EWLU Merion Inc (CE)

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

Note 1 – Organization

Merion, Inc. (the “Company”), a Nevada corporation, was formed on February 4, 2011. Its predecessor, E-World USA Holding, Inc., was a California company incorporated in 2007 (“E-World CA”). In April 2011, E-World CA entered into a merger agreement with its wholly-owned subsidiary, E-World USA Holding, Inc., a Nevada corporation (“E-World NV”) that was the survivor of the merger and became the Company. Under the Merger Agreement, the Company issued 90,000,000 shares of its common stock on a one for one basis for each share of E-World CA’s common stock issued and outstanding at the date of the merger. In addition, the Company issued Type A Warrants and Type B Warrants in exchange for comparable warrants issued and outstanding of E-World CA at the date of the merger. On June 27, 2017, the Company filed an amendment to its Articles of Incorporation with the Secretary of State for the State of Nevada to change its name from E-World NV to Merion, Inc.

The Company is a provider of health and nutritional supplements and personal care products currently sold on the internet through our websites, www.dailynu.com and www.merionus.com, and to wholesale distributors.

On January 1, 2018, the Company entered into an Asset Purchase Agreement (the “Purchase Agreement”) with SUSS Technology Corporation (the “Seller”), pursuant to which the Seller agreed to sell to the Company substantially all of the assets associated with the manufacture of dietary supplements (the “Asset Sale”) for an aggregate purchase price (the “Purchase Price”) of $1,000,000 and 1,000,000 shares of the Company’s common stock (the “Purchase Shares”) valued at $320,000. The Company has evaluated this transaction to determine whether it is considered to be an asset purchase or business purchase and concluded such transaction was an asset purchase in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) section 805-10-55.

The Seller was one of our major suppliers during the years ended December 31, 2017 and 2016. These assets meet all industry nutritional and dietary supplement manufacturing standards, including U.S. Food and Drug Administration and Good Manufacturing Practice compliance and Current Good Manufacturing Practice regulations. In addition to manufacturing the nutritional supplements that it sells, the Company also began production of hard capsules, tablets, solid beverage (sachet packaging), teabags, powder, granules, dietary supplements for export, softgel capsules and health food from these assets for any potential new customers who need these products, similar to our Original Equipment Manufacturer (“OEM”) business. In May 2018, the Company began manufacturing certain of the nutritional supplements that it sells.

Note 2 – Going Concern

Management has determined there is substantial doubt about our ability to continue as a going concern as a result of our lack of significant revenues, significant recurring losses, and negative working capital. If we are unable to generate significant revenue or secure additional financing, we may be required to cease or curtail our operations. Our financial statements do not include adjustments that might result from the outcome of this uncertainty.

Management is trying to alleviate the going concern risk by: engaging external sales representatives to sell the Company’s products, investigating and securing various financing resources, including but not limited to borrowing from the Company’s major shareholder, private placements, and the possibility of raising funds through a future public offering.

Note 3 – Summary of Significant Accounting Policies

Basis of Presentation

These unaudited condensed financial statements have been presented by the Company in accordance with the accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments consisting of normal recurring adjustments considered necessary for a fair presentation of the financial statements, have been included. Interim results are not necessarily indicative of results to be expected for the full year. The information included in this Form 10-Q should be read in conjunction with information included in the Company’s annual report on Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission on March 28, 2019.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant accounting estimates reflected in the Company’s financial statements include the useful lives of property and equipment, the collectability of receivables and impairment on long-live assets. Actual results could differ from those estimates.

Cash and cash equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents are comprised primarily of money market accounts and foreign and domestic bank accounts. To reduce its credit risk, the Company monitors the credit standing of the financial institutions that hold the Company’s cash and cash equivalents.

Accounts Receivable

Trade accounts receivable are periodically evaluated for collectability based on credit history with customers and their current financial condition. Bad debt expense or write-offs of receivables are determined on the basis of loss experience, known and inherent risks in the receivable portfolio, and current economic conditions.

