<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.




                  FOR THE QUARTERLY PERIOD ENDED APRIL 4, 1999

                         Commission File Number 0-20684



                            AUREAL SEMICONDUCTOR INC.
             (Exact name of registrant as specified in its charter)

          DELAWARE                                             94-3117385
(State or other jurisdiction of                             (I.R.S. Employer
incorporation or organization)                           Identification Number)

                              4245 TECHNOLOGY DRIVE
                                FREMONT, CA 94538
                    (Address of principal executive offices)
                            Telephone: (510) 252-4245

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 [ ]

Indicate by check mark whether the registrant has filed all documents required
to be filed by Section 12, 13 or 15 (d) of the Securities Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a court.

                                 Yes [X] No [ ]

At May 2, 1999, 68,282,981 shares of common stock, $0.001 par value, of the
registrant were outstanding.

This report on Form 10-Q contains 22 pages. The exhibit index is on page 22.



<PAGE>   2

                            AUREAL SEMICONDUCTOR INC.


                                    FORM 10-Q

                                Table of Contents

<TABLE>
<CAPTION>
                                                                                                    Page
<S>                                                                                                 <C>
PART I.  FINANCIAL INFORMATION
        Item 1.  Financial Statements ........................................................        3
        Item 2.  Management's Discussion and Analysis of Financial Condition and Results of
                 Operations ..................................................................       11

PART II.  OTHER INFORMATION
        Item 1.  Legal Proceedings............................................................       21
        Item 5.  Other Information ...........................................................       21
        Item 6.  Exhibits and Reports on Form 8-K ............................................       22
</TABLE>



                                       2
<PAGE>   3

                          PART I. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS




                            AUREAL SEMICONDUCTOR INC.

               INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)

     The Interim Condensed Consolidated Financial Statements of Aureal
Semiconductor Inc. have been prepared by Aureal, without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principals have been
omitted pursuant to such rules and regulations. The disclosures included in the
Interim Condensed Consolidated Financial Statements should be read in
conjunction with Aureal's audited financial statements at January 3, 1999 and
the notes thereto included in the 1998 Annual Report on Form 10-K.

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

    The Interim Condensed Consolidated Financial Statements reflect, in the
opinion of management, all adjustments (which include only normal recurring
adjustments) necessary for a fair presentation of financial position, results of
operations and cash flows for such periods. The results of operations for the
fiscal quarter ended April 4, 1999 are not necessarily indicative of the results
that may be expected for any subsequent quarter or the entire fiscal year ending
January 2, 2000.



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<PAGE>   4

AUREAL SEMICONDUCTOR INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                             April 4,        January 3,
                                                                              1999             1999
                                                                            ---------        ---------
                                                                           (Unaudited)
<S>                                                                        <C>               <C>
ASSETS:

  Current assets:
      Cash and cash equivalents                                             $     137        $      87
      Restricted cash                                                              --                6
      Accounts receivable, net of allowances of $561 
        and $289, respectively                                                  6,136            4,781
      Inventories                                                               3,561            3,916
      Deferred fair value of debt related warrants                                924              924
      Prepaid loan fees and other current assets                                  921              757
                                                                            ---------        ---------
         Total current assets                                                  11,679           10,471
  Property and equipment:
      Machinery and equipment                                                   5,084            4,636
      Furniture, fixtures and improvements                                        686              639
                                                                            ---------        ---------
                                                                                5,770            5,275
      Accumulated depreciation and amortization                                (3,185)          (2,795)
                                                                            ---------        ---------
         Net property and equipment                                             2,585            2,480
      Long-term portion of fair value of debt related warrants and
       other assets                                                               345              687
                                                                            ---------        ---------
         Total assets                                                       $  14,609        $  13,638
                                                                            =========        =========


LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):

  Current liabilities:
      Line of credit                                                        $   7,829        $   4,329
      Accounts payable                                                          6,867            5,966
      Accrued compensation and benefits                                         1,670            1,765
      Other accrued liabilities                                                 1,034            1,061
      Current portion of pre-petition claims                                      963              936
                                                                            ---------        ---------
         Total current liabilities                                             18,363           14,057
  Long-term portion of pre-petition claims and deferred obligations .             602              889
                                                                            ---------        ---------
         Total liabilities                                                     18,965           14,946

  Stockholders' equity (deficit):
      Preferred stock, $0.001 par value, authorized shares-5,000,000:
         Series A: Authorized shares - 500; Issued and outstanding
         shares - 35 and 249,  respectively                                        --               --
         Series B: Authorized shares - 60,000; Issued and outstanding
         shares - 41,785 and 40,966,  respectively                                 --               --
         Series C: Authorized shares - 1,500; Issued and outstanding
         shares - 78 and 600,  respectively                                        --               --
      Additional paid-in capital                                               42,979           51,421
      Common stock, $0.001 par value:
         Authorized shares - 200,000,000; Issued and outstanding
         shares - 67,313,990 and 47,676,334,  respectively                         67               48
      Additional paid-in capital                                              129,380          119,790
      Accumulated deficit                                                    (176,782)        (172,567)
                                                                            ---------        ---------
         Total stockholders' equity (deficit)                                  (4,356)          (1,308)
                                                                            ---------        ---------
         Total liabilities and stockholders' equity (deficit)$                 14,609        $  13,638
                                                                            =========        =========
</TABLE>

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



                                       4
<PAGE>   5

AUREAL SEMICONDUCTOR INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)






<TABLE>
<CAPTION>
                                                           Quarter Ended
                                                     April 4,        March 29, 
                                                       1999            1998
                                                     --------        --------
                                                           (Unaudited)
<S>                                                  <C>             <C>     
Net sales                                            $ 12,578        $  3,582
Cost of sales                                           8,321           2,793
                                                     --------        --------
Gross Margin                                            4,257             789

Operating expenses:
    Research and Development                            3,365           2,618
    Sales and Marketing                                 2,072           1,356
    General and Administrative                          1,167             860
                                                     --------        --------
        Total operating expenses                        6,604           4,834

Operating loss                                         (2,347)         (4,045)

    Amortization of debt related warrants                (231)           (750)
    Interest expense                                     (433)         (1,031)
    Other income (expense), net                           (10)            340
                                                     --------        --------
Loss from operations before income taxes               (3,021)         (5,486)

Provision for income taxes                                 --              --
                                                     --------        --------

Net loss                                             $ (3,021)       $ (5,486)
                                                     ========        ========

Accretion/dividends related to preferred stock       $ (1,194)       $     --
                                                     ========        ========

Net loss attributable to common stockholders         $ (4,215)       $ (5,486)
                                                     ========        ========

Net loss per share: basic and diluted                $  (0.07)       $  (0.13)
                                                     --------        --------

Weighted average common shares outstanding             56,330          41,969
                                                     ========        ========
</TABLE>



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



                                       5
<PAGE>   6

AUREAL SEMICONDUCTOR INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)



<TABLE>
<CAPTION>
                                                                       Quarter Ended
                                                                  April 4,        March 29,
                                                                    1999            1998
                                                                  --------        --------
                                                                        (Unaudited)
<S>                                                               <C>             <C>      
OPERATING ACTIVITIES
Net loss from operations                                          $ (3,021)       $ (5,486)
Adjustments to reconcile net loss from operations
  to net cash used in operating activities:
    Depreciation and amortization                                      775           1,022
    Changes in operating assets and liabilities:
        Restricted cash                                                  6              (4)
        Accounts receivable                                         (1,355)         (2,615)
        Inventories                                                    355          (5,234)
        Prepaid expenses and other current assets                     (494)           (149)
        Other assets                                                   342             (15)
        Accounts payable                                               901           6,182
        Accrued compensation and benefits, and
          other accrued liabilities                                   (122)            183
                                                                  --------        --------
Net cash used in operating activities                               (2,613)         (6,116)
                                                                  --------        --------

