NOTE 5: STOCK-BASED COMPENSATION

Adtalem maintains three stock-based incentive plans: the 2003 Stock Incentive Plan, the Amended and Restated Incentive Plan of 2005 and the Fourth Amended and Restated Incentive Plan of 2013. Under these plans, directors, key executives and managerial employees are eligible to receive incentive stock or nonqualified options to purchase shares of Adtalem’s common stock. The Fourth Amended and Restated Incentive Plan of 2013 and the Amended and Restated Incentive Plan of 2005 also permit the granting of stock appreciation rights, RSUs, performance-based RSUs and other stock and cash-based compensation. Although options remain outstanding under the 2003 and 2005 incentive plans, no further stock-based grants will be issued from these plans. The Fourth Amended and Restated Incentive Plan of 2013 and the Amended and Restated Incentive Plan of 2005 are administered by the Compensation Committee of the Board. Options are granted for terms of up to ten years and can vest immediately or over periods of up to five years. The requisite service period is equal to the vesting period. The option price under the plans is the fair market value of the shares on the date of the grant.

Stock-based compensation expense is measured at the grant date based on the fair value of the award. Adtalem accounts for stock-based compensation granted to retirement eligible employees that fully vests upon an employee’s retirement under the non-substantive vesting period approach. Under this approach, the entire stock-based compensation expense is recognized at the grant date for stock-based grants issued to retirement eligible employees. For non-retirement eligible employees, stock-based compensation expense is recognized as expense over the employee requisite service period. With the adoption of ASU 2016-09 on July 1, 2017, we account for forfeitures of outstanding but unvested grants in the period they occur.

At March 31, 2018, 8,300,454 authorized but unissued shares of common stock were reserved for issuance under Adtalem’s stock-based incentive plans.

The following is a summary of options activity for the nine months ended March 31, 2018:

						Weighted
				Weighted		Average		Aggregate
				Average		Remaining		Intrinsic
	Number of			Exercise		Contractual		Value
	Options			Price		Life (in Years)		(in thousands)
Outstanding at July 1, 2017		2,794,850		$	34.68
Options Granted		491,275			33.90
Options Exercised		(779,637	)		29.98
Options Forfeited		(73,015	)		29.72
Options Expired		(561,849	)		46.80
Outstanding at March 31, 2018		1,871,624			33.01		6.45	$	28,465
Exercisable at March 31, 2018		818,215		$	39.84		3.64	$	7,557

The following is a summary of stock appreciation rights activity for the nine months ended March 31, 2018:

						Weighted
	Number of			Weighted		Average		Aggregate
	Stock			Average		Remaining		Intrinsic
	Appreciation			Exercise		Contractual		Value
	Rights			Price		Life (in Years)		(in thousands)
Outstanding at July 1, 2017		99,500		$	45.04
Rights Exercised		(34,100	)		38.71
Rights Expired		(65,400	)		48.34
Outstanding at March 31, 2018		-			-		-	$	-
Exercisable at March 31, 2018		-		$	-		-	$	-

The total intrinsic value of options exercised for the nine months ended March 31, 2018 and 2017 was $10.7 million and $5.5 million, respectively.

The fair value of Adtalem’s stock option awards was estimated using a binomial model. This model uses historical cancellation and exercise experience of Adtalem to determine the option value. It also takes into account the illiquid nature of employee options during the vesting period.

The weighted average estimated grant date fair value of options granted at market price under Adtalem’s stock-based incentive plans during the first nine months of fiscal years 2018 and 2017 was $14.63 and $9.09, per share, respectively. The fair value of Adtalem’s stock option grants was estimated assuming the following weighted average assumptions:

	Fiscal Year
	2018			2017
Expected Life (in Years)		6.68			6.88
Expected Volatility		41.45	%		42.41	%
Risk-free Interest Rate		1.95	%		1.41	%
Dividend Yield		0.00	%		1.19	%
Pre-vesting Forfeiture Rate		NA			10.00	%

The expected life of the options granted is based on the weighted average exercise life with age and salary adjustment factors from historical exercise behavior. Adtalem’s expected volatility is computed by combining and weighting the implied market volatility, the most recent volatility over the expected life of the option grant and Adtalem’s long-term historical volatility. On February 16, 2017, Adtalem discontinued payment of cash dividends, resulting in the elimination of a dividend yield from the assumptions. The pre-vesting stock option forfeiture rate for fiscal year 2017 was based on Adtalem’s historical stock option forfeiture experience. With the adoption of ASU 2016-09 on July 1, 2017, we account for forfeitures as they occur. Therefore, no pre-vesting stock option forfeiture rate applies for fiscal year 2018.

If factors change and different assumptions are employed in the valuation of stock-based grants in future periods, the stock-based compensation expense that Adtalem records may differ significantly from what was recorded in previous periods.

During the first nine months of fiscal year 2018, Adtalem granted 501,540 RSUs to selected employees and directors. Of these, 239,290 are performance-based RSUs and 262,250 are non-performance-based RSUs. Performance-based RSUs are earned by the recipients over a three-year period based on achievement of certain mission-based and academic goals, achievement of a minimum level of Adtalem’s earnings before interest, taxes, depreciation and amortization (“EBITDA”) or achievement of a minimum level of return on invested capital (“ROIC”). Non-performance-based RSUs are subject to restrictions which lapse ratably over one, three or four-year periods on the grant anniversary date based on the recipient’s continued service on the Board, employment with Adtalem or upon retirement. During the restriction period, the recipient of the non-performance based RSUs has the right to receive dividend equivalents, if any. This right does not pertain to the performance-based RSUs. The following is a summary of RSU activity for the nine months ended March 31, 2018:

				Weighted
				Average
	Number of			Grant Date
	RSUs			Fair Value
Nonvested at July 1, 2017		1,279,667		$	26.14
RSUs Granted		501,540			34.34
RSUs Vested		(367,384	)		31.28
RSUs Forfeited		(162,012	)		28.77
Nonvested at March 31, 2018		1,251,811		$	28.01

The weighted average estimated grant date fair value of RSUs granted at market price under Adtalem’s stock-based incentive plans during the first nine months of fiscal years 2018 and 2017 was $34.34 and $23.89, per share, respectively.

The following table shows total stock-based compensation expense included in the Consolidated Statements of Income (Loss) (in thousands):

	Three Months Ended March 31,						Nine Months Ended March 31,
	2018			2017			2018			2017
Cost of Educational Services	$	876		$	1,267		$	3,510		$	4,254
Student Services and Administrative Expense		1,861			2,692			7,459			9,038
Restructuring Expense		-			-			548			-
		2,737			3,959			11,517			13,292
Income Tax Benefit		(554	)		(1,383	)		(4,655	)		(4,653	)
Net Stock-Based Compensation Expense	$	2,183		$	2,576		$	6,862		$	8,639

As of March 31, 2018, $25.6 million of total pre-tax unrecognized stock-based compensation expense related to nonvested grants is expected to be recognized over a weighted average period of 2.5 years. The total fair value of options and RSUs vested during the nine months ended March 31, 2018 and 2017 was approximately $14.3 million and $13.0 million, respectively.

There was no capitalized stock-based compensation cost at each of March 31, 2018, June 30, 2017 and March 31, 2017.

Adtalem has an established practice of issuing new shares of common stock to satisfy stock-based grant exercises. However, Adtalem also may issue treasury shares to satisfy stock-based grant exercises under certain of its stock-based incentive plans.