Annual Report 2015 Revolutionising the treatment of ARDS and activation of tumour immunity Contents faron ph arm ac euti cals corpor ate gover nance Saving Lives Endothelial Barrier Is Everything Highlights strat egic report Introduction Chairman’s Statement Operational Review Financial Review Principal Risks and Uncertainties pipeli ne Overview Traumakine® The INTEREST Study Clevegen® 4 5 6 8 9 10 12 14 17 18 22 24 Overview Board of Directors Directors’ Report Corporate Governance Report Directors’ Remuneration Report Statement of Directors’ Responsibilities finan cial repo rt Statement of Comprehensive Income Balance Sheet Statement of Cash Flows Statement of Changes in Equity Notes 27 28 32 35 39 43 44 45 46 47 48 3 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 fa ron pha rmaceut ic als Saving Lives Faron Pharmaceuticals Ltd is a drug discovery and development company focused on creating novel treatments for medical conditions with significant unmet needs. Faron is based in Turku, Finland. The Company has identified several molecular mechanisms involved in the control of endothelial functions as a source of innovations. Faron currently has a pipeline of prod- ucts focusing on acute organ traumas, cancer immunotherapy and vascular damage. The Company’s lead candi- date Traumakine®, has been developed to treat Acute Respiratory Distress Syndrome (“ARDS”), a rare, severe, life-threatening medical condition for which there is currently no approved treatment. Traumak- pharmaceutical ine® is now in a pan-European pivotal Phase III study (INTEREST). Besides Traumakine®, Faron’s pipeline consists of early stage assets includ- ing a pre-clinical anti-Clever-1 antibody named Clevegen®. Clevegen® is fo- cused on converting the immune envi- ronment around a tumour from being immune suppressive to immune stimu- lating and represents a novel im muno- oncology approach. Faron Pharmaceu- ticals Ltd is listed on London AIM under the ticker ‘FARN’. 4 fa ron pha rmaceut ic als Endothelial Barrier Is Everything Imagine cars speeding in a dark tunnel, 100,000 kilometers long, without lights, at a speed of 700–800 km/h, navigat- ing their way to their destinations. The situation described above ap- plies to cells, which migrate in our vasculature system and need to move around. This movement is part of the normal surveillance system to detect any harmful event that would put our existence at risk. This is our innate de- fense system, but it also provides the initial immunological reaction against any foreign material entering the body. The “GPS” for these moving cells is a molecular recognition system con- sisting of special molecules on the surface of migrating cells and their counterparts on the surface of vascular endothelial cells. These “homing” mole- cules form an essential cellular traffick- ing guidance system, which we all need to maintain our normal physiology. Un- fortunately, many diseases utilise this system as well. This calls for ways to control the guidance system in order to prevent or heal diseases. Among these diseases the most harmful ones are extended inflammations and cancer spread. Our vascular system also includes a drainage system called lymphatics. The same guidance system also operates there but the recognition molecules are unique. In both of these capillary net- works the endothelial cells control the entry of migrating cells and maintain a barrier between circulation and tis- sues. Without this barrier, we encounter a catas trophic situation, which can lead to life-threatening conditions. Faron has identified several new en- dothelial molecules involved in this guid- ance system and the maintenance of the endothelial barrier. We believe that the control of these molecules provides a unique way to treat many life- threatening conditions with high unmet medical needs. Our two lead indications – acute respiratory lung injury and control of tu- mour immunity – are both based on the malfunction of the endothelial barrier, both of which we have learned to control. We hope that our 2015 Annual Report inspires you to explore our technologies, which have originated from world-class academic laboratories and developed by Faron as a novel proprietary treatment for Acute Respiratory Distress Syndrome (ARDS) and tumour immune suppression. 