NOTE 8. 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, 2017, 2,114,286 and 6,329,079 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 awards to employees, consultants and others. No further grants may be made under the 2004 Equity Incentive Plan. As of December 31, 2017, there were options granted and outstanding to purchase 2,114,286 and 2,945,999 shares of Common Stock under the 2004 Equity Incentive Plan and the 2013 Incentive Plan, respectively, and there were 3,098,000 restricted stock units granted and outstanding under the 2013 Incentive Plan. Also, as of December 31, 2017, there were 557,050 shares reserved for options and 2,500 restricted stock units issued as inducement grants to new employees outside of equity compensation plans. During the three months ended December 31, 2017, no options or restricted stock units were granted under the 2004 Equity Incentive Plan, no options or restricted stock units were granted under the 2013 Incentive Plan, and 115,000 options and 2,500 restricted stock units were granted as inducement awards to new employees outside of equity incentive plans.

The following table summarizes 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, 2017		5,549,543	$	6.00
Granted		115,000		3.60
Cancelled		(47,207)		13.70
Exercised		–		–
Balance At December 31, 2017		5,617,336	$	5.89		6.3 years	$	2,474,103
Exercisable At December 31, 2017		4,169,205	$	6.40		5.6 years	$	1,301,464

Stock-based compensation expense related to stock options for the three months ended December 31, 2017 and 2016 was $900,659 and $1,438,459, 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 the Company for the three months ended December 31, 2017 and 2016 was $348,899 and $215,539, respectively.

The intrinsic value of the options exercised during the three months ended December 31, 2017 and 2016 was $0 and $0, respectively.

As of December 31, 2017, the pre-tax compensation expense for all outstanding unvested stock options in the amount of approximately $4,067,828 will be recognized in the Company’s results of operations over a weighted average period of 1.8 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 the Company’s 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,
	2017	2016
Dividend yield	—	—
Risk-free interest rate	2.05 – 2.22%	1.34 – 1.44%
Volatility	110%	79%
Expected life (in years)	6.25	6.25
Weighted average grant date fair value per share of options granted	$3.03	$4.49

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, 2017, the Company issued 2,500 RSUs as an inducement award to a new employee outside of the equity incentive plans. At vesting, each outstanding RSU will be exchanged for one share of the Company’s Common Stock. RSU recipients may elect to net share settle upon vesting, in which case the Company pays the employee’s income taxes due upon vesting and withholds a number of shares of Common Stock of equal value. RSU 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 RSUs:

	Number of RSUs			Weighted- Average Grant Date Fair Value
Unvested at September 30, 2017		3,108,000		$	2.45
Granted		2,500			3.51
Vested		(10,000	)		5.22
Forfeited		—			—
Unvested at December 31, 2017		3,100,500		$	2.44

During the three months ended December 31, 2017 and 2016, the Company recorded $1,191,882 and $985,983 of expense related to RSUs, respectively. Such expense is included in stock-based compensation expense in the Company’s Consolidated Statement of Operations and Comprehensive Loss.

For RSUs, 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, 2017, the pre-tax compensation expense for all unvested RSUs in the amount of approximately $1,534,292 will be recognized in the Company’s results of operations over a weighted average period of 1.0 years.