Yep fivefeet8 got it right..
it uses an external MP3 audio and video decoder that some software in the ROM controls it was pretty simple on boot up it checked for a PS1 game or VCD if it was a VCD it ran the VCD player program if not it ran the PS1 game.
By the way you could stick an audio codec on the parrallel port or read raw CD data on it since SONY brought all that out from the PSX. It's a nifty piece of hardware for the PSX, for $70 it's not too bad a price if you have an old playstation you want to use as an SVCD/VCD player.
VCD's can be played by most DVD players save Sony's Ps2 won't (grrr).
Cyb