The accounts receivable balance and allowance for doubtful accounts are as follows:

Movement of allowance for doubtful accounts is as follows:

Inventories

Inventories are valued at the lower of cost (determined on a first-in, first-out basis) or net realizable value. Inventory consists of nutritional products, beauty products, and raw materials in our manufacturing facility. Management reviews inventory on hand for estimated obsolescence or unmarketable items, as compared to future demand requirements and the shelf life of the various products. Based on the review, the Company records inventory write-downs when costs exceed expected net realizable value. The inventories’ shelf lives are approximately 3 years.

Property and Equipment, net

Property and equipment are stated at cost, net of accumulated depreciation. Upon disposition, the cost and related accumulated depreciation and amortization is removed from the books, and any resulting gain or loss is included in operations. The Company provides depreciation and amortization using the straight-line method over the estimated useful lives of various classes as follows:

Repairs and maintenance are charged to operations when incurred while betterments and renewals are capitalized.

Right-of-use Asset and Lease Liabilities

In February 2016, the FASB issued ASU 2016-02 “Leases (Topic 842).” The new standard requires lessees to recognize lease assets (“right of use”) and lease obligations (“lease liabilities”) for leases previously classified as operating leases under generally accepted accounting principles on the balance sheet for leases with terms in excess of 12 months. The standard is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. The Company adopted this standard as of January 1, 2019 utilizing the practical expedients approach.

Impairment of Long-Lived Assets

Long-lived assets, including property, equipment and intangible assets with finite lives, are reviewed for impairment whenever events or changes in circumstances (such as a significant adverse change to market conditions that will impact the future use of the assets) indicate that the carrying value of an asset may not be recoverable. The Company assesses the recoverability of the assets based on the undiscounted future cash flows the assets are expected to generate and recognizes an impairment loss when estimated discounted future cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When the Company identifies an impairment, the Company reduces the carrying amount of the asset to its estimated fair value based on a discounted cash flow approach or, when available and appropriate, to comparable market values.

Deferred Revenue

Deferred revenue represents product deposits advanced by customers on specified product orders or on future orders that have not been shipped as of the balance sheet date. Deferred revenue also represents shipping fee deposits advanced by customers in relation to the unshipped product orders. Deferred revenue is reduced when the related sale is recognized in accordance with the Company’s revenue recognition policy.

Accrued Bonus

Accrued bonus represents amounts earned by the Company’s affiliate members (the “Affiliated Members”) for successful product sales. These bonuses are in the form of rebate credits that can be used to order the Company’s products, or cash rebates provided to Affiliate Members upon request.

Fair Value of Financial Instruments

The Financial Accounting Standard Board (“FASB”) accounting standards codification (“ASC”), FASB ASC 825 Financial Instruments, requires that the Company discloses estimated fair values of financial instruments.

As defined in ASC 820 Fair Value Measurement, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes the market data of similar entities in its industry or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company classifies fair value balances based on the observability of those inputs. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurement).

The three levels of the fair value hierarchy are as follows:

Level 1 – Quoted prices that are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 – Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly observable as of the reporting date and includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.

Revenue Recognition

On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers (ASC 606) using the modified retrospective method for contracts that were not completed as of January 1, 2018. This did not result in an adjustment to retained earnings upon adoption of this new guidance, as the Company’s revenue was recognized based on the amount of consideration we expect to receive in exchange for satisfying the performance obligations.

The core principle underlying the revenue recognition ASU is that the Company will recognize revenue to represent the transfer of goods and services to customers in an amount that reflects the consideration to which the Company expects to be entitled in such exchange. This will require the Company to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time, based on when control of goods and services transfers to a customer. The Company’s revenue streams are recognized at a point in time, based on when control of goods and services transfers to a customer.

