<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 March 31, 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
       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 May 7, 1997 was 49,217,199

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

<PAGE>   2

                                 S3 INCORPORATED
                                    FORM 10-Q


                                      INDEX

<TABLE>
<CAPTION>
                                                                                        PAGE
<S>                                                                                     <C> 
        Item 1. Condensed Consolidated Financial Statements:


                Condensed Consolidated Balance Sheets
                March 31, 1997 and December 31, 1996                                      3

                Condensed Consolidated Statements of Income
                Three months ended March 31, 1997 and 1996                                4

                Condensed Consolidated Statements of Cash Flows
                Three months ended March 31, 1997 and 1996                                5

                Notes to Unaudited Condensed Consolidated Financial Statements           6-7


        Item 2.  Management's Discussion and Analysis of
                    Financial Condition and Results of Operations                       8-20


        PART II. OTHER INFORMATION

        Item 1.  Legal Proceedings                                                 Not Applicable

        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                                        21

        Signatures                                                                       22
</TABLE>




                                  Page 2 of 22


<PAGE>   3

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

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

                                     ASSETS

<TABLE>
<CAPTION>
                                                                              March 31,          December 31,
                                                                                1997                 1996
                                                                          ---------------     ---------------
                                                                            (Unaudited)
<S>                                                                       <C>                 <C>    
Current assets:
   Cash and equivalents                                                          $82,164             $94,616
   Short-term investments                                                         64,413              62,768
   Accounts receivable (net of allowances of $2,181 in 1997
       and $2,648 in 1996)                                                        96,883              76,120
   Inventories, net                                                               53,316              53,466
   Prepaid expenses and other                                                     34,071              34,369
                                                                          ---------------     ---------------
               Total current assets                                              330,847             321,339

Property and equipment,  net                                                      39,498              34,047
Production capacity rights                                                        14,400              14,400
Investment in joint venture                                                       97,631              93,430
Other assets                                                                      28,860              17,246
                                                                          ---------------     ---------------
               Total                                                            $511,236            $480,462
                                                                          ===============     ===============

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable                                                              $49,674             $51,160
   Notes payable                                                                  24,335              17,802
   Accrued liabilities                                                            15,466              12,687
   Income taxes payable                                                           10,108               7,361
                                                                          ---------------     ---------------
               Total current liabilities                                          99,583              89,010

Notes payable                                                                     14,400              14,400
Other liabilities                                                                  8,651               6,452
                                                                          ---------------     ---------------
               Total liabilities                                                 122,634             109,862
                                                                          ---------------     ---------------

Convertible Subordinated Notes                                                   103,500             103,500

Commitments and contingencies (Notes 4 and 5)

Stockholders' equity:
   Common Stock, $.0001 par value; 70,000,000 shares authorized;
   48,998,325 and 48,331,794 shares outstanding in 1997 and 1996                171,590             169,411
   Unrealized loss on short-term investments                                       (152)                (54)
   Retained earnings                                                             113,664              97,743
                                                                          ---------------     ---------------
               Total stockholders' equity                                        285,102             267,100
                                                                          ---------------     ---------------
               Total                                                            $511,236            $480,462
                                                                          ===============     ===============
</TABLE>

See accompanying notes to the unaudited condensed consolidated financial
statements.



                                  Page 3 of 22

<PAGE>   4

                                 S3 INCORPORATED
                   CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                      (In thousands, except per share data)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                               Three Months Ended
                                                                         --------------------------------
                                                                           March 31,         March 31,
                                                                             1997               1996
                                                                         --------------     -------------
<S>                                                                       <C>               <C>     
    Net sales                                                                 $138,166          $110,072

    Cost of sales                                                               80,923            66,510
                                                                         --------------     -------------

    Gross margin                                                                57,243            43,562

    Operating expenses:
        Research and development                                                18,942            14,721
        Selling, marketing and administrative                                   12,630            10,914
                                                                         --------------     -------------
                   Total operating expenses                                     31,572            25,635
                                                                         --------------     -------------

    Income from operations                                                      25,671            17,927

