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Nuance And Speechworks Nuance And Speechworks Document Transcript

  • Stephens Inc. Wireless Applications & Services June 6, 2001 Timothy J. Quillin tquillin@stephens.com 501.377.8078 M. Raza Rafiq rrafiq@stephens.com SAY WHAT? Initiating Research Coverage of the Speech Recognition Leaders Nuance Communications (NUAN – OUTPERFORM) SpeechWorks International (SPWX – OUTPERFORM) ©2001 Stephens Inc. This report has been prepared solely for informative purposes as of its stated date and is not a solicitation, or an offer, to buy or sell any security. It does not purport to be a complete description of the securities, markets or developments referred to in the material. Information included in the report was obtained from internal and external sources which we consider reliable, but we have not independently verified such information and do not guarantee that it is accurate or complete. Such information is believed to be accurate on the date of issuance of the report, and all expressions of opinion apply on the date of issuance of the report. No subsequent publication or distribution of this report shall mean or imply that any such information or opinion remains current at any time after the stated date of the report. We do not undertake to advise you of any changes in any such information or opinion. We, our employees, officers, directors and/or affiliates may from time to time have a long or short position in the securities mentioned and may sell or buy such securities. Additional information available upon request. Stephens Inc., 111 Center Street, Little Rock, Arkansas 72201, (501) 377-2000, FAX (501) 377-8003, Member NYSE, NASD, SIPC
  • Stephens Inc. Wireless Applications & Services NUANCE COMMUNICATIONS (NUAN-NASDAQ) June 6, 2001 Timothy J. Quillin, 501.377.8078 Initial Report M. Raza Rafiq OUTPERFORM Price (as of 06/05/01): ........................................$17.56 NUANCE COMMUNICATIONS INC COM (NUAN) Jun 2, 2000 - Jun 5, 2001 High: 182.00 52-Week Range: .................................. $182.00 - $8.86 U.S. Dollar (Split / Spinoff -Adjusted) Low: 8.86 Last: 17.52 Dividend/Yield: ....................................................... 0% 200 180 160 140 Market Capitalization: ......................... $561.1 million 120 100 80 Shares Outstanding: ................................. 32.0 million 60 Estimated Float (Shares):......................... 30.7 million 40 Average Daily Volume (Shares): .................1,603,755 20 Book Value Per Share: ........................................$8.88 LTM Sales: .............................................. $54.9 million Debt/Capital:.......................................................... .0% Volume in Millions (max/avg) 10 ROE (LTM): .......................................................... NM 1 Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May 12-Month Price Target:.....................................$20.00 Cash Chart Courtesy of FactSet Research Systems Inc. FYDec. Rev. (Mil.) % Change EPS 2000A $51.8 165% ($0.59) 2001E $42.5 (18%) ($1.29) 2002E $70.0 64.8% ($0.53) 3-Year Estimate CAGR (Rev.) (2000A-2003E): 27.3% Nuance Communications, based in Menlo Park, California, develops, markets and supports natural voice interface software that enables anytime, anywhere access via telephone to Internet content and corporate data. In addition to Nuance 7.0, its core speech recognition software, the Company offers verification software, a voice browser and will soon offer text-to-speech software. Its customers include wireless and wireline carriers, enterprises and speech portals. HIGHLIGHTS AND CONSIDERATIONS • We are initiating coverage of Nuance Communications with an OUTPERFORM rating and a $20 price target. • In general, we foresee rapid growth for Nuance over the next several years, as its speech recognition software is deployed to improve productivity, lower costs, enhance customer service and even generate revenue. • We believe that 2001 will prove to be a pivotal year in the speech recognition industry, mostly in terms of developer and customer education. Speech recognition is one of the keys to true anytime, anywhere Internet access and should eventually be viewed as a core enabler of enterprise mobility. • Based mostly on anecdotal evidence and our own perception, we view Nuance as slightly more forward thinking than its speech recognition software peers. • At this stage in the market’s development, there is still a great deal of customer education required, which makes it more challenging to sell primarily through channel partners, as Nuance does. In 1Q01, Nuance experienced a 40% sequential decline in revenue to $11 million, as the technology spending slowdown had a profound impact on its business. ©2001 Stephens Inc. This report has been prepared solely for informative purposes as of its stated date and is not a solicitation, or an offer, to buy or sell any security. It does not purport to be a complete description of the securities, markets or developments referred to in the material. Information included in the report was obtained from internal and external sources which we consider reliable, but we have not independently verified such information and do not guarantee that it is accurate or complete. Such information is believed to be accurate on the date of issuance of the report, and all expressions of opinion apply on the date of issuance of the report. No subsequent publication or distribution of this report shall mean or imply that any such information or opinion remains current at any time after the stated date of the report. We do not undertake to advise you of any changes in any such information or opinion. We, our employees, officers, directors and/or affiliates may from time to time have a long or short position in the securities mentioned and may sell or buy such securities. Additional information available upon request. Stephens Inc., 111 Center Street, Little Rock, Arkansas 72201, (501) 377-2000, FAX (501) 377-8003, Member NYSE, NASD, SIPC
  • Stephens Inc. Wireless Applications & Services SPEECHWORKS INTERNATIONAL (SPWX-NASDAQ) June 6, 2001 Timothy J. Quillin, 501.377.8078 Initial Report M. Raza Rafiq OUTPERFORM Price (as of 06/05/01): ........................................$14.50 SPEECHWORKS INTL INC COM (SPWX) 52-Week Range: .................................. $108.50 - $4.81 Aug 1, 2000 - Jun 5, 2001 U.S. Dollar (Split / Spinoff -Adjusted) High: 108.50 Low: 4.81 Last: 14.40 Dividend/Yield: ....................................................... 0% 120 100 Market Capitalization: ......................... $455.4 million 80 60 Shares Outstanding: ................................. 31.4 million 40 Estimated Float (Shares):......................... 27.9 million 30 20 Average Daily Volume (Shares): ....................831,250 Book Value Per Share: ........................................$5.27 10 LTM Sales: .............................................. $36.0 million Debt/Capital:....................................................... .0.6% Volume in Thousands (max/avg) 14950 ROE (LTM): .......................................................... NM 786 12-Month Price Target:.....................................$19.00 Aug Sep Oct Nov Dec Jan Feb Mar Apr May Cash Chart: Courtesy of FactSet Research Systems Inc. FYDec Rev. (Mil.) % Change EPS 2000A $30.0 114.3% ($0.92) 2001E $49.1 63.4% ($0.82) 2002E $74.6 52.0% ($0.28) 3-Year Estimate CAGR (Rev.) (2000A-2003E): 55.5% SpeechWorks International, headquartered in Boston, Massachusetts, is a leading provider of over-the-telephone automated speech recognition solutions to carriers, enterprises and speech portals. SpeechWorks provides a total speech recognition solution, including technology, tools and professional services. In addition to its flagship speech recognition software, SpeechWorks 6, the Company offers a text-to-speech product and the SpeechSite turnkey call automation solution. HIGHLIGHTS AND CONSIDERATIONS • We are initiating coverage of SpeechWorks International with an OUTPERFORM rating and a $19 price target. • In general, we foresee rapid growth for SpeechWorks over the next several years, as its speech recognition software is deployed to improve productivity, lower costs, enhance customer service and even generate revenue. • We believe that 2001 will ultimately be considered a pivotal year in the development of the speech recognition industry, mostly in terms of developer and customer education. Speech recognition is one of the keys to true anytime, anywhere Internet access and should eventually be viewed as a core enabler of enterprise mobility. • At this stage in the market’s development, there is still a great deal of customer education required, which favors SpeechWorks’ solutions sales approach. • In the first quarter, SpeechWorks grew revenue by 8% sequentially to $11 million. The Company’s focus on providing comprehensive customer solutions seems to be translating into exceptional results, at least in the current environment. ©2001 Stephens Inc. This report has been prepared solely for informative purposes as of its stated date and is not a solicitation, or an offer, to buy or sell any security. It does not purport to be a complete description of the securities, markets or developments referred to in the material. Information included in the report was obtained from internal and external sources which we consider reliable, but we have not independently verified such information and do not guarantee that it is accurate or complete. Such information is believed to be accurate on the date of issuance of the report, and all expressions of opinion apply on the date of issuance of the report. No subsequent publication or distribution of this report shall mean or imply that any such information or opinion remains current at any time after the stated date of the report. We do not undertake to advise you of any changes in any such information or opinion. We, our employees, officers, directors and/or affiliates may from time to time have a long or short position in the securities mentioned and may sell or buy such securities. Additional information available upon request. Stephens Inc., 111 Center Street, Little Rock, Arkansas 72201, (501) 377-2000, FAX (501) 377-8003, Member NYSE, NASD, SIPC
  • TABLE OF CONTENTS INVESTMENT CONCLUSION AND SUMMARY ........................................................................................... 6 OUTLOOK ........................................................................................................................................................... 6 Nuance Communications.................................................................................................................................. 7 SpeechWorks International............................................................................................................................... 7 Speech Recognition and VoiceXML................................................................................................................ 7 Technologies .................................................................................................................................................. 10 Sales Strategies............................................................................................................................................... 12 Staying Power................................................................................................................................................. 14 Capitalization ................................................................................................................................................. 14 Customer and Geographic Diversity.......................................................................................................... 14 Management/Employees............................................................................................................................ 16 Product Development ................................................................................................................................ 16 VALUATION ..................................................................................................................................................... 17 Cash Flow....................................................................................................................................................... 18 Catalysts ......................................................................................................................................................... 19 Risks............................................................................................................................................................... 20 CONCLUSION ................................................................................................................................................... 20 NUANCE COMPANY DESCRIPTION ............................................................................................................ 