The ASU requires the use of a new five-step model to recognize revenue from customer contracts. The five-step model requires that the Company (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue when (or as) the Company satisfies each performance obligation. The application of the five-step model to the revenue streams compared to the prior guidance did not result in significant changes in the way the Company records its revenue. Upon adoption, the Company evaluated its revenue recognition policy for all revenue streams within the scope of the ASU under previous standards and using the five-step model under the new guidance and confirmed that there were no differences in the pattern of revenue recognition.

The Company continues to derive its revenues from sales contracts with its customers with revenues being recognized upon delivery of products. Persuasive evidence of an arrangement is demonstrated via sales contracts and invoices; and the sales price to the customer is fixed upon acceptance of the sales contract. Sales rebates or discounts are recognized as a reduction of revenue. The Company recognizes revenue when control of the goods is transferred upon shipment to the customer by the Company and collectability of payment is reasonably assured. These revenues are recognized at a point in time after all performance obligations are satisfied.

The Company also recognizes revenue on shipping and handling fees charged to the Company’s customers. Shipping and handling fee revenue is recognized when products have been delivered at a point in time. Shipping and handling fee revenues totaled $930 and $1,136 for the three months ended September 30, 2019 and 2018, respectively, and totaled $27,354 and $4,299 for the nine months ended September 30, 2019 and 2018, respectively.

Product returns are allowed for unopened products purchased under regular sales terms within 60 days. Allowances for product returns are provided at the time the sale is recorded using historic return rates for each country and the relevant return pattern. Historically the Company has a return rate of nearly zero. Hence, the allowance as of September 30, 2019 and December 31, 2018 is estimated at $0.

In addition to the Company’s 60-day return policy, the Company, at its discretion, may accept a customer’s application for a buy-back of products previously sold within one year at 90% of the original product’s cost less commissions and shipping costs. The Company implemented its buy-back policy on January 1, 2012. To date, the Company has not received any buy-back applications. As a result, no allowance for buy-backs had been recorded as of September 30, 2019 and December 31, 2018.

The majority of the Company’s product sales are generated from China. Product sales generated from other countries or within the United States are immaterial to our financial statements. Currently, all of the Company’s OEM and packaging sales are generated from the United States. While all products are priced in U.S. currency, the Company accepts payments in both U.S. dollars and Hong Kong dollars.

Shipping and Handling Expenses

Shipping and handling costs incurred by the Company are included in selling expenses and totaled $4,154 and $10,564 for the three months ended September 30, 2019 and 2018, respectively, and totaled $24,117 and $31,405 for the nine months ended September 30, 2019 and 2018, respectively.

Research and Development (“R&D”) Expenses

Research and development expenses include salaries and other compensation-related expenses paid to the Company’s research and product development personnel while they are working on R&D projects, as well as raw materials used for the R&D projects. R&D expenses incurred by the Company are included in the general and administrative expenses and totaled $0 and $3,223 for the three months ended September 30, 2019 and 2018, respectively, and totaled $904 and $3,605 for the nine months ended September 30, 2019 and 2018, respectively.

Income Taxes

The Company utilizes ASC 740 Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Deferred taxes are also recognized for net operating losses that can be carried forward. A valuation allowance is established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

Basic and Diluted Earnings (Loss) Per Share

Generally accepted accounting principles regarding earnings per share (“EPS”) require presentation of basic and diluted earnings (loss) per share in conjunction with the disclosure of the methodology used in computing such earnings (loss) per share.

Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average of common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. These common stock equivalents are not included when the Company has a loss because they would be anti-dilutive.

2,300,000 shares of restricted common stock with weighted average effect of 755,876 and 1,260,686 diluted shares are excluded in the diluted EPS calculation for the three and nine months ended September 30, 2019, respectively, due to its anti-dilutive nature. There were no other potential dilutive securities outstanding for the three and nine months ended September 30, 2019 and 2018.

