<PAGE>
===============================================================================
                                     
                               UNITED STATES
                    SECURITIES AND EXCHANGE COMMISSION
                          Washington, D.C.  20549
                                     
                            ___________________
                                     
                                 FORM 10-Q

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

             For the Quarterly Period Ended September 30, 1998

                                    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 No. 0-23596
                            ___________________

                         C-CUBE MICROSYSTEMS INC.
          (Exact name of registrant as specified in its charter)

            Delaware                       77-0192108
(State or other jurisdiction of         (I.R.S. Employer
 incorporation or organization)       Identification No.)

                    1778 McCarthy Boulevard
                  Milpitas, California  95035
     (Address and zip code of principal executive offices)

Registrant's telephone number, including area code:    (408) 944-6300

Former name, former address and former fiscal year, if changed since last
year:     N/A

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.

                        [X]  Yes         [   ]  No

Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

As of October 31, 1998, 37,538,349 shares of the registrant's Common Stock
were outstanding.
===============================================================================
 <PAGE>                                    
                          C-CUBE MICROSYSTEMS INC.
                                     
                             TABLE OF CONTENTS


                                                                      Page
Part I.   Financial Information 

Item 1.   Financial Statements:
          Condensed Consolidated Balance Sheets
          September 30, 1998 and December 31, 1997 .................... 3

          Condensed Consolidated Statements of Income
          Quarter and nine months ended September 30, 1998 and 1997 ... 3

          Condensed Consolidated Statements of Cash Flows
          Nine months ended September 30, 1998 and 1997 ............... 5

          Notes to Condensed Consolidated Financial Statements ........ 6

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


Part II.  Other Information

Item 1.    Legal Proceedings ......................................... 18

Item 2.    Changes in Securities and Use of Proceeds ................. 18

Item 3.    Defaults Upon Senior Securities ........................... 18

Item 4.    Submission of Matters to a Vote of Security Holders ....... 18

Item 5.    Other Information ......................................... 18

Item 6.    Exhibits and Reports on Form 8-K .......................... 18

Signatures ........................................................... 19

                                     -2-
<PAGE>



                      PART I.  FINANCIAL INFORMATION

Item 1.     Financial Statements

<TABLE>
<CAPTION>
                         C-CUBE MICROSYSTEMS INC.
                   CONDENSED CONSOLIDATED BALANCE SHEETS
                 (In thousands, except par value amounts)
                                (Unaudited)
                                     
                                                   September 30,  December 31,
                                                       1998          1997 (1)
                                                   ------------   ------------
<S>                                                <C>            <C>
                                    ASSETS
Current assets:                                                   
  Cash and equivalents ........................... $   147,795    $   145,034
  Short-term investments .........................      30,694         21,316
  Accounts receivable -- net .....................      33,011         40,606
  Inventories ....................................      16,549         15,270
  Deferred income taxes ..........................      12,599         11,496
  Other current assets ...........................      15,920         14,666
                                                   ------------   ------------ 
          Total current assets ...................     256,568        248,388
Property and equipment -- net ....................      28,709         23,561
Production capacity rights .......................      14,000         18,200
Distribution rights -- net .......................       1,524          1,648
Purchased technology -- net ......................       6,792          9,408
Other assets .....................................       1,075          2,903
                                                   ------------   ------------
          Total                                    $   308,668    $   304,108
                                                   ============   ============
                                       
                     LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:                                              
  Accounts payable ............................... $    16,864    $     9,221
  Accrued liabilities ............................      26,477         23,806
  Income taxes payable ...........................      16,065          2,467
  Deferred contract revenue ......................       5,090          3,895
  Current portion of long-term obligations .......         568            608
                                                   ------------   ------------
          Total current liabilities ..............      65,064         39,997
Long-term obligations ............................      24,020         87,462
Deferred income taxes ............................       2,179            869
                                                   ------------   ------------
          Total liabilities ......................      91,263        128,328
                                                   ------------   ------------
Minority interest in subsidiary ..................          11            365
Stockholders' equity:                                             
  Common stock, $0.001 par value, 150,000 shares                  
     authorized; shares outstanding: 1998 -- 
     37,507; 1997 -- 36,688 ......................     211,697        203,728
  Accumulated translation adjustments ............      (1,911)        (1,969)
  Unrealized gain (loss) on investments ..........          70            (17)
  Retained earnings (deficit) ....................       7,538        (26,327)
                                                   ------------   ------------
          Total stockholders' equity .............     217,394        175,415
                                                   ------------   ------------
          Total .................................. $   308,668     $  304,108
                                                   ============   ============
</TABLE>

(1) Derived from the December 31, 1997 audited balance sheet included in the
    1997 Annual Report on Form 10-K of C-Cube Microsystems Inc.

           See notes to condensed consolidated financial statements.