5 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 FARON PHARMACEUTICALS LTD ANNUAL REPORT 2015 fa ron pha rmaceut ic als Highlights 2015 • Established the pivotal pan-European Phase III INTEREST trial for Traumakine® in development for the treatment of Acute Res- piratory Distress Syndrome (“ARDS”) including 55 hospitals with significant intensive care units in seven European countries (UK, France, Germany, Spain, Italy, Belgium and Finland). • First Patient recruited in Phase III INTEREST trial in December 2015. • Entered into agreements with A&B (HK) Company Limited and CMS Pharma Co. Ltd in mainland China, Hong Kong, Macau and Taiwan (the “Greater China Area”) to license Traumakine® in May 2015. • Reported second contract period on the EU FP7 programme for Traumakine® ending 30 November, 2015 triggering next period payments if accepted. • Entered into a collaboration agreement with the Turku PET Centre, one of the largest positron emission tomography centers in Eu- rope, on the development of novel cancer immunotherapy Cleve- gen® in June 2015. • Agreement with Swiss-based Selexis SA for SUREtechnology Platform™ and SURE CHO-M Cell Line™ for use in the develop- ment and production of Clevegen® in November 2015. • Key Publication on Novel Cancer Immunotherapy Mechanism Re- lated to Clevegen® published in Journal of Immunology in Novem- ber 2015. • Granted €1.5 million in funding to progress the preclinical devel- opment of Clevegen®, Faron´s novel cancer immunotherapy drug candidate. The funding was awarded by Tekes, the Finnish Fund- ing Agency for Innovation in December 2015. 6 ANNUAL REPORT 2015 FARON PHARMACEUTICALS LTD Financial Highlights • Successful AIM IPO in November 2015, raising €14.2 million in new funds for the Company. • €5.1 million pre-IPO funding from A&B (HK) Company Limited in May 2015, in conjunction with Traumakine® agreement for Greater China. • Total equity raised of €19.3 million (net €16.9 million) being used to fund initial pan-European Phase III INTEREST trial in respect of Traumakine® for treatment of Acute Respiratory Distress Syn- drome (“ARDS”) as well as progressing Clevegen®, the Compa- ny’s early stage cancer immunotherapy programme. • Generated €0.5 million (2014: €1.0 million) revenues mainly from milestone payments from Maruishi. In addition the Com- pany recorded grant income of €0.7 million (2014: €0.1 million) from the EU FP7 grant. • Tekes granted a €1.5 million R&D loan to progress the Clevegen® programme. • On 31 December 2015 the Company held cash balances of €11.1 million (2014: €0,2 million). • The operating loss for the financial year ended 31 December 2015 was €6.2 million (2014: €1.4 million loss) • Net assets on 31 December 2015 were €11.2 million (2014: €0.5 million1) Post-Period End Highlights • On 7th January 2016, Faron announced positive results from the Phase II Japanese study for Traumakine® conducted by Faron’s Japanese licensing partner, Maruishi Pharmaceutical Co., Ltd. • On 1st March 2016 Faron announced a patent application to fur- ther strengthen protection for its novel Traumakine® formulation (FP-1201-lyo), seeking exclusivity for the next 20 years which would reinforce Faron’s global patent protection strategy for the product. • Recruitment is on track and Faron anticipates that all 55 sites for the Traumakine® clinical trial will be open in April 2016. 1 The net assets on 31 December 2014 include the €1.1 million con- vertible loan that was converted to equity in January 2015. 7 FARON PHARMACEUTICALS LTD ANNUAL REPORT 2015 strategi c report Addressing Significant Unmet Medical Needs Faron is a drug discovery and development com- pany focused on creating novel treatments for medical conditions with significant unmet needs. The Company has a pipeline of clinical stage products for the treatment of acute organ traumas, cancer immunotherapy and vascular damage. 8 Strategy Faron’s strategy is to maximise the po- tential of its pipeline of drug candidates and to progress the development of its lead product Traumakine®. Faron has identified several new endothelial mol- ecules involved in the maintenance of the endothelial barrier which is a thin layer or membrane of cells that lines blood and lymphatic vessels to separate blood content from tissues. The Com- pany believes that the control of these molecules provides a unique way to treat many life-threatening conditions with high unmet medical needs. Faron collaborates with its strategic partners in research, manufacturing and drug development to bring new pharma- ceutical products to market in a timely and cost-effective manner. Faron has formed a core team of leading scien- tists in capillary biology and dis eases arising from vascular leakage. The Com- pany has established links with leading laboratories and clinics based at Turku University in Finland, University College London and other institutions. To date, Faron has operated on a relative ly low cost basis by employing only key members of staff and out- sourcing where possible. Typically all development work up to the proof-of- concept stage of drug development is carried out in the innovators’ laborato- ries. The Company outsources all of its manufacturing activities in relation to its products to third parties and collab- orates with Contract Research Organi- sations (CROs) to carry out the clinical development programmes. Faron mon- itors and evaluates potential commer- cial opportunities for its established drug candidates like Traumakine® and Clevegen®, as and when they arise, and will consider how best to crystallise as much value as possible for Sharehold- ers, which may include holding rights in main territories for