NOTE 9. STOCK-BASED COMPENSATION

Arrowhead has three plans that provide for equity-based compensation. Under the 2000 Stock Option Plan, 38,000 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 2,734,840 shares for the grant of stock options, stock appreciation rights, restricted stock awards and performance unit/share awards to employees, consultants and others. The 2013 Incentive Plan reserves 4,000,000 shares for the grant of stock options, stock appreciation rights, restricted stock awards and performance awards to employees, consultant and others. As of June 30, 2014, there were options granted and outstanding to purchase 38,000, 2,638,652 and 736,875 shares of Common Stock under the 2000 Stock Option Plan, the 2004 Equity Incentive Plan and the 2013 Incentive Plan, respectively. Also, as of June 30, 2014, there were 410,085 shares reserved for options issued outside of equity compensation plans as inducement grants to new employees. During the nine months ended June 30, 2014, no options were granted under the 2004 Equity Incentive Plan, 765,000 were issued under the 2013 Incentive Plan and 165,000 options were granted outside of equity incentive plans as inducement stock options to new employees.

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, 2012		1,910,794		$	6.10
Granted		1,509,166		$	2.03
Cancelled		—		$	—
Exercised		(675	)	$	3.93
Balance At September 30, 2013		3,419,285		$	4.68
Granted		930,000		$	14.05
Cancelled		(148,561	)	$	5.88
Exercised		(377,112	)	$	6.28
Balance At June 30, 2014		3,823,612		$	6.75		8.3 years	$	30,271,011
Exercisable At June 30, 2014		1,532,180		$	5.80		7.3 years	$	13,666,712

Stock-based compensation expense for the three and nine months ended June 30, 2014 was $1,070,631 and $2,186,653, respectively. Stock-based compensation expense for the three and nine months ended June 30, 2013 was $363,593 and $1,114,375, 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 aggregate grant date fair value of the options granted by the Company during the three and nine months ended June 30, 2014 is estimated at $1,176,000 and $8,295,600, respectively. The aggregate grant date fair value of the options granted by the Company during the three and nine months ended June 30, 2013 is estimated at $1,094,295 and $1,197,588, respectively.

The intrinsic value of the options exercised during the three and nine months ended June 30, 2014 was $371,334 and $3,606,061, respectively. No options were exercised during the three and nine months ended June 30, 2013.

As of June 30, 2014, the pre-tax compensation expense for all unvested stock options in the amount of approximately $10,514,619 will be recognized in the Company’s results of operations over a weighted average period of 3.2 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,
	2014	2013
Dividend yield	—	—
Risk-free interest rate	1.8% to 2.5%	0.7% to 1.3%
Volatility	69%	69%
Expected life (in years)	6.25 to 9.72	5.5 to 6.25
Weighted average grant date fair value per share of options granted	$8.92	$1.26

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.

Restricted Stock Units

Restricted Stock Units (RSUs) are granted under the Company’s 2013 Incentive Plan. During the nine months ended June 30, 2014, the Company issued 470,000 restricted stock units to certain members of management and certain members of its Board of Directors. At vesting each RSU will be exchanged for one share of the Company’s Common Stock. The RSUs issued to management vest in equal installments on the one and two year anniversary of the date of grant. The RSUs issued to the members of the Board of Directors vest upon the one year anniversary of the date of grant.

The following table summarizes the activity of the Company’s Restricted Stock Units:

	Number of RSUs		Weighted- Average Grant Date Fair Value
Unvested at September 30, 2013		-	$	-
Granted		470,000		14.54
Vested		-		-
Forfeited		-		-
Unvested at June 30, 2014		470,000	$	14.54

The Company recorded $968,051 and $1,571,611 of expense relating to restricted stock units during the three and nine months ended June 30, 2014 respectively, and such expense is included in stock-based compensation expense. There was no expense relating to restricted stock units during the three and nine months ended June 30, 2013.

As of June 30, 2014, the pre-tax compensation expense for all unvested restricted stock units in the amount of approximately $5,291,302 will be recognized in the Company’s results of operations over a weighted average period of 1.5 years.