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On December 6th, Nuance Communications (NASDAQ:NUAN) held their Analyst/Investor Day Presentation, and shed a lot of light on their prolific catalogue of products for 2013 and beyond. Artificial intelligence. Voice biometrics. Collaborative filtering. Speech recognition. Predictive models. Tech-savvy terminology like this is peppered throughout the transcript. Although Nuance has established a beachhead in voice recognition technologies, CEO Paul Ricci and his cohorts believe there is a paradigm shift currently underway. This was the crux of the presentation.

Just like investing, speech recognition is less than a perfect science. It's a complex and multidimensional business. Nuance is arguably the top company in the sector. If we peel back the layers to examine the behind-the-scenes processing of Apple's (NASDAQ:AAPL) voice generated Siri platform, you'll find Nuance Communications at work. It's undetermined whether iPhone aficionados have completely bought into the technology, but in increments, the science is improving with the advent of intelligent systems. I utilize their Dragon Dictation application on my iPhone, and for lack of a better expression, it works.

Nuance is engaged in three primary markets: mobile & consumer, enterprise self-service, and healthcare. Although I'll be touching on the medical and corporate call center aspects of Nuance's business, the primary thrust of this article will focus on the mobile and consumer division. This is because although all three segments are thriving, it's the mobile and consumer space that is growing the fastest, and may elevate the company to elite status.

Right off the bat, CEO Ricci states that Nuance has a privileged position across most of the leading smartphone platforms in the world. The company is very excited to have cemented a series of agreements with Samsung (OTC:SSNLF), and they are going to extrapolate that smartphone leadership position to other connected devices. Most notably televisions, desktops, laptops, tablets, and automobiles. Mr. Ricci expounds on this:

We're going through a paradigm shift. And that paradigm shift is towards more intelligent systems; virtual assistance; interactive systems that incorporate speech, natural language processing; some amount of knowledge domain and reasoning, and that paradigm shift is moving. It was first articulated in the smartphone market is moving to incorporate platforms and products across the mobile consumer and electronics industry.

This computer science is called "Deep Belief Networking", where neural networks are applied to speech recognition and other pattern-recognition problems. In essence, algorithms are utilized to synthesize all of the user inputs on a communications device. Previously, it was cost prohibitive, and the technology just wasn't there. You needed a mainframe to crunch the numbers. However, with cloud computing becoming the norm, as opposed to an outlier, the technology is moving forward. Nuance is putting a full-court press on the science to maximize user experience on multiple devices.

Vlad Sejnoha is one of Mr. Ricci's go-to guys and explains the process:

We try to be efficient about the use of resources to optimize the user experience by tapping into the cloud transparently to the user. So our natural language understanding framework is flexibly distributable across the cloud in multiple devices. This is very important because increasingly, our users expect a continuity of experience across devices. Whether they're interacting with applications on their phone, in the car or increasingly on their TV.

What's happening is that as more and more of your devices are connected to the cloud, the sample size of what your inputs are become much larger, and enables not only the end user, but multiple users to improve the process. This includes not only speech recognition capabilities, but other input procedures like manual data input on the keyboard. Mr. Sejnoha goes on to say:

So among the many input modalities we support is tracing on the keyboard, we call it Swiping, where we use predictive algorithms that map the gestures onto character sequences and also perform autocomplete. As every user uses Swipe, the information goes up into the cloud where it's aggregated and mined and we discover new terms, new language patterns and immediately update the language model for that user.

This is not a half-baked idea. However, we all know that human behavior is not very logical, and although Nuance Communications is making improvements to previous input technologies, instantaneous gratification may not be in the cards for awhile. You still may be frustrated with some of Siri's capabilities. It's a slow motion process. Let's examine the company's three business segments individually to determine what is in store for 2013.

Mobile and Consumer

Mike Thompson is the General Manager of the mobile division. Here are some bullet points as to what the company's strong assets are for their most visible division for the next few years.