as long as it is feasi- ble, and in certain circumstances up to the marketing stage. strategi c report Chairman´s Statement Faron has made significant progress with its pipeline in the last year. The small but highly experienced manage- ment team is passionate about and committed to their work in life-saving drug development. The Company has chosen to develop new drugs for true unmet medical needs in two critical areas, Acute Respiratory Distress Syn- drome (ARDS) and cancer immuno- therapy. These two apparently diverse clinical indications are built on Faron’s thorough scientific knowledge of the endothelial barrier function and control providing a solid basis to successfully execute the Traumakine® and Cleve- gen® projects. Faron’s lead drug candidate Trau- makine®, now in the pivotal, pan-Euro- pean Phase III INTEREST trial, is at the heart of the Company’s mission. It aims to treat ARDS, an orphan, life-threaten- ing medical condition which currently has no available drug treatment. ARDS is not common, annually about 370,000 people across Europe and the US are diagnosed, but the condition is serious with about 30 to 45% mortal- ity rate. Data from a Phase I/II study of Traumakine® for ARDS, published in the Lancet, was associated with an 81% re- duction in the odds of 28 day mortality rate. We believe that Traumakine® rep- resents a significant opportunity to help ARDS patients, the hospitals that treat these patients and the patients´ families. Immunotherapy offers enormous po- tential for cancer treatment by stimulat- ing the patient’s own natural immune re- sponse to combat the disease. Faron’s pre-clinical immunotherapy candidate Clevegen® causes conversion of the immune environment around a tumour from immune suppressive to immune stimulating, by reducing the number of tumour-associated macrophages (TAMs). We believe that Clevegen® is well differentiated from other immuno- therapies through its specific targeting of M2 TAMs which facilitate tumour growth, while leaving intact the M1 TAMs that support immune activation against tumours. In November 2015, Faron was ad- mitted to trading on the AIM market of the London Stock Exchange. The capital raised is devoted to advancing the Com- pany’s two programmes and provides a positive start for 2016. With the AIM listing, I would like to welcome new Shareholders on behalf of the new Board, and thank the previ- ous Board, employees and advisors for a successful 2015. At the time of the listing, the previous Chairman, Matti Manner, stepped down and became Vice-Chairman. We are all indebted to him for his previous leadership. A number of new Board members were appointed at the listing: Dr Jonathan Knowles, Mr Leopoldo Zambeletti, Dr Huaizheng Peng and myself, Dr Frank Armstrong as Chairman. It is a privilege to participate in the ongoing success achieved by Faron. The Board is very grateful to the staff of the Company and particularly to Dr Markku Jalkanen (CEO) and Mr Yrjö Wichmann (CFO) for their commitment and leadership. Fa- ron is an ambitious company and this is reflected in the employees and lead- ership of the Company. The Board is committed to delivering the strategy described in the IPO Ad- mission Document. Our key focus is to complete the recruitment for the Phase III INTEREST trial during 2016, as we regard this as a major value inflection point for Shareholders. We also believe that the progress on Clevegen® by our scientific collaborators will provide ex- citing news in 2016. We will continue to look for opportunities to deliver and enhance value to our Shareholders as well as patients who will benefit from the new drugs Faron is developing. Dr Frank M Armstrong – Chairman 9 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 strategi c report Operational Review “We are very excited to become part of the international, publicly quoted biotech sector, which is a key driver in the generation of new pharmaceutical treatments for unmet medical needs.” “Traumakine® has been granted Orphan Drug Designation in Europe which allows a period of 10 years of market exclusivity following marketing approval by the EMA.” 10 2015 has been a transformational year for Faron which saw the Company join- ing AIM in November 2015 and achieving a number of scientific and development milestones. Faron’s business growth prospects continue as outlined in the IPO Admission Document in November 2015. We are very excited to become part of the international, publicly quoted biotech sector, which is a key driver in the gener- ation of new pharmaceutical treatments for unmet medical needs. The main reason for the IPO was to help us execute the further development of our exciting pipeline projects, Trau- makine® and Clevegen®. The pre-IPO round in May 2015 allowed us to initiate preparation for the pivotal, pan-Euro- pean Phase III INTEREST trial for Trau- makine® and the proceeds from the IPO round enabled full execution of all the re- quired agreements to open study sites. We can now