Why would each of Roger Enrico, the former CEO of PepsiCo (PEP), Jack Greenberg, the former CEO of McDonald's (MCD), Rick Lenny, the former CEO of Hershey's (HSY), and two former CEOs of Kraft (MDLZ), Dick Mayer and Bob Morrison, not only invest in an unknown food ingredients company, but also agree to serve on its advisory board?
And why would Ed Smith, Managing Partner of Brightline Capital and the grandson of the former CEO of Northern Trust, form a Special Purpose Vehicle, Brightline Ventures, to serve as a conduit for the investments of these former high-level Fortune 100 executives in this company?
We spent the past few months seeking answers to these questions, and doing an extensive amount of additional due diligence on the company in question, Z Trim Holdings (OTCQB:ZTHO). Its main product is Z-Trim, a natural, minimally-processed, taste-neutral, zero-calorie food ingredient that was originally developed and patented by the USDA.
Although it has been a long journey, it now appears as though Z Trim has overcome its biggest hurdle: how to scale and manufacture Z Trim in a profitable way. With a new outsourced manufacturing facility now up and running that will eventually be able to increase its manufacturing capacity by 30X, for the first time in its history, Z Trim will not be constrained by its inability to scale manufacturing. This is extremely significant and undoubtedly a major reason why these well-connected and savvy individuals invested millions of dollars in Z Trim over the past few years.
How bright is Z Trim's future? On Page 3 of the company's Investor Presentation, management's 5-year revenue goal is $1 billion dollars. While a heady goal, it is not unobtainable. Demand will be very strong for Z-Trim given that it possesses a number of unique and beneficial properties that food companies will crave. In addition, with recent FDA approval allowing the company to incorporate Z-Trim into meat applications, and with new products being developed for such industrial verticals as fracking, petroleum coke, paper, and steel, the company's total addressable markets have increased into the multi-billions.
Z-Trim Was Developed By The USDA
Before we delve into what the next few years could hold in store for Z Trim, it's important to understand the obstacles the company has negotiated to reach this point. Let's rewind to 1996, when the USDA introduced Z-Trim with considerable enthusiasm bordering on euphoria to the American public. At the time, the biochemist who created it, George Inglett, stated "It's a new generation in fighting fat and it can provide another instrument for the food industry." The highly respected consumer advocacy organization, Center for Science in The Public Interest, endorsed Z-Trim, declaring it "to be safe and a useful tool for losing weight."
Unfortunately, the USDA could not figure out the logistics of manufacturing it. Z-Trim seemed to be the ultimate conundrum, a wonderful product that nonetheless bedeviled some of the world's smartest scientists - they created it, but could not mass produce it.
Enter Circle Group, The Predecessor Company To Z Trim Holdings
Unable to figure out how to mass produce it, the USDA eventually decided to license the product to Fiber-Gels Technologies, a technology holding interest that was purchased by Circle Group in 2002. At this point in time, Z Trim Holdings had not yet been incorporated. Put simply, Circle Group was the predecessor company to Z Trim Holdings ten years ago.
After licensing Z-Trim, Circle Group's CEO, Greg Halpern spent the next few years promoting his new product to potential investors and customers. In early 2004, Mr. Halpern touted a contract win from Nestle (OTCPK:NSRGY).The company's stock went parabolic, only to crash later in the year when the contract was canceled by Nestle after Mr. Halpern was unable to deliver the product in a timely or reliable fashion.
New Management Takes The Reins In Late 2007
After a series of missteps over the following number of years, Mr. Halpern resigned from his role as CEO and was replaced by Steve Cohen, the current CEO of Z Trim Holdings. Over the past five years, Mr. Cohen has methodically re-built the company step-by-step.
Among many important moves orchestrated by Mr. Cohen, perhaps the most important of them all was hiring Kyle Hanah, a process engineer formerly of Conagra Foods (CAG). Originally hired in 2008 as Z Trim's plant engineer, Mr. Hanah has since been promoted to the role of VP of Technology. Since joining Z Trim, Mr. Hanah figured out a way to speed the production process from a batch per week to a batch per day. As further improvements were made to the production process, Mr. Hanah and Mr. Cohen concluded that they would be able to mass produce Z-Trim in a profitable manner.