                                     -3-
<PAGE>

<TABLE>
<CAPTION>
                         C-CUBE MICROSYSTEMS INC.
                CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                 (In thousands, except per share amounts)
                                (Unaudited)
                                     
                                     
                                            Quarter Ended       Nine Months Ended
                                            September 30,         September 30,
                                         -------------------   -------------------
                                            1998       1997      1998       1997
                                         --------   --------   --------   --------
<S>                                      <C>        <C>        <C>        <C>
Net revenues ........................... $ 86,162   $ 81,717   $255,997   $246,947
Costs and expenses:                                                   
  Cost of revenues .....................   38,757     36,750    116,768    109,003
  Research and development .............   18,867     16,798     55,134     47,860
  Selling, general and administrative ..   15,207     13,555     43,756     38,965
                                         --------   --------   --------   --------
     Total .............................   72,831     67,103    215,658    195,828
                                         --------   --------   --------   --------
Income from operations .................   13,331     14,614     40,339     51,119
Other income (expense), net ............    1,636        (33)     2,547     (1,635)
                                         --------   --------   --------   --------
Income before income taxes, minority                                  
  interest and extraordinary item ......   14,967     14,581     42,886     49,484
Income tax expense .....................    4,490      4,958     12,869     16,865
                                         --------   --------   --------   --------
Income before minority interest and   
  extraordinary item ...................   10,477      9,623     30,017     32,619
Minority interest in net loss of       
  subsidiary ...........................     (185)       (40)      (354)      (123)
                                         --------   --------   --------   --------
Income before extraordinary item .......   10,662      9,663     30,371     32,742
Extraordinary gain on repurchase of    
  convertible notes (net of tax)........    2,356         --      3,494         --
                                         --------   --------   --------   --------
Net income ............................. $ 13,018   $  9,663   $ 33,865   $ 32,742
                                         ========   ========   ========   ========
Basic earnings per share:                                             
  Income before extraordinary item ..... $   0.29   $   0.26   $   0.82   $   0.90
  Extraordinary item (net of tax) ......     0.06         --       0.09         --
                                         --------   --------   --------   --------
  Net income ........................... $   0.35   $   0.26   $   0.91   $   0.90
                                         ========   ========   ========   ========
Diluted earnings per share:                                           
  Income before extraordinary item ..... $   0.28   $   0.25   $   0.79   $   0.85
  Extraordinary item (net of tax) ......     0.06         --       0.09         --
                                         --------   --------   --------   --------
  Net income ........................... $   0.34   $   0.25   $   0.88   $   0.85
                                         ========   ========   ========   ========
Shares:                                                               
  Basic ................................   37,424     36,606     37,215    36,417
  Diluted ..............................   39,686     42,055     40,769    41,521
                                     
</TABLE>                                     

         See notes to condensed consolidated financial statements.

                                     -4-
<PAGE>

<TABLE>
<CAPTION>
                          C-CUBE MICROSYSTEMS INC.
              CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                              (In thousands)
                                (Unaudited)

                                                       Nine Months Ended September 30,
                                                       -------------------------------
                                                            1998             1997
                                                         ----------       ----------
<S>                                                      <C>              <C>
Cash flows from operating activities:                            
  Net income ...........................................  $ 33,865         $ 32,742
  Adjustments to reconcile net income to net cash                
     provided by operating activities:                                    
     Extraordinary gain on repurchase of
       convertible notes ...............................    (3,494)              --
     Minority interest in subsidiary ...................      (354)            (123)
     Depreciation and amortization .....................    13,327           12,343
     Deferred income taxes .............................       207            2,766
     Changes in assets and liabilities:                          
        Receivables ....................................     7,519           (4,441)
        Inventories ....................................    (1,314)           1,119
        Other current assets ...........................     2,926           11,576
        Accounts payable ...............................     7,731           (2,895)
        Accrued liabilities ............................     1,946            6,011
        Income taxes payable ...........................    11,195            3,373
        Deferred revenue ...............................     1,195               --
                                                         ----------       ----------
  Net cash provided by operating activities ............    74,749           62,471
                                                         ----------       ----------
Cash flows from investing activities:                            
  Sales and maturities of short-term investments .......    26,956           12,050
  Purchases of short-term investments ..................   (36,073)         (10,827)
  Capital expenditures .................................   (14,778)         (10,951)
  Other assets .........................................       592               98
                                                         ----------       ----------
  Net cash used in investing activities ................   (23,303)          (9,630)
                                                         ----------       ----------
Cash flows from financing activities:                             
  Bank borrowings ......................................    39,541               --
  Repayment of bank borrowings .........................   (39,541)              --
  Repayments of capital lease obligations ..............      (411)            (460)
  Sale of common stock .................................     7,704            8,090
  Collection of stockholder notes receivable ...........        --              305
  Repurchase of convertible subordinated notes .........   (56,077)              --
                                                         ----------       ----------
  Net cash provided by (used in) financing activities ..   (48,784)           7,935
                                                         ----------       ----------
Exchange rate impact on cash and equivalents ...........        99             (106)
                                                         ----------       ----------
Net increase in cash and equivalents ...................     2,761           60,670
Cash and equivalents, beginning of period ..............   145,034           76,241
                                                         ----------       ----------
Cash and equivalents, end of period .................... $ 147,795         $136,911
                                                         ==========       ==========
Supplemental schedule of noncash investing and                   
  financing activities:
  Unrealized gain on investments ....................... $      87         $     13
  Forgiveness of note payable for production 
    capacity rights ....................................        --           24,500
  Equipment acquired under lease .......................     1,382               --
  Cash paid during the period for:                               
     Interest .......................................... $   3,659         $  2,914
     Income taxes ......................................     1,011            5,169
         
</TABLE>
             See notes to condensed consolidated financial statements.
                         
