NOTE 7. STOCK-BASED COMPENSATION

Arrowhead has two plans that provide for equity-based compensation. Under the 2004 Equity Incentive Plan and 2013 Incentive Plan, as of December 31, 2015, 2,537,018 and 5,084,284 shares, respectively, of Arrowhead’s Common Stock are reserved for the grant of stock options, stock appreciation rights, restricted stock awards and performance unit/share award to employees, consultants and others. No further grants may be made under the 2004 Equity Incentive Plan. As of December 31, 2015, there were options granted and outstanding to purchase 2,537,018 and 2,384,144 shares of Common Stock under the 2004 Equity Incentive Plan and the 2013 Incentive Plan, respectively, and there were 877,500 restricted stock units granted and outstanding under the 2013 Incentive Plan. Also, as of December 31, 2015, there were 544,622 shares reserved for options and 46,667 restricted stock units issued as inducement grants to new employees outside of equity compensation plans. During the three months ended December 31, 2015, no options or restricted stock units were granted under the 2004 Equity Incentive Plan, 82,000 options and 0 restricted stock units were granted under the 2013 Incentive Plan, and no options and restricted stock units were granted as inducement awards to new employees outside of equity incentive plans.

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, 2015.................		5,435,640		6.71
Granted......................................		82,000		5.96
Cancelled....................................		(47,169)		8.56
Exercised....................................		(4,687)		5.45
Balance At December 31, 2015......................		5,465,784	$	6.69		7.6 years	$	6,925,846
Exercisable At December 31, 2015		2,956,400	$	6.12		6.8 years	$	4,766,553

Stock-based compensation expense related to stock options for the three months ended December 31, 2015 and 2014 was $1,217,217 and $981,399, respectively. The Company does not recognize an 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 grant date fair value of the options granted by Arrowhead for the three months ended December 31, 2015 and 2014 is estimated at $365,876 and $3,596,618, respectively.

The intrinsic value of the options exercised during the three months ended December 31, 2015 and 2014 was $3,515 and $23,774, respectively.

As of December 31, 2015, the pre-tax compensation expense for all outstanding unvested stock options in the amount of approximately $10,850,029 will be recognized in the Company’s results of operations over a weighted average period of 2.5 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:

	Three months ended December 31,
	2015	2014
Dividend yield..................................	—	—
Risk-free interest rate..............................	1.47 – 1.81%	1.61 – 1.85%
Volatility......................................	89%	75%
Expected life (in years).............................	6.25	6.25
Weighted average grant date fair value per share of options granted	$4.46	$3.66

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

The risk-free interest rate is based on that of 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), including time-based and performance-based awards, were granted under the Company’s 2013 Incentive Plan and as inducement grants granted outside of the Plan. During the three months ended December 31, 2015 and 2014, the Company issued 0 restricted stock units and 30,000 restricted stock units, respectively, to certain members of management. Of the restricted stock units granted during the three months ended December 31, 2014, 30,000 were granted outside of the Plan as an inducement grant to a new employee. At vesting, each RSU will be exchanged for one share of the Company’s Common Stock. Restricted stock unit awards generally vest subject to the satisfaction of service requirements or the satisfaction of both service requirements and achievement of certain performance targets.

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, 2015...................		934,167		$	9.18
Granted........................................		—			—
Vested........................................		(10,000	)		5.22
Forfeited.......................................		—			—
Unvested at December 31, 2015........................		924,167		$	9.22

The Company recorded $1,163,126 and $1,033,457 of expense relating to restricted stock units during the three months ended December 31, 2015 and 2014, respectively. Such expense is included in stock-based compensation expense in the Company’s Consolidated Statement of Operations and Comprehensive Loss.

For restricted stock units, the grant date fair value of the award is based on the Company’s closing stock price at the grant date, with consideration given to the probability of achieving performance conditions for performance based awards.

As of December 31, 2015, the pre-tax compensation expense for all unvested restricted stock units in the amount of approximately $2,529,700 will be recognized in the Company’s results of operations over a weighted average period of 1.7 years.