Item
8.01 Other
Information
Special
Note — This report contains forward−looking statements that are based on our
current expectations. Actual results may differ materially from those expressed
or implied by those forward−looking statements because of a number of risks and
uncertainties. See “Disclosures About Forward−Looking Statements”
below.
Update
Regarding Z Trim’s Internal Investigation and Status with Respect to Amex
Listing Requirements
Background.
On
August
17, 2007, we received a deficiency letter from the American Stock Exchange
(“Amex”) notifying us that the staff of the Amex had determined we were not in
compliance with certain of Amex’ continued listing standards. The
deficiencies (which are described in our Current Report on Form 8-K filed August
23, 2007) included failure to report Section 16(a) filing delinquencies, failure
of the board to subject a related party transaction to review by the Audit
Committee, granting stock options in a manner contrary to our stock option
plans, failure to properly account for stock option grants with exercise prices
below fair market value on the date of grant, failure to provide certain
information to Amex, and allowing internal control weaknesses to
exist.
In
response to the deficiency letter, we prepared and submitted to Amex a
compliance plan outlining our proposal for regaining compliance with Amex’
continued listing standards and addressing the matters contained in the
deficiency letter. The compliance plan was accepted by Amex on
November 2, 2007 (as reported in our Current Report on Form 8-K filed November
5, 2007).
Internal
Investigation.
Pursuant
to the compliance plan, we conducted an internal investigation relating to
the
primary issues of concern identified by Amex, principally including equity
accounting and the related control environment. We engaged the
independent accounting firm of Blackman Kallick Bartelstein LLP (“Blackman”) to
perform certain procedures to assist us with our internal
investigation. The objective of Blackman’s engagement was to help us
assess the financial reporting figures, processes, and internal controls related
to our equity transactions for the period January 1, 2002 through June 30,
2007,
and to make specific recommendations to strengthen the reporting and control
environment. Their procedures consisted principally of obtaining an
understanding of the equity process at Z Trim, by inquiry, observation, testing,
and reperformance, in an effort to assist us with our:
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review
and reconciliation of our corporate records, minutes, transfer agent
records, public disclosures, and accounting related to stock options,
warrants, and common stock;
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analysis
of significant accounting policies and procedures surrounding equity
transactions;
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determination
of whether any stock options have not been issued in accordance with
our
stock option plans;
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review
of option pricing methodology;
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review
of all minutes illustrating shareholder approval of equity
issuances;
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review
of stock option certificates issued to
individuals;
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determination
of our adherence to filing requirements related to equity
transactions;
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consideration
of our quantitative and qualitative analysis of the findings outlined
below and of our historical financial statements to make determinations
as
to whether equity transactions were presented in accordance with
accounting principles generally accepted in the United States of
America
(USGAAP) and whether any of our Securities and Exchange Commission
filings
or financial statements should be amended or
restated;
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consideration
of best practices for us with respect to equity transactions and
related
financial reporting; and
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review
of our internal controls surrounding equity transactions and the
related
financial reporting process.
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Issues
and Findings.
Blackman
has completed its engagement and has identified the following significant
issues:
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During
the 5-1/2 year review period, we made a total of 191 stock option
grants
covering an aggregate of 15,179,087 shares without documentation
of
approval of those grants in the Board
minutes.
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During
the 5-1/2 year review period, our Board minutes reflect approval,
but
after the date of grant, of 70 stock option grants covering an aggregate
of 12,980,000 shares.
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During
the period 2004 through 2007, we issued a total of 7 stock option
grants
covering 736,337 shares where the exercise price was below the fair
market
value of our common stock on the date of grant. As a
result, none of those grants are eligible for tax treatment as incentive
stock options.
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During
the period 2002 through 2007, we issued a total of 21 stock option
grants
covering 3,684,000 shares where the exercise price was below 110%
of the
fair market value of our common stock on the date of grant and the
recipient was the beneficial owner of 10% or more of our outstanding
equity. As a result, none of those grants are eligible
for tax treatment as incentive stock
options.
