1997.

        OTHER INCOME (EXPENSE), NET

        Other expense, decreased to $(0.7) million for the three months ended
September 30, 1997, from $0.3 million of interest income for the three months
ended September 30, 1996. Other expense decreased to $(1.0) million for the nine
months ended September 30, 1997, from $2.0 million of interest income for the
nine months ended September 30, 1996. The decrease is attributable to the
interest expense incurred on $103.5 million aggregate principal amount of
convertible subordinated notes, which were issued by the Company in September
1996. The interest expense is partially offset by the interest income due to the
higher average amounts of cash and short-term investments as a result of the net
proceeds from the sale of the convertible subordinated notes in September of
1996.

        INCOME TAXES

        The Company's effective tax rate for the three months and nine months
ended September 30, 1997 is 30% and 36% respectively, compared to an effective
tax rate for the three months and nine months ended September 30, 1996 of 34%.
The change in tax rate is primarily attributable to the Company's expansion into
higher national and subnational tax rate jurisdictions.

        LIQUIDITY AND CAPITAL RESOURCES

        Cash used for operating activities for the nine months ended September
30, 1997 was $0.3 million, as compared to $21.5 million for the nine months
ended September 30, 1996. The Company experienced an increase from December 31,
1996 in accounts receivable, other assets, accrued liabilities, deferred revenue
and other liabilities. These increases were partially offset by decreases in
inventories and income taxes payable. The Company experienced an increase in
accounts receivable from the level at December 31, 1996 due to the substantial
concentration of sales in September 1997 resulting from increased shipments in
the third month of the third quarter over either of the first two months of the
quarter relative to what the Company experienced in previous quarters as well as
an increase in days sales outstanding.

        Investing activities for the nine months ended September 30, 1997 and
1996 reflected property and equipment purchases, net, of $25.4 million and $12.5
million, respectively and sales of short term investments of $18.2 and $11.4
million respectively. Technology investments of $16.2 million include an equity
investment in Faroudja, Inc. and various patent technology acquisitions.
Continued expansion of the Company's business may require higher levels of
capital equipment purchases, technology investments, foundry investments and
other payments to secure manufacturing capacity.

        Financing activities provided cash of $9.4 and $113.1 million in the
nine months ended September 30, 1997 and 1996. Borrowings on the line of credit
and proceeds from the issuance of common stock were the principal financing
activities that generated cash in the nine months ended September 30, 1997. The
Company completed a private placement of $103.5 million aggregate principal
amount of convertible subordinated notes which was the principal financing
activity that generated cash during the nine month period ended September 30,
1996. 


                                 Page 13 of 24
<PAGE>   14
        Working capital at September 30, 1997 and December 31, 1996 was $184.8
million and $225.5 million, respectively. At September 30, 1997, the Company's
principal sources of liquidity included cash and equivalents of $67.4 million
and $44.7 million in short-term investments. In addition, the Company has a
$75.0 million unsecured revolving line of credit that expires September 26,
1999. The Company had $10.0 million outstanding under the line of credit as of
September 30, 1997. In addition, the Company has a separate secured equipment
line of credit totaling $7.6 million. The Company had $5.9 million outstanding
under this secured equipment line of credit at September 30, 1997. The Company
believes that its available funds and its anticipated funds from operations will
satisfy the Company's projected working capital, existing foundry supply
agreement and capital expenditure requirements for at least the next 12 months.

        In order to obtain an adequate supply of wafers, especially wafers
manufactured using advanced process technologies, the Company has entered into
and will continue to consider various possible transactions, including the use
of "take or pay" contracts that commit the Company to purchase specified
quantities of wafers over extended periods, equity investments in, advances or
issuances of equity securities to wafer manufacturing companies in exchange for
guaranteed production or the formation of joint ventures to own and operate or
construct wafer fabrication facilities. Manufacturing arrangements such as these
may require substantial capital investments, which may require the Company to
seek additional equity or debt financing. There can be no assurance that such
additional financing, if required, will be available when needed or, if
available, will be on satisfactory terms. In addition, the Company may, from
time to time, as business conditions warrant, invest in or acquire businesses,
technology or products that complement the business of the Company.

