Investors have responded to digital audio technology specialist Digital Theater Systems (NASDAQ:DTSI) with a fair bit of static since its early 2004 highs.

The company's earnings and guidance, reported on Thursday, aren't likely to help much in the short term. Total sales were up about 12% from the previous fourth quarter, and net income (excluding an inventory write-off) was down from the prior year.

Although the company was able to show double-digit growth in the consumer sector, the cinema business grew only by mid-single digits as hardware sales were soft. Margins were also weak because of a combination of lower gross margins and higher selling, general, and administrative expenses, caused in part by legal fees and financial compliance with the Sarbanes-Oxley Act.

All that said, the company still ended the quarter with $117 million in cash and securities -- almost $6.50-per-share's worth.

Digital Theater operates in what is essentially a duopoly with Dolby Laboratories, even though Dolby is far larger than Digital Theater, with about $290 million in revenue for its year ended September 2004. Dolby is soon going public, and it will, along with its bankers, be working hard to cast itself in the best light possible. Dolby's road shows and presentations to investors may put some pressure on Digital Theater.

Nevertheless, there is some cause for longer-term optimism. In addition to the DVD and home theater markets, the PC, game, and car audio markets all look to be major potential growth areas.

Although competitors such as Philips (NYSE:PHG), RealNetworks (NASDAQ:RNWK), SRSLabs (NASDAQ:SRSL), and others undoubtedly want a piece of that business, Digital Theater has worked hard to build relationships with its licensees. There are also some meaningful barriers to entry, especially to be included in a technology standard. What's more, Digital Theater aggressively protects its intellectual property and intends to pursue additional violators in 2005.

For now at least, Digital Theater is in something of a holding pattern. Although the company's technology is included in the next-generation DVD standard (HD-DVD) and in Blu-Ray, sales of players for those media aren't likely to take off in earnest until 2006 or 2007. In the meantime, sales of DVD players are tapering off, and the company's business in home theaters, other consumer products, and cinemas looks lukewarm.

Though the stock trades at more than 27 times trailing earnings, the enterprise value-to-free cash flow ratio is below 20, and the company does have a large amount of cash on the balance sheet. So while growth is sluggish at present, Digital Theater should be able to hold out until the introduction of next-generation consumer electronics. If that happens, investors might be treated to the sweet sounds of success.

Fool contributor Stephen Simpson, CFA, has no ownership interest in any stocks mentioned.