(

)

Summary of Significant Accounting Policies

A summary of the Company

’s significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows:

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Build-A-Bear Workshop, Inc. an

d its wholly-owned subsidiaries. All significant intercompany accounts are eliminated in consolidation.

Fiscal Year

The Company operates on a

- or

-week fiscal year ending on the Saturday closest to

December

31.

Subsequent to year-end, the Company’s Board of Directors approved a change in the Company’s fiscal year-end to the Saturday closest to

January 31,

see Note

– Subsequent Event for additional information. The periods presented in these financial statements are fiscal

2017

(

weeks ended

December 30, 2017),

fiscal

2016

(

weeks ended

December 31, 2016)

and fiscal

2015

(

weeks ended

January 2, 2016).

References to years in these financial statements relate to fiscal years or year ends rather than calendar years.

Cash and Cash Equivalents

Cash and cash equivalents include cash and short-term highly liquid investments with an original maturity of

three

months or less held in both domestic and foreign financial institutions.

The majority of the Company

’s cash and cash equivalents exceed federal deposit insurance limits. The Company has

not

experienced any losses in such accounts and management believes that the Company is

not

exposed to any significant credit risk on cash and cash equivalents.

Inventories

Inventories are stated at the lower of cost or

net realizable value, with cost determined on an average-cost basis. Inventory includes supplies of

$2.7

million and

$3.1

million as of

December 30, 2017

and

December 31, 2016,

respectively. A reserve for estimated shortage is accrued throughout the year based on detailed historical averages. The inventory reserve was

$1.0

million as of both

December 30, 2017

and

December 31, 2016.

Receivables

Receivables consist primarily of amounts due to the Company in relation to tenant allowances,

wholesale and corporate product sales, franchisee royalties and product sales, certain amounts due from taxing authorities and licensing revenue. The Company assesses the collectability of all receivables on an ongoing basis by considering its historical credit loss experience, current economic conditions, and other relevant factors. Based on this analysis, the Company has established an allowance for doubtful accounts of

$3.1

million and

$3.6

million as of

December 30, 2017

and

December 31, 2016,

respectively.

Property and Equipment

Property and equipment consist of leasehold improvements, furniture and fixtures, computer equipment and software, building and land

and are stated at cost. Leasehold improvements are depreciated using the straight-line method over the shorter of the useful life of the assets or the life of the lease which is generally

ten

years. Furniture and fixtures and computer equipment are depreciated using the straight-line method over the estimated service lives ranging from

three

seven

years. Computer software includes certain costs, including internal payroll costs incurred in connection with the development or acquisition of software for internal use and

is amortized using the straight-line method over a period of

three

five

years. New store construction deposits are recorded at the time the deposit is made as construction-in-progress and reclassified to the appropriate property and equipment category at the time of completion of construction, when operations of the store commence. Maintenance and repairs are expensed as incurred and improvements are capitalized. Gains or losses on the disposition of fixed assets are recorded upon disposal.

Other Intangible Assets

Other intangible assets consist primarily of initial costs related to trademarks and other intellectual

property. Trademarks and other intellectual property represent

third

-party costs that are capitalized and amortized over their estimated lives ranging from

one

three

years using the straight-line method.

Other Assets

Other assets consist primarily of

the non-current portion of prepaid income taxes, deferred leasing fees and deferred costs related to franchise agreements. Prepaid income taxes through

December 31, 2016

were amortized through income tax expense over the life of the related asset. After fiscal

2016,

the remaining balance of prepaid income taxes was adjusted to retained earnings. Deferred leasing fees are initial, direct costs related to the Company’s operating leases and are amortized over the term of the related leases. Deferred franchise costs are initial costs related to the Company’s franchise agreements that are deferred and amortized over the life of the respective franchise agreement. Amortization expense related to other assets was

$0.1

million for each of the fiscal years

2017,

2016

and

2015.

Long-lived Assets

Whenever facts and circumstances indicate that the carrying value of a long-lived asset

may

not

be recoverable, the carrying value is reviewed. If this review indicates that the carrying value of the asset will

not

be recovered, as determined based on projected undiscounted cash flows related to the asset over its remaining life, the carrying value of the asset is reduced to its estimated fair value.