INVESTING ACTIVITIES
Acquisition of property and equipment                                 (505)           (832)
                                                                  --------        --------
Net cash used in investing activities                                 (505)           (832)
                                                                  --------        --------

FINANCING ACTIVITIES
Proceeds from Line of Credit                                        14,468           7,225
Repayment on Line of Credit                                        (11,013)         (4,200)
Principal payments on pre-petition claims                             (260)           (844)
Proceeds (expenses) from issuance of stock, net of
   issuance costs                                                      (27)          4,737
                                                                  --------        --------
Net cash provided by financing activities                            3,168           6,918
                                                                  --------        --------

Net increase/(decrease) in cash and cash equivalents                    50             (30)
Cash and cash equivalents at beginning of period                        87             135
                                                                  --------        --------
Cash and cash equivalents at end of period                        $    137        $    105
                                                                  ========        ========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Interest paid                                                     $    360        $    749

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING
  ACTIVITIES

Accretion/dividends on preferred stock                            $  1,194              --
</TABLE>

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



                                       6
<PAGE>   7

AUREAL SEMICONDUCTOR INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


1.  THE COMPANY AND RECENT FINANCIAL EVENTS

    Aureal Semiconductor Inc., together with its subsidiaries Crystal River
Engineering, Inc., and Aureal Semiconductor Limited specialize in the design and
marketing of audio semiconductor technologies for use in both the PC and
consumer electronics markets. Crystal River Engineering, Inc., founded in 1987
and acquired by Aureal in the second quarter of 1996, has been a pioneer in the
development of 3D audio technologies. Aureal Semiconductor Limited, located in
Hong Kong, was established in March of 1998 as a sales, technical support and
field engineering office. Our business involves the development and sale of
audio processing semiconductor chips and audio-based add-in cards for use in
PC's, as well as the licensing of technology which is designed to define and
develop advanced audio standards in the marketplace. Our stock symbol on the OTC
Bulletin Board is AURL.

     In March 1999, our board of directors approved a subscription rights
offering, under which we will offer for sale $20 million of our common stock, at
a price of $0.60 per share. Stockholders of our common stock on April 22, 1999
are being offered, on a pro-rata basis, the opportunity to purchase new shares
of our common stock. Our two largest stockholders, Oaktree Capital Management
LLC and TCW Special Credits, or any combination thereof, have agreed to purchase
any remaining unsubscribed shares of this offering up to a maximum amount of $20
million. We understand that TCW and Oaktree, holders of all of our series B
preferred stock, intend to convert their shares of series B preferred stock into
20.5 million shares of common stock upon the closing of the rights offering. We
have also agreed to issue an additional 26.2 million shares of common stock to
holders of our series B preferred stock who convert their shares into common
stock upon the closing of the rights offering. These additional 26.2 million
shares will not be registered, but we will grant standard demand and piggyback
registration rights to the holders of those shares. These actions will
effectively eliminate most of our preferred stock and convert it to common
stock.

    On April 5, 1999, we publicly announced this capital restructuring plan. In
addition to the $20 million subscription rights offering, we also announced the
approval by our board of directors, subject to stockholder approval, of a
one-for-fifteen reverse stock split. These actions should make it possible for
us to qualify for NASDAQ national market listing in the near future.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

    Basis of Presentation

    We, the management of Aureal Semiconductor Inc., have prepared the following
Interim Condensed Consolidated Financial Statements without audit, pursuant to
the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been omitted pursuant to such rules and regulations. The disclosures
included in the Interim Condensed Consolidated Financial Statements should be
read in conjunction with our audited financial statements at January 3, 1999 and
the notes thereto included in our 1998 Annual Report on Form 10-K.

    The Interim Condensed Consolidated Financial Statements reflect, in the
opinion of management, all adjustments (which include only normal recurring
adjustments) necessary for a fair presentation of financial position, results of
operations and cash flows for such periods. The results of operations for the
fiscal quarter ended April 4, 1999 are not necessarily indicative of the results
that may be expected for any subsequent quarter or the entire fiscal year ending
January 2, 2000.



                                       7
<PAGE>   8

    Inventories

    Inventories are stated at the lower-of-cost-or-market value on a first-in
first-out basis. We do not consider any inventory to be raw material, since our
initial point of purchase is for fabricated silicon wafers. Net inventories at
April 4, 1999 and January 3, 1999 consisted of the following, in thousands:

<TABLE>
<CAPTION>
                                  April 4, 1999       January 3, 1999
<S>                               <C>                 <C>   
Work-In-Process                       $2,380              $2,460
Finished Goods                         1,181               1,456
                                      ------              ------
       Total Inventories              $3,561              $3,916
                                      ======              ======
</TABLE>

    Property and Equipment

    Property and equipment are stated at cost and depreciated utilizing the
straight-line method over their estimated useful lives (one and one-half to five
years). Leasehold improvements are amortized utilizing the straight-line method
over their estimated useful lives or the term of the lease whichever is shorter.
Maintenance and repairs are expensed as incurred.

    Revenue Recognition

    Our major sources of revenue consist of sales of proprietary design,
advanced audio semiconductor chips and boards, and licensing of related audio
technologies. Revenue is recognized upon shipment for product sales. Licensing
revenues are recognized upon delivery of licensed product if a non-cancelable
contract has been signed, the fees are fixed and determinable, collection of the
recognized fees is probable, and there are no remaining significant obligations.

    Comprehensive income

     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income", which
we adopted in the first quarter of fiscal 1998. Statement of Financial
Accounting Standards No. 130 requires that we disclose all non-owner changes in
equity, such as cumulative foreign currency translation adjustments, certain
minimum pension liabilities and grains and losses on available-for-sale
securities. During the first quarters of both 1999 and 1998, we had no elements
of comprehensive income.

    Concentration of Financial Instrument Risks and Credit Risks

    Financial instruments which potentially subject us to concentration of
market risk consist primarily of our line of credit. Concentration of market
risk on the line of credit is related to changes in the prime lending rate, as
the majority of our debt bears interest rates which fluctuate with changes in
the prime lending rate. Our credit risk consists primarily of trade receivables.
Some of these trade receivables are the result of sales to foreign companies. We
have established an allowance for doubtful accounts based on the credit risks of
the business in general.

    Valuation of Warrants

    In connection with the establishment of our current credit facility in June
of 1998, we issued warrants to purchase 1.35 million shares of our common stock.
The fair value of these warrants was estimated utilizing the Black-Scholes
valuation method as approximately $1.8 million and is being amortized over the
two-year term of the credit facility.

    Loss Per Share

    The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 128, which is effective for financial statements for
periods ending after December 15, 1997. Statement of Financial Accounting
Standards No. 128 requires that the calculation for basic earnings per share
exclude the dilutive effect of common stock equivalents in the calculation for
basic net income (loss) per share. Diluted earnings per share under Statement of
Financial Accounting Standards No. 128, is calculated using the weighted average
number of common shares and common stock equivalent shares outstanding during
the period. Common equivalent shares are computed using the treasury stock
method for outstanding warrants and stock options. Common equivalent



                                       8
<PAGE>   9

shares are excluded from the diluted earnings per share computation only if
their effect is anti-dilutive. No common stock equivalents were included in the
calculations for any fiscal period presented as, due to the net loss position,
any affect would be anti-dilutive.

