NOTE 7 – EQUITY INCENTIVE PLANS

Incentive stock option plan. The Company has a long-term incentive plan, which was approved by Fred's stockholders, under which an aggregate of 1,200,159 shares as of January 28, 2012 (1,446,199 shares as of January 29, 2011) are available to be granted. These options expire five years to seven from the date of grant. Options outstanding at January 28, 2012 expire in fiscal 2012 through fiscal 2019.

The Company grants stock options to key employees including executive officers, as well as other employees, as prescribed by the Compensation Committee (the “Committee”) of the Board of Directors. The number of options granted is directly linked to the employee’s job classification. Options, which include non-qualified stock options and incentive stock options, are rights to purchase a specified number of shares of Fred's common stock at a price fixed by the Committee. Stock options granted have an exercise price equal to the market price of Fred's common stock on the date of grant. The exercise price for stock options issued under the plan that qualify as incentive stock options within the meaning of Section 422(b) of the Code shall not be less than 100% of the fair value as of the date of grant. The option exercise price may be satisfied in cash or by exchanging shares of Fred's common stock owned by the optionee for at least six months, or a combination of cash and shares. Options have a maximum term of five to seven and one-half years from the date of grant. Options granted under the plan generally become exercisable ratably over five years or ten percent during each of the first four years on the anniversary date and sixty percent on the fifth anniversary date. The rest vest ratably over the requisite service period. Stock option expense is generally recognized using the graded vesting attribution method. The plan contains a non-compete provision and a provision that if the Company meets or exceeds a specified operating income margin during the most recently completed fiscal year that the annual vesting percentage will accelerate from ten to twenty percent during that vesting period. The plan also provides for annual stock grants at the fair value of the stock on the grant date to non-employee directors according to a non-discretionary formula. The number of shares granted is dependent upon current director compensation levels.

Employee Stock Purchase Plan. The 2004 Employee Stock Purchase Plan (the “2004 Plan”), which was approved by Fred's stockholders, permits eligible employees to purchase shares of our common stock through payroll deductions at the lower of 85% of the fair market value of the stock at the time of grant or 85% of the fair market value at the time of exercise. There were 52,526, 63,680 and 60,350 shares issued during fiscal years 2011, 2010 and 2009, respectively. There are 1,410,928 shares approved to be issued under the 2004 Plan and as of January 28, 2012 there were 974,307 shares available.

The following represents total stock based compensation expense (a component of selling, general and administrative expenses) recognized in the consolidated financial statements (in thousands):

(in thousands)	2011		2010		2009
Stock option expense	$	455	$	552	$	789
Restricted stock expense		1,446		1,173		573
ESPP expense		174		161		233
Total stock-based compensation	$	2,075	$	1,886	$	1,595

Income tax benefit on stock-based compensation	$	573	$	509	$	364

The Company uses the Modified Black-Scholes Option Valuation Model (“BSM”) to measure the fair value of stock options granted to employees. The BSM option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock volatility and option life. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

The fair value of each option granted is estimated on the date of grant using the BSM with the following weighted average assumptions:

Stock Options	2011			2010			2009
Expected volatility		41.2	%		42.1	%		42.5	%
Risk-free interest rate		1.8	%		2.9	%		2.6	%
Expected option life (in years)		5.13			5.84			5.84
Expected dividend yield		0.9	%		0.7	%		0.6	%

Weighted average fair value at grant date	$	4.35		$	5.18		$	4.66

Employee Stock Purchase Plan
Expected volatility		27.6	%		32.3	%		73.2	%
Risk-free interest rate		0.3	%		0.6	%		0.1	%
Expected option life (in years)		0.63			0.63			0.63
Expected dividend yield		0.9	%		0.6	%		0.4	%

Weighted average fair value at grant date	$	3.32		$	2.53		$	3.85

The following is a summary of the methodology applied to develop each assumption:

Expected Volatility — This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. The Company uses actual historical changes in the market value of our stock to calculate expected price volatility because management believes that this is the best indicator of future volatility. The Company calculates weekly market value changes from the date of grant over a past period representative of the expected life of the options to determine volatility. An increase in the expected volatility will increase compensation expense.

Risk-free Interest Rate — This is the yield of a U.S. Treasury zero-coupon bond issue effective at the grant date with a remaining term equal to the expected life of the option. An increase in the risk-free interest rate will increase compensation expense.

Expected Lives — This is the period of time over which the options granted are expected to remain outstanding and is based on historical experience. Options granted have a maximum term of seven and one-half years. An increase in the expected life will increase compensation expense.

