4. Stock-Based Compensation

The Company follows the provisions of the FASB ASC Topic 718, “Compensation — Stock Compensation” (“ASC 718”), which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and non-employee directors including employee stock options. Stock compensation expense based on the grant date fair value estimated in accordance with the provisions of ASC 718 is recognized as an expense over the requisite service period.

For stock options granted as consideration for services rendered by non-employees, the Company recognizes compensation expense in accordance with the requirements of FASB ASC Topic 505-50, “Equity Based Payments to Non-Employees.” Non-employee option grants that do not vest immediately upon grant are recorded as an expense over the requisite service period of the underlying stock options. At the end of each financial reporting period prior to vesting, the value of these options, as calculated using the Black-Scholes option-pricing model, will be re-measured using the fair value of the Company’s common stock and the non-cash compensation recognized during the period will be adjusted accordingly. Since the fair market value of options granted to non-employees is subject to change in the future, the amount of the future compensation expense will include fair value re-measurements until the stock options are fully vested.

Stock-Based Compensation

The Company is currently using the Black-Scholes option-pricing model to determine the fair value of all its option grants. For option grants issued in the three and nine month periods ended September 30, 2013 and 2012, the following assumptions were used:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2013			2012			2013			2012
Weighted average risk-free interest rate		1.75	%		1.57	%		1.26	%		0.94	%
Weighted average expected volatility		107.30	%		115.20	%		76.27	%		88.70	%
Weighted average expected lives (years)		6.25			10.00			5.93			6.05
Weighted average expected dividend yield		0.00	%		0.00	%		0.00	%		0.00	%

The weighted average fair value of options granted during the three month periods ended September 30, 2013 and 2012 was $4.24 and $4.20, respectively. The weighted average fair value of options granted during the nine month periods ended September 30, 2013 and 2012 was $4.05 and $2.10, respectively.

The Company’s expected common stock price volatility assumption is based upon the volatility of a composition of comparable companies. The expected life assumptions for employee grants were based upon the simplified method provided for under ASC 718-10. The expected life assumptions for non-employees were based upon the contractual term of the option. The dividend yield assumption of zero is based upon the fact that the Company has never paid cash dividends and presently has no intention of paying cash dividends. The risk-free interest rate used for each grant was also based upon prevailing short-term interest rates. The Company has estimated an annualized forfeiture rate of 5.0% for options granted to its employees and 0% forfeiture rate for directors. The Company will record additional expense if the actual forfeitures are lower than estimated and will record a recovery of prior expense if the actual forfeiture rates are higher than estimated.

The following table summarizes the activity of Company’s stock option plan for the period January 1, 2013 to September 30, 2013:


	Total Number of Shares			Weighted Average Exercise Price
Outstanding at January 1, 2013		2,128,266		$	3.00
Granted		430,003			6.16
Exercised		(2,000	)		2.55
Cancelled		—			—

Outstanding at September 30, 2013		2,556,269		$	3.47

Options exercisable at September 30, 2013		873,809		$	3.13

Employee Stock Purchase Plan

On June 7, 2013, the Compensation Committee approved an employee stock purchase plan (“ESPP”), subject to the approval of the Company’s stockholders within twelve months of the date the ESPP was adopted. The ESPP allows employees to contribute a percentage of their cash earnings, subject to certain maximum amounts, to be used to purchase shares of the Company’s common stock on each of two semi-annual purchase dates. The purchase price is equal to 90% of the market value per share on either (a) the date of grant of a purchase right under the ESPP or (b) the date on which such purchase right is deemed exercised, whichever is lower. The maximum number of shares available for issuance pursuant to the ESPP is equal to the lesser of: (a) 50,000 shares, increased on each anniversary of the adoption of the ESPP by one percent (1%) of the total shares of stock then outstanding, and (b) 113,333 shares.

With our ESPP, fair value is determined at the beginning of the purchase period and amortized over the term of each exercise period. The fair value of each ESPP purchase was estimated on the date of the grant using the Black-Scholes option-pricing model (using the risk-free interest rate, expected term, expected volatility, and dividend yield variables). The risk-free interest rate used was based upon the prevailing short-term interest rates. The Company’s expected volatility is based upon the volatility of a composition of comparable companies for the expected term. The expected life assumption was based upon the purchase period and the dividend yield assumption of zero is based upon the fact that the Company has never paid cash dividends and presently has no intention of paying cash dividends.

The following assumptions were used to value the shares under the ESPP for the three and nine month periods ended September 30, 2013:


Weighted average risk-free interest rate	0.09	%
Weighted average expected volatility	88.68	%
Weighted average expected lives (years)	0.50
Weighted average expected dividend yield	0.00	%

Total stock-based compensation expense under our ESPP was $5,100 for the three and nine months ended September 2013, respectively.

As of September 30, 2013, an aggregate of 50,000 shares of common stock were authorized and available for issuance under the ESPP.

Predecessor (RNAi) Stock-Based Compensation

Stock-based compensation expense prior to the completion of the spinoff from Galena on April 27, 2012 was allocated to the carved out financial statements based on an estimate of time spent by Galena employees, board members, scientific advisory board members and outside consultants on RXi related matters. Galena options held by current RXi employees were cancelled at the date of the completion of the spin-off except for options to purchase an aggregate of 477,191 shares of Galena common stock. The Company will continue to recognize stock compensation expense on the non-cancelled options as they vest. Under the terms of the option awards, these options will continue to vest as long as the individuals are employed by RXi. As of September 30, 2013, 468,941 options remain outstanding with a range of exercise prices from $0.65 to $7.50.

Of the total stock-based compensation expense recorded by RXi, approximately $3,200 and $13,800 related to options issued by Galena for the three months ended September 30, 2013 and 2012, respectively.

Of the total stock-based compensation expense recorded by RXi, approximately $10,000 and $260,000 related to options issued by Galena for the nine months ended September 30, 2013 and 2012, respectively.