    Accretion related to the beneficial conversion features of the series A
preferred and the series C preferred, and the dividend / accretion rate of 8% on
all three series of preferred stock totaled $1.2 million during the first
quarter of 1999. These charges were recorded directly to accumulated deficit and
are included as a component of net loss per share attributable to common
stockholders.

3.  CREDIT FACILITY

    On June 5, 1998, in conjunction with the elimination of the previous line of
credit, we entered into a two year $40 million revolving credit facility with
Transamerica Business Credit Corporation and Goldman Sachs Credit Partners L.P.
partially secured by our assets. Terms of the credit facility provide for up to
$32.5 million borrowing availability related to specific accounts receivable,
referred to as Tranche A, with an additional $7.5 million of availability
unrelated to specific collateral requirements, referred to as Tranche B.
Interest on borrowings under the two-year agreement is at the rates of prime
plus 3% for Tranche A borrowings and prime plus 5% percent for Tranche B
borrowings. We are subject to certain covenant restrictions under the credit
facility and have paid a $600,000 fee to the lenders in connection with the
initiation of the credit facility.

    Also in conjunction with the establishment of the new credit facility, we
issued warrants to purchase 1.35 million shares of our common stock to the
lenders under the credit facility. These warrants are exercisable at any time
over their five-year life at the exercise price of $2.156 per share of common
stock.

    At April 4, 1999, our borrowings under this credit facility included $4.2
million of Tranche A borrowings at an interest rate of 10.75% and $3.6 million
of Tranche B borrowings at an interest rate of 12.75%. Our unused borrowing
availability under Tranche B was $4.9 million. At quarter-end April 4, 1999, our
financial ratios were out of compliance with financial covenant requirements for
the credit facility; however, at May 17, 1999 we had secured a waiver of
non-compliance for these specific covenant requirements.

4.  EQUITY FUNDING

     In March 1999, our board of directors approved a subscription rights
offering under which we will offer for sale $20 million of our common stock, at
a price of $0.60 per share. Stockholders of our common stock on April 22, 1999
are being offered, on a pro-rata basis, the opportunity to purchase new shares
of our common stock. Our two largest stockholders, Oaktree and TCW, or any
combination thereof, have agreed to purchase any remaining unsubscribed shares
of this offering up to a maximum amount of $20 million. We understand that TCW
and Oaktree, holders of all of our series B preferred stock, intend to convert
their shares of series B preferred stock into 20.5 million shares of common
stock upon the closing of the rights offering. We have also agreed to issue an
additional 26.2 million shares of common stock to holders of our series B
preferred stock who convert their shares into common stock upon the closing of
the rights offering. These additional 26.2 million shares will not be
registered, but we will grant standard demand and piggyback registration rights
to the holders of those shares. These actions will effectively eliminate most of
our preferred stock and convert it to common stock.

    At our 1999 annual meeting of stockholders, we are seeking stockholder
approval for a one-for-fifteen stock split. At that time, we will also be
seeking stockholder approval for an increase in the number of shares for the
option plan. These actions have not been reflected in the accompanying
consolidated financial statements.

5.  INCOME TAXES

    We were not required to provide for income taxes in the first quarters of
1999 or 1998 due to our net operating losses. No tax benefit has been recorded
for the losses due to the uncertainty as to the realizability. At January 3,
1999, we had available net operating loss carryforwards of approximately $308
million to reduce future taxable income.



                                       9
<PAGE>   10

6.  INDUSTRY SEGMENTS

    Aureal operates in a single segment which includes three product revenue
groups. During the first quarter of 1999 we generated $4.1 million in revenues
from the sale of chips, $7.8 million from the sale of board-level products and
$0.7 million in revenues from licensing agreements. During the same period in
1998, revenues from chips were $3.3 million and $0.3 million from licensing
agreements.



                                       10
<PAGE>   11

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. ANY FORWARD-LOOKING STATEMENTS MADE HEREIN ARE MADE
PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION ACT
OF 1995. INVESTORS ARE CAUTIONED THAT ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE PROJECTED IN ANY FORWARD-LOOKING STATEMENTS DUE TO A NUMBER OF FACTORS
INCLUDING, BUT NOT LIMITED TO, OUR DEPENDENCE ON THE PERSONAL COMPUTER AND
CONSUMER ELECTRONICS INDUSTRIES AND ON PRODUCT LINES BASED ON NEW TECHNOLOGIES;
FOUNDRY CAPACITY, AVAILABILITY AND RELIABILITY; COMPETITION AND PRICING
PRESSURES; OUR ABILITY TO SECURE ADDITIONAL FINANCING; AND OTHER RISKS DETAILED
BELOW AND FROM TIME TO TIME IN OUR FILINGS WITH THE SECURITIES AND EXCHANGE
COMMISSION. FOR A FURTHER DISCUSSION OF THE RISKS RELATING TO OUR BUSINESS, SEE
THE RISK FACTORS SECTION OF MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITIONS AND RESULTS OF OPERATIONS.

OVERVIEW

        Aureal Semiconductor Inc. is a producer of digital audio semiconductor
and board-level products and advanced digital audio technologies for the
personal computer and consumer electronics markets. We contract with independent
silicon manufacturers, which in the semiconductor industry are called foundries,
for production of our semiconductor products, and thus we do not fabricate our
own semiconductor products. The foundry that manufactures the majority of our
semiconductor products is one of the three largest foundries in the world that
manufactures products exclusively for other companies. Our objective is to be a
leading provider of advanced digital audio solutions for the personal computer
and consumer electronics markets.

       During the first few months of 1999, some significant events were:

-   In April, 1999, we announced that Sony Electronics had begun shipping two
    new VAIO brand desktops incorporating our Vortex2 audio processors. With the
    introduction of these machines, Sony became the first manufacturer to design
    Vortex2 audio processors directly onto a PC motherboard.
-   Also in April 1999, we announced the availability of a new digital audio
    accelerator for desktop and notebook PCs, the Vortex AU8810. This new chip
    is a low-cost, motherboard solution resulting from the integration of audio
    and modem capabilities.
-   March 1999, we released our final A3D 2.0 software development kit, which
    enables the creation of interactive 3D audio content, to the general
    development community. This kit had previously only been available to
    selected game developers. We received an extremely positive response to the
    new kit, with demand for CDs and Internet downloads of the kit reaching into
    the thousands.
-   Also in March 1999, we announced the formation of a partnership with
    Flatland Online, Inc. As part of this partnership, we have integrated our
    A3D 2.0 standard into Flatland's tools and web browser extension software
    providing easy-to-use positional audio for the 3D web enhanced by our Aureal
    Wavetracing technology.
-   On February 22, 1999, we received Computer Gaming World's prestigious Gaming
    Hardware of the Year award for our Vortex2 audio processor. This event was
    significant because it was the first time that the award was presented to an
    audio hardware company, signifying a shift in industry focus from graphics
    to audio. Also in February, we began web-based distribution of our A3D Pro
    sound design software. This marked our first foray into electronic commerce.
-   In January 1999, we began direct sales to systems integrators. We also
    announced an extension of our relationship with Compaq Computer Corporation,
    in which Compaq agreed to ship our Vortex sound card products in their new
    Presario 5600 desktop computer products.

