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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q
(Mark One)

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from   to __________. 

Commission File Number:  001-32134
Z Trim Holdings, Inc.
(Exact name of registrant as specified in its charter)
 
Illinois
36-4197173
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

 
1011 Campus Drive, Mundelein, Illinois                                                                 60060
(Address of principal executive offices)                                                                 (Zip Code)
(847) 549-6002
(Registrant’s telephone number, including area code)
 
 
(Former name, former address and former fiscal year, if changed since last report)

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý  No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  ý  No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ¨                                                                                                            Accelerated filer ¨
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)                                  Smaller reporting company ý
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes  ¨  No ý
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:
 
 
Class
 
Outstanding at August 12, 2014
Common Stock, $0.00005 par value
 
39,734,854
 
1
 
 

 

Z TRIM HOLDINGS, INC.
     
 FORM 10-Q QUARTERLY REPORT
Table of Contents
 
     
Item
 
Page
 
PART I
 
   
Item l.
Financial Statements (see below)
3
     
Item 2.
Management's Discussion and Analysis of Financial
3
 
Condition and Results of Operations
 
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
15
     
Item 4.
Controls and Procedures
15
     
PART II
   
     
Item 1.
Legal Proceedings
16
     
Item 1A.
Risk Factors
16
     
Item 5.
Other Information
16
     
Item 6.
Exhibits
16
     
SIGNATURES
   16
     
EXHIBIT INDEX
    17
     
Financial Statements
Balance Sheets
 
 
At June 30, 2014 (unaudited) and December 31, 2013
F-1
     
 
Statements of Operations
 
 
for the three and six months ended June 30, 2014 and 2013 (unaudited)
F-2
     
 
Statements of Cash Flows
 
 
for the six months ended June 30, 2014 and 2013 (unaudited)
F-3
     
 
Notes to Financial Statements  (unaudited)
F-4
 
2
 
 

 


PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements.

See Financial Statements beginning on page F-23.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of
                Operation.

Cautionary Statement Regarding Forward Looking Information

This report contains or incorporates by reference various forward-looking statements concerning the Company’s prospects that are based on the current expectations and beliefs of management. Forward-looking statements may contain words such as “anticipate,” “believe,” “estimate,” “expect,” “objective,” “projection” and similar expressions or use of verbs in the future tense, which are intended to identify forward-looking statements; any discussions of periods after the date for which this report is filed are also forward-looking statements. The forward-looking statements contained herein and such future statements involve or may involve certain assumptions, risks, and uncertainties, many of which are beyond the Company’s control, which could cause the Company’s actual results and performance to differ materially from what is expected.  Readers are cautioned not to place undue reliance on such forward-looking statements.  The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.  There can be no assurance that the forward-looking statements contained in this document will, in fact, transpire or prove to be accurate.

In addition to the assumptions and other factors referenced specifically in connection with such statements, factors that could cause or contribute to our actual results differing materially from those discussed herein or for our stock price to be adversely affected include, but are not limited to:

- our history of operating losses and our inability to achieve or guarantee profitable operations in the future or to continue operations;
- the risk that we will be unable to pay our debt obligations as they become due or that we will be able to find sufficient financing to fund our operations;
- risk that there will not be market acceptance of our products;
- our plans for commercialization of our products;
- possible problems in implementing new relationships or the failure to achieve the desire benefits from such relationships;
- our reliance on a limited number of product offerings;
- our product development efforts, including risk that we will not be able to produce our products in a cost-effective manner;
- our substantial dependence on the manufacturing facility owned by our toll manufacturer;
- our ability to secure new customers, maintain our current customer base and deliver product on a timely basis;
- our dependence on a small concentration of customers;
- possible issuances of common stock subject to options, warrants and other securities that may dilute the interest of stockholders, and/or future exercise of such options and warrants;
- our ability to protect technology through patents;
- our ability to protect our proprietary technology and information as trade secrets and through confidentiality agreements or other similar means;
- the effects of the 2015 expiration of the USDA patent we have employed in manufacturing our products;
- competition from larger, more established companies with far greater economic and human resources;
- fluctuations in the availability of raw materials and the price for agricultural products;
- the effect of changes in the pricing and margins of products;
- the potential loss of key personnel or other personnel disruptions;
- possible product recalls due to adulteration of products or materials, future regulatory action, or other concerns;
- our ability to comply with all government regulation and retain favorable regulatory status, such as GRAS status, of our products and ingredients;
- risk that we will not be able to remediate identified material weaknesses in our disclosure controls and procedures and internal control over financial reporting;
- sufficient voting power by one large stockholder to make corporate governance decisions that could have significant effect on us and the other stockholders;
- our nonpayment of dividends to common stockholders and lack of plans to pay dividends to common stockholders in the future;
- our need for additional financing;
- our ability to successfully defend future litigation, including possible claims related to products liability and infringement of intellectual property, as well as the outcome of regulatory actions and inquiries;
- future sale of a substantial number of shares of our common stock that could depress the trading price of our common stock, lower our value and make it more difficult for us to raise capital;
- our additional securities available for issuance, which, if issued, could adversely affect the rights of the holders of our common stock;
- our stock is classified as a penny stock and subject to additional regulation as such; and
- our stock price is likely to be highly volatile due to a number of factors, including a relatively limited public float and potential for short sales of our stock.

 
In addition, see Risk Factors in Part I, Item 1A of the Company’s 2013 Annual Report on Form 10-K for a further discussion of some of the factors that could affect future results.
 
The following discussion is intended to assist in understanding the financial condition and results of operations of Z Trim Holdings, Inc. You should read the following discussion along with our financial statements and related notes included in this Form 10-Q.

Unless the context requires otherwise, in this report, the “Company,” “Z Trim,” “Z Trim Holdings,” “we,” “us” and “our” refer to Z Trim Holdings, Inc.
 
3
 
 

 
Overview

Z Trim Holdings, Inc. is a bio-technology company that owns existing, and develops new, products and processes that transform agricultural by-products into multi-functional ingredients used in food manufacturing and other industries.   The Company currently sells a line of products to the food industry that can help manufacturers reduce their costs, improve the quality of finished goods, and also help solve many production problems.  The Company’s innovative technology provides value-added ingredients across virtually all food industry categories.  These all-natural products offer a range of functional attributes, including helping to reduce fat and calories, adding fiber, improving shelf-stability, preventing oil migration, and enhancing binding capacityall without degrading the taste and texture of the final food products.  Perhaps most significantly, Z Trim’s ingredients can help extend the life of finished products, potentially increasing its customers’ gross margins.
 
The Company, through an exclusive license to technology patented by the United States Department of Agriculture (the “USDA”), has developed products that manage moisture to help reduce production costs and improve nutritional value in finished foods, while maintaining the essential taste and mouth-feel associated with full-fat products.  The global market for Z Trim’s line of products spans the entire food and nutritional beverage industry, including fat-free, low-fat, reduced-fat and full-fat, across meats, baked goods, dairy and non-dairy products, snacks, beverages, dressings, sauces and dips.
 
We currently manufacture our products at a facility owned by our toll manufacturer, AVEKA Nutra Processing, LLC (“ANP”). Our original facility, which we phased out in the third quarter of 2013, was a prototype plant, the first of its kind to produce our innovative products.
 
In July 2012, the Company opened an industrial products division focusing on the manufacture, marketing and sales of products designed specifically for industrial applications, including oil drilling fluids, petroleum coke, charcoal briquettes, hydraulic fracturing, and paper and wood adhesives.  When used in industrial operations, we believe that Z Trim’s products can reduce costs, enhance supply-chain reliability, limit environmental impact, and improve finished product quality compared to current products such as guar gum, xanthan gum, CMC, lignosulfonates and starches used as binders, adhesives, viscofiers or emulsifiers.
 
In January 2013, the Company entered into a joint development agreement with Newpark Drilling Fluids LLC, a subsidiary of Newpark Resources, Inc., to develop new, environmentally-friendly drilling fluids that incorporate Z Trim's proprietary industrial materials that could replace products such as guar and xanthan gums in drilling applications.
 
Current Trends and Recent Developments Affecting the Company

Sales and Manufacturing

Sales for the second quarter of 2014 declined 44% as compared to the same period in 2013.  The reasons for the decline were that two customers had discontinued product lines that incorporated the Company’s ingredients for reasons other than the performance of the particular ingredients.  In addition, two of the larger customers of the Company had on hand sufficient inventory, therefore, eliminating the need to place orders during the second quarter.  Company management believes that it will not have similar issues in the third and fourth quarters for 2014.   Sales for the first six months of fiscal 2014 were down 29% as compared to the first six months of fiscal 2013.
 
On July 16, 2014, the Company announced that it had retained Chandler Horton, a former VP of R&D at Keystone Foods, LLC, as an External Consultant.  Mr. Horton will advise and assist the management team in several critical areas of the company's food ingredient business, including: sales and marketing initiatives; strategic partnership opportunities; and raising awareness about Z Trim solutions in key domestic and offshore markets.
 
Mr. Horton spent over 37 years at Keystone, a global food services company that supplies some of the world's finest consumer brands with high-quality, fresh and frozen animal protein products including poultry, beef, pork and fish.  As Vice President of R&D, he led the company's customer centric research and development process, which focuses on consumer needs and tastes as well as operational productivity and sustainability as it relates to new food products.
 
On June 18, 2014 the Company announced that it had retained Gordon F. Brunner, a former Chief Technology Officer of Procter & Gamble® (NYSE: PG), as an External Consultant.  Mr. Brunner will assist the management team in several key areas, including: the review of all matters relating to the company's intellectual property; research and development of products, processes and applications derived from that property; the investigation of strategic research partnership opportunities; and initiatives designed to raise awareness regarding Z Trim's technology capabilities in relevant commercial, industrial, scientific and investment sectors.
 
Mr. Brunner spent nearly four decades at Procter & Gamble. As Senior Vice President, Chief Technology Officer and Head of Worldwide Research and Development, he was instrumental in accelerating product innovation and led the creation of one of the most effective global R&D organizations. A native of Des Plaines, IL, Mr. Brunner earned a BS in Biochemical Engineering from the University of Wisconsin and an MBA from Xavier University. He has served on Z Trim's Advisory Board since 2011.
 
4
 
 

 
On April 22, 2014, the Company announced it engaged the services of two new distributors – SPI Group (www.spigroup.net) and Unipex Solutions Canada (http://www.unipex.ca/en/index.php). 
 
SPI Group is a distributor of specialty ingredients to food, nutritional, and nutraceutical manufacturers in the Western United States and Canada.
 
Unipex Solutions Canada, a leader in the distribution of active ingredients and specialty chemicals, offers a wide range of distinctive services and customized solutions throughout North America. Additionally, their sales force has technical expertise in key markets such as personal care, pharmaceutical, nutraceutical, and nutrition, as well as industrial specialties including lubricants, HI&I, and oil & gas.

 
In 2011, the Company entered into a Custom Processing Agreement (“CPA”) with ANP, part of the AVEKA Group, in order to provide the Company with a partner for future manufacturing initiatives.  The CPA provides that ANP will perform certain services related to the Company’s dietary fiber product, including manufacturing, processing, packaging and storage/warehousing for an initial term of three years.  The CPA automatically renews at the end of the initial term for an additional two-year term unless either party provides written notice to the other within the specified time frame.  Start-up activities began in the third quarter of 2012, and production began in the fourth quarter of 2012. The CPA provides for minimum production volumes of 40,000 pounds per month and average volumes of 100,000 pounds per month, with the ability to increase future production volume to potentially as much as 1 million pounds per month.  However, due to factors, including start-up problems, changes in customer demand, inability of parties to perform their obligations and factors outside the Company’s control, the Company cannot assure that production will begin as anticipated or that it will achieve these levels.

 
Funding Initiatives

On February 11, 2014 the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $200,000 in a convertible senior secured note.  The note matures in two years (February 11, 2016) and bears interest at 12.5% computed based on a 365-day year.  Accrued interest is payable either at maturity or quarterly at the option of Mr. Smith in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $2.25, subject to adjustment as provided in the note.  If on the maturity date of the note, the thirty day trailing average closing price of the Company’s Common Stock (the “Trailing Average Price”) is below $2.25, the Conversion Price on the maturity date will be reduced to the Trailing Average Price, but to not less than $1.25.  The note is secured by the assets of the Company, which security interest is expressly subordinate to the interest of Fordham Capital Partners LLC described below, pursuant to an intercreditor agreement between Mr. Smith and Fordham dated March 18, 2014.
 
On March 24, 2014, Fordham Capital Partners, LLC (“Fordham”) extended a $500,000 revolving loan (the “Equipment Loan”) to Z Trim Holdings, Inc. (the “Company”) evidenced by an Equipment Revolving Note (the “Note”) issued by the Company to Fordham.  The Note requires monthly payments of principal of $10,417 plus interest, commencing on April 24, 2014 and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Note is calculated at a fixed rate of 20% per annum.  The Note may be prepaid in full at any time; provided that if the Company prepays the Note prior to September 24, 2014 (such six-month period, the “Guaranteed Interest Period”), it must pay a prepayment penalty equal to the amount by which (i) the aggregate interest that Fordham would have received on the Note during the Guaranteed Interest Period had there been no prepayment exceeds (ii) the aggregate interest paid by the Company prior to the date of prepayment.
 
