10-K 1 r41114110k.htm FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013 r41114110k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ý  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2013

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission File No. 000-54885


 
Respect Your Universe, Inc.
(Exact name of registrant as specified in its charter)

Nevada
20-0641026
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

818 North Russell Street, Portland, Oregon
97227
(Address of principal executive offices)
(Zip Code)

1-877-798-8326
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
o Yes          ý No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
 
o Yes           ý No
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
ý Yes          o No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
ý Yes          o No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
 
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company ý
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  oYes   ýNo
 
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter:  $14,915,840 as of June 28, 2013.
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:  76,273,500 shares of common stock as of April 11, 2014.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Part III incorporates by reference certain information from the registrant’s definitive proxy statement for the 2014 Annual Meeting of Shareholders to be filed on or before April 30, 2014.
 


 
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FORWARD-LOOKING STATEMENTS
 
This annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended. Forward-looking statements may also be made in our other reports filed with or furnished to the United States Securities and Exchange Commission (the “SEC”). The words “believe,” “expect,” “anticipate,” “optimistic,” “intend,” “plan,” “aim,” “will,” “may,” “should,” “could,” “would,” “likely” and similar expressions are intended to identify forward-looking statements. Examples of forward-looking statements include statements pertaining to, among other things: (1) our product line; (2) our business plan; (3) future capital expenditures; (4) the enforceability of our intellectual property rights; (5) projections of market prices and costs; (6) supply and demand for our products; and (7) our need for, and our ability to raise, capital.
 
The material assumptions supporting these forward-looking statements include, among other things: (1) our ability to obtain any necessary financing on acceptable terms; (2) timing and amount of capital expenditures; (3) the enforcement of our intellectual property rights; (4) our ability to launch new product lines; (5) retention of skilled personnel; (6) continuation of current tax and regulatory regimes; (7) current exchange rate and interest rates; and (8) general economic and financial market conditions.
 
These statements are not guarantees of future performance, and therefore you should not put undue reliance upon them. Some of the factors that may cause actual results to differ materially from those indicated in these statements are found in the section “Risk Factors” in this annual report on Form 10-K, and also include without limitation:
 
 
·
Our dependence on additional financing to sustain our business;
 
 
·
our cash flow problems have caused us to be delinquent in payments to vendors and other creditors;
 
 
·
our failure to comply with the agreements relating to our outstanding indebtedness, including as a result of events beyond our control, could result in an event of default that could materially and adversely affect our results of operations and our financial condition;
 
 
·
unique difficulties and uncertainties inherent in the apparel business;
 
 
·
changes in general economic or market conditions that could impact consumer demand for our products;
 
 
·
our sales and profitability may decline as a result of increasing product costs and decreasing selling prices;
 
 
·
risks associated with our product lines, including our ability to launch additional product lines in the future, the fluctuating cost of raw materials, and our dependence on third party suppliers;
 
 
·
our ability to execute on our business plan;
 
 
·
our ability to compete with other companies with greater resources than we have;
 
 
·
the enforceability of our intellectual product rights;
 
 
·
our ability to retain the services of our senior management and key employees;
 
 
·
our ability to sell excess inventory; and
 
 
·
our ability to renew leased retail facilities.
 
The forward-looking statements contained in this Form 10-K reflect our views and assumptions only as of the date of this Form 10-K.  We undertake no obligation to update or revise any forward-looking statements after the date on which the statement is made.
 
As used in this Form 10-K and unless otherwise indicated, the terms “we”, “us”, “our” and “RYU” refer to Respect Your Universe, Inc. Unless otherwise specified, all dollar amounts are expressed in United States dollars.
 
 
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RESPECT YOUR UNIVERSE, INC.
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2013

INDEX TO FORM 10-K
 
 
PART I
 
Page
     
Item 1
Business
5
Item 1A
Risk Factors
7
Item 1B
Unresolved Staff Comments
12
Item 2
Properties
13
Item 3
Legal Proceedings
13
Item 4
Mine Safety Disclosures
13
     
     
PART II
   
     
Item 5
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
13
Item 6
Selected Financial Data
15
Item 7
Management’s Discussion and Analysis of Financial Condition and Results of Operations
15
Item 7A
Quantitative and Qualitative Disclosures About Market Risk
22
Item 8
Financial Statements and Supplementary Data
23
Item 9
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
24
Item 9A
Controls and Procedures
24
Item 9B
Other Information
25
     
 
PART III
   
     
Item 10
Directors, Executive Officers and Corporate Governance
26
Item 11
Executive Compensation
26
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
26
Item 13
Certain Relationships and Related Transactions, and Director Independence
26
Item 14
Principal Accounting Fees and Services
26
     
 
PART IV
   
     
Item 15
Exhibits, Financial Statement Schedules
28
 
 
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PART I
 
Item 1
Business
 
Overview
 
We are a vertically integrated, active lifestyle apparel brand focused on the needs of individuals and athletes alike. Our men's and women's performance and active wear lines are specially designed for people who love to move, feel comfortable and look great. Crafted from organic and/or recycled materials, our products are also designed to help nurture the environment. 
 
We were incorporated in the State of Nevada in November 2008.  Our corporate headquarters and operations are located in Portland, Oregon, a major hub in our industry.  We have a senior leadership team with extensive experience in the retail and apparel industry.  All products are designed, developed and tested at our corporate headquarters, and production takes place in top-grade factories in our industry.
 
We sell our products through three primary channels: wholesale, retail and e-commerce.  Our initial product line launched in February 2012, which coincided with the roll out of our online store at ryu.com.  In October 2012, we opened our first retail store located at The Shoppes at the Palazzo in Las Vegas, Nevada, and in December 2013, we opened our second retail store located at Westlake Center in downtown Seattle, Washington.  The Las Vegas landlord elected to terminate our lease so our retail store was closed in February 2014.  We continue to operate and evolve our wholesale channel through a variety of customers.
 
In the fourth quarter of 2012, our management determined that we were no longer a development stage enterprise based on the following three circumstances:

 
(i)
Principal operations were underway,
 
(ii)
we were producing and marketing a full line of men’s and women’s apparel, and
 
(iii)
we were generating revenues through all three of our sales channels.
 
Product Lines
 
Our products include performance and lifestyle apparel and accessories that are environmentally friendly and meet the demands of an active lifestyle.   Our men’s and women’s apparel lines are comprised of up to 90 percent organic and recycled materials, utilizing top-grade yarn and fabric suppliers throughout the world.  We currently market two commercial product lines targeted for the Spring/Summer (“Spring”) and Fall/Holiday (“Fall”) seasons.
 
We released a limited Spring 2013 line in March 2013 that included approximately 18 new men’s and women’s styles. Approximately 10 additional styles were designed for the Fall 2013 season and have received these styles at our warehouse as of September 2013.
 
Our Spring 2014 line has been designed and developed.  It includes approximately 20 new men’s and 20 new women’s styles as well as additional accessories and a limited number of carryover styles.  Many of these styles have been received at our warehouse and will continue to be received as funds are available to satisfy purchase obligations. Our Fall 2014 line has been designed and production is expected to begin as funds become available.
 
Product Research and Development
 
We believe our research and development efforts are a key factor for success.  We believe that Portland’s proximity to a vast pool of apparel design talent, along with its eco-conscious reputation, provides us much of the resources and skills needed to support our product development and growth.  We use technical innovation in the construction of our apparel to create products that enhance an active lifestyle.  Our products are manufactured with technical fabrications produced by third parties and developed in collaboration with our product development team.
 
We had contracted with Exit 21 Global Solutions, LLC (“Exit 21”), a consulting firm controlled by a former Chief Executive Officer and our former Chief Operating Officer, to assist us in the design, development and sourcing all of our products through our Spring 2013 product line.  Beginning with our Fall 2013 product line creation, for which work commenced in April 2012, we were no longer contracting with Exit 21 and were managing product creation directly using internal resources supplemented with independent contractors as required.
 
 
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Product Manufacturing
 
We outsource the commercial manufacturing of our product lines to factories primarily outside of the United States.  During 2012 and 2013, production occurred primarily at manufacturers located in Asia.  Our independent suppliers buy raw materials in bulk for the manufacturing of our apparel and accessories.
 
Our international sources of supply are subject to the usual risks of doing business abroad, such as possible revaluation of currencies, import duties, safeguard measures, trade restrictions, and restrictions on the transfer of funds and, in certain parts of the world, political instability and terrorism. We have not, to date, been materially affected by any such risk, but cannot predict the likelihood of such developments occurring in the future.
 
Product Distribution
 
We have deployed a multi-channel distribution strategy to deliver our products to consumers.  Our wholesale channel consists of various retail customers.   Because of the transition of the brand, the composition of these customers is anticipated to change from customers that focus within the niche sport of Mixed Martial Arts to customers that focus on a broader market of active lifestyle apparel.   Our e-commerce channel consists of the ryu.com web store, which was launched in February 2012 and provides a global consumer base access to our entire product line.  Our third channel, retail, includes our first retail stores in Las Vegas, Nevada (closed February 2014), and Seattle, Washington.
 
We have contracted with third parties to outsource our inventory receiving, warehousing and our product fulfillment needs.
 
Product Marketing
 
We create awareness and demand for our products through the following marketing strategies: digital marketing, media placements, product seeding, sports marketing and social media.
 
We use digital marketing strategies to bring consumers to our website at ryu.com to introduce them to our brand and present our product lines for sale through our web store.  We have partnered with a public relations firm to support our brand development through distribution of news releases to local and national media, strategic media placements that will introduce our brand to target consumers and through social media support.
 
We have established a social media strategy for communicating directly with consumers to build awareness and interest in Respect Your Universe.  Through the use of platforms including Facebook, Twitter, Instagram and Pinterest, we are attempting to build a strong community following and interacting with our brand.
 
Our marketing efforts have focused on creating relationships with professional and amateur athletes, and celebrities through sponsorship and endorsement agreements.  During 2012 we had endorsement agreements with several professional athletes including Jonny Gomes (MLB), Phil Heath (bodybuilding), Jon Fitch (MMA) and other professional athletes spanning various sports.  In 2013, we executed an endorsement agreement with Liz Arch (creator of Primal Yoga), and Alexander Ludwig (The Hunger Games, Lone Survivor, Viking).
 
Competition
 
The market for athletic apparel is highly competitive.  We compete with a significant number of apparel brands, as well as wholesalers and direct sellers of performance and lifestyle athletic apparel.  Many of our competitors have significant advantages over our company in terms of brand recognition, scale, operating histories, greater number of locations, capital and other resources.  The intense competition and the rapid changes in technology and consumer preferences constitute significant risk factors for our operations in the industry.
 
 
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We are a company that has only recently commenced commercial operations.  Accordingly, there can be no assurances that we can successfully compete in our industry.  We believe that the vision of our brand, which is to inspire people with active lifestyles to respect themselves, others and the world they live in, is compelling and relevant to small segment of consumers.  We also believe that our vision, combined with a strategy of using high quality performance lifestyle apparel as a platform for delivering our brand’s message, differentiates us and will enable us to obtain a competitive position in the industry.
 
Patents and Trademarks
 
On December 10, 2008, a U.S. federal trademark registration was filed for RYU. This trademark is owned by Respect Your Universe, Inc. The U.S. Patent and Trademark Office (“USPTO”) has given the RYU trademark serial number of 77630773. 
 
On December 10, 2008, a U.S. federal trademark registration was filed for RESPECT YOUR UNIVERSE. This trademark is owned by Respect Your Universe, Inc. The USPTO has given the RESPECT YOUR UNIVERSE trademark serial number of 77630779.
 
We intend to continue to strategically register, both domestically and internationally, existing patents, trademarks and copyrights that are consistent with our vision for the future of our brand.  Additionally, we intend to strategically register both domestically and internationally, patents, trademarks and copyrights that we develop in the future.
 
Employees
 
We currently have eleven full time employees and no part-time employees.  Our employees are responsible for performing or overseeing all operations of the Company.  Specifically, our employees’ direct responsibilities include, but are not limited to, seeking the investment capital necessary to build and help sustain commercial operations, creating and executing our marketing, branding and sales strategy, driving the overall product design strategy, directing product development, operations, sales, finance and general administrative duties.
 
Item 1A
Risk Factors

If we do not obtain additional financing our business may fail.
 
As of December 31, 2013, we had cash and cash equivalents in the approximate amount of $252,153 and a net loss of $5,365,373 for the year ended December 31, 2013.  As such, we will require additional financing in the very near future to sustain our business operations. We currently do not have any arrangements for such financing and we may not be able to obtain financing when required. The decline in the price of our shares and our poor credit history has and will impact our ability to obtain future financing. Obtaining additional financing would be subject to a number of factors, including our ability to initially attract investments prior to substantial revenue generation, and thereafter our ability to grow our brand. We can provide investors with no assurance that we will ever achieve profitable operations, and thus we face a high risk of business failure. Our ability to achieve and maintain profitability and positive cash flow is dependent upon:
·
 
·
Our ability to market and sell our product to the levels anticipated;
 
·
our ability to generate profits from the sale of those products; and
 
·
our ability to create a successful brand.