        The cyclical nature of the semiconductor industry periodically results
in shortages of advanced process wafer fabrication capacity such as the Company
experiences from time to time. The Company's ability to maintain adequate levels
of inventory is primarily dependent upon the Company obtaining sufficient supply
of products to meet future demand, and any inability of the Company to maintain
adequate inventory levels may adversely affect its relations with its customers.
In addition, because the Company must order products and build inventory
substantially in advance of product shipments, there is a risk that the Company
will forecast incorrectly and produce excess or insufficient inventories of
particular products because the Company's products are volatile and subject to
rapid technology and price change. This inventory risk is heightened because
certain of the Company's key customers place orders with short lead times. The
Company's customers' ability to reschedule or cancel orders without significant
penalty could adversely affect the Company's liquidity, as the Company may be
unable to adjust its purchases from its independent foundries to match such
customer changes and cancellations. To the extent the Company produces excess or
insufficient inventories of particular products, the Company's operating results
could be adversely affected.

FACTORS THAT MAY AFFECT RESULTS

   Fluctuations in Quarterly Operating Results

        The Company's operating results have historically been, and will
continue to be, subject to quarterly and other fluctuations due to a variety of
factors, including changes in pricing policies by the Company, its competitors
or its suppliers, anticipated and unanticipated decreases in unit average
selling prices of the Company's products, availability and cost of products from
the Company's suppliers, changes in the mix of products sold and in the mix of
sales by distribution channels, the gain or loss of significant customers, new
product introductions by the Company or its competitors, market acceptance of
new or enhanced versions of the Company's products, seasonal customer demand,
and the timing of significant orders. Operating results could also be adversely
affected by general economic and other conditions affecting the timing of
customer orders and capital spending, a downturn in the market for PCs, order
cancellations or rescheduling and the other factors discussed below. These
factors could adversely affect demand for the Company's products. In addition,
the


                                  Page 14 of 24
<PAGE>   15
pricing environment for graphics accelerators has recently experienced
increasing pricing pressures and is expected to continue to experience pricing
pressures, due in part to aggressive pricing from certain of the Company's
competitors. In particular, the Company's Trio family of integrated 2D
accelerators, which accounted for a majority of the Company's revenues in 1996,
experienced significant decreases in average selling prices in 1997. The
graphics accelerator market is transitioning from 2D acceleration to 3D
acceleration, and the Company has introduced its ViRGE family of 2D/3D
accelerators in response to this transition. As a result of the entry of
competitors into the 3D acceleration market, the Company has experienced and
anticipates that it may continue to experience increased pricing pressures on
average selling prices for the ViRGE family of 2D/3D accelerators. If the
transition occurs slower than expected, if the Company's 2D/3D products do not
achieve market acceptance, or if pricing pressures increase above normal
anticipated levels, the Company's operating results could be adversely affected.
Further, because the Company is continuing to increase its operating expenses
for personnel and new product development, the Company's operating results would
be adversely affected if such budgeted sales levels were not achieved. PC
graphics and multimedia subsystems include, in addition to the Company's
products, a number of other components which are supplied by third-party
manufacturers. Any shortage of such components in the future could adversely
affect the Company's business and operating results. Furthermore, it is possible
that the Company's products may be found to be defective after the Company has
already shipped significant volume production. There can be no assurance that
the Company would be able to successfully correct such defects or that such
corrections would be acceptable to customers, and the occurrence of such events
could have a material adverse effect on the Company's business and operating
results.

        Because the Company must order products and build inventory
substantially in advance of product shipments, and because the markets for the
Company's products are volatile and subject to rapid technological and price
changes, there is a risk that the Company will forecast incorrectly and produce
excess or insufficient inventories of particular products. In addition, the
Company's customers may change delivery schedules or cancel orders without
significant penalty. To the extent the Company produces excess or insufficient
inventories of particular products, the Company's operating results could be
adversely affected.

        The Company ships more product in the third month of each quarter than
in either of the first two months of the quarter, with shipments in the third
month higher at the end of the month. This pattern, which is common in the
semiconductor industry, is likely to continue. The concentration of sales in the
last month of the quarter may cause the Company's quarterly results of
operations to be more difficult to predict. Moreover, a disruption in the
Company's production or shipping near the end of a quarter could materially
reduce the Company's net sales for that quarter. The Company's reliance on
outside foundries and independent assembly and testing houses reduces the
Company's ability to control, among other things, delivery schedules.