Pursuant to the Security Agreement, dated March 24, 2014, between the Company and Fordham (the “Security Agreement”), the Equipment Loan is secured by a first priority security interest in all of the Company’s equipment (as more specifically defined in the Security Agreement, the “Collateral”).  The Security Agreement also contains customary restrictive covenants, including without limitation, covenants prohibiting the Company from (i) granting additional liens in the Collateral, (ii) selling, leasing or transferring the Collateral, (iii) entering into certain merger, consolidation or other reorganization transactions, and (iv) creating, incurring or assuming additional indebtedness, in each case subject to certain exceptions.  The Security Agreement also contains customary events of default.  If an event of default under the Security Agreement occurs and is continuing, Fordham may declare any outstanding obligations under the Credit Agreement immediately due and payable.  After an event of default, interest on the Note would accrue at a rate of 25% per annum.
 
Additionally, pursuant to the Factoring Agreement, dated March 24, 2014, between the Company and Fordham, Fordham may purchase any Accounts of the Company (the “Factoring Agreement”).  To secure payment and performance of the Company’s liabilities and obligations to Fordham, including obligations under the Factoring Agreement, the Company granted Fordham a security interest in all of the Company’s (i) Accounts, (ii) Inventory, (iii) Chattel Paper, Deposit Accounts, Documents, Equipment, Financial Assets, Fixtures, General Intangibles, Instruments, Investment Property, Letter-of-Credit Rights, Securities, Software and Supporting Obligations, (iv) books and records of Seller which relate to Accounts, (v) all amounts owing to the Company under the Factoring Agreement, and (vi) Proceeds of the foregoing.  The Factoring Agreement terminates at any time that the Equipment Loan is paid in full.
 
On April 25, 2014, the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $300,000 in a convertible subordinated secured note.  The note matures in two years (April 25, 2016) and bears interest at 14% computed based on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  The note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
5
 
 

 
On April 30, 2014, the Company issued a 14% convertible subordinated secured note to each of Morris Garfinkle, Mark Hershhorn, Brian Israel and Edward B. Smith, Directors of the Company, in the principal amount of $19,000, for director fees due and payable to them (the “Director Notes”).  Each Director Note matures in two years (April 30, 2016) and bears interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the Director Note, the director may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each Director Note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  Each Director Note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On May 12, 2014, the Company issued 14% convertible subordinated secured notes to both Morris Garfinkle and CKS Warehouse in the principal amount of $75,000 each.  Both notes mature in two years (May 12, 2016) and bear interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of each note, Mr. Garfinkle and CKS Warehouse may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  Each note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On July 15, 2014, the Company entered into an agreement with Edward Smith III, pursuant to which Mr. Smith agreed to lend the Company $64,000 in an unsecured note payable.  The note matures in 90 days (October 15, 2014) without interest payable on the unpaid principal and subject to the terms of the Company’s agreements with its secured creditors.
 
On July 16, 2014, the Company and Fordham Capital Partners, LLC entered into an Amended and Restated Equipment Revolving Note (the “Amended Note”) in the amount of $582,841.63.  The Amended Note requires monthly payments of principal of $12,143 plus interest, commencing on July 24, 2014 and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Amended Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Amended Note is calculated at a fixed rate of 22% per annum.
 
Also on July 16, 2014, the Company and Fordham Capital Partners, LLC entered into a First Amendment to Security Agreement in which the Amended Note is secured by a first priority security interest in all of the Company’s equipment under substantially the same terms and covenants as stated in the original Security Agreement indicated above.
 
On July 25, 2014, the Company and Fordham Capital Partners, LLC entered into an Amended and Restated Equipment Revolving Note (the “Second Amended Note”) in the amount of $668,750.  The Second Amended Note requires one monthly payment of principal of $12,143 plus interest, commencing on July 25, 2014 followed by successive monthly installments of principal of $13,679 plus interest and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Second Amended Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Second Amended Note is calculated at a fixed rate of 22% per annum.
 
Also on July 25, 2014, the Company and Fordham Capital Partners, LLC entered into a Second Amendment to Security Agreement in which the Second Amended Note is secured by a first priority security interest in all of the Company’s equipment under substantially the same terms and covenants as stated in the original and the First Security Agreement indicated above.
 
On August 6, 2014, the Company issued a 14% convertible subordinated secured note to Edward B. Smith in the principal amount of $264,000.  The note matures in two years (August 6, 2016) and bears interest at 14% computed on a 365-day year.  Under this note Mr. Smith has provided $200,000 of cash as of August 6, 2014 and the parties agreed to include the unsecured funds in the amount of $64,000 provided by Mr. Smith on July 15, 2014 and include those amounts as part of this subordinated secured transaction.  The loan agreement executed by the parties on July 15, 2014 is now null and void.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under this note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  The note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
6
 
 

 
Results of Operations

Three Months Ended June 30, 2014 Compared with Three Months Ended June 30, 2013

Revenues

Revenue for the three months ended June 30, 2014 was $212,154, as compared to revenue of $382,126 for the three months ended June 30, 2013, a decrease of 44%.  Our revenue for the three months ended June 30, 2014 and 2013 was entirely attributable to product sales.  The reasons for the decline were that two customers had discontinued product lines that incorporated the Company’s ingredients for reasons other than the performance of the particular ingredients.  In addition, two of the larger customers of the Company had on hand sufficient inventory, therefore, eliminating the need to place orders during the second quarter.  Company management believes that it will not have similar issues in the third and fourth quarters for 2014.

Cost of Revenues

Cost of revenues for products sold for the three months ended June 30, 2014 and 2013 was $215,971 and $597,292, respectively, a decrease of $381,321 or 63.8%.  The decrease in costs of goods sold in the current year’s period was attributable to our total reliance on our outside toll manufacturer to produce sellable product. Costs that previously were related to the Company’s manufacturing of products at our pilot facility are now classified as research and development costs. We believe that sustained increases in sales and monthly production volume will enable us to allocate our fixed costs over a greater number of finished goods and further reduce the cost of goods sold in the future to improve margins.  As we continue to increase production pursuant to the CPA with ANP, we expect that this will result in greater efficiencies in our production process and also result in improved margins.  However, there can be no assurance that greater efficiencies or improved margins can be achieved.

Gross Loss

Gross loss for the three months ended June 30, 2014 was $3,817, or approximately 1.8% of revenues, as compared to a gross loss of $215,166, or approximately 56% of revenues for the three months ended June 30, 2013.  Gross income or loss reflects a number of factors that can vary from period to period, including those described above.

Operating Expenses

As a result of all manufacturing activity being moved to ANP, direct manufacturing costs that were previously included with Costs of Revenue are now related to the Company’s efforts at research and development of new products and processes using different feed stocks, expanded grade applications and more efficient manufacturing methods.  These costs are being classified as operating expenses for the three months ended June 30, 2014.  Therefore, operating expenses for the three months ended June 30, 2014 were $1,518,291 (including $397,990 of research and development costs) as compared to $1,624,701 (which includes $2,000 of research and development costs) for the three months ended June 30, 2013, a decrease of $106,410, or 6.6%.

The significant components of selling, general and administrative expenses are as follows:

 
Three Months Ended June 30,
 
2014
 
2013
Stock based compensation expenses
 $363,560
 
 $758,535
Salary expenses
 319,320
 
 322,746
Professional fees
 17,630
 
 90,724
Non-manufacturing depreciation expenses
 560
 
 928
Employment recruiting expenses
 -
 
 297
Investor relation expense
 5,389
 
 55,030
       
 
 $706,459
 
 $1,228,260
 
7
 
 

 
The decrease in stock-based compensation was attributable to a decrease in market price for the stocks on the date employee stock options were granted.  Professional fees were higher in 2013 due to legal fees incurred regarding a settlement with a former provider of investment services and work related to potential capital raising activities. Investor relations expense was higher due to work related to potential capital raising activities in 2013.  Excluding stock-based compensation expenses, directors’ fees and non-manufacturing depreciation expenses, which are non-cash items, our operating expenses, excluding research and development costs, for the three months ended June 30, 2014 and 2013 were $680,182 and $865,239, respectively.  Operating expenses excluding non-cash items is a non-Generally Accepted Accounting Principles (“non-GAAP”) financial measure and is provided by our management to provide further information regarding uses of cash during the periods presented.  This non-GAAP measure, we believe, will assist our investors to better understand our uses of cash resources with respect to operating expenses during the periods presented.  The GAAP presentation is as set forth in our financial statements.

Included as research and development costs are the following:
 
 
Three Months Ended June 30,
 
2014
 
2013
Salary and employee benefits
 $90,599
 
 $-
Depreciation expense
 164,595
 
 -
Utilities
 51,337
 
 -
Product analysis and testing
 65,182
 
 -
Repairs and supplies
 11,378
 
 -
Other
 14,898
 
 2,000
       
 
 $397,989
 
 $2,000
 
Operating Loss

The operating loss for the three months ended June 30, 2014 decreased to $1,522,108 compared to $1,839,867 for the three months ended June 30, 2013 due to the reasons described above.

Other Income (Expenses)

Other expense for the three months ending on June 30, 2014 was $51,969 as compared to other income of $4,922,094 for the three months ending on June 30, 2013.  The decrease in other income (expenses) of $4,974,063 was primarily due to the decrease in the fair value of our derivatives, which resulted in additional income of $4,929,042 during 2013. The decrease in the fair value of the derivative liability resulted from the conversion of derivative securities during the period that originally led to the recognition of the derivative liability.   Interest expense on debt of $43,066 incurred during the three months ended June 30, 2014 related to the short-term borrowings and convertible note payable discussed above.  There was no interest expense recognized during the three months ended June 30, 2013 due to all convertible notes payable being converted to common stock during fiscal year 2012.

Net Loss

As a result of the above, for the three months ended June 30, 2014, we reported a net loss of $1,574,077 as compared to net income of $3,082,227 for the three months ended June 30, 2013.

Basic and Diluted Net Income (Loss) per Share

The basic and diluted net loss per share for the three months ended June 30, 2014 was $0.04 as compared to the basic and diluted net income per share of $0.10 and $0.08, respectively, for the three months ended June 30, 2013.

8
 
 

 
Six Months Ended June 30, 2014 Compared with Six Months Ended June 30, 2013

Revenues

Revenue for the six months ended June 30, 2014 was $528,624, as compared to revenue of $745,957 for the six months ended June 30, 2013, a decrease of 29%.  Our revenue for the six months ended June 30, 2014 and 2013 was entirely attributable to product sales.  The reasons for the decline were that two customers had discontinued product lines that incorporated the Company’s ingredients for reasons other than the performance of the particular ingredients.  In addition, two of the larger customers of the Company had on hand sufficient inventory, therefore, eliminating the need to place orders during the second quarter.  Company management believes that it will not have similar issues in the third and fourth quarters for 2014.  

Cost of Revenues

Cost of revenues for products sold for the six months ended June 30, 2014 and 2013 was $529,952 and $1,266,765, respectively, a decrease of $736,813 or 58.2%.  The decrease in costs of goods sold in the current year’s period was attributable to our total reliance on our outside toll manufacturer to produce sellable product. Costs that previously were related to the Company’s manufacturing of products at our pilot facility are now classified as research and development costs. We believe that sustained increases in sales and monthly production volume will enable us to allocate our fixed costs over a greater number of finished goods and further reduce the cost of goods sold in the future to improve margins.  As we continue to increase production pursuant to the CPA with ANP, we expect that this will result in greater efficiencies in our production process and also result in improved margins.  However, there can be no assurance that greater efficiencies or improved margins can be achieved.

Gross Loss

Gross loss for the six months ended June 30, 2014 was $1,328, or approximately 0.3% of revenues, as compared to a gross loss of $520,808, or approximately 69.8% of revenues for the six months ended June 30, 2013.  Gross loss reflects a number of factors that can vary from period to period, including those described above.

Operating Expenses

As a result of all manufacturing activity being moved to ANP, direct manufacturing costs that were previously included with Costs of Revenue are now related to the Company’s efforts at research and development of new products and processes using different feed stocks, expanded grade applications and more efficient manufacturing methods.  These costs are being classified as operating expenses for the six months ended June 30, 2014.  Therefore, operating expenses for the six months ended June 30, 2014 were $3,018,279 (including $796,367 of research and development costs) as compared to $3,458,151 (which includes $58,678 of research and development costs) for the six months ended June 30, 2013, a decrease of $439,872, or12.7%.