The Company performs an annual assessment of the store assets in the direct-to-consumer (“DTC”) segment, based on operating performance and forecasts of future performance. Total impairment charges were

$0.1

million,

$2.7

million and

$0.3

million in fiscal years

2017,

2016

and

2015,

respectively. See Note

– Property and Equipment for further discussion regarding the impairment of long-lived assets.

The calculation of fair value requires multiple assumptions regarding our future operations to determine future cash flows, including but

not

limited to, sales volume, margin rates and discount rates.

If different assumptions were used in the analysis, it is possible that the amount of the impairment charge

may

have been significantly different than what was recorded.

Deferred Rent

Certain of the Company

’s operating leases contain predetermined fixed escalations of minimum rentals during the original lease terms. For these leases, the Company recognizes the related rental expense on a straight-line basis over the life of the lease and records the difference between the amounts charged to operations and amounts paid as deferred rent. The Company also receives certain lease incentives in conjunction with entering into operating leases. These lease incentives are recorded as deferred rent at the beginning of the lease term and recognized as a reduction of rent expense over the lease term. In addition, certain of the Company’s leases contain future contingent increases in rentals. Such increases in rental expense are recorded in the period that it is probable that store sales will meet or exceed the specified target that triggers contingent rental expense.

Franchises

The Company defers initial,

one

-time nonrefundable franchise fees and amortizes them over the

initial term of the respective franchise agreements, which extend for periods up to

years. The Company’s obligations under the contract are ongoing and include operations and product development support and training, generally concentrated around new store openings. Continuing franchise fees are recognized as revenue as the fees are earned.

Retail Revenue Recognition

Net retail sales are net of discounts, exclude sales tax, and are recognized at the time of sale.

For e-commerce sales, revenue is recognized at the time of shipment. Shipping and handling costs billed to customers are included in net retail sales.

Revenues from the sale of gift cards are recognized at the time of redemption. Unredeemed gift cards are included in gift cards and customer deposits on the consolidated balance sheets. For gift cards issued prior to

December 2015,

the Company recorded income from unredeemed gift cards

under the delayed recognition method when the likelihood of redemption by a customer is considered remote. For fiscal

2015,

these unredeemed gift cards were recorded as an offset to selling, general and administrative expenses due to immateriality. Beginning in

December 2015,

the Company established Build-A-Bear Card Services LLC and issued all future gift cards under this entity. For these unredeemed gift cards, gift card breakage revenue is recorded as a component of net retail sales based on historical redemption patterns and under the redemption recognition method. The total unredeemed gift card amount recorded as net retail sales from breakage was

$8.3

million,

$4.5

million and

$0.5

million in fiscal years

2017,

2016

and

2015,

respectively.

The Company has a customer loyalty program, Build-A-Bear

Bonus Club, whereby guests enroll in the program and receive points based on the value of the transaction and receive awards for various discounts on future purchases after achieving defined point thresholds. Historical patterns for points converting into awards and ultimate award redemption are applied to actual points and awards outstanding at the respective balance sheet date to calculate the liability and corresponding adjustment to net retail sales.

Management reviews these patterns and assesses the adequacy of the deferred revenue liability at the end of each fiscal quarter. Due to the estimates involved in these assessments, adjustments to the historical rates are generally made

more often than annually in order to allow time for more definite

trends to emerge. Based on the year-end assessments, the adjustment was

$0.1

million for fiscal years

2017

and

2015

and

adjustment for fiscal

2016.

The deferred revenue balance for the loyalty program was

$1.4

million and

$1.8

million as of

December 31, 2017

and

December 30, 2016

respectively.

Cost of Merchandise Sold

Cost of merchandise sold

- retail includes the cost of the merchandise, including royalties paid to licensors of

third

-party branded merchandise; store occupancy cost, including store depreciation and store asset impairment charges; cost of warehousing and distribution; packaging; stuffing; damages and shortages; and shipping and handling costs incurred in shipment to customers. Cost of merchandise sold - commercial includes the cost of the merchandise, including royalties paid to licensors of

third

-party branded merchandise; cost of warehousing and distribution; packaging; stuffing; damages and shortages; and shipping and handling costs incurred in shipment to customers.

Selling, General, and Administrative Expenses

Selling, general, and administrative expenses include store payroll and related benefits, advertising, credit card fees, store supplies

and store closing costs, as well as central office management payroll and related benefits, travel, information systems, accounting, insurance, legal, and public relations. It also includes depreciation and amortization of central office leasehold improvements, furniture, fixtures, and equipment, as well as amortization of trademarks and intellectual property.