fully utilise the €6.0 million EU grant to support this final step of Traumakine® development in Europe. Traumakine® Development Faron’s lead drug Traumakine® is cur- rently in Phase III development for the treatment of Acute Respiratory Distress Syndrome (“ARDS”). ARDS is a severe, life-threatening medical condition char- acterised by widespread capillary leak- age and inflammation in the lungs, most often as a result of sepsis, pneumonia or significant trauma. Currently there are no pharmacological treatments for ARDS, an orphan disease with a high, 30 to 45% mortality rate. Traumakine® has been granted Orphan Drug Designa- tion in Europe which allows a period of 10 years of market exclusivity following marketing approval by the EMA. In December 2015, the first patient was recruited into the Traumakine® pan-Eu- ropean Phase III INTEREST trial. The recruitment of the first patient, so soon after the Company’s recent IPO is con- sistent with the anticipated timeline of 12 to 18 months required to complete recruitment for the pivotal Phase III trial for Traumakine®. The Phase III IN- TEREST trial is being led by Professor Geoff Bellingan from University College London Hospital and Professor Marco Ranieri from the University of Rome. Subject to the completion of successful Phase III INTEREST trial and achieve- ment of regulatory approvals, Trauma- kine® could be the first effective, mech- disease-specific anistically-targeted, pharmacotherapy for ARDS patients. To date, Faron has entered into agreements with two pharmaceutical companies to carry out the clinical de- velopment and commercialisation of Traumakine® in Japan and the Greater China Area. Faron owns the IPR and marketing rights in respect of Trauma- kine® in all other territories. A&B (HK) Company Limited and CMS Pharma Co. Ltd – In May 2015, Faron entered into a licence and asset transfer agreement with A&B (HK) for the commercialisation of Traumakine® in the Greater China Area. It is intended that A&B (HK)’s commercialisation ac- tivities of Traumakine® will be conduct- ed by a member of the CMS Group, a rapidly growing pharmaceutical group listed on the Hong Kong Stock Ex- change. Alongside this agreement, A&B (HK) provided equity funding of €5.1 mil- lion in aggregate. CMS Pharma Co. Ltd owns the right to import, register, mar- ket, distribute, promote and sell Trau- makine® in the Greater China Area. FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Maruishi Pharmaceutical Co., Ltd – In 2011 Faron licensed to Maruishi, a Jap- anese pharmaceutical company, the rights to develop and commercialise Traumakine® in Japan. In January 2016, Faron announced that Maruishi had ob- tained positive results from the Phase II Japanese study for Traumakine®. Based on these results Maruishi is now plan- ning a pivotal clinical trial to be conduct- ed in Japan. Clevegen® Development One of Faron’s key areas of focus is to develop a cancer treatment that sup- ports the hosts’ immune defences against tumours, as these are often sup- pressed in cancer patients. Faron’s sec- ond most advanced drug development project, Clevegen®, revolves around Clever-1, a cell surface molecule involved in cancer growth and spread. The active pharmaceutical ingredient of Clevegen® is a humanised anti- Clever-1 antibody. In June 2015, Faron entered into a collaboration agreement with the Turku PET Centre, one of the largest positron emission tomography centres in Eu- rope, for the development of Clevegen®. The PET project will assist Faron in opti- mising the use of Clevegen® for cancer treatment, as well as guide diagnosis, pre-clinical and clinical development and measure potentially novel clinical end points to demonstrate efficacy. In November 2015, the Journal of Im- munology, the highly ranked journal of the American Association of Immunol- ogy, published data on Clever-1 function related to Faron’s novel cancer immuno- therapy antibody Clevegen®. Following this, in December 2015, Faron was granted €1.5 million funding from Tekes, the Finnish Funding Agency for Innovation, to progress the pre-clini- cal development of Clevegen®. The fund- ing is a government loan (“Loan”), which covers 50% of the budgeted cost of the pre-clinical development of Clevegen®. Future Outlook ”Subject to the completion of successful Phase III INTEREST trial and achievement of regulatory approvals, Traumakine® could be the first effective, mechanistically- targeted, disease-specific pharmacotherapy for ARDS patients.” The key aim for Faron in 2016 is the completion of the Phase III INTEREST trial recruitment. We anticipate that all 55 sites will be open in April 2016 and the observed recruitment is already higher than the anticipated 0.5 patients/ site/month. We therefore reiterate that the INTEREST trial results should be available in H2 2017. We also expect our contracted, scientific collaborators to generate exciting new data on Clever-1 function in tumour immune suppression. Markku Jalkanen – CEO 11 