                                     -5-
<PAGE>

                         C-CUBE MICROSYSTEMS INC.

            NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                (Unaudited)


1.   Basis of presentation

       The unaudited condensed consolidated financial statements contained
  in this report have been prepared by C-Cube Microsystems Inc. ("C-Cube"
  or the "Company"). In the opinion of management, such financial
  statements include all normal recurring adjustments and accruals
  necessary for a fair presentation of the Company's financial position as
  of September 30, 1998, and the results of operations for the quarters
  and nine months ended September 30, 1998 and 1997 and cash flows for the
  nine months ended September 30, 1998 and 1997. Certain information and
  footnote disclosures normally included in financial statements prepared
  in accordance with generally accepted accounting principles have been
  condensed or omitted in accordance with the rules and regulations of the
  Securities and Exchange Commission. This unaudited quarterly information
  should be read in conjunction with the audited consolidated financial
  statements of C-Cube and the notes thereto included in the Company's
  Annual Report on Form 10-K for the year ended December 31, 1997.

2.   Inventories

       Inventories are stated at the lower of cost (first-in, first-out)
  or market. Cost is computed on a currently adjusted standard basis
  (which approximates actual cost on a current average or first-in, first-
  out basis). Inventories consist of:

<TABLE>
                                     September 30,   December 31,
                                         1998           1997
                                     -------------   ------------
                                            (in thousands)
             <S>                     <C>             <C>

             Finished goods ........  $    4,797      $   9,158
             Work-in-process .......       5,208          3,852
             Raw materials .........       6,544          2,260
                                      -----------     ---------- 
                       Total .......  $   16,549      $  15,270
                                      ===========     ==========
</TABLE>

                                     -6-
<PAGE>

3.    Earnings per share

        The following table sets forth the computation of basic and diluted
  earnings per share (in thousands, except per share amounts):

<TABLE>
                                                    Quarter Ended      Nine Months Ended
                                                    September 30,        September 30,
                                                 ------------------    ------------------
                                                  1998       1997       1998       1997
                                                 -------    -------    -------    -------
  <S>                                            <C>        <C>        <C>        <C>
  Numerator:                                                           
   Income before extraordinary item ............ $10,662    $ 9,663    $30,371    $32,742
   Extraordinary item ..........................   2,356        --       3,494         --
                                                 -------    -------    -------    -------
   Numerator for basic earnings per share ......  13,018      9,663     33,865     32,742
   Addback interest income after tax related                                  
     to convertible shares .....................     333        883      2,031      2,649
                                                 -------    -------    -------    -------
   Numerator for diluted earnings per share .... $13,351    $10,546    $35,896    $35,391
                                                 =======    =======    =======    =======
  Denominator:                                                         
   Weighted-average shares - denominator for
     basic earnings per share ..................  37,424     36,606     37,215     36,417
   Convertible shares ..........................   1,216      2,809      2,247      2,809
   Dilutive common stock equivalents, using
     treasury stock method .....................   1,046      2,640      1,307      2,295
                                                 -------    -------    -------    -------
   Denominator for diluted earnings per share ..  39,686     42,055     40,769     41,521
                                                 =======    =======    =======    =======
  Basic earnings per share ..................... $  0.35    $  0.26    $  0.91    $  0.90
                                                 =======    =======    =======    =======
  Diluted earnings per share ................... $  0.34    $  0.25    $  0.88    $  0.85
                                                 =======    =======    =======    =======
</TABLE>

4.   Comprehensive income

        In the first quarter of 1998, the Company adopted Statement of
   Financial Accounting Standards No. 130, "Reporting Comprehensive
   Income," which requires an enterprise to report, by major components and
   as a single total, the change in net assets during the period from
   nonowner sources. For the quarter and nine months ended September 30,
   1998, comprehensive income, which was comprised of the Company's net
   income for the periods, changes in accumulated translation adjustments
   and unrealized gains (losses) on investments, was $13.1 million and
   $34.0 million, respectively. Comprehensive income for the quarter and
   nine months ended September 30, 1997 was $9.5 million and $32.5 million,
   respectively.

5.   Extraordinary item

        During the second and third quarters of the current year, the
  Company recognized extraordinary gains of $1.1 million and $2.4 million,
  respectively, or $0.03 and $0.06 per diluted share, net of related
  income taxes of $0.8 million and $1.6 million. During the second
  quarter, the Company repurchased $20.7 million of the face value of the
  Company's 5-7/8% Convertible Subordinated Notes due 2005 at 88.4% of the
  principal amount, with accrued interest to the date of repurchase.
  During the third quarter, the Company repurchased $42.8 million
  additional Convertible Subordinated Notes at an average of 88.4% of the
  principal amount, with accrued interest to the date of repurchase.

                                     -7-
<PAGE>

6.   Recently issued accounting standards

        In June 1997, the Financial Accounting Standards Board ("FASB")
  issued Statement of Financial Accounting Standards 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 this statement will
  not impact the Company's consolidated financial position, results of
  operations or cash flows. The Company will adopt this statement in its
  financial statements for the year ending December 31, 1998.
  
