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Sound Idea: SRS Execs’ Contacts Led to Microsoft Deal

Tom Yuen’s SRS Labs Inc. might be a bit player in the quickly burgeoning market for Internet-based multimedia, but it’s getting a boost from one of the biggest names in the business.

The inconspicuous Santa Ana maker of sound processing technology took on a higher profile late last week with an equity investment from Microsoft Corp. and a licensing agreement that will enlist SRS’s technology in some of the software giant’s most contested battlegrounds.

The news sent SRS stock soaring: It opened Friday at 39, nearly twice its Thursday close, and reached 47 before closing at 33 5/8. Volume was 24 times normal.

Although neither Microsoft nor SRS officials would disclose terms of the investment, it is rumored to be in the $5 million range.

The deal comes on the heels of a restructuring by SRS chief executive Yuen that will create three new divisions in an attempt to speed up his company’s return to profitability. In its most recent financial statement, SRS posted its first significant earnings in a year, $300,000, on sales of $10 million.

The new business units will add a more visible consumer element,and presumably, more revenue,to the company’s existing business of supplying original equipment manufacturers with components to boost sound quality in brand-name consumer electronics products, such as stereo receivers and Walkman tape players.

Yuen said he’s confident the developments are the company’s first step in pushing the company out of “no man’s land” and penetrating new segments, while luring more customers in existing markets.

“We want those eyeballs,” he said, echoing a popular sentiment used in the Internet arena to describe the race for consumers’ attention.

Reaching Out for Customers

In Yuen’s case “earlobes” might be a more accurate turn of phrase. Unlike the already crowded video market, he said, sound and music touch many different segments, from PCs to car stereos to mobile phones.

Best known as a co-founder of AST Computers, Yuen helped finance SRS in 1993 and took over its day-to-day operations last year in the midst of languishing financial performance and the departure of several key executives. Since then, its stock languished in a $2.50 to $5-per-share range until it began climbing last December. It reached the $20 level before last week’s announcement.

Yuen owns 26% of the company.

Under the restructuring, SRS Labs will become a holding company with multiple subsidiaries. In addition to its existing SRSWOWcast.com (Internet broadcasting) and Valence (a Hong-Kong-based outsourced chip designer) units, the restructured company will have several new products groups: one that designs SRS-branded devices to enhance sound for everything from video games to VCRs; a voice-technology company working on speech-recognition devices and technology that makes transmitted voices more intelligible; and an Asian version of its SRSWOWcast venture. Each was launched with less than $1 million, Yuen said.

Yuen hinted that his strategy might require acquisitions of other companies or their technologies, but he wouldn’t say whether any deals are in the works now.

The Valence subsidiary is already on track to go public in the third quarter, and Yuen said he’s planning the same for the other units. He likens the strategy to that of a technology incubator

The moves are designed to augment the company’s licensing fees from stereo and home theater equipment makers with a line of SRS-branded merchandise and Internet content.

“This is a significant opportunity,a bigger one, I have to say, than AST was,” Yuen said. “AST was a Cinderella story; this is another one in the making.”

AST Research had grown from a three-man garage operation in 1980 into one of the largest PC manufacturers in the world before drowning in a flood of new competitors and low-cost PCs that obliterated margins for just about everyone in the industry in the last half of the ’90s.

“PC manufacturing these days is no more than assembling a jigsaw puzzle,” Yuen said, pointing out the degree to which the market has become a commodities business.

New Strategy

Still, the PC plays a central role in the Microsoft deal and in much of SRS’s newest strategy.

Terms of the licensing agreement are being kept under wraps, but Microsoft is betting big on Internet multimedia and will probably incorporate SRS’ “WOW” sound-processing software into its default media player, the built-in application that plays sound and video files in the Windows operating environment. The software is designed to enhance the quality of sound played through the tiny desktop speakers that come with most systems and add theater-quality sound to Internet broadcasts of all bandwidths.

During AST’s heyday, Yuen and SRSWOWcast general manager Chuck Cortright worked frequently with Microsoft chairman Bill Gates and chief executive Steve Balmer. Those relationships helped open doors at Microsoft when Cortright e-mailed Balmer a few months ago to pitch the technology.

SRS has been distributing the technology free as a software add-on to Microsoft’s media player and Winamp, an AOL-owned music player that helped popularize the MP3 format. Microsoft, AOL and Seattle-based Real Networks Inc. have battled fiercely in recent months to make their multimedia players,and more importantly, the pricey software used to encode and transmit them,the prevailing standard. Each has added a variety of bells and whistles to make its playback software more appealing to consumers.

The software behemoth has also announced wireless applications that fit well with SRS’ voice-enhancement and wireless technology.

In addition to giving SRS the blessing of the world’s biggest name in software, Yuen said, the Microsoft agreement will thrust his company’s technology onto the Windows desktop of millions and, thanks to cross-promotional efforts, create user traffic for SRS’ WOWcast site. Microsoft’s multimedia guide will link to WOWcast’s content, which plans to add more music and entertainment through deals with outside production companies.

Room for Growth

While Yuen contends that there’s still room for growth in his company’s traditional OEM home electronics markets, he says the PC and Internet multimedia segments show the most promise. Thanks to faster computers and Internet connections, users are beginning to think of their PCs as entertainment centers, and most of them are not yet equipped with the sound-enhancement technology needed to make the units competitive with home theater systems.

The company will tackle the home electronics market with low-cost alternatives to Dolby and DTS systems on the market now. Two examples: a system that simulates surround sound using only two speakers and another that converts ordinary VCR stereo sound to 5.1-channel common in DVD players.

“Our biggest challenge will be not getting sidetracked by all the glitter and forgetting we run a business,” Yuen said. n

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