We have a history of operating losses and negative cash flow that will continue into the foreseeable future. If we fail to execute our strategy to achieve and maintain profitability in the future, investors could lose confidence in the value of our common shares, which could cause our stock price to further decline and adversely affect our ability to raise additional capital. If we fail to obtain additional short-term financing, we would not have adequate liquidity to fund our operations, would not be able to continue as a going concern and could be forced to seek relief through a filing under U.S. Bankruptcy Code.

Our cash flow problems have caused us to be delinquent in payments to vendors and other creditors.

Our lack of financial resources has caused us to delay payment of our obligations as they became due in the ordinary course of our business.  Such delays have damaged some of our vendor and professional relationships, and have caused us to incur additional expenses in the payment of late charges and penalties.  As of December 31, 2013, we had current liabilities of $1,744,771 of which a significant portion was and remains past due.  If we are unable to make timely future payments to our vendors or repair the relationships with our current vendors, we may be unable to find vendors suitable to us.

Our failure to comply with the agreements relating to our outstanding indebtedness, including as a result of events beyond our control, could result in an event of default that could materially and adversely affect our results of operations and our financial condition.

On December 9, 2013, we issued a promissory note to one investor in the amount of $500,000, which is secured against all of our property and is due in full on January 1, 2015. If there were an event of default under this note or any of the agreements relating to our outstanding indebtedness, the holders of the defaulted debt could cause all amounts outstanding with respect to that debt to be due and payable immediately. Our assets or cash flow may not be sufficient to fully repay borrowings under our outstanding debt instruments if accelerated upon an event of default. Further, if we are unable to repay, refinance or restructure our indebtedness under our secured debt, the holders of such debt could proceed against the collateral securing that indebtedness. In addition, any event of default or declaration of acceleration under one debt instrument could also result in an event of default under one or more of our other debt instruments. Last, we could be forced into bankruptcy or liquidation. As a result, any default by us on our indebtedness could have a material adverse effect on our business and could impact our ability to make payments under the notes.
 
 
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Because of the unique difficulties and uncertainties inherent in the apparel business, we face a high risk of business failure.
 
Potential investors should be aware of the difficulties normally encountered by apparel companies and the high rate of failure of such enterprises. The likelihood of success must be considered in light of the problems, expenses, difficulties, complications and delays encountered in connection with the design, manufacture and sale of the products that we plan to offer, as well as the highly competitive landscape of the apparel industry. These potential problems include, but are not limited to, unanticipated problems relating to manufacturing and sales, lack of branding and marketing traction with consumers, and additional costs and expenses that may exceed current estimates.
 
Our success depends on our ability to maintain the value and reputation of our brand.

Our success depends on the value and reputation of our brand. Our brand is integral to our business as well as to the implementation of our strategies for expanding our business. We have repositioned and will continue to reposition our brand from primarily targeting a mixed martial arts consumer to a broader performance and lifestyle consumer. The market’s acceptance of our repositioned brand is a key factor to our success. Maintaining, promoting and positioning our brand will depend largely on the success of our marketing and merchandising efforts and our ability to provide a consistent, high quality guest experience. We rely on social media, as one of our marketing strategies, to have a positive impact on both our brand value and reputation. Our brand could be adversely affected if we fail to achieve these objectives or if our public image or reputation were to be tarnished by negative publicity. Negative publicity regarding the production methods of any of our suppliers or manufacturers could adversely affect our reputation and sales and force us to locate alternative suppliers or manufacturing sources.

An economic downturn or economic uncertainty in our key markets may adversely affect consumer discretionary spending and demand for our products.
  
Many of our products may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, particularly those in North America and other factors such as consumer confidence in future economic conditions, fears of recession, the availability of consumer credit, levels of unemployment, tax rates and the cost of consumer credit. As global economic conditions continue to be volatile or economic uncertainty remains, trends in consumer discretionary spending also remain unpredictable and subject to reductions due to credit constraints and uncertainties about the future. The current volatility in the United States economy in particular has resulted in an overall slowing in growth in the retail sector because of decreased consumer spending, which may remain depressed for the foreseeable future. These unfavorable economic conditions may lead consumers to delay or reduce purchase of our products. Consumer demand for our products may not reach our sales targets, or may decline, when there is an economic downturn or economic uncertainty in our key markets, particularly in North America. Our sensitivity to economic cycles and any related fluctuation in consumer demand may have a material adverse effect on our financial condition.

Our sales and profitability may decline as a result of increasing product costs and decreasing selling prices.

Our business is subject to significant pressure on pricing and costs caused by many factors, including intense competition, constrained sourcing capacity and related inflationary pressure, pressure from consumers to reduce the prices we charge for our products and changes in consumer demand. These factors may cause us to experience increased costs, reduce our sales prices to consumers or experience reduced sales in response to increased prices, any of which could cause our operating margin to decline if we are unable to offset these factors with reductions in operating costs and could have a material adverse effect on our financial conditions, operating results and cash flows.

If we are unable to anticipate consumer preferences and successfully develop and introduce new, innovative and updated products, we may not be able to achieve profitability.

Our success depends on our ability to identify and originate product trends as well as to anticipate and react to changing consumer demands in a timely manner. All of our products are subject to changing consumer preferences that cannot be predicted with certainty. If we are unable to introduce new products or novel technologies in a timely manner or our new products or technologies are not accepted by our customers, our competitors may introduce similar products in a more timely fashion, which could hurt our goal to be viewed as a leader in apparel innovation. Our new products may not receive consumer acceptance as consumer preferences could shift rapidly to different types of apparel or away from these types of products altogether, and our future success depends in part on our ability to anticipate and respond to these changes. Failure to anticipate and respond in a timely manner to changing consumer preferences could lead to, among other things, lower sales, excess inventory levels, and further deterioration of operating results. Even if we are successful in anticipating consumer preferences, our ability to adequately react to and address those preferences will in part depend upon our continued ability to develop and introduce innovative, high-quality products. Our failure to effectively introduce new products that are accepted by consumers could result in a decrease in net revenue and excess inventory levels, which could have a material adverse effect on our financial condition.
 
 
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Our results of operations could be materially harmed if we are unable to accurately forecast customer demand for our products.

To ensure adequate inventory supply, we must forecast inventory needs and place orders with our manufacturers based on our estimates of future demand for particular products. Our ability to accurately forecast demand for our products could be affected by many factors, including our ability to raise sufficient equity or debt capital in a timely manner, an increase or decrease in customer demand for our products or for products of our competitors, our failure to accurately forecast customer acceptance of new products, product introductions by competitors, unanticipated changes in general market conditions, and weakening of economic conditions or consumer confidence in future economic conditions. If we fail to accurately forecast customer demand, we may experience excess inventory levels or a shortage of products available for sale in our stores or for delivery to customers.

Inventory levels in excess of customer demand or purchased in excess quantities, may result in inventory write-downs or write-offs and the sale of excess inventory at discounted prices, which would cause our gross margin to suffer and could impair the strength and exclusivity of our brand.  Conversely, if we underestimate customer demand for our products, our manufacturers may not be able to deliver products to meet our requirements, and this could result in damage to our reputation and customer relationships.
  
The fluctuating cost of raw materials could increase our cost of goods sold and cause our results of operations and financial condition to suffer.

Our costs for raw materials are affected by, among other things, weather, consumer demand, speculation on the commodities market, the relative valuations and fluctuations of the currencies of producer versus consumer countries, and other factors that are generally unpredictable and beyond our control. Increases in the cost of raw materials or the prices we pay for our cotton yarn and cotton-based textiles, could have a material adverse effect on our cost of goods sold, results of operations, financial condition and cash flows.

We rely on third-party suppliers to provide fabrics for and to produce our products, and we have limited control over them and may not be able to obtain quality products on a timely basis or in sufficient quantity.

We do not manufacture our products or the raw materials for them and rely instead on third-party suppliers.  Due to our financial condition, we have delayed payments to our manufactures, which has had a negative impact on our relationships with them.   If we fail to make or delay payments to our manufactures, those manufactures may refuse to work for us and we may have difficulties finding other manufactures that are willing to make our products on terms acceptable to us or which are competitive in the marketplace.

Many of the specialty fabrics used in our products are technically advanced textile products developed and manufactured by third parties and may be available, in the short-term, from only one or a very limited number of sources. We have no long-term contracts with our suppliers or manufacturing sources, and we compete with other companies for fabrics, raw materials, production and import quota capacity.
 
We have occasionally received, and may in the future continue to receive, shipments of products that fail to comply with our technical specifications or that fail to conform to our quality control standards. We have also received, and may in the future continue to receive, products that meet our technical specifications but that are nonetheless unacceptable to us. Under these circumstances, unless we are able to obtain replacement products in a timely manner, we risk the loss of net revenue resulting from the inability to sell those products and related increased administrative and shipping costs. Additionally, if defects in the manufacture of our products are not discovered until after such products are purchased by our customers, our customers could lose confidence in the technical attributes of our products and our results of operations could suffer and our business could be harmed.

We may in the future experience a significant disruption in the supply of fabrics or raw materials from current sources and we may be unable to locate alternative materials suppliers of comparable quality at an acceptable price, or at all. In addition, if we experience significant increased demand, or if we need to replace an existing supplier or manufacturer, we may be unable to locate additional supplies of fabrics or raw materials or additional manufacturing capacity on terms that are acceptable to us, or at all, or we may be unable to locate any supplier or manufacturer with sufficient capacity to meet our requirements or to fill our orders in a timely manner. Identifying a suitable supplier is an involved process that requires us to become satisfied with its quality control, responsiveness and service, financial stability and labor and other ethical practices. Even if we are able to expand existing or find new manufacturing or fabric sources, we may encounter delays in production and added costs as a result of the time it takes to train our suppliers and manufacturers in our methods, products and quality control standards. Delays related to supplier changes could also arise due to an increase in shipping times if new suppliers are located farther away from our markets or from other participants in our supply chain. Any delays, interruption or increased costs in the supply of fabric or manufacture of our products could have an adverse effect on our ability to meet customer demand for our products and our results in lower net revenue and income from operations both in the short and long term.
 
 
9

 
 
Our reliance on third-party providers for all warehouse and fulfillment functions reduces our ability to control the warehousing and fulfillment processes, which could harm our sales, reputation, and overall business.

We have entered into an agreement to outsource most of our warehouse and fulfillment functions to third-party providers where our inventory is held at sites managed by an independent contractor who will then perform most of our warehousing, packaging and fulfillment services. We depend on independent contractor fulfillers to properly fulfill customer orders in a timely manner and to properly protect our inventories. The contractor's failure to ship products to customers in a timely manner, to meet the required quality standards, to correctly fulfill orders, to maintain appropriate levels of inventory, or to provide adequate security measures and protections against excess shrinkage could cause us to miss delivery date requirements of our customers or incur increased expense to replace or replenish lost or damaged inventory or inventory shortfall.  The failure to make timely and proper deliveries may cause our customers to cancel orders, refuse to accept deliveries, impose non-compliance charges through invoice deductions or other charge-backs, demand reduced prices or reduce future orders, any of which could harm our sales, reputation and overall profitability. Our excess inventory held at these facilities may be damaged due to the length of time that they are at the facility, which may not be covered by the contractor or our insurance.

We operate in a highly competitive market and the size and resources of some of our competitors may allow them to compete more effectively than we can, resulting in a decrease in our net revenue.

The market for apparel is highly competitive. Competition may result in pricing pressures, reduced profit margins or lost market share or a failure to grow our market share, any of which could substantially harm our business and results of operations. We compete directly against wholesalers and direct retailers of athletic apparel, including large, diversified apparel companies with substantial market share and established companies expanding their production and marketing of technical athletic apparel, as well as against retailers specifically focused on athletic, active, lifestyle, and other categories of  apparel. We also face competition from wholesalers and direct retailers of traditional commodity athletic apparel, such as cotton T-shirts and sweatshirts. Many of our competitors are large apparel and sporting goods companies with strong worldwide brand recognition, such as Nike, Inc., Lululemon Athletica Inc., adidas AG, which includes the adidas and Reebok brands, and The Gap, Inc., which includes the Athleta brand. Because of the fragmented nature of the industry, we also compete with other apparel sellers. Many of our competitors have significant competitive advantages, including longer operating histories, larger and broader customer bases, more established relationships with a broader set of suppliers, greater brand recognition and greater financial, research and development, store development, marketing, distribution and other resources than we do. In addition, our athletic and other categories of apparel are sold at a price premium to comparable apparel.

Our competitors may be able to achieve and maintain brand awareness and market share more quickly and effectively than we can. Many of our competitors promote their brands through traditional forms of advertising, such as print media and television commercials, and through celebrity endorsements, and have substantial resources to devote to such efforts. Our competitors may also create and maintain brand awareness using traditional forms of advertising more quickly than we can. Our competitors may also be able to increase sales in their new and existing markets faster than we do by emphasizing different distribution channels than we do, such as catalog sales or an extensive franchise network, as opposed to distribution through retail stores, wholesale or internet, and many of our competitors have substantial resources to devote toward increasing sales in such ways.

In addition, because we own no patents or exclusive intellectual property rights in the technology, fabrics or processes underlying our products, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrication techniques and styling similar to our products.

Our fabrics and manufacturing technology are not patented and can be imitated by our competitors.

