NOTE 9. STOCK-BASED COMPENSATION

Arrowhead has two plans that provide for equity-based compensation. Under the 2000 Stock Option Plan, 153,200 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 1,965,860 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, 2012, there were options granted and outstanding to purchase 153,200 and 1,767,894 shares of Common Stock under the 2000 Stock Option Plan and the 2004 Equity Incentive Plan, respectively. During the year ended September 30, 2012, 988,300 options were granted under the 2004 Equity Incentive Plan, and 251,200 options were granted outside of Equity Incentive plans as inducement stock options to new employees, hired in conjunction with the Company’s acquisition of its Madison research facility in October 2011. All share and per share data in this footnote has been adjusted to reflect the 1 for 10 reverse stock split effected on November 17, 2011.

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, 2010		812,334		$	10.62
Granted		20,000			5.86
Cancelled		(100,539	)		21.32
Exercised		(2,699	)		5.10


	Number of Options Outstanding			Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term		Aggregate Intrinsic Value
Balance At September 30, 2011		729,096			9.03
Granted		1,229,500			4.40
Cancelled		(42,919	)		11.77
Exercised		(4,883	)		5.20

Balance At September 30, 2012		1,910,794		$	6.01		8.2 years	$	0

Exercisable At September 30, 2012		811,214		$	7.96		6.6 years	$	0

Stock-based compensation expense for the year ended September 30, 2012 and 2011 was $1,241,404 and $1,376,921, respectively. For the years ended September 30, 2012 and 2011, $0 and $27,519, respectively, of this expense is included in discontinued operations. 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. 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, 2012 and 2011 is estimated at $4,091,117 and $93,004, respectively. The aggregate fair value of options granted by Calando during the years ended September 30, 2012 and 2011 is estimated at $33,690 and $33,870, respectively.

The intrinsic value of the options exercised during the years ended September 30, 2012 and 2011 was $0 and $3,666, respectively.

As of September 30, 2012, the pre-tax compensation expense for all unvested stock options at Arrowhead in the amount of approximately $3,738,217 will be recognized in our results of operations over a weighted average period of 3.1 years. As of September 30, 2012, the pre-tax compensation expense for all unvested stock options at Calando in the amount of approximately $63,250 will be recognized in our results of operations over a weighted average period of 2.6 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,
	2012	2011
Dividend yield	—	—
Risk-free interest rate	0.9% to 1.7%	1.11% to 2.90%
Volatility	90% -100%	100%
Expected life (in years)	5.5 to 6.25	5.5 to 6.25
Weighted average grant date fair value per share of options granted	$3.32	$4.70

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.