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Fair Value Measurements & Derivative Instruments
 6 Months Ended
Mar. 31, 2012
Fair Value Measurements & Derivative Instruments [Abstract]  
Fair Value Measurements & Derivative Instruments

NOTE 9. FAIR VALUE MEASUREMENTS & DERIVATIVE INSTRUMENTS

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 March 31, 2012 and September 30, 2011 for assets and liabilities measured at fair value on a recurring basis:

March 31, 2012:

 

     Level I      Level II      Level III      Total  

Cash and cash equivalents

    $ 3,595,112       $ —         $ —         $ 3,595,112   

Marketable securities

    $ 78,680       $ —         $ —         $ 78,680   

Derivative assets

    $ —         $ —         $ 170,500       $ 170,500   

Derivative liabilities

    $ —         $ —         $ 1,643,403       $ 1,643,403   

September 30, 2011:

            
     Level I      Level II      Level III      Total  

Cash and cash equivalents

    $ 7,507,389       $ —         $ —         $ 7,507,389   

Marketable securities

    $ 634,585       $ —         $ —         $ 634,585   

Derivative assets

    $ —         $ —         $ 161,125       $ 161,125   

Derivative liabilities

    $ —         $ —         $ 944,980       $ 944,980   

As part of the sale of proceeds from the sale of Unidym in January 2011, Arrowhead received a bond from Wisepower in the face amount of $2.5 million. The bond is convertible to Wisepower common stock at a price of $2.00 per share. The conversion feature is subject to derivative accounting as prescribed under ASC 815. Accordingly, the fair value of the conversion feature on the date of issuance was estimated using an option pricing model and recorded on the Company's consolidated balance sheet as a derivative asset. The fair value of the conversion feature is estimated at the end of each reporting period and the change in the fair value of the conversion feature is recorded as a nonoperating gain/loss as change in value of derivatives in Company's Consolidated Statement of Operations. A portion of the bond is owed to a third party, as such the company records a derivative asset for the entire conversion feature and records a derivative liability for the portion related to the third party. The original fair value of the derivative relating to the third party was $26,310; the fair value at September 30, 2011 was $6,854, and the fair value at March 31, 2012 was $7,253. The gain from the change in value of the derivative asset, net of the derivative liability, for the six months ended March 31, 2012 was $8,977, and is reflected in the change in value of derivatives in the Company's consolidated statement of operations.

During the six months ended March 31, 2012, the Company recorded a gain from the change in fair value of the derivative asset, net of $9,375. The assumptions used in valuing the derivative asset as of March 31, 2012 were as follows:

 

Risk free interest rate

      0.51%   

Expected life

      1.8 Years   

Dividend yield

      none   

Volatility

      72%   

The following is a reconciliation of the derivative asset for the six months ended March 31, 2012:

 

Value at October 1, 2011

    $     161,125  

Receipt of instruments

      —     

Increase in value

      9,375   

Net settlements

      —     
  

 

 

  

Value at March 31, 2012

    $     170,500   
  

 

 

  

 

As part of the equity financing on June 17, 2010, Arrowhead issued warrants to acquire up to 329,649 shares of Common Stock (the "Warrants") which contain a mechanism to adjust the strike price in the event of certain dilutive issuances of equity securities. Under certain provisions of the Warrants, if, during the term of the Warrants, the Company issues Common Stock at a price lower than the exercise price of the Warrants, the exercise price of the Warrants would be reduced to the amount equal to the issuance price of the Common Stock. Because the Warrants have this feature, the Warrants are 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 is estimated at the end of each reporting period and the change in the fair value of the Warrants is recorded as a nonoperating gain or loss in the Company's consolidated statement of operations. During the six months ended March 31, 2012, the Company recorded a non-cash loss from the change in fair value of the derivative liability of $677,032. The assumptions used in valuing the derivative liability as of March 31, 2012 were as follows:

 

Risk free interest rate

      0.51%   

Expected life

      3.7 Years   

Dividend yield

      none   

Volatility

      100%   

The following is a reconciliation of the derivative liability related to these warrants through March 31, 2012:

 

Value at September 30, 2011

    $ 907,233   

Receipt of instruments

      —     

Change in value

      677,032   

Net settlements

      —     
  

 

 

  

Value at March 31, 2012

    $ 1,584,265   
  

 

 

  

In conjunction with the financing of Ablaris during the year ended September 30, 2011, Arrowhead sold exchange rights to certain investors whereby the investors have the right to exchange their shares of Ablaris for a prescribed number of Arrowhead shares based upon a predefined ratio. The exchange rights have a seven-year term. During the first year, the exchange right allows the holder to exchange one Ablaris share for 0.06 Arrowhead shares (as adjusted for a subsequent reverse stock split). This ratio declines to 0.04 in the second year, 0.03 in the third year and 0.02 in the fourth year. In the fifth year and beyond the exchange ratio is 0.01. Exchange rights for 675,000 Ablaris shares were sold during the year ended September 30, 2011, and remain outstanding at March 31, 2012. The exchange rights are subject to derivative accounting as prescribed under ASC 815. Accordingly, the fair value of the exchange rights 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 exchange rights is estimated at the end of each reporting period and the change in the fair value of the exchange rights is recorded as a nonoperating gain or loss in the Company's Consolidated Statement of Operations. During the six months ended March 31, 2012, the Company recorded a non-cash loss from the change in fair value of the derivative liability of $20,993. The assumptions used in valuing the derivative liability as of March 31, 2012 were as follows:

 

Risk free interest rate

      0.8%   

Expected life

      6.0 Years   

Dividend yield

      none   

Volatility

      100%   

The following is a reconciliation of the derivative liability related to these exchange rights through March 31, 2012:

 

Value at September 30, 2011

    $    30,892   

Receipt of instruments

      —     

Change in value

      20,993   

Net settlements

      —     
  

 

 

  

Value at March 31, 2012

    $    51,885   
  

 

 

  

The carrying amounts of the Company's other financial instruments, which include accounts receivable, accounts payable, and accrued expenses approximate their respective fair values due to the relatively short-term nature of these instruments.