A world leader in an emerging field 4D pharma plc Annual Report and Accounts 2017 4 D p h a r m a p l c A n n u a l R e p o r t a n d A c c o u n t s 2 0 1 7 We are pioneers in harnessing bacteria as a novel and revolutionary class of medicines: Live Biotherapeutics World-class science is the foundation of medical discovery. To turn this into life-changing medicines: that requires something more. To turn this into a whole new class of medicines: that requires something special. We are building something special at 4D pharma. Live Biotherapeutics have the potential to transform the way in which many diseases are treated. But to realise that potential, the sector needs robust clinical data. We are well positioned to deliver that data. In 2017, we laid foundations that have positioned 4D to transform the sector; with four clinical programmes set to deliver data and a number of development programmes heading towards the clinic, 4D will play the lead role in defining the sector. What makes us different? We understand that bacteria in the human intestine – known as the gut microbiome – have an important function in health and disease, but importantly – we understand how they function, and how they function as a drug. Understanding how they function means that our Live Biotherapeutics are potentially providing new and effective treatments for IBS and Crohn’s Disease and game-changing treatments for cancer, asthma and autoimmune conditions such as rheumatoid arthritis and multiple sclerosis. 4D and the Live Biotherapeutics we develop have the potential to transform the way in which many challenging diseases are treated. What sets us apart? ° We are targeting a new, safer approach to drug development ° We are a fully integrated microbiome company with the capability to progress from research to production to clinic ° We understand mechanism: how our products exert their therapeutic effects and act as a drug ° We have developed and wholly own the largest intellectual property estate in the field Learn more about what we do page 2 Stay up to date on our website 4dpharmaplc.com Highlights Financial highlights Total comprehensive loss after tax (£m) £19.4m 17 16 15 10.3 7.7 Expenditure on research and development (£m) £16.9m Total equity (£m) £69.8m 19.4 17 16 15 16.9 10.2 8.4 17 16 15 69.8 86.5 92.7 Cash, cash equivalents and cash on deposit (£m) Adjusted loss per share* (pence) £50.0m 26.08p 17 16 15 50.0 68.8 85.4 17 16 15 15.21 12.62 26.08 Operational highlights ° Successful progression of our proprietary clinical programmes in Irritable Bowel Syndrome and Paediatric Crohn’s Disease ° Completion of the first clinical trial of the MicroDx diagnostic and patient stratification platform, validating the platform and representing achievement of the initial milestone from the acquisition of 4D Pharma Cork Limited in February 2016 ° Data generated in this clinical study demonstrated: our ability to use patient microbiome and metabolite profiles to differentiate IBS subjects from healthy individuals; and the commonalities of the microbiome across all IBS subtypes, supporting the use of Blautix, our Live Biotherapeutic for the treatment of IBS, in all these subgroups ° Development of our intellectual property estate, the largest in the microbiome sector, to help secure and consolidate our leading position in the field, having at year end 207 granted patents and 320 patent applications, from 32 patent families ° Securing GMP certification for the production of Live Biotherapeutics at our development and manufacturing facility in León, Spain, with the potential capacity to run up to 100 million capsules per annum * Basic and diluted. Adjusted loss per share excludes non-recurring costs (see note 9). Strategic report 02 4D pharma at a Glance 04 Chairman’s Statement 05 Chief Executive Officer’s Report 08 Our Business Model and Strategy 10 Our Key Performance Indicators 11 Risk and Risk Management Corporate governance 14 Board of Directors 15 Corporate Governance Statement 18 Report of the Audit and Risk Committee 20 Report of the Remuneration Committee 22 Directors’ Report 24 Statement of Directors’ Responsibilities Financial statements 25 Independent Auditor’s Report 28 Group Statement of Total Comprehensive Income 29 Group Statement of Financial Position 30 Company Statement of Financial Position 31 Group Statement of Changes in Equity 32 Company Statement of Changes in Equity 33 Group Cash Flow Statement 34 Company Cash Flow Statement 35 Notes to the Financial Statements 61 Company Information 4D pharma plc Annual Report and Accounts 2017 01 4dpharmaplc.com 4D pharma at a Glance Leaders in an emerging field We are well positioned to turn world-class microbiome science into safer new therapies for patients. 4D has grown from pioneering microbiome research to the only integrated, world-leading Live Biotherapeutics company. Developing science, delivering therapies. Live Biotherapeutics – disruptive new medicines Live Biotherapeutics are a regulated, emerging and disruptive new class of medicines, which have the potential to transform the way in which we treat many diseases. Our Live Biotherapeutics are strains of gut commensal bacteria which have been originally isolated from healthy humans. These are then cultured and grown before being encapsulated, administered orally and delivered selectively to the gut where they exert their therapeutic effects on the patient. Watch our new video: 4dpharmaplc.com Beyond gastrointestinal disease Why mechanism matters Highly attractive safety profile Live Biotherapeutics are delivered to the gut, but can have far-reaching effects at anatomically distant sites of the body. Gut bacteria have evolved to manipulate the human immune system and we are harnessing this to develop Live Biotherapeutics. Utilising this, we are developing Live Biotherapeutics for diseases as diverse as cancer and asthma and even conditions of the central nervous system such as Parkinson’s disease and multiple sclerosis. Human gut bacteria contain thousands of genes. Understanding which of these genes – and their products – interact with the human body in a beneficial way is key to identifying new Live Biotherapeutics. Our scientists have deep expertise in microbiology, immunology and bioinformatics, which allows us to select our candidates based on an understanding of interactions at the molecular level. Toxicity and unwanted side effects are a constant challenge in drug development. Safety concerns account for more than 50% of drug programme terminations and can also lead to sub-optimal treatment regimens, a concern for both patients and clinicians. Our Live Biotherapeutics are originally isolated from healthy human donors and consequently have excellent safety profiles. This allows us to safely expedite our products into the clinic, getting them to the patients that need them more rapidly. 02 4D pharma plc Annual Report and Accounts 2017 STRATEGIC REPORT An integrated biopharma company MicroRx – our proprietary discovery platform Our discovery platform, MicroRx, allows us to rapidly identify strains of gut bacteria which may have a therapeutic effect in specific diseases. Using MicroRx, we interrogate our proprietary library of more than 6,000 bacterial strains for pathway-specific effects on the host immune system. Importantly, we understand mechanism. We elucidate the mechanisms by which our Live Biotherapeutics exert their effects with exquisite detail, including the identification of bacterial effector molecules and their cognate human receptors. Unlike traditional drug discovery, which involves multiple rounds of hit and lead optimisation to identify a clinical candidate – a process which can take a number of years – we can progress from concept to clinic-ready product in as little as 24 months, helping us get our therapies to patients who need them more rapidly. In-house development and manufacturing We have a 1,500m2 GMP-certified development and manufacturing facility with the capacity to produce up to 100 million capsules of product per year. Our team has decades of expertise in anaerobic fermentation, and the know-how to scale and produce our Live Biotherapeutics ready for clinical testing and beyond. Clinical operations Our expanded clinical operations team is in place to manage our multiple clinical studies as we advance through the clinic. By the end of 2018, we plan to have four clinical programmes underway in parallel and with programmes in areas such as multiple sclerosis and rheumatoid arthritis in the final stages of development. Development pipeline Source Gut microbiota from healthy humans Isolation Individual bacterial strains on selective media Identification of bacteria using genome sequencing Microbiology Functional screen Immunology Gut physiology Microbiology Mechanism of action Immunology Gut physiology Mechanisms Pre-clinical models Efficacy Pre-clinical models RCB Scale-up Lyophilisation Stability Safety Potency Development Discovery Pre-clinical Development Phase I Phase II Phase III Gastro-intestinal Blautix Irritable Bowel Syndrome Thetanix Crohn’s Disease Rosburix Ulcerative colitis Immuno-oncology MRx518 Solid tumours Respiratory MRx0004 Asthma MRx0001 Allergic asthma Autoimmune MRx0006 Rheumatoid arthritis MRx0002 Multiple sclerosis Others CNS Neurodegeneration Autism Others 4D pharma plc Annual Report and Accounts 2017 03 4dpharmaplc.comS Chairman’s Statement With its upcoming programme of trials, 4D is well placed to deliver meaningful clinical data to support the use of Live Biotherapeutics across multiple indications Strategic objectives Since the Group’s initial public offering, 4D has grown rapidly to become a world leader in the development of Live Biotherapeutics, an “end-to-end” microbiome company, from research to development and manufacture. Our research teams continue to further the understanding, both of our programmes and their mechanisms, and of the microbiome generally. The past twelve months have seen the validation of MicroDx, our diagnostic platform enabling the stratification of IBS patients. Our GMP-certified facility in León, Spain, has enabled the development scale-up for our candidate strains and has increased clinical/production capacity to up to 100 million capsules per annum. Meanwhile our increasing intellectual property estate helps secure our leading position in the field. As we move forward, our key goal is to deliver meaningful clinical data to support the use of Live Biotherapeutics across multiple indications. I believe that through our upcoming programme of clinical trials, we are well positioned to achieve this. Our people We could not have achieved what we have without the continued support of our staff throughout our sites in Europe, and also those involved in our wider collaborations. I would like to thank them all for their contribution to the progress we have made in 2017. Governance and Board The Board is committed to maintaining high standards of governance, both at Board level and operationally throughout the business. The Company’s Corporate Governance Statement can be found on pages 15 to 17. David Norwood Non-Executive Chairman 20 April 2018 Consistent progress to lead a burgeoning field Companies Publications 2014 4D pharma is founded and MicroRx platform developed 2015 First clinical trial in IBS and MRx0518 discovered 2016 Second clinical trial in paediatric Crohn’s Disease 10,000 s n o i t a c i l b u P 8,000 6,000 4,000 2,000 2018 Target four programmes in the clinic and two immuno-oncology clinical studies in UK and US 2017 GMP certification for manufacturing facility and 200+ patents granted 100 80 60 40 20 0 C o m p a n e s i 0 12 13 14 15 Year 16 17 18 04 4D pharma plc Annual Report and Accounts 2017 STRATEGIC REPORT Chief Executive Officer’s Report In 2017, 4D has made significant progress towards its goal of delivering Live Biotherapeutics as safe and effective therapies 4D’s approach Current clinical programmes If we step back and look at what 4D is trying to do (namely to bring to market not only new drugs but a new therapeutic modality), it is not an easy task. The FDA approved only 22 new drugs in 2016 and only eight of those were first in class. Nevertheless, we believe 4D is well positioned to achieve its goals. With any new drug, whether or not first in class, or new modality there is risk. Any new drug or modality brings concern over safety, and it is rightly the top priority for the industry and regulators. More than 50% of traditional drug programme failures can be attributed to safety. Notwithstanding this, given the pull for new or better medicines, industry and investors are prepared to accept such risks and, as we have recently seen with the interest in CAR-T therapies, successfully bringing a new therapeutic class to market can deliver significant value to investors. It is widely believed that Live Biotherapeutics and the microbiome will go some way to address such risks, by bringing a different approach to treatment regimes and to disease, and doing so safely. This puts a high expectation on Live Biotherapeutics and the field of microbiome research, and to date the field has fallen short of this expectation. Building upon our work and investment in research, clinical progression and manufacturing capability, we believe 4D is well positioned to change this. During 2017 we have laid the groundwork to take our products into patients across a host of disease areas with the aim to provide robust clinical data to demonstrate the potential of Live Biotherapeutics. We have worked with regulators and clinicians, both in Europe and the United States, to develop Blautix, our clinical programme in Irritable Bowel Syndrome (“IBS”). Building on the patient data from the phase I trials, which both reinforced the safety of our Live Biotherapeutics and highlighted promising efficacy signals, we believe Blautix to address a key underlying cause of the disease and not just the symptoms, as is the case with current available treatments. Consequently, we are looking to address the IBS subtypes (IBS-C (constipation) and IBS-D (diarrhoea)) in our upcoming phase II trial. Targeting commencement of dosing in the second half of 2018, the trial will be conducted in both Europe and the United States. The trial will look to dose up to 500 patients, to give sufficient power to indicate efficacy, as well as providing further insights into a disease which is estimated to affect over 10% of the global population, but, irrespective of its prevalence, is not yet well understood. We have completed dosing in the phase I study of Thetanix, our clinical programme in Paediatric Crohn’s Disease, and we will report the outcome of this study in the coming months. Moving to the next stage of the development of Thetanix, we have decided to initially focus our efforts on the adult population. The rationale for this is that, whilst the need for a safe and effective paediatric solution remains high, it is a reflection of the severe nature of the disease that our recruitment for the phase Ib trial was slow, with a number of eligible patients screened experiencing flare before they could enter the trial. We will explore opportunities to remain active with this group of patients and continue to involve those patients and clinicians we have been working with. The Thetanix phase II study will recruit adult Crohn’s Disease patients and we anticipate making regulatory submissions for this study in the second half of 2018. Oncology and other pending clinical programmes An area of increasing interest in the microbiome field, and one 4D has long focussed on, is oncology. In late 2015 our proprietary MicroRx discovery platform identified a bacterium, MRx0518, that had shown efficacy in pre-clinical cancer models. Through 2017, we have concentrated on two areas of MRx0518 development, firstly unpicking the mode of action and secondly preparing for clinical studies. We believe understanding mechanism is critical to the development of Live Biotherapeutics as a therapeutic class; we do not believe the field can continue to take an “ecobiotic” approach to therapeutics, simply relying on a correlation of the presence/ absence of bacteria. We aim to understand how the bacteria influence disease by using MicroRx to pick out strains that have a functional effect on pathways that are known (by clinicians, regulators and industry alike) to be associated with disease. As recently announced, 4D has highlighted key aspects of the mode of action of MRx0518, identifying a specific component of the bacteria that stimulates pathways known to be associated with the body’s response to cancer; these findings are to be investigated further in upcoming clinical trials. 4D pharma plc Annual Report and Accounts 2017 05 4dpharmaplc.comS Chief Executive Officer’s Report continued Oncology and other pending clinical programmes continued Our approach to the clinical development of MRx0518 encompasses parallel studies to evaluate safety, efficacy and anti-tumour immunity in the monotherapy and combination settings. Our first trial in oncology is a monotherapy study investigating the effect of MRx0518 on patients with solid tumours in the neoadjuvant setting. We are treating patients between diagnosis, where a biopsy is taken, and resection, with a follow-up post-surgery. In addition to the safety data this trial will generate for MRx0518, the study will provide 4D the opportunity to investigate the impact on MRx0518 on a “clean” immune system. Patients enrolled in the study will have early stage disease and thus their immune system will not have been previously exposed to cycles of other cancer therapies. The early stage of intervention in this trial further demonstrates the lower risk our Live Biotherapeutics represent in terms of safety, but also provides potential insights into how MRx0518 may influence treatment regimes post-surgery. Working with leading institutions as partners, such as Imperial College as well as the MD Anderson Cancer Center in Houston, one of the world’s most respected institutions focussed on cancer patient care and research, our work in oncology has led to the development of strategies to understand the potential of Live Biotherapeutics, whether as a single agent, adjuvant or in combination. Furthermore, our involvement with these groups and in this space has led us to look at the potential of addressing other diseases associated with the side effects of cancer treatment with our Live Biotherapeutics, further demonstrating the impact we believe Live Biotherapeutics can have in the oncology space. In a similar way to the development of our cancer programmes, we are continuing to advance our programme in asthma. Targeting regulatory submission for the study in Q3 2018, 4D will investigate the use of MRx0004 in a phase I/II study in asthma patients with poorly controlled symptoms. The trial will primarily investigate the safety of MRx0004 and will additionally have a suite of secondary endpoints to give an indication of efficacy. Development Key to the success of our programmes is the ability to deliver therapies to patients. During 2017 4D further upgraded its development and manufacturing facility in León in Spain, and it is now a standalone fully operational GMP-certified facility for the production of Live Biotherapeutics. The team at León has now provided multiple batches of clinical material across a number of programmes and, with 4D’s development team, is working on the development and scale-up of the next strains coming through the R&D platform. Research and intellectual property Coming full circle back to research, and from where 4D started, our scientific teams continue to lead in the understanding of mechanisms of action of our existing programmes, to discover new potential disease areas of interest, and to support our clinical efforts. 