21 Software Products........................................................................................................................................... 23 Nuance 7.0................................................................................................................................................. 23 Nuance Verifier ......................................................................................................................................... 24 Nuance Vocalizer ...................................................................................................................................... 24 Nuance Voyager ........................................................................................................................................ 25 Nuance Voice Web Server ........................................................................................................................ 25 SpeechObjects ........................................................................................................................................... 25 Nuance Developer’s Toolkit...................................................................................................................... 25 Professional Services...................................................................................................................................... 25 Management ................................................................................................................................................... 26 SPEECHWORKS COMPANY DESCRIPTION................................................................................................ 26 SpeechWorks Relationships with AT&T, AOL and Net2Phone.................................................................... 28 Software Products........................................................................................................................................... 29 SpeechWorks 6.5....................................................................................................................................... 30 SpeechSite ................................................................................................................................................. 31 Speechify................................................................................................................................................... 31 ETI-Eloquence........................................................................................................................................... 32 SpeechSecure ............................................................................................................................................ 32 Professional Services...................................................................................................................................... 33 Management ................................................................................................................................................... 33 Stephens Inc. 4
  • FIGURES Figure 1 SPEECH RECOGNITION INDUSTRY  Flow Diagram of a Voice-Enabled Customer Care Application................................................................................................................................................................. 8 Figure 2 SPEECH RECOGNITION INDUSTRY  Product Comparison............................................................ 11 Figure 3 SPEECH RECOGNITION INDUSTRY  Key End-Users .................................................................... 13 Figure 4 SPEECH RECOGNITION INDUSTRY  Margin Comparison for 2000.............................................. 13 Figure 5 SPEECH RECOGNITION INDUSTRY  Capitalization Comparison.................................................. 15 Figure 6 SPEECH RECOGNITION INDUSTRY  Customer Concentration Comparison ................................. 15 Figure 7 SPEECH RECOGNITION INDUSTRY  Geographic Concentration Comparison .............................. 15 Figure 8 SPEECH RECOGNITION INDUSTRY  Insider Ownership Comparison........................................... 16 Figure 9 WIRELESS APPLICATIONS INDUSTRY  Valuation Comparison................................................... 17 Figure 10 NUANCE COMMUNICATIONS  Discounted Cash Flow Analysis .................................................. 18 Figure 11 SPEECHWORKS INTERNATIONAL  Discounted Cash Flow Analysis ......................................... 19 Figure 12 NUANCE COMMUNICATIONS  Revenue Composition, 1Q01....................................................... 21 Figure 13 NUANCE COMMUNICATIONS  Selected Customers...................................................................... 22 Figure 14 NUANCE COMMUNICATIONS  Nuance 7.0................................................................................... 23 Figure 15 SPEECHWORKS INTERNATIONAL  Revenue Composition, 1Q01............................................. 27 Figure 16 SPEECHWORKS INTERNATIONAL  Selected Customers............................................................. 28 Figure 17 SPEECHWORKS INTERNATIONAL  Examples of Speech-Activated Services............................. 29 Figure 18 SPEECHWORKS INTERNATIONAL  SpeechWorks Platform ....................................................... 30 Figure 19 SPEECHWORKS INTERNATIONAL  SpeechWorks 6.5 Platform ................................................. 32 Figure 20 NUANCE COMMUNICATIONS  Earnings Model, FY2000A-FY2002E......................................... 38 Figure 21 NUANCE COMMUNICATIONS — Financial Data FY2000A-FY2002E............................................ 39 Figure 22 SPEECHWORKS INTERNATIONAL  Earnings Model, FY2000A-FY2002E................................. 40 Figure 23 SPEECHWORKS INTERNATIONAL  Financial Data, FY2000A-FY2002E ................................... 41 Stephens Inc. 5
  • INVESTMENT CONCLUSION AND SUMMARY We are initiating We are initiating research coverage of Nuance Communications and SpeechWorks research coverage of International with identical OUTPERFORM ratings. We are genuinely excited about NUAN and SPWX the potential of speech recognition software to transform the way in which we interact with OUTPERFORM with Internet content and corporate data. We believe that the success of both Nuance and ratings. SpeechWorks will be driven primarily by the market’s rapid growth over the next several years and doubt that either of the companies will succeed at the expense of the other. At present, speech Currently, speech recognition technology is used primarily to deflect calls from live recognition customer service representatives. The economic benefit is reduced headcount. In technology is used organizations without a touchtone system, the savings is substantial. Whereas live agent mostly to deflect calls service could easily cost an organization several dollars per call, a self-service system from live customer powered by speech recognition may cost less than $0.50. In most cases, a well-designed service voice recognition system will also result in lower overall costs than a touchtone system by representatives. improving the customer experience and reducing the caller’s propensity to seek live agent help. Speech recognition Longer term, speech recognition software could fundamentally change how consumers technology may access Internet content via either independent or wireless carrier-controlled voice portals. eventually be part of Perhaps more interestingly, mobile professionals will eventually have a truly ubiquitous a multi-modal means of accessing corporate data from the road. Speech recognition technology may platform in which eventually be part of a multi-modal platform in which voice input is married to graphic voice input is married output. For example, a field service technician might query a corporate database by to graphic output. speaking into a handheld device the question, “Where is my next appointment?” and receive a vocal response with the customer’s name and problem along with a map viewable on the device. In the short run, we In the short run, we favor SpeechWorks’ greater revenue visibility and focus on customer favor SPWX’s solutions. At this stage in the market’s development, there is still a great deal of solutions model with customer education required, which makes it more challenging to sell software primarily its greater revenue through channel partners, as does Nuance. We are also impressed with SpeechWorks visibility. In the long alliances with AT&T, AOL and Net2Phone and see these relationships as key run, we like NUAN’s differentiators (see page 30 for more details). Longer term, though, we foresee a large pure software model. group of skilled developers and systems integrators emerging that will be able to implement complex speech recognition solutions. So in the long run, we favor Nuance’s pure software model, which has positive implications in terms of margins and sustainable growth. In the first quarter 2001, Nuance experienced a 40% sequential decline in revenue to $11.0 million, as the technology spending slowdown had a profound impact on its business. SpeechWorks, on the other hand, grew revenue by 8% sequentially to a nearly identical $11.1 million. SpeechWorks’ focus on providing comprehensive customer solutions seems to be translating into exceptional results, at least in the current environment. OUTLOOK In no uncertain terms, we believe that speech We emphatically believe that most speech recognition initiatives are on hold until recognition initiatives economic conditions improve. We do not expect that either Nuance or SpeechWorks will are on hold until grow revenue significantly until at least 2002. However, our longer-term view is much economic conditions more sanguine. We believe that 2001 will ultimately be considered a pivotal year in the improve. evolution of the speech recognition industry, mostly in terms of developer and customer Stephens Inc. 6
  • education. Speech recognition is one of the keys to true anytime, anywhere Internet access and should eventually be viewed as a core enabler of enterprise mobility. Nuance Communications For NUAN, we We forecast total Company revenue of $9.9 million in 2Q01 (ending June 30), a 10% forecast total revenue sequential decline, and $42.5 million for the full year 2001, an 18% decline from the of $9.9 million in previous year. We expect a cash loss of ($1.29) in 2001. Clearly the Company is 2Q01. suffering from the slowdown in technology spending this year. In 2002 we forecast total revenue to grow by 65%, slightly surpassing $70 million, with license revenue more than doubling. We expect a cash loss of ($0.53), as margins should continue to improve. We anticipate that the Company will use over $100 million of its cash in 2001 and 2002 before turning cash flow positive in 2003 as it leverages its cost structure over a rapidly expanding revenue base. SpeechWorks International For SPWX, we forecast total revenue We forecast total Company revenue of $11.6 million in 2Q01 (ending June 30), a 5% of $11.6 million in sequential increase, and $49.1 million for the full year 2001, an impressive 63% increase 2Q01. from 2000. We expect a cash loss of ($0.82) in 2001. SpeechWorks is faring remarkably well in the current environment, in marked contrast to Nuance. In 2002 we forecast total revenue to grow by 52% to slightly under $75 million, with license revenue growing slightly faster at a 58% clip. We expect a cash loss of ($0.28), as margins should continue to improve. We anticipate that the Company will use over $80 million of its cash in 2001 and 2002 before turning cash flow positive in 2003 as it too leverages its cost structure over a rapidly expanding revenue base. We anticipate rapid In general, we foresee rapid growth for both SpeechWorks and Nuance over the next growth for both several years, as speech recognition software is deployed to improve productivity, lower SPWX and NUAN costs, enhance customer service and even generate revenue. over the next several years. When considering an investment in Nuance or SpeechWorks, there are four key issues to examine: • The outlook for the speech recognition industry; • Nuance’s and SpeechWorks’ underlying technologies; • Their sales strategies; and • Their ability to weather an economic downturn. Speech Recognition and VoiceXML Effective and useful speech recognition, the process of converting audible signals into digital symbols, has been one of the holy grails of technology for the past 20 years. Speech recognition has the power to transform the way we interact with machines. Speech is a natural, efficient and flexible interface with computers. Lack of processing The barrier to usable technology has been as much a lack of raw processing speed as a speed has been a lack of modeling knowledge. However, with the rapid advances in computing power barrier to usable over the past decade, the technology is beginning to turn up in our everyday life. In fact, speech recognition a portion of this report was authored without the use of a keyboard using IBM’s Via technology. Voice dictation software and an iMac. From a user’s perspective, the product is marginally useful but frustratingly far from perfection. Neither Nuance nor SpeechWorks offers dictation software. Stephens Inc. 7