The intellectual property rights in the technology, fabrics and processes used to manufacture our products are owned or controlled by our suppliers and are generally not unique to us. Our ability to obtain intellectual property protection for our products is therefore limited and we currently own no patents or exclusive intellectual property rights in the technology, fabrics or processes underlying our products. As a result, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrics and styling similar to our products. Because many of our competitors have significantly greater financial, distribution, marketing and other resources than we do, they may be able to manufacture and sell products based on our fabrics and manufacturing technology at lower prices than we can. If our competitors do sell similar products to ours at lower prices, our net revenue and profitability could suffer.

Our failure or inability to protect our intellectual property rights could diminish the value of our brand and weaken our competitive position.

We currently rely on a combination of copyright, trademark, trade dress and unfair competition laws, as well as confidentiality procedures and licensing arrangements, to establish and protect our intellectual property rights. We cannot assure you that the steps taken by us to protect our intellectual property rights will be adequate to prevent infringement of such rights by others, including imitation of our products and misappropriation of our brand. In addition, intellectual property protection may be unavailable or limited in some foreign countries where laws or law enforcement practices may not protect our intellectual property rights as fully as in the United States or Canada, and it may be more difficult for us to successfully challenge the use of our intellectual property rights by other parties in these countries. If we fail to protect and maintain our intellectual property rights, the value of our brand could be diminished and our competitive position may suffer.
 
 
10

 
 
We may not be able to successfully open profitable new store locations in a timely manner, if at all, which could harm our results of operations.

Our growth will depend on our ability to successfully open and operate new stores. Sales at these stores are derived, in part, from the volume of foot traffic in these locations. Our ability to successfully open and operate new stores depends on many factors, including, among others, our ability to:

 
Identify suitable store locations, the availability of which is outside of our control;
 
negotiate acceptable lease terms, including desired tenant improvement allowances;
 
hire, train and retain store personnel and field management;
 
immerse new store personnel and field management into our corporate culture;
 
source sufficient inventory levels; and
 
successfully integrate new stores into our existing operations and information technology systems.
 
Successful new store openings may also be affected by our ability to initiate our marketing efforts in advance of opening our first store in a new market. We typically rely on our marketing efforts to build awareness of our brand and demand for our products. There can be no assurance that we will be able to successfully implement our marketing efforts in a particular market in a timely manner, if at all. Additionally, we may be unsuccessful in identifying new markets where our apparel and other products and brand image will be accepted or the performance of our stores will be considered successful.
 
Our ability to source our merchandise profitably or at all could be hurt if new trade restrictions are imposed or existing trade restrictions become more burdensome.

The United States and the countries in which our products are produced or sold internationally have imposed and may impose additional quotas, duties, tariffs, or other restrictions or regulations, or may adversely adjust prevailing quota, duty or tariff levels. We have expanded our relationships with suppliers outside of China, which, among other things, has resulted in increased costs and shipping times for some products. Countries impose, modify and remove tariffs and other trade restrictions in response to a diverse array of factors, including global and national economic and political conditions, which make it impossible for us to predict future developments regarding tariffs and other trade restrictions. Trade restrictions, including tariffs, quotas, embargoes, safeguards and customs restrictions, could increase the cost or reduce the supply of products available to us or may require us to modify our supply chain organization or other current business practices, any of which could harm our business, financial condition and results of operations

Our employees are critical to our success, and the loss of key personnel could harm our business.
 
Our performance is substantially dependent on the continued services and performance of our executive officers and other key personnel. We have an employment agreement with our CEO, which is due to expire on December 31, 2014. The agreement will automatically renew if neither party gives notice of termination. We do not have any employment agreement with our CFO. No key man life insurance has been purchased on any of our executive officers. Our performance also depends on our ability to retain and motivate our officers. The loss of the services of any of our officers could have a material adverse effect on our business, prospects, financial condition and results of operations.

Our financial condition has caused us to lose key employees and we have experienced a high turnover of employees. In addition, our financial condition may prevent us from hiring additional key employees. The loss of the members of our product design team have resulted in a loss of continuity in our product. As a result of these factors, we may be unable to develop and introduce new products successfully and in a cost-effective and timely manner, and any new products we develop and offer may never achieve market acceptance. Competition for such personnel is intense, and we cannot assure you that we will be successful in attracting and retaining such personnel. The failure to attract and retain the necessary technical, managerial and marketing personnel could have a material adverse effect on our business, prospects, financial condition and results of operations. Our future success also depends on our ability to identify, attract, hire, train, retain and motivate other highly skilled technical, managerial and marketing personnel.

We are dependent on our information technology systems and third-party servicers, and systems failures, interruptions or breaches of security could have an adverse effect on our financial condition and results of operations.

Our business is dependent on the successful and uninterrupted functioning of our information technology systems setup by third-party providers, as we outsource many of our major systems. We rely on the controls of these provides in lieu of controls set up by us. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions.
 
 
11

 
 
Risks Relating to our Common Shares
 
Our stock is a penny stock. Trading of our stock may be restricted by the SEC’s penny stock regulations, which may limit our shareholders’ ability to buy and sell our stock.
 
Our stock is a penny stock. The SEC has adopted Rule 15g-9 which generally defines “penny stock” to be any equity security that has a market price (as defined) of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors”. The term “accredited investor” refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC, which provides information about penny stocks and the nature and level of risks in the penny stock market.
 
The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common shares.
 
The Financial Industry Regulatory Authority sales practice requirements may also limit our shareholders’ ability to buy and sell our stock.

In addition to the “penny stock” rules described above, the Financial Industry Regulatory Authority, or “FINRA”, has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low-priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low-priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common shares, which may limit your ability to buy and sell our stock and have an adverse effect on the market for common shares.
 
The exercise of outstanding options and warrants may have a dilutive effect on the price of our common shares.
 
To the extent that outstanding stock options and warrants are exercised, dilution to our shareholders will occur. Moreover, the terms upon which we will be able to obtain additional equity capital may be adversely affected, since the holders of the outstanding options and warrants can be expected to exercise them at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable to us than the exercise terms provided by the outstanding options and warrants.
 
We do not expect to pay dividends in the future. Any return on investment may be limited to the value of our common shares.
 
We do not currently anticipate paying cash dividends in the foreseeable future. The payment of dividends on our common shares will depend on earnings, financial condition and other business and economic factors affecting it at such time as the board of directors may consider relevant. Our current intention is to apply net earnings, if any, in the foreseeable future to increasing our capital base and development and marketing efforts. There can be no assurance that our company will ever have sufficient earnings to declare and pay dividends to the holders of our common shares, and in any event, a decision to declare and pay dividends is at the sole discretion of our board of directors. If we do not pay dividends, our common shares may be less valuable because a return on your investment will only occur if its stock price appreciates.
 
Item 1B
Unresolved Staff Comments
 
Not required for a smaller reporting company.
 
 
12

 
 
Item 2
Properties
 
Our corporate headquarters and principal operations are located at 818 North Russell Street, Portland, Oregon 97227. We lease this facility, which expires in 2014, for $2,500 per month.
 
On December 13, 2013, we entered into a lease with Westlake Center Associates Limited Partnership to lease a 2,082 sq. ft. retail location in the Westlake Center in Seattle Washington. Please see Note 15 in the financial statements for a description of our obligations. The lease is for a period of five years (subject to our early termination right at year three if sales targets are not met) and it contains standard covenants, representations and warranties, and termination provisions. The landlord also has the right to relocate us during the term of the lease.
 
We outsource the manufacturing of our products and the distribution and warehousing needs for our products to third parties and as such have no current plans to lease or own space for such needs.  We believe that our current locations will be sufficient for the operation of our business over the next twelve months, and expect to find replacement facilities for its corporate headquarters or extend the existing lease.
 
Item 3
Legal Proceedings
 
We know of no material pending legal proceedings to which our company or our subsidiaries is a party or of which any of our properties, or the properties of our subsidiaries, is the subject. In addition, we do not know of any such proceedings contemplated by any governmental authorities.
 
We know of no material proceedings in which any of our directors, officers or affiliates, or any registered or beneficial stockholder is a party adverse to our company or our subsidiaries or has a material interest adverse to our company or our subsidiaries.
 
Item 4                 Mine Safety Disclosures
 
Not applicable.
 
PART II
 
Item 5
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Our Common Stock trades on the OTCQB Marketplace, operated by OTC Markets Group Inc. under the symbol “RYUN” as well as on the Toronto Venture Stock Exchange under the symbol “RYU”.

The following table sets forth the quarterly high and low bid prices for our Common Stock during the last two fiscal years, as reported by the OTCQB. The quotations reflect inter-dealer prices, without retail mark-up, markdown or commission, and may not necessarily represent actual transactions.

 
Bid Prices ($)
Quarter Ended
High
Low
     
March 31, 2012
1.14
0.93
June 30, 2012
1.05
0.80
September 30, 2012
0.91
0.64
December 31, 2012
0.82
0.45
March 31, 2013
0.56
0.30
June 30, 2013
0.41
0.20
September 30, 2013
0.29
0.18
December 31, 2013
0.20
0.06
 
On April 11, 2014, the closing price for the common stock on the OTCBB was $0.07 per share.
 
Transfer Agents
 
The shares of our common stock are issued in registered form. The transfer agent and registrar for our common stock is Quicksilver Stock Transfer, LLC located at 6623 Las Vegas Blvd. South, #255 Las Vegas, Nevada 89119 and our co-transfer agent is Olympia Trust Company located at 1003, 750 West Pender Street, Vancouver, British Columbia V6C2T8.
 
Holders
 
As of April 10, 2014, we had 168 holders of our common stock. 
 
 
13

 
 
Registration Rights
 
In connection with our private placements that closed on February 5, 2014, and November 8, 2013, we agreed to use commercially reasonable efforts to file a registration statement on Form S-1 to register the shares issued in those offerings within 90 days of the date of the closing. As of April 10, 2014, we have not filed the registration statement.
 
Dividend Policy
 
We have never declared or paid any cash dividends on our common stock. We currently intend to retain future earnings, if any, to increase our working capital and do not anticipate paying any cash dividends in the foreseeable future.
 
In the event that we obtain authorization to issue any preferred stock and issue such stock, we must not declare, pay or set apart for payment any dividend or other distribution (unless payable solely in shares of our common stock or other class of stock junior to our preferred stock as to dividends or upon liquidation) in respect of our common stock, nor must we redeem, purchase or otherwise acquire for consideration shares of any of the foregoing, unless dividends, if any, payable to holders of our preferred stock for the current period (and in the case of cumulative dividends, if any, payable to holders of our preferred stock for the current period and in the case of cumulative dividends, if any, for all past periods) have been paid, are being paid or have been set aside for payment, in accordance with the terms of our preferred stock, as fixed by our board of directors.
 
Other than as stated above, there are no restrictions in our articles of incorporation or bylaws that prevent us from declaring dividends. The Nevada Revised Statutes, however, do prohibit us from declaring dividends where, after giving effect to the distribution of the dividend:
 
 
Would not be able to pay our debts as they become due in the usual course of business; or
 
 
our total assets would be less than the sum of our total liabilities plus the amount that would be needed to satisfy the rights of stockholders who have preferential rights superior to those receiving the distribution.
 
Recent Sales of Unregistered Securities
 
Since the beginning of our fiscal year ended December 31, 2013, we have not sold any equity securities that were not registered under the Securities Act of 1933 that were not previously reported in a quarterly report on Form 10-Q or in a current report on Form 8-K.
 
Equity Compensation Plan Information
 
On June 10, 2011, we adopted the 2011 Incentive Award Plan (the “2011 Plan”) and on May 18, 2012, the Board of Directors approved certain revisions to the 2011 Plan, resulting in our 2012 Stock Option (the “2012 Plan”) whereby the aggregate number of securities reserved for issuance was revised to 8,487,925 shares of our common stock. On June 7, 2013, the Board of Directors approved certain revisions to the 2012 Plan, resulting in our 2013 Stock Option Plan (the “2013 Plan”), whereby the aggregate number of securities reserved for issuance was revised to 11,702,425.
 
The following table gives information about our common stock that may be issued under our existing equity compensation plan grants as of December 31, 2013.
 

Plan category
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights
(a)
Weighted-average exercise
price of outstanding options,
warrants and rights
(b)
 
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(c)
Equity compensation plans
approved by security holders
6,601,420
$0.89
5,101,005
Equity compensation plans not
approved by security holders
Nil
Nil
Nil
Total
6,601,420
$0.89
5,101,005
 
 
14

 

Summary of 2013 Plan Terms

If the shares are listed on the TSX Venture Exchange, the following terms apply to our plan:

 
The number of shares which may be reserved in any 12 month period for issuance to any one individual upon exercise of all stock options held by that individual may not exceed 5% of the issued and outstanding Shares of our company at the time of the grant;

 
The number of shares which may be reserved in any 12 month period for issuance to any one consultant may not exceed 2% of the issued and outstanding Shares and the maximum number of Shares which may be reserved in any 12 month period for issuance to all persons engaged in investor relations activities may not exceed 2% of the issued and outstanding Shares of our company;

 
Options granted to any person engaged in investor relations activities will vest in stages over 12 months with no more than ¼ of the stock options vesting in any three month period;

 
Stock options granted to optionees engaged in investor relations activities on behalf of our company expire 30 days after such optionees cease to perform such investor relations activities for our company; and

 
The exercise price of any stock options granted under the 2013 Plan shall be determined by the board of directors, but may not be less than the closing price of the Shares on the TSX Venture Exchange on the last trading day immediately preceding the date of the grant of such stock options (less any discount permissible under TSX Venture Exchange rules).
 
