STOCK-BASED COMPENSATION

6 Months Ended

Jul. 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				Twenty-Six Weeks Ended
	July 29, 2017		July 30, 2016		July 29, 2017		July 30, 2016
Stock option expense	$	442	$	304	$	969	$	(120	)
Restricted stock expense		1,448		387		2,014		1,513
ESPP expense		93		51		185		103
Total stock-based compensation	$	1,983	$	742	$	3,168	$	1,496
Income tax benefit on stock-based compensation	$	538	$	170	$	791	$	379

The fair value of each option granted during the thirteen and twenty-six week periods ended July 29, 2017 and July 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						Twenty-Six Weeks Ended
	July 29, 2017			July 30, 2016			July 29, 2017			July 30, 2016
Stock Options
Expected volatility		43.9	%		33.2	%		41.5	%		33.3	%
Risk-free interest rate		2.0	%		1.4	%		2.1	%		1.5	%
Expected option life (in years)		5.84			5.84			5.84			5.84
Expected dividend yield		1.87	%		1.80	%		1.86	%		1.79	%
Weighted average fair value at grant date	$	4.99		$	4.05		$	4.35		$	4.06
Employee Stock Purchase Plan
Expected volatility		98.8	%		60.3	%		80.3	%		59.8	%
Risk-free interest rate		1.0	%		0.9	%		1.0	%		0.9	%
Expected option life (in years)		0.50			0.50			0.38			0.38
Expected dividend yield		0.78	%		0.79	%		0.59	%		0.59	%
Weighted average fair value at grant date	$	7.67		$	3.78		$	6.31		$	3.60

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 may 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 to ten 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 33,878 shares issued during the twenty-six weeks ended July 29, 2017. There are 1,410,928 shares approved to be issued under the 2004 Plan and as of July 29, 2017, there were 652,029 shares available.

Stock Options

The following table summarizes stock option activity during the twenty-six weeks ended July 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		215,573			12.40
Cancelled		(120,140	)		15.19
Exercised		—			—
Outstanding at July 29, 2017		1,703,089		$	13.29		5.7		—
Exercisable at July 29, 2017		319,403		$	15.66		4.7		—

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 July 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 July 29, 2017, total unrecognized stock-based compensation expense net of estimated forfeitures related to non-vested stock options was approximately $3.1 million, which is expected to be recognized over a weighted average period of approximately 3.9 years. The total fair value of options vested during the twenty-six weeks ended July 29, 2017 was $827.4 thousand.

Restricted Stock

The following table summarizes restricted stock activity during the twenty-six weeks ended July 29, 2017:

	Number of Shares			Weighted-Average Grant Date Fair Value
Non-vested Restricted Stock at January 29, 2017		598,784		$	15.08
Granted		182,124			12.18
Forfeited / Cancelled		(36,647	)		18.18
Vested		(219,886	)		15.09
Non-vested Restricted Stock at July 29, 2017		524,375		$	13.86

The aggregate pre-tax intrinsic value of restricted stock outstanding as of July 29, 2017 is $3.6 million with a weighted average remaining contractual life of 6.6 years. The unrecognized compensation expense net of estimated forfeitures, related to the outstanding stock is approximately $4.0 million, which is expected to be recognized over a weighted average period of approximately 4.3 years. The total fair value of restricted stock awards that vested during the twenty-six weeks ended July 29, 2017 was $3.3 million.