  • Both Nuance and SpeechWorks focus on telephony solutions in which the speech recognition software understands, rather than just transcribes, natural human language. Current systems are able to understand elements of a full sentence by using either 1) a finite “grammar,” or vocabulary, that will include all variations in the way a particular request can be voiced, 2) a multi-word probabilistic model (N-Grams), or 3) a keyword spotting algorithm. New statistical models, such Nuance’s Say Anything or SpeechWorks’ How May I Help You, are helping build better natural language recognition by dynamically learning from user behavior. This natural language understanding, along with other software components, makes it possible to create user-friendly customer service solutions (see Figure 1). The brokerage and airline industries have been early adopters of speech-driven self-help systems for retrieving quotes and flight information, respectively. These proprietary solutions are generally built on Interactive Voice Response (IVR) platforms from vendors such as InterVoice-Brite or Avaya. The return on investment is generally quite high, as the software helps reduce calls to live customer service agents. Figure 1 SPEECH RECOGNITION INDUSTRY  Flow Diagram of a Voice- Enabled Customer-Care Application Source: VoiceXML Forum Stephens Inc. 8
  • VoiceXML might The recent emergence of the VoiceXML standard is likely to accelerate the deployment prove to be a catalyst of speech recognition technology. Compared to proprietary IVR solutions, VoiceXML for the deployment of leverages existing corporate investments in Web infrastructure, simplifies the speech recognition development effort by creating an open standard, and supports more deployment options technology. (e.g., hosted applications). Both Nuance and SpeechWorks are proponents of VoiceXML, though Nuance seems to be more vocal regarding the importance of the standard to the industry. VoiceXML is a Web- VoiceXML is a Web-based markup language like HTML (hypertext markup language). based markup Unlike the graphical HTML, VoiceXML uses a voice browser with audio output language that uses a (computer-synthesized and/or recorded) and audio input (voice and/or keypad tones). voice browser with The goal is to enable voice access and interactive voice response (e.g., by telephone, audio output and PDA, or desktop) to Web-based content and applications. Among the potential speech input. recognition solutions utilizing VoiceXML are the following: • Customer service. This is the most typical speech recognition solution and is really just a much more robust version of simple touchtone self-service. With VoiceXML, a caller could be routed from one VoiceWeb site to another. For example, a retail store’s voice site might transfer a caller to a specific vendor’s site if the customer wants product information. • Content. This might include the ability to retrieve personalized information such as address books, calendars, weather reports, travel information and stock quotes. Portals such as TellMe, BeVocal and HeyAnita offer voice content. • Unified messaging (UM). UM allows users to access e-mail, voice mail, instant messaging (IM), short messaging service (SMS) and faxes in one place, either in text or spoken format. • Intranets. For instance, users could order supplies or access human resources information. More interestingly, field sales personnel might place orders by phone or access a CRM (customer relationship management) system. • E-Commerce. Usage in this area probably makes sense only in specific applications such as stock trading or ticket purchases, though Office Depot already successfully processes orders from business customers via a speech recognition system. Our due diligence This may not be the breakthrough year for VoiceXML applications, however. The leads us to believe decrease in technology spending is having a profound impact on emerging technologies that there is such as speech recognition. Corporations are now generally reluctant to deploy new substantial interest in technology even in light of clear evidence of substantial ROI. However, the education speech recognition. process has not stopped. Our due diligence leads us to believe that, while most companies are reluctant to acquire the technology this year, there is substantial interest in speech recognition. We believe that this interest will translate into accelerated sales in 2002. Although the potential market for speech recognition software is difficult to quantify, we have no doubt that it is big. Cahners In-Stat Group expects the market for speech recognition software to grow from $200 million today to $2.7 billion by 2005. This strikes us as an ambitious forecast but still indicative of the market’s potential. Just in streamlining In the streamlining of customer service operations alone, we would expect a significant customer service market opportunity. We can quantify this specific market opportunity in terms of overall operations, we would call center headcount reduction. We estimate that there are over 4 million call center expect a market seats throughout the world. Assuming just $25,000 per seat, the total labor costs are opportunity of $1 approximately $100 billion. We believe that at least 20% of the seats could be displaced billion. by speech recognition systems for a total cost reduction of $20 billion. If annual software Stephens Inc. 9
  • expenditures are just 5% of the cost reduction, this segment of the market is still a $1 billion opportunity. Consumer demand for broader VoiceXML applications is still unproven. While we cannot envision surfing the Voice Web anytime soon, we believe that consumers will ultimately embrace numerous specific services, such as voice dialing and unified messaging. Speech recognition technology should help overcome the input constraints of small handheld devices, especially with the introduction of 2.5G and 3G networks that will allow simultaneous voice and data connections. Perhaps the key to winning consumer acceptance, though, is designing intelligent and friendly user interfaces. Simple things like the rhythm or tone of speech output can have a profound impact on user acceptance. The biggest threats to The biggest threats to the speech recognition software market are commoditization of the the market are core technology and increased competition. Both Nuance and SpeechWorks purchased commoditization of most of their core technology from third parties, including speech recognition technology the core technology from SRI International and MIT, respectively. While their current products are much and increased more advanced than the technology the companies purchased, there is still the threat, competition. albeit a weak one, of a movement towards open source code for the core speech recognition technology as VoiceXML is developed. Nuance’s and SpeechWorks’ competition includes the embattled Lernout&Hauspie, InfoSpace (Locus Dialogue), and Philips Electronics as well as the original VoiceXML sponsors—AT&T, IBM, Lucent and Motorola. We are most concerned about IBM, which has developed high-quality speech recognition software but is not currently marketing products to the enterprise market. However, if Nuance and SpeechWorks prove that there is a viable market, IBM may devote more resources to this area. Technologies On the surface, At first glance, and even at second glance, Nuance and SpeechWorks appear to be very NUAN and SPWX similar organizations. Both market speech recognition software to telecommunications appear to be very carriers, enterprises and portals that enables access to Internet content and corporate data similar organizations. via telephones. Both posted approximately $11 million in revenue in the latest quarter, and both have market capitalizations near $450 million. Certainly their product lines bear a striking similarity (see Figure 2). Overall, we do not believe that either firm can claim technical superiority. Still, there is a bit of an “East Coast/West Coast” feud between the two Companies that deserves closer examination. Nuance can trace its roots back to SRI International, an independent R&D and consulting shop based in Menlo Park. Nuance was founded as a vehicle to commercialize SRI’s voice interface software. Nuance’s speech recognition technology uses the Hidden Markov Model (HMM), a statistical process model used in speech recognition since the early 1970s, combined with Gaussian-mixture processing, which divides digitized speech into short segments for faster processing. By and large, we do Similarly, the SpeechWorks technology, developed at MIT, relies on segmental systems not believe that either rather than the frame-based HMM to account for the entire phonetic segment, which firm can claim again allows for faster processing and increases accuracy. So, the core technologies are technical superiority. not a significant point of differentiation. Stephens Inc. 10
  • Figure 2 SPEECH RECOGNITION INDUSTRY  Product Comparison Product NUAN SPWX Speech Recognition Engine Nuance 7.0 SpeechWorks 6.5 Text-To-Speech Vocalizer Speechify/Eloquence Authentication Verifier SpeechSecure Browser Voyager Speech Browser VoiceXML Tools VoiceXML Interpreter OpenVXI Developer Tools SpeechObjects DialogModules Statistical Language Models Say Anything How May I Help You Turnkey Auto-Attendant na SpeechSite Source: Company documents and Stephens Inc. Nuance claims that its software handles noisy environments better than SpeechWorks’ as a result of its extensive work with General Motors. SpeechWorks disputes the claim, and we have not found any independent verification. What is indisputable is that Nuance’s speech recognition software supports 25 languages, while SpeechWorks, supports just 18. However, we cannot imagine that support for the additional seven languages is a significant driver of revenue. Likewise, Nuance’s verification software, instant messaging product and its voice browser are points of differentiation but are not significant revenue contributors. System architecture is Perhaps the biggest difference between the two technologies is the system architecture. the biggest difference Nuance uses a distributed client/server architecture, while SpeechWorks favors an “N+1 between the sparing” approach. We find the Nuance approach more impressive, but our due diligence technologies offered leads us to believe that buyers of IVR systems are as likely to favor SpeechWorks’ single by SPWX and NUAN. server “in the skins” approach. Key points regarding each architecture are listed on the next page. Stephens Inc. 11
  • Nuance’s Distributed Architecture O Balances load across multiple servers. O High fault tolerance. O More efficient use of hardware. O More accuracy by leveraging multiple CPUs. SpeechWorks’ N+1 Sparing O Relies on a single server with a backup. O Seamless integration with IVR platforms. Source: Company Documents Although text-to-speech (TTS) is not yet a meaningful contributor to earnings for either We believe that the Company at this time, the product has a bright future, and it is worth noting the TTS software offered differences between the Nuance and SpeechWorks offerings. While Nuance’s offering by both NUAN and has yet to ship, we doubt that its U.S. English version will be technically superior to the SPWX has bright Speechify product SPWX licensed from AT&T. On the other hand, SpeechWorks’ other prospects. TTS offering, Eloquence, supports multiple languages but is based on a less natural sounding formant technology. Nuance may have an edge selling its new product to multinational customers. We summarize the key points regarding TTS below. Nuance’s Vocalizer O Has not shipped. O Cobbled together from multiple vendors, including Lucent and Fonix. O Will support nine languages with state-of-the-art concatenated technology. SpeechWorks’ Speechify/Eloquence O Speechify technology licensed from AT&T. O Speechify may be best on the market—licensed by Microsoft, AOL and Yahoo! O Eloquence product supports 13 languages but uses outdated formant technology, which produces a less life-like voice. Source: Company Documents Net-net, we are not convinced that either Company’s product line is wildly superior to the other, and our feedback from systems integrators indicates that neither is substantively better. Still, based mostly on anecdotal evidence and our own perception, we view Nuance as slightly more forward thinking than its speech recognition software peers. Sales Strategies NUAN and SPWX offer Not only are Nuance’s and SpeechWorks’ technologies similar, but also the customers their products to that use their products are comparable (see Figure 3). It almost appears that customers in similar customers. each key market segment are evenly divided between the two competitors. In 2000, NUAN derived However, there is a very clear difference in the way in which Nuance and SpeechWorks 72% of its revenue market their products. In 2000, 72% of Nuance’s revenue was achieved through through resellers versus resellers, including 22% of sales through Nortel. In contrast, SpeechWorks derived just SPWX's 38%. 38% of its 2000 revenue from resellers, OEMs and ASPs, including 16% from call automation vendor InterVoice-Brite. SpeechWorks has a more significant professional services organization and even resells hardware as part of its end-to-end solutions. Stephens Inc. 12