        Interest income                                                          1,752             1,006
        Interest expense                                                       (1,622)                 -
        Other income (expense)                                                   (122)                 -
                                                                         --------------     -------------
    Other income, net                                                                8             1,006
                                                                         --------------     -------------
    Income before income taxes                                                  25,679            18,933

    Provision for income taxes                                                   9,758             6,625
                                                                         --------------     -------------
    Net income                                                                 $15,921           $12,308
                                                                         ==============     =============
    Net income per share:
        Primary                                                                  $0.31             $0.25
                                                                         ==============     =============
        Assuming full dilution                                                   $0.30             $0.25
                                                                         ==============     =============

    Common and equivalent shares used in computing per share amounts:

        Primary                                                                 52,118            50,047
                                                                         ==============     =============
        Assuming full dilution                                                  57,481            50,047
                                                                         ==============     =============
</TABLE>



See accompanying notes to the unaudited condensed consolidated financial
statements.



                                  Page 4 of 22

<PAGE>   5

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

<TABLE>
<CAPTION>
                                                                                        Three Months Ended
                                                                                    --------------------------
                                                                                     March 31,       March 31,
                                                                                       1997             1996
                                                                                    ----------       ---------
<S>                                                                                 <C>               <C>    
     Operating activities:
       Net income                                                                      $15,921         $12,308
       Adjustments to reconcile net income to net cash provided by
       operating activities:
         Deferred income taxes                                                           3,378            (472)
         Depreciation and amortization                                                   3,697           2,276
         Equity in income from joint venture                                            (4,201)              - 
         Changes in assets and liabilities:
           Accounts receivable                                                         (20,763)          3,056
           Inventories                                                                     150          (4,596)
           Prepaid expenses and other                                                   (1,726)         (2,874)
           Accounts payable                                                             (1,486)        (10,973)
           Accrued liabilities and other                                                 4,622           4,864
           Income taxes payable                                                          2,747           1,210
                                                                                    ----------       ---------
       Net cash provided by operating activities                                         2,339           4,799
                                                                                    ----------       ---------
     Investing activities:
       Property and equipment purchases, net                                            (8,375)         (5,331)
       Investment in real estate partnership                                                 -          (2,100)
       Sales/maturities of short-term investments, net                                  (1,743)          1,835
       Other assets                                                                    (11,855)              -
                                                                                    ----------       ---------
       Net cash used for investing activities                                          (21,973)         (5,596)
                                                                                    ----------       ---------
     Financing activities:
       Sale of common stock, net                                                         2,182             639
       Borrowings of notes payable, net                                                  5,000           2,000
                                                                                    ----------       ---------
       Net cash provided by financing activities                                         7,182           2,639
                                                                                    ----------       ---------
     Net increase (decrease) in cash and equivalents                                   (12,452)          1,842

     Cash and cash equivalents at beginning of period                                   94,616          69,289
                                                                                    ----------       ---------
     Cash and cash equivalents at end of period                                        $82,164         $71,131
                                                                                    ==========       =========
</TABLE>


<PAGE>   6

            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, necessary for a fair presentation of the
financial position at March 31, 1997 and December 31, 1996, and the operating
results and cash flows for the three months ended March 31, 1997 and 1996. 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,
1996, included in the Company's Form 10-K filed with the Securities and Exchange
Commission.

     The results of operations for the three months ended March 31, 1997 are not
necessarily indicative of the results that may be expected for the future
quarters or the year ending December 31, 1997.


2.  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>
                                                   March 31,       December 31,
Inventories consist of:                              1997             1996
                                                  -----------      -----------
                                                          (in thousands)
<S>                                                    <C>              <C>   
Work in progress                                      $23,468          $22,556
Finished goods                                         29,848           30,910
                                                  -----------      -----------
   Total                                              $53,316          $53,466
                                                  ===========      ===========
</TABLE>

3.  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 potential effect of the conversion
of the 5 3/4% Convertible Subordinated Notes outstanding during the period and
the elimination of the related interest and deferred issue costs, net of income
taxes.




