DTS Inc. (Nasdaq: DTSI) is a $560 million digital audio technology company that develops and licenses consumer surround-sound products and provides the audio platform for the new high-definition Blu-ray format.

DTS decoders are in virtually every major brand of 5.1-channel surround processors, and there are more than 300 million DTS-licensed consumer electronics products available worldwide. A pioneer in multi-channel audio, DTS technology is in home theatre, car audio, PC and game console products, as well as DVD-Video, Surround Music and DVD-ROM software.

Earnings Momentum

The company delivered a 25% earnings beat in early March and, excluding royalties from compliance activities, revenue for the fiscal year ended December 31, 2014 was $130.6 million, an increase of 10% compared to $118.8 million in 2013. An upside surprise of $2.7 million in revenue from the company’s royalty audit program pushed Q4 revenues to $35.2 million.

Consensus EPS estimates for this year and next were subsequently bumped by over 13% to $1.30 and $1.61, representing 23% earnings growth.

This key provider of audio technology for nearly every consumer device became a Zacks #1 Rank on March 6 right after that report and the stock has moved quietly sideways, appearing poised for a breakout to 4-year highs above $34.

The Products

Assuming Blu-ray continues to grow in popularity and opens up new end-markets in PCs and video game consoles, DTS will benefit as a provider of mandatory-use technology that should become a meaningful earnings driver for the company. Blu-ray revenues currently comprise about 20% of the total.

Two new products include Headphone:X and Play-Fi and each represent new growth opportunities in consumer markets.

Headphone:X enables a smartphone equipped with this technology to provide an experience of up to 11.1 surround sound audio performance. Play-Fi wireless speaker technology, which allows mobile devices to play from their music library, is now available on 15 speaker models and is beginning to generate revenues.

Barrington Research, whose analysts have a $41 price target on DTSI shares, had this to say recently about the Headphone:X growth opportunity...

A key corporate initiative has been the aggressive pursuit of agreements to ensure the company’s inclusion on mobile devices, with Headphone:X providing a key incentive for device manufacturers to incorporate DTS’ technology. Management expects that beginning around mid-2015, Headphone:X-enabled smartphones should begin coming to market.

Headphone:X will likely prove to be among the biggest game changers for DTS, providing a differentiating reason for cell phone and tablet manufacturers to incur the royalty obligation to include this technology on their devices. The earliest wins have been in China, with Headphone:X being incorporated into new phone models from Huawei (a large global player) plus vivo, nubia, and letv.

Including the PC, mobile and connected TV categories, network connected devices have grown to account for 50% of total revenues. Strength in the TV segment is due to higher penetration among manufacturers and the company has potential to offer more products for the 4K TV upgrade cycle. PC revenues have increased as a result of the company’s contract with Hewlett Packard .

Management expects the number of Play-Fi SKUs in the market to double (from 15 to 30) by the end of 2015 and the launch of new mobile phones incorporating DTS technology in the second half of 2015 as well.

Finally, thirteen manufacturers representing nearly 90 percent of the Home AVR and surround processor market, including Denon, Onkyo, Pioneer and Yamaha, are preparing to launch products supporting DTS:X, their next-generation object-based codec technology, in 2015.

The Sound of Innovation

DTS is a series of multichannel audio technologies owned by DTS, Inc. (formerly known as Digital Theater Systems, Inc.), an American company specializing in digital surround sound formats used for both commercial/theatrical and consumer grade applications. It was known as The Digital Experience until 1995.

In 1990, DTS burst onto the scene with its master-quality sound of Steven Spielberg’s blockbuster, Jurassic Park. Ever since, motion picture sound has changed forever. Today, every major film studio in the United States uses DTS multi-channel digital sound, and virtually all major Hollywood feature films are released in DTS format.

In 2008, the cinema division was divested to form DTS Digital Cinema. In 2009 DTS Digital Cinema was purchased by Beaufort International Group Plc. and became known as Datasat Digital Entertainment. Beginning in 2011, the DTS cinema branding has been dropped, in favor of the Datasat Digital Sound branding.

In 2012 DTS acquired the business of SRS Labs, including over 1,000 audio patents and trademarks. These technology patents allow the company to earn relatively high margins on licensing and royalty streams.

Institutional Investors Are Listening

I like the fundamental story here because of the earnings outlook, the financial stability (low debt), the patents, the new products, and the industry trends in consumer products and cars for exceptional audio quality. The fact that Apple paid $3 billion for Beats doesn't hurt either, although most of that was for the music library.

But what put the stock on my radar initially was that I saw strong institutional net accumulation in the fourth quarter of 2014, with buyers collecting 7.6% more shares than were held at the end of the prior quarter, lead by the $52 billion Teachers Advisors pension fund. And BlackRock Inc. started a 1.8 million share position in January.

If the new products infiltrate consumer devices as analysts expect, we should see more funds seeking small-cap Technology growth to have been adding shares of DTSI in Q1 when the 13F filings are released in May.