  • Figure 3 SPEECH RECOGNITION INDUSTRY  Key End-Users Industry NUAN SPWX Financial Services Fidelity Investments Ameritrade Charles Schwab CSFBdirect TD Waterhouse E*TRADE Airlines American Airlines United Airlines British Airways Continental Airlines Telecommunications Sprint PCS BellSouth Telespree WorldCom Portals BeVocal AOLbyPhone Tellme HeyAnita Source: Company reports and Stephens Inc. We believe that the The bottom line, in our opinion, is that Nuance sells products, while SpeechWorks sells bottom line is that solutions. As we mentioned earlier in the report, at this early stage in the market’s Nuance sells growth, it may be necessary to hold the customers’ hands through the design and products, while implementation phases. Thus, SpeechWorks’ direct sales approach appears to be more SpeechWorks sells successful in the current environment, as witnessed by its 8% sequential sales growth in solutions. the 1Q01 compared to Naunce’s 40% sequential decline. In recognition of this, Nuance recently introduced a comprehensive set of design and production services aimed at helping businesses build voice applications. To be clear, though, we do not expect that Nuance will build a large systems integration organization. As this market matures and more qualified integrators emerge, the need for direct customer contact may decrease. Therefore, Nuance’s pure software model may ultimately prove to have positive implications for both sustainable growth and attractive margins. NUAN should In terms of margins, Nuance’s numbers are closer to what we expect from a software firm generally have higher (see Figure 4). In 2000, the Company’s revenue from software licenses was roughly 72% gross margins than of total revenue, and its gross margin was close to 80%. On the other hand, SPWX. SpeechWorks derives just 54% of total revenue from product licenses, and its gross margin in 2000 was closer to 60%. In addition, Nuance’s R&D expense as a percent of revenue was higher than SpeechWorks’, while SpeechWorks’ administration costs were much higher than those of Nuance (though this is somewhat misleading due to expense allocation). Interestingly, sales and marketing expenses for the two competitors were an identical 66% of sales. Figure 4 SPEECH RECOGNITION INDUSTRY  Margin Comparison for 2000 FY2000 NUAN SPWX Gross Margin 79% 63% S&M % of Rev. 66% 66% R&D % of Rev. 39% 29% G&A % of Rev. 19% 58% Note: Comparisons ot G&A expenses are generally a challenge due to different allocation methods. Source: Company reports and Stephens Inc. Stephens Inc. 13
  • Another difference is in revenue recognition. For Nuance, the revenue clock starts at zero each quarter and, thus, there is little visibility. SpeechWorks, on the other hand, often recognizes revenue over the approximate six months that it takes to implement the software or solution. The upshot is that SpeechWorks’ management enjoys 50% visibility into the next quarter’s results, which is obviously a comfort in this uncertain market. Staying Power The fundamental The issue of the moment is how well any given software vendor can hold up in a difficult question is, How well macroeconomic environment and an overall tech spending slowdown. We have little can software vendors doubt that speech recognition systems have a substantial quantifiable ROI, especially in hold up in a difficult customer service and auto-attendant applications. However, there is still a great deal of macroeconomic skepticism from potential customers, and therefore, we are pessimistic about the near- environment? term prospects for both Companies’ products. In 2001, we may be more likely to see limited-scope test projects (e.g., an internal voice directory) to evaluate the potential for speech recognition rather than sweeping business process changes to truly take advantage of the technology. Again, we believe that SpeechWorks’ direct customer interaction will help it outpace Nuance in the short run. In any case, we are Regardless of the specifics, we are not assuming that either firm will grow rapidly in not assuming that 2001. We do, however, foresee a bright long-term future for speech recognition and for either Company will the two Companies. So we will examine the Companies’ staying power, or their ability grow rapidly in 2001. to emerge from what may be a challenging 2001 as strong, if not stronger, businesses— capitalization, customer and geographic diversity, management and employee commitment, and product development. Capitalization First, we must consider the two Companies’ cash positions and their capital requirements over the next year or two, as it may be a challenge to raise additional funds in the current environment. Both companies completed an IPO in 2000 and are well capitalized. We estimate that neither one will require additional capital over the next three years (see Figure 5). Customer and Geographic Diversity Next, we consider the Companies’ customer and geographic diversification. We tend to We tend to place a premium on place a premium on firms with a broadly diversified customer base in terms of geography companies with a and vertical industry groups. Both service roughly the same customer base, and neither broadly diversified appears over-exposed to any customer or group of customers. The top five customers for customer base in each of them make up roughly half of revenue (see Figure 6). However, Nuance is much terms of geography farther along in terms of international expansion, with almost half of its revenue derived and vertical industry from overseas compared to less than 10% at SpeechWorks (see Figure 7). Clearly, this groups. has not necessarily helped in 2001, but its broad geographic reach should serve it well in the future. Stephens Inc. 14
  • Figure 5 SPEECH RECOGNITION INDUSTRY  Capitalization Comparison, 1Q01 ($ in millions) NUAN SPWX Cash and Short-term Inv. $206.07 $98.09 Total Assets 275.49 147.88 Debt 0.00 0.67 Total Liabilities 33.07 10.38 Total Liab. and Equity 275.49 147.88 EBITDA Loss in 1Q ($14.42) ($8.29) Cash in Years 3.6 3.0 Source: Company reports and Stephens Inc. Figure 6 SPEECH RECOGNITION INDUSTRY  Customer Concentration Comparison, 1Q01 NUAN SPWX Top 5 Other Top 5 47% 49% 51% Other 53% Source: Company reports and Stephens Inc. Figure 7 SPEECH RECOGNITION INDUSTRY  Geographic Concentration Comparison, 1Q01 NUAN SPWX International 9% International 47% U.S. 53% U.S. 91% Source: Company reports and Stephens Inc. Stephens Inc. 15
  • Management/Employees Third, we evaluate management’s and employees’ commitment to building a world-class organization. Anecdotally, we can vouch for enthusiasm throughout the Nuance organization after spending three days at its V-World conference and were impressed by Nuance’s shared culture. While we have not had the same broad exposure to SpeechWorks’ employees, our feedback from customers indicates that its people have a strong commitment to service. We generally believe We generally believe that the SpeechWorks/Nuance competition has a positive impact on that the SPWX/NUAN employee morale and generates pride at both organizations. The common pursuit of the competition has a two firms, though, is more usable speech recognition technology and, thus, an improved positive impact on man/machine interface. This quest tends to attract some of the brightest minds in the employee morale at world. both organizations. More substantively, neither one’s management has a particularly impressive level of insider ownership, which might suggest an obvious incentive to build value for the long run (see Figure 8). Clearly, though, the insider stake at SpeechWorks is substantively greater. Figure 8 SPEECH RECOGNITION INDUSTRY  Insider Ownership Comparison NUAN Shares SPWX Shares Total Insider Ownership 1,175,561 or 4% 3,460,016 or 11% Float 30,780,439 27,947,984 Total Shares Outstanding 31,956,000 31,408,000 Source: Company reports and Stephens Inc. Product Development Currently NUAN Finally, we believe it is important to consider the ability of each Company to develop or holds one U.S. patent acquire technology that will keep it at the vanguard of the sector. One clue might come versus SPWX’s five. from their patent portfolios. Nuance holds one U.S. patent and has multiple patents pending. SpeechWorks has 5 U.S. patents and has filed for another 12 in the U.S. and several others overseas. While software patents should not be viewed as protection from competition, they at least provide some legal grounds to defend core technologies. Neither company Neither Company appears to have any defensible intellectual property, and both have appears to have any licensed nonexclusive core technology. That said, improvements in speech recognition defensible intellectual software are made through trial and error. Both NUAN and SPWX are distancing property, and both themselves from potential competitors by learning at the speed of their market share and have licensed constantly improving their products. So a new market entrant could license SRI or MIT nonexclusive core technology, but it would be five years behind the times. technology. Nuance currently employs approximately 120 engineers, and its cash R&D expenses of $5.24 million equaled 48% of revenue in the first quarter. SpeechWorks has over 100 engineers on its payroll, and cash R&D expenses of $3.35 million were roughly 30% of first quarter revenue. Our point here is that both Companies possess experience and R&D commitment that, should translate into a growing portfolio of valuable intellectual property, which we view favorably. Stephens Inc. 16
  • VALUATION Based on a price to revenue analysis, neither the shares of Nuance nor SpeechWorks could be considered inexpensive (see Figure 9). However, their leadership positions in an attractive but nascent market may warrant premium multiples. Figure 9 WIRELESS APPLICATIONS INDUSTRY  Valuation Comparison (dollars in millions except per share amounts) Stephens 6/5/01 Shares Market Revenue P/Revenue Company Ticker Rating Price Out Cap CY00A CY01E 2000 2001 724 Solutions SVNX $8.76 53.6 $469.4 $21.2 $72.3 22.1 6.5 Aether Systems AETH N 11.58 40.5 468.4 58.2 149.3 8.1 3.1 At Road ARDI 1.90 42.9 81.5 10.6 29.9 7.7 2.7 AvantGo AVGO 2.28 31.3 71.5 16.3 34.5 4.4 2.1 Comverse Technology* CMVT 67.52 187.5 12,660.0 1,225.1 1,461.4 10.3 8.7 Extended Systems XTND B 7.77 10.7 83.4 39.1 28.4 2.1 2.9 GoAmerica GOAM 2.40 52.3 125.6 13.9 91.2 9.1 1.4 InfoSpace INSP 3.83 323.1 1,237.6 214.6 214.8 5.8 5.8 Nuance Comm. NUAN O 17.56 32.0 561.1 51.8 42.5 10.8 13.2 Omnisky OMNY 2.30 60.1 138.1 11.1 38.3 12.5 3.6 Openwave Systems OPWV N 42.99 177.8 7,642.5 286.6 551.0 26.7 13.9 Portal Software PRSF 5.31 168.2 893.1 268.3 350.2 3.3 2.6 Pumatech* PUMA O 3.81 44.2 168.5 38.3 43.7 4.4 3.9 SignalSoft SGSF 8.75 23.6 206.5 13.6 32.6 15.1 6.3 SpeechWorks Int'l SPWX O 14.50 31.4 455.3 30.0 49.1 15.2 9.3 TeleComm. Systems TSYS O 4.00 27.4 109.6 66.9 81.2 1.6 1.3 Average 9.9 5.5 * Revenue for the 12-month periods ending in January; all others are calendar year. Note: Companies in bold are Stephens Inc. estimates. Source: IBES and Stephens Inc. Our 12-month price Our 12-month price targets are based on a price to revenue multiple applied to our second targets are based on a 12-month revenue estimate for each firm. Our 12-month target for Nuance is $20.00, or price to revenue 14% above the current price, based on a price to revenue multiple of 8 applied to our multiple applied to second 12-month revenue estimate of just over $80 million. our second 12-month revenue estimate for Our 12-month price target for SpeechWorks is $19.00, or 31% above the current price, each firm. based on a price to revenue multiple of 7 applied to our second 12-month revenue estimate of $83.4 million. We afford Nuance a slightly higher multiple than SpeechWorks based on the slightly higher gross margins that should be possible with its indirect sales model. Stephens Inc. 17
