FC: Preliminary thoughts on Zero Knowledge's planned public offering

From: Declan McCullagh (declanat_private)
Date: Tue Jun 04 2002 - 17:48:45 PDT

  • Next message: Declan McCullagh: "FC: Skullduggery in Europe: What happened at secret police summit?"

    Zero Knowledge's prospectus posted on the sedar.com site offers up an 
    unprecedented look at the financials of the company. I just read it; here 
    are some preliminary notes:
    * For the fiscal year June 30, 2000 to June 30, 2001, ZKS made Can$1 
    million in revenue. They lost Can$36 million.
    * In U.S. dollars, that's $650,000 revenue -- and a loss of $24 million.
    * After layoffs, from the nine months ending March 30, 2002 (the most 
    recent numbers), the company made Can$1.7 million in revenue. But the net 
    loss was still Can$20 million.
    * During the height of the Freedom product, revenue was only $400K/year in 
    software licenses.
    * ZKS has leased (mostly in a 10-year lease) about 44,000 square feet of
    office space in Montreal. At only 81 current employees, that's 543 
    sq-feet/employee -- enough for a comfortable studio apartment for each 
    person. Only 4,000 square feet have been sublet. A football field, by 
    comparison, is about 50,000 square feet.
    * Cash reserves are dwindling fast. As of June 30, 2001, ZKS had Can$15 
    million in the bank. Now they have only Can$3 million.
    * The company's current burn rate is almost, according to statement F-3, as 
    much as Can$2 million a month. Without a substantial revenue uptick or a 
    short-term loan, ZKS could simply run out of cash. To be fair, some of that 
    revenue could come in with new deals with HP and other companies described 
    in the prospectus.
    * Can$1.3 million/year of remaining cash will be eaten up by four fat 
    executive salaries that remain hefty, even given the dismal financial 
    situation. Each of the three Hill family members gets Can$270K a year, with 
    the CEO receiving Can$470K.
    * If my calculations are correct, and barring a cash infusion from 
    licensing, soon ZKS' liabilities, such as accounts payable and long-term 
    debt, will be more than the company's assets.
    Question: Given the above, what's the future of an IPO? (Keep in mind that 
    ZKS had also planned an abortive IPO in 2000.)
    Here's the prospectus:
    Previous Politech message:
    Below is an article that David Akin wrote before the prospectus was 
    published based on interviews with ZKS execs.
    Report on Business: Canadian
    Zero-Knowledge learns a valuable lesson Dot-com firm finds no amount of hype
    can replace old-fashioned business values, DAVID AKIN reports
    The Globe and Mail
    A little over a year ago, Zero-Knowledge Systems Inc. of Montreal was on top
    of the dot-com world in Canada.
    It had just concluded a third round of financing, bringing the total amount
    of money raised by the privacy software maker to $54-million (U.S.).
    Its employee base had soared to 247 from 83 in less than a year. The
    privately held company and its products were getting lots of positive press
    in the important U.S. market. In Canada, Austin and Hamnett Hill, company
    co-founders and brothers, made the cover of R.O.B. Magazine and Shift. And
    Austin was asked to advise Finance Minister Paul Martin on the technology
    Then the dot-com bubble burst. Markets crashed, investors got nervous, and
    technology spending dried up.
    For all its promise, Zero-Knowledge found itself in a heap of trouble. But
    while dozens of its Internet and software peers in Canada folded,
    Zero-Knowledge held on. The founding family -- Austin and Hamnett are
    executive vice-presidents and father, Hammie, is the chief financial officer
    -- brought in new executives to help.
    Now, more than a year after the bubble burst, the story of Zero-Knowledge is
    a business school lesson -- that no amount of hype, publicity, and dot-com
    pixie dust can replace the good, old-fashioned value that businesses succeed
    when they sell things that a lot of people find useful.
    Company executives concede that, until early last year, the company operated
    under flawed governing assumptions: that there's an infinite supply of
    capital; speed and size are everything; and, because privacy was the Next
    Big Thing, all they had to do was build the best privacy protection software
    and the technology would sell itself.
    Those assumptions were similar to what guided most dot-com startups of the
    late 1990s and many of their venture capital partners.
    Now, Zero-Knowledge executives cite different guiding principles. First, the
    company will do only what someone is willing to pay for. Second, it