  • Nuance is at the epicenter of an evolution. Almost all sophisticated mobile devices today are shipping with some kind of capabilities in the areas where Nuance participates. And the outlook for that is only increasing.
  • The Mobile and Consumer Division is built on the Dragon family. It's the company's most mature market.
  • On desktop, the original Dragon NaturallySpeaking has been historically an aftermarket product. That's changing dramatically. The desktop, laptop, Ultrabook space has converged with mobile phones and tablets. The entire Dragon desktop portfolio is being optimized and driven towards an OEM business. This is a major shift. It'll include embedded technologies and connected technologies.
  • We launched Dragon TV in January of this year. We have now shipped 750,000 voice-enabled smart televisions. The best televisions at Costco (NASDAQ:COST) or any other retail store, you go to the high end ones, like Samsung Smart TV, those have voice recognition; LG, they have voice recognition. That market is going to continue to grow.
  • This is a picture of the cloud. Dragon cloud traffic was zero in 2009, when we launched our first Dragon dictation downloadable application. We have grown to, and done five billion cloud-based transactions since Q1 2010. And we expect that this number will, based on the curve, actually grow even faster.
  • We are the only company in the world with the diversity of the following things: we process traffic from IOS, Android (NASDAQ:GOOG), RIM (RIMM), Symbian, many, many different flavors of Android.

The mobile and consumer division has growth between 25% and 30% each year for the past four years. It's important to note that back in 2009, they had no connectivity revenue at all.

Enterprise

Robert Weideman is in charge of the enterprise area of operations. Think call centers, or, automated customer service solutions. As Mr. Weideman noted: "You don't want to frustrate customers with speech recognition that doesn't know what you're saying. You also don't want a robotic voice talking back to you.". I thought it was interesting that 60% of all phone calls to contact centers emanated from mobile devices.

Because of global partners like Avaya, Cisco (NASDAQ:CSCO), Huawei and Genesys, Nuance is able to expand their language portfolios on a worldwide basis. Natural Language Understanding and voice biometrics help the company maintain a lead in international automated customer service. Last year the division achieved 12% revenue growth. Seven percent of that growth was organic.

Health Care

Nuance has established an indisputable market-leading franchise in front-end speech and capture. With physicians, this dovetails into adapting Dragon Medical to take advantage of government subsidies from the HITECH Act. The HITECH Act is part of the US Government Stimulus Plan where almost $30 billion has been slotted to reimburse physicians and hospitals for adopting electronic health records (EHR) in their practices. With a current minuscule market penetration of 10%, the US Government's goal is to equip 90% of doctors with electronic health records by 2019.

Janet Dillone heads the medical division of Nuance. She reports that 2012 had very strong double-digit organic growth, a top-line of $670 million, and a three year CAGR of 20%. This was helped by strong relationships with Cerner (NASDAQ:CERN), the largest healthcare IT company in the world, and Epic, one of the fastest growing healthcare IT companies globally.

Conclusion

This was a dense and meaty report. Far too much information to be effectively covered in a few short paragraphs. Nuance's public profile has recently been elevated with the inclusion of Siri in the newer iPhones. It initially goosed the stock, but it has since come down to more reasonable valuations.

Tim Cook, Steve Jobs' hand-picked successor at Apple recently nixed Google's mapping application, so continued relationships with Apple are not guaranteed. However, my take is that because of the public outrage from jettisoning the Google app, Apple will probably stick with the technology leaders going forward for native applications. Nuance certainly fits that bill.

I think the planets are aligned for Nuance to make a multi-year run. Just utilizing regression analysis, Nuance looks primed to continue its slow and steady ascent on the stock charts. The going rate for the equity is $22, very close to its 52 week low of $19. The 52 week high was $31. Crunching the numbers courtesy of Yahoo Finance, we can see that its projected 5 year CAGR is 16.5%, and the current P/E is 11.5. On a PEG Ratio metric, that is a bargain.

Source: Nuance Communications: The Epicenter Of An Evolution