Fair Value Measurements

3 Months Ended

Dec. 31, 2016

NOTE 8. FAIR VALUE MEASUREMENTS

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 December 31, 2016 and September 30, 2016 for assets and liabilities measured at fair value on a recurring basis:

December 31, 2016:

	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	102,105,569	$	—	$	—	$	102,105,569
Derivative liabilities	$	—	$	—	$	118,795	$	118,795

September 30, 2016:

	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	85,366,448	$	—	$	—	$	85,366,448
Derivative liabilities	$	—	$	—	$	1,602,626	$	1,602,626

As part of a financing in December 2012, Arrowhead issued warrants to purchase up to 912,543 shares of Common Stock (the “2012 Warrants”) of which 265,161 warrants were outstanding at December 31, 2016. Further, as part of a financing in January 2013, Arrowhead issued warrants to purchase up to 833,530 shares of Common Stock (the “2013 Warrants” and, together with the 2012 Warrants, the “Warrants”) of which 12,123 warrants were outstanding at December 31, 2016. Each of the Warrants contains a mechanism to adjust the strike price upon the issuance of certain dilutive equity securities. If during the terms of the Warrants, the Company issues Common Stock at a price lower than the exercise price for the Warrants, the exercise price would be reduced to the amount equal to the issuance price of the Common Stock. As a result of these features, 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 non-operating gain or loss as change in value of derivatives in the Company’s Consolidated Statement of Operations and Comprehensive Loss. During the three months ended December 31, 2016 and 2015, the Company recorded a non-cash gain/(loss) from the change in fair value of the derivative liability of $1,454,831 and $(21,574), respectively.

The assumptions used in valuing the derivative liability were as follows:

2012 Warrants	December 31, 2016	September 30, 2016
Risk-free interest rate	0.85%	0.68%
Expected life	0.9 Years	1.2 Years
Dividend yield	—	—
Volatility	79%	89%

2013 Warrants	December 31, 2016	September 30, 2016
Risk-free interest rate	0.85%	0.68%
Expected life	1.0 Years	1.3 Years
Dividend yield	—	—
Volatility	79%	89%

The following is a reconciliation of the derivative liability related to these warrants:

Value at September 30, 2016	$	1,565,874
Issuance of instruments		—
Change in value		(1,454,831	)
Net settlements		—
Value at December 31, 2016	$	111,043

In conjunction with the financing of Ablaris in fiscal 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 of Common Stock based upon a predefined ratio. The exchange rights have a seven-year term and a current exchange ratio of 0.01. Exchange rights for 675,000 Ablaris shares were sold in fiscal 2011, and 500,000 remain outstanding at December 31, 2016. 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 non-operating gain or loss in the Company’s Consolidated Statement of Operations and Comprehensive Loss. During the three months ended December 31, 2016 and 2015, the Company recorded a non-cash gain/(loss) from the change in fair value of the derivative liability of $29,000 and $(1,950), respectively.

The assumptions used in valuing the derivative liability were as follows:

	December 31, 2016	September 30, 2016
Risk-free interest rate	0.85%	0.68%
Expected life	1.2 Years	1.5 Years
Dividend yield	—	—
Volatility	79%	89%

The following is a reconciliation of the derivative liability related to these exchange rights:

Value at September 30, 2016	$	36,752
Issuance of instruments		—
Change in value		(29,000	)
Net settlements		—
Value at December 31, 2016	$	7,752

The derivative assets/liabilities are estimated using option pricing models that are based on the individual characteristics of the warrants or instruments on the valuation date, as well as assumptions for expected volatility, expected life and risk-free interest rate. Changes in the assumptions used could have a material impact on the resulting fair value. The primary input affecting the value of the Company’s derivatives liabilities is the Company’s stock price. Other inputs have a comparatively insignificant effect.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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