The significant components of selling, general and administrative expenses are as follows:
 
 
Six Months Ended June 30,
 
2014
 
2013
Stock based compensation expenses
 $614,719
 
 $1,435,467
Salary expenses
 653,463
 
 646,747
Professional fees
 96,536
 
 329,048
Non-manufacturing depreciation expenses
 1,122
 
 2,094
Employment recruiting expenses
 395
 
 590
Investor relation expense
 30,879
 
 124,130
       
 
 $1,397,114
 
 $2,538,076
 
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The decrease in stock-based compensation was attributable to a decrease in market price for the stocks on the date employee stock options were granted.  Professional fees were higher in 2013 due to legal fees incurred regarding a settlement with a former provider of investment services and work related to potential capital raising activities. Investor relations expense was higher due to work related to potential capital raising activities in 2013.  Excluding stock-based compensation expenses, directors’ fees and non-manufacturing depreciation expenses, which are non-cash items, our operating expenses, excluding research and development costs, for the six months ended June 30, 2014 and 2013 were $1,370,070 and $1,820,588, respectively.  Operating expenses excluding non-cash items is a non-Generally Accepted Accounting Principles (“non-GAAP”) financial measure and is provided by our management to provide further information regarding uses of cash during the periods presented.  This non-GAAP measure, we believe, will assist our investors to better understand our uses of cash resources with respect to operating expenses during the periods presented.  The GAAP presentation is as set forth in our financial statements.
 
Included as research and development costs are the following:
 
 
Six Months Ended June 30,
 
2014
 
2013
Salary and employee benefits
 $183,267
 
 $-
Depreciation expense
 329,191
 
 -
Utilities
 100,711
 
 -
Product analysis and testing
 138,730
 
 -
Repairs and supplies
 13,274
 
 -
Other
 31,194
 
 58,678
       
 
 $796,367
 
 $58,678
 
Operating Loss

The operating loss for the six months ended June 30, 2014 decreased to $3,019,607 compared to $3,978,959 for the six months ended June 30, 2013 due to the reasons described above.

Other Income (Expenses)

Other income for the six months ending on June 30, 2014 was $7,460 as compared to other expenses of $4,278,958 for the six months ending on June 30, 2013.  The increase in other income (expenses) of $4,286,418 was primarily due to the decrease in the fair value of our derivatives, which resulted in additional income of $4,326,997 as compared to the prior year. The decrease in the fair value of the derivative liability resulted from the conversion of derivative securities during the period that originally led to the recognition of the derivative liability.   Interest expense on debt of $48,298 incurred during the six months ended June 30, 2014 related to the short-term borrowings and convertible note payable discussed above.  There was no interest expense recognized during the six months ended June 30, 2013 due to all convertible notes payable being converted to common stock during fiscal year 2012.

Net Loss

As a result of the factors discussed above, for the six months ended June 30, 2014 and 2013, we reported net losses of $3,012,147 and $8,257,917, respectively.

Basic and Diluted Net Loss per Share

The basic and diluted net loss per share for the six months ended June 30, 2014 was $0.08 as compared to the basic and diluted net loss per share of $0.28 for the six months ended June 30, 2013.

Liquidity and Capital Resources

As of June 30, 2014, we had a cash balance of $16,887, a decrease from a balance of $443,472 at December 31, 2013.  At June 30, 2014, we had a working capital deficit of $418,682, as compared to working capital of $805,195 as of December 31, 2013.  The decrease in working capital primarily resulted from the increases in inventory, accounts payable and short-term borrowings as a result of an unanticipated change in the ordering pattern of several customers that resulted in a decrease in orders during the first six months of 2014.
 
On February 11, 2014 the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $200,000 in a convertible senior secured note.  The note matures in two years (February 11, 2016) and bears interest at 12.5% computed based on a 365-day year.  Accrued interest is payable either at maturity or quarterly at the option of Mr. Smith in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $2.25, subject to adjustment as provided in the note.  If on the maturity date of the note, the thirty day trailing average closing price of the Company’s Common Stock (the “Trailing Average Price”) is below $2.25, the Conversion Price on the maturity date will be reduced to the Trailing Average Price, but to not less than $1.25.  The note is secured by the assets of the Company, which security interest is expressly subordinate to the interest of Fordham Capital Partners LLC described below, pursuant to an intercreditor agreement between Mr. Smith and Fordham dated March 18, 2014.
 
On March 24, 2014, Fordham Capital Partners, LLC (“Fordham”) extended a $500,000 revolving loan (the “Equipment Loan”) to Z Trim Holdings, Inc. (the “Company”) evidenced by an Equipment Revolving Note (the “Note”) issued by the Company to Fordham.  The Note requires monthly payments of principal of $10,417 plus interest, commencing on April 24, 2014 and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Note is calculated at a fixed rate of 20% per annum.  The Note may be prepaid in full at any time; provided that if the Company prepays the Note prior to September 24, 2014 (such six-month period, the “Guaranteed Interest Period”), it must pay a prepayment penalty equal to the amount by which (i) the aggregate interest that Fordham would have received on the Note during the Guaranteed Interest Period had there been no prepayment exceeds (ii) the aggregate interest paid by the Company prior to the date of prepayment.
 
Pursuant to the Security Agreement, dated March 24, 2014, between the Company and Fordham (the “Security Agreement”), the Equipment Loan is secured by a first priority security interest in all of the Company’s equipment (as more specifically defined in the Security Agreement, the “Collateral”).  The Security Agreement also contains customary restrictive covenants, including without limitation, covenants prohibiting the Company from (i) granting additional liens in the Collateral, (ii) selling, leasing or transferring the Collateral, (iii) entering into certain merger, consolidation or other reorganization transactions, and (iv) creating, incurring or assuming additional indebtedness, in each case subject to certain exceptions.  The Security Agreement also contains customary events of default.  If an event of default under the Security Agreement occurs and is continuing, Fordham may declare any outstanding obligations under the Credit Agreement immediately due and payable.  After an event of default, interest on the Note would accrue at a rate of 25% per annum.
 
Additionally, pursuant to the Factoring Agreement, dated March 24, 2014, between the Company and Fordham, Fordham may purchase any Accounts of the Company (the “Factoring Agreement”).  To secure payment and performance of the Company’s liabilities and obligations to Fordham, including obligations under the Factoring Agreement, the Company granted Fordham a security interest in all of the Company’s (i) Accounts, (ii) Inventory, (iii) Chattel Paper, Deposit Accounts, Documents, Equipment, Financial Assets, Fixtures, General Intangibles, Instruments, Investment Property, Letter-of-Credit Rights, Securities, Software and Supporting Obligations, (iv) books and records of Seller which relate to Accounts, (v) all amounts owing to the Company under the Factoring Agreement, and (vi) Proceeds of the foregoing.  The Factoring Agreement terminates at any time that the Equipment Loan is paid in full.
 
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On April 25, 2014, the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $300,000 in a convertible subordinated secured note.  The note matures in two years (April 25, 2016) and bears interest at 14% computed based on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  The note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On April 30, 2014, the Company issued a 14% convertible subordinated secured note to each of Morris Garfinkle, Mark Hershhorn, Brian Israel and Edward B. Smith, Directors of the Company, in the principal amount of $19,000, for director fees due and payable to them (the “Director Notes”).  Each Director Note matures in two years (April 30, 2016) and bears interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the Director Note, the director may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each Director Note is $1.00. The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  Each Director Note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On May 12, 2014, the Company issued 14% convertible subordinated secured notes to both Mo Garfinkle and CKS Warehouse in the principal amount of $75,000 each.  Both notes mature in two years (May 12, 2016) and bear interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of each note, Mr. Garfinkle and CKS Warehouse may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  Each note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On July 15, 2014, the Company entered into an agreement with Edward Smith III, pursuant to which Mr. Smith agreed to lend the Company $64,000 in an unsecured note payable.  The note matures in 90 days (October 15, 2014) without interest payable on the unpaid principal and subject to the terms of the Company’s agreements with its secured creditors.
 
On July 16, 2014, the Company and Fordham Capital Partners, LLC entered into an Amended and Restated Equipment Revolving Note (the “Amended Note”) in the amount of $582,841.63.  The Amended Note requires monthly payments of principal of $12,143 plus interest, commencing on July 24, 2014 and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Amended Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Amended Note is calculated at a fixed rate of 22% per annum.
 
Also on July 16, 2014, the Company and Fordham Capital Partners, LLC entered into a First Amendment to Security Agreement in which the Amended Note is secured by a first priority security interest in all of the Company’s equipment under substantially the same terms and covenants as stated in the original Security Agreement indicated above.
 
On July 25, 2014, the Company and Fordham Capital Partners, LLC entered into an Amended and Restated Equipment Revolving Note (the “Second Amended Note”) in the amount of $668,750.  The Second Amended Note requires one monthly payment of principal of $12,143 plus interest, commencing on July 25, 2014 followed by successive monthly installments of principal of $13,679 plus interest and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Second Amended Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Second Amended Note is calculated at a fixed rate of 22% per annum.
 
Also on July 25, 2014, the Company and Fordham Capital Partners, LLC entered into a Second Amendment to Security Agreement in which the Second Amended Note is secured by a first priority security interest in all of the Company’s equipment under substantially the same terms and covenants as stated in the original and the First Security Agreement indicated above.
 
On August 6, 2014, the Company issued a 14% convertible subordinated secured note to Edward B. Smith in the principal amount of $264,000.  The note matures in two years (August 6, 2016) and bears interest at 14% computed on a 365-day year.  Under this note Mr. Smith has provided $200,000 of cash as of August 6, 2014 and the parties agreed to include the unsecured funds in the amount of $64,000 provided by Mr. Smith on July 15, 2014 and include those amounts as part of this subordinated secured transaction.  The loan agreement executed by the parties on July 15, 2014 is now null and void.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under this note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  The note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
To successfully grow our business, our management believes it must improve our cash position through greater and sustainable sales of our product lines, and increase the productivity and efficiency of the production process.  However, such an increase would depend on sustained or increased levels of purchases by existing and new customers and actual realization of our customers’ current demand levels, as well as the completion of changes in our production process, all of which cannot be assured. 
 
Certain of the Company’s warrants have reset provisions to the exercise price and conversion price if the Company issues equity or other derivatives at a price less than the exercise price set forth in such warrants. These reset provisions result in a derivative liability in our financial statements.  Our derivative liabilities decreased to $60,666 at June 30, 2014 from $95,049 at December 31, 2013.  Fair values for exchange traded securities and derivatives are based on quoted market prices. Where market prices are not readily available, fair values are determined using market based pricing models incorporating readily observable market data and requiring judgment and estimates.
 
In connection with the CPA with ANP, the Company agreed to make available to ANP a $500,000 line of credit at an interest rate of 5.5%.  The line of credit is only permitted to be used by ANP for operating costs, which excludes capital expenditures of equipment in excess of $5,000.   The loan is to be paid back to the Company in the form of discounts on production pricing commencing either two years after the first draw by ANP on the line of credit (other than the $10,000 the Company loaned ANP to assist it with the purchase of its Waukon, Iowa facility) or the first month after the Company has ordered 80,000 pounds of product for three consecutive months, whichever shall occur first.  All of ANP’s obligations under the line of credit, as well as the CPA, are specifically guaranteed by its parent company, AVEKA Inc.  As of June 30, 2014, the amount outstanding to ANP under the line of credit was $491,689.  This extension of credit to ANP had a material adverse impact on the Company’s cash resources, which has required the Company to seek additional capital resources to fund its operations.
 
On March 28, 2014 the Company entered into an amendment to the custom processing agreement with ANP relating to the repayment of the line of credit advances made by the Company plus interest.  Commencing on April 1, 2014, ANP agreed to begin paying the Company $5,000 per month to be applied to the advances made and accrued interest.
 
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The following discussion focuses on information in more detail on the main elements of the $426,585 net decrease in cash during the six months ended June 30, 2014 included in the accompanying Statements of Cash Flows. The table below sets forth a summary of the significant sources and uses of cash for the six month periods ended June 30:
 
 
2014
 
2013
Cash used in operating activities
 $(1,621,335)
 
 $(2,649,215)
Cash provided by financing activities
 1,194,750
 
 2,483,723
       
(Decrease) Increase in cash
 $(426,585)
 
 $(165,492)
 
Cash used in operating activities was $1,621,335 during the six month period ended June 30, 2014, compared to $2,649,215 in the six month period ended June 30, 2013.  Net losses of $3,012,147 and $8,257,917 for the six months ended June 30, 2014 and 2013, respectively, were the primary reasons for our negative operating cash flow in both periods.  The Company’s negative operating cash flow for the six months ended June 30, 2014 was offset by the effects of non-cash charges to income including stock-based compensation, shares issued for directors fees and depreciation. During the six months ended June 30, 2013 the Company’s negative operating cash flow was offset by $4,789,801 of expense related to the equity modification to warrants and changes in the fair value of the derivative liability as a result of warrants being exercised.
 
No cash was provided by or used in investing activities in either period.
 
Cash provided by financing activities was $1,194,750 in the six month period ended June 30, 2014, compared to $2,483,723 during the six month period ended June 30, 2013.  Over the last several years, the Company’s operations have been funded primarily through the sale of both equity and debt securities and the cash conversion of warrants into equity. During the first six months of 2014, the Company raised $500,000 in short-term borrowings and $726,000 from convertible notes payable from various related parties as discussed above.  The Company’s warrant exercise program raised approximately $2,405,989 in additional capital during the first six months of 2013.  The Company did not engage in any debt financing for the six months ended June 30, 2013.
 
