By Shaifali Puri

(FORTUNE Magazine) – hq: newton, mass. founded: 1982 sales: n.a. employees: 280 stock: privately held web address: www.dragonsys.com

How appropriate that software maker Dragon Systems would choose an archaic creature for its moniker and logo. In the technology world, this Newton, Mass., company seems positively medieval. First, there's the fact that Dragon Systems is old--it was founded 16 years ago by Janet and Jim Baker (who are 51 and 53 themselves). Then there's the company's financing: Dragon has never received a lick of venture capital money, subsisting instead on the Bakers' own money at first and then on honest-to-God sales. Headquarters is in a converted mill 20 minutes outside the old city of Boston. The only thing about Dragon Systems that doesn't evoke the days of yore is its technology.

Dragon is responsible for a breakthrough in speech-recognition software. Its application, NaturallySpeaking, lets users speak in a normal voice into a microphone plugged into a PC and watch as their words quickly appear on the computer screen, and as their commands are immediately followed. When the program makes a mistake in transcription, you tell it to highlight the erroneous passage and give it the correction--and it learns from its mistakes. Known as general-purpose continuous-speech recognition, NaturallySpeaking could radically alter the way people interact with their computers--and ultimately with other devices in their lives.

In the past, most dictation software required users to speak slowly and pause awkwardly between words. All that changed with $150 NaturallySpeaking; with its flexible 30,000-word vocabulary and a 95% accuracy rate, it was the first dictation software to allow for a normal manner of speaking on any subject. Following NaturallySpeaking's successful launch in June 1997, IBM, Dragon's fiercest competitor (and the Bakers' onetime employer), scrambled to market a rival product, ViaVoice ($130).

Neither program works perfectly. NaturallySpeaking can learn only a single user's voice (IBM's ViaVoice has multi-user capability but is less accurate). If you work in a particularly noisy office, you should expect quite a few errors.

So far, NaturallySpeaking is winning the speech-recognition battle. In the first four months of this year, it garnered Dragon Systems $6.8 million in sales, while IBM's speech-recognition revenues were just $5.2 million, according to PC Data, a research firm in Reston, Va. Janet Baker shrugs off concerns that IBM, with bigger budgets and greater brand recognition, will eventually slay Dragon. "We have spent practically nothing on advertising and marketing, and we're still beating them," she notes. "All we do is speech recognition. This is just a part of IBM's business."

According to Voice Information Associates, a Lexington, Mass., research firm, Dragon has lots of room to grow. They expect it to feed off an explosion in the speech-recognition market, which they estimate to reach $3 billion by 2001 as manufacturers race to incorporate the technology into devices like cell phones and hand-held organizers.

--Shaifali Puri