Dragon Hopes to Breathe Fire into Speech-Recognition Software

Dragon Systems aims to convince Wall Street that computers are indeed ready to talk.
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Dragon Systems

plans to dictate a clear message to Wall Street: Now when people talk, computers listen.

Next month the developer of speech-recognition software intends to raise $100 million on the

Nasdaq

, according to recent filings with the

Securities and Exchange Commission

. (Underwriter

Morgan Stanley Dean Witter

expects Dragon's offering to be priced the week of Feb. 15.)

The Newton, Mass.-based company hopes to convince Wall Street that speaking to computers is not just the stuff of

Jetsons

reruns. Thanks to readily available and powerful computer-processor chips, speech-recognition software is ready for more mainstream usage, says analyst Don DePalma with technology-research firm

Forrester Research

.

This year is going to be the year "where these technologies achieve a fairly visible position" in legal, medical and similar professions, he says. Judging by sales, Dragon seems to lead rivals such as

Lernout & Hauspie

(LHSPF)

and

IBM

(IBM) - Get Report

, DePalma adds.

Computerized speech has had a long gestation. As a graduate student in linguistics in the late 1970s, DePalma watched low-power mainframe computers buckle when they tried to process streams of words spoken at natural speed.

Although kinks in the technology still need straightening, this year the typical customer can spend an hour or so "training" the software to understand his or her voice.

Janet and James Baker, both Ph.D.s in computer science, founded Dragon in 1982 to develop speech-recognition products. They even licensed early versions to IBM. Late last year, James resigned as chief executive after back surgery, but together he and his wife Janet own 15.6 million shares, or 52% of outstanding stock. Another 38% is held by disk-drive maker

Seagate

(SEG)

; other listed holders include top executives.

Dragon's popular main product,

NaturallySpeaking

, is a software that responds to verbal commands and converts human speech to text on the PC. The NaturallySpeaking standard version 3.0 sells on Dragon's Web site for $109.

Dragon is peddling its wares through such partners as

Compaq's

(CPQ)

services division,

OfficeMax

(OMX)

and

Staples

(SPLS)

. Dragon pushes plenty of units through the well-established distributors

Ingram Micro

(IM)

and

Tech Data

(TECD) - Get Report

. End-users include

Bank of America

and the

Los Angeles Police Department

.

No wonder that for the first nine months in 1998, Dragon's revenue roared to $49.6 million, more than triple year-ago levels. The company showed a profit of $8.7 million, up from a loss of $5 million the year before, thanks to a widening of gross margins to 70% from 58%.

Dragon's NaturallySpeaking revenue constituted $39.7 million of the total, topping Lernout & Hauspie's sales of $22.9 million for comparable products. IBM declined to provide details on how much revenue it generates from its speech-recognition software.

Dragon has wrested market share while still charging higher prices than IBM and Lernout & Hauspie, according to Bill Meisel, president of the consulting firm

TMA Associates

in Tarzana, Calif. He has acted as a consultant for Lernout & Hauspie, but not for Dragon.

In recent tests by

PC Magazine

, Dragon bested both rivals in such categories as dictation and formatting. (The magazine did note that there is still room for improvement -- plain old typing takes less time than any of the programs used.)

Portfolio manager Wendell Liljedahl with the pension manager

Wilson Foster

is thinking about investing in Dragon after the stock has passed through the typical IPO volatility. Dragon, still a relative unknown, can compete with Big Blue: "End-users have become too sophisticated to be herded by brand names." Wilson Foster unloaded its stake in Lernout & Hauspie when its

problems with the SEC surfaced this fall.

Lernout & Hauspie has been aggressive in its acquisition strategy and bought out several of its customers, including the

Dictation Consortium

in June and

Globalink

in September. For the first nine months of 1998, Lernout & Hauspie had sales of $164 million and profits of $28.7 million, or 53 cents per share, excluding charges.

But Lernout & Hauspie's bookkeeping raised questions. The company took write-offs totaling $99 million, according to estimates by

Goldman Sachs

. The SEC is forcing it to restate its accounts to reduce write-offs for at least one acquisition, which will cut the company's future earnings. The SEC continues to review Lernout's transactions. Lernout & Hauspie stock has slipped from 45 in late October to 40 5/16 on Tuesday and trades well below its recent high of 63 reached in July.

Lernout & Hauspie's acquisition strategy may be distracting the company, according to some observers.

"It's a little less focused than Dragon," says TMA Associates' Meisel. "

Dragon grow

s mostly through internal growth. I would expect they're not going to change their stripes and go on an acquisition spree."

With an array of hot products and a clean set of accounting books, Dragon Systems is set to breathe fire on Wall Street.