    We are headquartered in Fremont, California, in a leased 36,000 square foot
building. In January 1999, we leased an additional 8,000 square feet of office
space in the vicinity of our Fremont headquarters. We maintain additional office
space in Austin, Texas and Hong Kong. As of April 4, 1999, we employed 125
people. Of this total, 80 were engaged in engineering functions, 32 were in
sales and marketing activities, and 13 were engaged in administrative support.

        Aureal, Aureal 3D, A3D and the A3D logo are registered trademarks of
Aureal Semiconductor Inc. Other trademarks referred to in this document belong
to their respective owners.



                                       11
<PAGE>   12

RESULTS OF OPERATIONS

First quarter 1999 compared to first quarter 1998

        Net sales

        Net sales for the first quarter of 1999 were $12.6 million compared to
$3.6 million in the first quarter of 1998. This 250% increase in sales was the
result of the commercial success in the marketplace of our Vortex and Vortex2
products. During the first quarter of 1999, we introduced our new low-cost
Vortex AU8810 and saw continued sales growth from our AU8820 chips, AU8820 sound
cards, AU8830 chips and AU8830 sound cards. Revenues from the first quarter of
1998 consisted mainly of sales of our AU8820 chips. Licensing revenues declined
from 9% of total revenues in the first quarter of 1998 to 6% in 1999.

        Gross margin

        Gross margin for the first quarter of 1999 was 34%. This was a 12 point
(or 55%) increase over the prior year's first quarter gross margin of 22%. This
increase in our gross margin was attributable to lower manufacturing costs and
significantly less startup costs for new products. During the first quarter of
1998, our total cost of goods included the costs of lower yields, extensive
testing and higher transportation costs incurred in association with the initial
manufacturing cycles of our AU8820 chip. Gross margin was positively affected in
both quarters by revenues from licensing. While we anticipate the continuation
of revenues from technology licensing agreements, we do not anticipate that they
will be a significant percentage of our total revenues in the future. We believe
that our gross margins could vary depending upon market demand for our various
products, new product introductions and the timing and volumes of licensing
revenues.

        Research and development

        Expenditures for research and development continue to be significant as
resources are allocated to create future audio products for both the PC and
consumer electronics markets. Spending in this area yields both short-term and
long-term product developments as we continue to bring new and improved products
to the audio forefront. Research and development expenses increased from $2.6
million in the first quarter of 1998 to $3.4 million in the first quarter of
1999 but declined as a percentage of net sales from 73% to 27%, respectively. We
expect research and development to continue to be a significant area of
investment for us as we develop new technologies and explore new audio
frontiers. We expect that the level of spending on research and development will
fluctuate, but we do not expect it to decline significantly in absolute dollars
in the future.

        Selling and marketing

        During the first quarter of 1999, we began to sell directly to the
system integrator channel. To affect this new distribution strategy, we
increased selling and marketing headcount, advertising expenses and headcount
related expenses such as travel and commissions. This resulted in a 53% increase
in spending in this area between the first quarters of 1999 and 1998,
respectively. While selling and marketing expenses increased in absolute dollar
terms from $1.4 million in 1998 to $2.1 million in 1999, these costs decreased
as a percent of net sales from 38% in 1998 to 16% in 1999. As we expand our
distribution model, we expect selling and marketing expenses will continue to
increase in absolute dollars in the future.

        General and administrative

        General and administrative expenses for the first quarter of 1999
increased 36% to $1.2 million from $0.9 million in 1998, but declined as a
percentage of net sales from 24% to 9% due to the significant increase in net
sales. This increase was the result of increased headcount and legal fees. We
expect that general and administrative expenses will increase in absolute dollar
terms over the next several periods due to headcount increases, the costs
associated with providing expanded infrastructure for our organization and
continuing legal fees.



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<PAGE>   13

Interest expense

        Interest expense for the first quarters of 1999 and 1998 decreased to
$0.4 million from $1.0 million, respectively. This decrease was the result of
the restructuring of our debt in 1998. In June 1998, we paid down and eliminated
our previous line of credit in connection with the exchange for our series B
preferred stock. This resulted in the decline of interest expense based on the
lower outstanding balance of our borrowings. Our current credit facility also
carries a lower interest rate than the prior line to the extent borrowings are
based on eligible accounts receivable borrowing availability.

        Amortization of debt-related warrants

        In August 1997, in conjunction with the expansion and extension of our
prior line of credit, we issued warrants to purchase 3.15 million shares of our
common stock to the lenders. Using the Black-Scholes valuation method, the
estimated fair value of the warrants was determined to be $5.0 million. This
value was amortized over the estimated life of the line of credit at the rate of
$.75 million per quarter. When the line of credit was converted to preferred
stock in June 1998, the remaining unamortized deferred costs related to the
warrants were netted against the outstanding loan balance and eliminated as a
reduction of the conversion value of the series B preferred shares.

        In connection with our new credit facility, we issued, in June of 1998,
warrants to purchase 1.35 million shares of our common stock. The fair value of
these warrants was estimated utilizing the Black-Scholes valuation method as
approximately $1.8 million and is being amortized over the two-year term of the
credit facility.

        Other income

        In the first quarter of 1998, we recognized $0.34 million of other
income primarily due to various receipts and credits resulting from favorable
resolutions to previously recorded liabilities. There were no significant
similar transactions in the first quarter of 1999.

        Income taxes

        We were not required to provide for income taxes in either the first
quarter of 1999 or 1998, respectively due to our net operating losses. No tax
benefit has been recorded for the net operating loss carryforwards due to the
uncertainty as to their realizability.


LIQUIDITY AND CAPITAL RESOURCES

        As of April 4, 1999, we had a working capital deficit of $6.7 million
and stockholders' deficit of $4.4 million. The $2.6 million net cash used in
operations during the first quarter of 1999 was approximately $3.5 million less
than we used in the first quarter of 1998. This was primarily due to lower
operating losses. Net cash used for investing in equipment and software tools
decreased from $0.8 million in 1998 to $0.5 million in 1999. Capital
expenditures of $0.5 million in the first quarter of 1999 and $0.8 in the same
period in 1998 consisted primarily of hardware and software tools utilized in
our research and development activities. Capital expenditures are anticipated to
increase significantly during 1999, to an estimated level of between $3 million
and $4 million for the year.

        Financing for first quarter of 1999 cash outlays was provided by our
line of credit. We expect to need additional cash to expand the business and to
finance additional inventory and accounts receiveable. It is extremely difficult
to estimate the cash flows, and the timing of these cash flows, due to our lack
of significant sales and customer payment history. We can make no assurance that
we will be able to generate positive cash flows in the future.

     In March 1999, our board of directors approved a subscription rights
offering under which we will offer for sale $20 million of our common stock, at
a price of $0.60 per share. Stockholders of our common stock on April 22, 1999
are being offered, on a pro-rata basis, the opportunity to purchase new shares
of our common stock. Our two largest stockholders, Oaktree and TCW, or any
combination thereof, have agreed to purchase any remaining unsubscribed shares
of this offering up to a maximum amount of $20 million. We understand that TCW
and Oaktree, holders of all of our series B preferred stock, intend to convert
their shares of series B preferred stock into 20.5 million shares of common
stock upon the closing of the rights offering. We have also agreed to issue an
additional 26.2 million shares of common stock to holders of our series B
preferred stock who convert 



                                       13
<PAGE>   14

their shares into common stock upon the closing of the rights offering. These
additional 26.2 million shares will not be registered, but we will grant
standard demand and piggyback registration rights to the holders of those
shares. These actions will effectively eliminate most of our preferred stock and
convert it to common stock.

