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. Under the 2004 Equity Incentive Plan, 1,965,860 shares of Common Stock are reserved 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 December 31, 2012, there were options granted and outstanding to purchase 152,900 and 1,510,694 shares of Common Stock under the 2000 Stock Option Plan and the 2004 Equity Incentive Plan, respectively, and 251,200 options outstanding that were issued outside of equity incentive plans, as inducement options to new employees hired in conjunction with the Company acquisition of its Madison research facility in October 2011.

During the three months ended December 31, 2012, 4,000 options were granted under the 2004 Equity Incentive Plan. 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, 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
Granted		(4,000	)		2.54
Cancelled		0			0
Exercised		0			0
Balance At December 31, 2012		1,914,794		$	6.00		7.9 years	$	—

Exercisable At December 31, 2012		887,102		$	7.61		7.2 years	$	—

Stock-based compensation expense for the three months ended December 31, 2012 and 2011 was $395,674 and $251,878, respectively. 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 during the three months ended December 31, 2012 and 2011 is estimated at $6,023 and $1,392,584, respectively. The aggregate fair value of options granted by Calando during the three months ended December 31, 2012 and 2011 is estimated at $0 and $33,690, respectively.

The intrinsic value of the options exercised during the three months ended December 31, 2011 was $0, there were no options exercised during the three months ended December 31, 2012.

As of December 31, 2012, the pre-tax compensation expense for all unvested stock options at Arrowhead in the amount of approximately $3,356,689 will be recognized in our results of operations over a weighted average period of 2.9 years. As of December 31, 2012, the pre-tax compensation expense for all unvested stock options at Calando in the amount of approximately $53,624 will be recognized in our 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 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:


	Three months ended December 31,
	2012	2011
Dividend yield	—	—
Risk-free interest rate	0.7% to 1.0%	1.4% to 1.7%
Volatility	69%	100%
Expected life (in years)	5.5 to 6.25	6.25
Weighted average grant date fair value per share of options granted	$1.51	$3.71

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.