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 June 30, 2018, 1,918,338 and 6,733,430 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 June 30, 2018, there were options granted and outstanding to purchase 1,918,338 and 3,204,521 shares of Common Stock under the 2004 Equity Incentive Plan and the 2013 Incentive Plan, respectively, and there were 3,295,665 restricted stock units granted and outstanding under the 2013 Incentive Plan. Also, as of June 30, 2018, there were 648,700 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 June 30, 2018, 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 79,000 options and no restricted stock units were granted as inducement awards to new employees outside of equity incentive plans. During the nine months ended June 30, 2018, no options or restricted stock units were granted under the 2004 Equity Incentive Plan, 467,000 options and 1,243,000 restricted stock units were granted under the 2013 Incentive Plan, and 272,000 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		739,000		4.71
Cancelled		(233,357)		6.97
Exercised		(283,627)		3.64
Balance At June 30, 2018		5,771,559	$	5.92		6.2 years	$	45,386,696
Exercisable At June 30, 2018		4,174,006	$	6.53		5.3 years	$	30,543,795

Stock-based compensation expense related to stock options for the three months ended June 30, 2018 and 2017 was $744,396 and $1,021,653, respectively. Stock-based compensation expense related to stock options for the nine months ended June 30, 2018 and 2017 was $2,503,060 and $3,558,082, 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 June 30, 2018 and 2017 was $640,687 and $70,937, respectively. The grant date fair value of the options granted by the Company for the nine months ended June 30, 2018 and 2017 was $2,933,593 and $849,816, respectively.

The intrinsic value of the options exercised during the three months ended June 30, 2018 and 2017 was $1,486,390 and $0, respectively. The intrinsic value of the options exercised during the nine months ended June 30, 2018 and 2017 was $1,837,064 and $35,512, respectively.

As of June 30, 2018, the pre-tax compensation expense for all outstanding unvested stock options in the amount of approximately $4,690,290 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 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:

	Nine Months Ended June 30,
	2018	2017
Dividend yield	—	—
Risk-free interest rate	2.1 – 2.8%	1.3 – 2.3%
Volatility	110%	79%
Expected life (in years)	6.25	5.75 - 6.25
Weighted average grant date fair value per share of options granted	$3.97	$1.33

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 June 30, 2018, the Company issued no RSUs under the 2013 Incentive Plan and no RSUs outside of the equity incentive plans. During the nine months ended June 30, 2018, the Company issued 1,243,000 RSUs under the 2013 Incentive Plan and 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		1,245,500			3.68
Vested		(1,005,333	)		2.35
Forfeited		(50,000	)		1.55
Unvested at June 30, 2018		3,298,167		$	2.96

During the three months ended June 30, 2018 and 2017, the Company recorded $1,524,369 and $691,575 of expense related to RSUs, respectively. During the nine months ended June 30, 2018 and 2017, the Company recorded $3,315,059 and $2,323,819 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 June 30, 2018, the pre-tax compensation expense for all unvested RSUs in the amount of approximately $2,950,140 will be recognized in the Company’s results of operations over a weighted average period of 2.6 years.