        Due to the foregoing factors, it is likely that in some future quarter
or quarters the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially and adversely affected.

      Importance of New Products; Rapid Technological Change

        The PC industry in general, and the market for the Company's products in
particular, is characterized by rapidly changing technology, evolving industry
standards, frequent new product introductions and significant price competition,
resulting in short product life cycles and regular reductions of unit average
selling prices over the life of a specific product. Products in the Company's
market typically have a life cycle of 12 to 24 months, with regular reductions
of unit average selling prices over the life of a specific product. The
successful development and commercialization of new products required to replace
or supplement existing products involve many risks, including the identification
of new product opportunities, the successful and timely completion of the
development process, and the selection of the Company's products by leading
systems suppliers and add-in card and motherboard manufacturers for design into
their products. There can be no assurance that the Company will successfully
identify new product opportunities and develop and bring to market in a timely
manner successful new products, that products or technologies developed by
others will not render the Company's products or 


                                 Page 15 of 24

<PAGE>   16
technologies noncompetitive, or that the Company's products will be selected for
design into its customers' products.

        The Company is continually developing new products to address changing
market needs, and its operating results may fluctuate from those in prior
quarters or may be adversely affected in quarters in which it is undergoing a
product transition or in which existing products are under price pressures due
to competitive factors. Market acceptance of the Company's products will also
depend upon acceptance of other components, such as memory, that the Company's
products are designed to work with. For example, the Company has recently
introduced accelerators designed to work with synchronous graphics RAM ("SGRAM")
and/or synchronous DRAM ("SDRAM") which the Company believes offer better
performance for its price than the more expensive video RAM ("VRAM"). However,
there can be no assurance that other memory technologies, such as Rambus DRAM,
will not achieve a greater degree of market acceptance than SGRAMs or SDRAMs.

        If new products are not brought to market in a timely manner or do not
address market needs or achieve market acceptance, then the Company's operating
results could be adversely affected. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."


      Dependence on Foundries and Other Third Parties

        The Company currently relies on several independent foundries to
manufacture its products either in finished form or wafer form. The Company
currently has long-term supply arrangements with two of its foundries, a "take
or pay" contract with Taiwan Semiconductor Manufacturing Company ("TSMC") and a
joint venture foundry, United Semiconductor Corporation ("USC"). In 1995, the
Company expanded and formalized its relationship with TSMC to provide additional
capacity over the 1996 to 2000 timeframe. The foundry agreement with TSMC
requires the Company to make certain annual advance payments to purchase certain
committed capacity amounts to be applied against the following year's capacity
or forfeit advance payments against such amounts. In addition, the Company
entered into an agreement with United Microelectronics Corporation ("UMC") and
Alliance Semiconductor Corporation to form a separate Taiwanese company, USC,
for the purpose of building and managing a semiconductor manufacturing facility.
The Company invested $53.0 million in 1996 and $36.4 million in 1995 for its
23.75% equity interest. The facility commenced production utilizing advanced
submicron semiconductor manufacturing processes in late 1996. The Company has
the right to purchase up to 31.25% of the output from the foundry. To the extent
the Company purchases excess inventories of particular products or chooses to
forfeit advance payments, the Company's operating results could be adversely
affected. To the extent USC experiences operating losses, the Company will
recognize its proportionate share of such losses and may be required to
contribute additional capital. The Company believes that a number of
manufacturers are expanding or planning to expand their fabrication capacity
over the next several years, which could lead to overcapacity in the market and
resulting decreases in costs of finished wafers. If the wafers produced by USC
cannot be produced at competitive prices, USC could sustain operating losses.
There can be no assurance that such operating losses will not have a material
adverse effect on the Company's results of operations.


                                  Page 16 of 24

<PAGE>   17
        The Company conducts business with its other current foundries by
delivering written purchase orders specifying the particular product ordered,
quantity, price, delivery date and shipping terms and, therefore, such foundries
are generally not obligated to supply products to the Company for any specific
period, in any specific quantity or at any specified price, except as may be
provided in a particular purchase order. To the extent a foundry terminates its
relationship with the Company or should the Company's supply from a foundry be
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, the Company may not have a sufficient amount of time to replace the
supply of products manufactured by that foundry. There can be no assurance that
the Company will obtain sufficient advanced process technology foundry capacity
to meet customer demand in the future. The Company is continuously evaluating
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, and there can be no assurance that
such sources will be able or willing to satisfy the Company's requirements on a
timely basis or at acceptable quality or per unit prices.

