NOTE 7. STOCK-BASED COMPENSATION

Arrowhead has two plans that provide for equity-based compensation. Under the 2004 Equity Incentive Plan and 2013 Incentive Plan, as of December 31, 2016, 2,467,979 and 5,064,151 shares, respectively, of Arrowhead’s Common Stock are reserved for the grant of stock options, stock appreciation rights, restricted stock awards and performance unit/share awards to employees, consultants and others. No further grants may be made under the 2004 Equity Incentive Plan. As of December 31, 2016, there were options granted and outstanding to purchase 2,467,979 and 3,212,743 shares of Common Stock under the 2004 Equity Incentive Plan and the 2013 Incentive Plan, respectively, and there were 783,334 restricted stock units granted and outstanding under the 2013 Incentive Plan. Also, as of December 31, 2016, there were 544,622 shares reserved for options and 23,333 restricted stock units issued as inducement grants to new employees outside of equity compensation plans. During the three months ended December 31, 2016, no options or restricted stock units were granted under the 2004 Equity Incentive Plan, 48,000 options were granted under the 2013 Incentive Plan, and no options or restricted stock units were granted as inducement awards to new employees outside of equity incentive plans.

The following table summarizes 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, 2016		6,691,200	$	6.56
Granted		48,000		6.50
Cancelled		(513,856)		7.24
Exercised		—		—
Balance At December 31, 2016		6,225,344	$	6.50		6.2 years	$	—
Exercisable At December 31, 2016		4,152,293	$	6.26		5.1 years	$	—

Stock-based compensation expense related to stock options for the three months ended December 31, 2016 and 2015 was $1,438,459 and $1,217,217, respectively. The Company does not recognize an income tax benefit as the Company is currently operating at a loss and an actual income tax benefit may not be realized. For non-qualified stock options, the loss creates a timing difference, resulting in a deferred tax asset, which is fully reserved by a valuation allowance.

The grant date fair value of the options granted by the Company for the three months ended December 31, 2016 and 2015 was $215,539 and $365,876, respectively.

The intrinsic value of the options exercised during the three months ended December 31, 2016 and 2015 was $0 and $3,515, respectively.

As of December 31, 2016, the pre-tax compensation expense for all outstanding unvested stock options in the amount of approximately $8,112,217 will be recognized in the Company’s results of operations over a weighted average period of 2.3 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:

	Three Months Ended December 31,
	2016	2015
Dividend yield	—	—
Risk-free interest rate	1.34 – 1.44%	1.41 – 1.81%
Volatility	79%	89%
Expected life (in years)	6.25	6.25
Weighted average grant date fair value per share of options granted	$4.49	$4.46

The dividend yield is zero as the Company currently does not pay a dividend.

The risk-free interest rate is based on that of 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), including time-based and performance-based awards, were granted under the Company’s 2013 Incentive Plan and as inducement grants granted outside of the Plan. During the three months ended December 31, 2016, the Company did not issue additional RSU awards. At vesting, each existing RSU will be exchanged for one share of the Company’s Common Stock. RSU recipients may elect to net share settle upon vesting, in which case the Company pays the employee’s income taxes withheld upon vesting and withholds a number of shares of equal value. RSU awards generally vest subject to the satisfaction of service requirements or the satisfaction of both service requirements and achievement of certain performance targets.

The following table summarizes the activity of the Company’s RSUs:

	Number of RSUs			Weighted- Average Grant Date Fair Value
Unvested at September 30, 2016		1,356,667		$	6.72
Granted		—			—
Vested		(550,000	)		7.02
Forfeited		—			—
Unvested at December 31, 2016		806,667		$	6.51

During the three months ended December 31, 2016 and 2015, the Company recorded $985,983 and $1,163,126 of expense, respectively. Such expense is included in stock-based compensation expense in the Company’s Consolidated Statement of Operations and Comprehensive Loss.

For RSUs, the grant date fair value of the award is based on the Company’s closing stock price at the grant date, with consideration given to the probability of achieving performance conditions for performance based awards.

As of December 31, 2016, the pre-tax compensation expense for all unvested RSUs in the amount of approximately $1,604,377 will be recognized in the Company’s results of operations over a weighted average period of 1.5 years.