The 2013 Plan will be administered by the board of directors of our company or a special committee of directors, either of which will have full and final authority with respect to the granting of all stock options thereunder.  Stock options may be granted under the 2013 Plan to such directors, officers, employees or consultants of our company, as the board of directors may from time to time designate.
 
The term of any stock options granted under the 2013 Plan shall be determined at the time of grant but, subject to earlier termination in the event of termination or in the event of death, the term of any stock options granted under the 2013 Plan may not exceed ten years. Options granted under the 2013 Plan are not to be transferable or assignable other than by will or other testamentary instrument or pursuant to the laws of succession.
 
Subject to certain exceptions, in the event that an employee, or consultant ceases to act in that capacity in relation to our company, stock options granted to such employee, consultant or management company employee under the 2013 Plan will expire one year after such individual or entity ceases to act in that capacity in relation to our company,  other than for cause, death, or disability. Options granted to an employee or consultant that ceases to act in that capacity in relation to our company are terminated immediately upon the employee or consultant being terminated for cause.  In the event of death of an option holder, options granted under the 2013 Plan expire one year from the date of the death of the option holder.

Issuer Purchases of Equity Securities

During the fiscal year ended December 31, 2013, we did not purchase any of our equity securities.
 
Item 6
Selected Financial Data
 
Not required for smaller reporting companies.
 
Item 7
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion of the financial condition and results of operations should be read in conjunction with the financial statements included herewith. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future.
 
Overview
 
We are a performance lifestyle brand that engages in the development, marketing and distribution of apparel and accessories. Our fiscal 2013 results demonstrate our continued focus on the development of our brand, products and attempted repositioning ourselves for sustainable, profitable long-term growth.
 
 
15

 
 
Results of Operations
 
Revenue
 
Revenues during the years ended December 31, 2013 and 2012 were $1,164,326 and $848,981, respectively. The increase of 37.1% is primarily due to increased retail store sale, which increased by $351,743 or 272.1%.  The increase in retail store revenues  in 2013 reflects a full year of operations compared with 2012 when the first retail store was opened in October 2012.  Sales from our website or e-commerce sales decreased by $33,185 or 11.2% in 2013 compared to 2012 which we believe is attributed to the brand repositioning underway.  Wholesale revenues were comparable in 2013 and 2012, but 2013 wholesale revenues included approximately $230,000 in closeout sales in 2013 compare to closeout sales of $0 during 2012.
 
Cost of Goods Sold
 
Cost of goods sold during the years ended December 31, 2013 and 2012 were $1,236,983 and $1,964,138, respectively.  The decrease in cost of goods sold for 2013 is primarily due to a 2012 lower of cost-or-market (“LCM”) adjustment of $1,401,220, as discussed in Note 5 to the financial statements, offset by increased costs attributed to higher 2013 sales.
 
During the fourth quarter of 2013, we identified specific inventories to sell through our wholesale channel at closeout prices.  Several factors led to this decision including review of sales of specific products lines that were underperforming, the need for additional working capital, an evaluation of how the inventory complemented the repositioned brand direction and the availability of an off-price sales channel on terms much more favorable than the channel used in 2012.  These fourth quarter 2013 factors and additional sales information during the first quarter of 2014, lead us to conclude that it was necessary to closeout a portion of our inventory.  As of December 31, 2013, we assessed the market value of a significant portion of our inventory on hand and determined that the market value was significantly less than its cost. As such, we recorded “LCM” adjustment of $387,947 in December 2013, as discussed in Note 5 to the financial statements.
 
During the fourth quarter of 2012, prior leadership identified specific inventories to sell through our wholesale channel at closeout prices.  Several factors led to this decision.  First, we acquired the services of a third-party consultant in September to assist us with expanding our wholesale channel and with strategically evaluating the salability of our current brand and product lines.  Second, with the opening of our first retail store in late October, we completed the introduction of our brand and product line to the market through all three of our sales channels.   Lastly, we initiated a rebranding strategy in December that no longer aligned with certain attributes of our current product lines.  Based on the collective input received during the quarter, we concluded that it was necessary to closeout a significant portion of our inventory.  As of December 31, 2012, we assessed the market value of a significant portion of our inventory on hand and determined that the market value was significantly less than its cost. As such, we recorded a “LCM” adjustment of $1,401,220 in December 2012, as discussed in Note 5 to the financial statements. The $230,000 closeout sale and related cost of goods sold described above represents closeout inventory sold at market-value during the year ended December 31, 2013.
 
Gross Loss
 
Gross loss during the years ended December 31, 2013 and 2012 were $72,657 and $1,115,157, respectively. Both of these amounts have been impacted by LCM adjustments of $387,947 and $1,401,220 in 2013 and 2012, respectively.  The gross loss in 2012 was driven by the LCM inventory adjustment described above. Additionally, in 2012 we recorded a write-off of $87,889 related to excess materials purchased in connection with the production of our product lines.
 
The table below presents our actual results by operating segment, as they relate to its revenue, cost of goods sold, gross (loss) profit and gross margin.  The LCM write-down described above is included within Wholesale, as we anticipate to close out the related goods through our wholesale channel.  The write-off of excess inventory is included in Other.
 
For the year ended December 31, 2013
   
Segment
       
   
Wholesale
   
Retail
   
E-commerce
   
Other
   
Total
 
Revenue
  $ 420,665     $ 481,023     $ 262,638           $ 1,164,326  
Cost of goods sold
    785,231       223,103       157,003       71,646       1,236,983  
Gross (loss) profit
  $ (364,566 )   $ 257,920     $ 105,635     $ (71,646 )   $ (72,657 )
Gross margin %
    -87%       54%       40%               -6%  
 
 
16

 
 
For the year ended December 31, 2012
   
Segment
       
   
Wholesale
   
Retail
   
E-commerce
   
Other
   
Total
 
Revenue
  $ 421,050     $ 129,280     $ 295,823     $ 2,828     $ 848,981  
Cost of goods sold
    1,665,384       40,762       136,429       121,563       1,964,138  
Gross (loss) profit
  $ (1,244,334 )   $ 88,518     $ 159,394     $ (118,735 )   $ (1,115,157 )
Gross margin %
    -296%       68%       54%       -4199%       -131%  
 
Selling and Marketing Costs
 
We incurred $1,347,380 and $3,390,574 in selling and marketing expenses during the years ended December 31, 2013 and 2012, respectively.  Expenses were incurred to generate sales and create awareness and demand for our products through sports marketing agreements, a celebrity endorsement agreement, product seeding, digital marketing and social media.   The significant decrease is primarily related to one marketing contract, which ended in December 2012.  This contract was not renewed as a result of our rebranding strategy.  This contract accounted for $0 and $ 1,087,977 in marketing expense during 2013 and 2012 respectively.  In addition to the non-renewal of this contract, cost cutting measures and refocused marketing expenditures were factors in the decrease in expense in 2013.
 
Of the total selling and marketing expense discussed above, selling expense was $253,072 and $745,629, during the years ended December 31, 2013 and 2012, respectively.  Of the total expense for 2013 and 2012, $71,577 and $878,434 was share-based (non-cash) expense primarily related to stock-for-services marketing arrangements.
 
Product Creation Costs
 
During the years ended December 31, 2013, we incurred product creation expenses of $523,368 compared to $905,737 incurred during the year ended December 31, 2012. Of the total amounts expensed, $1,000 and $513,426 were paid to Exit 21, an entity controlled by a former Chief Executive Officer and our former Chief Operation Officer, during 2013 and 2012, respectively.  Product creation expenses incurred consist of formulating product concepts, construction of prototypes related to our proposed new product lines.
 
General and Administrative Costs
 
General and administrative expenses for the year ended December 31, 2013 were $3,409,455 compared to $4,455,635 for the year ended December 31, 2012.  The overall decrease in general and administrative expenses is attributed to intentional efforts by current management in attempts to utilize resources effectively in light of sustained losses including reductions in professional fees from $642,859 in 2012 to $293,911 in 2013, and reduction in share-based (non-cash) expense primarily related to stock-for-services investor relations arrangement from $1,462,262 in 2012 to $352,253 in 2013.  These savings were offset by an increase in rent expense primarily attributed to the opening of the Las Vegas retail store in late October 2012.
 
Loss on impairments on intangible assets and property and equipment
 
During the year ended December 31, 2013, we incurred losses on impairments of $10,513.  During the fourth quarter of the year, we determined that the carrying value of a trademark exceeded its fair value and recorded a $4,790 charge.  During the first quarter of 2014, we were notified by the landlord of our Las Vegas retail store of their intent to terminate our lease as of the end of February 2014, and as a result, recorded an impairment loss of $5,723 for the estimated carrying value attributed with this accelerated termination of the site.   No impairment losses were recorded in 2012.
 
Net Loss
 
As a result of the above, our net loss for the year ended December 31, 2013 was $5,365,373 as compared to a loss of $9,868,603 for the comparable 2012 period.
 
Financial Condition
 
As of December 31, 2013, we had current assets of $1,378,984, current liabilities of $1,744,771 and a working capital deficit of $365,787 compared to current assets of $1,896,595, current liabilities of $617,050 and working capital of $1,279,545 at December 31, 2012.
 
Our cash balance as of December 31, 2013 was $252,153 compared to $295,211 at December 31, 2012.  In 2013, we raised $3,713,954 (including conversion of a $195,000 note payable) in three separate equity financing rounds, and in February 2014, we raised an additional $1,334,683 in equity financing.
 
 
17

 
 
During February 2012, we successfully raised $1,500,000 in additional capital though equity financing.  In April 2012, we filed a prospectus to become listed on the Canadian TSX Venture Exchange and a concurrent initial public offering in Canada.  The offering was successfully closed in August 2012 and we raised $4,476,930, net of direct offering costs.  On August 10, 2012, our shares began trading on the TSX Venture Stock Exchange under the ticker symbol RYU and we continue to be listed on the OTCQB under the ticker symbol RYUN.
 
Our financial statements have been prepared assuming that we will continue as a going concern.  We have incurred recurring net losses, negative cash flows from operations, and accumulated deficit which raise substantial doubt about our Company’s ability to continue as a going concern. Management has developed plans concerning these matters which are discussed in Note 2 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
Operating Activities
 
During the year ended December 31, 2013, we used cash in the amount of $4,098,723 in operating activities.  The principal adjustments to reconcile the net loss to net cash used in operating activities were depreciation and amortization of $252,597, share-based compensation - stock of $105,937, share-based compensation - options of $331,160, loss on impairments on intangible assets and property and equipment of $10,513, an increase in inventory of $386,080, and an increase in accounts payable and accrued expenses of $1,003,754.
 
By comparison, during the year ended December 31, 2012, we used cash in the amount of $8,015,690 in operating activities.  The principal adjustments to reconcile the net loss to net cash used in operating activities were share-based compensation - stock of $1,088,000, share-based compensation - options of $741,796, share-based compensation - warrants of $297,076, an increase in inventory of $1,232,533, a decrease in prepaid expenses of $684,207, and an increase in accounts payables and accrued expenses of $190,968.
 
Investing Activities
 
We used cash in the amount of $156,200 in investing activities during the year ended December 31, 2013.  Investing activities during the period included $138,719 for property and equipment purchases primarily related to the opening of our retail store, $17,481 for intangible assets, which included the development of patents and trademarks, website development costs and domain name.  All costs have been capitalized and depreciated or amortized over the expected useful lives of the assets.
 
By contrast, we used cash in the amount of $322,590 in investing activities during the year ended December 31, 2012.  Investing activities during the period included $171,072 for property and equipment purchases primarily related to the opening of our retail store, $135,148 for intangible assets, which included the development of patents and trademarks, website development costs and the acquisition of our new domain name.  All costs have been capitalized and depreciated or amortized over the expected useful lives of the assets.  We also paid $16,370 as a security deposit for our Las Vegas retail store.
 
Financing Activities
 
We continue to rely upon equity capital to fund operations and investments.  We raised $3,713,954 and $6,441,300 in equity capital through the issuance of common stock and warrants during 2013 and 2012, respectively.  The amount raised in 2013 includes the conversion of a $195,000 note payable.  In addition, we raised $1,334,683 in equity capital that closed in February 2014.
 
During the year ended December 31, 2013, we borrowed $499,934 as a term note until proceeds from a future private placement became available in sufficient amounts.  The note pays a coupon rate of 15% and in connection with the issuance of the note, we issued warrants to purchase up to 300,000 shares of common stock at an exercise price of $0.25 until January 1, 2015.  The note, which is collateralized by primarily all assets of our Company, is due January 1, 2015.  We paid $10,858 toward capital lease obligations, received gross proceeds from the sale of common stock and warrants of $3,713,954 (including notes payable converted to common stock of $195,000), of which $121,165 was paid in offering costs, and were advanced $130,000 as short term loans, for total net cash provided by financing activities of $4,211,865.  The $130,000 short term loans were advance to us under the provisions of a subscription agreement which ultimately closed in February 2014 as further explained in Note 18.
 