        Two of the Company's principal foundries, TSMC and UMC, and the
Company's foundry joint venture, USC, are located in the Science-Based
Industrial Park in Hsin Chu City, Taiwan. The Company currently expects these
three foundries to supply the substantial portion of the Company's products in
1997 and 1998. Disruption of operations at these foundries for any reason,
including work stoppages, fire, earthquakes or other natural disasters, would
cause delays in shipments of the Company's products, and could have a material
adverse effect on the Company's results of operations. 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 the Company's foundries' ability to supply the Company's
products, which could have a material adverse effect on the Company's results of
operations.

        The Company is using multiple sources for certain of its products, which
may require the Company's customers to perform separate product qualifications.
The Company has not, however, developed alternate sources of supply for certain
other products, and its newly introduced products are typically produced
initially by a single foundry until alternate sources can be qualified. The
requirement that a customer perform separate product qualifications or a
customer's inability to obtain a sufficient supply of products from the Company
may cause that customer to satisfy its product requirements from the Company's
competitors, which would adversely affect the Company's results of operations.

        The Company's products are assembled and tested by a variety of
independent subcontractors. The Company's reliance on independent assembly and
testing houses to provide these services involves a number of risks, including
the absence of adequate availability of certain packaging technologies, the
absence of guaranteed capacity and reduced control over delivery schedules,
quality assurance and costs. The Company also is subject to the risks of
shortages and increases in the cost of raw materials used in the manufacture or
assembly of the Company's products.


                                  Page 17 of 24

<PAGE>   18
        Constraints or delays in the supply of the Company's products, whether
because of capacity constraints, unexpected disruptions at the foundries or
assembly or testing houses, delays in obtaining additional production at
existing foundries or in obtaining production from new foundries, shortages of
raw materials, or other reasons, could result in the loss of customers and other
material adverse effects on the Company's operating results, including effects
that may result should the Company be forced to purchase products from higher
cost foundries or pay expediting charges to obtain additional supply.

      Transactions to Obtain Manufacturing Capacity; Future Capital Needs

        In order to obtain an adequate supply of wafers, especially wafers
manufactured using advanced process technologies, the Company has entered into
and may consider in the future various transactions, including the use of "take
or pay" contracts that commit the Company to purchase specified quantities of
wafers over extended periods, equity investments in or advances or issuances of
equity securities to wafer manufacturing companies in exchange for guaranteed
production capacity, or the formation of joint ventures to own and operate or
construct foundries or to develop certain products. Any of such transactions
would involve financial risk to the Company and could require the Company to
commit substantial capital or provide technology licenses in return for
guaranteed production capacity. In particular, the Company has entered into a
"take or pay" contract with TSMC and has entered into the USC joint venture. The
need to commit substantial capital may require the Company to seek additional
equity or debt financing. The sale or issuance of additional equity or
convertible debt securities could result in additional dilution to the Company's
stockholders. There can be no assurance that such additional financing, if
required, will be available when needed or, if available, will be on terms
acceptable to the Company.


      Dependence on Accelerator Product Line

        S3's products are designed to improve the graphics and multimedia
performance of Pentium-based PCs and Microsoft Windows, Windows NT and IBM OS/2
operating systems, the predominant standards in today's PC market. Any shift
away from such standards would require the Company to develop new products. The
Company expects 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. The Company has not previously
offered either single function or integrated accelerator products that provide
these functions, which have traditionally been provided by separate single
function chips or chipsets. The Company has been and will continue to be
required to expand the scope of its research and development efforts to provide
these functions, which will require the hiring of engineers skilled in the
respective areas and additional management and coordination among the Company's
design and engineering groups. Alternatively, the Company may find it necessary
or desirable to license or acquire technology to enable the Company to provide
these functions, and there can be no assurance that any such technology will be
available for license or purchase on terms acceptable to the Company.
Furthermore, there is a limited amount of space on PC motherboards, and
companies that offer solutions that provide the greatest amount of functionality
within this limited space may have a competitive advantage. While the Company's
strategy is to develop new and enhanced graphics and multimedia accelerator
products that will be complementary to present and future versions of Intel and
other Pentium-based microprocessors and integrate additional functionality,
there can be no assurance that the Company will be able to develop such new or
enhanced products in a timely manner or correctly anticipate the additional
functionality that will be required to compete effectively in this market. There
can be no assurance that, if developed, the Company's new or enhanced products
that incorporate these functions will achieve market acceptance. There also can
be no assurance that the market for graphics and multimedia accelerators will
continue to grow in the future or that new technological developments or changes
in standards will not result in decreased demand for graphics and multimedia
accelerators or for the Company's products that are not