Commitments/Contingencies:

AVEKA Nutra Processing, LLC Line of Credit.  As discussed under “Liquidity and Capital Resources” above, under the terms of the CPA with ANP, the Company agreed to make available to ANP a $500,000 line of credit (which includes $10,000 that the Company loaned ANP to assist ANP with the purchase of its Waukon, Iowa facility) at an interest rate of 5.5%.  As of June 30, 2014, the amount outstanding to ANP under the line of credit was $491,689.
 
Debt Instruments. On February 11, 2014 the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $200,000 in a convertible senior secured note.  The note matures in two years (February 11, 2016) and bears interest at 12.5% computed based on a 365-day year.  Accrued interest is payable either at maturity or quarterly at the option of Mr. Smith in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $2.25, subject to adjustment as provided in the note.  If on the maturity date of the note, the thirty day trailing average closing price of the Company’s Common Stock (the “Trailing Average Price”) is below $2.25, the Conversion Price on the maturity date will be reduced to the Trailing Average Price, but to not less than $1.25.  The note is secured by the assets of the Company, which security interest is expressly subordinate to the interest of Fordham Capital Partners LLC described below, pursuant to an intercreditor agreement between Mr. Smith and Fordham dated March 18, 2014.
 
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On March 24, 2014, Fordham Capital Partners, LLC (“Fordham”) extended a $500,000 revolving loan (the “Equipment Loan”) to Z Trim Holdings, Inc. (the “Company”) evidenced by an Equipment Revolving Note (the “Note”) issued by the Company to Fordham.  The Note requires monthly payments of principal of $10,417 plus interest, commencing on April 24, 2014 and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Note is calculated at a fixed rate of 20% per annum.  The Note may be prepaid in full at any time; provided that if the Company prepays the Note prior to September 24, 2014 (such six-month period, the “Guaranteed Interest Period”), it must pay a prepayment penalty equal to the amount by which (i) the aggregate interest that Fordham would have received on the Note during the Guaranteed Interest Period had there been no prepayment exceeds (ii) the aggregate interest paid by the Company prior to the date of prepayment.
 
Pursuant to the Security Agreement, dated March 24, 2014, between the Company and Fordham (the “Security Agreement”), the Equipment Loan is secured by a first priority security interest in all of the Company’s equipment (as more specifically defined in the Security Agreement, the “Collateral”).  The Security Agreement also contains customary restrictive covenants, including without limitation, covenants prohibiting the Company from (i) granting additional liens in the Collateral, (ii) selling, leasing or transferring the Collateral, (iii) entering into certain merger, consolidation or other reorganization transactions, and (iv) creating, incurring or assuming additional indebtedness, in each case subject to certain exceptions.  The Security Agreement also contains customary events of default.  If an event of default under the Security Agreement occurs and is continuing, Fordham may declare any outstanding obligations under the Credit Agreement immediately due and payable.  After an event of default, interest on the Note would accrue at a rate of 25% per annum.
 
Additionally, pursuant to the Factoring Agreement, dated March 24, 2014, between the Company and Fordham, Fordham may purchase any Accounts of the Company (the “Factoring Agreement”).  To secure payment and performance of the Company’s liabilities and obligations to Fordham, including obligations under the Factoring Agreement, the Company granted Fordham a security interest in all of the Company’s (i) Accounts, (ii) Inventory, (iii) Chattel Paper, Deposit Accounts, Documents, Equipment, Financial Assets, Fixtures, General Intangibles, Instruments, Investment Property, Letter-of-Credit Rights, Securities, Software and Supporting Obligations, (iv) books and records of Seller which relate to Accounts, (v) all amounts owing to the Company under the Factoring Agreement, and (vi) Proceeds of the foregoing.  The Factoring Agreement terminates at any time that the Equipment Loan is paid in full.
 
Following the quarter ended March 31, 2014, the Company entered into the following additional debt instruments:

On April 25, 2014, the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $300,000 in a convertible subordinated secured note.  The note matures in two years (April 25, 2016) and bears interest at 14% computed based on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  The note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On April 30, 2014, the Company issued a 14% convertible subordinated secured note to each of Morris Garfinkle, Mark Hershhorn, Brian Israel and Edward B. Smith, Directors of the Company, in the principal amount of $19,000, for director fees due and payable to them (the “Director Notes”).  Each Director Note matures in two years (April 30, 2016) and bears interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the Director Note, the director may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each Director Note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  Each Director Note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On May 12, 2014, the Company issued 14% convertible subordinated secured notes to both Mo Garfinkle and CKS Warehouse in the principal amount of $75,000 each.  Both notes mature in two years (May 12, 2016) and bear interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of each note, Mr. Garfinkle and CKS Warehouse may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  Each note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
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Following the six months ending June 30, 2014, the Company entered into the following additional debt instruments:

On July 15, 2014, the Company entered into an agreement with Edward Smith III, pursuant to which Mr. Smith agreed to lend the Company $64,000 in an unsecured note payable.  The note matures in 90 days (October 15, 2014) without interest payable on the unpaid principal and subject to the terms of the Company’s agreements with its secured creditors.
 
On July 16, 2014, the Company and Fordham Capital Partners, LLC entered into an Amended and Restated Equipment Revolving Note (the “Amended Note”) in the amount of $582,841.63.  The Amended Note requires monthly payments of principal of $12,143 plus interest, commencing on July 24, 2014 and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Amended Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Amended Note is calculated at a fixed rate of 22% per annum.
 
Also on July 16, 2014, the Company and Fordham Capital Partners, LLC entered into a First Amendment to Security Agreement in which the Amended Note is secured by a first priority security interest in all of the Company’s equipment under substantially the same terms and covenants as stated in the original Security Agreement indicated above.
 
On July 25, 2014, the Company and Fordham Capital Partners, LLC entered into an Amended and Restated Equipment Revolving Note (the “Second Amended Note”) in the amount of $668,750.  The Second Amended Note requires one monthly payment of principal of $12,143 plus interest, commencing on July 25, 2014 followed by successive monthly installments of principal of $13,679 plus interest and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Second Amended Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Second Amended Note is calculated at a fixed rate of 22% per annum.
 
Also on July 25, 2014, the Company and Fordham Capital Partners, LLC entered into a Second Amendment to Security Agreement in which the Second Amended Note is secured by a first priority security interest in all of the Company’s equipment under substantially the same terms and covenants as stated in the original and the First Security Agreement indicated above.
 
On August 6, 2014, the Company issued a 14% convertible subordinated secured note to Edward B. Smith in the principal amount of $264,000.  The note matures in two years (August 6, 2016) and bears interest at 14% computed on a 365-day year.  Under this note Mr. Smith has provided $200,000 of cash as of August 6, 2014 and the parties agreed to include the unsecured funds in the amount of $64,000 provided by Mr. Smith on July 15, 2014 and include those amounts as part of this subordinated secured transaction.  The loan agreement executed by the parties on July 15, 2014 is now null and void.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under this note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  The note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
Capital Expenditures.  At June 30, 2014, the Company has no material commitments for capital expenditures.
 
Lease commitments.  The Company leases a combined research and development and office facility located in Mundelein, Illinois.  The lease expires in May 2015 and the monthly rental payments are $21,361, inclusive of property taxes.  If the Company wishes to remain at this facility beyond the lease expiration date, it will need to negotiate a new lease with the landlord, which cannot be assured.
 
Litigation.  In July 2007, the Company and Greg Halpern, its former Chief Executive Officer in his individual capacity, were sued in the 20th Judicial Circuit Court, St. Clair County, Illinois by Joseph Sanfilippo and James Cluck for violation of the Consumer Fraud Act and damages in excess of $200,000. The trial court has issued a default order against the Company, and has denied the Company’s motion to reconsider.  Management believes that the trial court’s rulings were erroneous and that it has grounds for appeal, and that the underlying allegations are frivolous and wholly without merit and the Company will vigorously defend the claim. The outcome of this matter is unknown as of the date of this report.  However, the Company has allocated a reserve of $102,000 to satisfy any liability it may incur as a result of this matter.
 
In December 2011, the Company was sued in Circuit Court of the 17th Judicial District, Winnebago County, Illinois, by LIBCO Industries, Inc., alleging the Company breached a construction contract and tortiously interfered with a business relationship, and is seeking damages in excess of $185,000.  The case has subsequently been transferred to the 19th Judicial Circuit Court, Lake County, Illinois.  Management believes that the allegations are frivolous and wholly without merit and will vigorously defend the claim.  Related to this matter, Process Piping, LLC, a sub-contractor for LIBCO Industries, filed a mechanics lien on the property leased by the Company, claiming it was owed in excess of $95,000 by LIBCO Industries.  On March 6, 2012, the Company paid $62,500 to Process Piping, LLC in exchange for a release of its lien as well as an assignment of all of its claims against LIBCO Industries.  On January 31, 2013, the Circuit Court granted the Company’s motion for partial summary judgment on the tortious interference claim.  During the fourth quarter of 2013, the parties settled all outstanding matters and the case have been dismissed.  On January 21, 2014 as part of the settlement, the Company received $10,000 in cash and both parties provided releases of all respective claims.
 
14
 
 

 
Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements.
 
Critical Accounting Policies
 
Our financial statements have been prepared in conformity with GAAP. For a full discussion of our accounting policies as required by GAAP, refer to our Annual Report on Form 10-K for the year ended December 31, 2013. We consider certain accounting policies to be critical to an understanding of our condensed consolidated financial statements because their application requires significant judgment and reliance on estimations of matters that are inherently uncertain. The specific risks related to these critical accounting policies are unchanged at the date of this report and are described in detail in our Annual Report on Form 10-K.
 
Item 3. Quantitative and Qualitative Disclosure About Market Risks
 
Not Applicable.
 
Item 4. Controls and Procedures.
 
Evaluation of Disclosure Controls and Procedures.
 
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were not effective (1) to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (2) to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to us, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  This conclusion is based primarily on the material weakness in internal control over financial reporting which was disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013, where management identified material weaknesses consisting of ineffective controls over the control environment and financial statement disclosures, and our failure to complete the process of remediating these weaknesses by the end of the period covered by this Quarterly Report.
 
Changes in Internal Control Over Financial Reporting
 
There have been no changes in the Company’s internal control over financial reporting through the date of this report or during the quarter ended June 30, 2014, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
Limitations on the Effectiveness of Controls
 
Our Principal Executive Officer and Principal Financial Officer do not expect that our disclosure controls or internal controls will prevent all error and all fraud. Although our disclosure controls and procedures were designed to provide reasonable assurance of achieving their objectives, a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented if there exists in an individual a desire to do so. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
 
Furthermore, smaller reporting companies face additional limitations. Smaller reporting companies employ fewer individuals and find it difficult to properly segregate duties. Often, one or two individuals control every aspect of the Company's operation and are in a position to override any system of internal control. Additionally, smaller reporting companies tend to utilize general accounting software packages that lack a rigorous set of software controls.
 
Remediation of Material Weaknesses
 
As discussed above, as of December 31, 2013, we identified material weaknesses in our internal control over financial reporting primarily due to the Company not having developed accounting policies and procedures and effectively communicated to same to its employees.  Management plans to address these weaknesses by providing future investments in the continuing education of our accounting and financial professionals.
 
If the remedial measures described above are insufficient to address any of the identified material weaknesses or are not implemented effectively, or if additional deficiencies arise in the future, material misstatements in our interim or annual financial statements may occur in the future. Among other things, any unremediated material weaknesses could result in material post-closing adjustments in future financial statements.

15
 
 

 

PART II – OTHER INFORMATION

Item 1.  Legal Proceedings

In July 2007, the Company and Greg Halpern, its former Chief Executive Officer in his individual capacity, were sued in the 20th Judicial Circuit Court, St. Clair County, Illinois by Joseph Sanfilippo and James Cluck for violation of the Consumer Fraud Act and damages in excess of $200,000. The trial court has issued a default order against the Company, and has denied the Company’s motion to reconsider.  Management believes that the trial court’s rulings were erroneous and that it has grounds for appeal, and that the underlying allegations are frivolous and wholly without merit and the Company will vigorously defend the claim. The outcome of this matter is unknown as of the date of this report.  However, the Company has allocated a reserve of $102,000 to satisfy any liability it may incur as a result of this matter.
 

Item 1A.  Risk Factors

In addition to the risks and uncertainties discussed herein, particularly those discussed in the “Safe Harbor” Cautionary Statement and the other sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 2, see the risk factors set forth in Part I, Item 1A of our annual report on Form 10-K for the fiscal year ended December 31, 2013.
 
Item 5.  Other Information

The Company leases a combined research and development and office facility located in Mundelein, Illinois.  The facility is approximately 44,000 square feet.  On March 14, 2014, The Company extended the lease until May 2015 and the required monthly rental payments are $21,361, inclusive of property taxes.  Insurance and maintenance are billed when due.