     In June 1998, the FASB issued Statement of Financial Accounting
  Standards No. 133, "Accounting for Derivative Instruments and  Hedging
  Activities," which establishes accounting and reporting standards for
  derivative instruments, including certain derivative instruments
  embedded in other contracts, and for hedging activities. It requires
  that an entity recognize all derivatives as either assets or liabilities
  in the statement of financial position and measure those instruments at
  fair value. Adoption of this statement will not materially impact the
  Company's consolidated financial position, results of operations or cash
  flows. The Company is required to adopt this statement in the first
  quarter of fiscal year 2000, with early adoption permitted.

                                     -8-
<PAGE>

Item 2.            MANAGEMENT'S DISCUSSION AND ANALYSIS
             OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
                                     
   This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The forward-looking statements involve risks and
uncertainties. Actual results could differ materially from those projected
in the forward-looking statements as a result of certain factors, including
those set forth in this Item 2, those described elsewhere in this report
and those described in the Company's Form 10-K for the year ended December 31,
1997, other Form 10-Qs and other reports under the Securities Exchange
Act of 1934. Such forward-looking statements include, but are not limited
to, those statements marked with an asterisk (*) in this report. The
Company assumes no obligation to update any forward-looking statements.

Quarter Ended September 30, 1998

   The following table sets forth certain operating data as a percentage
of net revenues for the quarters ended September 30, 1998 and 1997:

<TABLE>   
                                              Quarter Ended September 30,
                                              ---------------------------
                                                  1998           1997
                                                 ------         ------
                                                 <C>            <C>
        Net revenues ........................... 100.0%         100.0%
        Costs and expenses:                         
          Cost of revenues .....................  45.0           45.0
          Research and development .............  21.9           20.6
          Selling, general and administrative ..  17.6           16.6
                                                 ------         ------
                  Total ........................  84.5           82.1
                                                 ------         ------
        Income from operations .................  15.5           17.9
        Interest income (expense), net .........   1.9           (0.0)
                                                 ------         ------
        Income before income taxes, minority                
          interest and extraordinary item ......  17.4           17.8
        Income tax expense .....................   5.2            6.1
                                                 ------         ------
        Income before minority interest and                    
          extraordinary item ...................  12.2           11.8
        Minority interest in net loss         
          of subsidiary ........................  (0.2)          (0.0)
                                                 ------         ------
        Income before extraordinary item .......  12.4           11.8
        Extraordinary gain (net of tax) ........   2.7            0.0
                                                 ------         ------
        Net income .............................  15.1%          11.8%
                                                 ======         ======
</TABLE>

   The Company's quarterly and annual operating results have been, and
will continue to be, affected by a wide variety of factors that could have
a material adverse effect on revenues and profitability during any
particular period, including the level of orders which are received and can
be shipped in a quarter, the rescheduling or cancellation of orders by its
customers, competitive pressures on selling prices, changes in product or
customer mix, availability and cost of foundry capacity and raw materials,
fluctuations in yield, loss of any strategic relationships, C-Cube's
ability to introduce new products and technologies on a timely basis,
unanticipated problems in the performance of the Company's next generation
or cost-reduced products, the ability to successfully introduce products in
accordance with OEM design requirements and design cycles, new product
introductions by the Company's competitors, market acceptance of products
of both C-Cube and its customers, compatibility of new products with
emerging digital video standards, supply constraints for other components
incorporated into its customers' products, fluctuations in foreign currency
exchange rates to the U.S. dollar, and the level of expenditures in
manufacturing, research and development, and sales, general and
administrative functions.
   
   In addition, C-Cube's operating results are subject to fluctuations in
the markets for its customers' products, particularly the consumer
electronics and personal computer markets, which have been extremely

                                     -9-
<PAGE>

volatile in the past, and the satellite broadcast and wireless cable
markets, which are in an early stage, creating uncertainty with respect to
product volume and timing. The Company has devoted a substantial portion of
its research and development efforts in recent quarters to developing chips
used in Digital Video Disk (DVD) systems. The Company's DVD products are
subject to the new product risks described in the preceding paragraph,
including in particular C-Cube's ability to timely introduce these products
and the market's acceptance of them, which could have a materially adverse
affect on its operating results. Furthermore, to the extent the Company is
unable to fulfill its customers' purchase orders on a timely basis, these
orders may be canceled due to changes in demand in the markets for its
customers' products. Historically, the Company has shipped a substantial
portion of its product in the last month of a given quarter. A significant
portion of C-Cube's expenses are fixed in the short term, and the timing of
increases in expenses is based in large part on the Company's forecast of
future revenues. As a result, if revenues do not meet the Company's
expectations, it may be unable to quickly adjust expenses to levels
appropriate to actual revenues, which could have a material adverse effect
on the Company's business and results of operations.
   
   Due to the Company's dependence on the consumer electronics market, the
substantial seasonality of sales in that market could impact the Company's
revenues and net income. In particular, C-Cube believes that there may be
seasonality in the Asia-Pacific region related to the Chinese New Year,
which falls within the first calendar quarter, which could result in
relatively lower product demand during the second and third quarters of
each year.* If in the future the geographic mix of the Company's sales
shifts towards the U.S. and Europe, C-Cube would anticipate higher revenues
and net income in the third and fourth calendar quarters as system
manufacturers in these regions make purchases in preparation for the
holiday season, and comparatively less revenues and net income in the first
and second calendar quarters.*
   
   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 revenues 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.
   