2017 was particularly significant in the development of our understanding of how the microbiome and metabolite profiles of patients can be used in both the diagnosis of disease and the identification of patients likely to respond to our Live Biotherapeutics. In March 2017, we reported interim clinical data demonstrating our ability to differentiate IBS patients from healthy individuals based on both microbiome and metabolite profiles, and the commonalities of the microbiome across all IBS subtypes. This observational study was completed in August and we are now well advanced in preparation for a larger, multi-centre trial, to further validate this work, at sites in the UK, Ireland and the US. In tandem with research, we have focussed on developing our intellectual property estate, the largest in the microbiome sector, to help secure and consolidate our leading position in the field, having at year end 207 granted patents and 320 patent applications, from 32 patent families. To enable this focus, we have had to postpone our desire to publish our work, but now, having gained a market-leading intellectual property position, over the coming year we will be actively seeking to publish our research in leading publications and at conferences. Financial summary In the year to December 2017, our cash and cash equivalents and short-term deposits reduced from £68.8 million to £50.0 million, with a loss before tax of £24.0 million (compared with £11.7 million in the year to December 2016), though this included £3.5 million of non-recurring costs arising from the revaluation of the contingent consideration on Cork after it achieved the first milestone. Our claim for research and development tax credit was £3.5 million (compared with £1.8 million in the year to December 2016). Our cash burn for the year was in line with expectation, reflecting among other things the increased costs of taking our existing clinical programmes forward, and preparing our next wave of programmes for upcoming phase I and II trials. 06 4D pharma plc Annual Report and Accounts 2017 STRATEGIC REPORT The Group continues to manage its cash deposits prudently and invests its funds across a number of financial institutions which have investment grade credit ratings. The deposits range from instant access to twelve-month term deposits and are regularly reviewed by the Board. Cash forecasts are updated monthly to ensure that there is sufficient cash available for the Group’s foreseeable requirements. More details on the Group’s treasury policies are provided in note 24 to the financial statements. Outlook Throughout 2017, 4D made significant progress towards its goal of producing Live Biotherapeutics as safe and effective therapies. Over the next twelve to 24 months, the Group will, through its clinical programmes, seek to lead the way in generating robust clinical data to support the use of this new class of drugs across multiple indications. Duncan Peyton Chief Executive Officer 20 April 2018 Upcoming 4D pharma clinical studies 2018 Q2 Q3 Immuno-oncology Clinical study: Phase Ib LBP candidate: MRx0518 Anticipated study opening: Q2 2018 Irritable Bowel Syndrome Clinical study: Phase II LBP candidate: Blautix Anticipated study opening: H2 2018 Crohn’s Disease Clinical study: Phase II LBP candidate: Thetanix Anticipated study regulatory submission: H2 2018 Asthma Clinical study: Phase I/II LBP candidate: MRx0004 Anticipated study regulatory submission: Q3 2018 4D pharma plc Annual Report and Accounts 2017 07 4dpharmaplc.comS Our Business Model and Strategy Leading pharma in a rapidly emerging field We source and isolate gut bacteria from healthy human donors The Live Biotherapeutics we develop are single strain to impact a specific disease pathway We work with partners and, through our trials, we develop and prove encapsulation We manufacture Live Biotherapeutics in our primary site We deliver our products to our clinic and ultimately to the patient Patients Partners Employees Regulators Creating value for World-leading research Description Performance Focus areas 4D seeks via its research base to lead the understanding of how the microbiome functions in health and disease, and advance the potential of Live Biotherapeutics, including by way of long-term collaborations with world-leading academic institutions. 4D mines its discovery platform MicroRx to identify Live Biotherapeutics that show therapeutic effect, with defined functional mechanisms of action applicable to target indications. In MicroDx, 4D is building a platform to exploit the microbiome for diagnosis, to aid the treatment of disease via patient stratification and provide better patient outcomes. 4D focusses on understanding the functionality of Live Biotherapeutics and the mechanisms by which they affect host biology and influence disease, and to do so across a number of disease areas, to broaden the impact of the microbiome. Rapid cost-effective development Description Performance Focus areas 4D seeks to dramatically reduce the development timelines of its programmes by reference to traditional pharma, establishing accelerated development processes for its Live Biotherapeutics. 4D targets its programmes to be ready for patient trials within 24 months from concept. 4D exploits the enhanced safety profiles of therapeutics that originate from a healthy human. This reduces pre-clinical testing and lead optimisation timelines, and allows first-in-man clinical studies in patients as well as healthy individuals. 4D seeks to leverage on every key element of the development process, to mine clinically relevant data, which can be accessed more swiftly due to the accelerated timelines. 08 4D pharma plc Annual Report and Accounts 2017 STRATEGIC REPORT Development and delivery Description Performance Focus areas 4D has long recognised the need to address and control manufacture and delivery issues early on, to ensure against any loss of flexibility and pace of development and maintain speed to the clinic, and further to enable multiple programmes to be run in parallel. In 2016 4D established its own development and manufacturing facility in León, Spain, via the acquisition of the production assets of Instituto Biomar, S.A. Since then, 4D has taken it to a GMP-certified facility, enabling the development scale-up for its candidate strains and increasing clinical/production capacity to up to 100 million capsules per annum. By bringing in house both manufacture for current and pending clinical programmes and development and scale-up of the strains coming through the R&D programme, 4D is continually expanding and refining proprietary know-how key to the development of Live Biotherapeutics. New regulatory framework Description Performance Focus areas Live Biotherapeutics are a class of drugs whose regulatory environment is new and evolving. 4D is working with the regulators and clinicians, both in Europe and the United States, to help understand and define this emerging class of therapeutics and the clinical processes affecting them. 4D seeks to set new standards for safety and delivery, building upon its increasing clinical know-how and experience. 4D regularly engages with world-renowned key opinion leaders in its target indications, to help understand and inform new approaches to disease, and to its cause, diagnosis and treatment. Intellectual property rights Description Performance Focus areas In this rapidly developing field, 4D believes it is vital to actively pursue patent protection for the innovations made. 4D has built up its intellectual property estate, the largest in the microbiome space in terms of coverage and geographical scope, to help secure and consolidate its leading position in the field. Having successfully established this leading position, 4D is commencing an extended programme of publications and conferences. 4D pharma plc Annual Report and Accounts 2017 09 4dpharmaplc.comS Our Key Performance Indicators Measuring our performance Although we are still in the early stages of our development, we track a series of metrics focussed primarily on science and product development whilst ensuring the business has sufficient resources which are being effectively allocated to ensure achievement of our strategic goals. The Board of 4D and management monitor the progress of our business, maintaining discipline throughout the different functions of the business as part of our strategic aim of delivering therapeutic products to the market and becoming a self-sustaining and cash-generative business. As we are currently in the pre-revenue stage of our development the core focus of the business is on innovation and progression of candidates in our pipeline through the clinic into approved products. Number of clinical studies commenced 2 +0% 17 16 15 1 Number of candidates manufactured for clinical trials 2 2 5 +0% 17 16 15 2 5 5 Number of patents granted 207 +149% 17 16 15 83 43 207 Pipeline progression performance measure – development of research Pipeline progression performance measure – development of product Research and innovation performance measure 4D was born out of innovation and this continues to be a cornerstone of the Group and in 2017 we continued to invest in people, facilities and technology. Our strategic aim is to commercialise Live Biotherapeutic products and as such a comprehensive portfolio of intellectual property is vital to the Group’s ability to achieve this. The Group’s portfolio of intellectual property is therefore a valuable asset and a significant amount of resource has been allocated to strengthening this portfolio during the year. Long-term value will be created via successful progression of the pipeline through clinical trials into commercial products. We currently have 17 wholly owned Live Biotherapeutic programmes in the pipeline across various stages of development. Without the ability to manufacture the products coming through the pipeline we will not be able to commercialise these. Cash, cash equivalents and cash on deposit (£m) £50.0m -27% R&D spend (£m) £16.9m +66% 17 16 15 50.0 68.8 85.4 17 16 15 16.9 10.2 8.4 Financial resource measure Financial allocation of resources We need to ensure that we have sufficient cash in hand and on deposit to cover the anticipated future costs of developing the science through our various strategic milestones. The split of overheads between research and development (“R&D”) and other costs, whilst not necessarily highlighting the qualitative aspects of that spend, does enable us to ensure that we are directing sufficient operating funds towards the advancement of our technology. 10 4D pharma plc Annual Report and Accounts 2017 STRATEGIC REPORT Risk and Risk Management Identifying and understanding key risks to the business During the year the Group has continued to grow and with this growth the management and mitigation of risk has become more important. In line with the development of the business we have continued to develop our internal systems of risk management. 4D operates within a complex regulatory environment, which is subject to change. The nature of Live Biotherapeutic product development exposes us to a number of additional risks and uncertainties which could affect our ability to meet our strategic goals, our business model and our operating environment. The Board is accountable for carrying out a robust assessment of the principal risks facing the Group, and has developed a risk management framework which provides the structure within which the principal risks affecting our business are managed and sets the tone, culture and appetite for risk. The key objectives for this process are to ensure that the risk appetite of the Board is embedded throughout the Group and fully understood by all members of the team who have responsibility for managing the risk and making key business decisions. This will then be encoded in systems of internal controls, which will seek to mitigate the principal risks that could affect the strategy and operation of our business model and finally to ensure that identified risks are reported to the relevant stakeholders in a timely manner. We are continuously developing and improving our risk management process through ongoing review and evaluation of the risks, clarifying our risk appetite and reviewing the longer-term viability of the business to make sure that we fully understand our risks and are managing them appropriately. These systems can be summarised as follows: Setting the tone Designing the system Implementation of the system and completion of review The Board Executive Leadership Team Ensures comprehensive and appropriate systems of risk management and control are in place across the Group Review of the principal risks within the Group and approval of the Group Risk Register Reports to the shareholders about the risk management within the Group Responsible for the design and implementation of the risk management and internal control systems Review of the Group-wide risk registers and reporting to the Board Department and subsidiary heads Maintenance of the department risk registers, implementation and monitoring of all internal controls Reporting to the Executive Leadership Team Review of process and outputs Review of high risk areas Risk registers 4D pharma plc Annual Report and Accounts 2017 11 4dpharmaplc.comS Risk and Risk Management continued Third-party patents could limit the Group’s freedom to operate Why is it important? Current mitigating actions Change in level of risk A third-party patent could be granted that affects a 4D technology or product. This could lead to us having to negotiate a licence, seeking to revoke the patent in legal proceedings, or even being unable to commercialise the future product, materially affecting future revenues. No change 4D is diligent in carrying out searches to identify potential third-party IP; a comprehensive freedom to operate strategy has been developed and implemented to ensure that no blocking patents owned by third parties are unexpectedly granted. The third-party patent landscape is under continuous review. The Group has developed and continues to develop comprehensive and wide-ranging filings of detailed patents across the Group’s technology portfolio. There have been a significant number of patents granted since the inception of 4D (including US and European patents on each of the lead projects) with a substantial year-on-year growth of the portfolio and an increasing number of new applications filed. Product development in a breakthrough technology could encounter unforeseen delays to programmes Why is it important? Current mitigating actions Change in level of risk Decrease Live Biotherapeutic products are a novel and emerging technology; neither 4D nor anyone else has taken a product through development to the marketplace. We are currently working on a number of wholly owned development programmes of our pipeline which will provide the Group with the opportunity to self-commercialise. Failure to complete development activities to plan may impact on the Group’s ability to bring products to market on time which would affect the timings of future revenues and hinder the Group’s ability to deliver its strategic goals. As we complete each stage of development and move through the clinic, we broaden our understanding of how to bring Live Biotherapeutic products to market. In addition, as we widen our programmes in different disease areas, we further mitigate the risk of failure of a single programme. While Live Biotherapeutic products are novel, the associated regulatory and clinical pathways are based on existing frameworks. During the year we have continued to make significant investments in our clinical team and we plan for this to continue in 2018 as we head into the clinic for both phase I and phase II trials. Security and resilience of our IT systems and data Why is it important? Current mitigating actions Change in level of risk In any business, but particularly in a business growing so readily in terms of staff and sites and in an emerging field, it is vital that we know that our systems are secure and efficient to protect our data and ensure efficient collaboration. Decrease We commissioned a review of our systems in 2016 and in 2017 these were successfully rolled out across the Group. These systems provide the Group with a secure, efficient platform through which we are able to share information and collaborate effectively across all sites and with external partners. 12 4D pharma plc Annual Report and Accounts 2017 STRATEGIC REPORT Failure to gain regulatory approval Why is it important? Current mitigating actions Change in level of risk We have continued to invest in the clinical and regulatory team during the year. Decrease The biotechnology and pharmaceutical markets are highly regulated by government authorities in the UK, the US and Europe. These regulatory requirements are a major factor in determining whether a substance can be developed into a marketable product and the amount of time and cost associated with such development. Even if products are approved, they may still face subsequent regulatory difficulties which could result in delays and therefore financial loss. Exchange rate movements Why is it important? Current mitigating actions Change in level of risk Although 4D reports its results in Sterling, a significant proportion of our operations trade in local currency and as such the Group has a large exposure to the Euro and to a lesser extent the US Dollar. Fluctuations in these currencies could therefore impact the Sterling operating costs and therefore the cash flows of the Group. We constantly monitor currencies and their movements against Sterling. As the Group is currently pre-revenue the exposure affects the cost of operations and although the size of the exposure is significant we have sufficient cash resources to manage these changes and have planned these prudently into our forward forecasts. No change UK referendum to leave the European Union (“EU”) – Brexit Why is it important? Current mitigating actions Change in level of risk The UK decision to leave the EU could have a significant impact on the way the Group operates, both in terms of our foreign subsidiaries, overseas suppliers and in eventual revenue from any products which get to market. At the moment we are not certain of the impact that this will have on trade tariffs, taxation, the impact on the nature of international trade including access to trade and the exchange rate which affects the relative cost and income that will be recognised in the accounts and in future planning. As the Group is currently pre-revenue the impact is currently limited to fluctuations in costs and as a result of the exchange rate and any cross border tariffs. Through constant monitoring of the situation the Group remains reactive and looks to adjust its policies accordingly to minimise any adverse factors resulting from the ongoing negotiations. The Group reviews its cash flow projections for changes in exchange rates and the impact it would have and manages its holdings in funds accordingly. Increase The Strategic Report on pages 2 to 13 was approved by the Board on 20 April 2018 and signed on its behalf by: Duncan Peyton Chief Executive Officer 20 April 2018 4D pharma plc Annual Report and Accounts 2017 13 4dpharmaplc.comS Board of Directors We believe in the importance of good corporate governance David Norwood Non-Executive Chairman A R David has had a long career building a number of science, technology and investment companies. He is the founder of IP Group plc, one of the UK’s leading technology commercialisation businesses, and a shareholder in the Company. Previously, he was chief executive of stockbroker Beeson Gregory (acquired by Evolution Group plc) after it acquired IndexIT Partnership, a technology advisory boutique he had founded in 1999. He was a founding shareholder of Evolution Group plc (recently acquired by Investec), and also co-founder of Ora Capital plc. He has been a founder and director of many UK technology companies including Oxford Nanopore Technologies Limited, Proximagen Limited, Synairgen plc, Ilika Technologies Limited, Oxford Catalysts and Plectrum Petroleum (acquired by Cairn Energy plc). He has also acted as seed investor and/or advisor to Wolfson Microelectronics Limited, Nanoco Technologies Limited, Tissue Regenix Group plc and Arc International (now part of Synopsys). He is also non-executive chairman of Abaco Capital plc and Genomics plc. Alexander Stevenson Chief Scientific Officer Alex began his career as a microbiologist, working in research for a number of years before joining an NYSE-quoted drug development company. He subsequently moved into pharmaceutical and healthcare investment and has fulfilled a number of board-level investment and operational management roles. He was a director and shareholder in Aquarius Equity from 2008, where he was responsible for identifying new investments and developing and implementing scientific strategies both pre and post-investment. These included Tissue Regenix Group plc, C4X Discovery Holdings plc and Brabant Pharma (subsequently sold to Zogenix, Inc.). Prior to joining Aquarius Equity, Alex worked for IP Group plc, where he specialised in life sciences investments identifying, developing and advising a number of companies in its portfolio, some of which went on to list on AIM. He joined IP Group following its acquisition of Techtran Group Limited in 2005. A R Audit and Risk Committee Remuneration Committee Chairman Duncan Peyton Chief Executive Officer Duncan has a proven track record in identifying, investing and growing businesses within the pharmaceutical sector. He was the founder of Aquarius Equity, a specialist investor in businesses within the life sciences sector, which provided investors with access to innovative, high growth potential companies that delivered significant capital growth. Duncan started his career in a bio-science start-up business, which ultimately went on to list on the London Stock Exchange, subsequently qualified as a corporate finance lawyer with Addleshaw Goddard, then Addleshaw Booth & Co, and later joined 3i plc as an investment manager. Duncan founded Aquarius in 2005, which made founding investments into Nanoco Technologies Limited, Auralis Limited (subsequently sold to ViroPharma), Tissue Regenix Group plc, Brabant Pharma (subsequently sold to Zogenix) and C4X Discovery plc. Thomas Engelen Non-Executive Director A R Thomas has been a founder and/or non-executive director of a number of UK life sciences companies including Colonis Pharma Limited, Warneford Partners Limited, Martindale Pharma Limited and Pneumagen Limited. Thomas has supported private equity and other investors in over 50 potential deal transactions, on targets in Europe and the USA, from cash constrained/chapter 11 to cash rich with enterprise value of up to $1 billion. Before this Thomas worked in life sciences for over 20 years in senior executive roles. Starting in 1987 at Akzo Nobel Pharma, he worked with hospital products, diagnostics and medical equipment as general manager for the Middle East and Africa. After this he led Rosemont Pharmaceuticals in Leeds in niche oral liquid medicines, followed by being president of Organon in Brazil. He was promoted to VP The Americas, and lastly to CMO at Organon, in charge of the global product portfolio, based in the USA. Returning to Europe he led Novartis Consumer Health in the UK. Thomas has also acted as non-executive chairman at Akcros Holdings Limited, Penlan Healthcare and Quantum Pharmaceutical. 