Item 6.  Exhibits

See the Exhibit Index included as the last part of this report (following the signature page), which is incorporated herein by reference.
 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 


Z TRIM HOLDINGS, INC.
(Registrant)


Date: August 12, 2014
/s/ Steven J. Cohen
 
 
Steven J. Cohen
Chief Executive Officer

Date: August 12, 2014                                                                           /s/ Brian Chaiken
 
 
Brian Chaiken
Chief Financial Officer (Principal Financial Officer)

16

 
 

 

EXHIBIT INDEX
Z TRIM HOLDINGS, INC.
Form 10-Q for Quarter Ended June 30, 2014

 
Exhibit Number
 
Description
 
10.1
Unsecured and Noninterest Bearing Note Payable dated July 15, 2014, to Edward B. Smith in the principal amount of $64,000.+*
   
10.2
Amended and Restated Equipment Revolving Note dated July 16, 2014, issued by Z Trim Holdings, Inc. in favor of Fordham Capital Partners, LLC.(1)
   
10.3
First Amendment to Security Agreement dated July 16, 2014, between Z Trim Holdings, Inc. and Fordham Capital Partners, LLC.(1)
   
10.4
Second Amended and Restated Equipment Revolving Note dated July 25, 2014, issued by Z Trim Holdings, Inc. in favor of Fordham Capital Partners, LLC.(2)
   
10.5
Second Amendment to Security Agreement dated July 25, 2014, between Z Trim Holdings, Inc. and Fordham Capital Partners, LLC.(2)
 
10.6
14% Convertible Subordinated Secured Note dated August 6, 2014, to Edward B. Smith in the principal amount of $264,000.(3)
 
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
 
31.2
Certification of Principal Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
 
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
32.2
Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
101.INS
XBRL Instance Document
 
101.SCH
XBRL Taxonomy Extension Schema Document
 
101.CAL
XBRL Taxonomy Extension Calculation Link base Document
 
1.01 LAB
XBRL Extension Labels Link base Document
 
101.PRE
XBRL Taxonomy Extension Presentation Link base Document
 
101.DEF
XBRL Taxonomy Extension Definition Link base Document
 
_______

+ Management compensatory plan or arrangement.

* Filed herewith.

(1)  
Incorporated herein by reference to the Company’s Form 8-K filed with the Securities and Exchange Commission on July 21, 2014.

(2)  
Incorporated herein by reference to the Company’s Form 8-K filed with the Securities and Exchange Commission on July 24, 2014.

(3)  
Incorporated herein by reference to Edward Smith's Form 4 filed with the Securities and Exchange Commission on August 7, 2014.
 
17

 
 

 

     
INDEX TO FINANCIAL STATEMENTS
         
                     
                   
PAGE
                     
Balance Sheets at June 30, 2014 (unaudited) and December 31, 2013
       
F-1
                     
Statements of Operations for the three and six months ended June 30, 2014 and 2013 (unaudited)
 
F-3
                     
Statements of Cash Flows for the six months ended June 30, 2014 and 2013 (unaudited)
   
F-4
                     
Notes to Financial Statements as of June 30, 2014 and 2013 (unaudited)
     
F-5
 
18
 
 

 
Z TRIM HOLDINGS, INC.
       
BALANCE SHEET
       
         
ASSETS
       
         
   
(Unaudited)
   
   
6/30/14
 
12/31/13
         
Current Assets
       
Cash and cash equivalents
 
 $16,887
 
 $443,472
Accounts receivable
 
 179,570
 
 380,238
Inventory
 
 769,326
 
 544,535
Prepaid expenses and other assets
 
 64,464
 
 136,887
         
Total current assets
 
 1,030,247
 
 1,505,132
         
Long Term Assets
       
        Note receivable
 
 $549,208
 
 $550,650
        Other assets
 
 56,097
 
 11,892
        Property and equipment, net
 
 1,469,993
 
 1,800,306
         
Total long term assets
 
 2,075,298
 
 2,362,848
         
TOTAL ASSETS
 
 $3,105,545
 
 $3,867,980
         
LIABILITIES & STOCKHOLDERS' EQUITY (DEFICIT)
       
         
   
(Unaudited)
   
   
6/30/14
 
12/31/13
         
Current Liabilities
       
Accounts payable
 
 $693,351
 
 $374,566
Short-term borrowings
 
 468,750
 
 -
Accrued expenses and other
 
 189,984
 
 194,144
Accrued liquidated damages
 
 36,178
 
 36,178
        Derivative liabilities
 
 60,666
 
 95,049
Total Current Liabilities
 
 1,448,929
 
 699,937
         
Long-term convertible notes payable to related parties
 
 726,000
 
 -
         
Total Liabilities
 
 2,174,929
 
 699,937
         
Stockholders' Equity (Deficit)
       
Common stock, $0.00005 par value; authorized 200,000,000 shares; issued and outstanding 39,734,854 and 39,449,138 shares, June 30, 2014 and December 31, 2013, respectively
 1,987
 
 1,973
Additional paid-in capital
 
 130,814,267
 
 130,039,561
Accumulated deficit
 
 (129,885,638)
 
 (126,873,491)
         
Total Stockholders' Equity (Deficit)
 
 930,616
 
 3,168,043
         
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY (DEFICIT)
 
 $3,105,545
 
 $3,867,980
 
The accompanying notes are an integral part of the financial statements.
F-1

 
 

 

Z TRIM HOLDINGS, INC.
               
STATEMENTS OF OPERATIONS (Unaudited)
               
                 
   
Three Months Ended
 
Six Months Ended
   
June 30,
     
June 30,
   
   
2014
 
2013
 
2014
 
2013
REVENUES:
               
  Products
 
 $212,154
 
 $382,126
 
 $528,624
 
 $745,957
    Total revenues
 
 212,154
 
 382,126
 
 528,624
 
 745,957
                 
COST OF REVENUES:
               
  Products
 
 215,971
 
 597,292
 
 529,952
 
 1,266,765
    Total cost of revenues
 
 215,971
 
 597,292
 
 529,952
 
 1,266,765
                 
GROSS MARGIN
 
 (3,817)
 
 (215,166)
 
 (1,328)
 
 (520,808)
                 
OPERATING EXPENSES:
               
Research and development costs
 
 397,990
 
 -
 
 796,367
 
 -
Selling, general and administrative
 
 1,120,301
 
 1,624,701
 
 2,221,912
 
 3,458,151
    Total operating expenses
 
 1,518,291
 
 1,624,701
 
 3,018,279
 
 3,458,151
                 
OPERATING LOSS
 
 (1,522,108)
 
 (1,839,867)
 
 (3,019,607)
 
 (3,978,959)
                 
OTHER INCOME (EXPENSES):
               
Rental and other income
 
 -
 
 -
 
 200
 
 -
Interest income
 
 6,777
 
 6,857
 
 13,558
 
 13,695
Interest expense - other
 
 (1,875)
 
 -
 
 (2,383)
 
 (39)
Interest expense - debt
 
 (43,066)
 
 -
 
 (48,298)
 
 -
Change in fair value - derivative
 
 (13,805)
 
 4,915,237
 
 34,383
 
 497,187
Expense for modification of warrants
 
 -
 
 -
 
 -
 
 (4,789,801)
Settlement gain (loss)
 
 -
 
 -
 
 10,000
 
 -
    Total other income (expenses)
 
 (51,969)
 
 4,922,094
 
 7,460
 
 (4,278,958)
                 
NET  INCOME (LOSS)
 
 $(1,574,077)
 
 $3,082,227
 
 $(3,012,147)
 
 $(8,257,917)
                 
Less Preferred Dividends
 
 -
 
 -
 
 -
 
 56,144
                 
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS
 
 $(1,574,077)
 
 $3,082,227
 
 $(3,012,147)
 
 $(8,314,061)
NET INCOME (LOSS) PER SHARE - BASIC
 
 $(0.04)
 
 $0.10
 
 $(0.08)
 
 $(0.28)
NET INCOME (LOSS) PER SHARE - DILUTED
 
 $(0.04)
 
 $0.08
 
 $(0.08)
 
 $(0.28)
                 
Weighted Average Number of Shares Basic
 
 39,734,854
 
 32,208,939
 
 39,731,697
 
 29,551,265
Weighted Average Number of Shares Diluted
 
 39,734,854
 
 37,720,441
 
 39,731,697
 
 29,551,265
 
The accompanying notes are an integral part of the financial statements.
F-2
 

 
 

 

Z TRIM HOLDINGS, INC.
     
STATEMENTS OF CASH FLOWS (Unaudited)
     
       
FOR THE SIX MONTHS ENDED JUNE 30
2014
 
2013
       
CASH FLOWS FROM OPERATING ACTIVITIES
     
Net loss
 $(3,012,147)
 
 $(8,257,917)
Adjustments to reconcile loss from continuing operations to
     
net cash used in operating activities:
     
Stock based compensation - stock options vested
 614,719
 
 1,435,467
Common shares issued for director fees
 160,001
 
 200,002
Shares & warrants issued for services
 -
 
 61,133
Loss on equity modification
 -
 
 4,789,801
Depreciation
 330,313
 
 321,979
Change in derivative liability, net of bifurcation
 (34,383)
 
 (497,187)
Changes in operating assets and liabilities:
     
Accounts receivable
 200,668
 
 (131,568)
Inventory
 (224,791)
 
 (525,561)
Prepaid expenses and other assets
 28,218
 
 (2,318)
Note receivable
 1,442
 
 (13,637)
Accounts payable and accrued expenses
 314,625
 
 (29,409)
CASH USED IN OPERATING ACTIVITIES
 (1,621,335)
 
 (2,649,215)
       
CASH FLOWS FROM FINANCING ACTIVITES
     
Proceeds from exercise of stock options
 -
 
 77,734
Proceeds from exercise of warrants
 -
 
 2,405,989
Borrowing on short term debt
 500,000
 
 -
Borrowing on long term note payable
 726,000
 
 -
Principal payments on debt
 (31,250)
 
 -
CASH PROVIDED BY FINANCING ACTIVITIES
 1,194,750
 
 2,483,723
NET (DECREASE) INCREASE IN CASH
 (426,585)
 
 (165,492)
       
CASH AT BEGINNING OF PERIOD
 443,472
 
 644,804
CASH AT THE PERIOD ENDED JUNE 30
 $16,887
 
 $479,312
       
Supplemental Disclosures of Cash Flow Information:
     
        Cash paid during the period for interest
 $25,023
 
 $-
        Cashless exercise of warrants
 $-
 
 $16
        Cashless exercise of options
 $-
 
 $4
        Shares issued for stock payable related to settlement loss
 $-
 
 $1,881,250
        Preferred stock conversion
 $-
 
 $2,690,056
        Change in derivative liability due to exercise of warrants
 $-
 
 $1,817,360
        Change in derivative liability due to conversion of preferred stock
 $-
 
 $2,761,688
        Dividends payable declared
 $-
 
 $56,144
       
 
The accompanying notes are an integral part of the financial statements.
F-3
 
 

 
Z TRIM HOLDINGS, INC.
Notes to Financial Statements
June 30, 2014
(Unaudited)
 
NOTE 1 – NATURE OF BUSINESS
 
Z Trim Holdings, Inc. is a bio-technology company that owns existing, and develops new, products and processes that transform agricultural by-products into multi-functional ingredients used in food manufacturing, energy and other industries. The Company’s products can be used by food manufacturers and processors, restaurants, schools, and the general public worldwide, as well as in industrial applications. The Company continues to explore all available options for its other Z Trim technologies and related assets. The Company owns an exclusive license to Z Trim, a natural, agriculture-based functional food ingredient.
 
NOTE 2 – GOING CONCERN
 
These financial statements have been prepared on a going concern basis, which implies the Company will continue to realize its assets and discharge its liabilities in the normal course of business. The Company had an accumulated net loss equal to $129,885,638 as of June 30, 2014. This factor raises substantial doubt regarding the ability of the Company to continue as a going concern. The continuation of the Company as a going concern is dependent upon the continued financial support from its shareholders, the ability of the Company to obtain necessary debt and equity financings, and the ability of the Company to improve operating margins. These financial statements do not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
 
 NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Presentation of Interim Information

The financial information at June 30, 2014 is unaudited, but includes all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation of the financial information set forth herein, in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information, and with the instructions to Form 10-Q. Accordingly, such information does not include all of the information and footnotes required by U.S. GAAP for annual financial statements. For further information, refer to the financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
 
The results for the six months ended June 30, 2014 may not be indicative of results for the year ending December 31, 2014 or any future periods.

Use of Estimates
 
The preparation of the accompanying financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Revenue Recognition
 
The Company generally recognizes product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable. In instances where the final acceptance of the product is specified by the customer, revenue is deferred until all acceptance criteria have been met. No provisions were established for estimated product returns and allowances based on the Company’s historical experience.