During the year ended December 31, 2012, we borrowed $200,005 against our line of credit as a bridge loan until proceeds from the IPO in Canada became available.  The balance including interest of $712 was subsequently repaid in the same quarter.  We also repaid $25,000 to related parties, paid $10,258 towards capital lease obligations and received gross proceeds from the sale of common stock and warrants of $6,441,300, of which $471,270 was paid in offering costs for net cash provided by financing activities of $5,934,772.  Non-cash financing activities during the 2012 period included warrants issued for capital lease of $9,044 and capital lease obligations incurred to acquire intangible assets of $114,490.
 
 
18

 
 
Liquidity and Management’s Plan
 
We commenced operations as a development stage enterprise in 2009 and have incurred losses from inception.  As shown in the accompanying financial statements, we incurred a net loss of $5,365,373 in 2013, had a working capital deficit of $365,787 as of December 31, 2013, and had net cash used in operating activities of $4,098,723 during 2013.
 
As of December 31, 2013, our cash balance was $252,153, and management determined that the Company would have to raise significant additional equity and or debt capital during 2014 in order to support current operations and planned development.  These factors raise substantial doubt as to our ability to continue as a going concern.
 
Although our operations began in 2009, we did not emerge from a development stage until the fourth quarter of 2012.  Activities before 2012 included product research and development, establishing supply sources, developing markets, recruiting personnel and raising capital.  In January 2012, we launched our initial men’s line with a limited number of styles of apparel and accessories.  This line was made available to retailers in January 2012 and direct-to-consumers through our web store in February 2012.  In July 2012, we added to our men’s line and introduced our first line of women’s apparel and accessories.  In late October 2012, we opened our first retail store in Las Vegas, Nevada.
 
Sales generated in 2012 fell significantly short of expectations.  Management attributes this shortfall primarily to the Company’s initial positioning as a premium performance apparel brand within the niche sport of Mixed Martial Arts (MMA), lower than expected sales generated through our association with a major MMA promoter, as well as an emphasis on generating a significant percentage of total sales through an undeveloped wholesale channel.  Consequently, we carried significant excess inventory as of December 31, 2012.  As described in Note 5 to the financial statements, after assessing the market value of our inventory on hand at year-end, management determined that significant write-downs were appropriate in 2012 and in 2013.  In light of these findings, disappointing operating results and weakened cash position, the Company adopted plans and began implementation in early 2013 to rebrand the Company and expand the operations with the objective of rebranding the company to a broader customer base with a focus on e-commerce and retail channels.
 
While progress has been made on the 2013 plan, overall results have been disappointing and equity capital goals have fallen short of target.  Accordingly, management has adjusted and expanded their plans for 2014 and can be summarized as follows:
 
1.
Reposition the brand to support our customer’s active lifestyles
 
2.
Reduced quantity of inventory purchases of our branded product
 
3.
Offering third-party brands that enhance and complement the brand
 
4.
Sourcing more product from North American production facilities
 
5.
Fabric differentiation
 
6.
Enhanced retail store experience incorporating virtual shopping
 
7.
Enhanced web experience and target markets
 
8.
Liquidation of slow-moving and excess inventories
 
9.
Explore license agreements to accelerate growth
 
10.
Continue to focus on equity and debt capital raising
 
11.
Increase opening of new physical retail stores including outlets
 
12.
Develop and evaluate an acquisition strategy, commence implementation if viable
 
While we continue to believe that our wholesale channel will play a major role in our long-term growth plans, we also anticipate that we will need to shift our growth strategy in the near term and place greater emphasis on developing our brand through our retail and e-commerce channels.
 
Management plans to seek additional capital to support and expand its operations and raised a total of $3,713,954 (including conversion of a $195,000 note payable) of capital and $499,934 from the proceeds of a note payable during 2013, and raised an additional amount in February 2014 raised $1,334,683 through the issuance of equity securities as discussed in Note 18 to the financial statements.  While management plans to generate increasing revenues and to continue financing our company through the issuances of additional equity securities or debt instruments, there can be no assurance that sufficient revenue or financing will occur to meet our cash needs for the next 12 months.  The ability to achieve our projected future operating results is based on a number of assumptions which involve significant judgment and estimates, which cannot be assured.  If we are unable to achieve our projected operating results, our liquidity could be adversely impacted and we may need to seek additional sources of liquidity.  Our operating results could adversely affect our ability to raise additional capital to fund our operations and there is no assurance that debt or equity financing will be available in sufficient amount, on acceptable terms, or in a timely basis.  Therefore, a continuation of our recent historical operating results could result in our inability to continue as a going concern.
 
 
19

 
 
Critical Accounting Policies
 
Our significant accounting policies are summarized in Note 3 to the financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. Our management believes that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would affect our results of operations, financial position or liquidity for the periods presented in this report.
 
We believe the following critical accounting policies and procedures, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:
 
Inventory
 
Inventory is valued on a lower of cost or market basis based upon the weighted average method of inventory costing.  Market value is estimated based upon assumptions made about future demand and retail market conditions.  If we determine that the estimated market value of our inventory is less than the carrying value of such inventory, we record a charge to cost of goods sold to reflect the lower of cost or market.  The market value estimates are based on a number of factors, including assumptions and estimates for projected sales and other operating performance measures. Changes in estimates or the application of alternative assumptions could produce significantly different results. These assumptions and estimates may change in the future due to changes in economic conditions, changes in our ability to meet sales and profitability objectives or changes in our business operations or strategic direction.
 
Impairment of Long-Lived Assets

Long-lived assets are amortized over their estimated useful lives and are measured for impairment only when events or circumstances indicate the carrying value may be impaired. In these cases, we estimate the future undiscounted cash flows to be derived from the asset or asset group to determine whether a potential impairment exists. If the sum of the estimated undiscounted cash flows is less than the carrying value of the asset, we recognize an impairment loss, measured as the amount by which the carrying value exceeds the estimated fair value of the asset.

We review and test our intangible assets with indefinite useful lives for impairment in the fourth quarter of each year and when events or changes in circumstances indicate that the carrying amount of such assets may be impaired. Our intangible assets with indefinite lives consist of trademarks and domain name. In the impairment tests for trademarks and domain name, we compare the estimated fair value of each asset to its carrying amount. The fair values are generally estimated using a discounted cash flow model under the income approach. If the carrying amount of the asset exceeds its estimated fair value, we calculate impairment as the excess of carrying amount over the estimate of fair value.

If events or circumstances indicate the carrying value of intangible assets with finite lives may be impaired, we estimate the future undiscounted cash flows to be derived from the asset or asset group to determine whether a potential impairment exists. If the sum of the estimated undiscounted cash flows is less than the carrying value of the asset, we recognize an impairment loss, measured as the amount by which the carrying value exceeds the estimated fair value of the asset.

Impairment charges are classified as a component of operating expenses. The impairment tests and related fair value estimates are based on a number of factors, including assumptions and estimates for projected sales, income, cash flows, discount rates, remaining useful lives and other operating performance measures. Changes in estimates or the application of alternative assumptions could produce significantly different results. These assumptions and estimates may change in the future due to changes in economic conditions, changes in our ability to meet sales and profitability objectives or changes in our business operations or strategic direction.
 
Revenue Recognition
 
We recognize product revenue when persuasive evidence of an arrangement exists, when title passes and the risks and reward of ownership have passed to the customer, the fee is fixed or determinable, and collectability is probable.
 
Revenue is recorded net of discounts and an allowance for estimated returns. The allowance for estimated returns related to web sales and retail sales is currently 3% of sales based on our return policy on our direct-to-consumer sales. The allowance for estimated returns related to wholesale sales is currently 4% based on our historical wholesale customer returns. The allowance is reflected as an accrued liability on the balance sheet.
 
 
20

 
 
Income Taxes
 
Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities at tax rates expected to be in effect when such assets or liabilities are realized or settled. Deferred income tax assets are reduced by valuation allowances when necessary.
 
Assessing whether deferred tax assets are realizable requires significant judgment. We consider all available positive and negative evidence, including historical operating performance and expectations of future operating performance. The ultimate realization of deferred tax assets is often dependent upon future taxable income and therefore can be uncertain. To the extent we believe it is more likely than not that all or some portion of the asset will not be realized, valuation allowances are established against our deferred tax assets, which increase income tax expense in the period when such a determination is made.
 
Income taxes include the largest amount of tax benefit for an uncertain tax position that is more likely than not to be sustained upon audit based on the technical merits of the tax position. Settlements with tax authorities, the expiration of statutes of limitations for particular tax positions, or obtaining new information on particular tax positions may cause a change to the effective tax rate.
 
Share-Based Payments
 
We estimate the cost of share-based payments to employees based on the award’s fair value on the grant date and recognize the associated expense ratably over the requisite period.  The estimated cost is derived using the Black-Scholes option-pricing model, which includes assumptions that are highly subjective. We may adjust these assumptions periodically to reflect changes in market conditions and historical experience.  Consequently, expenses reported for share-based payments to employees in the future may differ significantly from those reported in the current period.
 
When estimating fair value, we have considered the following variables:
 
 
The risk-free interest rate assumption is based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant.
 
 
We have not paid any dividends on common stock since our inception and do not anticipate paying dividends on our common stock in the foreseeable future.
 
 
The expected life of the award is computed using the “simplified” method as permitted under the provisions of Staff Accounting Bulletin (“SAB”) 107.
 
 
The expected volatility is based on the historical volatility of our common stock based on the daily quoted closing trading prices and comparison to peer data.
 
 
The forfeiture rate is based on an estimate of awards not expected to fully vest.
 
The straight-line attribution method is used for awards that include vesting provisions.  If an award is granted, but vesting does not occur, any previously recognized expense is reversed in the period in which the termination of service occurs.
 
We measure the fair value of share-based payments to non-employees at the measurement date, which occurs at the earlier of the date performance commitment is reached or performance is completed.  Recognition of share-based payments occurs as services are received.  We treat fully-vested, non-forfeitable shares issued to non-employees in the same manner as if it had paid for the services received with cash.  Unvested, forfeitable shares are accounted for as unissued until the point vesting occurs.
 
Regarding warrants issued in connection with stock offerings and those issued to non-employees as consideration for services, the Company’s warrant contracts are accounted for in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification 815-40, Derivatives and Hedging – Contracts in Entity’s Own Equity. All such warrant agreements contain fixed strike prices and number of shares that may be issued at the fixed strike price, and do not contain exercise contingencies that adjust the strike price or number of shares issuable upon settlement of the warrants. All such warrant agreements are exercisable at the option of the holder and settled in shares of our company. All such warrant agreements are initially measured at fair value on the grant date and accounted for as part of permanent equity.
 
 
21

 
 
Contractual Commitments
 
The following table presents our non-cancelable contractual commitments:
   
2014
   
2015
   
2016
   
2017
   
2018
   
Thereafter
 
Inventory purchase obligations (1)
  $ 662,173                                
Operating leases (2)
  $ 160,010     $ 132,563     $ 134,162     $ 135,808     $ 125,914     $ 0  
Capital lease (2)
  $ 10,919     $ 11,115     $ 11,314     $ 11,516     $ 11,723     $ 36,012  
 
 
(1)
See inventory purchase obligations in Note 15 to Financial Statements.
 
 
(2)
See operating and capital leases in Note 15 to Financial Statements.
 
Recent Accounting Pronouncements
 
In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This ASU permits an entity to make a qualitative assessment of whether it is more likely than not that indefinite-lived intangible assets are impaired before calculating the fair value of the assets.  After assessment of certain qualitative factors, if it is determined to be more likely than not that an indefinite-lived asset is impaired, entities must perform the quantitative impairment test.  Otherwise, the quantitative test becomes optional.  The amended guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted.  The Company adopted this guidance in 2013 without a material impact on its financial position, results of operations or cash flows.

In July 2013, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” ASU 2013-11 amends the guidance related to the presentation of unrecognized tax benefits and allows for the reduction of a deferred tax asset for a net operating loss (“NOL”) carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. ASU 2013-11 is effective for annual and interim periods for fiscal years beginning after December 15, 2013, and early adoption is permitted. Since ASU 2013-11 relates only to the presentation of unrecognized tax benefits, we do not expect our adoption of ASU 2013-11 in January 2014 will have a material effect on our financial position, results of operations or cash flows.
 
Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities” (SPEs).
 
Item 7A                      Quantitative and Qualitative Disclosures About Market Risk
 
Not required for smaller reporting companies.
 
 
22

 
 
Item 8
Financial Statements and Supplementary Data
 

RESPECT YOUR UNIVERSE, INC.
 
 
 FINANCIAL STATEMENTS
 
 
AS OF December 31, 2013 and 2012, and for the years then ended
 
 
 
TABLE OF CONTENTS
 
 
Page
   
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
F-1
FINANCIAL STATEMENTS:
 
       Balance Sheets
F-2
       Statements of Operations
F-3
       Statements of Stockholders’ Equity
F-4
       Statements of Cash Flows  
F-5
       Notes to Financial Statements  
F-6
 
 
23

 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
 
To the Board of Directors and Stockholders of:
 
Respect Your Universe, Inc.
 