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In
each of 2002 and 2004 our option grants to a single recipient in
a
calendar year exceeded 1 million shares by an aggregate of 910,000
shares
over both years. As a result, the grants that exceed the 1
million-share threshold are not eligible for tax treatment as incentive
stock options. In addition, the grants that exceed the 1
million-share threshold are not allowed under our stock incentive
plan.
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Our
officers, directors and 10% shareholders failed to file (or filed
late)
certain Section 16(a) reports (Forms 3, 4 and 5). With respect
to current officers and directors, a total of 24 such delinquent
filings
occurred with respect to a total of 34 transactions during the January
1,
2002 through June 30, 2007 review
period.
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Between
March 2004 and June 2007 we issued 5,642,435 shares of common stock
and
warrants covering 1,939,507 shares of common stock without the common
stock (or the shares underlying the warrants) being listed with
Amex. Of those shares, we applied for listing, but were denied,
with respect to 4,000,000 shares, we exceeded our approval with respect
to
an equity raise by 180,852 shares and warrants to purchase an additional
824,507 shares, and we never applied for listing with respect to
the
balance of 1,461,583 shares and warrants for an additional 1,115,000
shares.
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Until
April of 2007 we had no formal equity policies and procedures, including
with respect to options and
warrants.
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There
is no formal management review and approval of quarterly reconciliations,
related equity journal entries, or Black-Scholes-Merton assumptions
and
calculations.
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Access
to key spreadsheets is not
controlled.
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Blackman
also made the following findings:
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Our
overall accounting for stock options generally has been appropriate
since
January 1, 2002. Blackman did note the following variances,
which we determined not to be material: Total variances of
approximately $75,000 should have been recorded or disclosed for
the
period from January 1, 2002 through June 30, 2007. Of this
amount, $57,000 relates to the period from January 1, 2002 through
December 31, 2005, which amounts should have been disclosed in a
footnote
as pro forma compensation expense. The remaining $18,000 should
have been recorded as expenses for the period from January 1, 2006
through
June 30, 2007.
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Based
on a review of our quarterly and year-end filings regarding equity
transactions, except for the Shemesh and Tobian transaction requiring
restatement as described in our Current Report on Form 8-K filed
November
2, 2007, no material discrepancies came to Blackman’s attention that would
lead Blackman to recommend the restatement of those
filings.
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Our
overall accounting for warrants generally has been appropriate since
January 1, 2002.
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Company
Assessment.
Our
management team and Audit Committee have completed the internal investigation
and have reviewed Blackman’s report of its findings. We agree with
Blackman’s findings and our assessment of our internal investigation includes
the following conclusions:
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We
have the following control deficiencies that constitute material
weaknesses in our internal control over financial
reporting:
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account
reconciliations over equity transactions were not always properly
and
timely performed, and the reconciliations and their supporting
documentation were not consistently reviewed for completeness, accuracy,
and timely resolution of reconciling items;
and
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we
did not design and maintain effective controls to ensure the completeness,
accuracy, and timeliness of the recording and reporting of equity
transactions.
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We
must strengthen our policies and procedures with respect to financial
reporting, equity transactions, related party transaction monitoring,
spreadsheet controls, human resources and information
technology.
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We
must more closely monitor Section 16(a) reporting persons to encourage
their compliance with reporting obligations and must more carefully
disclose any known failures to so
file.
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We
must be more cognizant of the parameters of our stock option plan
and
either grant awards pursuant to the plan within the plan’s parameters, or
purposefully outside the plan (if at
all).
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We
must refrain from issuing stock or granting warrants for which no
prior
listing with Amex has been
obtained.
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Remedial
Actions.
Our
management, under new leadership since August of this year, immediately
recognized that we had control and process deficiencies and began taking
remedial action even before the internal investigation was
commenced. We have been actively engaged in the planning for, and
implementation of, remediation efforts to address the material weaknesses and
other issues arising from our internal investigation. These remediation efforts,
outlined below, are intended both to address the identified issues and enhance
our overall financial control and disclosure environment.
Our
new leadership team is committed to achieving and maintaining a strong control
environment, high ethical standards, and financial reporting integrity. This
commitment is accompanied by a renewed management focus on decision-making
and
processes that are intended to achieve maximum shareholder value over the
long-term.
We
will
continue our efforts to establish or modify specific processes and controls
to
provide reasonable assurance with respect to the accuracy and integrity of
accounting entries and the appropriate documentation, review, and approval
of
those entries. These efforts include implementation and clarification of
specific accounting and finance policies, and enhancing the development,
communication, and monitoring of processes and controls to ensure that
appropriate account reconciliations are performed, documented, and reviewed
as
part of standardized procedures.
Some
of
the specific remedial actions our new management team has completed or will
pursue include the following:
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We
have implemented equity control policies and will seek to strengthen
those
policies.
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We
have appointed a new independent director to our board and plan to
nominate additional independent directors this
year.
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We
have engaged new independent auditors (see Item 4.01 of this
report).
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We
have invested in the implementation of additional and enhanced information
technology systems commensurate with the needs of our business and
our
financial reporting requirements and have engaged an independent
firm to
advise us in this regard.
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We
have initiated a number of changes to our human resources policies
and
have engaged an independent firm to audit our human resources
functions.
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We
have engaged a separate accounting firm to help us prepare for compliance
with our upcoming Sarbanes-Oxley Section 404 compliance
requirements.
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We
will apply (or reapply, as the case may be) with Amex to list the
shares
of common stock (and stock underlying warrants) issued by us without
current Amex approval.
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We
have treated stock option grants that do not meet the criteria for
incentive stock options as nonqualified stock options, and will comply
with the associated tax reporting requirements. We intend to
amend our 2004 tax return to properly record approximately $5 million
of
tax benefit from the exercise of nonqualified stock options in that
year. There is no journal entry required for financial
statement purposes until the company takes advantage of this benefit
by
offsetting taxable income.
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The
Audit
Committee has directed management to develop a detailed plan and timetable
for
the implementation of the foregoing remedial measures no later than December
17,
2007, with an expectation of achieving an earlier completion date. In addition,
under the direction of the Audit Committee, management will continue to review
and make necessary changes to the overall design of our internal control
environment, as well as policies and procedures to improve the overall
effectiveness of internal control over financial reporting.
We
believe the measures described above
will remediate the material weaknesses we have identified and strengthen our
internal control over financial reporting. We are committed to continuing to
improve our internal control processes and to diligently review our financial
reporting controls and procedures. As we continue to evaluate and work to
improve our internal control over financial reporting, we may determine to
take
additional measures to address control deficiencies or determine to modify,
or
in appropriate circumstances not to complete, certain of the remediation
measures described above.
Risks
of Non-Compliance.
We
continue to be non-compliant with Amex’ continued listing standards and are
subject to periodic review by Amex regarding our compliance plan and are
required to provide Amex with periodic updates in connection with the compliance
plan. Failure to make progress consistent with the compliance plan or to regain
compliance with the continued listing standards by December 17, 2007 will likely
result in Amex initiating delisting proceedings with respect to our common
stock.
Disclosures
About Forward−Looking Statements
. This report contains
forward−looking statements within the safe harbor provisions of the Private
Securities Litigation Report Act of 1995. All statements other than those that
are purely historical are forward−looking statements. Words such as “expect,”
“anticipate,” “believe,” “estimate,” “intend,” “plan,” “potential” and similar
expressions also identify forward−looking statements. Forward−looking statements
include statements regarding expected materiality or significance, the
quantitative effects of the restatement or the audit, and any anticipated
conclusions of the Company, the Audit Committee or management. Because these
forward−looking statements involve risks and uncertainties, there are important
factors that could cause our actual results, as well as our expectations
regarding materiality or significance, to differ materially from those in the
forward−looking statements. These factors include the risk that our material
weakness in internal control over financial reporting may require us to make
additional adjustments. Furthermore, there can be no assurance that additional
issues or matters will not arise from the Amex investigation. For a discussion
of a variety of risk factors affecting our business and prospects, see “Risk
Factors” in our Annual Report on Form 10−KSB for the year ended December 31,
2006 and our subsequent filings with the Securities and Exchange
Commission.