Your mistake is very easy:
in this line:
:state=10,plrdistwithin=40:state=1,playertake,coloff,plrsound=audiobank\misc\ping.wav,hudshow=itemprompt,hudfadeout=itemprompt
you show a hud(hudshow) and immediately fade it out(hudfadeout)
Then you start no timer!!! and you do not go to state=12, you go to state=1
Correct version:
;Artificial Intelligence Script
;Header
desc = Pickup Item Show HUD
;Triggers
:state=0:hudreset,hudx=50,hudy=50,hudimagefine=E\Program Files\The Game Creators\FPS Creator\Files\texturebank\user\paper1.png,hudname=itemprompt,hudhide=4000,hudmake=display,state=10
:state=1,etimergreater=5000:hudfadeout=paper1,state=13
:state=10,plrdistwithin=40:state=1,playertake,etimerstart,coloff,plrsound=audiobank\misc\ping.wav,hudshow=itemprompt
;End of Script