   The market price of C-Cube's common stock has fluctuated significantly
since its initial public offering in April 1994. The market price of the
common stock could be subject to significant fluctuations in the future
based on factors such as announcements of new products by C-Cube or its
competitors, quarterly fluctuations in C-Cube's financial results or other
semiconductor or digital video networking companies' financial results,
changes in analysts' estimates of C-Cube's financial performance, general
conditions in the semiconductor and digital video networking industries,
conditions in the financial markets and general conditions in the global
economy which might adversely affect consumer purchasing. In addition, the
stock market in general has experienced extreme price and volume
fluctuations, which have particularly affected the market prices for many
high technology companies and which have often been unrelated to the
operating performance of the specific companies. The market price of
C-Cube's common stock has declined substantially from its historic highs,
and may continue to experience significant fluctuations in the future.
   
   Year 2000
   
   The Company is aware of the issues associated with the programming code
in existing computer systems as the millennium (Year 2000) approaches. The
Year 2000 problem is pervasive and complex, as virtually every computer
operation will be affected by the rollover of the two digit year value to
00. The issue is whether computer systems will properly recognize date
sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause
a system to fail. C-Cube has initiated a Year 2000 project designed to
identify and assess the risks associated with its information systems,
products, operations and infrastructure, suppliers and customers that are

                                     -10-
<PAGE>

not Year 2000 compliant, and to develop, implement and test remediation and
contingency plans to mitigate these risks. C-Cube is replacing or upgrading
systems, equipment and facilities that are known to be Year 2000 non-
compliant. For the Year 2000 non-compliance issues identified to date, the
cost of upgrade or remediation is not expected to be material to the
Company's operating results.* If implementation of replacement systems is
delayed, or if significant new non-compliance issues are identified, the
Company's results of operations or financial condition could be materially
adversely affected.
   
   INFORMATION SYSTEMS. A review of the Company's information systems has
been completed and the Company has initiated the work necessary for the
existing systems to become Year 2000 compliant. Testing of all information
systems will be conducted over the next year. The Company is also actively
reviewing its hardware and systems infrastructure, such as networks, in
order to ensure that they are Year 2000 compliant. Based on the current
status of the assessments and remediation plans made to date, the Company
does not expect total Year 2000 related costs pertaining to its information
systems and hardware and systems infrastructure to be material.*
   
   PRODUCTS. The Company has assessed the capabilities of its products
sold to customers and has not identified any problems related to Year 2000
compliance. The Company is in the process of identifying and assessing the
risks related to integrated systems that include third party products sold
by its DiviCom subsidiary. The Company believes its current products are
Year 2000 compliant; however, since all customer situations cannot be
anticipated, particularly those involving third party products, C-Cube may
see an increase in warranty and other claims as a result of the Year 2000
transition. In addition, litigation against the Company regarding Year 2000
compliance issues may occur in the future. For these reasons, the impact of
customer claims could have a material adverse impact on the Company's
results of operations or financial condition.
   
   OPERATIONS AND INFRASTRUCTURE. Machinery and equipment and other items
used in the operations and facilities of the Company have been inventoried
and are currently being assessed for Year 2000 compliance. The assessment
to date has not uncovered any material issues.
   
   SUPPLIERS. C-Cube is in the process of contacting its critical
suppliers to determine whether their operations, products and services are
Year 2000 compliant. Where practicable, C-Cube will attempt to mitigate its
risks with respect to the failure of suppliers to be Year 2000 compliant.
In the event that suppliers are not Year 2000 compliant, the Company will
seek alternative sources of supplies. However, such failures remain a
possibility and could have an adverse impact on the Company's results of
operations or financial condition.
   
   CUSTOMERS. The Company is actively responding to all customer requests
for compliance, surveys and other general information related to its
Year 2000 programs. The Company will also request assurance from its key
customers that they, and their products which incorporate C-Cube's
products, are Year 2000 compliant.
   
   GENERAL. The Company does not currently expect its costs associated
with the Year 2000 problem to be material, and expects to be able to fund
these costs through operating cash flows.* However, the Company has not yet
completed its assessments, developed remediation plans for all problems,
developed contingency plans, or completely implemented or tested any of its
remediation plans. The risks associated with the Year 2000 problem can be
difficult to identify and to address, and could result in material adverse
consequences to the Company. Even if the Company, in a timely manner,
completes all of its assessments, identifies and tests remediation plans
believed to be adequate, and develops contingency plans believed to be
adequate, some problems may not be identified or corrected in time to
prevent material adverse consequences to the Company.
   
                                     -11-
<PAGE>

   As the Year 2000 project continues, the Company may discover additional
Year 2000 problems, may not be able to develop, implement, or test
remediation or contingency plans in a timely manner, or may find that the
costs of these activities exceed current expectations and become material.
In many cases, the Company is relying on assurances from suppliers and
customers that new and upgraded information systems and other products will
be Year 2000 compliant. The Company plans to test certain third-party
products, but cannot be sure that its tests will be adequate or that, if
problems are identified, they will be addressed by the supplier in a timely
and satisfactory way.
   