14 4D pharma plc Annual Report and Accounts 2017 CORPORATE GOVERNANCE Corporate Governance Statement Chairman’s introduction On behalf of the Board, I am pleased to present our Corporate Governance Statement for the year ended 31 December 2017. Since the Company’s initial public offering, as the Company and the Group have grown, the Board has maintained a regular review and evaluation of its effectiveness, and that of the wider governance structure of the Group. As an AIM-quoted company, the Company is not required to comply with the UK Corporate Governance Code. The Board has nevertheless always sought to apply policies and procedures which reflect the principles of good governance and best practice reflected in the Code, as appropriate to the size, nature and stage of development of the Company. We believe the Company’s governance structure has facilitated the growth and development of the Group. However, as set out in the Corporate Governance Statement, as the Group continues to grow, we will maintain this evaluation and take the governance steps necessary to support the Group’s development. David Norwood Non-Executive Chairman 20 April 2018 This section of the Annual Report describes the Group’s corporate governance structures and processes and how they have been applied during the year ended 31 December 2017. The Company’s ordinary shares have been admitted to trading on AIM of the London Stock Exchange and the Company is subject to the continuing requirements of the AIM Rules. The UK Corporate Governance Code sets out the principles of good practice in relation to corporate governance which should be followed by companies with a full listing on the London Stock Exchange. Although the Company is not required to comply with the UK Corporate Governance Code by virtue of being an AIM-quoted company, the Board seeks to apply the QCA Corporate Governance Code for Small and Mid-Size Quoted Companies (“QCA Guidelines”) to the extent appropriate and practical for a company of its nature and size. This section provides general information on the Group’s adoption of the QCA Guidelines. Board composition and responsibility The Board consists of four Directors, two of whom are Non-Executive. The names of the Directors, together with their biographical details, are set out on page 14. The Board has determined that Thomas Engelen is independent in character and judgement, and that there are no relationships or circumstances which could materially affect or interfere with the exercise of his independent judgement. Thomas previously provided ad hoc consultancy services to the Company’s subsidiary 4D Pharma Research Limited which were consequential to his former role as one of its Non-Executive Directors. Such services ceased in early 2015, prior to 4D Pharma Research Limited becoming a wholly owned subsidiary, and the Board does not believe that such historical services compromise his independence in any way. The Board has determined that David Norwood is not independent, by virtue only of his holding of ordinary shares in the Company, summarised on page 23. The Board has nevertheless determined that (save only for his holding of ordinary shares) there are no relationships or circumstances which could materially affect or interfere with the exercise of his independent judgement. The Board remains satisfied with its composition and the balance between Executive and Non-Executive Directors, which allows it to exercise objectivity in decision making and proper control of the Group’s business. The Board notes the recommendation in the QCA Guidelines that a company should have at least two independent non-executive directors and should not be dominated by one person or a group of people. The Board believes it meets this recommendation, save only in respect of the holding of ordinary shares in the Company by David Norwood. Decision making The Board’s primary objective is to focus on adding value to the assets of the Group by identifying and assessing business opportunities and ensuring that potential risks are identified, monitored and controlled. Material issues are reserved to a decision of the Board, including approval (and review of performance) of the Group’s strategic aims and objectives; approval of the annual operating and capital expenditure budgets (and any material changes to them); approval of all financial statements and results; and maintenance of a sound system of internal control and risk management. The implementation of Board decisions and day-to-day operations of the Group are delegated to Executive Directors. 4D pharma plc Annual Report and Accounts 2017 15 4dpharmaplc.comG Corporate Governance Statement continued Board composition 4 50+ members Executive 2 Non-Executive 2 Decision making continued The Board meets both at regular intervals and also at short notice to consider specific matters (for example proposed material transactions). The Board receives appropriate and timely information prior to each meeting, with a formal agenda and Board and Committee papers being distributed several days before meetings take place. Any Director may challenge Group proposals, and decisions are taken democratically after discussion. Any Director who feels that any concern remains unresolved after discussion may ask for that concern to be noted in the minutes of the meeting. Any specific actions arising from such meetings are agreed by the Board and then followed up by management. The Non-Executive Directors constructively challenge and help develop proposals on strategy and bring strong, independent judgement, knowledge and experience to the Board’s deliberations. The Directors are given access to independent professional advice at the Group’s expense when the Directors deem it is necessary in order for them to carry out their responsibilities. The Group has effective procedures in place to deal with conflicts of interest. The Board is aware of other commitments of its Directors, and changes to these commitments are reported to the Board. Appointment and re-election of Directors All Directors of the Company have been appointed (or re-appointed) by shareholders; the Chairman was appointed to the Board by resolution of the shareholders of the Company on 5 February 2014 (prior to the admission of the Company shares to trading on AIM on 18 February 2014), and will offer himself for re-election at the forthcoming Annual General Meeting of the Company. Each of the Directors is subject to retirement by rotation and re-election in accordance with the articles of association of the Company. All Directors appointed by the Board are subject to election by shareholders at the first Annual General Meeting after their appointment. Board evaluation Given its composition and flexibility, the Board has been able, since the admission of the Company’s shares to trading on AIM, to maintain a regular evaluation of its effectiveness and that of its Committees. It is believed that the Board and its Committees have functioned well throughout this period, meeting with appropriate regularity and with Directors free to voice differing opinions. In particular, the Board still considers its composition to be appropriate (in view of the size and requirements of the Group’s business, and the need to maintain a practical balance between Executives and Non-Executives). However, it also considers that the Group is nearing the position where the Board would benefit from additional independent input. The Board is actively considering potential candidates for a further independent Non-Executive Director. Committees The Board has established an Audit and Risk Committee and a Remuneration Committee, with formally delegated duties and responsibilities. The Board has, since the admission of the Company’s shares to trading on AIM, kept under regular review the possible establishment of a nomination committee. The Board remains of the view that, given the current composition of the Board, it is not appropriate to have a nomination committee. This will continue to be kept under regular review by the Board. 16 4D pharma plc Annual Report and Accounts 2017 CORPORATE GOVERNANCE50 + L The Audit and Risk Committee Meetings The Audit and Risk Committee comprises Thomas Engelen as Chairman and David Norwood as the other member of the Committee. Thomas Engelen is an independent Director and has recent and relevant financial experience. The Committee has primary responsibility for monitoring the quality of internal controls, ensuring that the financial performance of the Company is properly measured and reported on, and reviewing reports from the Company’s auditor relating to the Company’s accounting and internal controls, in all cases having due regard to the interests of shareholders. A report from the Chairman of the Audit and Risk Committee is on pages 18 and 19. The number of Board and Committee meetings attended by each of the Directors during the year is shown below: Full Board Audit and Risk Committee Remuneration Committee Number of meetings in year Attendance: Executive Directors Duncan Peyton Dr Alexander Stevenson Non-Executive Directors David Norwood Thomas Engelen 7 7 7 7 6 1 — — 1 1 1 — — 1 1 The Remuneration Committee Approach to risk and internal control The Board is responsible for establishing and maintaining the Group’s systems of internal control. The primary responsibility for monitoring the quality of internal control has been delegated to the Audit and Risk Committee. Reference is made to the statement on Risk and Risk Management on pages 11 to 13. Communicating vision and strategy The Directors seek to visit institutional shareholders at least twice a year. In addition, all shareholders can attend the Company’s Annual General Meeting, where there is an opportunity to question the Directors as part of the agenda, or more informally after the meeting. Communication with shareholders is seen as an important part of the Board’s responsibilities, and care is taken to ensure that all price-sensitive information is made available to all shareholders at the same time. The Company has established a formal and transparent procedure for developing policy on Executive remuneration and for fixing the remuneration packages of individual Directors and senior management. The Remuneration Committee comprises Thomas Engelen as Chairman and David Norwood as the other member of the Committee. The Committee reviews the performance of the Executive Directors and senior management and determines their terms and conditions of service, including their remuneration and the grant of incentives, having due regard to the interests of shareholders. A report from the Chairman of the Remuneration Committee is on pages 20 and 21. The Board believes that, in accordance with the QCA Guidelines, the Audit and Risk Committee and the Remuneration Committee have the necessary character, skills and knowledge to discharge their duties and responsibilities effectively; notwithstanding that (given the overall composition of the Board) there is not a majority of members who are independent Non-Executive Directors. Each Committee is, however, chaired by an independent Non-Executive Director. 4D pharma plc Annual Report and Accounts 2017 17 4dpharmaplc.comG Report of the Audit and Risk Committee The Committee acts independently of management to ensure the interests of shareholders are protected in relation to financial reporting, internal controls and risk management. Members ° Thomas Engelen (Chairman) ° David Norwood As Chairman of the Audit and Risk Committee, I am pleased to present our report for the year ended 31 December 2017. The Audit and Risk Committee is a sub-committee of the Board and is responsible for reviewing all aspects of the financial reporting of the business and all aspects of internal control. The Committee represents the interests of our shareholders in relation to the integrity of information and the effectiveness of the audit processes in place. Key responsibilities The Committee acts independently of management to ensure the interests of shareholders are protected in relation to financial reporting, internal controls and risk management. The principal duties of the Committee are to: ° monitor the integrity of the Group’s financial reporting including the review of significant financial reporting judgements; ° advise the Board on whether, taken as a whole, the Annual Report and Accounts are fair, balanced and understandable; ° advise the Board on principal risks, their mitigation and risk appetite; ° review the robustness of our risk management and internal controls; ° oversee the external audit process including monitoring the auditor’s independence, objectivity, effectiveness and performance; and ° approve any engagement by the external auditor outside of the Group’s audit. The Committee manages the relationship with the external auditor on behalf of the Board to ensure that the external auditor continues to be independent, objective and effective in its work, and also considers the re-appointment of the auditor each year. RSM UK Audit LLP was appointed as auditor in 2014 following a comprehensive tender process. Each year the Committee considers the continued independence of the external auditor and the effectiveness of the external audit process, to determine whether to recommend to the Board that the current auditor be re-appointed. The Committee has reviewed the external audit process in the year through meetings and reviewing the reports from the external audit team. The Committee has concluded that the external audit process was effective and is satisfied that the scope of the audit is appropriate and that significant judgements have been robustly challenged. Composition and meetings The Audit Committee during the year under review has consisted of two Non-Executive Directors. The Committee is chaired by me, Thomas Engelen, with David Norwood as the other member. I am an independent Director and have recent and relevant financial experience. There was one meeting held in the year ended 31 December 2017 in April. Committee meetings are also attended by Stephen Dunbar, the Finance Director, and representatives from the external auditor. 18 4D pharma plc Annual Report and Accounts 2017 CORPORATE GOVERNANCE Significant issues relating to the financial statements The specific issues considered by the Audit Committee in the year under review, in relation to the financial statements, are shown below. Valuation of goodwill and other intangible assets Testing of goodwill and other intangible assets for potential impairment is complex and requires a number of management estimates and sensitivities to be applied, which inevitably requires judgement and is a recurring matter. The forecasting tools developed by management to help assess the values of intangible assets and goodwill were updated for variables that were known to have changed. The Committee reviewed the reports together with the assumptions, judgements and sensitivities applied to the valuations and underlying models for impairment testing purposes. Following this review and after discussions with management the Committee is satisfied that no impairment charge should be recorded in the year to 31 December 2017 and that the disclosures in the financial statements are appropriate. Thomas Engelen Chairman of the Audit and Risk Committee 20 April 2018 4D pharma plc Annual Report and Accounts 2017 19 4dpharmaplc.comG Report of the Remuneration Committee The Committee aims to attract, retain and motivate the executive management of the Company, and set remuneration at an appropriate level. Members ° Thomas Engelen (Chairman) ° David Norwood As Chairman of the Remuneration Committee, I am pleased to present our report for the year ended 31 December 2017. This report does not constitute a Directors’ remuneration report in accordance with the Companies Act 2006. As a company whose shares are admitted to trading on AIM, the Company is not required by the Companies Act 2006 to prepare such a report. Key responsibilities The Remuneration Committee is a sub-committee of the Board. Its principal purpose is to determine and agree with the Board the framework and broad policy for remuneration, and to determine the remuneration packages and service contracts of the Executive Directors, the Company Secretary and such other members of the executive management as it considers appropriate. Among other things, the Committee shall approve the design of, and determine targets for, any performance incentive schemes operated by the Company and approve the awards made under such schemes. Composition and meetings During the year the members of the Committee were me, Thomas Engelen, an independent Non-Executive Director, and David Norwood, the Non-Executive Group Chairman. All members served on the Committee throughout the year and to the date of this report. I was Chairman of the Committee throughout this period. There was one meeting held of the Committee in the year ended 31 December 2017, held in April. The meeting was convened to consider and review the Group’s remuneration policy, and to approve annual awards to senior management under the Group’s Long Term Incentive Plan. There were no changes to the remuneration or service agreements of the Executive Directors during the period. Policy on Executive remuneration The Committee aims to attract, retain and motivate the executive management of the Company, and set remuneration at an appropriate level to promote the long-term success of the Group, in line with its strategic objectives. The overall policy of the Board is to ensure that executive management is provided with appropriate incentives to encourage enhanced performance and, in a fair and responsible manner, rewarded for its contribution to the success of the Group. The main elements of the remuneration packages for Executive Directors and senior management are as follows: Basic annual salary The base salary is reviewed annually. The review process is undertaken by the Remuneration Committee and takes into account several factors, including the current position and development of the Group, individual contributions and market salaries for comparable organisations. The Company does not provide an occupational pension scheme for Executive Directors, nor does it make contributions into the private pension schemes of Executive Directors. 