Quarterly report pursuant to Section 13 or 15(d)

COMMITMENTS AND CONTINGENCIES

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COMMITMENTS AND CONTINGENCIES
3 Months Ended
Mar. 31, 2020
Commitments and Contingencies Disclosure [Abstract]  
COMMITMENTS AND CONTINGENCIES

Legal Matters

 

In the ordinary course of business, the Company enters into agreements with third parties that include indemnification provisions which, in its judgment, are normal and customary for companies in the Company’s industry sector. These agreements are typically with business partners, clinical sites, and suppliers. Pursuant to these agreements, the Company generally agrees to indemnify, hold harmless, and reimburse indemnified parties for losses suffered or incurred by the indemnified parties with respect to the Company’s product candidates, use of such product candidates, or other actions taken or omitted by us. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. As a result, the estimated fair value of liabilities relating to these provisions is minimal. Accordingly, the Company has no liabilities recorded for these provisions as of March 31, 2020 and December 31, 2019.

 

In July 2018 the Company received notice of the expiration and termination of a license agreement dated January 19, 2016 acquired through the Share Exchange by our subsidiary Exactus BioSolutions, Inc that the Company recognized as an intangible asset from Digital Diagnostics, Inc. (“Digital Diagnostics”) related to our FibriLyzer and MatriLyzer technologies.  In addition, on December 14, 2018 we received a letter from KD Innovation, Ltd. (“KDI”) and Dr. Krassen Dimitrov, our former director seeking payment for alleged past due consulting fees from June 2017 through November 2018 pursuant to a Consulting Agreement dated January 20, 2016.  On January 23, 2019, Digital Diagnostics, made a demand for compensation against the Company in connection with an alleged breach of a License Agreement. Under the terms of these agreements, the parties are required to arbitrate claims.  Although we dispute the material allegations made by Digital Diagnostics and KDI, if such actions were successful damages could be awarded against us.

 

On December 14, 2018, the Company received a termination and demand notice from KD Innovation, Ltd, an entity 100% owned by a former Board member, in connection with a consulting agreement KDI entered into with the Company’s subsidiary, Exactus Biosolutions, Inc., on or about January 20, 2016. No lawsuit has been filed; however, in the event a lawsuit is filed, the Company intends to vigorously contest the matter. On September 9, 2019, Dr. Krassen Dimitrov, a former director, commenced an arbitration proceeding against the Company and its wholly-owned subsidiary Exactus Biosolutions, Inc. before the American Arbitration Association.  The complaint alleges breach of a consulting agreement for services by Dr. Dimitrov during 2017-2019, among other claims, and seeks $750,000 in damages.  The Company has filed an answer denying the claims and asserting numerous counterclaims against Dr. Dimitrov and his affiliated entities, KD Innovation Ltd., and Digital Diagnostics, Inc.  An arbitrator has been appointed in the matter and on May 1, 2020 issued a procedural order suspending further proceedings.

 