   Because the Company uses a variety of information systems and has
additional systems embedded in its operations and infrastructure, the
Company cannot be sure that all of its systems will work together in a
Year 2000-compliant fashion. Furthermore, the Company cannot be sure that
it will not suffer business interruptions, either because of its own
Year 2000 problems or those of its customers or suppliers whose Year 2000
problems may make it difficult or impossible for them to fulfill their
commitments to the Company. If the Company fails to satisfactorily resolve
Year 2000 issues related to its products in a timely manner, it could be
exposed to liability to third parties.
   
   The Company has not developed a "worst case" scenario with respect to
Year 2000 issues, but instead has focused its resources on identifying
material, remediable problems and reducing uncertainties generally, through
the Year 2000 project described above.
   
    If the Company or the third parties with which it has relationships
were to cease or not successfully complete its or their Year 2000
remediation efforts, the Company would encounter disruptions to its
business that could have a material adverse effect on its business,
financial position and results of operations. The Company could be
materially and adversely impacted by widespread economic or financial
market disruption or by Year 2000 computer system failures at third parties
with which it has relationships.
   
   Net Revenues

   Net revenues in the third quarter of 1998 were $86.2 million, an
increase of 5.4% over the $81.7 million reported in the corresponding
quarter a year ago. Revenue from the Company's family of encoder products
increased due to growth in sales of communications products, which was led
by DiviCom, and increased sales of the Company's DVxpress and DVxpert
families of codecs. Revenue from MPEG-2 decoder chips used primarily in
digital settop boxes and in DVD-ROMs on PCs increased from the third
quarter of 1997 due to customers' adoption of the Company's AViA and ZiVA
families of decoder chips and the wider acceptance of the DVD format. The
Company also had sales from the introduction of its CVD decoder which is
compliant with the new Chao Ji VCD standard. These increases were partially
offset by a decrease in revenues from MPEG-1 decoder chips used in VideoCD
players sold primarily in China, due to price reductions made in response to
competitive pricing pressures.
   
   International revenues accounted for 56% of net revenues for the third
quarter, compared to 65% for the same period last year. The Company expects
that international revenues will continue to represent a significant
portion of net revenues.* The Company's success will depend in part upon
its ability to manage international marketing and sales operations. In
addition, C-Cube purchases a substantial portion of its manufacturing
services from foreign suppliers. C-Cube's international manufacturing and
sales are subject to changes in foreign political and economic conditions
and to other risks including currency or export/import controls, changes in
tax laws, tariffs and freight rates and changes in the ownership and/or
leadership of international customers that may result in delayed or
canceled orders. For example, China is the primary market for VideoCD and
Chao Ji VCD players utilizing the Company's decoder products. As a
consequence, any political or economic instability in China could
significantly reduce demand for the Company's products. The Company has made
a significant investment in additional foundry capacity in Taiwan and is
subject to the risk of political instability in Taiwan, including but not
limited to the

                                     -12-
<PAGE>

potential for conflict between Taiwan and the People's Republic of China.
The Company sells products to customers in Korea and is subject to the risk
of economic and political instability in Korea, including the potential for
conflict between North and South Korea. In addition, the Company sells
certain of its products in international markets and buys certain products
from its foundries in currencies other than the U.S. dollar and, as a
result, currency fluctuations could have a material adverse effect on the
Company's business and results of operations. With respect to international
sales that are denominated in U.S. dollars, increases in the value of the
U.S. dollar relative to foreign currencies can increase the effective price
of and reduce demand for the Company's products relative to competitive
products priced in the local currency. The United States has considered
trade sanctions against Japan and has had disputes with China relating to
trade and human rights issues. If trade sanctions were imposed, Japan or
China could enact trade sanctions in response. Because a number of the
Company's current and prospective customers and suppliers are located in
Japan and China, trade sanctions, if imposed, could have a material adverse
effect on C-Cube's business and results of operations. Similarly,
protectionist trade legislation in either the United States or foreign
countries could have a material adverse effect on the Company's ability to
manufacture or sell its products in foreign markets.
   
   The Asian consumer electronics markets accounted for approximately 45%
of total Company sales in the third quarter of 1998 and are expected to
continue to account for a substantial, though declining, percentage of
sales in the future.* The economic crisis in Asia has been characterized by
increases in idle production capacity, real estate vacancies, unemployment
and bank failures, and has resulted in currency devaluation, falling
consumer spending and domestic price deflation. Any of these factors could
significantly reduce the demand for the end user goods in which the
Company's products are incorporated. In the third quarter of 1998, most of
the Company's sales in Asia were of decoder chips, which are used in
VideoCD players. The Company believes purchases of VideoCD and Chao Ji VCD
players are not as likely to be deferred as are purchases of higher priced
consumer durables and production equipment, which have dramatically impacted
U.S. export sales.* However, there can be no assurance that the Company will
not experience reduced sales of its products into Asia because of declining
consumer spending or because of its customers' increasing difficulty in
obtaining letters of credit, which the Company has required prior to
shipment.