Allowance for Doubtful Accounts
Management of the Company makes judgments as to its ability to collect outstanding receivables and provide allowances for the portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices. For those invoices not specifically reviewed, provisions are provided at differing rates, based upon the age of the receivable. In determining these percentages, management analyzes its historical collection experience and current economic trends. If the historical data the Company uses to calculate the allowance for doubtful accounts does not reflect the future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed and the future results of operations could be materially affected.  As of June 30, 2014 and December 31, 2013 the allowance for doubtful accounts was $0.
 
F-4
 
 

 
Accounting for Derivative Instruments
 
All derivatives have been recorded on the balance sheet at fair value based on the lattice model calculation. These derivatives, including embedded derivatives in the Company’s warrants which have reset provisions to the exercise price and conversion price if the Company issues equity or other derivatives at a price less than the exercise price set forth in such warrants, are separately valued and accounted for on the Company’s balance sheet. Fair values for exchange traded securities and derivatives are based on quoted market prices. Where market prices are not readily available, fair values are determined using market based pricing models incorporating readily observable market data and requiring judgment and estimates.
 
Lattice Valuation Model
 
The Company valued the warrants and the conversion features in its formerly outstanding convertible notes and preferred stock using a lattice valuation model, with the assistance of a valuation consultant. The lattice model values these instruments based on a probability weighted discounted cash flow model. The Company uses the model to develop a set of potential scenarios. Probabilities of each scenario occurring during the remaining term of the instruments are determined based on management's projections and the expert’s calculations. These probabilities are used to create a cash flow projection over the term of the instruments and determine the probability that the projected cash flow will be achieved. A discounted weighted average cash flow for each scenario is then calculated and compared to the discounted cash flow of the instruments without the compound embedded derivative in order to determine a value for the compound embedded derivative.
 
Cash and cash equivalents
 
For purposes of the statement of cash flows, the Company considers all highly liquid investments with a maturity of three months or less to be cash equivalents. There was $16,887 in cash at June 30, 2014 and $443,472 at December 31, 2013.

Fair value of financial instruments

The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, inventory, accounts payable and accrued liabilities. The estimated fair value of cash, accounts receivable, accounts payable and accrued liabilities approximate their carrying amounts due to the short-term nature of these instruments.  None of these instruments are held for trading purposes.
 
The Company has utilized various types of financing to fund its business needs, including convertible debt with warrants attached. The Company reviews its warrants and any conversion features of securities issued as to whether they are freestanding or contain an embedded derivative and, if so, whether they are classified as a liability at each reporting period until the amount is settled and reclassified into equity with changes in fair value recognized in current earnings. At June 30, 2014, the Company had warrants to purchase common stock outstanding, the fair values of which are classified as a liability.
 
Inputs used in the valuation to derive fair value are classified based on a fair value hierarchy which distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs). The hierarchy consists of three levels:
 
Level one — Quoted market prices in active markets for identical assets or liabilities
 
Level two — Inputs other than level one inputs that are either directly or indirectly observable; and
 
Level three — Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.
 
F-5
 
 

 
Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter. The Company’s only asset or liability measured at fair value on a recurring basis is its derivative liability associated with warrants to purchase common stock. The Company classifies the fair value of these warrants under level three. The fair value of the derivative liability at June 30, 2014 was $60,666 compared to $95,049 as of December 31, 2013.  The decrease in fair value for the six months ended June 30, 2014 was $34,383 as compared to $497,187 for the six months ended June 30, 2013.  Below is a hierarchy table of the components of the derivative liability:
 
   
Carrying
 
Fair Value Measurements Using
     
   
Value
 
Level 1
 
Level 2
 
Level 3
 
Total
                     
Derivative Liabilities
                   
12/31/13
 
 $95,049
 
 $-
 
 $-
 
 $95,049
 
 $95,049
                     
Change in derivative liabilities due to
                   
       settlements
 
 -
 
 -
 
 -
 
 -
 
 -
Change in derivative liabilities valuation
 (34,383)
 
 -
 
 -
 
 (34,383)
 
 (34,383)
   
 (34,383)
 
 -
 
 -
 
 (34,383)
 
 (34,383)
                     
Derivative Liabilities
                   
6/30/14
 
 $60,666
 
 $-
 
 $-
 
 $60,666
 
 $60,666

Concentrations
 
Cash and cash equivalents are maintained with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and therefore bear minimal risk.
 
Inventory
 
Inventory is stated at the lower of cost or market, using the first-in, first-out method.  The Company follows standard costing methods for manufactured products.
 
Property and Equipment
 
Property and equipment are stated at cost less accumulated depreciation.  Maintenance and repair costs are expensed as incurred.  Depreciation is calculated on the accelerated and straight-line methods over the estimated useful lives of the assets. Estimated useful lives of five to ten years are used for machinery and equipment, office equipment and furniture, and automobile. Estimated useful lives of up to five years are used for computer equipment and related software. Depreciation and amortization of leasehold improvements are computed using the term of the lease.
 
Intangible Assets
 
Intangible assets were carried at the purchased cost less accumulated amortization. Amortization was computed over the estimated useful lives of the respective assets, generally from fifteen to twenty years.
 
Impairment of Long-Lived Assets
 
Long-lived assets and certain identifiable intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstance indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets and certain identifiable intangible assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
 
Income Taxes
 
The amount of current and deferred taxes payable or refundable is recognized as of the date of the financial statements, utilizing currently enacted tax laws and rates.  Deferred tax expenses or benefits are recognized in the financial statements for the changes in deferred tax liabilities or assets between years.
 
Advertising Costs
 
The Company expenses all advertising costs as incurred.  The amounts for the six months ended June 30, 2014 and 2013 were $90 and $250, respectively.
 
Income (Loss) Per Common Share
 
Basic net income (loss) per share includes no dilution and is computed by dividing net income (loss) available to common stockholders by the weighted average number of common stock outstanding for the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding and, when diluted, potential shares from options and warrants to purchase common stock using the treasury stock method.
 
F-6
 
 

 
Cashless Exercise of Warrants/Options
 
The Company has issued warrants to purchase common stock where the holder is entitled to exercise the warrant via a cashless exercise, when the exercise price is less than the fair value of the common stock. The Company accounts for the issuance of common stock on the cashless exercise of warrants on a net basis.
 
Stock-Based Compensation

The Company estimates the fair value of share-based payment awards made to employees and directors, including stock options, restricted stock and employee stock purchases related to employee stock purchase plans, on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense ratably over the requisite service periods.  We estimate the fair value of each share-based award using the Black-Scholes option pricing model. The Black-Scholes model is highly complex and dependent on key estimates by management. The estimates with the greatest degree of subjective judgment are the estimated lives of the stock-based awards and the estimated volatility of the Company’s stock price. The Company recognized pre-tax compensation expense related to stock options of $614,719 and $1,435,467 for the six months ended June 30, 2014 and 2013, respectively.
 
New Accounting Pronouncements

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income
 
In February 2013, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update which adds new disclosure requirements for items reclassified out of accumulated other comprehensive income. The update requires entities to disclose additional information about reclassification adjustments, including changes in accumulated other comprehensive income balances by component and significant items reclassified out of accumulated other comprehensive income. The update was effective for the Company in the first quarter of 2013. The update primarily impacted our disclosures and did not have a material impact on our financial position, results of operations or cash flows.
 
Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists
 
In July 2013, the FASB issued an accounting standards update which requires an entity to present an unrecognized tax benefit, or portion thereof, in the statement of financial position as a reduction to a deferred tax asset for a net operating loss carryforward or a tax credit carryforward, with certain exceptions related to availability. The update was effective in the first quarter of 2014. The update did not have a material impact on the Company’s financial position, results of operations or cash flows.
 
Testing Indefinite-Lived Intangible Assets for Impairment
 
In July 2012, the FASB issued an accounting standards update which provides, subject to certain conditions, the option to perform a qualitative, rather than quantitative, assessment to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. The update was effective for the Company in the first quarter of 2013. The update may, under certain circumstances, reduce the complexity and costs of testing indefinite-lived intangible assets for impairment and did not have a material impact on the Company’s financial position, results of operations or cash flows.
 
 
NOTE 4 – INVENTORY
 
At June 30, 2014 and December 31, 2013, inventory consists of the following:
 
 
6/30/14
 
12/31/13
Raw materials
 $34,448
 
 $27,575
Packaging
 7,298
 
 8,178
Work-in-process
 16,270
 
 33,527
Finished goods
 711,310
 
 475,255
       
 
 $769,326
 
 $544,535
 
 
F-7
 
 

 
NOTE 5 – PROPERTY AND EQUIPMENT, NET
 
At June 30, 2014 and December 31, 2013,  property and equipment, net consists of the following:
 
   
6/30/14
 
12/31/13
Production, engineering and other equipment
 
$6,422,110
 
$6,422,110
Leasehold improvements
 
2,904,188
 
2,904,188
Office equipment and furniture
 
603,182
 
603,182
Computer equipment and related software
 
140,238
 
140,238
   
$10,069,718
 
$10,069,718
Accumulated depreciation
 
($8,599,725)
 
($8,269,412)
Property and equipment, net
 
$1,469,993
 
$1,800,306
 
Depreciation expense was $330,313 and $321,979 for the six months ended June 30, 2014 and 2013, respectively.  During the six months ended June 30, 2014 and 2013, the Company did not sell any equipment.

 
NOTE 6 – NOTE RECEIVABLE
 
On October 17, 2011, the Company entered into a Custom Processing Agreement (the “Agreement”) with AVEKA Nutra Processing, LLC (“ANP”), part of the AVEKA Group, in order to provide the Company with a partner for future manufacturing initiatives.
 
The Agreement provides that ANP will perform certain services related to the Company’s dietary fiber product, including manufacturing, processing, packaging and storage/warehousing for an initial term of three years.  The Agreement automatically renews at the end of the initial term for an additional two year term unless either party provides written notice to the other within the specified time frame.     Production pursuant to the Agreement began in November 2012 and is still in the process of being ramped up to contractual minimum production volumes of 40,000 pounds per month and average volumes of 100,000 pounds per month, with the ability to increase future production volume to potentially as much as 1,000,000 pounds per month.
 
In addition, the Company agreed to make available to ANP a $500,000 line of credit (which includes $10,000 that the Company loaned ANP to assist it with the purchase of its Waukon, Iowa facility) at an interest rate of 5.5%.  The line of credit is only permitted to be used by ANP for operating costs which excludes capital expenditures of equipment in excess of $5,000.  ANP may not draw down on the line of credit more than $75,000 in any given thirty day period.  The loan is to be paid back to the Company in the form of discounts on production pricing commencing either two years after the first draw by ANP on the line of credit (other than the $10,000 the Company loaned ANP to assist it with the purchase of its Waukon, Iowa facility) or the first month after the Company has ordered 80,000 pounds of product for three consecutive months, whichever shall occur first.  All of ANP’s obligations under the line of credit, as well as the Agreement, are specifically guaranteed by its parent company, AVEKA Inc.
 
On March 28, 2014 the Company entered into an amendment to the custom processing agreement with Aveka Nutra Processing LLC relating to the repayment of the line of credit advances made by the Company plus interest.  Commencing on April 1, 2014, Aveka Nutra Processing agreed to begin paying the Company $5,000 per month to be applied to the advances made and accrued interest.  As of June 30, 2014, the amount outstanding to ANP under the line of credit was $491,689 and accrued interest on the advance was $57,519.
 
F-8
 
 

 
NOTE 7 – SHORT-TERM BORROWINGS
 
On March 24, 2014, Fordham Capital Partners, LLC (“Fordham”) extended a $500,000 revolving loan (the “Equipment Loan”) to Z Trim Holdings, Inc. (the “Company”) evidenced by an Equipment Revolving Note (the “Note”) issued by the Company to Fordham.  The Note requires monthly payments of principal of $10,417 plus interest, commencing on April 24, 2014 and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Note is calculated at a fixed rate of 20% per annum.  The Note may be prepaid in full at any time; provided that if the Company prepays the Note prior to September 24, 2014 (such six-month period, the “Guaranteed Interest Period”), it must pay a prepayment penalty equal to the amount by which (i) the aggregate interest that Fordham would have received on the Note during the Guaranteed Interest Period had there been no prepayment exceeds (ii) the aggregate interest paid by the Company prior to the date of prepayment.
 
Pursuant to the Security Agreement, dated March 24, 2014, between the Company and Fordham (the “Security Agreement”), the Equipment Loan is secured by a first priority security interest in all of the Company’s equipment (as more specifically defined in the Security Agreement, the “Collateral”).  The Security Agreement also contains customary restrictive covenants, including without limitation, covenants prohibiting the Company from (i) granting additional liens in the Collateral, (ii) selling, leasing or transferring the Collateral, (iii) entering into certain merger, consolidation or other reorganization transactions, and (iv) creating, incurring or assuming additional indebtedness, in each case subject to certain exceptions.  The Security Agreement also contains customary events of default.  If an event of default under the Security Agreement occurs and is continuing, Fordham may declare any outstanding obligations under the Credit Agreement immediately due and payable.  After an event of default, interest on the Note would accrue at a rate of 25% per annum.
 