                                  Page 18 of 24

<PAGE>   19
compatible with such changed standards. For example, in 1996, there was an
absence of an industry standard 3D graphics API. As a result, the Company
developed and promoted its proprietary API. Microsoft has since introduced its
Direct3D API, which has emerged as the standard API for 3D acceleration. While
the Company's 3D accelerators currently support the Company's proprietary API
and Microsoft's Direct 3D API, there can be no assurance that another API will
emerge as an industry standard that the Company's accelerators will not support.
While the PC industry in recent periods has been characterized by substantial
demand, such demand has historically been cyclical, and there can be no
assurance that this demand will continue in future periods or that demand for
the Company's products will continue. The occurrence of any such events would
have a material adverse effect on the Company's operating results.

      Substantial Competition

         The market for the Company's products is extremely competitive and is
characterized by declining selling prices over the life of a particular product
and rapid technological changes. The Company's principal competitors for
graphics accelerators include ATI Technologies, Inc., Cirrus Logic, Inc., Matrox
Graphics Inc., and Trident Microsystems, Inc. The Company's principal
competitors in the multimedia market include the companies named in the
preceding sentence and a number of smaller companies which may have greater
flexibility to address specific market needs. Potential competitors in these
markets include both large and emerging domestic and foreign semiconductor
companies. In particular, there is a significant number of established and
emerging companies that have developed, are developing or have announced plans
to develop 3D graphics chips, including Intel Corporation and Lockheed Martin
Corporation, which have announced that they are jointly developing such chips,
which are currently expected to become available in the second half of 1997, and
Texas Instruments Incorporated, which has announced a development and marketing
agreement with 3Dlabs Inc., Ltd. In addition, Intel Corporation has entered into
a definitive agreement to acquire Chips and Technologies, Inc., a leading
provider of accelerators for the mobile PC market. There can be no assurance
that the Company's product offerings to address the demand for the next
generation of 2D/3D accelerators will be competitive, and if such product
offerings are not competitive, the Company's results of operations in 1997 and
future periods could be materially and adversely affected. The entry of
additional competitors into the 2D/3D accelerator market has resulted in and is
expected to continue to result in pricing pressures on average selling prices of
the Company's products. To the extent the Company expands its product line to
add products with additional functionality, it will encounter substantial
competition from established semiconductor companies and may experience
competition from companies designing chips based on different technologies, such
as software-centric multimedia processors. Further, the need of PC manufacturers
to rapidly introduce a variety of products aimed at different segments of the PC
market may lead to the shift by such system OEMs to the purchase of graphics and
multimedia add-in cards provided by others. Certain of the Company's competitors
supply both add-in cards and accelerator chips, which may provide those
competitors with an advantage over suppliers such as the companies that supply
only accelerator chips. In addition, certain of the Company's potential
competitors that supply add-in cards and/or motherboards, such as Intel
Corporation, may seek to use their card/board business to leverage the startup
of their graphics accelerator business. Certain of the Company's current and
potential competitors have greater technical, manufacturing, financial and
marketing


                                  Page 19 of 24

<PAGE>   20
resources than the Company. The Company believes that its ability to compete
successfully depends upon a number of factors both within and outside of its
control, including product performance, product features, product availability,
price, quality, timing of new product introductions by the Company and its
competitors, the emergence of new graphics and PC standards, customer support,
and industry and general economic trends. There can be no assurance that the
Company will have the financial resources, technical expertise, or marketing,
distribution and support capabilities to compete successfully. The Company's
future success will be highly dependent upon the successful development and
introduction of new products that are responsive to market needs. There can be
no assurance that the Company will be able to successfully develop or market any
such products.

      Customer Concentration

        The Company expects a significant portion of its future sales to remain
concentrated within a limited number of strategic customers. This concentration
is also reflected in the Company's accounts receivable where greater than 50% of
the balance is held by three customers at September 30, 1997. 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 could have a material
adverse effect on the Company's operating results.