20 4D pharma plc Annual Report and Accounts 2017 CORPORATE GOVERNANCE Directors’ remuneration The remuneration of the Directors who served on the Company’s Board during the year to 31 December 2017 is as follows: 31 December 2017 31 December 2016 Base salary and fees £000 Total £000 Base salary and fees £000 Executive Directors Duncan Peyton Dr Alexander Stevenson Non-Executive Directors David Norwood Thomas Engelen 101 101 25 25 252 101 101 25 25 252 101 101 25 25 252 Total £000 101 101 25 25 252 There were no bonus or pension schemes for the Directors during the year ended 31 December 2017. Discretionary annual bonus All Executive Directors and senior managers are eligible for a purely discretionary annual bonus. This takes into account exceptional individual contribution, business performance and technical and commercial progress, along with financial results. Long-term incentives The Group operates a long-term share incentive scheme; all Group Executive Directors and employees are eligible for the granting of awards under the scheme. Details of the awards made under the scheme during the year are provided in note 21 to the financial statements. All such awards vest after three years and are subject to individual performance criteria. There were no awards during the year to the Directors of the Company. Benefits in kind The Company provides taxable healthcare benefits for Executives. Policy on Non-Executive Directors’ remuneration Non-Executive Directors receive a fixed fee and do not receive any pension payments or other benefits, nor do they participate in bonus or incentive schemes. The Board reviews Non-Executive remuneration to ensure that it is in line with current market rates in order to attract and retain high calibre individuals. Service contracts Directors’ interests in share capital At 31 December 2017, and at the date of this report, David Norwood held 7,000,000 ordinary shares in the Company’s share capital, or 10.7% (31 December 2016: 10.8%); each of Duncan Peyton and Dr Alexander Stevenson held 6,250,286 ordinary shares in the Company’s share capital, or 9.5% (31 December 2016: 9.6%); and Thomas Engelen held 500,000 shares in the Company’s share capital, or 0.8% (31 December 2016: 0.8%). Duncan Peyton and Dr Alexander Stevenson have service agreements with an indefinite term providing for a maximum of twelve months’ notice by either party. No Director was granted any share options in the year ended 31 December 2017; none of the Directors held any share options at 31 December 2017. Non-Executive Directors are employed on letters of appointment which may be terminated on not less than three months’ notice. Thomas Engelen Chairman of the Remuneration Committee 20 April 2018 4D pharma plc Annual Report and Accounts 2017 21 4dpharmaplc.comG Directors’ Report The Directors present their report together with the audited consolidated financial statements, along with the Auditor’s Report for the year ended 31 December 2017. Research and development spend R&D 68+ £16.9m 2017 2016 £10.2m Pages 2 to 24 inclusive (together with sections of the Annual Report incorporated by reference) comprise a Directors’ Report that has been drawn up and presented in accordance with and in reliance upon applicable English company law and the liabilities of Directors in connection with that report shall be subject to the limitations and restrictions provided by such law. Strategic Report In accordance with section 414C(11) of the Companies Act 2006 and the Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013, the Group has chosen to set out in the Strategic Report information required by schedule 7 of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008. remains in force as at the date of approval of the Directors’ Report. Research and development activities The principal activity of the Group is research and development, a review of which is included in the CEO’s Report on pages 5 to 7. Total research and development spend in the year to 31 December 2017 was £16.9 million (31 December 2016: £10.2 million). No development expenditure was capitalised in the current year or the year to 31 December 2016. Subsequent events There have been no important events affecting the Company or the Group since the year end. Directors Dividends The Directors who held office during the year, and as at the date of signing the financial statements, and brief biographical descriptions of the Directors, are set out on page 14. The beneficial and non-beneficial interests of the Directors in the Company’s ordinary shares of 0.25 pence are disclosed in the Report of the Remuneration Committee on pages 20 and 21. No Director had an interest in any contract that was significant in relation to the Group’s business at any time during the year. The Directors do not recommend payment of a dividend nor was there a dividend in the year to 31 December 2016. Employment policies The Group is committed to ensuring the health and safety of its employees in the workplace. This includes the provision of regular medical checks. The Group is committed to keeping employees as fully informed as possible with regard to the Group’s performance and prospects and seeks their views, wherever possible, on matters which affect them as employees. Directors’ indemnity insurance The Group has maintained insurance throughout the year for its Directors and officers against the consequences of actions brought against them in relation to their duties for the Group. Such provision Financial instruments Details of the Group’s financial risk management objectives and policies are disclosed in note 24 to the financial statements. 22 4D pharma plc Annual Report and Accounts 2017 CORPORATE GOVERNANCE32 + L Substantial shareholders The Company has been notified of the following interests of shareholders of 3% or more of the issued ordinary share capital of the Company at 31 December 2017, based on the ordinary shares in issue of 65,493,842 (31 December 2016: 64,858,150): Number of 0.25 pence ordinary shares as at 31 December 2017 % of issued capital Number of 0.25 pence ordinary shares as at 31 December 2016 % of issued capital Woodford Investment Management Invesco Asset Management Limited David Robert Norwood Duncan Joseph Peyton Dr Alexander James Stevenson Lansdowne Partners 17,514,561 9,163,617 7,000,000 6,250,286 6,250,286 3,000,000 26.7 14.0 10.7 9.5 9.5 4.6 17,514,561 9,163,617 7,000,000 6,250,286 6,250,286 3,000,000 27.0 14.1 10.8 9.6 9.6 4.6 There were no notified significant changes in these holdings between 31 December 2017 and the date of the signing of these financial statements. Share capital and funding As at 31 December 2017 share capital comprised 65,493,842 ordinary shares of 0.25 pence each. There is only one class of share and all shares are fully paid. No share carries any right to fixed income, and each share carries the right to one vote at general meetings of the Company. Full details of the Group’s and the Company’s share capital movements during the year are given in note 20 to the financial statements. Details of shares under option are provided in note 21 to the financial statements. Corporate Governance Statement The Group’s statement on corporate governance can be found in the Corporate Governance Statement on pages 15 to 17. Going concern The CEO’s Report on pages 5 to 7 outlines the business activities of the Group, along with the factors which may affect its future development and performance, and discusses the Group’s financial position, along with details of its cash flow and liquidity. Reference is made to the statement on Risk and Risk Management on pages 11 to 13. Having prepared management forecasts and made appropriate enquiries, the Directors are satisfied that the Group has adequate cash and other resources for the foreseeable future, as the Group is at the start-up stage of its business lifecycle. Accordingly, they have continued to adopt the going concern basis in preparing the Group and Company financial statements. Disclosure of information to the auditor The Directors who held office at the date of approval of this Directors’ Report confirm that: ° so far as they are each aware, there is no relevant audit information of which the Group’s auditor is unaware; and ° each Director has taken all the steps that he ought to have taken as a Director to make himself aware of any relevant audit information, and to establish that the Group’s auditor is aware of that information. Auditor RSM UK Audit LLP has indicated its willingness to continue in office. Ordinary resolutions to re-appoint RSM UK Audit LLP as auditor and to authorise the Directors to agree their remuneration will be proposed at the forthcoming Annual General Meeting. Annual General Meeting The Annual General Meeting of the Company will be held on 21 May 2018 at 11 a.m. at the Gridiron Building, 1 Pancras Square, London N1C 4AG. Recommendation The Board considers that the resolutions to be proposed at the Annual General Meeting are in the best interests of the Company and it is unanimously recommended that shareholders support these proposals as the Board intends to do in respect of its own holdings. The Directors’ Report was approved by the Board on 20 April 2018 and was signed on its behalf by: Duncan Peyton Chief Executive Officer 20 April 2018 4D pharma plc Annual Report and Accounts 2017 23 4dpharmaplc.comG The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the 4D pharma plc website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Statement of Directors’ Responsibilities In relation to the Annual Report and financial statements The Directors are responsible for preparing the Strategic Report, the Directors’ Report and the financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare Group and Company financial statements for each financial year. The Directors are required by the AIM Rules of the London Stock Exchange to prepare Group financial statements in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the European Union (“EU”) and have elected under company law to prepare the Company financial statements in accordance with IFRS as adopted by the EU. The Group financial statements are required by law and IFRS adopted by the EU to present fairly the financial position of the Group and the Company and the financial performance of the Group. The Companies Act 2006 provides in relation to such financial statements that references in the relevant part of that Act to financial statements giving a true and fair view are references to their achieving a fair presentation. Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and the Company and of the profit or loss of the Group and the Company for that period. In preparing each of the Group and Company financial statements, the Directors are required to: a. select suitable accounting policies and then apply them consistently; b. make judgements and accounting estimates that are reasonable and prudent; c. state whether they have been prepared in accordance with IFRSs adopted by the EU; and d. prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group and the Company will continue in business. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Group’s and the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Group and the Company and enable them to ensure that the financial statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Group and the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. 24 4D pharma plc Annual Report and Accounts 2017 CORPORATE GOVERNANCE Independent Auditor’s Report To the members of 4D pharma plc Opinion We have audited the financial statements of 4D pharma plc (the ‘parent company’) and its subsidiaries (the ‘group’) for the year ended 31 December 2017 which comprise the group statement of consolidated total comprehensive income, the group and parent company statements of financial position, the group and parent company statements of changes in equity, the group and parent company statements of cash flows and notes to the financial statements, including a summary of significant accounting policies. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the Companies Act 2006. In our opinion: ° the financial statements give a true and fair view of the state of the group’s and of the parent company’s affairs as at 31 December 2017 and of the group’s loss for the year then ended; ° the group financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union; ° the parent company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the Companies Act 2006; and ° the financial statements have been prepared in accordance with the requirements of the Companies Act 2006. Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (ISAs (UK)) and applicable law. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the financial statements section of our report. We are independent of the group and parent company in accordance with the ethical requirements that are relevant to our audit of the financial statements in the UK, including the FRC’s Ethical Standard as applied to listed entities and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. audit strategy, the allocation of resources in the audit and directing the efforts of the engagement team. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. Impairment of intangible assets (Refer to pages 38 and 39 regarding the accounting policy in respect of intangible assets, page 36 in respect of critical judgements and estimates applied by the Directors and note 11 to the financial statements on pages 48 and 49.) Conclusions relating to going concern The risk We have nothing to report in respect of the following matters in relation to which the ISAs (UK) require us to report to you where: ° the directors’ use of the going concern basis of accounting in the preparation of the financial statements is not appropriate; or ° the directors have not disclosed in the financial statements any identified material uncertainties that may cast significant doubt about the group’s or the parent company’s ability to continue to adopt the going concern basis of accounting for a period of at least twelve months from the date when the financial statements are authorised for issue. Key audit matters Key audit matters are those matters that, in our professional judgement, were of most significance in our audit of the financial statements of the current period and include the most significant assessed risks of material misstatement (whether or not due to fraud) we identified, including those which had the greatest effect on the overall No amortisation was provided against the intellectual property as whilst they were deemed to be separately identifiable under IFRS 3 Business Combinations, they are not yet generating economic benefit. Due to the regulatory and other uncertainties inherent in the development and the success of the Group’s programmes there is a risk that if programme scales are not achieved an impairment may need to be required. Our response We have challenged management’s workings and calculation by reference to the underlying valuation models and assumptions. We have assessed whether the models used in the prior year are still appropriate and have assessed the sensitivity analysis to consider whether there is appropriate headroom. We highlight that management have used the base case valuation outcome in respect of the valuation models in each assessment which is considered to be prudent and appropriate given the stage of the programme lifecycles. We have assessed the adequacy of the financial statement disclosures. 4D pharma plc Annual Report and Accounts 2017 25 4dpharmaplc.comF Independent Auditor’s Report continued To the members of 4D pharma plc Carrying value of intra-group balances (Refer to page 40 regarding the accounting policy in respect of investments, page 40 regarding the accounting policy in respect of financial assets and note 12 to the financial statements on pages 50 and 51.) The risk The Company has material receivables from subsidiary undertakings that are currently loss making. As a consequence, there is a significant risk that these are impaired and need to be written down. At the 31 December 2017, the carrying value of amounts due from group undertakings amounted to £33,159k (2016: £24,114k) in the Company Statement of Financial Position. Our response As part of our procedures we obtained management’s impairment review and underlying calculations and challenged the assumptions used therein before concluding whether or not there are any indicators of impairment against the carrying value of amounts due from group undertakings. We reviewed forecasts and considered whether they were consistent with the forecasts prepared by management in relation to going concern. We challenged management and obtained explanations as to how future income estimates were calculated assessing whether they were reasonable and corroborated to supporting evidence. Our application of materiality When establishing our overall audit strategy, we set certain thresholds which help us to determine the nature, timing and extent of our audit procedures and to evaluate the effects of misstatements, both individually and on the financial statements as a whole. During planning we determined a magnitude of uncorrected misstatements that we judge would be material for the financial statements as a whole (FSM). During planning FSM was calculated as £1,124,500, which was not changed during the course of our audit. We agreed with the Audit Committee that we would report to them all unadjusted differences in excess of £10,000 as well as differences below those thresholds that, in our view, warranted reporting on qualitative grounds. An overview of the scope of our audit As part of our planning we assessed the risk of material misstatement including those that required significant auditor consideration at the component and group level. Procedures were then performed to address the risk identified and for the most significant assessed risks of material misstatement, the procedures performed are outlined above in the key audit matters section of this report. Other information The directors are responsible for the other information. The other information comprises the information included in the annual report, other than the financial statements and our auditor’s report thereon. Our opinion on the financial statements does not cover the other information and, except to the extent otherwise explicitly stated in our report, we do not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If we identify such material inconsistencies or apparent material misstatements, we are required to determine whether there is a material misstatement in the financial statements or a material misstatement of the other information. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. Opinions on other matters prescribed by the Companies Act 2006 In our opinion, based on the work undertaken in the course of the audit: ° the information given in the Strategic Report and the Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements; and ° the Strategic Report and the Directors’ Report have been prepared in accordance with applicable legal requirements. Matters on which we are required to report by exception In the light of the knowledge and understanding of the group and the parent company and their environment obtained in the course of the audit, we have not identified material misstatements in the Strategic Report or the Directors’ Report. We have nothing to report in respect of the following matters in relation to which the Companies Act 2006 requires us to report to you if, in our opinion: ° adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or 26 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements. A further description of our responsibilities for the audit of the financial statements is located on the Financial Reporting Council’s website at: http://www.frc.org.uk/ auditorsresponsibilities. This description forms part of our auditor’s report. This report is made solely to the company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Graham Bond FCA (Senior Statutory Auditor) For and on behalf of RSM UK AUDIT LLP, Statutory Auditor Chartered Accountants 3 Hardman Street Manchester M3 3HF 20 April 2018 ° the parent company financial statements are not in agreement with the accounting records and returns; or ° certain disclosures of directors’ remuneration specified by law are not made; or ° we have not received all the information and explanations we require for our audit. Responsibilities of directors As explained more fully in the directors’ responsibilities statement set out on page 24, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view, and for such internal control as the directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, the directors are responsible for assessing the group’s and the parent company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the group or the parent company or to cease operations, or have no realistic alternative but to do so. Auditor’s responsibilities for the audit of the financial statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material 4D pharma plc Annual Report and Accounts 2017 27 4dpharmaplc.comF Group Statement of Total Comprehensive Income For the year ended 31 December 2017 Research and development costs Administrative expenses Foreign currency (losses)/gains Operating loss before non-recurring costs Non-recurring costs Operating loss after non-recurring costs Finance income Finance expense Loss before taxation Taxation Loss for the year Other comprehensive income: Exchange differences on translating foreign operations Loss for the year and total comprehensive income for the year Loss per share Basic and diluted for the year The basic and diluted loss per share are the same as the effect of share options is anti-dilutive. The notes on pages 35 to 61 form an integral part of these financial statements. Year to 31 December 2017 £000 Year to 31 December 2016 £000 Notes 4 4 4 5 7 7 8 (16,911) (3,529) (431) (10,220) (2,866) 799 (20,871) (12,287) (3,474) — (24,345) (12,287) 482 (123) 652 (71) (23,986) (11,706) 3,541 (20,445) 1,843 (9,863) 1,057 (389) (19,388) (10,252) 9 (31.41)p (15.21)p 28 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS Group Statement of Financial Position At 31 December 2017 Registered no. 08840579 Assets Non-current assets Property, plant and equipment Intangible assets Taxation receivables Current assets Inventories Trade and other receivables Taxation receivables Short-term investments and cash on deposit Cash and cash equivalents Total assets Liabilities Current liabilities Trade and other payables Non-current liabilities Deferred tax Other payables Total liabilities Net assets Capital and reserves Share capital Share premium account Merger reserve Translation reserve Other reserve Share-based payments reserve Retained earnings Total equity At 31 December 2017 £000 At 31 December 2016 £000 Notes 10 11 15 13 14 15 16 16 17 18 19 20 20 21 5,211 14,674 56 3,859 14,299 23 19,941 18,181 253 3,238 4,308 38,133 11,865 57,797 77,738 4,982 4,982 965 2,005 2,970 7,952 238 2,651 3,315 40,111 28,661 74,976 93,157 4,937 4,937 963 774 1,737 6,674 69,786 86,483 164 162 108,296 105,909 958 668 (864) 440 958 (389) (864) 138 (39,876) (19,431) 69,786 86,483 Approved by the Board and authorised for issue on 20 April 2018. The notes on pages 35 to 61 form an integral part of these financial statements. Duncan Peyton Director 20 April 2018 4D pharma plc Annual Report and Accounts 2017 29 4dpharmaplc.comF Company Statement of Financial Position At 31 December 2017 Registered no. 08840579 Assets Non-current assets Property, plant and equipment Intangible assets Investment in subsidiaries Current assets Loans to subsidiaries Trade and other receivables Taxation receivables Short-term investments and cash on deposit Cash and cash equivalents Total assets Liabilities Current liabilities Trade and other payables Non-current liabilities Other payables Total liabilities Net assets Capital and reserves Share capital Share premium account Merger reserve Share-based payments reserve Retained earnings Total equity At 31 December 2017 £000 At 31 December 2016 £000 Notes 10 11 12 12 14 15 16 16 17 19 20 20 21 576 849 11,671 13,096 256 889 6,128 7,273 33,159 24,114 428 478 38,133 11,060 83,258 96,354 1,345 1,345 1,979 1,979 3,324 350 455 40,111 27,778 92,808 100,081 1,018 1,018 774 774 1,792 93,030 98,289 164 162 108,296 105,909 958 440 (16,828) 93,030 958 138 (8,878) 98,289 The Company has elected to take the exemptions under section 408 of the Companies Act 2006 not to present the parent company’s Statement of Comprehensive Income. The Company’s loss for the year was £7.950 million (31 December 2016: £3.489 million). Approved by the Board and authorised for issue on 20 April 2018. The notes on pages 35 to 61 form an integral part of these financial statements. Duncan Peyton Director 20 April 2018 30 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS Group Statement of Changes in Equity For the year ended 31 December 2017 At 1 January 2016 Issue of share capital (net of expenses) Total transactions with owners recognised in equity for the year Loss and total comprehensive income for the year Foreign currency losses arising on consolidation of subsidiaries Issue of share-based compensation Share capital £000 Share premium £000 Merger Translation reserve reserve £000 £000 161 102,003 1 3,906 958 — 1 3,906 — — — — — — — — — — — — — — (389) — Other reserve £000 (864) — — — — — Share- based payment reserve £000 Retained earnings £000 Total equity £000 7 (9,568) 92,697 — — — 3,907 — 3,907 — (9,863) (9,863) — 131 — — (389) 131 At 31 December 2016 162 105,909 958 (389) (864) 138 (19,431) 86,483 Issue of share capital (net of expenses) 2 2,387 Total transactions with owners recognised in equity for the year Loss and total comprehensive income for the year Foreign currency gains arising on consolidation of subsidiaries Issue of share-based compensation 2 2,387 — — — — — — — — — — — — — — 1,057 — — — — — — — — — 2,389 — 2,389 — (20,445) (20,445) — 302 — — 1,057 302 At 31 December 2017 164 108,296 958 668 (864) 440 (39,876) 69,786 Details regarding the purpose of each reserve within equity are given in note 22. 4D pharma plc Annual Report and Accounts 2017 31 4dpharmaplc.comF Company Statement of Changes in Equity For the year ended 31 December 2017 At 1 January 2016 Issue of share capital (net of expenses) Total transactions with owners recognised in equity for the year Loss and total comprehensive income for the year Issue of share-based compensation Share capital £000 Share premium £000 161 102,003 1 1 — — 3,906 3,906 — — At 31 December 2016 162 105,909 Issue of share capital (net of expenses) Total transactions with owners recognised in equity for the year Loss and total comprehensive income for the year Issue of share-based compensation 2 2 — — 2,387 2,387 — — Merger reserve £000 958 — — — — 958 — — — — At 31 December 2017 164 108,296 958 Details regarding the purpose of each reserve within equity are given in note 22. Share- based payment reserve £000 7 — — — 131 138 — — — 302 440 Retained earnings £000 (5,389) — — (3,489) — Total £000 97,740 3,907 3,907 (3,489) 131 (8,878) 98,289 — — (7,950) — 2,389 2,389 (7,950) 302 (16,828) 93,030 32 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS Group Cash Flow Statement For the year ended 31 December 2017 Loss after taxation Adjustments for: Depreciation of property, plant and equipment Amortisation of intangible assets Loss/(profit) on disposal of property, plant and equipment Finance income Finance expense Contingent consideration Share-based compensation Cash flows from operations before movements in working capital Changes in working capital: Increase in inventories Increase in trade and other receivables Increase in taxation receivables Increase/(decrease) in trade and other payables Cash outflow from operating activities Cash flows from investing activities Purchases of property, plant and equipment Purchase of software and other intangibles Acquisition of subsidiaries net of cash acquired Cash received on disposal of assets Interest received Monies drawn from deposit Net cash inflow from investing activities Cash flows from financing activities Hire purchase payments Net cash outflow from financing activities (Decrease)/increase in cash and cash equivalents Cash and cash equivalents at the start of the year Cash and cash equivalents at the end of the year 16 Year to 31 December 2017 £000 Year to 31 December 2016 £000 (20,445) (9,863) Notes 10 11 7 7 5 21 11 730 252 79 (482) 123 3,474 302 405 213 (2) (652) 71 — 131 (15,967) (9,697) (15) (588) (1,009) 389 (210) (762) (715) (2,142) (17,190) (13,526) (1,885) (194) — — 509 1,978 408 (14) (14) (16,796) 28,661 11,865 (2,243) (76) (1,615) 15 776 43,553 40,410 — — 26,884 1,777 28,661 4D pharma plc Annual Report and Accounts 2017 33 4dpharmaplc.comF Company Cash Flow Statement For the year ended 31 December 2017 Loss after taxation Adjustments for: Depreciation of property, plant and equipment Amortisation of intangible assets Loss on disposal of property, plant and equipment Finance income Finance expense Contingent consideration Share-based compensation Cash flows from operations before movements in working capital Changes in working capital: (Increase)/decrease in trade and other receivables (Increase)/decrease in taxation receivables Increase/(decrease) in trade and other payables Cash outflow from operating activities Cash flows from investing activities Purchases of property, plant and equipment Purchase of software and other intangibles Investment in share capital in subsidiary* Loans to subsidiary undertakings Interest received Monies placed on deposit Net cash (outflow)/inflow from investing activities (Decrease)/increase in cash and cash equivalents Cash and cash equivalents at the start of the year Cash and cash equivalents at the end of the year Notes Year to 31 December 2017 £000 Year to 31 December 2016 £000 (7,950) (3,489) 10 11 5 10 11 12 16 95 221 79 (481) 120 3,474 131 (4,311) (83) (23) 303 (4,114) (493) (182) — 63 201 — (652) 71 — 131 (3,675) 1,466 81 (1,750) (3,878) (104) (14) (2) (14,416) (14,237) 509 1,978 (12,604) (16,718) 27,778 11,060 776 43,553 29,972 26,094 1,684 27,778 * During the year 4D pharma plc converted £5.372 million of loans to subsidiary undertakings into investments in 4D Pharma Leon, S.L.U., a subsidiary undertaking. Since this represented the conversion of existing loans, no further cash was transferred and so is not noted in the Cash Flow Statement above. Further details on the transaction can be found in note 12. 34 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS Notes to the Financial Statements For the year ended 31 December 2017 1. General information 4D pharma plc (the “Company”) is an AIM-quoted company incorporated and domiciled in the UK. The locations and principal activities of the subsidiaries are set out in note 12. The Company is incorporated in England and Wales. The registered office is 9 Bond Court, Leeds LS1 2JZ. These Group financial statements consolidate those of the Company and its subsidiaries (together referred to as the “Group” and individually as “Group entities”) for the year ended 31 December 2017. The principal activities of the Group are the research and development of Live Biotherapeutic drug products. The financial statements of 4D pharma plc and its subsidiaries (the “Group”) for the year ended 31 December 2017 were authorised for issue by the Board of Directors on 20 April 2018 and the Statement of Financial Position was signed on the Board’s behalf by Duncan Peyton. The significant accounting policies adopted by the Group are set out in note 3. 2. Basis of preparation (a) Statement of compliance The Group’s financial statements have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union (“IFRS”) and IFRS Interpretations Committee (“IFRSIC”) interpretations as they apply to the financial statements of the Group for the year ended 31 December 2017 and the requirements of the Companies Act 2006 applicable to companies reporting under IFRS. (b) Basis of measurement The parent company and Group financial statements have been prepared on the historical cost basis except for the methods used to measure fair values of assets and liabilities, which are discussed in the respective notes and in note 3. (c) Going concern The Chief Executive Officer’s Report on pages 5 to 7 outlines the business activities of the Group along with the factors which may affect its future development and performance. The Group’s financial position is discussed in the Financial Review on pages 6 and 7 along with details of its cash flow and liquidity. Note 24 to the financial statements sets out the Group’s financial risks and the management of those risks. Having prepared management forecasts and made appropriate enquiries, the Directors are satisfied that the Group has adequate resources for the foreseeable future. Accordingly they have continued to adopt the going concern basis in preparing the Group and Company financial statements. (d) Functional and presentational currency These financial statements are presented in Pounds Sterling, which is the Group’s functional currency. All financial information presented has been rounded to the nearest thousand. (e) Use of estimates and judgements The preparation of financial statements requires management to make estimates and judgements that affect the amounts reported for assets and liabilities as at the reporting date and the amounts reported for revenues and expenses during the year. The nature of estimation means that actual amounts could differ from those estimates. Estimates and judgements used in the preparation of the financial statements are continually reviewed and revised as necessary. While every effort is made to ensure that such estimates and judgements are reasonable, by their nature they are uncertain and, as such, changes in estimates and judgements may have a material impact on the financial statements. The key sources of estimation uncertainty and critical accounting policies that have a significant risk of causing material adjustment to the carrying amount of assets and liabilities within the next financial year are discussed below. (i) Taxation Management judgement is required to determine the amount of tax assets that can be recognised, based upon the likely timing and level of future taxable profits together with an assessment of the effect of future tax-planning strategies. The value of the unrecognised tax losses for the Group at 31 December 2017 was £32.691 million. The value of the additional deferred tax asset not recognised at the year end is £5.645 million. Further information is included in note 8. (ii) Research and development Careful judgement by the Directors is applied when deciding whether the recognition requirements for development costs have been met. This is necessary as the economic success of any product development is uncertain until such time as technical viability has been proven and commercial supply agreements are likely to be achieved. Judgements are based on the information available at each reporting date which includes the progress with testing and certification and progress on, for example, establishment of commercial arrangements with third parties. In addition, all internal activities related to research and development of new products are continuously monitored by the Directors. Further information is included in note 3. 4D pharma plc Annual Report and Accounts 2017 35 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 2. Basis of preparation continued (e) Use of estimates and judgements continued (iii) Intangible fixed assets and goodwill Estimated impairment of intangible fixed assets and goodwill The Group tests annually whether intangible fixed assets and goodwill have suffered any impairment, in accordance with the accounting policy stated in note 3. The potential recoverable amounts of intangible fixed assets and goodwill have been determined based on value-in-use calculations. These calculations require the use of estimates both in arriving at the expected future cash flows and the application of a suitable discount rate in order to calculate the present value of these flows. There is a degree of judgement involved in making assessments of attributable values on acquisition and making impairment assessments. More detail is given in notes 3(h) and 3(i). Valuation of intangibles on acquisition Valuation of an early stage drug discovery pharmaceutical company is a notoriously difficult task. Analysis of financial history gives little indication of future performance. Despite this, for products currently in development, sales potentials can be estimated and management has used its own experience as well as consulting with external experts to establish best estimates of sales pricing and revenue forecasting and these can provide the starting point for valuing these products and ensuring that their value has not been impaired. In addition, clinical development risks, measured as product attrition failure rates, incurred as drugs progress through the clinic are reasonably well documented and can be applied as meaningful risk adjusters to account for the chance of development failure. 3. Significant accounting policies The accounting policies set out below are applied consistently by Group entities. (a) Basis of consolidation (i) Business combinations Business combinations are accounted for using the acquisition method as at the acquisition date – i.e. when control is transferred to the Group. Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. In assessing control, the Group takes into consideration potential voting rights that are currently exercisable. The Group measures goodwill at the acquisition date as: ° the fair value of the consideration transferred; plus ° the recognised amount of any non-controlling interests in the acquiree; plus ° if the business combination is achieved in stages, the fair value of the pre-existing equity interest in the acquiree; less ° the net recognised amount (generally fair value) of the identifiable assets acquired and liabilities assumed. Transaction costs, other than those associated with the issue of debt or equity securities, that the Group incurs in connection with a business combination are expensed as incurred. (ii) Subsidiaries Subsidiaries are entities controlled by the Group. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases. 36 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 3. Significant accounting policies continued (a) Basis of consolidation continued (iii) Transactions eliminated on consolidation Intra-group balances and transactions, and any unrealised income and expenses arising from intra-group transactions, are eliminated in preparing the consolidated financial statements. Unrealised gains arising from transactions with equity-accounted investees are eliminated against the investment to the extent of the Group’s interest in the investee. Unrealised losses are eliminated in the same way as unrealised gains, but only to the extent that there is no evidence of impairment. (b) Foreign currency transactions Transactions in foreign currencies are initially recorded in the functional currency by applying the spot rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are retranslated at the functional currency rate of exchange ruling at the reporting date. All foreign currency transaction differences are recognised in the Income Statement. Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rates as at the date of the transaction. Non-monetary items measured at fair value in a foreign currency are translated using the exchange rates at the date when the fair value was determined. These values are retranslated at the year-end rates with the movement between the original cost and retranslated cost being included in other comprehensive income and the translation reserve. (c) Segmental reporting An operating segment is a component of an entity that engages in business activities from which it may earn revenues and incur expenses, whose operating results are regularly reviewed by the Group’s chief operating decision maker, being the Chief Executive Officer, to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. As at the reporting date the Group operated as a single segment. (d) Lease payments Leases are classified as finance leases wherever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases which are expensed directly to the Income Statement. Assets held under hire purchase agreements and finance leases are recognised as assets of the Group at their fair value or, if lower, at the present value of the minimum lease payments, each determined at the inception of the lease. The corresponding liability is included in the Group Statement of Financial Position as a hire purchase obligation. Lease payments are apportioned between finance charges and a reduction of the lease obligations so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged to the Group Income Statement. Rentals payable under operating leases are charged to the Group Income Statement on a straight-line basis over the term of the lease. (e) Finance income and finance expense Finance income comprises interest income on funds invested and changes in the fair value of financial assets at fair value through profit or loss. Interest income is recognised as interest accrues using the effective interest rate method. Finance expense comprises interest expense on borrowings, changes in the fair value of financial assets at fair value through the Group Statement of Comprehensive Income, impairment losses recognised on financial assets and losses on hedging instruments that are recognised in profit or loss. All borrowing costs are recognised using the effective interest method. 4D pharma plc Annual Report and Accounts 2017 37 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 3. Significant accounting policies continued (f) Income tax Income tax expense comprises current and deferred tax. Income tax expense is recognised in the Income Statement except to the extent that it relates to items recognised directly in equity or in other comprehensive income. Current income tax assets and liabilities for the current and prior years are measured at the amount expected to be recovered from, or paid to, the tax authorities. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted by the reporting date. Deferred income tax is recognised on all temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements with the following exceptions: ° where the temporary difference arises from the initial recognition of goodwill or of an asset or liability in a transaction that is not a business combination and that at the time of the transaction affects neither accounting nor taxable profit or loss; and ° in respect of taxable temporary differences associated with investments in subsidiaries where the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future. Deferred income tax assets and liabilities are measured on an undiscounted basis using the tax rates and tax laws that have been enacted or substantively enacted by the date and which are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled. Deferred income tax assets are recognised to the extent that it is probable that future taxable profits will be available against which differences can be utilised. An asset is not recognised to the extent that the transfer or economic benefits in the future is uncertain. (g) Property, plant and equipment Property, plant and equipment are recognised initially at cost. After initial recognition, these assets are carried at cost less any accumulated depreciation and any accumulated impairment losses. Cost comprises the aggregate amount paid and the fair value of any other consideration given to acquire the asset and includes costs directly attributable to making the asset capable of operating as intended. Depreciation is computed by allocating the depreciable amount of an asset on a systematic basis over its useful life and is applied separately to each identifiable component. The following bases and rates are used to depreciate classes of assets: Plant and machinery – straight-line over five to ten years Fixtures, fittings and office equipment – straight-line over three to five years Leasehold improvements – straight-line over five to ten years The carrying values of property, plant and equipment are reviewed for impairment if events or changes in circumstances indicate that the carrying value may not be recoverable, and are written down immediately to their recoverable amount. Useful lives and residual values are reviewed annually and where adjustments are required these are made prospectively. A property, plant and equipment item is derecognised on disposal or when no future economic benefits are expected to arise from the continued use of the asset. Any gain or loss arising on the derecognition of the asset is included in the Income Statement in the year of derecognition. (h) Intangible assets Intellectual property and patents The carrying value of intangible fixed assets is reviewed annually for impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable. At each reporting date the Group reviews the carrying value of its intangible assets to determine whether there is any indication that those assets have suffered an impairment loss. If any such indication exists the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss. Where the asset does not generate cash flows that are independent from other assets, the Group estimates the recoverable amount of the cash-generating unit to which the asset belongs. A cash-generating unit is the smallest identifiable group of assets that generates cash inflows from other assets or groups of assets. 38 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 3. Significant accounting policies continued (h) Intangible assets continued Intellectual property and patents continued Recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset, for which the estimates of future cash flows have not been adjusted. If the recoverable amount of an asset is estimated to be less than its carrying amount, the carrying amount of the asset is reduced to its recoverable amount. An impairment loss is recognised as an expense immediately. Where an impairment loss subsequently reverses, the carrying amount of the assets is increased to the revised climate of its recoverable amount, but so that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognised for the asset in prior years. A reversal of an impairment loss is recognised in profit or loss immediately. Amortisation is provided on the fair value of the asset and is calculated on a straight-line basis over its useful life. Amortisation is recognised within the Statement of Comprehensive Income. Intellectual property and patents acquired as part of a business combination are only amortised once technical viability has been proven and commercial agreements are likely to be achieved. Patents includes the costs associated with acquiring and registering patents in respect of intellectual property rights. Patents are amortised on a straight-line basis over their useful lives of up to 20 years from the date of filing the patent. Goodwill Goodwill on acquisitions, being the excess of the fair value of the cost of acquisition over the Group’s interest in the fair value of the identifiable assets and liabilities acquired, is capitalised and tested for impairment on an annual basis. Any impairment is recognised immediately in profit or loss and is not subsequently reversed. For the purpose of impairment testing goodwill is allocated to cash-generating units of 4D pharma plc, which represent the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Software Software is recognised initially at cost. After initial recognition, these assets are carried at cost less any accumulated amortisation and any accumulated impairment losses. Cost comprises the aggregate amount paid and the fair value of any other consideration given to acquire the asset and includes costs directly attributable to making the asset capable of operating as intended. Amortisation is computed by allocating the amortisation amount of an asset on a systematic basis over its useful life and is applied separately to each identifiable component. Amortisation is applied to software over three to five years on a straight-line basis. The carrying value of software is reviewed for impairment if events or changes in circumstances indicate that the carrying value may not be recoverable, and is written down immediately to their recoverable amount. Useful lives and residual values are reviewed annually and where adjustments are required these are made prospectively. A software item is derecognised on disposal or when no future economic benefits are expected to arise from the continued use of the asset. Any gain or loss arising on the derecognition of the asset is included in the Income Statement in the year of derecognition. Internally generated intangible assets Expenditure on research activities is recognised in the Statement of Comprehensive Income as incurred. Expenditure arising from the Group’s development is recognised only if all of the following conditions are met: ° an asset is created that can be identified; ° it is probable that the asset created will generate future economic benefits; ° the development cost of the asset can be measured reliably; ° the Group has the intention to complete the asset and the ability and intention to use or sell it; ° the product or process is technically and commercially feasible; and ° sufficient resources are available to complete the development and to either sell or use the asset. Where these criteria have not been achieved, development expenditure is recognised in profit or loss in the year in which it is incurred. The Group has adopted the industry standard approach to the treatment of development expenditure by capitalising development costs at the point where regulatory approval is reached and the probability of generating future economic benefits is high. 4D pharma plc Annual Report and Accounts 2017 39 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 3. Significant accounting policies continued (i) Impairment of assets An asset’s recoverable amount is the higher of an asset’s or cash-generating unit’s fair value less costs to sell and its value in use and is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. Where the carrying value of an asset exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. In determining fair value less costs of disposal, an appropriate valuation model is used; these calculations are corroborated by valuation multiples, or other available fair value indicators. Impairment losses on continuing operations are recognised in the Income Statement in those expense categories consistent with the function of the impaired asset. (j) Investments in subsidiaries Investments in and loans to subsidiaries are stated in the Company’s Statement of Financial Position at cost less provision for any impairment plus the cost of any share options issued to employees of subsidiary companies. See note 3(o) for further details. (k) Inventories Inventories are stated at the lower of cost and net realisable value. Cost based on latest contractual prices includes all costs incurred in bringing each product to its present location and condition. Net realisable value is based on estimated selling price less any further costs expected to be incurred to disposal. Provision is made for slow-moving or obsolete items. (l) Cash, cash equivalents and short-term investments Cash and cash equivalents comprise cash at hand and deposits with maturities of three months or less. Short-term investments comprise deposits with maturities of more than three months, but no greater than twelve months. (m) Trade and other payables Trade and other payables are non-interest bearing and are initially recognised at fair value. They are subsequently measured at amortised cost using the effective interest rate method. (n) Financial assets and liabilities Financial assets and liabilities are recognised when the Group becomes party to the contracts that give rise to them and are classified as financial assets and liabilities at fair value through the Group Statement of Comprehensive Income. The Group determines the classification of its financial assets and liabilities at initial recognition and re-evaluates this designation at each financial year end. A financial asset or liability is generally derecognised when the contract that gives rise to it is settled, sold or cancelled or expires. At the year end, the Group had no financial assets or liabilities designated at fair value through the Group Statement of Comprehensive Income. (o) Share-based payments Equity-settled share-based payment transactions are measured with reference to the fair value at the date of grant, recognised on a straight-line basis over the vesting period, based on the Company’s estimate of shares that will eventually vest. Fair value is measured using a suitable option pricing model. At each reporting date before vesting, the cumulative expense is calculated, representing the extent to which the vesting period has expired and management’s best estimate of the achievement or otherwise of non-market conditions and the number of equity instruments that will ultimately vest. The movement in cumulative expense since the previous reporting date is recognised in the Group Statement of Comprehensive Income, with a corresponding entry in equity. Where the terms of an equity-settled award are modified or a new award is designated as replacing a cancelled or settled award, the cost based on the original award terms continues to be recognised over the remainder of the original vesting period. In addition, an expense is recognised over the remainder of the new vesting period for the incremental fair value of any modification, based on the difference between the fair value of the original award and the fair value of the modified award, both as measured on the date of modification. No reduction is recognised if this difference is negative. Where awards are granted to the employees of the subsidiary company, the fair value of the awards at grant date is recorded in the Company’s financial statements as an increase in the value of the investment with a corresponding increase in equity via the share-based payment reserve. 40 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 3. Significant accounting policies continued (p) Share capital Proceeds on issue of shares are included in shareholders’ equity, net of transaction costs. The carrying amount is not remeasured in subsequent years. (q) New accounting standards and interpretations Adoption of IFRS The Group and Company financial statements have been prepared in accordance with IFRS, IAS and IFRS Interpretations Committee (“IFRSIC”) effective as at 31 December 2017. The Group and Company have not chosen to adopt any amendments or revised standards early. IFRS issued but not yet effective At the date of issue of these financial statements, the following accounting standards and interpretations, which have not been applied, were in issue but not yet effective. The potential effects for the implementation of IFRS 16 are currently under consideration as they are expected to be significant. However, for the remaining standards listed below, the Directors do not anticipate adoption will have a material impact on the financial statements or they consider the implementation too uncertain to speculate on the impact on the accounts at this point in time. IFRS 9 IFRS 15 IFRS 17 IFRIC 22 IFRIC 23 Financial Instruments Revenue from Contracts with Customers Insurance Contracts Effective 1 January 2018 Effective 1 January 2018 Effective 1 January 2021 Foreign Currency Transactions and Advance Consideration Effective 1 January 2018 Uncertainty over Income Tax Treatments Effective 1 January 2019 Various standards Annual Improvements to IFRSs 2015–2017 Cycle Various Amendments to IAS 40 Transfers of Investment Property Amendments to IAS 28 Long-term Interests in Associates and Joint Ventures Amendments to IFRS 9 Prepayment Features with Negative Compensation Effective 1 January 2018 Effective 1 January 2019 Effective 1 January 2019 Amendments to IFRS 4 Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts Effective 1 January 2018 Amendments to IFRS 2 Classification and Measurement of Share-based Payment Transactions Effective 1 January 2018 IFRS 16 Leases IFRS 16 introduces a comprehensive model for the identification of lease arrangements and accounting treatments for both lessors and lessees. IFRS 16 will supersede the current guidance including IAS 17 Leases and the related interpretations when it becomes effective. IFRS 16 distinguishes leases and service contracts on the basis of whether an identifiable asset is controlled by a customer. Distinctions of operating leases (off Statement of Financial Position) and finance leases (on Statement of Financial Position) are removed for lessee accounting, and are replaced by a model where a right-of-use asset and corresponding liability have to be recognised for all leases by lessees (i.e. all on Statement of Financial Position) except for short-term leases and leases of low value assets. The right-of-use asset is initially measured at cost and subsequently measured at cost (subject to certain exceptions) less accumulated depreciation and impairment losses, adjusted for any measurement of the lease liability. The lease liability is initially measured at the present value of the lease payments that are not paid at that date. Subsequently, the lease liability is adjusted for interest and lease payments, as well as the impact of lease modifications, amongst others. Furthermore, the classification of cash flows will also be affected as operating lease payments under IAS 17 are presented as operating cash flows, whereas under the IFRS 16 model, the lease payments will be split into a principal and interest portion which will be presented as financing and operating cash flows respectively. In contrast, for finance leases where the Group is a lessee, as the Group has already recognised an asset and a related finance lease liability for the lease arrangement, the Directors of the Company do not anticipate that the application of IFRS 16 will have a significant impact on the amounts recognised in the Group’s consolidated financial statements. The Directors are currently assessing the impact of IFRS 16 as the changes are likely to have a significant impact on the financial results. 4D pharma plc Annual Report and Accounts 2017 41 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 4. Operating loss By nature: Operating loss is stated after charging: Research and development expense Depreciation of property, plant and equipment Amortisation of intangible assets Staff costs (see note 6) Operating lease rentals: – Land and buildings – Equipment – Other contractual commitments Other research and development costs Administrative expenses Depreciation of property, plant and equipment Amortisation of intangible assets Loss/(profit) on disposal of property, plant and equipment Staff costs (see note 6) Operating lease rentals: – Land and buildings – Equipment Auditor’s remuneration Legal and professional Consultancy Other administrative costs Foreign currency losses/(gains) Auditor’s remuneration: Audit services: – Fees payable to Company auditor for the audit of the parent and the consolidated accounts – Auditing the financial statements of subsidiaries pursuant to legislation – Non-audit services Total auditor’s remuneration 5. Non-recurring costs Year to 31 December 2017 £000 Year to 31 December 2016 £000 686 229 3,335 118 37 1,916 10,590 16,911 44 23 79 1,141 113 1 49 253 5 1,821 3,529 431 35 10 4 49 349 213 1,604 457 2 1,837 5,758 10,220 34 22 (2) 840 44 — 56 838 202 832 2,866 (799) 38 10 8 56 As detailed in other payables (see note 19) on 23 August 2017 contingent consideration became due following the achievement of 4D Pharma Cork Ltd’s initial milestone. The contingent liability was initially calculated upon the acquisition based on the discounted probability of the potential liability at the time of acquisition. With the successful completion of the first milestone the management has had to reassess the probability of success of subsequent milestones and therefore increase the contingent liability. This has resulted in the non-recurring cost in the year to 31 December 2017 of £3.474 million (31 December 2016: £Nil). 