        Our existing line of credit is a two year $40 million revolving credit
facility with Transamerica and Goldman Sachs entered into on June 5, 1998. Terms
of this credit facility provide for up to $32.5 million borrowing availability
related to specific accounts receivable, referred to as Tranche A, with an
additional $7.5 million of availability that is unrelated to specific collateral
requirements referred to as Tranche B. Interest on borrowings under the two-year
agreement is at the rates of Prime plus 3% on Tranch A borrowings and Prime plus
5% on Tranche B borrowings. We are subject to certain covenant restrictions
under the credit facility and have paid a $600,000 fee to the lenders in
connection with the initiation of the credit facility.

     At April 4, 1999, our borrowings under this credit facility included $4.2
million of Tranche A borrowings at an interest rate of 10.75% and $3.6 million
of Tranche B borrowings at an interest rate of 12.75%. Our unused borrowing
availability under Tranche B was $4.9 million. In anticipation of the receipt of
funds from the $20 million subscription rights offering, we are considering
reducing the maximum borrowing availability under our line of credit. At
quarter-end April 4, 1999, our financial ratios were out of compliance with
financial covenant requirements for the credit facility; however, at May 17,
1999, we had secured a waiver of non-compliance for these specific covenants.


DISCLOSURE REGARDING THE YEAR 2000

        Year 2000 Readiness Disclosure: Some computer, software, and other
equipment include computer code in which calendar year data is abbreviated to
only two digits. As a result of this design protocol, some of these systems
could fail to operate or fail to produce correct results if the year "00" is
interpreted to mean 1900 instead of 2000. These problems are widely expected to
increase in frequency and severity as the year 2000 approaches and are commonly
referred to as the "year 2000 problem."

Assessment:
        The year 2000 problem affects the some of the computers, software and
other equipment that we use, operate or maintain for our operations. We have
developed a year 2000 readiness plan to assess our exposure to the year 2000
problem, implement solutions and develop necessary contingency plants. This plan
has been reported to our board of directors and progress is reported to them on
a regular basis. To date we have obtained verification and validation from the
majority of our independent third party software and hardware suppliers of the
year 2000 compliance of their products.

Internal infrastructure:
        Of the systems we are currently using, the components of our mission
critical software are year 2000 compliant as are the majority of the software
packages we employ as engineering tools. Upon completion of the evaluation and
assessment of all of our software packages and hardware, we will commence the
process of modifying, upgrading and replacing and systems that have been
assessed as adversely affected. We expect to complete this process before the
occurrence of any material disruption of our business.

        In addition to computers and software packages, there are office
equipment such as fax machines, telephone switches, security systems and other
common devices which may be affected by the year 2000 problem. Of these pieces
of equipment, we have identified our voice mail system as needing replacement or
upgrade and are anticipating that this will be completed by mid-1999.

Products and software programs:
        We have tested our products for year 2000 problems. This testing was
completed during the first quarter of 1999. Our engineering staff performed
compliance testing on all A3D drivers, utilities and supporting software using
testing methods and measurements that specifically addressed potential risks to
seamless integration into the year 2000 environment. Our A3D product passed both
functional and usage tests without errors due to year 2000 non-compliance.



                                       14
<PAGE>   15

        We estimate the cost of completing any required modifications, upgrades
or replacements of our internal systems to not be significant. All systems that
we have tested to date are year 2000 compliant, except for our voice mail system
which we expect to upgrade to be compliant by mid-1999. We believe that the
systems that we have not tested can be replaced or modified in the normal course
of business.

Suppliers:
        We are checking the web sites of third-party suppliers of components
used in the manufacture of our products to determine if these suppliers are
certifying that the components they provide us are year 2000 compliant. To date,
we believe all critical components that we obtain from third party suppliers are
year 2000 compliant, except that Microsoft has not indicated that Windows 95 and
its office mail programs are year 2000 compliant. We expect that we will be able
to resolve any significant year 2000 problems with Microsoft and any other
third-party suppliers of components; however, there can be no assurance that
these suppliers will resolve any or all year 2000 problems before the occurrence
of a material disruption to the operation of our business. Any failure of these
third parties to timely resolve year 2000 problems with their systems could have
a material adverse effect on our business, operating results and financial
condition.

Most likely consequences of year 2000 problems:
        We expect to identify and resolve all year 2000 problems before they
materially adversely affect our business operations; however, we believe that it
is not possible to determine with complete certainty that all year 2000 problems
affecting us have been identified or corrected. The number of devices that could
be affected and the interactions among these devices are simply too numerous. In
addition, no one can accurately predict how many year 2000 problem-related
failures will occur or the severity, duration, or financial consequences of
these perhaps inevitable failures. As a result, we believe that we could
experience a significant number of operational inconveniences and inefficiencies
for us, our contract manufacturers, and our customers that will divert
management's time and attention and financial and human resources from ordinary
business activities. We also believe that it is possible that there may be
business disputes alleging that we failed to comply with the delivery terms of
contracts.

Contingency plans:
        We will develop contingency plans to be implemented if our efforts to
correct identifiable year 2000 problems are not effective. Depending on the
systems identified as non-compliant, these plans could include: accelerated
replacement of affected equipment or software, short to medium-term use of
backup equipment and software; increased work hours for our personnel; and use
of contract personnel to correct on an accelerated schedule any year 2000
problems that arise or to provide manual workarounds for information systems.
Our implementation of any of these contingency plans could have a material
adverse effect on our business, operating results and financial condition.

Disclaimer:
        The discussion of our efforts and expectations relating to year 2000
compliance are forward-looking statements. Our ability to achieve year 2000
compliance and the level of incremental costs associated therewith, could be
adversely affected by, among other things, the availability and cost of
programming and testing resources, third party suppliers' ability to modify
proprietary software, and unanticipated problems identified in the ongoing
compliance review.

RISK FACTORS

        In addition to the other information in this report or incorporated in
this report by reference, you should consider carefully the following factors in
evaluating Aureal and our business:

WE ARE OFFERING OUR CURRENT STOCKHOLDERS SUBSCRIPTION RIGHTS FOR OUR COMMON
STOCK

        We are offering holders of our common stock as of April 22, 1999 the
right to subscribe for and purchase up to an aggregate 33,333,333 shares of our
common stock at $0.60 per share. Every stockholder that exercises their
subscription rights may also elect to purchase shares that other stockholders
have elected not to acquire. In the event that all 33,333,333 shares are not
subscribed for by our stockholders, Oaktree and TCW, or any combination thereof,
have agreed to purchase all remaining shares. If holders of our common stock on
the record date elect not to subscribe to the rights offering, their percentage
ownership of Aureal will be immediately and substantially diluted by the rights
offering. In addition, holders who acquired our stock after the record date and
hence are not



                                       15
<PAGE>   16

able to participate in the rights offering, will experience immediate and
substantial dilution of their percentage ownership of Aureal.

WE HAVE ANNOUNCED A ONE-FOR-FIFTEEN REVERSE STOCK SPLIT AND THE MARKET PRICE OF
OUR COMMON STOCK MAY DECLINE

        Our stock price may decline because we have announced our intentions to
effect a one-for-fifteen reverse stock split. Many companies that have announced
and then effected reverse stock splits have seen their stock price fall, both
before and after the reverse split is effected. On March 31, 1999, our board of
directors approved a one-for-fifteen reverse split in our common stock. While a
reverse stock split does not in any way affect the value of, or your investment
in, Aureal, the markets may react negatively to it which could cause our stock
price to decline further. We cannot assure you that, as a result of the reverse
stock split, our stock price will not decline to a price that is less than
fifteen times the price of our stock prior to the reverse stock split.