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 strategi c report Financial Review Key Performance Indicator Taxation The Company’s tax credit for the fiscal year 2015 can be recorded only after the Finnish tax authorities have ap- proved the tax report and confirmed the amount of tax-deductible losses for 2015. The total amount of cumulative tax losses carried forward approved by tax authorities on 31 December 2015 was €5.7 million (2014: €3.2 million). These losses can be utilised during the years 2019 to 2024 by offsetting them against profits. In addition, Faron has €2.8 million research and development costs incurred in the financial years 2010 and 2011 that have not yet been deducted in its taxation. This amount can be deducted over an indefinite peri- od at the Company’s discretion. Net cash inflow from financing activities increased by €17.3 million to €18.1 mil- lion for the year due to the receipt of net proceeds of €18.1 million from an equity placings completed in May-June 2015 and the IPO in November 2015. Financial Position As at 31 December 2015, total cash and cash equivalents held were €11.1 mil- lion (2014: €0.2 million). Headcount Average headcount of the Company for the year was 6 (2014: 5). The increase in headcount is attributable to the com- mencement of the Phase III INTEREST trial. Losses Shares and Share Capital Loss before income tax was €6.2 million (2014: €1.4 million). Net loss for the year was €6.2 million (2014: €1.4 million), representing a loss of €0.30 per share (2014: €0.09 per share) (adjusted for the changes in share capital). Cash Flows The Company had a net cash inflow of €10.8 million for the year ended 31 De- cember 2015, compared to a net cash inflow of €0.2 million for the previous year. Cash used by operating activities increased by €6.8 million to €7.1 million for the year, compared to €0.4 million for the year ended 31 December 2014. This was driven by an increase in research and development investments, as well as an overall increase in general and ad- ministration costs. increased On 24 February 2015, the number of Ordinary Shares was to 1,623,791 by the issue of 78,166 new Or- dinary Shares at a subscription price of €14.40. The shares were issued due to conversion of the 2014 convertible loan, which so became fully converted. The subscription price was credited in full to the Company’s reserve for invested un- restricted equity, and the share capital of the Company was not increased. The conversion did not have a cash effect in 2015; On 19 May 2015, the number of Ordi- nary Shares was increased to 1,843,356 by the issue of 219,565 new Ordinary Shares at a subscription price of €15.41. The subscription price was credited in full to the Company’s reserve for invested unrestricted equity, and the share capital of the Company was not increased; Faron is a late clinical stage drug de- velopment company with no recurring sales and thus the primary Key Perfor- mance Indicators (KPI) followed by the Board focus on cash balances and other related information. During 2015, the Company generated €10.8 million free cash flow mainly due to the successful fundraising. The Board will consider the appropriateness of monitoring addition- al KPIs as the Company’s operations advance. Revenue and Other Operating Income The Company’s revenue was €0.5 mil- lion for the year ended 31 December 2015 (2014: €0.9 million), which com- prised of milestone income from license partner Maruishi and sale of excess API (Active Pharmaceutical Ingredient) material. The Company also recorded €0.7million (2014: €0.1 million) of other operational income. This comprised of income recognised from the European Commission FP7 grant in support of the Traumakine® programme. There were no new sources of other operating in- come during the year. Share-based Compensation As part of the IPO process, a number of options were awarded to Directors and key personnel. This had no cash impact on the results for the year, however ac- counting standards require this share based compensation to be recognised in the Consolidated Statement of Com- prehensive Income, resulting in a charge of €0.5 million (2014: €0.0 million). 12 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 On 9 June 2015, the number of Ordinary Shares was increased to 1,926,555 Ordi- nary Shares by the issue of 83,199 new Ordinary Shares at a subscription price of €20.03. The subscription price was credited in full to the Company’s reserve for invested unrestricted equity, and the share capital of the Company was not increased; By resolution of the Extraordinary General Meeting held on 15 September 2015, the number of Ordinary Shares was increased to 19,265,550 by the is- sue of 17,338,995 new Ordinary Shares to the Shareholders without payment in proportion to their holdings so that nine Ordinary Shares were issued for each ex- isting Ordinary Share (the “Share Split”); By resolution of a Board Meeting held on 16 September 2015, the Company issued 151,400 