Store Preopening Expenses

Store preopening expenses

include costs incurred prior to store openings, remodels and relocations including certain store set-up, labor and hiring costs, rental charges, payroll, marketing, travel and relocation costs. They are expensed as incurred and are included in selling, general and administrative expenses.

Advertising

The costs of

advertising and marketing programs are charged to operations in the

first

period the program takes place. Advertising expense was

$19.0

million,

$20.7

million and

$25.3

million for fiscal years

2017,

2016

and

2015

, respectively.

Income Taxes

Income taxes are accounted for using a balance sheet approach known as the liability method. The liability method accounts for deferred income taxes by applying the

rate, based on enacted tax law, that will be in effect in the period in which the temporary differences, between the book basis and the tax basis of assets and liabilities, reverse or are settled. Deferred taxes are reported on a jurisdictional basis.

Tax positions are reviewed at least quarterly and adjusted as new information becomes available. The recoverability of deferred tax assets is evaluated by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These estimates of future taxable income inherently require significant judgment. To the extent it is considered more likely than

not

that a deferred tax asset will be

not

recovered, a valuation allowance is established.

The Company accounts for its total liability for uncertain tax positions according to the provisions of ASC

740

25.

The Company recognizes estimated interest and penalties related to unrecognized tax benefits in income tax expense. See Note

—Income Taxes for further discussion including the impact of the

December 22, 2017

enactment of The Tax Cuts and Job Act (“Act”).

ncome

Per Share

Under the

two

-class method, b

asic income per share is determined by dividing net income allocated to common stockholders by the weighted average number of common shares outstanding during the period. In periods of net loss,

effect is given to the Company’s participating securities as they do

not

contractually participate in the losses of the Company. Diluted income per share reflects the potential dilution that could occur if options to issue common stock were exercised. In periods in which the inclusion of such instruments is anti-dilutive, the effect of such securities is

not

given consideration.

Stock-Based Compensation

The Company has share-based compensation plans covering

certain management groups and its Board of Directors. The Company accounts for share-based payments utilizing the fair value recognition provisions of ASC

718.

The Company recognizes compensation cost for equity awards over the requisite service period for the entire award. See Note

– Stock Incentive Plans for additional information. For fiscal

2017,

2016,

and

2015,

selling, general and administrative expense includes

$3.4

million,

$3.0

million and

$2.1

million, respectively, of stock-based compensation expense.

Comprehensive

Income (

Los

)

Comprehensive

income (loss) is comprised of net income (loss) and foreign currency translation adjustments.

eferred Compensation Plan

The Company maintains a Deferred Compensation Plan for the benefit of certain management employees. The investment funds offered to the participant generally correspond to the funds offered in the Company

’s

401

(k) plan, and the account balance fluctuates with the investment returns on those funds. The fair value of the assets, classified as trading securities, and corresponding liabilities are based on unadjusted quoted market prices for the funds in active markets with sufficient volume and frequency (Level

). As of

December 30, 2017,

the current portions of the assets and related liabilities of less than

$0.1

million are presented in prepaid expenses and other current assets and accrued expenses in the accompanying consolidated balance sheets, and the non-current portions of the assets and the related liabilities of

$1.0

million are presented in other assets, net and other liabilities in the accompanying consolidated balance sheets. As of

December 31, 2016,

the current portions of the assets and related liabilities of

$0.1

$0.7

million are presented in other assets, net and other liabilities in the accompanying consolidated balance sheets.

Fair Value of Financial Instruments

For purposes of financial reporting, management has determined that the fair value of financial instruments, including cash and cash equivalents, receivables,

short term investments, accounts payable and accrued expenses, approximates book value at

December 30, 2017

and

December 31, 2016.

Use of Estimates

The preparation of the consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The assumptions used by management in future estimates could change significantly due to changes in circumstances, including, but

not

limited to, challenging economic conditions. Accordingly, future estimates

may

change significantly.

Significant items subject to such estimates and assumptions include the calculation of revenue from gift card breakage, valuation of long-lived assets, including deferred income tax assets, and the determination of deferred revenue under the Company’s customer loyalty program.

Sales Tax Policy

The Company

’s revenues in the consolidated statement of operations are net of sales taxes.