On September 25, 2019, Jonathan Gilbert, a former director, filed and served a complaint against the Company in the courts of Nassau County, New York. The complaint alleges that Mr. Gilbert is entitled to retain certain cancelled equity awards and seeks specific performance and damages. In February 2019, the Company granted 1,000,000 options to purchase shares of the Company’s Common Stock to a former director of the Company, Jonathan Gilbert, with vesting terms pursuant to the respective stock option agreement. The former director resigned as a director of the Company in August 2019. The options have a term of 10 years from the date of grant and was exercisable at an exercise price at $0.01. The Company already recognized $320,000 of compensation expense which relates to the vesting of 500,000 stock options prior to his resignation. After Jonathan Gilbert’s resignation, he filed a complaint against the Company disputing his rights to receive the Company’s common stock through the exercise of his stock options. In January 10, 2020, Mr. Gilbert and the Company entered into a Settlement and General Release Agreement and both parties agreed to such consideration. The Company will issue to Mr. Gilbert 375,000 shares of the Company’s common stock whereby 187,500 shares of common stock shall be issued immediately (“First Tranche”) and another 187,500 shares of common stock shall be issued immediately and held by the transfer agent and delivered on the six month anniversary of this agreement (“Second Tranche”) (collectively the First and Second Tranche shall be called “Settlement Stock”). The Settlement Stock is by virtue of the exercise of Mr. Gilbert’s stock options and any required payments from the exercise of the stock options have been credited or forgiven. The Settlement Stock which is issued under the Stock Option Plan based upon the exercise of the stock options registered pursuant to the Company’s registration statement on form S-8 (File no. 333-229025). The Company and Mr. Gilbert have released and discharged each other from all claims and demands. In January 2020, Mr. Gilbert dismissed the lawsuit against the Company. Pursuant to the Settlement and General Release Agreement dated in January 2020, the Company recorded the issuance of 375,000 shares at par value upon the exercise of the 375,000 stock options and cancelled the remaining 625,000 stock options during fiscal 2019.

 

On February 26, 2020 a complaint was filed against the Company in the Circuit Court, Palm Beach County, Florida on behalf of two former employees of the Company.  The case is entitled Ryan Borcherds and Miriam Martinez vs. Exactus, Inc. (Case No. 103978709). These former employees were hired in January 2020.  The complaint alleges the Company failed to pay wages and compensation to 2 employees under the Fair Labor Standards Act, breach of contract and violation of various Florida statutes, including allegations on behalf of other similarly situated persons.  On May 8, 2020, an amended complaint was filed against the Company in the Circuit Court, Palm Beach County, Florida on behalf of six former employees. The amended case is entitled Ryan Bocherds, Marc Reiss, Jeannine Boffa, Benjamin Blair, Miriam Martinez and Michael Amoroso vs. Exactus, Inc, (Case No. 50-2020-CA-002274-MB). The other four former employees were hired between April 2019 and December 2019. As of December 31, 2019, the Company has recorded total accrued salaries of $26,494 from these four former employees who were hired in fiscal 2019. The complaint seeks approximately $82,000 in unpaid wages plus special damages, liquidated damages, interest and attorney’s fees. The Company intends to vigorously contest the matter.

 

Leases

 

On March 1, 2019, the Company, through its majority-owned subsidiary, EOW, entered into a farm lease agreement for a lease term of one year. The lease premise is located in Cave Junction, Oregon and consist of approximately 100 acres. The lease requires the Company to pay 5% of the net income realized by the Company from the operation of the lease farm. The lease shall continue in effect from year to year except for at least a 30-day written notice of termination (see Note 7).

 

On March 1, 2019, the Company, through its majority-owned subsidiary, EOW, entered into a farm lease agreement for a lease term of one year. The lease premise is located in Glendale, Oregon and consist of approximately 100 acres. The lease requires the Company to pay $120,000 per year, whereby $50,000 was payable upon execution and $70,000 shall be payable prior to planting for agricultural use or related purposes. The lease shall continue in effect from year to year except for at least a 30-day written notice of termination (see Note 7).

 

On April 30, 2019, the Company, through its majority-owned subsidiary, EOW, entered into a farm lease agreement for a lease term of one year. The lease premise is located in Cave Junction, Oregon and consists of approximately 38 acres. The lease requires the Company to pay $76,000 per year, whereby $38,000 was payable upon execution and $38,000 shall be payable on September 15, 2019 and 2% of the net income realized by the Company from the operation of the lease farm. The Company has paid the initial payment of $26,000 and the remaining $12,000 was paid directly to the landlord by an affiliated company who is renting the portion of the lease property from the Company. The affiliated company is owned by two managing members of EOW. EOW is in the process of arranging a sub-lease agreement with the affiliated company. The lease shall continue in effect from year to year for five years except for at least a 30-day written notice of termination (see Note 7).