WE HAVE SUSTAINED LOSSES IN THE PAST AND WE EXPECT TO SUSTAIN LOSSES IN THE
FUTURE

        We emerged from bankruptcy protection in December 1994. Since that time,
we have recorded an accumulated deficit of $177 million as of April 4, 1999.
This deficit is comprised of $160 million of incurred losses and $17 million of
accretion and dividends on our preferred stock. We generated the majority of our
revenues in 1997 and 1996 through technology licensing transactions. The
majority of our revenues in 1998 and the first quarter of 1999 came from the
sale of advanced audio products. We expect that the majority of our future
revenues will be derived from the sale of advanced audio products. However, we
will not be profitable unless we sell significant volumes of our advanced audio
products in the future.

A DIRECTOR OF AUREAL HAS VOTING CONTROL OVER A SUBSTANTIAL AMOUNT OF OUR STOCK
AND MAY, THEREFORE, INFLUENCE OUR AFFAIRS

        As of March 22, 1999, Richard Masson, a director of Aureal, is deemed to
have voting control over approximately 59% of our common stock as a result of
his affiliations with Oaktree and TCW. As a result of the amount of our stock
deemed to be under the stockholder voting control of Mr. Masson, Mr. Masson may
directly and indirectly influence the affairs of Aureal requiring stockholders'
approval. Oaktree and TCW also own 100% of the outstanding shares of our series
B preferred stock, which, upon the closing of our rights offering, will convert
into approximately 20.5 million shares of our common stock. In addition, we have
agreed to issue an additional 26.2 million shares of our common stock to Oaktree
and TCW upon their conversion of our series B preferred stock on the closing of
the rights offering. In connection with the rights offering, Oaktree and TCW
have the right to subscribe for an aggregate of 19.7 million shares of our
common stock. Accordingly, Mr. Masson can be deemed to be, and after the rights
offering will be able to, control all matters requiring approval by our
stockholders, including the election of directors and the approval of mergers or
other business combinations.

INVESTORS MAY FIND IT DIFFICULT TO TRADE OUR COMMON STOCK ON THE
OVER-THE-COUNTER ELECTRONIC BULLETIN BOARD

        Our common stock trades only on the Over-the-Counter Electronic Bulletin
Board. We currently do not meet the requirements for listing on the Nasdaq
National Market or any national stock exchange. However, we believe that our
common stock will qualify for listing on the Nasdaq National Market after we
effect a one-for-fifteen reverse stock split. Because our common stock trades on
the Bulletin Board, an investor may find it very difficult to sell or to obtain
accurate quotations as to the market value of our common stock. Furthermore,
because our common stock is not listed on the Nasdaq National Market, trading in
our common stock is also subject to certain rules promulgated by the SEC under
the Securities Exchange Act of 1934. These rules require additional disclosure
by broker-dealers in connection with any trades involving a stock defined as a
penny stock. Generally, a penny stock is any non-Nasdaq National Market listed
equity security that has a market price of less than $5.00 per share, subject to
certain exceptions. Our common stock meets the definition of a penny stock. The
additional burdens imposed upon broker-dealers by such requirements may
discourage broker-dealers from affecting transactions in our common stock and
may limit the ability of purchasers of our common stock to resell our common
stock in the secondary market.



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<PAGE>   17

WE EXPECT THE AVERAGE SELLING PRICE OF OUR PRODUCTS TO DECREASE WHICH MAY REDUCE
GROSS MARGINS AND REVENUES

        Product prices in the audio technology industry generally decrease over
the life of a particular product. The willingness of prospective customers to
design our products into their products depends to a significant extent upon our
ability to price our products at levels that are cost-effective for these
customers. As the markets for our products mature and competition increases, we
anticipate that prices for our products will decline over time. If we are unable
to reduce our costs sufficiently to offset declines in our product prices, or if
we are unable to introduce new, higher performance products with higher product
prices, our gross margins and revenues could decline.

WE DEPEND ON A CREDIT FACILITY TO FUND OUR BUSINESS OPERATIONS

        Because we have not been profitable to date, we have had to fund our
losses through a combination of equity and debt financings. In June 1998, we
entered into a credit facility that provides for an aggregate maximum borrowing
of $40 million. The interest rate on the credit facility is generally the prime
rate plus 3% to 5%. Accordingly, while the credit facility provides us with
needed working capital, the high cost of servicing any borrowing under it could
negatively affect our liquidity. In addition, the credit facility may not be
sufficient to meet our working capital requirements. In the event we must secure
capital in addition to the line of credit and the proceeds we receive from this
rights offering, there can be no assurance that such capital will be available
on acceptable terms or at all. Our inability to secure such potential future
financing, if necessary, would materially adversely affect our business,
financial condition and results of operations.

TO COMPETE EFFECTIVELY IN THE AUDIO TECHNOLOGY MARKET, WE NEED TO DEVELOP NEW
AUDIO TECHNOLOGIES THAT ARE WIDELY ACCEPTED BY OUR CUSTOMERS

        Our success depends on our ability to develop and market new audio
technologies aimed at advancing the level of audio quality in personal computers
and consumer electronics devices. To be successful, we must timely develop new
products that we can sell at competitive prices to our customers who will design
them into their products. In order for our customers to design our advanced
audio products into their personal computers and consumer electronic products,
we must:
        -  anticipate market trends;
        -  anticipate the performance and functionality requirements of our
           current and potential customers;
        -  develop and produce products that meet the timing and pricing
           requirements of our current and potential customers; and
        -  produce products that can be available in a timely manner consistent
           with our current and potential customers' development and production
           schedules.

        We are expanding our business model to provide for an increased number
of audio-related products, including audio cards and audio communications
combination cards. We may require additional working capital funds for this
expansion to provide for incremental inventory and broader marketing programs. A
number of factors may limit the success of our expansion, and each could
negatively impact our business and results of operations. These factors include:

        -  the failure of the market for advanced audio products to grow; 

        -  reduced demand for our products as a result of increased competition
           in this market; unforeseen technological change; and

        -  our potential failure to introduce new versions of products that our
           customers and the market accept.

        A failure to develop new audio technologies that will be accepted by our
customers could materially adversely affect our ability to generate revenues.

NEW GENERATIONS OF MICROPROCESSORS AND OTHER NEW TECHNOLOGIES MAY DECREASE
DEMAND FOR OUR PRODUCTS

        We also face the risk that new generations of microprocessors that are
capable of performing the function of advanced audio products will greatly
reduce demand for our products. Each successive generation of microprocessors
has provided increased performance, which could, in the future, result in a
microprocessor capable of performing advanced audio functions to an extent that
diminishes or eliminates the need or preference for our products. In addition,
each new generation of technology, including digital audio technology, generally
requires increased processing power. The increased capabilities of
microprocessors in the future may lower demand for our products which will
materially adversely affect our business, financial condition and results of
operations. 



                                       17
<PAGE>   18

INTENSE COMPETITION IN THE MARKET FOR AUDIO PRODUCTS AND ADVANCED AUDIO
TECHNOLOGIES COULD PREVENT AUREAL FROM INCREASING REVENUE AND PREVENT AUREAL
FROM ACHIEVING PROFITABILITY

        The markets for audio products and advanced audio technologies are
intensely competitive and are characterized by evolving industry standards that
result in:

        -  short product life cycles;
        -  significant pressure to improve price and performance; and
        -  frequent new product introductions.