warrants (each warrant representing an entitlement to sub- scribe for one Ordinary Share) to Whit- man Howard (which were subscribed on 16 September 2015). The warrants are divided into two tranches: in the first tranche, 109,800 warrants with a sub- scription price of €1.55 (“A Warrants”), and in the second tranche, 41,600 war- rants with a subscription price of €2.01 (“B Warrants”). Any “A” Warrants shall be exercised during the subscription period commencing on 2 November 2015 and ending on 7 May 2018. Any “B” Warrants shall be exercised during the subscrip- tion period commencing on 2 November 2015 and ending on 28 May 2018; By resolution of the Extraordinary General Meeting held on 15 September 2015, the Company adopted the 2015 Share Option Plan and granted the Op- tions detailed in Directors´ Remuneration Report set out in the Annual Report and Accounts. By resolution of a Board Meeting held on 11 November 2015, the Company resolved to issue (i) 2,417,113 Ordinary Shares without payment into treasury, in order for such Ordinary Shares to be transferred to Placees pursuant to the Placing on a delivery versus payment basis on Admission, (ii) 44,044 Ordinary Shares and VCT shares and EIS shares pursuant to the placing, and (iii) 1,384,997 Ordinary Shares as subscription shares pursuant to the subscription. Pre-IPO Financing In May – June 2015 the Company raised a total of €5,049,972 issuing a total of 302,764 new shares to A&B (HK) Com- pany Limited in two separate tranches with an average subscription price of €16.68 . After the Share Split the number of shares increased to 3,027,640 and the average subscription price was €1.67. A&B is a Hong Kong company, which is related to CMS by virtue of both having a common controlling shareholder. IPO The Company was admitted to trading on AIM in November 2015 alongside the issue of 3,846,154 new shares with a subscription price of 260 pence, or €1.83, per share raising £10,000,000, or €14,210,967. A total of 16 investors par- ticipated in the IPO of which 12 were new investors in the Company. The majority of the funds raised and the new inves- tors were from the UK. At 31 December 2015, the Company had issued a total of 23,111,704 shares. All shares are ordi- nary shares with equal rights. Money Raised to Date To date, the Company has been funded with a total of approximately €32.8 mil- lion, made up of a combination of equity, debt and grant funding, which has been used to develop the Company’s products and intellectual property. The Company has also generated revenues of €3.3 mil- lion to date through the receipt of mile- stone payments pursuant to certain of its licensing arrangements and the sale of surplus raw materials. Yrjö E K Wichmann – CFO 13 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 strategi c report Principal Risks and Uncertainties Faron is a late clinical stage biopharmaceutical company and, in common with other companies operating in this field, is subject to a number of risks and uncertainties. The principal risks and uncertainties identified by Faron for the year ended 31 December 2015 are below. Research and Development Faron’s lead drug candidate is in clini- cal stage of development and may not be successful in the clinical trials and thus Faron may not be able to develop approved or marketable products. Tech- nical risk is also present at each stage of the discovery and development pro- cess of other, earlier stage products with challenges in biology (including the ability to produce candidate drugs with appropriate safety, efficacy and usability characteristics). Additionally, drug de- velopment is a highly regulated environ- ment which itself presents technical risk through the need for study designs and data to be accepted by regulatory agen- cies. Furthermore, there can be no guar- antee that the Company will be able to, or that it will be commercially advanta- geous for the Company to, monetise the value of its intellectual property through entering into licensing deals with phar- maceutical companies. Commercial industry, being biotechnolo- Faron’s gy and pharmaceutical industries, are very competitive. The Company’s com- include major multinational petitors pharmaceutical companies, biotech- nology companies and research insti- tutions. Many of its competitors have substantially greater financial, techni- cal and other resources, such as larger research and development staff. The Company’s competitors may succeed in developing, acquiring or licensing drug product candidates that are more effec- tive or less costly than any product can- didate which the Company is currently developing or may develop, which may have a material adverse impact on the Company. Dependence on Key Personnel and Scientific and Clinical Collaborators The Company’s success is highly de- pendent on the expertise and experience of the Directors and the key Manage- ment. Whilst the Company has entered into employment and other agreements with each of these key personnel, the