 

On July 9, 2019, the Company entered into a Commercial Lease Agreement (the “Lease”) with Skybar Holdings, LLC, a Florida limited liability company. Pursuant to the Lease, the Company will rent the entire first floor (consisting of approximately 4,000 square feet) of a property located in Delray Beach, Florida (the “Premises”). The Company plans to develop the Premises to create a hemp-oriented health and wellness retail venue, including education, clothing and cosmetics, and explore franchise opportunities. The initial term of the Lease is 5 years commencing August 1, 2019, with two 5-year extension options. The Lease includes a right of first refusal in favor of the Company to lease any space that becomes available on the 2nd and 3rd floor of the Premises and a right of first refusal to purchase the Premises. Pursuant to the Lease, the Company will pay rent equal to forty thousand dollars per month in advance in addition to all applicable Florida sales and/or federal taxes. Effective one year from the lease commencement date and each year thereafter, the rent shall increase at least three percent (3%) per year. The lessor of the Premises is a limited liability company owned or controlled by Vladislav (Bobby) Yampolsky, the manager and controlling member of C2M, the Company’s largest stockholder.

 

On July 1, 2019, the Company entered into an office lease agreement for a lease term of six months beginning July 1, 2019 ending December 31, 2019 for a total rental of $6,052 for six months. The lease premise is located in Delray Beach, Florida. In December 2019, the Company and landlord agreed to extend the lease for another 6-month term from January 2020 to June 2020 with the same terms in the original lease agreement.

 

Master Product Development and Supply Agreement

 

On January 8, 2019, the Company entered into a Master Product Development and Supply Agreement (the “Development Agreement”) with Ceed2Med, LLC (“C2M”). C2M has provided the Company access to expertise, resources, skills and experience suitable for producing products with active phyto-cannabinoid (CBD) rich ingredients including isolates, distillates, water soluble, and proprietary formulations. Under the Development Agreement, the Company has been allotted a minimum of 50 and up to 300 kilograms per month, and up to 2,500 kilograms annually, of active phyto-cannabinoid (CBD) rich ingredients for resale. The Company expects to be able to offer tinctures, edibles, capsules, topical solutions and animal health products manufactured for us by C2M to satisfy demand for branded and white-label products that the Company intends to offer to sell in the future. The founders of C2M established their first CBD business in 2014. C2M will also be responsible for overseeing all farming and manufacturing activities of the Company.

 

Whereas, in consideration for the Development Agreement, C2M was issued 8,385,691 shares of our Common Stock on January 8, 2019. Additionally, the Company granted immediately vested 10-year options to purchase 750,000 shares of Common Stock to founders of C2M, with exercise price of $0.32 per share. As a result, C2M was our largest shareholder holding (inclusive of the vested options) approximately 51% of our outstanding Common Stock on the date of the Development Agreement.

 

C2M will provide personnel necessary for the Company's growth. Utilizing C2M employees and facilities, the Company has been able to rapidly access resources and opportunities in the hemp-derived CBD industry. Emiliano Aloi of C2M became a member of our Advisory Board in January 2019 and was appointed President of the Company on March 11, 2019.

 

Management and Services Agreement

 

As previously disclosed, on March 11, 2019, the Company acquired, through our majority-owned subsidiary, EOW, from the Company’s largest shareholder, C2M, certain rights to a 50.1% limited liability membership interest in certain farm leases and operations in Oregon in order to enter into the business of hemp farming for the 2019 grow season. During May 2019, the Company appointed Emiliano Aloi, the President of the Company, to the additional position of co-manager of EOW. The Company farmed approximately 200 acres of hemp for harvest and production during 2019. 