Concentration of Credit Risk

Financial instruments

Financial instruments that potentially subject the Company to concentrations of credit risk are cash, accounts receivable, and other receivables arising from its normal business activities. The Company maintains balances at financial institutions which, from time to time, may exceed Federal Deposit Insurance Corporation (FDIC) insured limits for the banks located in the United States, or may exceed Hong Kong Deposit Protection Board (HKDPB) insured limits for the banks located in Hong Kong. The Company had approximately $494,000 of uninsured balances as of September 30, 2019.

Major Customers and Suppliers

For the three months ended September 30, 2019, one customer accounted for approximately 64% of the Company’s sales and for the three months ended September 30, 2018, two customers accounted for approximately 40% (28% and 12%) of the Company’s sales.

For the nine months ended September 30, 2019, no customer accounted for more than 10% of the Company’s sales and for the nine months ended September 30, 2018, two customers accounted for approximately 55% (42% and 13%) of the Company’s sales.

As of September 30, 2019, two customers accounted for approximately 95% (83% and 12%) of the Company’s accounts receivables. As of December 31, 2018, one customer accounted for 100% of the Company’s accounts receivable.

For the three months ended September 30, 2019, three suppliers accounted for 100% (67%, 22% and 11%) of the Company’s product purchases and for the three months ended September 30, 2018, three suppliers accounted for approximately 66% (32%, 18% and 16%) of the Company’s product purchases.

For the nine months ended September 30, 2019, four suppliers accounted for approximately 70% (24%, 19%, 17% and 10%) of the Company’s product purchases and for the nine months ended September 30, 2018, three suppliers accounted for approximately 50% (25%, 14% and 11%) of the Company’s product purchases.

Related Parties

A party is considered to be related to the Company if the party directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and other parties with which the Company may deal if one party controls or can significantly influence management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests is also a related party.

New Accounting Pronouncements

In June 2018, the FASB issued ASU No. 2018-07, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, or ASU 2018-07. ASU 2018-07 simplifies the accounting for share-based payments made to nonemployees so the accounting for such payments is substantially the same as those made to employees. Under this ASU, share based awards to nonemployees will be measured at fair value on the grant date of the awards, entities will need to assess the probability of satisfying performance conditions if any are present, and awards will continue to be classified according to Accounting Standards Codification (“ASC”) 718 upon vesting, which eliminates the need to reassess classification upon vesting, consistent with awards granted to employees. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The adoption of this ASU did not have any material effect on the Company’s unaudited condensed consolidated financial statements.

In May 2019, the FASB issued ASU 2019-05, which is an update to ASU Update No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which introduced the expected credit losses methodology for the measurement of credit losses on financial assets measured at amortized cost basis, replacing the previous incurred loss methodology. The amendments in Update 2016-13 added Topic 326, Financial Instruments—Credit Losses, and made several consequential amendments to the Codification. Update 2016-13 also modified the accounting for available-for-sale debt securities, which must be individually assessed for credit losses when fair value is less than the amortized cost basis, in accordance with Subtopic 326-30, Financial Instruments— Credit Losses—Available-for-Sale Debt Securities. The amendments in this Update address those stakeholders’ concerns by providing an option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost basis. For those entities, the targeted transition relief will increase comparability of financial statement information by providing an option to align measurement methodologies for similar financial assets. Furthermore, the targeted transition relief also may reduce the costs for some entities to comply with the amendments in Update 2016-13 while still providing financial statement users with decision-useful information. ASU 2019-05 is effective for the Company for annual and interim reporting periods beginning January 1, 2020. The Company is currently evaluating the impact of this new standard on its consolidated financial statements and related disclosures.

The Company does not believe other recently issued but not yet effective accounting standards, if currently adopted, would have a material effect on the Company’s unaudited condensed consolidated financial statements.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current year presentation. These reclassifications have no effect on the accompanying statements of operations and cash flows.

Depreciation expense totaled $10,763 and $17,290 for the three months ended September 30, 2019 and 2018, respectively.

Depreciation expense totaled $44,124 and $53,346 for the nine months ended September 30, 2019 and 2018, respectively.