42 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 6. Staff costs Wages and salaries Social security costs Pension contributions Share-based compensation Directors’ remuneration (including benefits in kind) included in the aggregate remuneration above comprised: Year to 31 December 2017 Year to 31 December 2016 Research and development Administrative £000 £000 2,597 528 51 159 868 104 26 143 Total £000 3,465 632 77 302 Research and development £000 Administrative £000 1,371 201 32 — 621 74 14 131 840 Total £000 1,992 275 46 131 2,444 3,335 1,141 4,476 1,604 Emoluments for qualifying services — 252 252 — 252 252 Directors’ emoluments (excluding social security costs, but including benefits in kind) disclosed above include £101,323 (31 December 2016: £101,238) paid to the highest paid Director. The Directors were not granted any share options in the year ended 31 December 2017 or the year ended 31 December 2016 and none of the Directors held any share options at 31 December 2017. An analysis of the highest paid Director’s remuneration is included in the Report of the Remuneration Committee. The average number of employees during the year (including Directors) was as follows: Group Directors Scientific and administrative staff Company Directors Scientific and administrative staff 7. Finance income and finance expense Finance income Bank interest receivable Finance expense Hire purchase interest Unwinding of discount Other interest payable Year to 31 December 2017 Number Year to 31 December 2016 Number 4 89 93 4 53 57 Year to 31 December 2017 Number Year to 31 December 2016 Number 4 17 21 4 6 10 Year to 31 December 2017 £000 Year to 31 December 2016 £000 482 652 (2) (120) (1) (123) 359 — (71) — (71) 581 Bank interest receivable includes £128,926 (31 December 2016: £156,681) which is receivable after the year end. 4D pharma plc Annual Report and Accounts 2017 43 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 8. Taxation The tax credit is made up as follows: Current income tax Total current income tax Adjustment in respect of prior years Current deferred tax Current year charge Total deferred tax Year to 31 December 2017 £000 Year to 31 December 2016 £000 (3,557) (1,843) 16 — — — — — Total income tax credit recognised in the year (3,541) (1,843) The income tax credit can be reconciled to the accounting loss as follows: Loss before taxation Tax at the average standard rate of 18.95% (31 December 2016: 20.1%) Effects of: Expenses not deductible for tax purposes Adjustments to foreign currency translations on subsidiaries Enhanced research and development expenditure Property, plant, equipment and software timing differences Deferred tax not provided on losses Adjustment in respect of prior years Effects of variation on tax reclaims over the standard rate Tax income tax credit recognised in the year Year to 31 December 2017 £000 Year to 31 December 2016 £000 (23,986) (4,544) (11,706) (2,356) 714 — (2,561) 6 1,853 17 974 56 8 (1,410) 20 1,154 — 685 (3,541) (1,843) The tax rate for the current year is lower than the prior year, due to changes in the UK corporation tax rate from 20% to 19% from 1 April 2017. Further reductions to the UK corporation tax rates were substantively enacted as part of the Finance Bill 2016 on 6 September 2016. These reduce the main rate to 17% from 1 April 2020 with the revised rate forming the basis for the UK portion of the deferred tax calculation noted below. At 31 December 2017, the Group had tax losses available for carry forward of approximately £32.691 million (31 December 2016: £12.262 million). The Group has not recognised deferred tax assets relating to such earned forward losses of approximately £5.645 million (31 December 2016: £2.452 million). At 31 December 2017, the Company had tax losses available for carry forward of approximately £7.827 million (31 December 2016: £2.974 million). The Company has not recognised deferred tax assets relating to such earned forward losses of approximately £1.331 million (31 December 2016: £0.595 million). Group’s management considers that there is insufficient evidence of future taxable income, taxable temporary differences and feasible tax-planning strategies to utilise all of the cumulative losses. If future income differs from current projections, this could significantly impact the tax charge or benefit in future years. The management has therefore concluded that a deferred tax asset should not be recognised until such point that the probability of its realisation becomes more certain. 44 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 9. Loss per share (a) Basic and diluted Loss for the year attributable to equity shareholders Weighted average number of shares: Ordinary shares in issue Basic loss per share Year to 31 December 2017 £000 Year to 31 December 2016 £000 (20,445) (9,863) 65,084,561 64,858,150 (31.41)p (15.21)p The basic and diluted loss per share are the same as the effect of share options is anti-dilutive. (b) Adjusted Adjusted loss per share is calculated after adjusting for the effect of non-recurring expenses in relation to the reassessment of the contingent liability. Reconciliation of adjusted loss after tax: Reported loss after tax Non-recurring costs Adjusted loss after tax Adjusted basic loss per share Year to 31 December 2017 £000 Year to 31 December 2016 £000 (20,445) 3,474 (16,971) (9,863) — (9,863) (26.08)p (15.21)p 4D pharma plc Annual Report and Accounts 2017 45 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 10. Property, plant and equipment Group Cost At 31 December 2015 Additions Additions on business combinations Disposals Exchange rate adjustment At 31 December 2016 Additions Disposals Reclassifications Exchange rate adjustment At 31 December 2017 Depreciation At 31 December 2015 Provided during the year Released on disposal Exchange rate adjustment At 31 December 2016 Provided during the year Released on disposal Reclassifications Exchange rate adjustment At 31 December 2017 Net book value At 31 December 2017 At 31 December 2016 At 31 December 2015 Plant and machinery £000 Fixtures, fittings and office equipment £000 Leasehold improvements £000 1,124 1,894 625 (15) (44) 3,584 1,381 — 24 257 5,246 201 318 (2) (20) 497 592 — 2 38 1,129 4,117 3,087 923 94 88 — — (2) 180 102 (1) (73) 1 209 6 32 — — 38 34 — (12) — 60 149 142 88 Total £000 1,322 2,243 959 (15) (62) 4,447 1,929 (112) (49) 319 104 261 334 — (16) 683 446 (111) — 61 1,079 6,534 — 55 — (2) 53 104 (33) — 10 134 945 630 104 207 405 (2) (22) 588 730 (33) (10) 48 1,323 5,211 3,859 1,115 Included in the totals above are the following assets held under hire purchase or finance leases; these agreements are secured against the assets to which they relate. 46 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 10. Property, plant and equipment continued Group assets under hire purchase and finance lease agreements Cost At 31 December 2015 and 31 December 2016 Additions Exchange rate adjustment At 31 December 2017 Depreciation At 31 December 2015 and 31 December 2016 Provided during the year At 31 December 2017 Net book value At 31 December 2017 At 31 December 2015 and 31 December 2016 Plant and machinery £000 Total £000 — 44 2 46 — 8 8 38 — — 44 2 46 — 8 8 38 — During the year the Group reviewed the assets capitalised under computer equipment and identified the components relating to software. Where components relate to software, these have been reclassified in tangible fixed assets with the value included in intangibles under the software heading. See note 11 for details. Company Cost At 31 December 2015 Additions Transfer to subsidiary entities At 31 December 2016 Additions Disposals Reclassifications At 31 December 2017 Depreciation At 31 December 2015 Provided during the year Released on disposal At 31 December 2016 Provided during the year Released on transfer to subsidiary entities Reclassifications At 31 December 2017 Net book value At 31 December 2017 At 31 December 2016 At 31 December 2015 Plant and machinery £000 Fixtures, fittings and office equipment £000 Leasehold improvements £000 200 56 (168) 88 99 — 34 221 7 18 (14) 11 33 — 5 49 172 77 193 75 41 — 116 96 (1) (34) 177 3 22 — 25 28 — (6) 47 130 91 72 104 7 — 111 298 (111) — 298 — 23 — 23 34 (33) — 24 274 88 104 Total £000 379 104 (168) 315 493 (112) — 696 10 63 (14) 59 95 (33) (1) 120 576 256 369 There were no assets held under hire purchase or finance leases in the Company. 4D pharma plc Annual Report and Accounts 2017 47 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 Software £000 Patents £000 Intellectual property £000 Goodwill £000 Total £000 3,316 — 5,683 — 6,330 76 8,267 (2) 8,999 14,671 — — 391 9,390 194 49 395 15,309 — — — — — — — 159 213 372 252 10 1 635 15 71 — (2) 84 194 49 4 331 2 13 15 52 10 1 78 253 69 13 1,076 5 — — 1,081 — — — 1,923 — 2,584 — 4,507 — — — 1,081 4,507 — — — — — — — 157 200 357 200 — — 557 524 724 919 4,507 4,507 1,923 9,390 8,999 3,316 14,674 14,299 6,171 11. Intangible assets Group Cost At 31 December 2015 Additions Additions on business combinations Exchange rate adjustment At 31 December 2016 Additions Reclassifications Exchange rate adjustment At 31 December 2017 Amortisation At 31 December 2015 Provided during the year At 31 December 2016 Provided during the year Reclassifications Exchange rate adjustment At 31 December 2017 Net book value At 31 December 2017 At 31 December 2016 At 31 December 2015 48 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 11. Intangible assets continued Company Cost At 31 December 2015 Additions At 31 December 2016 Additions At 31 December 2017 Amortisation At 31 December 2015 Provided during the year At 31 December 2016 Provided during the year Reclassifications At 31 December 2017 Net book value At 31 December 2017 At 31 December 2016 At 31 December 2015 Software £000 Patents £000 Total £000 — 14 14 182 196 — 2 2 22 1 25 171 12 — 1,076 — 1,076 — 1,076 — 199 199 199 — 398 678 877 1,076 1,076 14 1,090 182 1,272 — 201 201 221 1 423 849 889 1,076 Goodwill amounting to £9.390 million, intellectual property amounting to £4.507 million and patent rights amounting to £1.081 million relate to a single cash-generating unit (“CGU”), contained in the acquisitions of 4D Pharma Research Limited, 4D Pharma Leon, S.L.U. and 4D Pharma Cork Limited (formerly Tucana Health Limited). These entities together provide the necessary facilities and resources to enable the Group to successfully research, manufacture, gain approval for and commercialise Live Biotherapeutic products. Goodwill, which has arisen on the business combinations, represents staff and accumulated know-how after fair value has been attributed to all other assets and liabilities acquired. Intellectual property of £1.923 million recognised on the business combinations represents bacteria identified by the Group’s know-how and processes and at different stages of research and development, from early identification to patented strains of bacteria. Intellectual property of £2.584 million represents the methods and know-how in relation to the MicroDx platform acquired as part of 4D Pharma Cork Limited (formerly Tucana Health Limited). During the year goodwill, intellectual property, patents and associated property, plant and equipment was tested for impairment in accordance with IAS 36 Impairment of Assets. The recoverable amount of the CGU exceeds the carrying amount of goodwill, intellectual property, patents and associated property, plant and equipment. The recoverable amount of the CGU has been measured using a value-in-use calculation and, as such, no impairment was deemed necessary. The key assumptions used, which are based on both management’s past experience as well as externally provided reports, obtained in the prior year, for the value-in-use calculations are those relating to the risk-adjusted net present value of candidates that have been identified as potential future products as at 31 December 2017 and for which estimated potential peak sales and future cash flows have been estimated. In addition, an external valuation of intellectual property contained via the acquisition of 4D Pharma Cork Limited (formerly Tucana Health Limited) has been used. Valuation of an early stage drug discovery pharmaceutical company is a notoriously difficult task and an analysis of financial history gives little indication of future performance. Despite this, for products currently in development, sales potentials can be estimated and management has used its own experience as well as consulting with external experts to establish best estimates of sales pricing and revenue forecasting and these can provide the starting point for valuing these products and ensuring that their value has not been impaired. The recoverable amount of goodwill, intellectual property, patents and associated property, plant and equipment exceeds the carrying amount by 4,985%. The key assumption considered most sensitive for the value-in-use calculation is that regarding the discount rate applied to the net present value calculations. Management has performed sensitivity analysis on this key assumption and increased this from 10% to 20%. Due to the headroom which exists between the recoverable amount and the carrying value there is no reasonable possible change in this assumption that would cause the CGU’s carrying value to exceed its recoverable amount. 4D pharma plc Annual Report and Accounts 2017 49 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 12. Investment and loans to subsidiaries Company Non-current assets At 31 December 2015 Additions in the year At 31 December 2016 Loans converted to shares Share-based payments issued to employees in subsidiaries At 31 December 2017 By subsidiary 4D Pharma Research Limited 4D Pharma Cork Limited 4D Pharma Leon, S.L.U. At 31 December 2017 Company Current assets At 31 December 2015 Additions in the year At 31 December 2016 Additions in the year Loans converted to shares At 31 December 2017 By subsidiary 4D Pharma Research Limited 4D Pharma Cork Limited 4D Pharma Leon, S.L.U. At 31 December 2017 Ordinary shares £000 2,323 3,805 6,128 5,372 171 11,671 2,403 3,837 5,431 11,671 Loans to subsidiary undertakings £000 8,916 15,198 24,114 14,417 (5,372) 33,159 29,251 1,215 2,693 33,159 On 3 October 2017 the Company converted €6.052 million of existing loans into ordinary shares in 4D Pharma Leon, S.L.U. at a rate of €1.127: £1 creating an additional investment in shares of £5.372 million and reducing the Group loans by a corresponding amount. Details of the share-based payments issued to employees in subsidiaries are included in note 21. 50 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 12. Investment and loans to subsidiaries continued Subsidiary undertakings Subsidiary undertaking Country of incorporation Registered office Principal activity Holding at 31 December 2017 4D Pharma Research Limited Scotland 4D Pharma Cork Limited Ireland Life Sciences Innovation Building, Cornhill Road, Aberdeen AB25 2ZS Room 447, Food Sciences Building, University College Cork, Western Road, Cork T12 YN60 Research and development 100% Research and development 100% 4D Pharma Leon, S.L.U. Spain Microbiomics Limited England and Wales The Microbiota Company Limited England and Wales Parque Tecnológico de León, Parcela, M–10.4, 24009, Armunia, León, Spain Production of Live Biotherapeutics 9 Bond Court, Leeds LS1 2JZ 9 Bond Court, Leeds LS1 2JZ Dormant Dormant 100% 100% 100% The shares in all the companies listed above are held by 4D pharma plc. The following wholly owned subsidiaries were dormant and were wound up during the year to 31 December 2017: Subsidiary undertaking Schosween 18 Limited Country of incorporation England and Wales The following companies were exempt from the requirements of the Companies Act 2006 relating to the audit of individual accounts for the financial year ended 31 December 2017, by virtue of section 479A of the Companies Act 2006: Subsidiary undertaking The Microbiota Company Limited Microbiomics Limited 13. Inventories Consumables and materials Company number 09132301 08871792 At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 253 — 238 — The Directors consider that the carrying amount of inventories is the lower of cost and market value. During the year £1.388 million (31 December 2016: £1.641 million) of inventories were expensed to the Income Statement. 14. Trade and other receivables Prepayments At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 3,238 3,238 428 428 2,651 2,651 350 350 The Directors consider that the carrying amount of trade and other receivables approximates to their fair value. 4D pharma plc Annual Report and Accounts 2017 51 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 15. Taxation receivables Non-current receivables Corporation tax At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 56 56 — — 23 23 — — Non-current assets include research and development tax claims in overseas subsidiaries that are repayable in more than one year. Current receivables Corporation tax VAT At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 3,522 786 4,308 445 33 478 2,269 1,046 3,315 410 45 455 The Directors consider that the carrying amount of taxation receivables approximates to their fair value. 16. Cash, cash equivalents and deposits Short-term investments and cash on deposit Cash and cash equivalents At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 38,133 11,865 49,998 38,133 11,060 49,193 40,111 28,661 68,772 40,111 27,778 67,889 Under IAS 7 Statement of Cash Flows, cash held on long-term deposits (being deposits with maturity of greater than three months and no more than twelve months) that cannot readily be converted into cash has been classified as a short-term investment. The maturity on this investment was less than twelve months at the reporting date. Cash and cash equivalents at 31 December 2017 include deposits with original maturity of three months or less of £5 million (Group) and £5 million (Company). The Directors consider that the carrying value of cash and cash equivalents approximates their fair value. For details on the Group’s credit risk management refer to note 24. 17. Trade and other payables Current Trade payables Other payables Contingent consideration Taxation and social security Hire purchase and finance leases Accruals At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 1,803 1,000 695 — 264 10 2,210 4,982 27 — 146 — 172 1,163 35 2,560 581 — 598 254 35 — 482 — 247 1,345 4,937 1,018 Trade and other payables principally comprise amounts outstanding for trade purchases and ongoing costs. Trade payables are non-interest bearing and are typically settled on 30 to 45-day terms. 52 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 17. Trade and other payables continued The Directors consider that the carrying value of trade payables, other payables and accruals approximates to their fair value. The Group has financial risk management policies in place to ensure that any trade payables are settled within the credit time frame and no interest has been charged by any suppliers as a result of late payment of invoices during the reporting year presented herein. 18. Deferred tax At 31 December 2015 Arising on the fair value of intellectual property on the acquisition of subsidiaries At 31 December 2016 Exchange rate movement At 31 December 2017 Group £000 385 578 963 2 965 All deferred tax liabilities relate to the tax arising on fair value adjustment on the acquisition of subsidiaries and as such there is no provision for deferred tax in the Company. 