                                  Page 6 of 22

<PAGE>   7

    4.  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 year's capacity. The Company has signed
    promissory notes to secure these payments over the term of the agreement. At
    March 31, 1997, the remaining advance payments (and corresponding promissory
    notes) totaled $24.0 million ($9.6 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.

    5.  Contingencies

        The semiconductor and software industries are characterized by frequent
    litigation regarding patent and other intellectual property rights. The
    Company is party to various claims of this nature. 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.

    6.  Recently Issued Accounting Standard

        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 replaces 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 $0.33 and $0.26 for the quarters ended
    March 31, 1997 and 1996, respectively. Diluted EPS under SFAS 128 would not
    have been significantly different than fully diluted EPS reported for those
    periods.



                                  Page 7 of 22

<PAGE>   8


    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 high performance multimedia
    acceleration solutions 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.

         The following information should be read in conjunction with the
    "Management's Discussion and Analysis of Financial Condition and Results of
    Operations" on pages 23 through 28 of the Company's annual report on Form
    10-K for the year ended December 31, 1996.

    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
                                                   ----------------------------------------
                                                      March 31,              March 31,
                                                        1997                   1996
                                                   ----------------      ------------------
<S>                                                <C>                    <C>
    Net sales                                             100.0%                100.0%
    Cost of sales                                          58.6                  60.4
                                                   ----------------      ------------------
    Gross margin                                           41.4                  39.6
                                                   ----------------      ------------------
    Operating expenses:
        Research and development                           13.7                  13.4
        Selling, marketing and administrative               9.1                   9.9
                                                   ----------------      ------------------
            Total operating expenses                       22.8                  23.3
                                                   ----------------      ------------------
    Income from operations                                 18.6                  16.3
    Other income, net                                       -                      .9
                                                   ----------------      ------------------
    Income before income taxes                             18.6                  17.2
    Provision for income taxes                              7.1                   6.0
                                                   ----------------      ------------------
    Net income                                             11.5%                 11.2%
                                                   ================      ==================
</TABLE>



                                  Page 8 of 22

<PAGE>   9

        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.

        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 the U.S., Asia, and Europe. Net sales were $138.2 million for
    the three months ended March 31, 1997, a 26% increase above the $110.1
    million of net sales for the three months ended March 31, 1996. Net sales
    increased primarily as a result of the addition of the ViRGE product line
    and strong demand for the Company's 64-bit products that resulted in
    increased unit shipments. The increase in unit shipments was partially
    offset by lower overall average selling prices. Sales for the three months
    ended March 31, 1997 consisted primarily of the ViRGE and Trio families of
    integrated accelerators while sales for the three months ended March 31,
    1996 consisted primarily of the Trio family of integrated accelerators. 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.

        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
    continued in the first quarter of 1997. The Company expects that the
    graphics accelerator market will transition from 2D acceleration to 3D
    acceleration, and the Company introduced its ViRGE family of 2D/3D
    accelerators in response to this expected 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 graphic products do not achieve market acceptance, or if the
    pricing pressures increase, then the Company's operating results could be
    adversely affected. The Company currently expects that net sales for the
    three months ended June 30, 1997 will be below net sales for the three
    months ended March 31, 1997 due to seasonal factors and to substantial
    pricing pressures currently experienced by the Company's products.




                                  Page 9 of 22

<PAGE>   10

        Export sales accounted for 63% and 56% of net sales for the three months
    ended March 31, 1997 and 1996, respectively. Approximately 15% of export
    sales for the three months ended March 31, 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.

        Three customers accounted for 15%, 15% and 13% of net sales for the
    three months ended March 31, 1997 and three customers accounted for 16%, 13%
    and 12% of net sales for the three months ended March 31, 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 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 increased to 41.4% for the three months ended
    March 31, 1997 from 39.6% for the three months ended March 31, 1996. The
    increase was due to the Company achieving proportionately greater decreases
    in unit average costs compared to decreases in overall average selling
    prices. The unit average cost decreases were principally the result of
    changes in the Company's design method and manufacturing strategy and shifts
    to lower cost foundries. The Company currently expects its gross margin
    percentage to decrease below historical levels in the three months ended
    June 30, 1997 due to substantial pricing pressures and to fixed costs being
    spread over a revenue base that is expected to be smaller.