  • Cash Flow We believe that an assessment of a stock’s value should include a discounted cash flow analysis as a means to verify the plausibility of a valuation if not to pinpoint a price Our DCF analyses target. suggest that both NUAN’s and SPWX’s current valuations Our DCF analyses suggest that both Nuance’s and SpeechWorks’ current valuations are may be slightly low. basically fair, given our reasonable assumptions of slowly declining revenue growth beginning in 2005 and peak net margins in 2007 of roughly 20% for Nuance and 17% for SpeechWorks (see Figures 10 and 11). Importantly, we believe that Nuance’s $200 million in cash and SpeechWorks’ $100 million in cash should provide more than adequate capital for growth until both are expected to turn cash flow positive in FY2003. Figure 10 NUANCE COMMUNICATIONS  Discounted Cash Flow Analysis (dollars in millions except per share) 2000A 2001E 2002E 2003E 2004E 2005E 2010E Revenue $51.8 $42.5 $70.0 $107.0 $160.5 $232.7 $557.2 Year-to-Year Change (18%) 65% 53% 50% 45% 8% Net Margin NM NM NM 5% 10% 15% 20% Earnings ($23.5) ($49.0) ($21.5) $5.1 $16.0 $34.9 $111.4 Depreciation & Amortization 2.7 6.0 6.0 6.0 6.0 6.0 6.0 Non-Cash Compensation 4.9 5.3 1.9 1.9 1.9 1.9 1.9 Other (0.3) (2.4) (2.8) (3.4) (3.4) (3.4) (3.4) Cash from Operations ($21.1) ($45.4) ($18.3) $9.6 $20.5 $39.4 $115.9 Net Investments (9.1) (32.0) (6.0) (6.0) (6.0) (6.0) (6.0) Free Cash Flow ($30.2) ($77.4) ($24.3) $3.6 $14.5 $33.4 $109.9 Year-to-Year Change 306% 130% 8% Free Cash Flow Per Share (0.95) (2.42) (0.76) 0.11 0.46 1.05 3.44 Terminal Value $41.64 Shares Outstanding 32.0 2001-2010 Cash Flows Per Share $3 Terminal Value Per Share $10 Total Discounted Value Per Share $13 Excess Cash Per Share $1 Implied Market Price $14 per share Note: Our DCF analysis assumes a 15% discount rate, revenue growth accelerating to 65% in 2002 before declining to 8% in 2010, net margins improving to 20% by 2007 and a terminal value of roughly 12 times earnings. Source: Stephens Inc. and Company reports. Stephens Inc. 18
  • Figure 11 SPEECHWORKS INTERNATIONAL  Discounted Cash Flow Analysis (dollars in millions except per share amounts) 2000A 2001E 2002E 2003E 2004E 2005E 2010E Revenue $30.0 $49.1 $74.6 $112.9 $169.3 $245.5 $588.0 Year-to-Year Change 63% 52% 51% 50% 45% 8% Net Margin NM NM NM 3% 8% 12% 17% Earnings ($29.6) ($39.1) ($22.0) $3.9 $13.5 $29.5 $100.0 Depreciation & Amortization 1.9 10.0 10.0 10.0 10.0 10.0 10.0 Non-Cash Compensation 4.5 7.4 7.4 7.4 7.4 7.4 7.4 Other 4.1 (2.4) (2.7) (3.6) (3.6) (3.6) (3.6) Cash from Operations ($23.6) ($31.5) ($14.8) $17.7 $27.3 $43.3 $113.8 Net Investments (17.6) (11.4) (6.0) (6.0) (7.5) (9.0) (10.0) Free Cash Flow ($41.2) ($42.9) ($20.8) $11.7 $19.8 $34.3 $103.8 Year-to-Year Change 69% 73% 7% Free Cash Flow Per Share (1.31) (1.37) (0.66) 0.37 0.63 1.09 3.30 Terminal Value $40.52 2001-2010 Cash Flows Per Share $4 Terminal Value Per Share $10 Total Discounted Value Per Share $14 Excess Cash Per Share $0 Implied Market Price $14 per share Note: Our DCF analysis assumes a 15% discount rate, revenue growth slowly declining to 5% in 2010, net margins improving to 17% by 2007 and a terminal value of roughly 12 times earnings. Source: Stephens Inc. and Company reports Catalysts For better or worse, the futures of Nuance and SpeechWorks are dependent on the same sector trends. While we recognize the distinct capabilities of each Company, we tend to believe that their stocks will be driven by similar catalysts and will face comparable risks. New Customers: To a certain extent, both Nuance and SpeechWorks are “show me” stocks in the sense that the shares may not appreciate significantly until the Companies prove that a viable market exists by adding new high-profile customers. Product Developments: Both Companies continue to bring new products to the market, which should eventually translate into revenue. Acquisition Announcements: Somewhat related to the preceding point, we expect that Nuance and SpeechWorks may make small acquisitions to add to their product and service portfolios. New Alliances and Partnerships: Although this is quickly changing, there is a lack of qualified integrators and developers in the speech recognition sector. We look for SpeechWorks and especially Nuance to benefit from the addition of high-quality resellers and integration partners. Resellers would generally include hardware vendors such as InterVoice-Brite, which is a key SpeechWorks partner and a developing Nuance relationship. Systems integrators would include specialists such as Gold Systems as well as the bigger name consultants such as Accenture. Stephens Inc. 19
  • Risks Competition: As we mentioned earlier in the report, we believe that IBM could pose a real threat, as it has both quality technology which could be and strong relationships with enterprise customers. Commoditization: There is at least a modest threat of commoditization of the core speech recognition technology. Both Companies licensed technology from third parties at their inception, and though their products have evolved, the core source code could conceivably be utilized by any potential competitor. Service Failures: The biggest barrier to growing the market is getting potential customers comfortable with the technology. Any integration or deployment problems could generate long-term ill will to the detriment of future revenues. It is interesting to note that most failures are more a function of faulty user interface design rather than a failure of the core recognition software. Growing Pains: Both Companies could potentially face a period of hyper-growth over the next couple of years. While we believe that both management teams are solid, it may be a challenge to grow the businesses at the pace of the market’s growth. CONCLUSION We recommend both Again, we recommend both Nuance and SpeechWorks with OUTPERFORM ratings NUAN and SPWX based on our optimistic outlook for the speech recognition software market. We view with OUTPERFORM both as leaders in an important but nascent market. While we do not expect spectacular ratings. results in 2001, we believe that customers are continuing to evaluate the technology and will likely begin to deploy speech recognition solutions more aggressively in 2002. In the short run, we favor SpeechWorks, because it has greater revenue visibility and emphasizes comprehensive solutions and customer service. Longer term, we tend to favor Nuance’s indirect sales strategy and forward-thinking technology mindset. Still, we believe that both Companies will benefit from positive market dynamics and that both will prove to be wise investments for those who can tolerate the risk. Our 12-month price Our 12-month price target for Nuance is $20.00, or 14% below its current price, and our targets for NUAN and target price for SpeechWorks is $19.00, or 31% above its current price. SPWX are $20 and $19, respectively. We will become even more bullish when we see one or more of the following: • An increase in overall corporate technology spending. • Increased demand for speech recognition in various vertical industry solutions. • Signs that Nuance and SpeechWorks will remain leaders in the industry, evidenced by continued Fortune 500 customer wins. Stephens Inc. 20
  • NUANCE COMPANY DESCRIPTION NUAN is a provider Nuance, based in Menlo Park, California, is a provider of software and services that of software and enable the content and services of the Internet and telephone networks to be accessible services that enable from any telephone. The Company’s software platform consists of software servers that the content and perform speech recognition, natural language understanding, text-to-speech (TTS) services of the synthesis and voice authentication. Nuance also provides professional services to Internet and facilitate the development, implementation and support of applications operating on its telephone networks to software platform. be accessible from any telephone. Nuance software products are based on research originally conducted by SRI International. Upon its inception, Nuance received a license from SRI International to a number of patents and other proprietary rights, including a right to software relating to voice interface technologies. Since then, the Company has invested significantly in developing and improving this core technology. The license was exclusive until December 1999; subsequent to that the Company allowed the exclusivity to lapse. Nuance’s software offerings include Nuance 7.0, the Company’s core voice recognition software; Speechify, a speech synthesis software; Nuance Vocalizer, a text-to-speech (TTS) engine; Application Development Tools; Nuance Verifier, a speaker verification software; and Nuance Voyager, a voice browser. The Company licenses its products to software and service providers as well as enterprises. In the first quarter 2001, about half of it’s revenue was derived from services, though this was unusually low due to a sharp decline in software license revenue (see Figure 12). In May 2001, Nuance In May 2001, Nuance introduced a new speech recognition technology “Say Anything.” introduced a new Say Anything allows people to say whatever they want to speech systems to conduct speech recognition transactions or obtain information. Until now, developers have built applications by technology “Say predefining lists of what callers can say. Say Anything combines this capability with Anything.” statistical models that recognize free-style speech and extract key concepts to determine the meaning of user input. Say Anything is not yet generating revenue. Figure 12 NUANCE COMMUNICATIONS  Revenue Composition, 1Q01— ended 3/31/01 (In millions) Total Revenue = $11.01 Licenses Services $5.3 49% $5.7 51% Source: Company reports and Stephens Inc. Stephens Inc. 21
  • Nuance’s core Nuance’s core technology consists of speech recognition, natural language technology consists of understanding, TTS synthesis and voice authentication. The Company uses the Hidden speech recognition, Markov model for voice recognition. Under this approach, digitized speech is divided natural language into numerous short segments and statistical processes are used to analyze and interpret understanding, text- these segments. to-speech (TTS) synthesis and voice Natural language understanding is the ability of the software to extract relevant parts of authentication. the speech using rules established by the developer of the voice interface. The text-to- speech engine synthesizes text into speech, providing a natural sounding voice interface. Last but not least, voice authentication software provides security for applications using biometric speaker verification. Nuance sells its software and services across a variety of industries and market segments in the United States and internationally. Among the list of notable customers are American Airlines, Banco Bradesco, Charles Schwab, Fidelity Investments, OnStar, Sears, Siebel Systems and SprintPCS (see Figure 13). For instance, OnStar has integrated NUAN ‘s software into its virtual advisor platform that will deliver in-vehicle, hands-free access to a collection of Internet-based content. Cisco also announced a multi-year agreement with Nuance that will allow it to incorporate the Company’s speech recognition and voice authentication software into its Architecture for Voice, Video and Integrated Data (AVVID) products. More recently, Japan’s largest carrier, Japan Telecom, has licensed NUAN’s software to power its voice portal. Figure 13 NUANCE COMMUNICATIONS  Selected Customers Communications Travel Bell Atlantic (now Verizon) American Airlines British Telecommunications plc Delta Airlines CTBC Telecom (Brazil) Other Deutsche Telekom (Germany) Avon Sprint PCS Commonwealth of Virginia Southwestern Bell CTC Create (Japan) Telenor (Norway) Dreyfus Corporation Telia (Australia) Entergy Corporation Z-Tel Technologies Home Shopping Network Technology/Manufacturing National Car Rental Systems, Inc. Dell Japan Odeon Cinemas (United Kingdom) Ford Motor Company OnStar General Electric Co. Sears, Roebuck and Co. Sony Japan Siebel Systems Finance/Brokerage/Banking United Parcel Service American Century Voice Portals/Enhanced Service Providers American Express Financial Advisors BeVocal Banco Itau (Brazil) General Magic Banco Mercantil (Venezuela) GoSolo Technologies Charles Schwab & Co. GTG Technologies Fidelity Investments ShopTalk Merrill Lynch Tellme Networks Dot.coms Webversant Cheap Tickets Fingerhut Source: Company reports and Stephens Inc. Stephens Inc. 22
  • Software Products Nuance’s primary software products are Nuance 7.0, Nuance Vocalizer, Nuance Voyager, Nuance Web Server, SpeechObjects and the Nuance Developer’s Toolkit. Nuance 7.0 Nuance 7.0 is the Nuance 7.0 is the Company’s flagship software that provides speech recognition and Company’s flagship natural language understanding capabilities. The software has a unique distributed software that provides architecture that supports concurrent load balancing of speech recognition, natural speech recognition language understanding, voice authentication and text-to-speech synthesis. The and natural language architecture utilizes three primary components: the Recognition Server, Recognition understanding Client and Resource Manager (see Figure 14). capabilities. Figure 14 NUANCE COMMUNICATIONS  Nuance 7.0 Speech-Enabled Application Nuance Clients Resource Manager Nuance Nuance Nuance Nuance Server Server Server Server Source: Company documents and Stephens Inc. The Recognition Server performs speech recognition and verification. The Resource Manager balances the load across all the recognition servers. The Recognition Client interacts with the speech-enabled application. The unique architecture enables the separation of light client processing from volume CPU-intensive server processing. For a small system or a prototype, both the client and server can run on the same machine. The speech recognition and natural language understanding technology of the software is available for 25 languages and dialects. Stephens Inc. 23