Additionally, pursuant to the Factoring Agreement, dated March 24, 2014, between the Company and Fordham, Fordham may purchase any Accounts of the Company (the “Factoring Agreement”).  To secure payment and performance of the Company’s liabilities and obligations to Fordham, including obligations under the Factoring Agreement, the Company granted Fordham a security interest in all of the Company’s (i) Accounts, (ii) Inventory, (iii) Chattel Paper, Deposit Accounts, Documents, Equipment, Financial Assets, Fixtures, General Intangibles, Instruments, Investment Property, Letter-of-Credit Rights, Securities, Software and Supporting Obligations, (iv) books and records of Seller which relate to Accounts, (v) all amounts owing to the Company under the Factoring Agreement, and (vi) Proceeds of the foregoing.  The Factoring Agreement terminates at any time that the Equipment Loan is paid in full.
 
 
NOTE 8 – ACCRUED EXPENSES AND OTHER
 
At June 30, 2014 and December 31, 2013 accrued expenses consist of the following:
 
 
 
6/30/14
 
12/31/13
Accrued payroll and taxes
 $58,942
 
 $51,566
Accrued settlements
 102,000
 
 102,000
Accrued interest
 23,275
 
 -
Accrued expenses and other
 5,767
 
 40,578
       
 
 $189,984
 
 $194,144

F-9
 
 

 
 
NOTE 9 – CONVERTIBLE NOTES PAYABLE TO RELATED PARTIES
 
 
On February 11, 2014 the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $200,000 in a convertible senior secured note.  The note matures in two years (February 11, 2016) and bears interest at 12.5% computed based on a 365-day year.  Accrued interest is payable either at maturity or quarterly at the option of Mr. Smith in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $2.25, subject to adjustment as provided in the note.  If on the maturity date of the note, the thirty day trailing average closing price of the Company’s Common Stock (the “Trailing Average Price”) is below $2.25, the Conversion Price on the maturity date will be reduced to the Trailing Average Price, but to not less than $1.25.  The Conversion Price was greater than the closing stock price on the agreement date; therefore no beneficial conversion feature was recorded on this note.  The note is secured by the assets of the Company, which security interest is expressly subordinate to the interest of Fordham Capital Partners LLC described below, pursuant to an intercreditor agreement between Mr. Smith and Fordham dated March 18, 2014.
 
On April 25, 2014, the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $300,000 in a convertible subordinated secured note.  The note matures in two years (April 25, 2016) and bears interest at 14% computed based on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore no beneficial conversion feature was recorded on this note. The note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On April 30, 2014, the Company issued a 14% convertible subordinated secured note to each of Morris Garfinkle, Mark Hershhorn, Brian Israel and Edward B. Smith, Directors of the Company, in the principal amount of $19,000, for director fees due and payable to them (the “Director Notes”).  Each Director Note matures in two years (April 30, 2016) and bears interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the Director Note, the director may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each Director Note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore no beneficial conversion feature was recorded on this note.  Each Director Note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On May 12, 2014, the Company issued 14% convertible subordinated secured notes to both Mo Garfinkle and CKS Warehouse in the principal amount of $75,000 each.  Both notes mature in two years (May 12, 2016) and bear interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of each note, Mr. Garfinkle and CKS Warehouse may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore no beneficial conversion feature was recorded on this note.  Each note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
See “Subsequent Events” described in Note 20 below.
 
 
NOTE 10 – PREFERRED STOCK
 
 
On March 18, 2013, Brightline Ventures I converted the Series II Convertible Preferred Stock of $3,326,697 together with $533,000 of accrued dividends thereon into 3,859,697 shares of the Company’s Common Stock.  As of March 31, 2013 there was no Series II Convertible Preferred Stock outstanding.  The value of the Series II Preferred Stock and dividends converted was equal to the total value recorded to common stock and additional paid in capital with no gain or loss recorded as the conversion was consistent with the original agreement.  As a result of the preferred stock conversion, $2,690,056 was recorded to common stock and additional paid-in capital.
 
As of June 30, 2013, no shares of Series I or II Preferred Stock remained outstanding.
 
F-10
 
 

 
NOTE 11 – LIQUIDATED DAMAGES
 
In connection with certain private placements of the Company’s securities (the “Registrable Securities”) effected in 2008, the Company entered into registration rights agreements (the “RRA”) that required the Company to file a registration statement covering the Registrable Securities with the Securities and Exchange Commission no later than thirty days after the final closing as contemplated in the Private Placement Memorandum for the 2008 offering (the “Filing Deadline”), which the Company did not meet. Under the terms of the RRA, as partial compensation, the Company was required to make pro rata payments to each Investor in an amount equal to 1.5% of the aggregate amount invested by such Investor for each 30-day period or pro rata for any portion thereof following the Filing Deadline for which no registration statement was filed.  We obtained a release and waiver of the amounts due from almost all of the 2008 investors.   Under the terms of the RRA, we potentially owe, and have recognized as liquidated damages, $36,178 relating to holders from whom we did not receive waivers.
 
 
NOTE 12 – DERIVATIVE LIABILITIES
 
Certain of the Company’s warrants (as well as its formerly outstanding preferred stock and Convertible 8% Senior Secured Notes issued in 2008 and 2010) have reset provisions to the exercise price if the Company issues equity or other derivatives at a price less than the exercise price set forth in such warrants. This ratchet provision results in a derivative liability in our financial statements.
 
Our derivative liabilities decreased to $60,666 at June 30, 2014 from $95,049 at December 31, 2013.  The decrease in fair value during the six months ended June 30, 2014 was $34,383 as compared to $497,187 for the six months ended June 30, 2013.
 
The following tabular presentation reflects the components of derivative financial instruments on the Company’s balance sheet at June 30, 2014 and December 31, 2013:
 
 
6/30/14
 
12/31/13
Common stock warrants
 $60,666
 
 $95,049
Embedded conversion features for
     
  convertible debt or preferred shares
 -
 
 -
       
Total
 $46,861
 
 $95,049
       
Beginning balance
 $95,049
 
 $8,025,381
Bifurcated amount
 -
 
 -
Change in derivative liability valuation
 (34,383)
 
 (966,736)
Change in derivative liability - settlements
 -
 
 (6,963,596)
       
Total
 $60,666
 
 $95,049
 

F-11
 
 

 
NOTE 13 – EQUITY
 
Common Stock Issued to Directors

On January 2, 2014 the Company issued 285,716 shares of common stock to its four non-executive directors (71,429 shares each) Mark Hershhorn, Brian Israel, Morris Garfinkle and Edward Smith III. The Company recognized a total expense of $160,001 related to these issuances.  These shares were valued based on the closing price on the grant date.
 
Common Stock Issued on the Exercise of Stock Warrants and/or Options for Cash

During the first six months of 2014 there were no warrants or options exercised for cash.

During the first quarter of 2013, several investors participated in a warrant exercise program that resulted in the exercise of 1,756,088 warrants into 1,756,088 shares of the Company’s common stock.  The warrant program, which was open to all holders of $1.50 warrants, allowed those warrant holders to exercise their warrants for a $1.25 strike price during February 2013; it also required a waiver of the anti-dilution provisions in these warrants until February 28, 2013 so that those provisions would not be triggered by the exercises. The conversion of these warrants raised $2,195,110 of cash for the Company.   As a result of this warrant modification the Company recognized $4,789,801 of additional expense for previously issued warrants during the period ended March 31, 2013.  The value of the additional expense was based on the fair value of the warrant modification at the date the offer was made to the warrant holders calculated by using the Black-Scholes Model.  The key inputs utilized in this model include the Company’s stock price on the date of the modification of $2.30, the computed volatility of the Company’s stock price at 109.96% and the discount rate used based on a U.S. Treasury security for a comparable period to the remaining term of the warrants of .06%.
 
Also during the first quarter of 2013, in addition to the warrant exercise program, investors exercised 82,753 warrants and the Company received proceeds of $30,511.  During the quarter ended June 30, 2013, investors exercised 287,006 warrants and the Company received proceeds of $180,369.
 
During the six months ended June 30, 2013, two former employees exercised 91,400 stock options and the Company received proceeds of $77,734.
 
Common Stock Issued on the Cashless Exercise of Warrants and/or Stock Options
 
During the first and second quarters of 2014 the Company did not issue any shares of common stock on the cashless exercise of warrants or options.
 
During the first and second quarters of 2013 the Company issued 318,490 shares of common stock on the cashless exercise of 617,844 warrants.  Also during this period the Company issued 89,115 shares of Common Stock on the cashless exercise of 176,000 stock options.  In recognition of the cashless exercise of both the warrants and stock options, the Company recorded an increase to Common Stock of $20, offset by a $20 decrease to additional paid in capital.
 
Common Stock Payable
 
On February 12, 2013 (the “Settlement Date”), the Company entered into a settlement and release agreement with a former provider of investment services over compensation provided in a prior period for services in the raising of equity capital for the Company.  The agreement called for the Company to issue 875,000 shares of common stock to this party.  As of December 31, 2012, the Company recorded a common stock payable in the amount of $1,881,250, which was equal to the value of the 875,000 shares on the Settlement Date.  As of the Settlement Date, the Company issued the shares and recorded an increase to common stock and additional paid in capital with the offset to common stock payable.
 
Convertible Preferred Stock
 
On March 18, 2013, Brightline Ventures I converted Series II Convertible Preferred Stock of $3,326,697 together with $533,000 of accrued dividends thereon into 3,859,697 shares of the Company’s Common Stock.  As of June 30, 2013 there was no Series II Convertible Preferred Stock outstanding and, therefore, there were no accrued dividends at June 30, 2013.
 
As of June 30, 2014 there was no Convertible Preferred Stock outstanding.
 
F-12
 
 

 
NOTE 14 – STOCK-BASED COMPENSATION PLAN AND WARRANTS
 
The Company’s Incentive Compensation Plan (the “Plan”), which was last amended and restated with shareholder approval in December 2012, provides for the issuance of stock options, stock appreciation rights, restricted stock, restricted stock units and cash incentive awards.
 
A summary of the status of stock options under the Plan as of June 30, 2014 and December 31, 2013 is as follows:
 
   
6/30/14
         
12/31/13
   
   
Number of Shares
Weighted Average Exercise Price
Value
 
Number of Shares
Weighted Average Exercise Price
Outstanding at beginning of year
 9,583,762
 
 $1.16
 
 $7,829,187
 
 7,728,877
 
 $1.01
Granted
 
 2,069,300
 
 $0.57
 
 $3,321,013
 
 2,176,535
 
 $1.67
Exercised
 
 -
 
 $-
 
 $(191,500)
 
 (293,650)
 
 $0.98
Expired and Cancelled
 (160,000)
 
 $1.36
 
 $-
 
 (28,000)
 
 $2.18
   
 11,493,062
     
 10,958,700
 
 9,583,762
   
                     
Outstanding, end of period
 11,493,062
 
 $1.05
 
 10,958,700
 
 9,583,762
 
 $1.16
                     
Exercisable at end of period
 10,420,912
 
 $1.11
 
 $7,952,039
 
 9,536,262
 
 $1.17

During the six months ended June 30, 2014 the Company granted 2,069,300 options valued at $1,024,170.  Stock-based compensation expense for the three and six months ended June 30, 2014 was $363,560 and $614,719, respectively.  As of June 30, 2014, the unrecognized compensation cost related to all non-vested share-based compensation arrangements granted under the Plan was $382,406 and will be recognized in each of the remaining fiscal 2014 quarters.
 
During the six months ended June 30, 2013, the Company granted 2,176,535 options valued at $2,270,121.  Stock-based compensation expense for the three and six months ended June 30, 2013 was $676,932 and $1,435,467, respectively.
 
During the six months ended June 30, 2014, there were no stock options exercised either for cash or on a cashless basis.
 
During the six months ended June 30, 2013, two former employees exercised 91,400 stock options and the Company received proceeds of $77,734.  Also during this period the Company issued 89,115 shares of Common Stock on the cashless exercise of 176,000 stock options.
 