 

On July 31, 2019, the Company finalized and entered into a Management and Services Agreement in order to provide the Company project management and various other benefits associated with the farming rights, operations and opportunities with C2M, including assignment by C2M of C2M’s agreements and rights to acquire approximately 200 acres of hemp farming. Under the terms of the MSA, C2M agreed to provide further access to the opportunities and know-how of C2M, consented to the appointment of Emiliano Aloi, a seasoned hemp veteran previously an advisor and currently the Company’s President, and to provide the Company and EOW additional services consisting of, among other things:

 

right of participation for further investment and business opportunities in order to rapidly expand our business and operations in hemp-derived CBD;

 

executive, sourcing, vendor, product, production and other expertise and resources;

 

appointment of Aloi to the position of President;

 

introductions to farming and other financing;

 

designs for international “Hemp-Café” store design and franchise opportunities including plans, drawings, approvals and authorizations, leads and contacts;

 

access to leasing of prime real estate in Delray Beach Florida with an option to purchase, and the continuing assistance of the founder of C2M in connection with management, design, and promotion of the project;

 

drawings, designs and specifications for extraction, production and manufacturing facilities and resources;

 

brand development and support services.

 

The Company finalized the compensation arrangements for C2M as contemplated in connection with the March 2019 transactions and the additional agreements with C2M under the MSA following tax, accounting and legal review including the treatment of the issuance of preferred stock in connection with the transactions. While the assignment initially contemplated a $9 million payment from the Company to C2M, the parties agreed to payment in a new class of preferred stock, convertible above market. As a further condition to payment of the consideration, the value of the 50.1% interest in EOW was required to be not less than $25 million, with a third-party valuation and fairness opinion from a third-party prior to payment. The term of the MSA commenced on the date of this agreement.

 

In October 2019, the Company entered into an amendment to the MSA (the “MSA Amendment”). The MSA Amendment extended the termination date of the MSA to December 31, 2024 and expanded the scope of services to be provided by C2M to the Company. Included in the scope of services was to negotiate with the minority owners of EOW, an amendment to the Operating Agreement of EOW for the distribution and allocation to provide for up to 100% (from 50.1%) of the results of operations of the 2019 harvest or yield resulting from all plants germinated during the calendar year December 31, 2019.

 

Distribution and Profit-Sharing Agreement

 

On November 20, 2019, the Company entered into the Non-Exclusive Distribution and Profit-Sharing Agreement with Canntab Therapeutics USA (Florida), Inc. Pursuant to the agreement, which has a term of 2 years and is subject to automatic renewal. The Company is a non-exclusive distributor of certain Canntab products throughout the U.S. Canntab will not grant a third-party the right to promote, sell or deliver the products within the U.S. during the term of the agreement, subject to certain exceptions. In addition, the Company agreed to share equally with Canntab in the gross profits received from the sale of their products by the Company. With respect to Canntab’s sales of products, the Company will receive 10% of the gross profits. In connection with the Canntab Agreement, the Company also entered into a Supply Agreement with Canntab, which has a term of 2 years and is subject to automatic renewal, pursuant to which the Company agreed to sell hemp extracts to Canntab. Due to a need for additional warehouse space and disruptions caused by the Covid-19 pandemic, the Company has not distributed Canntab products to date.

 

Employment Agreements

 

Andrew Johnson, the Company’s Chief Strategy Officer, is serving under a two-year employment agreement adopted on March 11, 2019 at an annual salary of $110,000, which was increased to $150,000 on January 23, 2020. In addition, he will be entitled to an annual cash bonus, in an amount as determined by the board of directors, if the Company meets or exceeds criteria adopted by the Compensation Committee of the Board of Directors. He shall also be eligible for grants of awards under stock option or other equity incentive plans of the Company as the Company’s Compensation Committee. For the 2019 year, he received a cash bonus of $100,000 to be paid in equal installments over the next 12 months which have been recorded in accrued expenses on the consolidated balance sheet as of March 31, 2020 and December 31, 2019.