   Gross Margin

   C-Cube's gross margin for the third quarter of 1998 was 55.0% compared
to a gross margin of 55.0% for the same quarter last year. Although the
average selling prices of the Company's products has declined, this decline
has been offset by reduced product costs. The Company has been able to
reduce product costs through the negotiation of lower foundry wafer prices,
the adoption of finer geometry fabrication processes, the redesign of
products to reduce die size and the use of lower priced assembly and test
vendors. The reduction of product costs has been partially offset by higher
product transition and technology integration costs.
   
   The markets into which C-Cube sells its products are subject to extreme
price competition. Thus, the Company expects to continue to experience
declines in the selling prices of its products over the life cycle of each
product.* In particular, C-Cube expects to continue to experience
significant price competition in the markets for decoder chips.* In order
to offset or partially offset declines in the selling prices of its
products, C-Cube must continue to reduce the costs of products through
product design changes, manufacturing process changes, volume discounts,
yield improvements and other savings negotiated with its manufacturing
subcontractors. Since the Company does not believe that it can continually
achieve cost reductions which fully offset the price declines of its
products, it expects gross margin percentages to decline for existing
products over their life cycles.*
   
   C-Cube does not operate its own manufacturing facilities and must make
volume commitments to subcontractors at prices that remain fixed over
certain periods of time. Therefore, the Company may not be able to reduce

                                     -13-
<PAGE>

its costs as rapidly as its competitors who perform their own
manufacturing. Failure of the Company to design and introduce, in a timely
manner, lower cost versions of existing products or higher gross margin new
products, or to successfully manage its manufacturing subcontractor
relationships, would have a material adverse effect on C-Cube's gross
margins.
   
   Research and Development Expenses

   In the third quarter of 1998, research and development expenses were
$18.9 million, or 22% of net revenues, compared with $16.8 million, or 21%
of net revenues in the third quarter of 1997. The increase in research and
development expenses primarily represents additional employee-related costs
associated with increases in product engineering staff, reflecting the
Company's continuing efforts to provide industry leading digital video
solutions at the chip and systems levels.

   Selling, General and Administrative Expenses

   Selling, general and administrative expenses increased to $15.2 million,
or 18% of net revenues, in the third quarter of 1998, compared to
$13.6 million, or 17% of net revenues, for the same quarter last year. The
increase was primarily due to increased headcount and related expenses.
   
   Other Income (Expense)
   
   Other income, net of other expense, was $1.6 million for the third
quarter of 1998, an increase from the net other expense amount of $33,000
for the third quarter of 1997. The improvement over the prior year quarter
is primarily due to higher interest income earned on higher average cash
and investment balances and lower interest expense on lower average
outstanding debt balances.
   
   Income Tax Expense
   
   The Company's effective tax rate for the third quarter of 1998 was 30%.
The Company's effective tax rate is less than the combined federal and
state statutory rate primarily due to tax credits and lower foreign tax
rates.

                                     -14-
<PAGE>

Nine Months Ended September 30, 1998
   
   The following table sets forth certain operating data as a percentage
of net revenues for the nine months ended September 30, 1998 and 1997:
   
<TABLE>
                                             Nine Months Ended September 30,
                                             -------------------------------
                                                  1998           1997
                                                 ------         ------
        <S>                                      <C>            <C>
        Net revenues ........................... 100.0%         100.0%
        Costs and expenses:                             
          Cost of revenues .....................  45.6           44.1
          Research and development .............  21.5           19.4
          Selling, general and administrative ..  17.1           15.8
                                                 ------         ------
                  Total ........................  84.2           79.3
                                                 ------         ------
        Income from operations .................  15.8           20.7
        Interest income (expense), net .........   1.0           (0.7)
                                                 ------         ------
        Income before income taxes, minority                    
          interest and extraordinary item ......  16.8           20.0
        Income tax expense .....................   5.0            6.8
                                                 ------         ------
        Income before minority interest                 
        and extraordinary item .................  11.7           13.2
        Minority interest in net loss        
          of subsidiary ........................  (0.1)          (0.0)
                                                 ------         ------
        Income before extraordinary item .......  11.9           13.3
        Extraordinary gain (net of tax) ........   1.4            0.0
                                                 ------         ------
        Net income .............................  13.2%          13.3%
                                                 ======         ======   
</TABLE>

   Net Revenues
   
   Net revenues for the nine months ended September 30, 1998 were 
$256.0 million, a 4% increase from $246.9 million in revenues during the
corresponding period in 1997. Revenue from the Company's family of encoder
products increased due to growth in sales of communications products, which
was led by DiviCom, and increased sales of the Company's DVxpress and
DVxpert families of codecs. Revenue from MPEG-2 decoder chips used
primarily in digital settop boxes and in DVD-ROMs on PCs increased from the
nine month period of 1997 due to customers' adoption of the Company's AViA
and ZiVA families of decoder chips and the wider acceptance of the DVD
format. The Company also had sales from the introduction of its CVD decoder
which is compliant with the new Chao Ji VCD standard. These increases were
partially offset by a decrease in revenues from MPEG-1 decoder chips used
in VideoCD players sold primarily in China, due to price reductions made in
response to competitive pricing pressures.
   
   Gross Margin
   
   C-Cube's gross margin percentage decreased to 54.4% in the first nine
months of 1998 from 55.9% in the comparable prior year period. The decline
in the gross margin percentage is due primarily to lower average selling
prices and higher product transition and technology integration costs.
   