We have audited the accompanying balance sheets of Respect Your Universe, Inc. (the "Company") as of December 31, 2013 and 2012, and the related statements of operations, stockholders' equity, and cash flows for each of the two years ended December 31, 2013. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the two years ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.
 
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company's recurring net losses, negative cash flows from operations, and accumulated deficit raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also discussed in Note 2 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
 
 
 
/s/ Deloitte & Touche, LLP
 
 
 
Portland, Oregon
 
April 15, 2014
 
 
F-1

 
 
RESPECT YOUR UNIVERSE, INC.
BALANCE SHEETS
 
             
   
December 31, 2013
   
December 31, 2012
 
             
ASSETS
           
             
Current assets
           
Cash
  $ 252,153     $ 295,211  
Due from factor, net
    31,602       37,786  
Accounts receivable
    -       8,674  
Inventory, net
    845,188       1,411,074  
Deposits
    107,395       56,878  
Prepaid expenses
    59,337       80,561  
Other current assets
    83,309       6,411  
Total current assets
    1,378,984       1,896,595  
                 
Property and equipment, net
    168,417       183,276  
                 
Other assets
               
Non-current inventory, net
    951,966       -  
Intangible assets, net
    167,587       259,638  
Other non-current assets
    -       16,370  
Total other assets
    1,119,553       276,008  
                 
Total assets
  $ 2,666,954     $ 2,355,879  
                 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Current liabilities
               
Accounts payable and accrued liabilities
  $ 1,603,852     $ 600,098  
Accounts payable - related party
    -       6,354  
Loans payable - related party
    130,000       -  
Current portion of capital lease
    10,919       10,598  
Total current liabilities
    1,744,771       617,050  
                 
Other liabilities
               
Note payable
    499,934          
Capital lease, net of current portion
    81,746       92,925  
Total other liabilities
    581,680       92,925  
                 
Stockholders’ equity
               
Common stock, $0.001 par value, 500,000,000
               
    shares authorized; 62,926,670 and 48,040,878
               
    shares issued and outstanding, respectively
    62,927       48,041  
Additional paid in capital
    23,563,404       19,518,318  
Accumulated deficit
    (23,285,828 )     (17,920,455 )
Total stockholders’ equity
    340,503       1,645,904  
                 
Total liabilities and stockholders' equity
  $ 2,666,954     $ 2,355,879  
 
See accompanying notes to financial statements
 
 
F-2

 

RESPECT YOUR UNIVERSE, INC.
STATEMENTS OF OPERATIONS
 
             
   
Year Ended
 
   
December 31, 2013
   
December 31, 2012
 
             
             
Revenue
  $ 1,164,326     $ 848,981  
                 
Cost of Goods Sold
    1,236,983       1,964,138  
                 
Gross loss
    (72,657 )     (1,115,157 )
                 
Operating expenses
               
Selling and Marketing
    1,347,380       3,390,574  
Product creation
    522,368       392,311  
Product creation - related party
    1,000       513,426  
General and administrative
    3,409,455       4,455,635  
Loss on impairments of intangible assets
               
and property and equipment
    10,513       -  
Total operating expenses
    5,290,716       8,751,946  
                 
Loss before income tax
    (5,363,373 )     (9,867,103 )
Income tax expense
    2,000       1,500  
                 
Net loss
  $ (5,365,373 )   $ (9,868,603 )
                 
Net loss per common share -
               
     basic and diluted
  $ (0.10 )   $ (0.23 )
                 
Weighted average number of common
               
     shares outstanding during the year -
               
     basic and diluted
    55,702,517       43,761,546  

See accompanying notes to financial statements

 
F-3

 

RESPECT YOUR UNIVERSE, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
 
                               
                               
                           
Total
 
   
Common Stock, $0.001 Par Value
   
Additional
   
Accumulated
   
Stockholders'
 
   
Shares
   
Amount
   
Paid in Capital
   
Deficit
   
Equity
 
                               
Balance, January 1, 2012
    39,433,378     $ 39,434     $ 11,420,979     $ (8,051,852 )   $ 3,408,561  
                                         
Issuance of common stock and warrants for cash
                                       
     ($0.84 - $1.00/share), net of offering costs of $471,270
    7,382,500       7,382       5,962,648       -       5,970,030  
                                         
Share-based compensation - stock ($0.68 - $1.17/share)
    1,225,000       1,225       1,086,775       -       1,088,000  
                                         
Share based compensation - options
    -       -       741,796       -       741,796  
                                         
Share based compensation - warrants
    -       -       297,076       -       297,076  
                                         
Issuance of warrants for capital lease
    -       -       9,044       -       9,044  
                                         
Net loss
    -       -       -       (9,868,603 )     (9,868,603 )
                                         
Balance, December 31, 2012
    48,040,878       48,041       19,518,318       (17,920,455 )     1,645,904  
                                         
Issuance of common stock and warrants for cash
                                       
     ($0.10 - $0.50/share), net of offering costs of $121,165
    14,604,542       14,605       3,578,184       -       3,592,789  
                                         
Share-based compensation - stock ($0.28 - $0.52/share)
    281,250       281       105,656       -       105,937  
                                         
Share based compensation - options
    -       -       331,160       -       331,160  
                                         
Share based compensation - warrants
    -       -       30,086       -       30,086  
                                         
Net loss
    -       -       -       (5,365,373 )     (5,365,373 )
                                         
Balance, December 31, 2013
    62,926,670     $ 62,927     $ 23,563,404     $ (23,285,828 )   $ 340,503  

See accompanying notes to financial statements

 
F-4

 
 
RESPECT YOUR UNIVERSE, INC.
STATEMENTS OF CASH FLOWS
 
             
   
Year Ended
 
   
December 31, 2013
   
December 31, 2012
 
             
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net loss
  $ (5,365,373 )   $ (9,868,603 )
Adjustments to reconcile net loss to net cash used in operating activities
               
Depreciation and amortization
    252,597       55,957  
Non-cash payments on capital lease obligations
    -       (709 )
Share-based compensation expense - stock
    105,937       1,088,000  
Share-based compensation expense - options
    331,160       741,796  
Share-based compensation expense - warrants
    30,086       297,076  
Loss on impairments of intangible assets and property and equipment
    10,513       -  
Changes in operating assets and liabilities
               
Due from factor, net
    6,184       (37,786 )
Accounts receivable, net
    8,674       (8,674 )
Inventory
    (386,080 )     (1,232,533 )
Deposits
    (34,147 )     137,845  
Prepaid expenses
    21,224       684,207  
Other current assets
    (76,898 )     (6,411 )
Accounts payable and accrued liabilities
    1,003,754       190,968  
Accounts payable - related party
    (6,354 )     (56,823 )
Net cash used in operating activities
    (4,098,723 )     (8,015,690 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchases of property and equipment
    (138,719 )     (171,072 )
Acquisition of intangible assets
    (17,481 )     (135,148 )
Other non-current assets
    -       (16,370 )
Net cash used in investing activities
    (156,200 )     (322,590 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Proceeds from credit facility
    -       200,005  
Repayments of credit facility
    -       (200,005 )
Proceeds from long-term note payable
    499,934          
Proceeds from loans payable, shareholder
    195,000       -  
Proceeds from other notes payable
    130,000          
Repayment of loans payable
    -       (25,000 )
Payments on capital lease obligation
    (10,858 )     (10,258 )
Proceeds from issuance of common stock and warrants
    3,518,954       6,441,300  
Offering costs
    (121,165 )     (471,270 )
Net cash provided by financing activities
    4,211,865       5,934,772  
                 
Net increase (decrease) in cash
    (43,058 )     (2,403,508 )
                 
Cash - beginning of year
    295,211       2,698,719  
                 
Cash - end of year
  $ 252,153     $ 295,211  
                 
Supplemental Disclosure of Cash Flow Information
               
Cash paid during the year for:
               
Interest
  $ 2,222     $ 2,501  
Taxes
  $ 1,500       -  
                 
Supplemental Disclosure of Non-Cash Financing Activity
               
Stock issued as repayment of note payable
  $ 195,000       -  
Warrants issued for capital lease
    -     $ 9,044  
Capital lease obligations incurred to acquire intangible assets
    -     $ 114,490  

See accompanying notes to financial statements
 
 
F-5

 
 
RESPECT YOUR UNIVERSE, INC.
NOTES TO FINANCIAL STATEMENTS


Note 1                          Organization and Nature of Operations
  
Respect Your Universe, Inc. (“the Company”), which was incorporated in 2008, is a vertically integrated, active lifestyle apparel brand that engages in the development, marketing and distribution of apparel and accessories. With operations based in Portland, Oregon, the Company’s products are sold through wholesale, retail and e-commerce channels.

Note 2                          Liquidity and Management’s Plan

The Company commenced operations as a development stage enterprise in 2009 and has incurred losses from inception.  As shown in the accompanying consolidated financial statements, the Company incurred a net loss of $5,365,373 in 2013 and had net cash used in operating activities of $4,098,723 during 2013.  Management believes that the Company will need to raise significant additional capital during 2014 in order to support current operations and planned development.  These factors raise substantial doubt as to our ability to continue as a going concern.
 
In 2012, the Company emerged from the development stage by launching its initial men’s apparel line in January and its initial women’s apparel line in July, and by opening its first retail store in Las Vegas, Nevada in October.  Sales generated in 2012 and 2013 fell significantly short of expectations.  During 2013, management began efforts to reposition the brand to appeal to a broader market, and has developed a plan to improve the business operations which will require additional issuance of equity securities or placement of debt.  There can there be no assurance that sufficient revenue or financing will occur to meet the Company’s cash needs for the next 12 months. Therefore, a continuation of our recent historical operating results could result in our inability to continue as a going concern.
 
The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that could result should the Company be unable to continue as a going concern.

Note 3                          Summary of Significant Accounting Policies

Basis of Presentation

The accompanying financial statements were prepared in accordance with accounting principles generally accepted in the United States.
 
Cash
 
The Company considers all highly liquid instruments purchased with a maturity of three months or less at date of acquisition to be cash equivalents.  There were no cash equivalents at December 31, 2013 and 2012, respectively.
 
Inventory
 
Inventory primarily consists of finished goods. The cost of finished goods inventory includes all costs incurred to bring inventory to its existing condition and location including product costs, inbound freight and duty.
 
Inventory is valued on a lower of cost-or-market (“LCM”) basis based upon the weighted average method of inventory costing.  Market value is estimated based upon assumptions made about future demand and retail market conditions.  If the Company determines that the estimated market value of its inventory is less than the carrying value of such inventory, it records a charge to cost of goods sold to reflect the lower of cost or market.  As discussed in Note 5, the Company recorded a charge to cost of goods sold related to an LCM adjustment of its inventory in 2013 and in 2012.
 
Property and Equipment
 
Property and equipment are stated at cost less accumulated depreciation.   The cost of repairs and maintenance is expensed as incurred.  Depreciation is provided on the straight-line method over the estimated useful lives of the assets.  Leasehold improvements are amortized on a straight-line basis over the lesser of the length of the lease, without consideration of optional renewal periods, and the estimated useful life of the assets, to a maximum of 5 years. Upon sale or other disposition of a depreciable asset, cost and accumulated depreciation are removed from property and equipment and any gain or loss is reflected as a gain or loss from operations.
 
The estimated useful lives are:
 
 
F-6

 
 
Leasehold improvements
1 - 5 years
Computers and office equipment
3 years
Furniture and fixtures
7 years
Software
3 years
Tradeshow and event equipment
2 - 3 years

Impairment of Long Lived Assets
 
Long-lived assets are amortized over their estimated useful lives and are measured for impairment only when events or circumstances indicate the carrying value may be impaired. In these cases, the Company estimates the future undiscounted cash flows to be derived from the asset or asset group to determine whether a potential impairment exists. If the sum of the estimated undiscounted cash flows is less than the carrying value of the asset, the Company recognizes an impairment loss, measured as the amount by which the carrying value exceeds the estimated fair value of the asset. Impairment charges for long-lived assets included in operating expense were $10,513 and $0 in 2013 and 2012, respectively.
 
Revenue Recognition
 
The Company recognizes product revenue when persuasive evidence of an arrangement exists, when title passes and the risks and reward of ownership have passed to the customer, the fee is fixed or determinable, and collectability is probable.
 
Revenue is recorded net of discounts and an allowance for estimated returns. The allowance for estimated returns related to web sales and retail sales is currently 3% of sales based on the Company’s return policy on its direct-to-consumer sales and historical returns activities. The allowance for estimated returns related to wholesale sales is currently 4% based on the Company’s historical wholesale customer returns. The allowance is reflected as an accrued liability on the balance sheet.
 
Cost of Goods Sold

Cost of goods sold includes the expenses incurred to acquire and produce inventory for sale, including product costs, inbound freight and duty costs, as well as provisions for reserves related to product shrinkage, excess or obsolete inventory, or LCM adjustments as required.
 
Shipping and Handling Costs
 
Costs associated with the Company’s third-party warehouse shipping and handling activities are included within operating expenses in the statement of operations.  Shipping costs associated with sales to customers, marketing related promotions and transfers of inventory from the Company’s distribution centers to its retail location are included as a component of selling and marketing expense.  Warehousing and handling costs are included in general and administrative expense and were $275,017 and $200,744 for 2013 and 2012, respectively.  Any shipping and handling costs billed to customers are recorded as revenue and the related out-bound shipping costs incurred by the Company are recorded as cost of goods sold.
 