19. Other payables Non-current payables Contingent consideration Hire purchase and finance leases Contingent consideration The non-current contingent consideration is made up as follows: At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 1,979 26 2,005 1,979 — 1,979 774 — 774 774 — 774 At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 Brought forward Contingent consideration Reassessment of contingent consideration to be satisfied in shares Discounting of estimated future cash flows 774 — 4,395 (921) 774 — 4,395 (921) Part settlement of contingent consideration in shares (2,389) (2,389) Unwinding of discount Analysed as follows: Within one year More than one year 120 1,979 — 1,979 1,979 120 1,979 — 1,979 1,979 — 985 — (282) — 71 774 — 774 774 — 985 — (282) — 71 774 — 774 774 The above contingent consideration relates to the amounts due on the remaining milestones which form part of the original contingent acquisition costs for the entire issued share capital in Tucana Health Limited (now 4D Pharma Cork Limited) on 10 February 2016. The contingent consideration is based on milestones, the first of which reflects the technical validation of the MicroDx diagnostic platform, enabling the stratification of IBS patients. MicroDx has been designed to diagnose, stratify and monitor the treatment of patients based on their gut microbiome, the bacteria which colonise the human gastrointestinal tract. 4D pharma plc Annual Report and Accounts 2017 53 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 19. Other payables continued Contingent consideration continued On 23 August 2017 635,692 ordinary shares were allotted in 4D pharma plc for an aggregate value of €2.6 million (at £3.7575 per 4D pharma plc share, being the average mid-market price of a 4D share for the five business days immediately preceding the date of allotment) and were admitted on 31 August 2017. The following table lists the inputs used in valuing the provision: The Group and the Company Share price Cost of capital Hire purchase and finance leases Hire purchase and finance leases Analysed as follows: Due between one and two years Due between two to five years 2017 755p 2016 757p 17.50% 17.50% At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 26 11 15 26 — — — — — — — — — — — — Repayment and interest rates on hire purchase and finance lease agreements are fixed at the contract date. The average effective borrowing rate for hire purchase and finance leases at 31 December 2017 was 3.95% over a weighted average remaining period of 39 months; there were no such agreements during the year to 31 December 2016. All hire purchase and finance lease agreements are secured by the Group against the assets to which they relate. 20. Share capital The Group and the Company Allotted, called up and fully paid ordinary shares of 0.25p At 1 January 2016 Shares issued on 10 February 2016 Shares issued on 8 April 2016 At 31 December 2016 Shares issued on 23 August 2017 At 31 December 2017 Ordinary shares Number Share capital £000 Share premium £000 Total £000 64,365,198 161 102,003 102,164 410,603 82,349 64,858,150 635,692 1 — 162 2 3,099 807 3,100 807 105,909 106,071 2,387 2,389 65,493,842 164 108,296 108,460 The balances classified as share capital and share premium include the total net proceeds (nominal value and share premium respectively) on issue of the Company’s equity share capital, comprising 0.25 pence ordinary shares. The Company issued 635,692 shares equating to €2.6 million in share capital at a five previous working day mid-market value of £3.7575 per share on 23 August 2017 with the payment representing the settlement of deferred consideration on the acquisition of 4D Pharma Cork Limited (formerly Tucana Health Limited) on achievement of its first milestone. The milestone achieved reflects the technical validation of the MicroDx diagnostic platform enabling the stratification of IBS patients. MicroDx has been designed to diagnose, stratify and monitor the treatment of patients based on their gut microbiome, the bacteria which colonise the human gastrointestinal tract. 54 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 21. Share-based payment reserve The Group and the Company At 31 December 2015 Share-based compensation At 31 December 2016 Share-based compensation At 31 December 2017 £000 7 131 138 302 440 The share-based payment reserve accumulates the corresponding credit entry in respect of share-based payment charges. Movements in the reserve are disclosed in the Group Statement of Changes in Equity. A charge of £301,570 has been recognised in the Statement of Comprehensive Income for the year (31 December 2016: £131,336). Share option schemes The Group operates the following unapproved share option scheme: 4D pharma plc 2015 Long Term Incentive Plan (“LTIP”) Share options were granted to staff members on 10 November 2015, 11 May 2016 and 24 May 2017. Share options are awarded to management and key staff as a mechanism for attracting and retaining key members of staff. These options vest over a three-year period from the date of grant and are exercisable until the tenth anniversary of the award. Exercise of the award is subject to the employee remaining a full-time member of staff at the point of exercise. The fair value benefit is measured using a Black Scholes model, taking into account the terms and conditions upon which the share options were issued. The Group and the Company Outstanding at the start of the year Granted during the year Outstanding at 31 December Exercisable at 31 December Weighted average exercise price of options The Group and the Company Outstanding at the start of the year Granted during the year Outstanding at 31 December 2017 Number 101,056 240,406 2016 Number 40,909 60,147 341,462 101,056 — — 2017 Pence 0.25 0.25 0.25 2016 Pence 0.25 0.25 0.25 For the share options outstanding as at 31 December 2017, the weighted average remaining contractual life is 2.03 years (31 December 2016: 2.13 years). No share options were exercised during the year (31 December 2016: none) and no share options were exercisable at 31 December 2017 or at 31 December 2016. The following table lists the inputs to the models used at the respective year ends: The Group and the Company Expected volatility Risk-free interest rate Expected life of options Weighted average exercise price Weighted average share price at date of grant 2017 52.50% 0.41% 3 years 0.25p 321p 2016 52.50% 1.4% 3 years 0.25p 771p 4D pharma plc Annual Report and Accounts 2017 55 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 21. Share-based payment reserve continued Share option schemes continued The range of exercise prices of share options outstanding at the end of the reporting period is between 321 pence and 771 pence per share option. The expected life of the options is based on historical data and is not necessarily indicative of exercise patterns that may occur. The expected volatility reflects the assumption that the historical volatility is indicative of future trends, which may also not necessarily be the actual outcome. No dividends were assumed to be paid in the foreseeable future. The model assumes, within the calculation of the charge, delivery of options that are dependent on a judgemental comparison to the total shareholder return against a specified comparator group of companies upon passing of the vesting period. No other features of options granted were incorporated into the measurement of fair value. 22. Capital and reserves The components of equity are as follows: Share capital The share capital account includes the par value for all shares issued and outstanding. Share premium account The share premium account is used to record amounts received in excess of the nominal value of shares on issue of new shares. Merger reserve The merger reserve comprises the premium arising on shares issued as consideration for the acquisition of subsidiary undertakings where merger relief under section 612 of the Companies Act 2006 applies. Translation reserve The translation reserve is composed of the exchange rate movements in non-cash assets for foreign subsidiaries which arise on the translation of foreign subsidiaries. Movements in the reserve are disclosed in the Group Statement of Changes in Equity. Other reserve The other reserve represents the balance arising on the acquisition of the former non-controlling interest in 4D Pharma Research Limited. Share-based payment reserve The share-based payment reserve accumulates the corresponding credit entry in respect of share-based compensation charges. Movements in the reserve are disclosed in the Group Statement of Changes in Equity. Retained earnings Retained earnings includes the accumulated profits and losses arising from the Group Statement of Comprehensive Income and certain items from other comprehensive income attributable to equity shareholders net of distributions to shareholders. 56 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 23. Commitments Operating lease commitments The Group leases premises under non-cancellable operating lease agreements. The future aggregate minimum lease and service charge payments under non-cancellable operating leases are as follows: Land and buildings: – Not later than one year – After one year but not more than five years Other leases: – Not later than one year – After one year but not more than five years At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 296 1,087 2 3 1,388 150 600 2 3 755 265 604 — — 869 43 117 — — 160 Capital expenditure The Group has no committed capital expenditure at 31 December 2017 nor at 31 December 2016. The Company has no committed capital expenditure at 31 December 2017 nor at 31 December 2016. Contractual commitments The Group has the following non-cancellable contractual commitments at the balance sheet date: Research and development: – Not later than one year – After one year but not more than five years 24. Financial risk management Overview At 31 December 2017 Group £000 At 31 December 2017 Company £000 At 31 December 2016 Group £000 At 31 December 2016 Company £000 2,642 5,146 7,788 2,099 4,738 6,837 1,220 1,874 3,094 1,220 438 1,658 This note presents information about the Group’s exposure to various kinds of financial risks, the Group’s objectives, policies and processes for measuring and managing risk, and the Group’s management of capital. The Board of Directors has overall responsibility for the establishment and oversight of the Group’s risk management framework. The Executive Directors report regularly to the Board on Group risk management. It is, and has been throughout the year, the Group’s policy that no speculative trading in financial instruments is undertaken. Capital risk management The Company reviews its forecast capital requirements on a half-yearly basis to ensure that entities in the Group will be able to continue as a going concern while maximising the return to stakeholders. The capital structure of the Group consists of equity attributable to equity holders of the parent, comprising issued share capital, reserves and retained earnings as disclosed in note 20 and in the Group Statement of Changes in Equity. Total equity was £69.786 million at 31 December 2017 (31 December 2016: £86.483 million). The Company is not subject to externally imposed capital requirements. Liquidity risk The Group’s approach to managing liquidity is to ensure that, as far as possible, it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Group’s reputation. 4D pharma plc Annual Report and Accounts 2017 57 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 24. Financial risk management continued Liquidity risk continued The Group manages all of its external bank relationships centrally in accordance with defined treasury policies. The policies include the minimum acceptable credit rating of relationship banks and financial transaction authority limits. Any material change to the Group’s principal banking facility requires Board approval. The Group seeks to mitigate the risk of bank failure by ensuring that it maintains relationships with a number of investment grade banks. At the reporting date the Group was cash positive with no outstanding borrowings, except for a hire purchase agreement secured against the assets to which it relates. Categorisation of financial instruments 31 December 2017 Group Fixed rate £000 Floating rate £000 Non-interest bearing £000 Cash, cash equivalents and short-term deposits 38,133 11,865 Cash, cash equivalents and short-term deposits 38,133 11,060 Trade and other payables Hire purchase and finance leases Company Inter-company loans Trade and other payables Categorisation of financial instruments 31 December 2016 Group Cash, cash equivalents and short-term deposits Trade and other payables Company — (36) — — 38,097 11,865 (4,944) 45,018 — — — — 38,133 11,060 Fixed rate £000 Floating rate £000 Non-interest bearing £000 50,111 18,661 — — 50,111 18,661 Total £000 49,998 (4,944) (36) 49,193 33,159 (1,321) 81,031 Total £000 68,772 (3,758) 65,014 67,889 24,114 (289) 91,714 — (4,944) — — 33,159 (1,321) 31,838 — (3,758) (3,758) — 24,114 (289) Cash, cash equivalents and short-term deposits 50,111 17,778 Inter-company loans Trade and other payables — — — — 50,111 17,778 23,825 All categories of financial assets and liabilities are measured at amortised cost with the exception of the contingent consideration which is measured at fair value through the Statement of Total Comprehensive Income using a level 3 valuation technique. The values disclosed in the above table are carrying values. The Board considers that the carrying amount of financial assets and liabilities approximates to their fair value. Interest rate risk As the Group has no significant borrowings the risk is limited to the reduction of interest received on cash surpluses held at bank which receive a floating rate of interest. The exposure to interest rate movements is immaterial. Maturity profile The Directors consider that the carrying amount of the financial liabilities approximates to their fair value. As all financial assets are expected to mature within the next twelve months an aged analysis of financial assets has not been presented. 58 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 24. Financial risk management continued Maturity of liabilities and cash outflows Group Trade and other payables Hire purchase and finance leases 2017 Between one and two years £000 Between two and five years £000 — 11 11 — 15 15 Less than one year £000 4,943 10 4,953 Less than one year £000 3,758 — 3,758 2016 Between one and two years £000 Between two and five years £000 — — — — — — As all financial liabilities in the Company are expected to mature within the next twelve months no maturity of liabilities has been presented. Foreign currency risk The Group’s principal functional currency is Sterling. However, the Group has two subsidiaries whose functional currency is the Euro and the Group as a whole undertakes certain transactions denominated in foreign currencies. The Group is exposed to currency risk on sales and purchases that are denominated in a currency other than the respective functional currency of the Company. These are primarily US Dollars (USD) and Euros (EUR). Transactions outside of these currencies are limited. The Group may use forward exchange contracts as an economic hedge against currency risk, where cash flow can be judged with reasonable certainty. Foreign exchange swaps and options may be used to hedge foreign currency receipts in the event that the timing of the receipt is less certain. There were no open forward contracts as at 31 December 2017 or at 31 December 2016 and the Group did not enter into any such contracts during these years. The split of Group assets between Sterling and other currencies at the year end is analysed as follows: Group Cash, cash equivalents and deposits Trade and other payables Hire purchase and finance leases 2017 2016 GBP £000 48,676 (3,439) — 45,237 USD £000 90 (35) — 55 EUR £000 Total £000 GBP £000 1,232 49,998 67,413 (1,469) (4,943) (36) (36) (831) — (273) 45,019 66,582 USD £000 11 (80) — (69) EUR £000 Total £000 1,348 68,772 (2,847) (3,758) — — (1,499) 65,014 Sensitivity analysis to movement in exchange rates The Directors have considered the transactions in foreign currency and have concluded that, as there is no sales revenue and the majority of the Group transactions are denominated in Sterling, the exposure to exchange rate risk is negligible. 4D pharma plc Annual Report and Accounts 2017 59 4dpharmaplc.comF Notes to the Financial Statements continued For the year ended 31 December 2017 25. Related party transactions Key management compensation Executive Directors: Salaries and short-term benefits Employer’s National Insurance and social security costs Fees for services provided as Non-Executive Directors: Salaries and short-term benefits Employer’s National Insurance and social security costs Other key management: Salaries and short-term benefits Employer’s National Insurance and social security costs Employer’s pension contributions Share-based payment charge Group Transactions with Directors and related entities Year to 31 December 2017 £000 Year to 31 December 2016 £000 202 25 227 50 4 54 775 134 26 302 1,237 202 25 227 50 2 52 451 54 — 131 636 During the year Aquarius Equity Partners Limited, an entity controlled by Duncan Peyton and Dr Alexander Stevenson, charged the Group £2,116 for office expenses (31 December 2016: £8,368). As at 31 December 2017 £Nil was due from Aquarius Equity Partners Limited (31 December 2016: £3,144). Transactions with key personnel and related entities During the year summ.it assist llp, an entity in which Stephen Dunbar is a partner, recharged the Group £3,593 for IT equipment and software (31 December 2016: £23,690), £377 for IT support (31 December 2016: £4,126), £65,939 for accounting and bookkeeping services (31 December 2016: £60,328), £12,500 for staff recruitment fees (31 December 2016: £Nil) and £3,718 for other costs (31 December 2016: £3,199). At the year end £5,065 was due to summ.it assist llp (31 December 2016: £6,766). 3C SAS, an entity owned by Christophe Carité, provided consultancy services to the Group of £Nil (31 December 2016: £182,324) and recharged costs of £Nil (31 December 2016: £73,029). At the year end £Nil was due to 3C SAS (31 December 2016: £Nil). Biomar Microbial Technologies, an entity in which Antonio Fernandez is a director, charged rent and building service costs to the Group of £302,487 (31 December 2016: £104,987). At the year end £5,469 was due to Biomar Microbial Technologies (31 December 2016: £27,411). Company Transactions between 100% owned Group companies have not been disclosed as these have all been eliminated in the preparation of the Group financial statements. Transactions with Directors and related entities During the year Aquarius Equity Partners Limited, an entity controlled by Duncan Peyton and Dr Alexander Stevenson, charged the Company £2,116 for office expenses (31 December 2016: £8,368). As at 31 December 2017 £Nil was due from Aquarius Equity Partners Limited (31 December 2016: £3,144). 60 4D pharma plc Annual Report and Accounts 2017 FINANCIAL STATEMENTS 4dpharmaplc.com 25. Related party transactions continued Company continued Transactions with key personnel and related entities During the year summ.it assist llp, an entity in which Stephen Dunbar is a partner, recharged the Company £3,593 for IT equipment and software (31 December 2016: £23,590), £377 for IT support (31 December 2016: £4,126), £65,939 for accounting and bookkeeping services (31 December 2016: £53,950), £12,500 for staff recruitment fees (31 December 2016: £Nil) and £3,718 for other costs (31 December 2016: £3,199). At the year end £5,065 was due to summ.it assist llp (31 December 2016: £5,854). 3C SAS, an entity owned by Christophe Carité, provided consultancy services to the Company of £Nil (31 December 2016: £182,324) and recharged costs of £Nil (31 December 2016: £73,029). At the year end £Nil was due to 3C SAS (31 December 2016: £Nil). All related party transactions during the current and previous year were considered to be at arm’s length. F Company Information Country of incorporation Auditor RSM UK Audit LLP 3 Hardman Street Manchester M3 3HF Nominated advisor and joint broker Zeus Capital Limited 82 King Street Manchester M2 4WQ and 10 Old Burlington Street London W1S 3AG United Kingdom Company number 08840579 Directors DR Norwood (Non-Executive Chairman) DJ Peyton AJ Stevenson T Engelen (Non-Executive) Company secretary and registered office LS Dale 4D pharma plc 9 Bond Court Leeds LS1 2JZ Joint broker Bryan Garnier & Co. Limited Beaufort House 15 St. Botolph Street London EC3A 7BB Registrar Link Asset Services The Registry 34 Beckenham Road Beckenham Kent BR3 4TU 4D pharma plc Annual Report and Accounts 2017 61 4 D p h a r m a p l c A n n u a l R e p o r t a n d A c c o u n t s 2 0 1 7 4D pharma plc 9 Bond Court Leeds LS1 2JZ