Note 6 – Debt

Due to third parties, interest bearing

The Company has borrowed money from third parties to fund operations. These third parties consist of the Chief Executive and Financial Officer’s friends and the spouse of a former board member of the Company. These advances have annual interest rates of 6% and 10%, are unsecured, and are due on demand. During the nine months ended September 30, 2019 and 2018, advances totaled $1,480,000 and $0, respectively. As of September 30, 2019 and December 31, 2018, the Company owed $1,500,000 and $109,030 to these third parties, respectively. In March 2019, the Company settled $89,030 of the debt owed to some of these third parties and converted the debt into the Company’s common stock (See Note 10 - Equity).

Interest expense for the three months ended September 30, 2019 and 2018 for the above loans amounted to $4,160 and $1,649, respectively.

Interest expense for the nine months ended September 30, 2019 and 2018 for the above loans amounted to $4,755 and $4,893, respectively.

In March 2019, the repayment term related to the amount of $20,000 was changed by the third party creditor from due on demand to due on March 20, 2024.

Due to third parties, non-interest bearing

The Company has borrowed money from third parties to fund operations. These third parties consist of the Chief Executive and Financial Officer’s friends and a former board member of the Company. These advances do not bear interest, are unsecured, and are due on demand. During the nine months ended September 30, 2019 and 2018, advances totaled $50,000 and $0, respectively. As of September 30, 2019 and December 31, 2018, the Company owed $100,000 and $0 to these third parties, respectively. In March 2019, the Company settled $32,000 of the debt owed to a third party and converted the debt into the Company’s common stock (See Note 10 - Equity). The Company also repaid $19,666 and $249,318 to a third party during the nine months ended September 30, 2019 and 2018, respectively.

In March 2019, the repayment term related to the amount of $50,000 was changed by the third party creditor from due on demand to due on March 20, 2024.

Note 7 – Related Party Transactions

Due to shareholder, interest bearing

In January 2016, Mr. Dinghua Wang, a major shareholder, director, Chief Executive and Financial Officer of the Company, pledged certain of his personal assets and obtained a personal loan from which he provided funds for the operations of the Company. In consideration for the funds the Company received, the Company agreed to pay the interest on this loan on Mr. Wang’s behalf. This loan has an annual borrowing rate of 9.99%. As of September 30, 2019 and December 31, 2018, the balance due to Mr. Wang, interest bearing, amounted to $471,603. The full balance of $471,603 was repaid in October 2019.

Interest expense for each of the three month periods ended September 30, 2019 and 2018 for the above loan amounted to $12,488.

Interest expense for each of the nine month periods ended September 30, 2019 and 2018 for the above loan amounted to $37,463.

Due to shareholder, non-interest bearing

From time to time, Mr. Dinghua Wang, a major shareholder, director, Chief Executive and Financial Officer of the Company, advances monies to the Company and the Company repays such advances. Such business transactions are recorded as due to or from Mr. Wang at the time of the transaction. During the nine months ended September 30, 2019 and 2018, advances totaled $193,272 and $84,041, respectively, and payments to Mr. Wang totaled $283,075 and $214,797, respectively. As of September 30, 2019 and December 31, 2018, the balance due to Mr. Wang, non-interest bearing, amounted to $2,418,248 and $2,508,051, respectively. This balance is unsecured and is due on demand.

In March 2019, the repayment term related to $2,000,000 of the total balance was changed by Mr. Wang from due on demand to due on March 20, 2024.

Due to employee

The Company has borrowed money from Vickie Ho, Executive Vice President of the Company, to fund operations. These advances do not bear interest, are unsecured, and are due on demand. As of September 30, 2019 and December 31, 2018, the Company owed $95,000 to such employee.

In March 2019, the repayment term related to the balance of $95,000 was changed by the employee from due on demand to due on March 20, 2024.

Advances from related parties, interest bearing

The Company has borrowed $30,000 from a related party to fund operations since July 2016. This related party is the son of the Company’s Chief Executive and Financial Officer. These advances have an annual interest rate of 10%, are unsecured and are due on demand. As of September 30, 2019 and December 31, 2018, the Company owed $30,000 to this related party.