retention of such personnel cannot be guaranteed. Should key personnel leave or no longer be party to agreements or collaborations with the Company, the Company’s business prospects, fi- nancial condition and/or results of op- erations may be materially adversely 14 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 affected. To develop new products and commercialise its current pipeline of products, the Company relies, in part, on the recruitment of appropriately quali- fied personnel, including personnel with a high level of scientific and technical expertise. There is currently a shortage of such personnel in the pharmaceuti- cal industry, meaning that the Company is likely to face significant competition in recruitment. The Company may be un able to find a sufficient number of appropriately highly-trained individuals to satisfy its growth rate which could affect its ability to develop as planned. Regulatory Environment The Company operates in a highly regu- lated environment. Whilst the Company will take every effort to ensure that the Company and its partners comply with all applicable regulations and reporting requirements, there can be no guaran- tee of this. Failure to comply with ap- plicable regulations could result in the Company being unable to successfully commercialise its products and/or re- sult in legal action being taken against the Company, which could have a mate- rial adverse effect on the Company. The Company will need to obtain various regulatory approvals (including from the FDA and the EMA) and com- ply with extensive regulations regarding safety, quality and efficacy standards in order to market its products. While efforts have been and will be made to ensure compliance with governmen- tal standards and regulations, there is no guarantee that any product will be able to achieve the necessary regula- tory approvals to promote that product in any of the targeted markets and any such regulatory approval may include significant restrictions for which the Company’s products can be used. In addition, the Company may be required to incur significant costs in obtaining or maintaining its regulatory approvals. Delays or failure in obtaining regulatory approval for products would likely have a serious adverse effect on the value of the Company and have a consequent impact on its financial performance. Intellectual Property and Proprietary Technology The Company relies and will rely on in- tellectual property laws and third party non-disclosure agreements to protect its patents and other proprietary rights. The IPR on which the Company’s busi- ness is based is a combination of patent applications and confidential business know-how. No assurance can be given that any currently pending patent appli- cations or any future patent applications will result in patents being granted. In addition, there can be no guarantee that the patents will be granted on a time- ly basis, that the scope of any patent protection will exclude competitors or provide competitive advantages to the Company, that any of the Company’s patents will be held valid if challenged, or that third parties will not claim rights in, or ownership of, the patents and other proprietary rights held by the Company. Despite precautions taken by the Company to protect its products, unau- thorised third parties may attempt to copy, or obtain and use the Company’s IPR and other technology that is incorpo- rated into its pharmaceutical products. In 15 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 addition, alternative technological solu- tions similar to the Company’s products may become available to competitors or prospective competitors of the Company. It should be noted that once granted, a patent could be challenged both in the relevant patent office and in the courts by third parties. Third parties can bring ma- terial and arguments, which the patent office granting the patent may not have seen at the time of granting the patent. Therefore, whilst a patent may be grant- ed to the Company it could in the future be found by a court of law or by the pat- ent office to be invalid or unenforceable or in need of further restriction. Should the Company be required to assert its IPR, including any patents, against third parties it is likely to use a significant amount of the Company’s resources as patent litigation can be both costly and time consuming. No assurance can be given that the Company will be in a po- sition to devote sufficient resources to pursue such litigation. Any unfavourable outcomes in respect of patent litigation could limit the Company’s IPR and activi- ties moving forward. The Directors do not believe that its lead pharmaceutical drug candi- dates, future drug candidates in de- velopment, and proprietary processes for generating those candidate com- pounds infringe the IPR of any third parties although shareholders should note the risk factor headed “US Patent owned by Biogen” in the Admission Document dated 18 November 2015. However, it is impossible to be aware of all third party intellectual property. The Company’s research has includ- ed searching and reviewing certain publicly available resources which are examined by senior levels of manage- ment in order to keep abreast of devel- opments in the field. 