        We expect competition to increase from existing competitors and from
other companies that may enter the markets for advanced audio products with
devices that may be less costly or provide higher performance or additional
features than the products we currently offer. However, we are unable to predict
the timing and nature of any such competitive product offerings.

        In addition, we anticipate that we will compete for the development of
new technologies and for the sale of semiconductor products with a number of
companies who have more extensive resources, including financial, manufacturing,
technical, marketing and distribution. Furthermore, some of these competitors
have greater intellectual property rights, broader product lines and
longer-standing relationships with their customers than we do. In addition to
our established competitors, we may also face competition from a number of
emerging companies. To remain competitive, we believe we must, among other
things, invest significant resources in developing new products and enhancing
our current products and maintaining customer satisfaction. If we fail to do so,
our products will not compete favorably with those of our competitors and our
revenue could be materially adversely affected.

WE MAY NOT HAVE AN ADEQUATE SUPPLY OF OUR PRODUCTS BECAUSE WE DEPEND ON
FOUNDRIES TO PRODUCE OUR PRODUCTS AND OUR PRODUCTS ARE DIFFICULT TO MANUFACTURE

        We do not manufacture our own products, and we depend on outside
manufacturing resources for production of all of our products. Currently, we
utilize one foreign semiconductor foundry and one contract manufacturer for
production of our board level products. These facilities have indicated to us
that they have the manufacturing availability to provide for our planned levels
of production of each of our products for the next 12 months; however, our
production relationship with them is based only upon purchase orders.
Consequently, they may not continue to adequately provide manufacturing capacity
to us for our current level of production or any potential increases in our
production levels. In the event that they cease to manufacture our products, we
would have to contract with alternative facilities. However, we may not be able
to timely contract with alternative facilities or to contract with them at all.
Such a situation could materially adversely affect our ability to sell products
to our customers, which in turn would hurt our financial condition and results
of operations.

        The manufacture of semiconductor products is a highly complex and
precise process. Minute levels of contaminants in the manufacturing environment,
defects in the masks used to print circuits on wafers, difficulties in the
fabrication process and other factors can cause a substantial percentage of
wafers to be rejected or a significant number of die on each wafer not to
function. Many of these problems are difficult to diagnose and potentially
time-consuming or expensive to remedy. The foundries that we employ may, in the
future, experience irregularities or adverse yield fluctuations in the
manufacturing processes of our products. In such event, our business, financial
condition and results of operations may be materially adversely affected.

OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER OF AUREAL

        Provisions in our amended and restated certificate of incorporation and
bylaws may have the effect of delaying or preventing a change of control or
changes in our management. These provisions include, among others:

        -  the division of the board of directors into three separate classes;
        -  the right of the board to elect the director to fill a space created
           by the expansion of the board;
        -  the ability of the board to alter our bylaws; and
        -  the requirement that at least 10% of the outstanding shares are
           needed to call a special meeting of stockholders.

        Furthermore, because we are incorporated in Delaware, we are subject to
the provisions of section 203 of the Delaware General Corporation Law. These
provisions prohibit certain large stockholders, in particular those owning 15%
or more of the outstanding voting stock, from consummating a merger or
combination with a 



                                       18
<PAGE>   19

corporation unless (1) 66 2/3% of the shares of voting stock not owned by this
large stockholder approve the merger or combination or (2) the board of
directors approves the merger or combination or the transaction which resulted
in the large stockholder owning 15% or more of our outstanding voting stock.

WE MAY NOT BE ABLE TO RETAIN OUR KEY ENGINEERING, MARKETING, SALES AND
MANAGEMENT PERSONNEL THAT WE NEED TO SUCCESSFULLY MANAGE OUR BUSINESS

        Our success depends to a significant extent upon the continued services
of key engineering, marketing, sales and management personnel. Our employees may
voluntarily terminate their employment with us at any time. We recognize the
value of the contributions of each of our employees, and we have developed
compensation programs, including stock programs open to all employees, designed
to retain our employees. However, competition for these employees is intense,
particularly in Silicon Valley, and the loss of the services of any one of these
employees could materially adversely affect our business, financial condition
and results of operations.

OUR PRODUCTS EMPLOY PROPRIETARY TECHNOLOGY AND THIS TECHNOLOGY MAY INFRINGE ON
THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES

        Our ability to compete successfully will depend, in part, on our ability
to protect our proprietary technology. We rely on a combination of patents,
trade secrets, copyright and trademark laws, nondisclosure agreements and other
contractual provisions and technical measures to protect our proprietary rights.
Nevertheless, such measures may not be adequate or safeguard the proprietary
technology underlying our advanced audio products. In addition, employees,
consultants and others who participate in the development of our products may
breach their agreements with us regarding our intellectual property, and we may
not have adequate remedies for any such breach. We also realize that our
proprietary information and trade secrets may become known through other means
not currently foreseen by us. Moreover, notwithstanding our efforts to protect
our intellectual property, our competitors may be able to develop products that
are equal or superior to our products without infringing on any of our
intellectual property rights. In addition, we may not be able to effectively
protect our intellectual property rights in certain countries. Our failure to
protect our proprietary technology may materially adversely affect our financial
condition and results of operations.

        Although we do not believe that our products infringe the proprietary
rights of any third parties, third parties may still assert infringement or
invalidity claims, or claims for indemnification resulting from infringement
claims, against us. The assertion of these claims could materially adversely
affect our business, financial condition and results of operations. In addition,
irrespective of the validity or the successful assertion of any claims, we could
incur significant costs in defending against these claims. In defending claims
of alleged infringement, we could incur significant expenses and waste resources
that could have a material adverse affect on our business, financial condition
and results of operations.

WE ARE INVOLVED IN LAWSUITS WITH CREATIVE AND E-MU WHICH COULD NEGATIVELY IMPACT
OUR BUSINESS

        In February 1998, Creative Technology Ltd. and its subsidiary, E-Mu
Systems, Inc., served us with a lawsuit for patent infringement that Creative
and E-Mu filed in the U.S. District Court, Northern District of California. The
lawsuit asserts that our original Vortex product infringes on a patent that
describes a specific implementation for an electronic musical instrument
designed by E-Mu. Creative and E-Mu seek, among other things, a preliminary and
permanent injunction against alleged continuing acts of infringement by us and
an accounting of damages plus interest. In response, we filed a motion for
summary judgment. In August 1998, E-Mu and Creative filed a motion for a
preliminary injunction with respect to our original Vortex and updated Vortex2
products. In October 1998, the court denied Creative's motion for preliminary
injunction. In addition, our motion for summary judgment was also denied. We
believe that the actions that Creative and E-Mu filed are without merit, and we
are vigorously defending against these actions. In December 1998, we filed a
lawsuit alleging patent infringement against Creative and E-Mu. Aureal believes
that Creative and E-Mu have infringed on two of our patents, Patent No.
5,596,644 entitled "Method and Apparatus for Efficient Presentation of
Hi-Quality 3-Dimensional Audio" and Patent No. 5,802,180 entitled "Method and
Apparatus for Efficient Presentation of 3-Dimensional Audio Including Ambient
Effects."

        Additional litigation may be necessary to resolve the claims asserted by
Creative and E-Mu and to resolve our claims against Creative and E-Mu and any
other claims asserted in the future to defend against claims of infringement or
invalidity or to enforce and protect our intellectual property rights. We cannot
assure you that we 



                                       19
<PAGE>   20

will prevail in any litigation with either of them. Also, any litigation,
whether or not determined in our favor or settled by us, would be costly and
would divert the efforts and attention of our management and technical personnel
from normal business operations; this could materially adversely affect our
business, financial condition and results of operations. Adverse determinations
in litigation could result in the loss of our proprietary rights, subject us to
significant liabilities, require us to seek licenses from third parties or
prevent us from producing certain core products. Any of these results could have
a material adverse affect on our business, financial condition and results of
operations.