        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.




                                  Page 10 of 22

<PAGE>   11

        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 $18.9
    million for the three months ended March 31, 1997, an increase of $4.2
    million from $14.7 million for the three months ended March 31, 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 video,
    3D, audio and communications.

        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. There can be no assurance 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.

        SELLING, MARKETING AND ADMINISTRATIVE EXPENSES

        Selling, marketing and administrative expenses were $12.6 million for
    the three months ended March 31, 1997, an increase of $1.7 million from
    $10.9 million for the three months ended March 31, 1996. Selling and
    marketing costs increased as a result of additional personnel, increased
    commissions associated with higher sales levels 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 in 1997.

        OTHER INCOME, NET

        Other income, net, decreased to $8,000 for the three months ended March
    31, 1997, from $1.0 million for the three months ended March 31, 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 of approximately
    $100.1 million from the sale of the convertible subordinated notes.

        INCOME TAXES

        The Company's effective tax rate for the three months ended March 31,
    1997 is 38%, compared to the 35% effective rate for the three months ended
    March 31, 1996. The increased tax rate is primarily attributable to the
    expiration of the federal research and development credit as of May 31,
    1997.



                                  Page 11 of 22

<PAGE>   12

        LIQUIDITY AND CAPITAL RESOURCES

        Cash provided by operating activities for the three months ended March
    31, 1997 was $2.3 million, as compared to $4.8 million for the three months
    ended March 31, 1996. The Company experienced an increase from December 31,
    1996 in accounts receivable, prepaid expenses and other, income tax payable
    and accrued liabilities and other. These increases were partially offset by
    a decrease in accounts payable. The Company experienced an increase in
    accounts receivable from the level at December 31, 1996 due to the
    substantial concentration of sales in March 1997 resulting from increased
    shipments in the third month of that quarter over either of the first two
    months of the quarter relative to what the Company experienced in previous
    quarters.

        Investing activities for the three months ended March 31, 1997 and 1996
    reflected property and equipment purchases, net, of $8.4 million and $5.3
    million, respectively, short term investments, and deferred royalties.
    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. In the first quarter of
    1996, the Company established a $20 million equity program for identifying
    and seeding technology investments in the areas of Internet development, 3D,
    graphics, video, audio and other technology growth areas.

        Financing activities provided cash of $7.2 million. Borrowings on the
    line of credit and proceeds from the issuance of common stock were the
    principal financing activities that generated cash in the period.

        In 1995, the Company entered into two long-term manufacturing capacity
    arrangements. The Company entered into an agreement with UMC and Alliance
    Semiconductor Corporation to form USC, a separate Taiwanese company, for the
    purpose of building and managing a semiconductor manufacturing facility in
    the Science Based Industrial Park in Hsin Chu City, Taiwan, Republic of
    China. 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. In addition, the Company expanded and formalized its relationship
    with 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, which total $24.0
    million as of March 31, 1997, over the term of the agreement. The Company
    paid $7.2 million in 1996.

        Working capital at March 31, 1997 and March 31, 1996 was $231.3 million
    and $153.1 million, respectively. At March 31, 1997, the Company's principal
    sources of liquidity included cash and equivalents of $82.2 million and
    $64.4 million in short-term investments. In addition, the Company has a
    $25.0 million unsecured revolving line of credit that expires June 1, 1997.
    The Company is currently in the process of renewing the line of credit. The
    Company had $5.0 million outstanding under the line of credit as of March
    31, 1997. In addition, the Company has two separate secured equipment lines
    of credit totaling $10.0 million. The Company had $6.5 million outstanding
    under these secured equipment lines of credit at March 31, 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, other than expenditures for future potential manufacturing
    agreements.

