NOTE 9. FAIR VALUE MEASUREMENTS

The Company measures its financial assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., exit price) in an orderly transaction between market participants at the measurement date. Additionally, the Company is required to provide disclosure and categorize assets and liabilities measured at fair value into one of three different levels depending on the assumptions (i.e., inputs) used in the valuation. Level 1 provides the most reliable measure of fair value while Level 3 generally requires significant management judgment. Financial assets and liabilities are classified in their entirety based on the lowest level of input significant to the fair value measurement. The fair value hierarchy is defined as follows:

Level 1—Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2—Valuations are based on quoted prices for similar assets or liabilities in active markets, or quoted prices in markets that are not active for which significant inputs are observable, either directly or indirectly.

Level 3—Valuations are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Inputs reflect management’s best estimate of what market participants would use in valuing the asset or liability at the measurement date.

The following table summarizes fair value measurements at June 30, 2018 and September 30, 2017 for assets and liabilities measured at fair value on a recurring basis:

June 30, 2018:

	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	27,995,386	$	—	$	—	$	27,995,386
Short-term investments		32,247,701		—		—		32,247,701
Long-term investments		17,574,331		—		—		17,574,331
Derivative liabilities		—		—		—		—
Contingent Consideration	$	—	$	—	$	—	$	—

September 30, 2017:

	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	24,838,567	$	—	$	—	$	24,838,567
Short-term investments		40,434,784		—		—		40,434,784
Long-term investments		—		—		—		—
Derivative liabilities		—		—		695,114		695,114
Contingent Consideration	$	—	$	—	$	—	$	—

As part of a financing in January 2013, Arrowhead issued warrants to purchase up to 833,530 shares of Common Stock (the “2013 Warrants”) of which 0 warrants were outstanding at June 30, 2018. Further, as part of a financing in December 2012, Arrowhead issued warrants to purchase up to 912,543 shares of Common Stock (the “2012 Warrants”) of which warrants to exercise 143,811 shares remained unexercised and were cancelled at their expiration during the three months ended December 31, 2017. Each of the Warrants contained a mechanism to adjust the strike price upon the issuance of certain dilutive equity securities. If during the terms of the Warrants, the Company issued Common Stock at a price lower than the exercise price for the Warrants, the exercise price would be reduced to the amount equal to the issuance price of the Common Stock. As a result of these features, the Warrants were subject to derivative accounting as prescribed under ASC 815. Accordingly, the fair value of the Warrants on the date of issuance was estimated using an option pricing model and recorded on the Company’s Consolidated Balance Sheet as a derivative liability. The fair value of the Warrants was estimated at the end of each reporting period and the change in the fair value of the Warrants was recorded as a non-operating gain or loss as change in value of derivatives in the Company’s Consolidated Statement of Operations and Comprehensive Loss. During the three months ended June 30, 2018 and 2017, the Company recorded a non-cash gain/(loss) from the change in fair value of the derivative liability of $0 and $61,915, respectively. During the nine months ended June 30, 2018 and 2017, the Company recorded a non-cash gain/(loss) from the change in fair value of the derivative liability of $432,141 and $1,490,863, respectively.

The following is a reconciliation of the derivative liability related to these Warrants:

Value at September 30, 2017	$	695,114
Issuance of instruments		—
Change in value		(432,141	)
Net settlements		(262,973	)
Value at June 30, 2018	$	—

The derivative assets/liabilities were estimated using option pricing models that are based on the individual characteristics of the warrants or instruments on the valuation date, as well as assumptions for expected volatility, expected life and risk-free interest rate. Changes in the assumptions used could have a material impact on the resulting fair value. The primary input affecting the value of the Company’s derivatives liabilities was the Company’s stock price. Other inputs have a comparatively insignificant effect.

As of September 30, 2015, the Company had a liability for contingent consideration related to its acquisition of the Roche RNAi business completed in 2011. The fair value measurement of the contingent consideration obligations is determined using Level 3 inputs. The fair value of contingent consideration obligations is based on a discounted cash flow model using a probability-weighted income approach. The measurement is based upon unobservable inputs supported by little or no market activity based on the Company’s assumptions and experience. Estimating timing to complete the development and obtain approval of products is difficult, and there are inherent uncertainties in developing a product candidate, such as obtaining U.S. Food and Drug Administration (FDA) and other regulatory approvals. In determining the probability of regulatory approval and commercial success, the Company utilizes data regarding similar milestone events from several sources, including industry studies and its own experience. These fair value measurements represent Level 3 measurements as they are based on significant inputs not observable in the market. Significant judgment is employed in determining the appropriateness of these assumptions as of the acquisition date and for each subsequent period. Accordingly, changes in assumptions could have a material impact on the amount of contingent consideration expense the Company records in any given period. In November 2016, the Company announced the discontinuation of its clinical trial efforts for ARC-520, ARC-AAT and ARC-521. Given this development, the Company assessed the fair value of its contingent consideration obligation to be $0 at June 30, 2018 and September 30, 2017.