   Research and Development Expenses

   In the first nine months of 1998, research and development expenses
were $55.1 million or 22% of net revenues, compared to $47.9 million, or
19% of net revenues, in the comparable prior year period. The increase in
research and development expenses primarily represents additional employee-
related costs associated with increases in product engineering staff,
reflecting the Company's continuing efforts to provide digital video
solutions at the chip and systems levels.

                                     -15-
<PAGE>

   Selling, General and Administrative Expenses

   Selling, general and administrative expenses increased to $43.8 million,
or 17% of net revenues in the first nine months of 1998, compared to
$39 million, or 16% of net revenues for the same period last year. The
increase was primarily due to increased headcount and related expenses.
   
   Other Income (Expense)
   
   Other income, net of other expense, was $2.5 million for the first nine
months of 1998, an increase from the net other expense amount of $1.6 million
for the nine months ended September 30, 1997. The increase is primarily
due to higher interest income earned on higher average cash and investment
balances and lower interest expense on lower average outstanding debt
balances during the first nine months of 1998 compared to the same period
last year.
   
   Income Tax Expense
   
   The Company's effective tax rate for the first nine months of 1998 was
30%. The Company's effective tax rate is less than the combined federal and
state statutory rate primarily due to tax credits and lower foreign tax
rates.

Liquidity and Capital Resources
   
   Cash, cash equivalents and short-term investments were $178.5 million
at September 30, 1998 compared to $166.4 million at the end of 1997.
Working capital decreased to $191.5 million at September 30, 1998 from
$208.4 million at the end of 1997.
   
   The Company's operating activities generated cash of $74.7 million in
the first nine months of 1998, mainly from operating income, reduced
accounts receivable and increased income taxes payable and accounts
payable. The increase in payables primarily was due to unusually
low accounts payable and income taxes payable balances at the end of 1997.
Receivable days outstanding decreased from 41 days at December 31, 1997 to
34 days at September 30, 1998.
   
   C-Cube's investing activities, exclusive of the sales and maturities of
$27.0 million and purchases of $36.1 million of short-term investments,
used cash of $14.2 million, primarily for capital expenditures.
   
   Cash used in financing activities was $48.8 million, primarily from
$56.1 million used to repurchase a portion of the Company's Convertible
Subordinated Notes, partially offset by proceeds of $7.7 million from sales
of stock pursuant to employee stock plans.
   
   At September 30, 1998, the Company had an available bank line of credit
of $30 million which expires May 1, 1999. Borrowings bear interest at LIBOR
plus 1.25% or the bank's prime rate (8.50% at September 30, 1998). The line
of credit agreement requires that the Company, among other things, maintain
a minimum tangible net worth, a minimum annual net income (no quarterly
loss exceeding $3 million), and certain financial ratios. In addition, this
agreement prohibits the payment of cash dividends. At September 30, 1998,
the Company was in compliance with these covenants, and there were no
outstanding balances under this line.
   
   Based on current plans and business conditions, C-Cube expects that its
cash, cash equivalents and short-term investments together with any amounts
generated from operations and available borrowings, will be sufficient to
meet the Company's cash requirements for at least the next 12 months.*
However, there can be no assurance that the Company will not be required to

                                     -16-
<PAGE>

seek other financing sooner or that such financing, if required, will be
available on terms satisfactory to the Company, or at all. In addition, the
Company has considered and will continue to consider various possible
transactions with foundries to secure additional foundry capacity, which
could include, without limitation, equity investments, prepayments, non-
refundable deposits or loans in exchange for guaranteed capacity, "take or
pay" contracts that commit the Company to purchase specified quantities of
wafers over extended periods, joint ventures or other partnership
relationships.

                                     -17-
<PAGE>
   
                         C-CUBE MICROSYSTEMS INC.
                        PART II.  OTHER INFORMATION


Item 1.    Legal Proceedings

           From time to time the Company is party to certain litigation or
           legal claims. Management has reviewed all pending legal matters and
           believes that the resolution of such matters will not have a
           significant adverse effect on the Company's financial position or
           results of operations.

Item 2.    Changes in Securities and Use of Proceeds

           None.

Item 3.    Defaults Upon Senior Securities

           None.

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

           None.

Item 5.    Other Information

           Not applicable.

Item 6.    Exhibits and Reports on Form 8-K

           (a)  Exhibits

                Exhibit
                Number           Description
                -------    -------------------------------------
                10.38     Amendment to Option Agreement dated May 30, 1997
                           with Taiwan Semiconductor Manufacturing Co., Ltd. 1

                27.1      Financial Data Schedule

           (b)  Reports on Form 8-K

                None.
          
          
                    
      
           1 The Company has requested confidential treatment from the
             Securities and Exchange Commission for the redacted portions of
             this exhibit.
      
                                     -18-
<PAGE>
          
                                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.

                                           C-Cube Microsystems Inc.
                                           (Registrant)


Dated:  November 12, 1998                  By:  /s/ Walt Walczykowski
       -------------------                     ---------------------------
                                                    Walt Walczykowski
                                                Vice President of Finance
                                               and Chief Financial Officer

                                     -19-
<PAGE>