NOTE 9. STOCK-BASED COMPENSATION

Arrowhead has three plans that provide for equity-based compensation, collectively the “Plans”. Under the 2000 Stock Option Plan, 38,000 shares of Arrowhead’s Common Stock are reserved for issuance upon exercise of non-qualified stock options. No further grants can be made under the 2000 Stock Option Plan. The 2004 Equity Incentive Plan reserves 2,659,852 shares for the grant of stock options, stock appreciation rights, restricted stock awards and performance unit/share awards by the Board of Directors to employees, consultants and others. The 2013 Incentive Plan reserves 4,000,000 shares for the grant of stock options, stock appreciation rights, restricted stock awards and performance unit/share awards by the Board of Directors to employees, consultants and others. As of September 30, 2014, there were options and restricted stock units outstanding of 38,000, 2,563,518, and 1,292,000 shares of Common Stock under the 2000, 2004 and 2013 Plans, respectively. Also, as of September 30, 2014, there were 467,322 shares reserved for options and restricted stock units issued outside of equity compensation plans, as inducement grants to new employees. During the year ended September 30, 2014, no options or restricted stock units were granted under the 2004 Equity Incentive Plan, 1,324,000 options and restricted stock units were granted under the 2013 Incentive Plan, and 185,000 options and 40,000 restricted stock units were granted outside of the Plans as inducement stock options and restricted stock units to new employees.

The following tables summarize information about stock options:

	Number of Options Outstanding			Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term		Aggregate Intrinsic Value
Balance At September 30, 2012		1,910,794			6.10
Granted		1,509,166			2.03
Cancelled		-			-
Exercised		(675	)		3.93
Balance At September 30, 2013		3,419,285			4.68
Granted		1,039,000			14.05
Cancelled		(152,582)			6.05
Exercised		(454,863)			6.00
Balance At September 30, 2014		3,850,840			6.99		8.1 years		$31,141,826
Exercisable At September 30, 2014		1,684,919			5.94		7.2 years		$15,518,772

Stock-based compensation expense related to stock options for the years ended September 30, 2014, 2013 and 2012 was $3,144,776, $1,536,271, and $1,241,404, respectively. There is no income tax benefit as the Company is currently operating at a loss and an actual income tax benefit may not be realized. For non-qualified stock options, the loss creates a timing difference, resulting in a deferred tax asset, which is fully reserved by a valuation allowance.

The fair value of the options granted by Arrowhead for the years ended September 30, 2014, 2013 and 2012 is estimated at $9,267,048, $2,843,575 and $4,091,117, respectively.

The intrinsic value of the options exercised during the years ended September 30, 2014, 2013 and 2012 was $4,360,850, $554, and $0, respectively.

As of September 30, 2014, the pre-tax compensation expense for all unvested stock options at Arrowhead in the amount of approximately $10,517,380 will be recognized in the Company’s results of operations over a weighted average period of 3.1 years.

The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which do not have vesting restrictions and are fully transferable. The determination of the fair value of each stock option is affected by our stock price on the date of grant, as well as assumptions regarding a number of highly complex and subjective variables. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input 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 assumptions used to value stock options are as follows:

	Year ended September 30,
	2014	2013	2012
Dividend yield	—	—	—
Risk-free interest rate	1.8% to 2.4%	0.7% to 2.3%	0.9% to 1.7%
Volatility	69%	69%	90% - 100%
Expected life (in years)	6.25 to 9.47	5.5 to 6.25	5.5 to 6.25
Weighted average grant date fair value per share of options granted	$8.92	$1.88	$3.32

The dividend yield is zero as the Company currently does not pay a dividend.

The risk-free interest rate is based on the U.S. Treasury bond.

Volatility is estimated based on volatility average of the Company’s Common Stock price.

Restricted Stock Units

Restricted Stock Units (RSUs) were granted under the Company’s 2013 Incentive Plan as well as inducement grants granted outside of the Plan. During the years ended September 30, 2014, 2013 and 2012 the Company issued 510,000, 0 and 0 restricted stock units to certain members of management and certain members of its Board of Directors, respectively. Of the restricted stock units granted, 470,000 were granted under the Company’s 2013 Incentive Plan and 40,000 were granted outside of the Plan as inducement grants to new employees. At vesting each RSU will be exchanged for one share of the Company’s Common Stock. The RSUs issued to management vest in equal annual installments over two to three years from the anniversaries of the date of grant. The RSUs issued to the members of the Board of Directors vest upon the one year anniversary of the date of grant.

The following table summarizes the activity of the Company’s Restricted Stock Units:

	Number of RSUs		Weighted- Average Grant Date Fair Value
Unvested at September 30, 2012		—	$	—
Granted		—		—
Vested		—		—
Forfeited		—		—
Unvested at September 30, 2013		—		—
Granted		510,000	$	14.58
Vested		—		—
Forfeited		—		—
Unvested at September 30, 2014		510,000	$	14.58

The Company recorded $2,551,397, $0 and $0 of expense relating to restricted stock units during the years ended September 30, 2014, 2013 and 2012, respectively, and such expense is included in stock-based compensation expense in the Company’s Consolidated Statement of Operations.

As of September 30, 2014, the pre-tax compensation expense for all unvested restricted stock units in the amount of approximately $4,913,516 will be recognized in the Company’s results of operations over a weighted average period of 1.5 years.