        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



                                  Page 12 of 22


<PAGE>   13

    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, and order cancellations or
    rescheduling. In particular, the market for PCs in 1996 experienced a
    weakening in the trends for demand as compared with 1995 and grew at a lower
    rate as compared with 1995. These factors could adversely affect demand for
    the Company's products. In addition, the pricing environment for graphics
    accelerators has recently experienced and is expected to continue to
    experience increasing pricing pressures due in part to the alleviation of
    supply constraints that contributed to more stable pricing in 1995 and 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 1996. The Company expects that the
    graphics accelerator market will transition from 2D acceleration to 3D
    acceleration, and the Company has introduced its ViRGE family of 2D/3D
    accelerators in response to this expected 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, 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


                                  Page 13 of 22


<PAGE>   14

    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 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. The Company also intends to add increased
    functionality to its multimedia products, such as system logic, audio,
    communications or other additional functions. Market acceptance of the
    Company's products will also depend



                                  Page 14 of 22

<PAGE>   15

    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 will be adversely affected. The Company's 1994
    operating results were adversely affected in part because the Company had
    made a strategic decision to transition its product offerings from 32-bit to
    64-bit accelerators during the first half of 1994, but due to a lack of PC
    system logic chipsets based on the PCI bus standard and a slower than
    anticipated shift from 32-to 64-bit graphics, sales of S3's PCI-based
    Vision64 family of accelerators were less than expected. During the same
    period of time, competitors' 32-bit integrated accelerator products offered
    a more competitive solution to the Company's customers and ultimately
    necessitated an adjustment in the valuation of the Company's 32-bit
    non-integrated inventory. In anticipation of a shift in demand from 2D to 3D
    technology, the Company has introduced and is continuing to develop products
    in its ViRGE family of 2D/3D multimedia accelerators. If the transition from
    2D to 3D in the PC market is slower than the Company expects or if these
    products are not brought to market in a timely manner or do not address
    market needs or achieve market acceptance, 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.

        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




                                  Page 15 of 22


<PAGE>   16

    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.
    Until 1996, due to worldwide semiconductor supply constraints, especially
    with respect to advanced process technologies required by the Company's
    products, the Company was unable to obtain a sufficient supply of products
    to enable it to meet demand and was required to allocate available supply of
    its products among its customers. 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. 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.

        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.



                                  Page 16 of 22


<PAGE>   17

      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 x86-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 x86-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 x86-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 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.



                                  Page 17 of 22

<PAGE>   18

      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, Microsoft has announced that it is developing a reference
    architecture, Talisman, with an alternative method of providing 3D
    functionality. Microsoft is working with a number of companies, including
    Cirrus Logic, Inc., Samsung Electronics Co., Ltd., Philips N.V. and Fujitsu
    Ltd., to implement this architecture. 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, such as audio,
    communications and system logic functions, 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 Company 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 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. 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.



                                  Page 18 of 22


<PAGE>   19

      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. The Company is in the final stage of implementing
    a new management information system. Any problems encountered with the new
    system could adversely affect the Company's operations. 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. In August 1996, the Company appointed a new President and
    Chief Executive Officer to replace Terry N. Holdt, who retired, and in March
    1997, the Company's Chief Financial Officer resigned, and there can be no
    assurance as to the effects of this management transition on the Company's
    business and operating results. 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
        Property

        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 is 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 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 andimportation 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.




                                  Page 19 of 22

<PAGE>   20

        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 1997. 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, 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
    estimates of the Company's performance by securities analysts, market
    conditions for high technology stocks in general, and other events or
    factors.



                                  Page 20 of 22

<PAGE>   21

    PART II. OTHER INFORMATION


    Item 6.    Exhibits and Reports on Form 8-K

    (a) Exhibits


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



    (b) Reports on Form 8-K

    No reports on Form 8-K were filed by the Company during the three months
    ended March 31, 1997.





                                  Page 21 of 22


<PAGE>   22

                                   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/DALE R. LINDLY
                         ------------------------------
                                 DALE R. LINDLY
                         Acting Chief Financial Officer
                  (Principal Financial and Accounting Officer)

                                  May 12, 1997



                                  Page 22 of 22

<PAGE>   23

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit 
   No.                       Description
--------                     -----------
<S>                  <C> 
   27                Financial Data Schedule
</TABLE>