  • Speech Recognition Software Customer Case Study (UPS) UPS, the world's largest package distribution company, needed a solution to enable its customers to schedule pickups and track packages using voice-only input. Touch-tone phones couldn't handle the 11- to 18-digit tracking numbers, and using customer service agents was too expensive. UPS utilized Nuance’s speech recognition software to develop an automatic speech recognition (ASR) application. Now, UPS customers can schedule pickups and track packages using voice. Source: Company reports and Stephens Inc. Nuance Verifier Nuance Verifier is a Nuance Verifier is a verification software that authenticates the identity of callers based verification software on their unique voiceprint. The software captures and stores the caller’s voiceprint that authenticates the during a short one-time enrollment process. Subsequently, callers who wish to enter the identity of callers system just speak, and their voice is compared by the software against their previously based on their unique enrolled voiceprint. If there is a match, the caller is accepted into the system. voiceprint. Speech Verification Customer Case Study (The Home Shopping Network) Operators at the Home Shopping Network (HSN) were handling roughly 48,000 calls per day from customers who had forgotten their HSN ID number. The company needed a solution that would automate the process to reduce costs. HSN utilized Nuance’s verification software to develop an ASR application. Today, customers calling HSN simply speak their phone numbers and are securely identified. The software provides a 95% automated rate in identifying and authenticating callers, so only 5% of callers are forwarded to an operator for assistance. Source: Company reports and Stephens Inc. Nuance Vocalizer Nuance Vocalizer is a Nuance Vocalizer is a text-to-speech software engine that converts text-based information text-to-speech into an audio format for access over the telephone. The software retrieves the waveforms software engine that from a database of prerecorded human speech. The output sounds natural because the converts text-based resulting speech is actually made up of concatenated units of human recordings. TTS information into an should prove to be especially important in unified messaging, as it will allow e-mails to audio format for be “read” over the phone. access over the telephone. Pricing is based on the number of TTS ports licensed. The list price per port is $600, but volume discounts are available. The software is currently available in developer’s release only, with general availability expected in first half of 2001. Stephens Inc. 24
  • Nuance Voyager Nuance Voyager is a Nuance Voyager is a voice browser that allows users to access traditional telephony voice browser that applications, voice portals and voice-enabled Internet content via telephone. The browser allows users to access runs on the Nuance Voice Web Server and is built on the Company’s core speech traditional telephony recognition and voice authentication software. These integrated technologies allow callers applications, voice to access secure content and conduct commerce over the telephone using sophisticated portals and voice- voiceprint capabilities. enabled Internet content via telephone. Nuance Voice Web Server Nuance Voice Web Nuance Voice Web Server facilitates the creation and modification of voice sites for Server facilitates the enterprises. The Server is comprised of the Nuance 7.0 Recognition Server and the creation and Nuance VoiceXML Interpreter. VoiceXML Interpreter is a software that processes modification of voice content developed in the Voice XML language. The combination of a recognition sites for enterprises. software and VoiceXML Interpreter allows enterprises to develop applications such as voice-activated dialing, telephone access to corporate intranets, and full-service voice portals that provide news, weather and stock quotes. SpeechObjects SpeechObjects are SpeechObjects are software components that developers utilize to create the voice user software components interface of an ASR application. These components have published application- that developers utilize programming interfaces that define the voice interface for specific tasks, such as request a to create the voice spoken account number, postal code or country name. For instance, a speech object that user interface of an understands a spoken date can be used for a banking transaction application. The ASR application. Company provides a royalty-free license to the source code for a set of SpeechObjects that captures commonly used information such as dates, times and dollar amounts. Nuance Developer’s Toolkit The Developer’s Nuance Developer’s Toolkit assists in the development, prototyping, deployment and Toolkit assists in the optimization of voice user interfaces for ASR applications. development, prototyping, The toolkit includes 25 foundation SpeechObject software components, V-Optimizer, a deployment and tool for analyzing and tuning deployed applications, and V-Builder, a tool that allows optimization of voice developers to build applications using both VoiceXML and SpeechObject software user interfaces for components. Voice interfaces developed using the toolkit can be integrated with ASR applications. telephony applications written in C/C++ or Java. Professional Services In the most recent reported quarter (1Q01), roughly half of Nuance’s revenue came from professional services whereas in the prior quarter accounted for approximately 28% of total revenue. The higher-than-normal percentage of total revenue was a result of lower- than-expected software sales. Nuance provides technical maintenance, development and support of its software products to its customers. In addition, the Company also offers prototype development, user interface design, grammar development, system testing, performance optimization and end-user acceptance studies. Developer education services are also offered. Stephens Inc. 25
  • Management Ronald Croen, President, Chief Executive Officer and Co-Founder. Mr. Croen has served as President since July 1994 and as CEO since October 1995. Prior to Nuance, he worked as a consultant to SRI International. From 1987 to 1989, he was with The Ultimate Corp. where he was Managing Director of European operations. Mr. Croen holds a J.D. from the University of Pennsylvania Law School and a B.A. from Tufts University. Dr. Michael Cohen, Vice President of Dialog Research & Development and Co- Founder. Dr. Cohen is one of the three technical founders of the Company. Prior to co- founding Nuance, he spent ten years at SRI’s Speech Technology and Research Lab. Dr. Cohen received his Ph.D. from the University of California at Berkeley. Lee-Tyler Mun, Vice President and Chief Technology Officer. Mr. Mun joined Nuance as CTO in March 2001. Prior to that, he was CIO of Realnames Corporation. Previously, Mr. Mun has also held senior IT positions at Citigroup, Inc., Oracle Corporation, Tandem Computers and Atmel Corporation. He holds a B.S. in decision and information science from Santa Clara University. Paul Scott, Senior Vice President of Worldwide Sales. Mr. Scott has served in his present capacity since February 2000. Prior to that, he was Senior Vice President Sales at Lucent Technologies. Mr. Scott holds a B.S. in Arts and Masters of Arts degree from Nothwestern University. Graham Smith, Vice President and Chief Financial Officer. Mr. Smith has been CFO since 1998. Prior to that, he was Vice President of Finance, Worldwide Operations at Oracle. Mr. Smith holds a B.Sc. from Bristol University and is a member of the Institute of Chartered Accountants in England and Wales. SPEECHWORKS COMPANY DESCRIPTION SPWX is a provider of SpeechWorks International, based in Boston, Massachusetts, is a provider of software software and services and services that enable customers to offer over-the-telephone automated speech that enable customers recognition (ASR) solutions. The Company’s portfolio of products includes software for to offer over-the- speech recognition, synthesis and verification. SpeechWorks also provides professional telephone ASR services to complement the sale, installation and operation of its products. systems. SpeechWorks was co-founded in 1994 by Michael Phillips and William O’Farrell. Its software products incorporate patented technologies and are based on research originally conducted at the Massachusetts Institute of Technology (MIT) by Mr. Phillips and others. The Company pays royalties to MIT equal to a percentage of its product license revenue. In 2000, the percentage was 1.3%. SpeechWorks’ software offerings include SpeechWorks 6.5, its flagship platform for voice recognition solutions development; SpeechSite, a packaged application solution; Speechify, a speech synthesis software; ETI-Eloquence, a TTS speech engine; and SpeechSecure, a speaker verification software. The Company licenses its products to software and service providers as well as enterprises. Currently about 55% of it’s revenue is derived from software licensing and the remainder from services (see Figure 15). Stephens Inc. 26
  • SpeechWorks’ core SpeechWorks’ core technology consists of speech recognition and text-to-speech (TTS) technology consists of synthesis. The speech recognition system is based on work on segmental systems speech recognition performed at MIT. The segmental approach takes into account the entire phonetic and text-to-speech segment, thereby reducing the overall amount of computation needed for a given (TTS) synthesis. recognition task. Barge-in technology is a key feature of the speech recognition system that allows callers to interrupt the outgoing prompts by speaking over them. In January 2001, the Company acquired Eloquent Technology, a developer of TTS synthesis software. The acquisition helped add 12 new languages to its TTS product offerings. SpeechWorks’ TTS products now support 13 languages. In June 2000, SpeechWorks launched Open Speech Web, an initiative that attempts to connect a variety of speech services, including portals, enterprise SpeechSites and directory services. The Open Speech Web, based on VoiceXML, allows callers to freely navigate among speech-enabled services. To support the initiative, the Company offers a VoiceXML speech browser and SpeechLinks software. The software is available as open source code. SpeechWorks offers The Company offers its products to a broad range of market segments (see Figure 16). its products to a Continental Airlines, E*TRADE, FedEx and McKesson HBOC are some of the major broad range of customers. In a more recent development, Microsoft announced an agreement with market segments. SpeechWorks to license its Speechify TTS engine. According to the agreement, the engine will also support the latest version of Microsoft’s speech application programming interface (SAPI 5.0). The TTS engine will likely initially be deployed in MSN for unified messaging but could have broader uses. We are cautiously optimistic that Microsoft could eventually become a meaningful customer. Figure 15 SPEECHWORKS INTERNATIONAL  Revenue Composition, 1Q01 ended 3/31/01 (In millions) $0.9 * 9% Total Revenue = $11.1 Product Licenses Professional Services Other Revenues $4.0 $6.09 37% 55% * Includes the effect of non-cash stock-based compensation Source: Company reports and Stephens Inc. Recently, SpeechWorks has also signed agreements with Union Pacific Railroad and Z- Tel Technologies. Union Pacific will speech-enable the operational process of releasing its empty railcars for its 30,000 freight customers, such as General Motors, while, Z-Tel has licensed the Speechify TTS engine. Stephens Inc. 27
  • Figure 16 SPEECHWORKS INTERNATIONAL  Selected Customers Communications Dot.coms BellSouth IntelliVentures Anyday.com CellularOne foodline.com E-Plus MapQuest.com WorldCom Synapse.com NEXTLINK Interactive (now XO Comm.) Xypoint Corporation SingTel Mobile Travel Technology/Manufacturing AirTran Airways Apple Computer Amtrak Aspect Communications Continental Airlines CIBC United Airlines CTL, Inc. Other Dialogic Corporation, an Intel company McKessonHBOC InterVoice-Brite Office Depot Maxxar Corporation Stop & Shop, an Ahold/USA Company Nortel Networks The Guardian Life Insurance Co. of America Finance/Brokerage/Banking Speech Portals/Enhanced Service Providers Bidwell and Company !hey Software CIBC Audiopoint, Inc. Citigroup everypath.com CSFB Direct HeyAnita.com E*TRADE NetByTel.com First Union National Bank PriceInteractive (now iBasis) Hyundai Securities Quack.com (acquired by AOL) Singapore Stock Exchange IT Solutions StockTrade TD Waterhouse Source: Company reports & Stephens Inc. SPWX’s Relationships with AT&T, AOL and Net2Phone SPWX’s contract with In June 2000, SpeechWorks signed a five-year contract to license, develop and sell AT&T allows the products based on AT&T’s technology. The technology primarily consists of AT&T’s Company to license, speech and text-to-speech software. The license is royalty free and nonexclusive, but the develop and sell Company has issued AT&T a little more than million shares of its common stock products based on outstanding in return for these licenses. AT&T has also agreed to assist SPWX in AT&T’s technology. marketing its products to AT&T’s business units and customers and may use these products for internal research and development. If the agreement is terminated, SPWX will retain the technology license that it received from AT&T. Stephens Inc. 28
