Company Spotlight - Nuance Communications (Nasdaq:NUAN)

  Talk of the Town

January 8, 2008 - The jittery market is really being felt among tech stocks, especially the ones that made big advances last year. Risk-oriented investors can use times like this to look for relative bargains among high growth stocks. Nuance Communications (Nasdaq:NUAN) might be one such stock.

Nuance has bolstered its leadership with a string of recent acquisitions, including Tegic, VoiceSignal, Dictaphone, and Focus Informatics. Tegic, which Nuance bought from Time Warner, makes technology that makes it easier to write text messages on cell phones by predicting words as they are written.

Investors have generally responded positively to the acquisitions, not to mention Nuance's fast-growing sales and profits. The stock price of NUAN started 2007 around $11.50 and climbed above $22 through October-December, but the recent sell-off has it back at $15.60 currently. Part of that pullback was prompted by a secondary offering of 7 million shares, along with an institutional investor selling off a big block. That put another $112.8 million in the company coffers. But the corporate outlook remains fantastic so unless that changes, it seems unlikely that buyers will stay away for long.

Analysts are forecasting EPS growth of 38.6% for the current fiscal year ending in September, and nearly 22% on average over the next five. Areas of growth include enterprise speech, health care dictation and transcription, and embedded speech. The company has relationships with Ford, Mercedes, Toyota, and Nokia. Voice search and communications is now adding meaningful results, too, as it works with leading content and search service providers.

After decades of development, this market still hasn't fully evolved into a predictable beast, but Nuance has survived the rough times and is on track for strong earnings growth ahead. The company's core business is profitable (has been since 2005) and growing fast -- EPS are expected to reach 79 cents this year from 57 cents in FY2007. Revenues are seen increasing to $886 million from $613 million a year ago, and sales are expected to surpass $1 billion for the fiscal year ending in September 2009.

Voice-driven computing is a very intriguing technology and a market with huge potential. There remains plenty of risk, but it's finally safe to say that speech recognition has grown from awkward novelty to mainstream commercial application. Early applications of speech recognition in the late 80s and early 90s were a well-publicized flop.

What's changed in the past 15 years? Plenty. Processor speeds have advanced tremendously, high-capacity memory costs have plunged, and the technology itself has been refined. Now voice driven technology works well at viable cost levels. Just as important is the fact that the market isn't limited to the desktop anymore. There is now an array of markets for speech recognition applications, not to mention text-to-speech applications. Internet usage is just one driver, others include cell phones, in-vehicle applications such as navigation and communication, consumer electronics, and a host of other non-PC computing devices.

Another long-term market driver is miniaturization. At some point it gets ridiculous to try and put a numeric keypad--much less a keyboard--on all the portable electronic devices we'll be using a few years down the road. Speech is the obvious answer for human interaction with these machines. Instead of asking humans to act more like computers, the computers will act more like humans by "listening" and "talking" to the user.

While there are certainly desktop applications for speech recognition, the grand prize is enabling access to information through non-PC devices over the Internet and other networks, including wireless. Web-based content such as stock quotes and entertainment information is increasingly available via speech. Booking airline tickets and tracking packages are just a few more examples of applications already in place. Drivers in many metro areas can access information to help them through the commute by dialing 511 and talking their way through voice-driven real-time reports on traffic conditions and public transit.

One opportunity that is especially intriguing is customer relationship management (CRM). This area is already a major focus for improved efficiency among businesses these days, and the cost savings of voice-driven computing solutions over call centers is massive. The key is to make it work well and leave customers with a positive result. Nuance's software advances the natural language performance and reduces the reliance on lists of predefined words, enabling more free-style speech by users.

Nuance is the result of several mergers that brought together many former competitors including ScanSoft, SpeechWorks, and Dictaphone. There are still plenty of rivals like Microsoft and Philips, along with specialist Intervoice, but Nuance is clearly among the leaders and investors have noticed.

It may be a few more years before speech-recognition becomes a mainstay in our lives, but the businesses built around this technology are making real progress and it's hard to deny this will eventually be a huge market. As a leader in commercializing speech recognition technology, Nuance is a company worth knowing, especially with profits on the books now and a market that is finally maturing.

- James Hale