THE FAILURE OF OUR KEY SUPPLIERS AND CUSTOMERS TO BE YEAR 2000 COMPLIANT COULD
NEGATIVELY IMPACT OUR BUSINESS

        We use a number of computer software programs and operating systems in
our internal operations, including applications used in financial business
systems and various administration functions. To the extent that these software
applications contain source code that is unable to appropriately interpret the
upcoming calendar year "2000," some level of modification or even possible
replacement of such source code or applications could be necessary. Given the
current information, we currently do not anticipate that such year 2000 costs
will have a material impact upon us. We have requested and obtained information
regarding year 2000 compliance from suppliers and providers of all of our
mission critical software systems. Based on the information we currently have,
all mission critical systems appear to be year 2000 compliant. We are currently
contacting major vendors and customers to obtain year 2000 compliance
certificates. The failure of any of our key suppliers or customers to be year
2000 compliant could have a material adverse effect on our business, financial
condition and results of operations.



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<PAGE>   21

PART II.  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     In February 1998, we were served with a suit for patent infringement filed
by Creative Technology Ltd., a Singapore corporation, commonly referred to as
Creative, and its subsidiary, E-Mu Systems, Inc., a California corporation,
commonly referred to as E-Mu. The suit alleges that a portion of our Vortex
audio processor infringes on a patent that describes a specific implementation
for an electronic musical instrument designed by E-Mu. Creative and E-Mu seek,
among other things, a preliminary and permanent injunction against continuing
acts of infringement by us and an accounting of damages plus interest. In
response, we filed a motion for summary judgement. In October of 1998, the court
issued its first ruling in this case denying the Creative motion for a
preliminary injunction. The court also denied our motion for a summary
judgement. Creative appealed the denial of the preliminary injunction, and on
May 6, 1999, the Federal Court of Appeals affirmed the District Court's ruling
denying the preliminary injunction. Further hearings were set for summer of
1999. We believe that the actions brought by Creative and E-Mu are without merit
and will continue to vigorously defend our position.

     In October 1998, Creative Labs, the U.S. based subsidiary of Creative.,
filed a second lawsuit against us. This new lawsuit claims "false advertising"
and "unfair business practices". These complaints center primarily on a
comparison chart prepared by Aureal and published by third parties on the world
wide web. We believe that this action is without merit and have commenced a
vigorous defense of this action. We have filed a response denying these
allegations and filed counterclaims against Creative Labs.

ITEM 5.    OTHER INFORMATION

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

    (a) Exhibit index at page 22.

    (b) Reports on Form 8-K: We filed no reports on Form 8-K during the first
        quarter ended April 4, 1999.


                                   SIGNATURES


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


                                            AUREAL SEMICONDUCTOR INC.



Date: May 17, 1999                          By: /s/ Kenneth A. Kokinakis
                                               ---------------------------------
                                            Kenneth A. Kokinakis
                                            President and Chief Executive
                                            Officer


Date: May 17, 1999                          By: /s/ David J. Domeier
                                               ---------------------------------
                                            David J. Domeier
                                            Senior Vice President of Finance
                                            Chief Financial Officer



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<PAGE>   22

                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit No.                          Description of Document
-----------                          -----------------------
<S>                <C>
 2.1               Agreement and Plan of Reorganization among Aureal, Aureal
                   Acquisition Corporation, a wholly-owned subsidiary of Aureal and
                   Crystal River Engineering, Inc., dated as of May 7, 1996 (1)
 2.2               Second Amended Joint Plan of Reorganization dated November 10, 1994
                   (4)
 3.1               Second Amended and Restated Certificate of Incorporation of Aureal
                   dated May 8, 1996 (2)
 3.2               Restated Bylaws of Aureal Semiconductor Inc. (5)
 4.3               Common Stock Purchase Agreement by and among Aureal and certain
                   entities and individuals dated August 6, 1997 (7)
 4.4               Preferred Stock Regulation D Subscription Agreement (Series A
                   Preferred Stock) (8)
 4.5               Certificate of Designation of Series A Preferred Stock of Aureal
                   Semiconductor Inc. (8)
 4.6               Preferred Stock Registration Rights Agreement (Common stock
                   underlying series A preferred stock)(8)
 4.7               Aureal Semiconductor Inc. regulation D Subscription Agreement for
                   Series C Preferred Stock (9)
 4.8               Certificate of Designation of Series C Preferred Stock of Aureal
                   Semiconductor Inc. (9)
 4.9               Registration Rights Agreement ( Common Stock underlying Series C
                   Preferred Stock) (9)
 4.10              Loan and Security Agreement (Goldman and TBCC Credit Facility) (9)
 4.11              Form of Warrant (Goldman and TBCC Warrants) (9)
 4.12              8% Series B Convertible Preferred Stock Purchase Agreement (9)
 4.13              Certificate of Designation of 8% Series B Convertible Preferred
                   Stock for Aureal Semiconductor, Inc. (9)
 4.14              Amendment Number 4 to Registration Rights Agreement (9)
 4.20              Form of Registration Rights Agreement among Oaktree, TCW and Aureal
                   Semiconductor, Inc. (11)
 10.2              1995 Stock Option Plan (3)
 10.3              Form of incentive option agreement and non-statutory stock
                   option agreement used under 1995 Stock Option Plan (3)
 10.4              1994 Stock Option Plan (4)
 10.5              Form of incentive option agreement and non-statutory stock
                   option agreement used under 1994 Stock Option Plan (4)
 10.6              Industrial space sublease with Chemical Waste Management, Inc. dated
                   September 13, 1995 (3)
 10.7              Form of indemnity agreement for directors and officers (5)
 10.8              1996 Outside Directors Stock Option Plan (6)
 10.9              Manufacturing, Purchasing and Distribution Agreement between Diamond
                   Multimedia Systems, Inc. and Aureal dated July 3, 1998 (10)
 27.1              Financial Data Schedule (Edgar Only)
</TABLE>

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

(1)  Incorporated by reference to the exhibits filed with Form 8-K dated May 22,
     1996 
(2)  Incorporated by reference to the exhibits filed with Form S-8
     (Registration number 333-09531) filed August 2, 1996
(3)  Incorporated by reference to the exhibits filed with Form 10-K for the year
     ended December 31, 1995
(4)  Incorporated by reference to the exhibits filed with Form 10-K for the year
     ended December 31, 1994
(5)  Incorporated by reference to the exhibits filed with Form 10-Q for the
     quarter ended September 29, 1996
(6)  Incorporated by reference to the exhibits filed with Form 10-K for the year
     ended December 29, 1996.
(7)  Incorporated by reference to the exhibits filed with Form S-3 (As
     Post-Effective Amendment No. 1, Registration number 333-3870) filed
     September 12, 1997.
(8)  Incorporated by reference to the exhibits filed with Form 8-K dated March
     16, 1998
(9)  Incorporated by reference to the exhibits filed with Form 8-K dated June
     15, 1998.
(10) Incorporated by reference to the exhibits filed with Form 10-Q for the
     quarter ended June 28,1998.
(11) Incorporated by reference to the exhibits filed with Form S-3 (Registration
     number 333-75631) filed April 2, 1999.


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