Foreign Currency

Assets and liabilities of the Company

’s foreign operations with functional currencies other than the U.S. dollar are translated at the exchange rate in effect at the balance sheet date, while revenues and expenses are translated at average rates prevailing during the year. Translation adjustments are reported in accumulated other comprehensive income, a separate component of stockholders’ equity. Gains and losses resulting from foreign exchange transactions, including the impact of the re-measurement of the Company’s balance sheet, are recorded as a component of selling, general and administrative expenses. The Company recorded income of

$1.6

million in fiscal

2017

and losses of

$0.3

million and

$2.3

million in fiscal

2016

and

2015,

respectively.

ecent Accounting Pronouncements

– Adopted in the current year

The Company adopted Accounting Standards Update (

“ASU”)

No.

2016

09,

Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting, effective

January 1, 2017.

The Company made an accounting policy election to account for forfeitures as they occur. The impact of this election, along with the adoption of the other provisions of the standard in the

first

quarter of

2017,

was to increase deferred tax assets by

$1.6

million, increase additional paid-in-capital by

$0.3

million, increase retained earnings by

$1.9

million and decrease taxes payable by

$0.6

million.

Additionally, the Company early adopted ASU

No.

2016

16,

Income Taxes

– Intra-Entity Transfers of Assets Other Than Inventory, effective

January 1, 2017.

Using the modified retrospective method, the impact of the adoption of the standard in the

first

quarter of

2017

was to increase deferred tax assets by

$1.0

million, decrease other assets, net by

$2.3

million and decrease retained earnings by

$1.3

million.

ecent Accounting Pronouncements – Pending adoption

May 2014,

the FASB issued Accounting Standards Update

No.

2014

09,

Revenue from Contracts with Customers (ASU

2014

), which will replace most existing revenue recognition guidance. The core principle of the ASU is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASU

2014

requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. ASU

2014

will be effective for the Company beginning in fiscal

2018

and allows for both retrospective and modified retrospective methods of adoption. In

2016,

the Company established a cross-functional team to use a detailed approach to assess the impact of the new standard. The team has reviewed current accounting policies and practices to identify potential differences that would result from applying the provisions of the new standard to the Company’s existing revenue contracts. To date, management has reviewed all types of the Company’s revenue sources and contracts. Internal controls have been designed and an accounting policy has been developed. The Company expects the most significant impact to result from changes to the accounting for deferred revenue, specifically related to gift card breakage. Breakage revenue, which is currently recognized for certain gift cards, when the likelihood of redemption becomes remote, will be recognized under the new guidance proportionately over the estimated customer redemption period, subject to the constraint that it must be highly probable that a significant reversal of revenue will

not

occur. In addition, the Company has identified minor changes to the timing of revenues for certain outbound licensing arrangements and international franchise agreements. The Company will adopt ASU

2014

effective the

first

day of fiscal

2018

using the modified retrospective method through a cumulative adjustment recorded to the opening fiscal

2018

retained earnings balance. The Company expects the pre-tax cumulative effect adjustment to retained earnings to be approximately

$12.3

million and the tax effect to be approximately

$3.0

million. As a result of this change, the Company expects a negative impact to revenue and pre-tax income of

$3.9

million in fiscal

2018

with the remaining balance of the cumulative effect adjustment predominantly impacting fiscal years

2019

and

2020.

February 2016,

the FASB issued Accounting Standards Update

No.

2016

02,

Leases

(ASU

2016

), which will replace most existing lease accounting guidance in U.S. GAAP. The core principle of the ASU is that an entity should recognize the rights and obligations resulting from leases as assets and liabilities. ASU

2016

requires qualitative and specific quantitative disclosures to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities, including significant judgments and changes in judgments. ASU

2016

will be effective for the Company beginning in fiscal

2019

and requires the modified retrospective method of adoption. Early adoption is permitted. The Company is in the process of determining the impact of ASU

2016

on its consolidated financial statements. Management expects a material impact to the consolidated balance sheet in the addition of significant right-of-use assets and related liabilities as the Company's retail locations are currently categorized as operating leases. In

2017,

the Company established a cross-functional team to use a detailed approach to assess the impact of the new standard. The Company is in the process of implementing new lease accounting software to assist in the quantification of the expected impact on the consolidated balance sheets and to facilitate the calculations of the related accounting entries and disclosures. See Note

– Commitments and Contingencies for further detail of the Company’s future minimum lease payments.