      Management of Growth; Dependence on Key Personnel

        Since its inception, the Company has experienced significant growth in
the number of its employees and in the scope of its operating and financial
systems, resulting in increased responsibilities for the Company's management.
To manage future growth effectively, the Company will need to continue to
improve its operational, financial and management information systems,
procedures and controls, and expand, train, motivate, retain and manage its
employee base. There can be no assurance that the Company will be able to manage
its growth effectively, and failure to do so could have a material adverse
effect on the Company's operating results.

        The Company's future success depends in part on the continued service of
its key engineering, sales, marketing and executive personnel, including highly
skilled semiconductor design personnel and software developers, and its ability
to identify and hire additional personnel. Competition for such personnel is
intense and there can be no assurance that the Company can retain and recruit
necessary personnel to operate its business and support its future growth. The
loss of key personnel could have a material adverse effect on the Company's
business and operating results. The Company does not maintain key man insurance
on any of its employees.

      Importance of Intellectual Property; Litigation Involving Intellectual P
roperty

        The Company's ability to compete will be affected by its ability to
protect its proprietary information. The Company has filed several United States
and foreign patent applications and to date has a number of issued United States
patents. The Company relies primarily on its trade secrets and technological
know-how in the conduct of its business. There can be no assurance that the
steps taken by the Company to protect its intellectual property will be adequate
to prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. The semiconductor and software industries
are characterized by frequent claims and related litigation regarding patent and
other intellectual property rights. The Company has been and can be in the
future party to various claims of this nature. Although the ultimate outcome of
these matters is not presently determinable, management presently believes that
the resolution of all such pending matters will not have a material adverse


                                  Page 20 of 24


<PAGE>   21
effect on the Company's operating results. There can be no assurance that third
parties will not assert additional claims or initiate litigation against the
Company, its foundries, or its customers with respect to existing or future
products. In addition, the Company may initiate claims or litigation against
third parties for infringement of the Company's proprietary rights or to
determine the scope and validity of the proprietary rights of the Company or
others. Litigation by or against the Company has in the past, in the case of the
Brooktree Corporation ("Brooktree") litigation, resulted and could in the future
result in substantial expense to the Company and diversion of the efforts of the
Company's technical and management personnel, whether or not litigation is
determined in favor of the Company. In the event of litigation to determine the
validity of any third-party claims, such litigation could result in significant
expense to the Company and divert the efforts of the Company's technical and
management personnel, whether or not litigation is determined in favor of the
Company. In the event of an adverse result in any such litigation, the Company
could be required to pay substantial damages, cease the manufacture, use, sale,
offer for sale and importation of infringing products, expend significant
resources to develop or obtain non-infringing technology, discontinue the use of
certain processes or obtain licenses to the technology which is the subject of
the litigation. There can be no assurance that the Company would be successful
in such development or acquisition or that any such licenses, if available,
would be available on commercially reasonable terms, and any such development or
acquisition could require expenditures by the Company of substantial time and
other resources. Any such litigation or adverse result therefrom could have a
material adverse effect on the Company's operating results.

        In October 1995, Brooktree filed a complaint against the Company in the
United States District Court for the Southern District of California, alleging
that the Company's current products infringe a Brooktree patent. Such a lawsuit
resulted in substantial expense to the Company to defend the action and diverted
the efforts of the Company's technical and management personnel. In August 1996,
the Company and Brooktree entered into a settlement and license agreement
pursuant to which all claims and counterclaims between the parties were
dismissed and the Company agreed to pay to Brooktree a license fee and royalties
related to certain product revenues over a five-year period.