  • SPWX’s contract with Also in June 2000, SpeechWorks signed a strategic agreement with AOL. Under the AOL covers areas agreement, SPWX has licensed its software to AOL and supports the development of such as software voice portals to AOL’s online services. In addition, AOL serves as a distribution channel licensing, marketing by licensing SpeechWorks’ software to third parties with content provided by AOL. We and development of believe that this agreement will help SPWX to gain some brand recognition, as AOL has voice portals for also agreed to place SPWX’s logo on select AOL Web pages. AOL’s online services. In connection with the agreement, AOL purchased over 400,000 shares of SPWX common stock in a private placement at a purchase price of $12.46. The Company also issued a warrant to AOL to purchase more than 765,000 shares of its common stock at an exercise price per share of $12.46. During the same time period, SPWX entered into a relationship with Net2Phone under which the Company has granted a software license to Net2Phone. SPWX also provides professional services to Net2Phone and pursue joint promotional and marketing efforts. Under the agreement, Net2Phone has acquired 321,000 shares of common stock in a private placement at a purchase price per share equal to $12.46. We believe these three relationships are important to SpeechWorks as they represent large potential customers and allow the Company to offer new products and differentiate itself from rivals. Software Products SPWX offers software products to enterprises and communications carriers that enable them to provide automated, speech-activated services (see Figure 17). Figure 17 SPEECHWORKS INTERNATIONAL  Examples of Speech-Activated Services Enabled By SpeechWorks International Customer Services Network Services Provided by a Function Provided by an Enterprise Communications Carrier Information Retrieval Price quotes Weather conditions Order/account status/update Traffic updates Product information Horoscopes Directions News and sports reports Communications Automated attendant/operator Speech-activated dialing Management Internal call routing Network call routing Voice/unified messaging Voice portals Transaction Processing Flight booking Call completion Restaurant reservations Cellular bill payment Product purchase or sale Hosted services Source: Company reports. SPWX’s software offerings consists of five separate speech recognition, synthesis and verification products for over-the-telephone applications. Stephens Inc. 29
  • SpeechWorks 6.5 SpeechWorks 6.5 is SpeechWorks 6.5 is the current release of the Company’s software platform for the current release of developing and deploying customized speech applications in a variety of languages. The the Company’s platform consists of a core recognition engine, building blocks, development and tuning software platform for tools. From an architectural standpoint, the software fits between the telephony platform developing and and the speech application (see Figure 18). deploying customized speech applications. Figure 18 SPEECHWORKS INTERNATIONAL  SpeechWorks Platform Source: Company documents The SMARTRecognizer engine is the foundation of the SpeechWorks 6.5 platform. It provides the technology for speech understanding capabilities over the telephone and can recognize more than 65,000 different words or phrases at each point in a call flow. Development and Tuning tools allow the developers to fine-tune and monitor the applications on an ongoing basis. DialogModules are patented, prepackaged software building blocks that enable developers to build speech applications. Each module performs a specific task within an application, such as capturing a Yes/no response or a telephone number from a caller to more complex tasks such as selecting an item from a large vocabulary list. SpeechWorks 6.5 is the Company’s most comprehensive product offering and is typically utilized in large custom speech application development projects. The platform is designed to be flexible, which is why it is not targeted towards a specific market segment. The Pricing of SpeechWorks 6.5 depends on number of employees and number of ports sufficient to handle the call volume. (Ports are telephone channels enabled to simultaneously play the output). Price per port varies from $1500 per port to $700, depending on the volume. Stephens Inc. 30
  • SpeechWorks platform Customer Case Study (United Airlines) United Airlines needed a solution to reduce the 1.5 million employee calls made by its own employees to its reservations representatives each year. By utilizing the SpeechWorks platform, United developed a prototype, integrated it with its existing middleware, performed several rounds of usability testing, refined the user interface and deployed the final version. Now its employees book their own flights instead of waiting to be connected to reservations representatives. Source: Company reports and Stephens Inc. SpeechSite SpeechSite is a Built on the SpeechWorks 6.5 platform, SpeechSite is a packaged application solution packaged application that delivers information services to callers through voice interface. The idea behind solution that delivers SpeechSite is that is extending the Web model to the telephone. information services to callers through The Company offers SpeechSite as a complete, turnkey solution utilizing content voice interface. supplied by the customer. The solution comes with the required hardware, software and professional services. The hardware platform currently consists of a Dell PC, running Windows NT, utilizing Intel’s Dialogic cards. The software consists of an engine that is responsible for executing the speech interface and connecting with the telephony system, and an administration component responsible for configurations and monitoring interfaces. The pricing of SpeechSite depends on the number of employees in an enterprise and the number of ports sufficient to handle the call volume. Entry level pricing starts at $40,000. SpeechSite Customer Case Study (McKesson HBOC) More than two-thirds of calls made to McKesson’s customer service were about routine questions and order placement. McKesson, a large pharmaceutical supply management and healthcare information technology company, needed a cost-effective solution to improve its information and transaction services. The company utilized SpeechWorks’ SpeechSite software to develop a custom information delivery application. The software application handles routine calls and allows customer service agents to focus on more complex issues. Source: Company documents and Stephens Inc. Speechify Speechify is a speech synthesis software Speechify is a speech synthesis software that converts text input from any source in real that converts text time into a spoken audio format, using sophisticated concatenation algorithms and actual input from any source human voice recordings (see Figure 19). The software was developed utilizing speech in real time into a technology licensed from AT&T. spoken audio format. Stephens Inc. 31
  • Figure 19 SPEECHWORKS INTERNATIONAL  SpeechWorks 6.5 Platform Source: Company documents The software comprises of a TTS engine and a voice database. The engine assimilates with the speech application and converts text inputs into a spoken voice over the telephony platform. Speechify has been Since its launch in December 2000, Speechify has been integrated into popular consumer integrated into phone services such as AOL by Phone and Yahoo! by Phone, both of which allow popular consumer subscribers to listen to incoming e-mail over any telephone. The software is sold to a phone services such broad range of customers that wish to extend their Web sites and databases to telephone as AOL by Phone and users. Customers include Microsoft, Z-Tel, Webversa, NetByTel, and Net2Phone. Yahoo! by Phone. Pricing is based on the number of TTS ports to be licensed. The list price per port is $650, but volume discounts are available. ETI-Eloquence ETI-Eloquence is a ETI-Eloquence is a TTS speech engine that uses parametric synthesis technology to turn TTS speech engine text-based content into spoken audio. The Company obtained the software through its that uses parametric acquisition of Eloquent Technology in January 2001. ETI-Eloquence has a small synthesis technology footprint that makes it practical for embedded devices such as in-car navigation systems, to turn text-based mobile phones and PDAs. The software is currently available in 13 languages. Price per content into spoken port varies from $600 to $700 per port. audio. SpeechSecure SpeechSecure is a SpeechSecure is a speaker verification software that uses biometric technology to speaker verification authenticate callers by their unique voiceprint. The software is based on technology software. licensed from both T-NETIX and Veritel. SpeechWorks currently offers the software as a DialogueModule (software building blocks) that customers can include in their voice applications. Stephens Inc. 32
  • Professional Services Approximately 37% of SpeechWorks’ revenue is derived from professional services. In addition to standard maintenance and support, it offers business consulting, project management, and application development. The Company also offers training in VoiceXML development through its Rapid Prototyping Center and SpeechWorks Institute. The prototyping center also allows potential customers to cost-effectively evaluate the capabilities of speech-activated applications. We should also mention that SpeechWorks’ highly regarded professional services business posts very respectable gross margins in the 30%-plus range. Management Stuart R. Patterson, Chief Executive Officer. Mr. Patterson joined the Company as President in September 1997 and became the CEO in May 1998. Prior to SpeechWorks, he served on the Board of BBG New Media, Inc. and held various management positions at Hewlett-Packard and Vicorp. Mr. Patterson went to college at Harvard University and attended graduate school at Yale. Richard J. Westelman, Chief Financial Officer. Mr. Westelman has served as the Company’s CFO since August 1998. Prior to that, he served as CFO at Dove Associates from June 1996 to August 1998. Mr. Westelman also spent four years at Pepsi where he was involved in acquisitions and business planning. He went to college at Harvard University and attended graduate school at Yale. Michael S. Phillips, Chief Technology Officer and Co-Founder. Mr. Phillips co- founded the Company in 1994. Before that, he was a Research Scientist in the Spoken Language Systems Group at the Massachusetts Institute of Technology. Mr. Phillips holds a B.S. in electrical engineering from Carnegie-Mellon University. Mark A. Holthouse, Senior Vice President Operations. Mr. Holthouse has held his position since joining the Company in March 1998. Previously, he co-founded Vicorp and served as its Managing Director from April 1987 to March 1996. Mr. Holthouse holds a B.S.E.E. from MIT and an MBA from Boston University. Joseph Murphy, Vice President Sales. Mr. Murphy has been as Vice President of Sales since August 1999. Prior to that, he held the same position at Rubric Inc., a Web-based marketing vendor. From August 1996 to June 1998, he was Director of Sales at Genesys Telecommunications. Mr. Murphy holds a B.A. in marketing from Boston College. Stephens Inc. 33
  • Public companies mentioned in this report: 724 Solutions Inc. (SVNX–$9.08) Aether Systems, Inc. (AETH–$12.03, NEUTRAL) Air Tran Holdings, Inc. (AAI–$10.59) AOL Time Warner Inc. (AOL–$51.00), a parent of MapQuest.com, Inc.; acquired Quack.com American Express Financial Advisors (AXP–$42.12) Ameritrade Holding Corporation (AMTD–$8.48) AMR Corporation (AMR–$38.29), parent of American Airlines ANC Rental Corporation (ANCX-$5.27), parent of National Rental Car System Apple Computer, Inc. (AAPL–$21.47) Aspect Communications Corporation (ASPT–$6.31) @t Road Inc. (ARDI–$2.05) AT & T Corp. (T–$21.17) AT&T Wireless Group (AWE–$17.30) AvantGo Inc. (AVGO–$3.10) Avaya Inc. (AV–$16.89) Avon Products, Inc. (AVP–$44.07) Banco Bradesco S.A. (BBQCY–$5.18) BellSouth Corporation (BLS–$40.80) British Airways plc (BAB–$54.94) British Telecommunications plc (BTY–$63.74) Canadian Imperial Bank of Commerce (CIBC) (BCM–$32.70) Certicom Corp. (CERT–$9.52) Cheap Tickets (CTIX–$12.35) Cisco Systems, Inc. (CSCO–$20.46) Citigroup Inc. (C–$51.60) Comverse Technology, Inc. (CMVT–$58.60) Continental Airlines, Inc. (CAL–$49.50) CSFBdirect Inc. (DIR–$5.02), formerly DLJ Direct Dell Computer Corp. (DELL–$24.61) Delta Airlines, Inc. (DAL–$47.02) Deutsche TeleKom AG, (DT–$21.12) E*TRADE Group, Inc. (ET–$7.86) Entergy Corporation (ETR–$43.50) ePlus Inc. (PLUS–$9.38) Extended Systems Incorporated (XTND–$8.40, NEUTRAL) Federated Department Stores Inc. (FD–$44.88), parent of Fingerhut Co. Inc. FedEx Corporation (FDX–$39.64) Fonix Corporation (FONX–$0.41) Ford Motor Company (F–$24.99) General Electric Company (GE–$49.67) General Magic, Inc. (GMGC–$1.18) Stephens Inc. 34