Interest expense for the three months ended September 30, 2019 and 2018 for the above loans amounted to $756.

Interest expense for the nine months ended September 30, 2019 and 2018 for the above loans amounted to $2,244.

In March 2019, the repayment term was changed by the related party from due on demand to due on March 20, 2024.

Advances from related parties, non-interest bearing

The Company has borrowed money from certain related parties to fund operations. The related parties consist of the Chief Executive and Financial Officer’s immediate family members and relatives. These advances do not bear interest, are unsecured and are due on demand. As of September 30, 2019 and December 31, 2018, the Company owed $518,839 to these related parties.

In March 2019, the repayment term for the $518,839 was changed by these related parties from due on demand to due on March 20, 2024.

*Represents 50% of meal and entertainment expenses and stock compensation expenses that are not deductible.

The Company uses the asset and liability method, where deferred tax assets and liabilities are determined based on the expected future tax consequences of temporary differences between the carrying amounts of assets and liabilities for financial and income tax reporting purposes. Deferred taxes are also recognized for net operating loss carry forwards which can be utilized to offset taxable income in the future. The cumulative net operating loss carryforwards that may be applied against future taxable income is approximately $7,132,000 for federal and state income taxes as of September 30, 2019. The cumulative net operating loss carry forward that may be applied against future taxable income is approximately $7,817,000 for federal and state as of December 31, 2018. Net operating loss for the years ended 2017 and 2018 will not expire but limited to 80% of income until utilized. Net operating loss for the years ended 2016 and prior will expire in the years 2031 to 2036. As deferred tax assets may not be fully realizable due to potential recurring losses, management has provided a 100% valuation allowance for the deferred tax assets.

The components of the deferred tax assets are as follows:

Changes in the value allowance for deferred tax assets decreased by $191,626 from $2,187,445 at December 31, 2018 to $1,995,819 at September 30, 2019. During the nine months ended September 30, 2019, the Company utilized $187,095 deferred tax assets from the prior period.

As of September 30, 2019, federal tax returns filed for 2016, 2017 and 2018 remain subject to examination by the taxing authorities. As of September 30, 2019, California tax returns filed for 2015, 2016, 2017 and 2018 remain subject to examination by the taxing authorities.

Note 9 – Leases

Effective January 1, 2019, the Company adopted ASU 2016-02, “Leases” (Topic 842), and elected the practical expedients that do not require us to reassess: (1) whether any expired or existing contracts are, or contain, leases, (2) lease classification for any expired or existing leases and (3) initial direct costs for any expired or existing leases. The Company adopted the practical expedient that allows lessees to treat the lease and non-lease components of a lease as a single lease component. There is no impact from the adoption of ASC 842 as of January 1, 2019, as the Company did not have any existing leases with a lease term in excess of twelve months on January 1, 2019.

In January 2019, the Company entered a new office lease agreement with a 5-year lease term starting in March 2019 and terminating in February 2024. Upon adoption of ASU 2016-02, the Company recognized lease liabilities of approximately $618,000, with corresponding right-of-use (“ROU”) assets in the same amount based on the present value of the future minimum rental payments of the new lease, using an effective interest rate of 4.78%, which is determined using an incremental borrowing rate. The remaining term of the lease is 4.33 years.

The Company also leases a factory space on a month-to-month basis, which it classifies as an operating lease. Leases with an initial term of 12 months or fewer are not recorded on the balance sheet.

The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

For the three months ended September 30, 2019 and 2018, lease expenses amounted to $45,286 and $20,392, respectively, of which, $10,500 and $0 are short-term lease expenses, respectively.

For the nine months ended September 30, 2019 and 2018, lease expenses amounted to $112,668 and $62,366, respectively, of which, $21,000 and $0 are short-term lease expenses, respectively.

The five-year maturity of the Company’s lease obligations is presented below: