Note 7 - Stock-Based Compensation

At the 2016 annual meeting, stockholders approved the Shore Bancshares, Inc. 2016 Stock and Incentive Plan (“2016 Equity Plan”), replacing the Shore Bancshares, Inc. 2006 Stock and Incentive Plan (“2006 Equity Plan”), which expired on that date. The Company may issue shares of common stock or grant other equity-based awards pursuant to the 2016 Equity Plan. Stock-based awards granted to date generally are time-based, vest in equal installments on each anniversary of the grant date and range over a one- to five-year period of time, and, in the case of stock options, expire 10 years from the grant date. As part of the 2016 Equity Plan, a performance equity incentive award program, known as the “Long-term incentive plan” allows participating officers of the Company to earn incentive awards of performance share/restricted stock units if certain pre-determined targets are achieved at the end of a three-year performance cycle. Stock-based compensation expense based on the grant date fair value is recognized ratably over the requisite service period for all awards and reflects forfeitures as they occur. The 2016 Equity Plan originally reserved 750,000 shares of common stock for grant, and 723,965 shares remained available for grant at March 31, 2017.

The following tables provide information on stock-based compensation expense for the three months ended March 31, 2017 and 2016.


	For the Three Months Ended
	March 31,
(Dollars in thousands)	2017		2016
Stock-based compensation expense	$	418	$	111
Excess tax benefits related to stock-based
compensation		2		3


	March 31,
(Dollars in thousands)	2017			2016
Unrecognized stock-based compensation
expense	$	345		$	70
Weighted average period unrecognized
expense is expected to be recognized		0.1	years		0.6	years

The following table summarizes restricted stock award activity for the Company under the 2016 Equity Plan for the three months ended March 31, 2017 and 2016.


	Three Months Ended March 31, 2017			Three Months Ended March 31, 2016
		Weighted Average			Weighted Average
	Number of	Grant Date		Number of	Grant Date
	Shares	Fair Value		Shares	Fair Value
Nonvested at beginning of period	17,066	$	11.46	12,488	$	8.74
Granted	7,378		16.44	8,524		11.16
Vested	(8,138)		13.92	(13,467)		9.49
Cancelled	-		-	-		-
Nonvested at end of period	16,306	$	12.49	7,545	$	10.16

The fair value of restricted stock awards that vested during the first three months of 2017 and 2016 was $113 thousand and $122 thousand, respectively.

Restricted stock units (RSUs) are similar to restricted stock, except the recipient does not receive the stock immediately, but instead receives it upon the terms and conditions of the Company’s long-term incentive plans which are subject to performance milestones achieved at the end of a three-year period. Each RSU cliff vests at the end of the three-year period and entitles the recipient to receive one share of common stock on a specified issuance date. The recipient does not have any stockholder rights, including voting rights, with respect to the shares underlying awarded RSUs until the recipient becomes the holder of those shares.

During 2016, the Company entered into a long-term incentive program agreement with officers of the Company and its subsidiaries to award RSUs based on a performance metric to be achieved as of December 31, 2018. These awards will cliff vest on this date, in which the final number of common shares to be issued will be determined. The range of RSUs which could potentially be awarded at the end of the performance cycle are between 12,214 shares and 48,871 shares, assuming a certain performance metric is met. In addition, two members of the long-term incentive plan from 2015 forfeited their RSUs due to leaving the Company before the end of the vesting period. The following table presents management’s evaluation of the probable number of common stock awards to be issued at the end of the performance cycle.

During 2015, the Company entered into a long-term incentive program agreement with officers of the Company and its subsidiaries to award RSUs based on performance metrics to be achieved as of December 31, 2017. These awards will cliff vest on this date, in which the final number of common shares to be issued will be determined. The range of RSUs which could potentially be awarded at the end of the performance cycle are 10,953 shares and 43,821 shares, assuming certain performance metrics are met. The following table presents management’s evaluation of the probable number of common stock awards to be issued at the end of the performance cycle.

The following table summarizes restricted stock units activity for the Company under the 2016 and 2006 Equity Plans for the three months ended March 31, 2017 and 2016.


	Three Months Ended March 31, 2017			Three Months Ended March 31, 2016
		Weighted Average			Weighted Average
	Number of	Grant Date		Number of	Grant Date
	Shares	Fair Value		Shares	Fair Value
Outstanding at beginning of period	46,342	$	10.64	-	$	-
Granted	-		-	26,943		9.49
Vested	-		-	-		-
Forfeited	-		-	-		-
Outstanding at end of period	46,342	$	10.64	26,943	$	9.49

The following table summarizes stock option activity for the Company under the 2016 Equity Plan for the three months ended March 31, 2017 and 2016.


	Three Months Ended March 31, 2017			Three Months Ended March 31, 2016
		Weighted Average			Weighted Average
	Number of	Grant Date		Number of	Grant Date
	Shares	Fair Value		Shares	Fair Value
Outstanding at beginning of period	62,086	$	8.29	61,327	$	8.05
Granted	1,202		10.99	12,443		11.12
Exercised	(859)		6.64	(450)		6.64
Expired/Cancelled	-		-	-		-
Outstanding at end of period	62,429	$	8.36	73,320	$	8.58

Exercisable at end of period	61,828	$	8.34	67,099	$	8.35

The weighted average fair value of stock options granted during 2017 was $10.99. The Company estimates the fair value of options using the Black-Scholes valuation model with weighted average assumptions for dividend yield, expected volatility, risk-free interest rate and expected lives (in years). The expected dividend yield is calculated by dividing the total expected annual dividend payout by the average stock price. The expected volatility is based on historical volatility of the underlying securities. The risk-free interest rate is based on the Federal Reserve Bank’s constant maturities daily interest rate in effect at grant date. The expected contract life of the options represents the period of time that the Company expects the awards to be outstanding based on historical experience with similar awards. The following weighted average assumptions were used as inputs to the Black-Scholes valuation model for options granted in 2017 and 2016.


	2017		2016
Dividend yield	0.84	%	0.73	%
Expected volatility	64.80	%	38.60	%
Expected forfeiture rate	-	%	-	%
Risk-free interest rate	2.42	%	1.75	%
Expected contract life (in years)	10 years		10 years

At the end of the first quarter of 2017, the aggregate intrinsic value of the options outstanding under the 2016 Equity Plan was $521 thousand based on the $16.71 market value per share of the Company’s common stock at March 31, 2017. Similarly, the aggregate intrinsic value of the options exercisable was $232 thousand at March 31, 2017. The intrinsic value on options exercised in 2017 was $8 thousand based on the $15.89 market value per share of the Company’s common stock at January 30, 2017. The intrinsic value on options exercised in the first three months of 2016 was $2 thousand based on the $11.35 market value per share of the Company’s common stock at February 8, 2016. At March 31, 2017, the weighted average remaining contract life of options outstanding was 6.7 years.