      International Operations

        The Company expects that export sales will continue to represent a
significant portion of net sales, although there can be no assurance that export
sales, as a percentage of net sales, will remain at current levels. In addition,
a substantial proportion of the Company's products are manufactured, assembled
and tested by independent third parties in Asia. Due to its export sales and
independent third party manufacturing, assembly and testing operations, and its
joint venture foundry, the Company is 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 sales price in local currencies of the Company's products in
foreign markets or increase the cost of wafers purchased by the Company, delays
resulting from difficulty in obtaining export licenses for certain technology,
tariffs and other barriers and restrictions, potentially longer payment cycles,
greater difficulty in accounts receivable collection, potentially adverse taxes,
and the burdens of complying with a variety of foreign laws. In addition, the
Company is subject to general geopolitical risks, such as political and economic
instability and changes in diplomatic and trade relationships, in connection
with its international operations. Two of the Company's independent foundries,
UMC and TSMC, and the Company's joint venture foundry, USC, are located in
Taiwan. The Company currently expects these three foundries to supply the
substantial portion of the Company's products in 1998. The People's Republic of
China and Taiwan at times experienced strained relations in 1995 and 1996, and
the worsening of relations or the development of hostilities between the two
parties could have a material adverse effect on the Company. Although the
Company has not to date experienced any material adverse effect on its
operations as a result of such regulatory, geopolitical, economic and other
factors, there can be no assurance that such factors will not adversely impact
the Company's operations in the future or require the Company to modify its
current business practices. In addition,


                                  Page 21 of 24

<PAGE>   22

the laws of certain foreign countries may not protect the Company's intellectual
property rights to the same extent as do the laws of the United States.

    Volatility of Stock Price

        The market price of the shares of Common Stock, like that of the common
stock of many other semiconductor companies, has been and is likely to be highly
volatile, and the market has from time to time experienced significant price and
volume fluctuations that are unrelated to the operating performance of
particular companies. The market price of the Common Stock could be subject to
significant fluctuations in response to quarter-to-quarter variations in the
Company's anticipated or actual operating results, announcements of new
products, technological innovations or setbacks by the Company or its
competitors, conditions in the semiconductor and PC industries, the commencement
of, developments in or outcome of litigation, changes in or the failure by the
Company to meet earnings estimates by securities analysts, market conditions for
high technology stocks in general, and other events or factors.

    Litigation

        In November 1997, several complaints were filed in federal and state
courts seeking an unspecified amount of damages on behalf of an alleged class of
persons who purchased shares of the Company's Common Stock at various times
between January 1, 1995 and November 3, 1997. The complaints name as defendants
the Company, certain of its officers and former officers and certain directors
of the Company and its outside auditors, asserting that they violated federal
and state securities laws by misrepresenting and failing to disclose certain
information about the Company's business. The Company has not formally responded
to the complaints. While management intends to defend the actions vigorously,
there can be no assurance that an adverse result or settlement with regards to
these lawsuits would not have a material adverse effect on the Company's
financial condition or results of operations.

                                  Page 22 of 24

<PAGE>   23
PART II. OTHER INFORMATION


Item 1.    Legal Proceedings

        In November 1997, several complaints were filed in federal and state
courts seeking an unspecified amount of damages on behalf of an alleged class of
persons who purchased shares of the Company's Common Stock at various times
between January 1, 1995 and November 3, 1997. The complaints name as defendants
the Company, certain of its officers and former officers and certain directors
of the Company and its outside auditors, asserting that they violated federal
securities laws by misrepresenting and failing to disclose certain information
about the Company's business. The Company has not formally responded to these
complaints. While Management intends to defend the actions vigorously, there can
be no assurance that an adverse result or settlement with regards 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 United States Securities and Exchange
Commission requests for information relating to the Company's recent restatement
announcement. The Company has responded and intends to continue to respond to
such requests.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

10.1   Revolving Credit Agreement dated as of September 26, 1997 by and among S3
Incorporated, the Lenders named therein, Comerica Bank - California as
Administrative Agent, and Fleet Bank as Documentation Agent.

27 Financial Data Schedule (filed only with the electronic submission of Form
10-Q in accordance with the Edgar requirements)

(b) No Reports on Form 8-K were filed by the Company during the three months
ended September 30, 1997.


                                  Page 23 of 24


<PAGE>   24
                                                 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)



                                       /S/WALTER D. AMARAL
                                  ------------------------------


                                          WALTER D. AMARAL
                                      Chief Financial Officer
                          (Principal Financial and Accounting Officer)

                                         November 19, 1997


                                  Page 24 of 24

<PAGE>   25
                                 EXHIBIT INDEX

  10.1            Revolving Credit Agreement dated as of September 26, 1997 by
                  and among S3 Incorporated, the Lenders named therein, Comerica
                  Bank - California as Administrative Agent, and Fleet Bank as
                  Documentation Agent.

  27              Financial Data Schedule