STOCK-BASED COMPENSATION

3 Months Ended

Apr. 29, 2017

Disclosure of Compensation Related Costs, Share-based Payments [Abstract]

STOCK-BASED COMPENSATION

NOTE 3: STOCK-BASED COMPENSATION

The Company accounts for its stock-based compensation plans in accordance with FASB ASC 718 “Compensation – Stock Compensation.” Under FASB ASC 718, stock-based compensation expense is based on awards ultimately expected to vest, and therefore has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant based on the Company’s historical forfeiture experience and will be revised in subsequent periods if actual forfeitures differ from those estimates.

FASB ASC 718 also requires the benefits of income tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required prior to FASB ASC 718. A summary of the Company’s stock-based compensation (a component of selling, general and administrative expenses) and related income tax benefit is as follows:

(in thousands):

	Thirteen Weeks Ended
	April 29, 2017		April 30, 2016
Stock option expense	$	527	$	(424	)
Restricted stock expense		567		1,127
ESPP expense		91		51
Total stock-based compensation	$	1,185	$	754
Income tax benefit on stock-based compensation	$	254	$	209

The fair value of each option granted during the thirteen week period ended April 29, 2017 and April 30, 2016 is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Thirteen Weeks Ended
	April 29, 2017			April 30, 2016
Stock Options
Expected volatility		40.6	%		33.7	%
Risk-free interest rate		2.2	%		1.5	%
Expected option life (in years)		5.84			5.84
Expected dividend yield		1.86	%		1.78	%
Weighted average fair value at grant date	$	4.11		$	4.08
Employee Stock Purchase Plan
Expected volatility		61.8	%		59.4	%
Risk-free interest rate		1.0	%		0.9	%
Expected option life (in years)		0.25			0.25
Expected dividend yield		0.40	%		0.40	%
Weighted average fair value at grant date	$	4.19		$	3.88

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.

Employee Stock Purchase Plan

The 2004 Employee Stock Purchase Plan (the “2004 Plan”), which was approved by Fred’s shareholders, 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 12,147 shares issued during the thirteen weeks ended April 29, 2017. There are 1,410,928 shares approved to be issued under the 2004 Plan and as of April 29, 2017, there were 673,760 shares available.

Stock Options

The following table summarizes stock option activity during the thirteen weeks ended April 29, 2017:

	Options			Weighted- Average Exercise Price		Weighted-Average Contractual Life (years)		Aggregate Intrinsic Value (000s)
Outstanding at January 28, 2017		1,607,656		$	13.55		6.0	$	2,070
Granted		157,017			11.92
Cancelled		(20,900	)		16.20
Exercised		-			-
Outstanding at April 29, 2017		1,743,773		$	13.37		6.2	$	2,990
Exercisable at April 29, 2017		207,879		$	16.05		4.3	$	37

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between Fred’s closing stock price on the last trading day of the period ended April 29, 2017 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. As of April 29, 2017, total unrecognized stock-based compensation expense net of estimated forfeitures related to non-vested stock options was approximately $3.6 million, which is expected to be recognized over a weighted average period of approximately 4.1 years. The total fair value of options vested during the thirteen weeks ended April 29, 2017 was $350.7 thousand.

Restricted Stock

The following table summarizes restricted stock activity during the thirteen weeks ended April 29, 2017:

	Number of Shares			Weighted-Average Grant Date Fair Value
Non-vested Restricted Stock at January 29, 2017		598,784		$	15.08
Granted		147,424			13.29
Forfeited / Cancelled		(35,105	)		18.34
Vested		(43,140	)		14.28
Non-vested Restricted Stock at April 29, 2017		667,963		$	14.57

The aggregate pre-tax intrinsic value of restricted stock outstanding as of April 29, 2017 is $9.9 million with a weighted average remaining contractual life of 6.5 years. The unrecognized compensation expense net of estimated forfeitures, related to the outstanding stock is approximately $5.3 million, which is expected to be recognized over a weighted average period of approximately 4.5 years. The total fair value of restricted stock awards that vested during the thirteen weeks ended April 29, 2017 was $615.3 thousand.