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option valuation model.  This model uses the assumptions listed in the table below for stock options granted in 2014.  Expected volatilities are based on the historical volatility of the Company’s stock.  The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
 
 
6/30/14
Weighted average fair value per option granted
$0.4968
Risk-free interest rate
1.75%
Expected dividend yield
0.00%
Expected lives
2.688
Expected volatility
98.91%
 
F-13
 
 

 
Stock options outstanding at June 30, 2014 are as follows:
 
       
Weighted
       
       
Average
 
Weighted
   
       
Remaining
 
Average
   
   
Options
 
Contractual
 
Exercise
 
Options
Range of Exercise Prices
 
Outstanding
 
Life
 
Price
 
Exercisable
$0.01-$1.50
 
 9,099,527
 
 2.5
 
 $0.75
 
 8,027,377
$1.51-$3.00
 
 2,268,535
 
 3.5
 
 $1.67
 
 2,268,535
$3.01-$5.00
 
 125,000
 
 3.6
 
 $3.11
 
 125,000
   
 11,493,062
 
 2.7
 
 $1.06
 
 10,420,912

 
Warrants
 
As of June 30, 2014, the Company has warrants outstanding to purchase 16,491,351 shares of the Company’s common stock, at prices ranging from $0.01 to $1.50 per share.  These warrants expire at various dates through November 2018.   The summary of the status of the warrants issued by the Company as of June 30, 2014 and December 31, 2013 are as follows:
 
   
6/30/14
     
12/31/13
   
   
Number of Warrants
Weighted Average Exercise Price
Number of Warrants
Weighted Average Exercise Price
Outstanding at beginning of year
 
 16,688,265
 
 $1.44
 
 23,392,811
 
 $1.46
Granted
 
 -
 
 $-
 
 4,010,295
 
 $1.18
Exercised
 
 -
 
 $-
 
 (2,287,730)
 
 $1.28
Cashless Exercises
 
 -
 
 $-
 
 (8,082,535)
 
 $1.43
Expired and Cancelled
 
 (196,914)
 
 $0.74
 
 (344,576)
 
 $0.88
   
 16,491,351
     
 16,688,265
   
                 
Outstanding, end of period
 
 16,491,351
 
 $1.44
 
 16,688,265
 
 $1.44
                 
Exercisable at end of period
 
 16,491,351
 
 $1.44
 
 16,688,265
 
 $1.44
 
F-14
 
 

 

There were no warrants granted during the six months ended June 30, 2014.  Also during this period there were no warrants exercised either for cash or on a cashless basis.
 
For the six months ended June 30, 2013, there were no warrants granted to investors.
 
During the three months ended March 31, 2013, several investors participated in a warrant exercise program that resulted in the exercise of 1,756,088 warrants into 1,756,088 shares of the Company’s common stock.  The warrant program, which was open to all holders of $1.50 warrants, allowed those warrant holders to exercise their warrants for a $1.25 strike price during February 2013. The conversion of these warrants raised $2,195,110 of gross proceeds for the Company.
 
Also during the first quarter of 2013, other investors exercised 82,753 warrants and received 82,753 shares of common stock with the Company receiving proceeds of $30,511.  During the quarter ended June 30, 2013, investors exercised 287,006 warrants and the Company received proceeds of $180,369.  During the first and second quarters of 2013 the Company issued 318,490 shares of Common Stock on the cashless exercise of 617,844 warrants.
 
 
NOTE 15 – MAJOR CUSTOMERS AND CREDIT CONCENTRATION
 
The Company’s customers are food manufacturers.  There were two significant customers that each accounted for greater than 10% of net sales for the six months ended June 30, 2014. These two customers accounted for 40% and 23% of total net sales, respectively.   In addition, the same two customers accounted for more than 10% each of total accounts receivable for the quarter ended June 30, 2014.  These customers accounted for 59% and 15% of the accounts receivable as of June 30, 2014, respectively.
 
The Company maintains cash deposits with major banks, which from time to time may exceed federally insured limits.  At June 30, 2014 and December 31, 2013, $0 and $193,472, respectively, were in excess of federally insured limits.  The Company periodically assesses the financial condition of the institutions and believes that the risk of any loss is minimal.

 
NOTE 16 – COMMITMENTS
 
 
Building Lease
 
The Company leases a combined research and development and office facility located in Mundelein, Illinois.  The facility is approximately 44,000 square feet.  On March 14, 2014, the Company extended the lease until May 2015 and the required monthly rental payments increased to $21,361, inclusive of property taxes.  Insurance and maintenance are billed when due.  If the Company wishes to remain at this facility beyond the lease expiration date, it will need to negotiate a new lease with the landlord, which cannot be assured.
 
The Company recognizes escalating lease expense on a straight line basis in accordance with current accounting standards.
 
For the six months ended June 30, 2014 and 2013, the Company recognized rent expense of $135,066 and $144,416, respectively. The future minimum annual rental payments and sub-lease income for the years ended December 31 under the lease terms are as follows:
 
Year Ended
Rentals
  2014
 $128,166
  2015
 85,444
  2016
 -
  2017
 -
  2018
 -
 
 $213,610
   
 
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NOTE 17 – PENDING LITIGATION/CONTINGENT LIABILITY
 
On July 7, 2007, the Company and Greg Halpern, its former Chief Executive Officer in his individual capacity, were served with a complaint by Joseph Sanfilippo and James Cluck for violation of the Consumer Fraud Act and is seeking damages in excess of $200,000.   The trial court has issued a default order against the Company, and has denied the Company’s Motion to reconsider.  Management believes that the trial court’s rulings were erroneous and that it has grounds for appeal, and that the underlying allegations are frivolous and wholly without merit and will vigorously defends the claim. The outcome of this matter is unknown as of the report date.  However, the Company has allocated a reserve of $102,000 to satisfy any liability it may incur as a result of this matter.
 
On or about December 12, 2011, the Company was sued in Circuit Court of the 17th Judicial District, Winnebago County, Illinois with a complaint by LIBCO Industries, Inc., alleging the Company breached a construction contract and tortiously interfered with a business relationship, and is seeking damages in excess of $185,000.  The case was subsequently transferred to the 19th Judicial Circuit Court, Lake County, Illinois.  Management believes that the allegations are frivolous and wholly without merit and will vigorously defend the claim.  Related to this matter, Process Piping, LLC, a sub-contractor for LIBCO Industries, filed a mechanics lien on the property leased by the Company, claiming it was owed in excess of $95,000 by LIBCO Industries.  On March 6, 2012, the Company paid $62,500 to Process Piping, LLC in exchange for a release of its lien as well as an assignment of all of its claims against LIBCO Industries. On January 31, 2013, the Circuit Court granted the Company’s motion for partial summary judgment on the tortious interference claim.  During the fourth quarter of 2013, the parties settled all outstanding matters and the case has been dismissed.  On January 21, 2014 as part of the settlement, the Company received $10,000 in cash and both parties provided releases of all respective claims.
 
 
NOTE 18 – RELATED PARTY TRANSACTIONS
 
On January 2, 2014 the Company issued 285,716 shares of common stock to its four non-executive directors (71,429 shares each) Mark Hershhorn, Brian Israel, Morris Garfinkle and Edward Smith III. The Company recognized a total expense of $160,001 related to these issuances.  These shares were valued based on the closing price on the grant date.
 
On February 11, 2014 the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $200,000 in a convertible senior secured note.  The note matures in two years (February 11, 2016) and bears interest at 12.5% computed based on a 365-day year.  Accrued interest is payable either at maturity or quarterly at the option of Mr. Smith in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $2.25, subject to adjustment as provided in the note.  If on the maturity date of the note, the thirty day trailing average closing price of the Company’s Common Stock (the “Trailing Average Price”) is below $2.25, the Conversion Price on the maturity date will be reduced to the Trailing Average Price, but to not less than $1.25.  The note is secured by the assets of the Company, which security interest is expressly subordinate to the interest of Fordham Capital Partners LLC described below, pursuant to an intercreditor agreement between Mr. Smith and Fordham dated March 18, 2014.
 
On April 25, 2014, the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $300,000 in a convertible subordinated secured note.  The note matures in two years (April 25, 2016) and bears interest at 14% computed based on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under the note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore no beneficial conversion feature was recorded on this note.  The note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On April 30, 2014, the Company issued a 14% convertible subordinated secured note to each of Morris Garfinkle, Mark Hershhorn, Brian Israel and Edward B. Smith, Directors of the Company, in the principal amount of $19,000, for director fees due and payable to them (the “Director Notes”).  Each Director Note matures in two years (April 30, 2016) and bears interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the Director Note, the director may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each Director Note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore no beneficial conversion feature was recorded on this note.  Each Director Note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
F-16
 
 

 
On May 12, 2014, the Company issued 14% convertible subordinated secured notes to both Mo Garfinkle and CKS Warehouse in the principal amount of $75,000 each.  Both notes mature in two years (May 12, 2016) and bear interest at 14% computed on a 365-day year.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of each note, Mr. Garfinkle and CKS Warehouse may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under each note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore no beneficial conversion feature was recorded on this note.  Each note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
On January 22, 2013 the Company issued 114,944 shares of common stock to its four non-executive directors, Mark Hershhorn, Morris Garfinkle, Brian Israel and Edward Smith (28,736 shares each). The Company recognized a total of expense of $200,002 related to these issuances.  These shares were valued based on the closing price on the grant date.
 
On February 27, 2013 Morris Garfinkle and Mark Hershhorn, Directors of the Company, participated in a warrant exercise program in which all holders of $1.50 warrants were allowed to exercise their warrants for a $1.25 strike price until February 28, 2013.  Mr. Garfinkle exercised 200,000 warrants and received 200,000 shares of Common Stock.  Mr. Hershhorn exercised 30,000 warrants and received 30,000 shares of Common Stock.  Also on this date, Mr. Hershhorn exercised other warrants, with various exercise prices, and received 28,525 shares of Common Stock.  On March 6, 2013, Mr. Garfinkle exercised other warrants, with various exercise prices, and received 26,571 shares of Common Stock.
 
On March 18, 2013, Brightline Ventures I converted 665,339 shares of preferred stock plus accrued dividends of $533,000 into 3,859,697 shares of the Company’s common stock as disclosed in Notes 10 and 13 above.
 
See “Subsequent Events” described in Note 20 below.
 
 
NOTE 19 – GUARANTEES
 
The Company from time to time enters into certain types of contracts that contingently require the Company to indemnify parties against third party claims. These contracts primarily relate to: (i) divestiture agreements, under which the Company may provide customary indemnifications to purchasers of the Company’s businesses or assets; (ii) certain real estate leases, under which the Company may be required to indemnify property owners for environmental and other liabilities, and other claims arising from the Company’s use of the applicable premises; and (iii) certain agreements with the Company's officers, directors and employees, under which the Company may be required to indemnify such persons for liabilities arising out of their employment relationship.  The terms of such obligations vary. Generally, a maximum obligation is not explicitly stated. Because the obligated amounts of these types of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, the Company has not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on its balance sheet as of June 30, 2014.
 
In general, the Company offers a one-year warranty for most of the products it sells.  To date, the Company has not incurred any material costs associated with these warranties.
 
F-17
 
 

 
 
NOTE 20 – SUBSEQUENT EVENTS
 
On July 15, 2014, the Company entered into an agreement with Edward Smith III, a Director and Shareholder of the Company, pursuant to which Mr. Smith agreed to lend the Company $64,000 in an unsecured note payable.  The note matures in 90 days (October 15, 2014) without interest payable on the unpaid principal and subject to the terms of the Company’s agreements with its secured creditors.
 
On July 16, 2014, the Company and Fordham Capital Partners, LLC entered into an Amended and Restated Equipment Revolving Note (the “Amended Note”) in the amount of $582,841.63.  The Amended Note requires monthly payments of principal of $12,143 plus interest, commencing on July 24, 2014 and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Amended Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Amended Note is calculated at a fixed rate of 22% per annum.
 
Also on July 16, 2014, the Company and Fordham Capital Partners, LLC entered into a First Amendment to Security Agreement in which the Amended Note is secured by a first priority security interest in all of the Company’s equipment under substantially the same terms and covenants as stated in the original Security Agreement indicated above.
 
On July 25, 2014, the Company and Fordham Capital Partners, LLC entered into an Amended and Restated Equipment Revolving Note (the “Second Amended Note”) in the amount of $668,750.  The Second Amended Note requires one monthly payment of principal of $12,143 plus interest, commencing on July 25, 2014 followed by successive monthly installments of principal of $13,679 plus interest and continuing until February 24, 2015, followed by a final balloon payment of the entire unpaid principal balance of the Second Amended Note and all accrued and unpaid interest on March 24, 2015.  The interest on the Second Amended Note is calculated at a fixed rate of 22% per annum.
 
Also on July 25, 2014, the Company and Fordham Capital Partners, LLC entered into a Second Amendment to Security Agreement in which the Second Amended Note is secured by a first priority security interest in all of the Company’s equipment under substantially the same terms and covenants as stated in the original and the First Security Agreement indicated above.
 
On August 6, 2014, the Company issued a 14% convertible subordinated secured note to Edward B. Smith in the principal amount of $264,000.  The note matures in two years (August 6, 2016) and bears interest at 14% computed on a 365-day year.  Under this note Mr. Smith has provided $200,000 of cash as of August 6, 2014 and the parties agreed to include the unsecured funds in the amount of $64,000 provided by Mr. Smith on July 15, 2014 and include those amounts as part of this subordinated secured transaction.  The loan agreement executed by the parties on July 15, 2014 is now null and void.  Accrued interest is payable at maturity in shares of the Company’s Common Stock.  At any time on or after the date that is 90 days after the date of issuance of the note, Mr. Smith may elect to convert the aggregate principal balance and accrued interest into shares of Common Stock of the Company.  The conversion price under this note is $1.00.  The conversion price was greater than the closing stock price on the agreement date; therefore, no beneficial conversion feature was recorded on this note.  The note is secured by the assets of the Company, which security interest is subordinate to the security interest granted to Fordham in connection with the Equipment Loan and the Factoring Agreement.
 
F-18