  • General Motors Corporation (GM–$57.33), owns OnStar GoAmerica, Inc. (GOAM–$2.85) iBasis Speech Solutions (IBAS–$3.90), formerly PriceInteractive International Business Machines Corporation (IBM–$115.27) InfoSpace, Inc. (INSP–$4.25) Intel Corp. (INTC–$28.74) InterVoice-Brite, Inc. (INTV–$10.58) Lernout & Hauspie Speech Products N.V. (LHSPQ–$6.25) Lucent Technologies Inc. (LU–$8.32) McKesson HBOC, Inc. (MCK–$34.03) (MEL–$45.70, BUY) a parent of Dreyfus Corporation Merrill Lynch & Co., Inc. (MER–$65.60) Microsoft Corporation (MSFT–$70.34) $14.70) Net2Phone, Inc. (NTOP–$9.35) Nortel Networks Corporation (NT–$13.33) Nuance Communications, Inc. (NUAN–$14.96, OUTPERFORM) Office Depot, Inc. (ODP–$9.70) OmniSky Corporation (OMNY–$2.30) Openwave Systems Inc. (OPWV–$41.73, NEUTRAL) Philips Electronics N.V. (PHG–$27.70) Portal Software, Inc. (PRSF–$5.31) Pumatech, Inc. (PUMA–$3.95, OUTPERFORM) Royal Ahold N.V. (AHO–$30.42), parent of The Stop & Shop Companies SBC Communications Inc. (SBC–$43.18), parent of Southwestern Bell, (see Cellular One) Sears, Roebuck & Company (S–$40.68) Siebel Systems, Inc. (SEBL–$45.36) SignalSoft Corporation (SGSF–$7.99) Singapore Telecommunications (SGTJY–$10.35), (also known as SingTel) Sony Corporation (SNE–$79.19) SpeechWorks International, Inc. (SPWX–$13.94, OUTPERFORM) Sprint PCS Group (PCS–$22.45) Sun Microsystems, Inc. (SUNW–$16.63) TD Waterhouse Group, Inc. (TWE–$11.92) T-NETIX, Inc. (TNTX-$2.68) TeleCommunications Systems, Inc. (TSYS–$3.99, OUTPERFORM) The Charles Schwab Corporation (SCH–$19.76) The Nomura Securities Co., Ltd. (NRSCY–$215.00) UAL Corporation (UAL–$37.23), parent co. of United Airlines Union Pacific Corporation (UNP–$57.70) United Parcel Service (UPS–$58.80) USA Networks, Inc. (USAI–$25.19), parent of The Home Shopping Network ns Inc. (VZ–$54.85), formerly Bell Atlantic and GTE Western Wireless Corporation (WWCA–$42.96), a sub. of Cellular One Group Stephens Inc. 35
  • WorldCom, Inc. (WCOM–$18.25) XO Communications Inc. (XOXO–$2.91), formerly NEXTLINK Communications Yahoo! Inc. (YHOO–$18.79) Z-Tel Technologies, Inc. (ZTEL–$2.07, OUTPERFORM) Private and Foreign Companies mentioned in this report: !hey Software Accenture (formerly Andersen Consulting) American Century Anyday.com Audiopoint Inc. Banco Itau (Brazil) Banco Mercantil (Venezula) BeVocal, Inc. Bidwell and Company Cellular One Group, partnership composed of subsides of Western Corp. and SBC Wireless CTBC Telecom (Brazil) CTC Create (Japan) Eloquent Technology (acquired by SpeechWorks) everypath.com First Union National Bank FMR Corp. (also known as Fidelity Investments) foodline.com Gold Systems Inc. GoSolo Technologies GTG Technologies Inc. HeyAnita Inc. Hyundai Securities Japan Telecom Co. Ltd. (Tokyo Exchange) Locus Maxxar Corporation NetByTel Odeon Cinemas (United Kingdom) OnStar ShopTalk SingTel Mobile SRI International (non-profit) Stock Trade Synapse Communications Telenor (Norway) Tellme Networks The Guardian Life Insurance Company of America Veritel Technologies Inc. Stephens Inc. 36
  • Webservant Webversa, Inc. Xypoint Corporation Stephens Inc. maintains a market in the common stock of Aether Systems, Extended Systems, Nuance Communications, Openwave Systems, Pumatech, SpeechWorks International, TeleCommunications Systems and Z-Tel Technologies and may act as principal in these transactions. Stephens Inc. has managed or co- managed an underwriting for Z-Tel Technologies within the past three years. LTM = last 12 months; NTM = next 12 months; STM = second 12 months BUY—one-year price appreciation expected to be greater than 20%; MARKET OUTPERFORMER—one- year price appreciation expected to be between 10% and 20%; NEUTRAL—one-year price appreciation expected to be less than 10%; SELL—whenever warranted. Stephens Inc. 37
  • Figure 20 NUANCE COMMUNICATIONS  Earnings Model, FY2000A-FY2002E (dollars and shares in millions, except per share amounts) 06/04/01 1QA 2QA 3QA 4QA 2000A 1QA 2QE 3QE 4QE 2001E 1QE 2QE 3QE 4QE 2002E REVENUE Licenses $6.0 $8.7 $10.5 $12.4 $37.6 $5.7 $5.1 $5.4 $5.9 $22.0 $7.7 $9.9 $12.9 $15.5 $46.0 Year-to-Year Change 46% 211% 291% 209% 176% (6%) (41%) (49%) (52%) (41%) 35% 95% 142% 164% 109% Services $1.9 $3.3 $4.0 $5.0 $14.3 $5.3 $4.8 $5.1 $5.3 $20.5 $5.6 $5.8 $6.1 $6.4 $24.0 Year-to-Year Change 133% 89% 137% 198% 140% 179% 45% 26% 5% 44% 4% 22% 22% 22% 17% Total Revenue $7.9 $12.0 $14.5 $17.4 $51.8 $11.0 $9.9 $10.4 $11.2 $42.5 $13.2 $15.8 $19.1 $22.0 $70.0 Year-to-Year Change 60% 164% 231% 206% 165% 39% (17%) (28%) (36%) (18%) 20% 59% 83% 96% 65% Total Cost of Revenue $1.6 $2.1 $3.1 $3.9 $10.8 $4.9 $4.4 $4.1 $4.0 $17.3 $3.9 $4.1 $4.4 $4.6 $17.0 Year-to-Year Change 36% 53% 146% 141% 97% 205% 104% 31% 2% 61% (19%) (5%) 7% 15% (2%) Gross Profit $6.3 $9.9 $11.4 $13.5 $41.1 $6.1 $5.6 $6.3 $7.2 $25.2 $9.3 $11.7 $14.7 $17.4 $53.0 Year-to-Year Change 68% 213% 266% 232% 191% (3%) (44%) (44%) (47%) (39%) 52% 110% 132% 142% 111% Gross Margin 79.8% 82.2% 78.6% 77.5% 79.3% 55.6% 56.0% 60.9% 64.2% 59.3% 70.2% 73.8% 77.1% 79.1% 75.7% Year-to-Year Point Change 3.6 12.8 7.5 6.1 7.2 -24.2 -26.2 -17.7 -13.3 -20.0 14.6 17.7 16.2 14.9 16.4 OPERATING EXPENSES $13.87 $16.55 $17.42 $23.06 $70.89 $22.60 $21.07 $21.07 $19.96 $84.70 $20.96 $20.96 $20.96 $20.96 $83.85 Year-to-Year Change 155% 133% 97% 94% 113% 63% 27% 21% (13%) 19% (7%) (1%) (1%) 5% (1%) Revenue $7.94 $12.00 $14.46 $17.41 $51.82 $11.01 $9.91 $10.40 $11.19 $42.50 $13.22 $15.79 $19.07 $21.96 $70.04 Year-to-Year Change 60% 164% 231% 206% 165% 39% (17%) (28%) (36%) (18%) 20% 59% 83% 96% 65% Expenses $15.47 $18.68 $20.51 $26.98 $86.21 $27.49 $25.42 $25.14 $23.97 $102.02 $24.90 $25.10 $25.32 $25.55 $100.84 Year-to-Year Change 134% 120% 103% 100% 102% 78% 36% 23% (11%) 18% (9%) (1%) 1% 7% (1%) Operating Income ($7.53) ($6.68) ($6.05) ($9.57) ($29.83) ($16.49) ($15.52) ($14.74) ($12.78) ($59.52) ($11.68) ($9.31) ($6.25) ($3.59) ($30.83) Year-to-Year Change (354%) (70%) (6%) (22%) (56%) (119%) (132%) (144%) (34%) (100%) 29% 40% 58% 72% 48% Operating Margin NM NM NM NM NM NM NM NM NM NM NM NM NM NM NM Year-to-Year Point Change NM NM NM NM NM NM NM NM NM NM NM NM NM NM NM Interest and Other Income, Net 0.32 1.15 1.53 3.69 6.70 3.00 2.90 2.80 2.70 11.39 2.60 2.50 2.40 2.30 9.79 Pretax Income (7.21) (5.52) (4.52) (5.87) (23.12) (13.49) (12.62) (11.94) (10.08) (48.13) (9.08) (6.81) (3.86) (1.29) (21.04) Tax Rate 0.0% (2.6%) (1.9%) (2.0%) (1.5%) (2.0%) (2.0%) (2.0%) (2.0%) 1.1% (2.0%) (2.0%) (2.0%) (2.0%) (32.5%) Provision For Taxes 0.00 0.15 0.09 0.12 0.35 0.15 0.25 0.24 0.20 0.84 0.18 0.14 0.08 0.03 0.42 Net Income ($7.21) ($5.67) ($4.61) ($5.99) ($23.47) ($13.64) ($12.87) ($12.18) ($10.28) ($48.97) ($9.26) ($6.95) ($3.93) ($1.32) ($21.46) Earnings Per Share ($0.31) ($0.20) ($0.15) ($0.19) ($0.83) ($0.43) ($0.40) ($0.37) ($0.31) ($1.51) ($0.28) ($0.21) ($0.12) ($0.04) ($0.64) Pro Forma Cash EPS* ($0.26) ($0.16) ($0.12) ($0.08) ($0.59) ($0.36) ($0.33) ($0.31) ($0.28) ($1.29) ($0.25) ($0.18) ($0.09) ($0.01) ($0.53) Shares Outstanding 23.5 28.8 29.8 31.5 28.4 32.0 32.4 32.6 32.8 32.4 33.0 33.2 33.4 33.6 33.3 *Excludes amortization of goodwill and other non-cash charges A-Actual. E-Stephens Inc. estimate. Source: Company documents and Stephens Inc. Stephens Inc 38
  • Figure 21 NUANCE COMMUNICATIONS — Financial Data FY2000A-FY2002E (dollars in millions, except per share amounts) STATEMENT OF CASHFLOWS 2000A 2001E 2002E Cash Flow from Operations Earnings (loss) from Continuing Operations ($23.47) ($48.97) ($21.46) Depreciation & Amortization 2.66 6.00 6.00 Deferred Taxes 0.00 0.00 0.00 Other (0.28) (2.44) (2.83) Cash from Operations (21.09) (45.41) (18.29) Net Investments (9.13) (32.00) (6.00) Free Cash Flow (30.21) (77.41) (24.29) Cash Flow from Financing Dividend 0.00 0.00 0.00 Change in Equity 233.58 0.00 0.00 Change in Debt (2.38) 0.00 0.00 Cash from Financing $231.20 $0.00 $0.00 Change in Cash 200.97 (77.41) (24.29) Beginning Cash 18.07 219.05 141.63 Ending Cash $219.05 $141.63 $117.34 BALANCE SHEET 2000A 2001E 2002E Total Assets $279.34 $233.21 $215.64 Debt 0.03 0.03 0.03 Total Liabilities 27.35 30.19 34.08 Total Shareholders' Equity 251.99 203.02 181.56 Total Liabilities and Equity $279.34 $233.21 $215.64 A-Actual. E-Stephens Inc. estimate Source: Company Document and Stephens Inc. Stephens Inc. 39
  • Figure 22 SPEECHWORKS INTERNATIONAL  Earnings Model, FY2000A-FY2002E (dollars and shares in millions, except per share amounts) 06/04/01 1QA 2QA 3QA 4QA 2000A 1QA 2QE 3QE 4QE 2001E 1QE 2QE 3QE 4QE 2002E REVENUE Product Licenses $2.6 $2.8 $4.9 $6.1 $16.4 $6.1 $6.1 $6.4 $7.0 $25.6 $8.1 $9.3 $10.7 $12.3 $40.4 Year-to-Year Change 665% 164% 562% 294% 344% 134% 119% 32% 15% 57% 33% 53% 67% 75% 58% Professional Services $2.2 $2.4 $3.1 $3.6 $11.3 $4.4 $4.8 $5.3 $5.8 $20.3 $6.4 $7.0 $7.7 $8.5 $29.7 Year-to-Year Change 96% 44% 138% 91% 89% 102% 103% 71% 60% 80% 46% 46% 46% 46% 46% Other Revenues 0.3 0.9 0.7 0.8 2.7 1.0 1.0 1.2 1.3 4.4 1.3 1.4 1.5 1.5 5.7 Year-to-Year Change -82.6% -19.9% 29.1% -12.0% -38.9% 195.7% 17.4% 70.9% 59.8% 64.8% 39.8% 33.4% 27.3% 21.6% 29.8% Non-cash Stock Based Compensation (0.3) (0.3) (0.3) (0.3) (0.3) (0.3) (1.2) (0.3) (0.3) (0.3) (0.3) (1.2) Year-to-Year Change NM NM - - - Total Revenue $5.1 $6.0 $8.6 $10.3 $30.0 $11.1 $11.6 $12.5 $13.8 $49.1 $15.5 $17.4 $19.6 $22.0 $74.6 Year-to-Year Change 55% 59% 237% 136% 114% 118% 93% 45% 34% 63% 40% 50% 56% 60% 52% Total Cost of Revenue $2.0 $2.7 $3.1 $3.2 $11.0 $4.2 $4.5 $4.8 $5.2 $18.7 $5.6 $6.1 $6.7 $7.3 $25.8 Year-to-Year Change (11%) 28% 96% 35% 33% 111% 65% 55% 65% 70% 35% 37% 40% 40% 38% Gross Profit $3.1 $3.3 $5.5 $7.1 $19.1 $6.9 $7.2 $7.7 $8.6 $30.4 $9.9 $11.3 $12.9 $14.7 $48.8 Year-to-Year Change 192% 97% 465% 252% 232% 123% 116% 40% 21% 60% 43% 58% 67% 72% 61% Gross Margin 61.0% 55.0% 64.0% 69.2% 63.5% 62.4% 61.6% 61.7% 62.2% 62.0% 63.7% 64.8% 65.8% 66.8% 65.4% Year-to-Year Point Change 28.7 10.8 25.8 22.8 22.5 1.3 6.6 -2.3 -7.0 -1.5 1.4 3.2 4.2 4.6 3.5 OPERATING EXPENSES $9.21 $10.67 $14.84 $16.87 $51.59 $18.43 $18.73 $18.73 $18.73 $74.61 $18.73 $18.73 $18.73 $18.73 $74.90 Year-to-Year Change 160% 139% 199% 98% 140% 100% 76% 26% 11% 45% 2% 0% 0% 0% 0% Revenue $5.09 $6.03 $8.62 $10.28 $30.02 $11.10 $11.63 $12.52 $13.81 $49.06 $15.51 $17.43 $19.59 $22.05 $74.57 Year-to-Year Change 55% 59% 237% 136% 114% 118% 93% 45% 34% 63% 40% 50% 56% 60% 52% Expenses $11.19 $13.38 $17.95 $20.04 $67.12 $22.61 $23.20 $23.53 $23.94 $93.28 $24.35 $24.86 $25.42 $26.04 $100.99 Year-to-Year Change 94% 103% 174% 85% 84% 102% 73% 31% 20% 39% 8% 7% 8% 9% 8% Operating Income ($6.11) ($7.35) ($9.32) ($9.75) ($32.53) ($11.51) ($11.57) ($11.00) ($10.14) ($44.22) ($8.84) ($7.44) ($5.83) ($3.99) ($26.10) Year-to-Year Change (147%) (164%) (134%) (50%) (107%) (88%) (57%) (18%) (4%) (36%) 23% 36% 47% 61% 41% Operating Margin NM NM NM NM NM NM NM NM NM NM NM NM NM NM NM Year-to-Year Point Change NM NM NM NM NM NM NM NM NM NM NM NM NM NM NM Interest and Other Income, Net 0.01 0.10 1.33 1.81 3.24 1.46 1.36 1.26 1.16 5.24 1.16 1.06 0.96 0.96 4.14 Pretax Income (6.10) (7.25) (7.99) (7.95) (29.29) (10.05) (10.21) (9.75) (8.98) (38.98) (7.68) (6.38) (4.87) (3.03) (21.96) Tax Rate 0.0% 0.0% 0.0% (3.9%) (1.1%) (0.3%) (0.3%) (0.3%) (0.3%) 1.1% (0.3%) (0.3%) (0.3%) (0.3%) (32.5%) Provision For Taxes 0.00 0.00 0.00 0.31 0.31 0.03 0.03 0.03 0.02 0.10 0.02 0.02 0.01 0.01 0.06 Net Income ($6.70) ($13.31) ($8.29) ($8.26) ($36.55) ($10.08) ($10.23) ($9.77) ($9.00) ($39.08) ($7.70) ($6.39) ($4.88) ($3.04) ($22.02) Earnings Per Share ($0.33) ($0.59) ($0.30) ($0.27) ($1.46) ($0.32) ($0.32) ($0.31) ($0.28) ($1.23) ($0.24) ($0.19) ($0.15) ($0.09) ($0.67) Pro Forma Cash EPS* ($0.29) ($0.29) ($0.20) ($0.17) ($0.92) ($0.19) ($0.21) ($0.19) ($0.16) ($0.82) ($0.12) ($0.08) ($0.04) $0.02 ($0.28) Shares Outstanding 20.0 22.4 27.7 30.2 25.0 31.4 31.7 32.0 32.3 31.9 32.6 32.9 33.2 33.5 33.1 *Excludes amortization of goodwill and other non-cash charges A-Actual. E-Stephens Inc. estimate. Source: Company documents and Stephens Inc Stephens Inc 40
  • Figure 23 SPEECHWORKS INTERNATIONAL  Financial Data, FY2000A-FY2002E (dollars and shares in millions, except per share amounts) STATEMENT OF CASHFLOWS 2000A 2001E 2002E Cash Flow from Operations Earnings (loss) from Continuing Operations ($29.60) ($39.08) ($22.02) Depreciation & Amortization 1.89 10.00 10.00 Deferred Taxes 0.00 0.00 0.00 Other 4.12 (2.41) (2.75) Cash from Operations (23.58) (31.49) (14.77) Net Investments (17.57) (11.40) (6.00) Free Cash Flow (41.15) (42.89) (20.77) Cash Flow from Financing Dividend 0.00 0.00 0.00 Change in Equity 129.56 0.00 0.00 Change in Debt (0.72) 0.00 0.00 Cash from Financing $128.84 $0.00 $0.00 Change in Cash 87.73 (42.89) (20.77) Beginning Cash 11.47 99.20 56.31 Ending Cash $99.20 $56.31 $35.54 BALANCE SHEET 2000A 2001E 2002E Total Assets $144.37 $107.86 $89.77 Debt 0.29 0.29 $0.29 Total Liabilities 12.94 15.51 $19.43 Total Shareholders' Equity 131.44 92.36 $70.33 Total Liabilities and Equity $144.37 $107.86 $89.77 A-Actual. E-Stephens Inc. estimate Source: Company Document and Stephens Inc. Stephens Inc 41