    recognizes that capital is scarce and must be earned. Third, it measures
    success by traditional benchmarks such as revenue, cost containment, and
    Company CEO Tamas Hevizi said the lesson for Zero-Knowledge was that
    consumers, by and large, don't make buying decisions based on technology.
    "But customers differentiate in who they buy from. That was the big shift
    for us. Consumers tend to buy a lot more from people they're already buying
    from. It was something we learned but I think a lot of companies didn't
    learn that. They assume you can come out with the greatest new product, and
    all of a sudden everyone's going to rush to you. That's just not how it
    That lesson wasn't cheap. Zero-Knowledge said it has gone from a peak gross
    burn rate of $3-million (Canadian) in December, 2000, to a rate this spring
    of about $1-million a month.
    "Part of the problem was that the measures for success then were how much
    money you raised, how many times you got your name in the press, and how
    much visibility you had," Austin Hill said. "So even though we were blowing
    through $3-million a month at our peak, there was still this perception
    that, oh well, that's nothing compared to the [Silicon] Valley companies."
    Said Hammie Hill: "No one was saying: What are your revenues going to be
    this year? What are your projected earnings?"
    At first, the company thought revenue would come from a consumer privacy
    protection product called Freedom, which it sold on a subscription basis for
    about $50 (U.S.) a year. But despite critical acclaim for Freedom, it was a
    bust, selling less than 15,000 units.
    And so the company brought in a new CEO -- Mr. Hevizi had been a Silicon
    Valley-based Ernst & Young consultant -- then shut down the Freedom product
    and went back to the drawing board.
    Layoffs soon followed, and today 80 people work for the company, down from
    last year's peak of 247.
    Success -- on a much smaller scale than first hoped -- is now within reach,
    the company said. A deal with Hewlett-Packard Co. of Palo Alto, Calif., will
    put Zero-Knowledge software on three million computers. Deals have also been
    signed, but not yet announced, with a major North American financial
    institution for the sale of 2.5 million software licences; with a major
    European telecommunications company and a major North American telco for
    more than six million licences; and with a networking equipment vendor for
    three million licences.
    But Zero-Knowledge has less than $5-million (Canadian) in cash on hand.
    Sales, though growing quickly, totalled only about $300,000 in March. The
    company wants one more round of financing to get it to the point where it is
    generating its own positive cashflow. Executives say they expect to sign the
    fourth financing deal soon.
    The company won't say when it expects to be cash-flow positive except to say
    there is -- finally -- light at the end of the tunnel.
    Zero-Knowledge said that for the nine months ended in March, it lost
    $19.3-million on sales of $1.7-million versus a loss of $26.1-million on
    about $720,000 in the same period last year.
    The company cautions that it's tough to compare the two years because of
    significant one-time restructuring costs that occurred last year and because
    the 2001 strategy to generate revenue was shelved.
    Through three rounds of financing between September, 1999, and March, 2001,
    Zero-Knowledge raised $52-million (U.S.) from some top Silicon Valley
    venture capitalists and some Canadian institutional investors. Net
    shareholders' equity at the end of March, according to Zero-Knowledge's
    financials, stood at $4.2-million (Canadian).
    With a long uphill climb before its existing shareholders see a return, the
    company has had to show prospective new investors it knows what it's doing.
    "As we are attracting new investors," Mr. Hevizi said, "we have to paint a
    path for them for growth, for revenue generation and ultimately for earnings
    growth and profitability." David Akin is national business and technology
    correspondent for CTV News and a contributing writer to The Globe and Mail.
    POLITECH -- Declan McCullagh's politics and technology mailing list
    You may redistribute this message freely if you include this notice.
    To subscribe to Politech: http://www.politechbot.com/info/subscribe.html
    This message is archived at http://www.politechbot.com/
    Declan McCullagh's photographs are at http://www.mccullagh.org/
    Like Politech? Make a donation here: http://www.politechbot.com/donate/

    This archive was generated by hypermail 2b30 : Tue Jun 04 2002 - 18:05:16 PDT