Dividend Yield — This is based on the historical yield for a period equivalent to the expected life of the option. An increase in the dividend yield will decrease compensation expense.

Forfeiture Rate — This is the estimated percentage of options granted that are expected to be forfeited or cancelled before becoming fully vested. This estimate is based on historical experience. An increase in the forfeiture rate will decrease compensation expense.

Stock Options. The following table summarizes stock option activity from January 31, 2009 through January 28, 2012:

	Options			Weighted- Average Exercise Price		Weighted- Averaged Contractual Life (years)		Aggregate Intrinsic Value (000s)
Outstanding at January 31, 2009		1,138,111		$	15.13		3.9	$	11
Granted		404,891			11.26
Forfeited / Cancelled		(281,072	)		15.06
Exercised		(600	)		13.25
Outstanding at January 30, 2010		1,261,330		$	13.91		3.1	$	73
Granted		51,352			12.55
Forfeited / Cancelled		(384,000	)		17.98
Exercised		(10,220	)		12.69
Outstanding at January 29, 2011		918,462		$	12.15		3.2	$	1,524
Granted		113,821			11.96
Forfeited / Cancelled		(218,844	)		14.39
Exercised		(18,063	)		12.12
Outstanding at January 28, 2012		795,376		$	11.52		3	$	2,831

Exercisable at January 28, 2012		514,457		$	11.68		2.3	$	1,752

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the excess of Fred's closing stock price on the last trading day of the fiscal year end and the exercise price of the option multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on that date. This amount changes based on changes in the market value of Fred's stock. As of January 28, 2012, total unrecognized stock-based compensation expense net of estimated forfeitures related to non-vested stock options was approximately $.45 million, which is expected to be recognized over a weighted average period of approximately 3.2 years.

Other information relative to option activity during 2011, 2010 and 2009 is as follows:

(dollars in thousands)	2011		2010		2009
Total fair value of stock options vested	$	642	$	792	$	1,249
Total pretax intrinsic value of stock options exercised	$	42	$	11	$	-

The following table summarizes information about stock options outstanding at January 28, 2012:

	Options Outstanding				Options Exercisable
Range of Exercise Prices	Shares	Weighted- Averaged Contractual Life (years)	Weighted- Average Exercise Price		Shares	Weighted- Average Exercise Price
$ 8.66 - $13.00	514,317	3.4	$	10.44	316,797	$	10.54
$13.02 - $14.02	234,957	2.3	$	13.28	167,840	$	13.27
$14.03 - $17.35	46,102	2.4	$	14.58	29,820	$	14.80
	795,376				514,457

Restricted Stock. The Company’s equity incentive plans also allow for granting of restricted stock having a fixed number of shares at a purchase price that is set by the Compensation Committee of the Company’s Board of Directors, which purchase price may be set at zero, to certain executive officers, directors and key employees. The Company calculates compensation expense as the difference between the market price of the underlying stock on the date of grant and the purchase price if any. Restricted shares granted under the plan have various vesting types, which include cliff vesting and graded vesting with a requisite service period of three to ten years. Restricted stock has a maximum term of five to ten years from grant date. Compensation expense is recorded on a straight-line basis for shares that cliff vest and under the graded vesting attribution method for those that have graded vesting.

The following table summarizes restricted stock from January 31, 2009 through January 28, 2012:

	Options			Weighted- Average Grant Date Fair Value
Non-vested Restricted Stock at January 31, 2009		352,784		$	12.39
Granted		58,993			12.38
Forfeited / Cancelled		(29,909	)		13.88
Exercised		(35,358	)		14.90
Non-vested Restricted Stock at January 30, 2010		346,510		$	12.01
Granted		168,736			13.44
Forfeited / Cancelled		(22,208	)		11.09
Exercised		(20,111	)		11.57
Non-vested Restricted Stock at January 29, 2011		472,927		$	12.55
Granted		396,830			3.84
Forfeited / Cancelled		(91,375	)		9.02
Exercised		(66,782	)		12.17
Non-vested Restricted Stock at January 28, 2012		711,600		$	7.74

The aggregate pre-tax intrinsic value of restricted stock outstanding as of January 28, 2012 is $10.7 million with a weighted average remaining contractual life of 5.1years. The unrecognized compensation expense net of estimated forfeitures, related to the outstanding restricted stock is approximately $4.4 million, which is expected to be recognized over a weighted average period of approximately 6.4 years. The total fair value of restricted stock awards that vested for the years ended January 28, 2012, January 29, 2011 and January 30, 2010 was $.9 million, $.2 million and $.5 million, respectively.

There were no significant modifications to the Company’s share-based compensation plans during fiscal 2011, 2010 or 2009.