Selling and Marketing Costs
 
Selling and marketing costs are expensed as incurred.  Advertising costs include expenses associated with sales and product catalogues, sponsorships of events and other consumer publication related activities.  Advertising expenses for the years ended December 31, 2013 and 2012 were $610,935 and $1,857,972 respectively. Accounting for consulting and sponsorship agreements is based upon the specific contract provisions and are expensed as the services are provided.
 
Product Creation Costs

The Company expenses product creation costs as incurred.  Product creation expenses consist of formulating product concepts, construction of prototypes related to the Company’s proposed new product lines, and the fitting and testing of the prototypes. Product creation expenses do not include routine, ongoing efforts to refine, enrich, or otherwise improve upon the qualities of existing products, adaptation of an existing capability to a particular requirement or customer's need as part of a continuing commercial activity, or seasonal or other periodic design changes to existing products.

Of the total amount expensed, and as reflected on the statement of operations, an allocation has been made to a related party classification for amounts incurred with an entity that is controlled by the Company’s former Chief Executive Officer and former Chief Operating Officer.

 
Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities at tax rates expected to be in effect when such assets or liabilities are realized or settled.

Assessing whether deferred tax assets are realizable requires significant judgment. The Company considers all available positive and negative evidence, including historical operating performance and expectations of future operating performance. The ultimate realization of deferred tax assets is often dependent upon future taxable income and therefore can be uncertain. To the extent the Company believes it is more likely than not that all or some portion of the asset will not be realized, valuation allowances are established against the Company’s deferred tax assets, which increase income tax expense in the period when such a determination is made.
 
 
F-7

 

Income taxes include the largest amount of tax benefit for an uncertain tax position that is more likely than not to be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information and based on the technical merits of the tax position. Settlements with tax authorities, the expiration of statutes of limitations for particular tax positions, or obtaining new information on particular tax positions may cause a change to the effective tax rate.

Risks and Uncertainties

The Company operates in an industry that is subject to intense competition and change in consumer demand.  The Company's operations are subject to significant risk and uncertainties including financial and operational risks and the potential risk of business failure.  See Note 2, Liquidity and Management’s Plan.

Share-Based Payments

The Company estimates the cost of share-based payments to employees based on the award’s fair value on the grant date and recognizes the associated expense ratably over the requisite period.  The estimated cost is derived using the Black-Scholes option-pricing model, which includes assumptions that are highly subjective.  The Company may adjust these assumptions periodically to reflect changes in market conditions and historical experience.  Consequently, expenses reported for share-based payments to employees in the future may differ significantly from those reported in the current period.
 
When estimating fair value, the Company has considered the following variables:
 
 
The risk-free interest rate assumption is based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant.
 
 
The Company has not paid any dividends on common stock since our inception and does not anticipate paying dividends on our common stock in the foreseeable future.
 
 
The expected life of the award is computed using the “simplified” method as permitted under the provisions of Staff Accounting Bulletin (“SAB”) 107.
 
 
The expected volatility is based on the historical volatility of our common stock based on the daily quoted closing trading prices and comparison to peer data.
 
 
The forfeiture rate is based on an estimate of awards not expected to fully vest.
 
The straight-line attribution method is used for awards that include vesting provisions.  If an award is granted, but vesting does not occur, any previously recognized expense is reversed in the period in which the termination of service occurs.
 
The Company measures the fair value of share-based payments to non-employees at the measurement date, which occurs at the earlier of the date performance commitment is reached or performance is completed.  Recognition of share-based payments occurs as services are received.  The Company treats fully-vested, non-forfeitable shares issued to non-employees in the same manner as if it had paid for the services received with cash.  Unvested, forfeitable shares are accounted for as unissued until the point vesting occurs.
 
Regarding warrants issued in connection with stock offerings and those issued to non-employees as consideration for services, the Company’s warrant contracts are accounted for in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (ASC) 815-40 - Derivatives and Hedging, Contracts in Entity’s Own Equity. All such warrant agreements contain fixed strike prices and number of shares that may be issued at the fixed strike price, and do not contain exercise contingencies that adjust the strike price or number of shares issuable upon settlement of the warrants. All such warrant agreements are exercisable at the option of the holder and settled in shares of the Company. All such warrant agreements are initially measured at fair value on the grant date and accounted for as part of permanent equity.
 
Earnings (Loss) per Share
 
Basic loss per share is computed by dividing net loss by weighted average number of shares of common stock outstanding during each period.  Diluted loss per share is computed by dividing net loss, adjusted for changes in income or loss that resulted from the assumed conversion of convertible shares, by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during the period.
 
The Company had the following potential common stock equivalents at December 31, 2013 and 2012:
 
   
2013
   
2012
 
Stock options, exercise price $0.21 - $2.26
    5,161,420       3,808,670  
Common stock warrants, conversion price $0.25 - $1.80
    13,716,167       6,924,276  
Unvested, forfeitable restricted stock grants
    -       281,250  
Total common stock equivalents
    18,877,587       11,014,196  

 
F-8

 
 
Since the Company incurred a net loss during the years ended December 31, 2013 and 2012, the effect of considering any common stock equivalents, if exercisable, would have been anti-dilutive.  Therefore, a separate computation of diluted loss per share is not presented.
 
Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.
 
Making estimates requires management to exercise significant judgment. It is at least reasonably possible that the estimate of the effect of a condition, situation or set of circumstances that existed at the date of the financial statements, which management considered in formulating its estimate could change in the near term due to one or more future confirming events. Accordingly, the actual results could differ significantly from estimates. Some of the more significant estimates relate to revenue recognition, including sales returns and claims from customers, slow-moving and close-out inventories, income taxes and stock-based compensation.
 
Fair Value of Financial Instruments
 
The Company measures assets and liabilities at fair value based on an expected exit price as defined by the authoritative guidance on fair value measurements, which represents the amount that would be received on the sale of an asset or paid to transfer a liability, as the case may be, in an orderly transaction between market participants. As such, fair value may be based on assumptions that market participants would use in pricing an asset or liability. The authoritative guidance on fair value measurements establishes a consistent framework for measuring fair value on either a recurring or non-recurring basis whereby inputs, used in valuation techniques, are assigned a hierarchical level.

The following are the hierarchical levels of inputs to measure fair value:

 
·
Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

 
·
Level 2: Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the assets or liabilities; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 
·
Level 3: Unobservable inputs reflecting the Company’s assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.
 
The Company's financial instruments consisted primarily of cash, accounts payable and accrued liabilities, accounts payable - related party, due from factor and loans payable - related party. The carrying amounts of the Company's financial instruments generally approximated their fair values as of December 31, 2013 and 2012, respectively, due to the short-term nature of such items.
 
Recent Accounting Pronouncements
   
In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This ASU permits an entity to make a qualitative assessment of whether it is more likely than not that indefinite-lived intangible assets are impaired before calculating the fair value of the assets.  After assessment of certain qualitative factors, if it is determined to be more likely than not that an indefinite-lived asset is impaired, entities must perform the quantitative impairment test.  Otherwise, the quantitative test becomes optional.  The amended guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted.  The Company adopted this guidance in 2013 without a material impact on its financial position, results of operations or cash flows.

In July 2013, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” ASU 2013-11 amends the guidance related to the presentation of unrecognized tax benefits and allows for the reduction of a deferred tax asset for a net operating loss (“NOL”) carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. ASU 2013-11 is effective for annual and interim periods for fiscal years beginning after December 15, 2013, and early adoption is permitted. Since ASU 2013-11 relates only to the presentation of unrecognized tax benefits, we do not expect our adoption of ASU 2013-11 in January 2014 will have a material effect on our financial position, results of operations or cash flows.

Note 4                   Due from Factor

In January 2012, the Company entered into a factoring agreement whereby it sells its wholesale trade accounts receivable to a factor without recourse. Under the agreement, the factor assumes the risk of loss resulting from a customer’s financial inability to pay at maturity, in exchange for a fee of 1.25% on the first $5,000,000 in gross factored receivables.  The fee for factored receivables in excess of $5,000,000 is 1.00%.  The minimum aggregate factoring charge payable under the agreement is $50,000 per year.

As part of the agreement, the factor provides all credit and collections support for the Company. Upon collection, the factor reimburses the Company for purchased invoices on a semi-weekly basis, net of factoring fees and chargebacks.
 
 
F-9

 

Note 5                          Inventories
 
Inventories, net, consist of finished goods inventory of $1,797,154 ($951,966 of which has been classified as non-current) and $1,411,074 for the years ended December 31, 2013 and 2012, respectively.
 
Adjustment for Lower of Cost-or-Market
 
As of December 31, 2013, the Company assessed the market value of its inventory on hand.  The Company determined that the market value of the product was less than its cost at both year ends.  As such, the Company recognized a LCM adjustment to inventory of $387,947 and $1,401,220 in December 2013 and 2012, respectively.
 
Note 6                          Prepaid Expenses
 
Prepaid expenses consist of the following as of December 31, 2013 and 2012:

   
2013
   
2012
 
Marketing
  $ 14,026       -  
Other
    45,311     $ 80,561  
Total prepaid expenses
  $ 59,337     $ 80,561  

Prepaid expenses are amortized over the related service periods, which are less than or equal to one year.

Note 7                          Property and Equipment
 
Property and equipment consist of the following as of December 31, 2013 and 2012:
 
   
2013
   
2012
 
Leasehold improvements
  $ 6,773     $ 141,355  
Construction in progress
    103,461        -  
Computers and office equipment
    41,809       22,840  
Furniture and fixtures
    19,689       12,692  
Software
    41,004       36,084  
Tradeshow and event equipment
    7,229       7,229  
      219,965       220,200  
Accumulated depreciation
    (51,548 )     (36,924 )
Property and equipment, net
  $ 168,417     $ 183,276  

 
Depreciation expense for the years ended December 31, 2013 and 2012 was $145,856 and $35,145, respectively.
     
During 2013, the Company was notified by the landlord of the Las Vegas retail store of their intent to prematurely terminate our lease, and as a result, recorded an impairment loss of $5,723 for the estimated carrying value attributed with this accelerated closure of the location.  No impairment losses were recorded in 2012.
 
Note 8                          Intangible Assets
 
Intangible assets consist of the following as of December 31, 2013 and 2012:
 
 
   
2013
   
2012
 
Patent and trademarks
  $ 44,052     $ 107,926  
Website development, net
     -       28,177  
Domain name
    123,535       123,535  
Intangible assets, net
  $ 167,587     $ 259,638  
 
 
 
F-10

 
 
Patents and Trademarks
 
The Company capitalizes legal fees and filing costs associated with the development of its patents and trademarks.  Patents and trademarks are amortized over an estimated useful life of 5 years using the straight-line method, however, patents and trademarks with indefinite useful lives are not amortized.  Amortization expense for the years ended December 31, 2013 and 2012 was $76,656 and $(1,168), respectively.  
 
Website Development
 
The Company capitalizes certain costs associated with the development of its website.  Other costs related to the planning and maintenance of the website are expensed as incurred.  Amortization is provided over the estimated useful life of 2 years using the straight-line method for financial statement purposes.
 
As of December 31, 2013 and 2012, the Company’s website development costs are as follows:
 
   
2013
   
2012
 
Website development
  $ 50,157     $ 50,157  
Accumulated amortization
    (50,157 )     (21,980 )
Website development, net
  $ -0-     $ 28,177  

The Company’s website was placed into service in February 2012.  Amortization expense for the years ended December 31, 2013 and 2012 was $28,177 and $21,980, respectively.

Domain Name
 
In February 2012, the Company capitalized the costs associated with the acquisition of its domain name, ryu.com.  The estimated useful life of the website domain is indefinite and accordingly related capitalized costs are not amortized. See Note 11, Capital Lease. As of December 31, 2013 and 2012, the Company determined that its domain name was not impaired.

Provision for Impairment
 
The Company reviews and tests its intangible assets with indefinite useful lives for impairment in the fourth quarter of each year and when events or changes in circumstances indicate that the carrying amount of such assets may be impaired. The Company’s intangible assets with indefinite lives consist of trademarks, and domain name. In the impairment tests for trademarks and domain name, the Company compares the estimated fair value of each asset to its carrying amount. The fair values of trademarks and domain name are generally estimated using a discounted cash flow method under the income approach. If the carrying amount of a trademark or domain name exceeds its estimated fair value, the Company calculates impairment as the excess of carrying amount over the estimate of fair value.
 
Impairment charges are classified as a component of operating expense. The impairment tests and related fair value estimates are based on a number of factors, including assumptions and estimates for projected sales, income, cash flows, discount rates, remaining useful lives and other operating performance measures. Changes in estimates or the application of alternative assumptions could produce significantly different results. These assumptions and estimates may change in the future due to changes in economic conditions, changes in the Company’s ability to meet sales and profitability objectives or changes in the Company’s business operations or strategic direction.
 
During 2013, the Company determined that the carrying value of a trademark exceeded its fair value and recorded a $4,790 impairment charge.  No impairment loss was recorded in 2012.
 