With its confidence re-built and a refined manufacturing plan in place, Z Trim's management faced a new problem: The company's existing plant was never meant to be anything more than a pilot plant. It became apparent Z Trim would need to outsource the manufacturing to a sophisticated particle contract manufacturer.
Enter Aveka. Founded by three former scientists from 3M Co. (MMM), Aveka is a contract manufacturer which specializes in manufacturing particle technology. Aveka's founders were so impressed with Z Trim's potential that they invested $3M of their own money to build a new plant specifically designed to manufacture Z-Trim. Here is what Aveka's founder, Dr. Willie Hendrickson, had to say about Z Trim last fall:
We look forward to helping Z Trim Holdings, Inc. become a major global supplier of multi-functional ingredients. Z Trim's products are truly born of a disruptive technology, which will change the way many companies make use of agricultural by-products.
As part of the agreement between Aveka and Z Trim, Aveka will scale production to eventually reach 1 million pounds of Z Trim product per month. With the first line of production up and running, Z Trim can now turn its sights to scaling its revenues and becoming profitable.
A Number Of Catalysts On The Horizon
With its new manufacturing plant on-line, we expect to see a number of catalysts emerge for the company over the next twelve months. These include:
Due to a much shorter sales cycle than those seen within the food industry, Z-Trim's industrial division could see contract wins materialize in the near-term. Because Z-Trim holds up to 30 times its own weight in water, it could serve as a very cost-effective replacement for both guar gum and also Xanthan Gum, products currently being used within the fracking space.
Z Trim should become a profitable business at a $2.5 million quarterly run-rate. We think profitability can be reached by the second quarter of 2013.
As capacity scales, we expect to see Z Trim's set of former high-level Fortune 100 investors and strategic advisers become more engaged and begin to open their formidable rolodexes to Z Trim's current management team. Think of how quickly revenues could scale for Z Trim if Mr. Greenburg, the former CEO of McDonald's, recommends McDonald's to utilize Z-Trim in its hamburger formulations. Considering that it just received FDA approval for meat applications, this is not too big of a stretch to envision.
What 2013 and 2014 Could Look Like For Z Trim
With its new plant on-line, we view Z Trim as a biotechnology company that has just received FDA approval for a new flagship drug. Yes, figuring out how to manufacture and scale Z-Trim is just that significant. With such an important catalyst having just been reached, we feel that revenues will grow steadily as we move into 2013.
Now, don't get us wrong. While we do not expect to see the company transform itself overnight, we do expect to see a significant ramp in sales begin in 2013. We consider it reasonable to expect a revenue growth rate of 400-500% year-over-year to around $12.5-$15 million in revenues in 2013 and a range of $45-$60 million in 2014. After all, in order to reach one billion in sales within five years, the company will need to get to $100 million pretty quickly.
Assuming the gross margin expansion begins to occur, as alluded to on Page 11 in the Investor Presentation, and the company books $12.5-$15 million in revenues, Z Trim would earn close to $0.10 a share in earnings in 2013, based upon 59 million shares outstanding. A $45-$60 million revenue line in 2014, would equate to $0.30 in earnings per share. A $100 million revenue line would equate to $0.65 in earnings.
Risks To Investing In Z-Trim
While the odds suggest a bright future for Z Trim, there are still a number of risks that investors should consider before investing in the stock. First, with around 59 million shares outstanding, the stock is certainly not cheap, with its $200 million market capitalization. Secondly, the company's balance sheet needs work. Investors should read through the most recent 10-Q to understand what we mean. We therefore feel that investors should not rush in to buy into Z Trim just yet. With the odds of a financing high in the near-term, investors should ease into their positions on pullbacks in the coming weeks.
Investors should also realize that ZTHO is a very illiquid stock, with its advisory board members owning a majority of the company through the Brightline conduit. ZTHO also trades on the pink sheets. It is therefore a stock that should only be considered by the most aggressive set of investors with a tolerance for risk.
On a final note, Z-Trim's management team does not yet have a viable Investor Relations strategy in place. Until they hire a reputable IR firm, it will be difficult for the company to engage with new institutional investors.
In summary, while a number of risks remain, we feel that Z Trim nonetheless offers investors a very unique opportunity to invest in a company at a major inflection point. We own it for the accounts that we oversee and are looking forward to adding to our shares after the company buttresses its balance sheet and as revenues begin to scale to profitable levels.