 

Derek Du Chesne, the Company’s current President, Chief Growth Officer, and a Director, is serving under a two-year employment agreement dated February 18, 2020 and entered into in connection with his service as Chief Growth Officer. Du Chesne’s base salary for the initial year of service will be $150,000, increasing to not less than $250,000 for the second year of service, subject to annual review by the Board of Directors. He will be entitled to quarterly cash bonuses based on a percentage of our net sales to be determined. In addition, Mr. Du Chesne will be entitled to annual cash bonuses as follows: (1) up to 250% of base salary for the 2020 calendar year, if: (A) Company’s net income on a consolidated basis for the 2020 fiscal year is equal to or in excess of $5,000,000; or (B) Company’s net sales on a consolidated basis is equal to or in excess of $40,000,000 during the 2020 fiscal year; and (2) 200% of base salary for the 2021 calendar year, subject to the satisfaction of performance criteria set by the Board in consultation with a third-party compensation expert and Mr. Du Chesne. He will be eligible to participate in the Company’s Equity Incentive Plan during his employment. Upon execution of the Agreement, he was granted options to purchase up to 1,000,000 shares of the Company’s common stock at a price of $0.50 per share. 250,000 of these options were vested immediately, with the remaining 750,000 options to vest in equal installments over the next twenty-four months. The employment agreement with Mr. Du Chesne is intended to provide direct incentives to increase company sales, while providing a reasonable base compensation for his service. Following his appointment as President, he is to receive 1,000,000 shares of common stock as additional compensation, with vesting and other terms to be decided by our Compensation Committee. On March 5, 2020, the Board of directors of the Company approved the repricing of Mr. Du Chesne’s stock options to 90% of the market price on the original date of grant or exercise price of $0.30 per share (see Note 10).

 

Distribution Agreements

 

On February 4, 2020, the Company entered into a Supply and Distribution Agreement with HTO Holdings Inc (dba “Hemptown, USA”), enabling the Company to purchase and sell Hemptown’s Cannabigerol (CBG) and Cannabidiol (CBD) products, including top flower, biomass and extracts (crude, isolates, distillates, and water soluble). Ceed2Med, LLC, the Company’s largest shareholder, is also a significant investor in Hemptown USA and is party to a distribution agreement with the Company. The Interim Chief Executive Officer and C2M, LLC will cooperate in developing plans to coordinate the Company’s efforts to introduce CBG and expand its efforts to sell CBD products. This agreement shall remain in force for a period of one year from effective date and shall renew automatically in one-year increments for three years unless either party gives written notice of its intention not to renew at least 60 days prior to expiration. On March 28, 2020, the Company amended the Supply and Distribution Agreement Pursuant to the amendment whereby the Company agreed to also (i) aid Hemptown’s management with product compliance requirements, (ii) participate in discussions related to Hemptown’s 2020 farming, harvesting and processing plans as well as joint supply scenarios, (iii) interact with Hemptown’s ingredient and manufacturing divisions to facilitate development of documents for selected SKUs to service the white label market, and (iv) aid Hemptown’s CEO in overseeing the entire supply chain to establish best practices in quality and compliance and lower costs. In addition, Hemptown agrees to pay the Company $3,500 a month in consulting fees.

 

On November 20, 2019, the Company entered into the Non-Exclusive Distribution and Profit-Sharing Agreement with Canntab Therapeutics USA (Florida), Inc. Pursuant to the agreement, which has a term of 2 years and is subject to automatic renewal. The Company is a non-exclusive distributor of certain Canntab products throughout the U.S. Canntab will not grant a third-party the right to promote, sell or deliver the products within the U.S. during the term of the agreement, subject to certain exceptions. In addition, the Company agreed to share equally with Canntab in the gross profits received from the sale of their products by us. With respect to Canntab’s sales of products, the Company will receive 10% of the gross profits. In connection with the Canntab Agreement, the Company also entered into a Supply Agreement with Canntab, which has a term of 2 years and is subject to automatic renewal, pursuant to which we agreed to sell hemp extracts to Canntab. Due to a need for additional warehouse space and disruptions caused by the Covid-19 pandemic, the Company has not distributed Canntab products to date.