Note 9                          Credit Facilities and Notes Payable

In December 2013 the Company entered into a term note (“Note”) in the principal amount of $499,934.  The Note has a maturity date of January 1, 2015 and bears interest of 15% per annum, which is payable quarterly, and is secured by all of the assets of the Company. In connection with the issuance of the Note, the Company issued warrants to purchase up to 300,000 shares of common stock at an exercise price of $0.25 until January 1, 2015.  The Company is in compliance with the covenants of the Note as of December 31, 2013.

During 2013 the Company was advanced funds totaling $130,000 in anticipation of participating in a private placement financing.  Under the terms of the private placement subscription agreement, the Company is entitled to utilize the proceeds as an interest free loan until the subscription is accepted and the certificates delivered.  Subsequent to year end, these advances were accepted as part of the private placement further described in note 18 – Subsequent events.

In June 2012, the Company entered into a one year, unsecured, credit facility. The credit facility had a maximum borrowing capacity of $500,000. Under this credit facility, the Company paid interest at a rate of 6% per year.  In July 2012, the Company made a $200,005 draw upon the credit facility.   This amount was repaid in August 2012 along with accrued interest in the amount of $712.  No balance was outstanding under the revolving credit facility at December 31, 2012.  The credit facility was terminated in February 2013.

Note 10                        Loans Payable - Related Party
 
On March 8, 2011, an entity affiliated with the Company’s then Chief Executive Officer loaned the Company $25,000. The loan is non-interest bearing, unsecured and was repaid on March 8, 2012.
 
 
F-11

 

Note 11                        Capital Lease
 

On February 1, 2012, the Company entered into a capital lease agreement to lease the domain name ryu.com for 10 years.  See Note 15 for disclosure related to future lease payments. At the end of the lease term, title to the domain name will automatically transfer to the Company.  See Note 8, Intangible Assets - Domain Name.
 
During the years ended December 31, 2013 and 2012, the Company incurred and paid interest in the amounts of $2,222 and $1,789, respectively.

Note 12                        Stockholders’ Equity
 
 
Stock Issued for Cash
 
Year ended December 31, 2013
 
In January 2013, the Company issued 2,000,000 shares of common stock as part of a private placement offering for $936,360 ($0.50/share), net of direct offering costs of $63,640.  The offering included a finder’s fee of 5% cash and 5% warrants on total gross proceeds. Details of the warrants issued are shown in the table below:
 
 Date
Quantity Granted
Vesting Schedule
Exercise Price
Expiration
January 2013
100,000
Fully vested upon issuance
$0.50
2
Years
 
 
In March 2013, as a continuation of the January 2013 offering, the Company issued 900,000 shares of common stock for gross proceeds of $441,495 ($0.50/share), net of direct offering costs of $8,505.  The offering included a finder’s fee of 5% cash and 5% warrants on $50,000 of the gross proceeds. Details of the warrants issued are shown in the table below:
 
Date
Quantity Granted
Vesting Schedule
Exercise Price
Expiration
March 2013
2,500
Fully vested upon issuance
$0.50
2
Years

 
In June 2013, the Company issued a total of 7,290,000 shares of common stock as part of a private placement offering for $1,775,783 ($0.25/share), net of direct offering costs of $46,717.  780,000 shares of this private placement were issued as repayment to the holder of the note payable discussed in Note 9, as directed by the holder of the note. Only the holders of these warrants have the right to exercise the warrants at the specified fixed strike price, according to the terms outlined above.  In conjunction with this offering, one warrant for each share issued was granted. Details of the warrants issued are shown in the table below:
 
Date
Quantity Granted
Vesting Schedule
Exercise Price
Expiration
June 2013
7,290,000
Fully vested upon issuance
$0.25
3
Years

In November 2013, the Company issued a total of 4,414,542 shares of common stock as part of a private placement offering for $439,151 ($0.10/share), net of direct offering costs of $2,303.  In conjunction with this offering, one warrant for each share issued was granted.  Only the holders of these warrants have the right to exercise the warrants at the specified fixed strike price, according to the terms outlined above.  Details of the warrants issued are shown in the table below:
 
 Date
Quantity Granted
Vesting Schedule
Exercise Price
Expiration
November 2013
4,414,542
Fully vested upon issuance
$0.10
3
Years

 
Year ended December 31, 2012
 
In February 2012, The Company issued 1,500,000 shares of common stock for $1,493,100 ($1.00/share), net of direct offering costs of $6,900.  The Company also issued the holders the following warrants:
 
Date
Quantity Granted
Vesting Schedule
Exercise Price
Expiration
February 2012
750,000
Fully vested upon issuance
$1.80
2.5
Years (1)
 
 
 
(1)
The Company may accelerate the expiry date of the warrants if the market price of the common stock reaches $4.00 for at least 20 consecutive trading days.
 
Only the holders of these warrants have the right to exercise the warrants at the specified fixed strike price, according to the terms outlined above.

In August 2012, the Company completed a registration statement to list on the Canadian TSX Venture Exchange (“TSXV”).  In connection with the listing, the Company closed an initial public offering and issued 5,882,500 shares of common stock for $4,476,930 ($0.84/share), net of offering costs of $464,370. Pursuant to the agreement between the Company and its placement agent, the Company issued the following warrants to the agent as part of the offering:
 
 
F-12

 
 
Date
Quantity Granted
Vesting Schedule
Exercise Price
Expiration
August 2012
294,125
Fully vested upon issuance
$1.49
2
Years

Only the holders of these warrants have the right to exercise the warrants at the specified fixed strike price, according to the terms outlined above.
 
In addition to the issuance of warrants discussed above, the Company issued the following warrants to multiple holders during the year ended December 31, 2012:
 
Date
 
Quantity Granted
 
Vesting Schedule
 
Exercise Price
   
Expiration
January 2012
    100,000  
Fully vested upon issuance
  $ 1.20       5  
Years
January 2012
    15,000  
Fully vested upon issuance
  $ 0.98       10  
Years
April 2012
    100,000  
Fully vested upon issuance
  $ 1.20       5  
Years
July 2012
    100,000  
Fully vested upon issuance
  $ 1.20       5  
Years
October 2012
    100,000  
Fully vested upon issuance
  $ 1.20       5  
Years
 
Only the holders of these warrants have the right to exercise the warrants at the specified fixed strike price, according to the terms outlined above.

Stock Issued for Services
 
For the year ended December 31, 2013, there was no stock issued for services.  During the years ended December 31, 2013 and 2012, the Company recognized expense of $105,937 and $1,088,000 related to stock issued for services, respectively.  On January 26, 2012, the Company issued 100,000 shares of common stock to a consultant for services rendered, for a total of $98,000 ($0.98/share), based upon the quoted closing trading price.
 
Stock Options
 
On June 10, 2011, the Company adopted the 2011 Incentive Award Plan (the “2011 Plan”) and on May 18, 2012, the Board of Directors approved certain revisions to the 2011 Plan, resulting in our 2012 Incentive Award Plan (the “2012 Plan”) whereby the aggregate number of securities reserved for issuance, set aside and made available for issuance under the Plan was revised from (i) not to exceed 10% of the issued and outstanding of our common stock at the time of granting of options (including all options granted by our Company to date) to (ii) 8,487,925 shares of our common stock.

On June 7, 2013, the Board of Directors approved certain revisions to the 2012 Plan, resulting in the Company’s 2013 Stock Option Plan (the “2013 Plan”) whereby the aggregate number of securities reserved for issuance set aside and made available for issuance under the Plan was revised from (i) 8,487,925 shares of the Company’s common stock at the time of granting the options (including all options granted by our Company to date) to (ii) 11,702,425 shares of the Company’s common stock.

The Company had the following stock option grants and forfeitures:

Year Ended December 31, 2013
 
   
Shares
   
Fair Market
   
Share Vesting Schedule
   
Expiration
 
Grant Date
 
Granted
   
Value
   
2011
   
2012
   
2013
   
2014
   
2015 and
thereafter
   
(Years)
 
January 2013
    500,000     $ 227,101       -       -       375,000       125,000       -       10  
March 2013
    1,550,000       465,607       -       -       762,500       387,500       400,000       10  
March 2013 (1)
    (63,500 )     (15,420 )     (13,500 )     -       -       (12,500 )     (37,500 )     10  
May 2013
    50,000       7,136       -       -       -       12,500       37,500       10  
June 2013
    200,000       90,751       -       -       100,000       -       100,000       10  
June 2013 (1)
    (2,256,250 )     (979,464 )     -       -       (400,000 )     (1,353,750 )     (502,500 )     5-10  
July 2013
    1,250,000       230,303       -       -       600,000       350,000       300,000       10  
September 2013
    930,000       191,675       -       -       130,000       317,500       482,500       10  
October 2013
    80,000       7,738       -       -       -       20,000       60,000       10  
December 2013 (1)
    (250,000 )     (31,556 )     -       -       -       (125,000 )     (125,000 )     10  
Total
    1,990,250     $ 193,871       (13,500 )     -       1,567,500       (278,750 )     715,000          
 
 
(1)
Options forfeited upon termination of employment.  The Company reversed $33,353 of expense related to the unvested portion of the forfeited stock options.
 
 
F-13

 
 
Year Ended December 31, 2012

   
Shares
   
Fair Market
   
Share Vesting Schedule
   
Expiration
 
Grant Date
 
Granted
   
Value
   
2011
   
2012
   
2013
   
2014
   
2015 and
thereafter
   
(Years)
 
January 2012
    770,000     $ 623,432       -       192,500       192,500       192,500       192,500       10  
March 2012
    4,000       2,880       -       4,000       -       -       -       10  
April 2012
    600,000       352,138       -       600,000       -       -       -       5  
May 2012 (1)
    (200,000 )     (85,495 )     -       (125,000 )     (25,000 )     (25,000 )     (25,000 )     10  
August 2012
    635,000       422,282       -       100,000       133,750       133,750       267,500       10  
August 2012 (1)
    (400,000 )     (79,666 )     (300,000 )     -       (25,000 )     (25,000 )     (50,000 )     10  
December 2012
    (40,000 )     (31,237 )     -       -       (10,000 )     (10,000 )     (20,000 )     10  
Total
    1,369,000     $ 1,204,334       (300,000 )     771,500       266,250       266,250       365,000          
 
 
(1)
Options forfeited upon termination of employment.  The Company reversed $25,544 of expense relating to the unvested portion of the forfeited stock options.

 
The Black-Scholes assumptions used for the years ended December 31, 2013 and 2012 are as follows:
 
   
2013
   
2012
 
Exercise price
  $ 0.14 - $0.52     $ 0.89 - $1.00  
Expected dividends
    0%       0%  
Expected volatility
    100%       100%  
Risk free interest rate
    0.98% - 2.03%       0.33% - 2.08%  
Expected term of option
 
4 – 10 years
   
2.5 – 10 years
 
Expected forfeitures
    10 - 35%       0%  

 
The following is a summary of the Company’s stock option activity:
 
Year Ended December 31, 2013

   
Options
   
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life
 
Average
Intrinsic
Value
 
Balance – December 31, 2012
    4,611,170     $ 1.22  
 8.34 years
  $ -  
Granted
    4,560,000       0.37            
Exercised
    -       -            
Forfeited/Cancelled
    (2,569,750 )     0.55            
Outstanding - December 31, 2013
    6,601,420     $ 0.89  
 8.48 years
  $ -  
Exercisable - December 31, 2013
    5,161,420     $ 0.82  
7.43 years
  $ -  
 
 
F-14

 
 
Year Ended December 31, 2012

   
Options
   
Weighted
Average
Exercise
Price
   
Weighted
Average
Remaining
Contractual
Life
   
Average
Intrinsic
Value
 
Balance – January 1, 2012
    3,242,170     $ 1.24    
8.58 years
    $ 558,000  
Granted
    2,009,000       0.94       -       -  
Exercised
    -       -       -       -  
Forfeited/Cancelled
    (640,000 )     1.63       -       -  
Outstanding - December 31, 2012
    4,611,170     $ 1.22    
8.34 years
    $ -  
Exercisable – December 31, 2012
    3,808,670     $ 1.07    
7.78 years
    $ -  

 
   
December 31, 2013
   
December 31, 2012
 
Grant date fair value of options
  $ 5,142,977     $ 4,880,683  
Weighted average grant date fair value
  $ 0.78     $ 1.06  
Outstanding options held by related parties
    3,627,670       2,532,670  
Exercisable options held by related parties
    2,582,670       1,932,670  
Fair value of stock options held by related parties
  $ 3,384,656     $ 3,309,540  
 
During the years ended December 31, 2013 and 2012, the Company recognized expense of $331,160 and $741,796 related to stock option grants, respectively.
 
Warrants
 
The Company granted the following warrants:
 
Year ended December 31, 2013
 
   
Shares
   
Fair Market
   
Share Vesting Schedule
   
Expiration
 
Grant Date
 
Granted
   
Value
   
2011
   
2012
   
2013
   
(Years)
 
                                     
January 2013
    100,000     $ 30,020       -       -       100,000       5  
January 2013 (1)
    100,000       -       -       -       100,000       2  
March 2013 (1)
    2,500       -       -       -       2,500       2  
June 2013 (2)
    7,290,000       -       -       -       7,290,000       3  
June 2013 (3)
    (5,415,151 )     -       (5,415,151 )     -       -       2  
November 2013(4)
    4,414,542       -       -       -