Preliminary thoughts on Zero Knowledge's planned public offering

Declan McCullagh declan at well.com
Tue Jun 4 17:50:12 PDT 2002


>Date: Tue, 04 Jun 2002 17:48:45 -0700
>To: politech at politechbot.com
>From: Declan McCullagh <declan at well.com>
>Subject: Preliminary thoughts on Zero Knowledge's planned public offering
>
>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:
>http://www.sedar.com/command_servlet?cmd=GetFile&lang=EN&documentType=Preliminary+long+form+prospectus+-+English&issuerNo=00017982&fileName=%2Fcsfsprod%2Fdata31%2Ffilings%2F00456562%2F00000001%2Fe%3A%5CZero%5CIPO-2002%5CPrelim%5CPreProsE.pdf
>
>Previous Politech message:
>http://www.politechbot.com/p-03618.html
>
>Below is an article that David Akin wrote before the prospectus was 
>published based on interviews with ZKS execs.
>
>-Declan
>
>---
>
>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
>DAVID AKIN
>
>05/13/2002
>The Globe and Mail
>Metro
>B5
>
>
>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
>economy.
>
>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
>earnings.
>
>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
>happens."
>
>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.





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