16 Financial The Company has incurred significant losses since its inception and does not have any approved or revenue-generat- ing products. The Company expects to incur losses for the foreseeable future, and there is no certainty that the busi- ness will generate a profit. The Compa- ny may not be able to raise additional funds that will be needed to support its product development programmes or commercialisation efforts, and any additional funds that are raised could cause dilution to existing investors. Operational The Company’s development and pros- pects depend to a significant degree on the experience, performance and con- tinued service of its senior management team including the Directors. The Com- pany has invested in its management team at all levels. The Directors also believe that the senior management team is appropriately structured for the Company’s size and is not overly de- pendent upon any particular individual. The company has entered into contrac- tual arrangements with these individu- als with the aim of securing the servic- es of each of them. Retention of these services or the identification of suitable replacements, however, cannot be guar- anteed. The loss of the services of any of the Directors or other members of the senior management team and the costs of recruiting replacements may have a material adverse effect on the Company and its commercial and financial per- formance and reduce the value of an investment in the Ordinary Shares. This report was approved by the Board on 9 March 2016 and signed on its behalf. FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 ANNUAL REPORT 2015 FARON PHARMACEUTICALS LTD PIPEL INE Revolutionising the Treatment of ARDS and Activation of Tumour Immunity Traumakine® is Faron’s spearhead project Research Pre-clinical Phase I/II Phase III Acute Respiratory Distress Syndrome (ARDS) Rupture of Abdominal Aortic Aneurysm (RAAA) Single organ injury Clevegen® Research Pre-clinical Phase I/II Phase III Anti-CD20 resistant lymphomas TAM-positive Hodgkin’s lymphomas Farbetic D-ARDS Faron has identified several molecular mechanisms involved in the control of endothelial functions as a source of innovation. The Company currently has a pipeline focusing on acute organ traumas, cancer immunotherapy and vascular damage. The fast evolving Faron pipeline con- sists of drug candidates (FP-1201-lyo and FP-1305) from two major Faron programmes – Traumakine® and Cleve- gen®, respectively. The lead indication of the Traumakine® programme is Acute Respiratory Distress Syndrome (ARDS). This and the other indications (Rupture of Abdominal Aortic Aneurysm RAAA) are all based on the same Chemistry and Manufacturing Controls (CMC) dossier sections, allowing fast protocol adjusted filing for indication expansion. Similarly, Clevegen® indications utilise one common dossier with a protocol adapted to each indication. 17 Faron´s lead candidate Traumakine® addresses the treatment of Acute Respiratory Distress Syndrome ARDS, a severe, orphan lung disease. Currently there is no pharmaceutical treatment for this condition with a reported mortality rate of 30 to 45%. The scientific rationale for Traumakine® treatment is based on the use of interferon-beta for the restoration of the endothelial barrier function in ARDS patients. 18 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 PIPELINE: TRAUMAKINE ® Acute Respiratory Distress Syndrome ARDS ARDS is a life-threatening medical condi- tion characterised by widespread inflam- mation in the lungs and sudden failure of the respiratory system. ARDS causes inflammation of the alveoli in the lungs which become unable to perform the normal oxygenation of blood. It is char- acterised by rapid breathing, difficulty getting enough air into the lungs and low blood oxygen levels. Common causes of ARDS are sepsis, pneumonia, aspira- tion of fumes, food or stomach contents going into the lung or significant trauma. The condition was first described in 1967 and gained wide attention during the Vietnam War when it was nicknamed “white lung” as X-rays presented the lungs of the patients as white. ARDS is the leading cause of res- piratory failure in intensive care unit patients requiring mechanical ventila- tion. Despite progress in critical care medicine ARDS is currently associated with a mortality rate of 30 to 45% de- pending on the severity of the condition. Although ARDS mortality has decreased in the last decade due to improvements in supportive care and in the treatment of the underlying conditions, it still re- mains high. Currently, patients suffering from ARDS are generally treated with lung-protective mechanical ventilation. This treatment is accompanied by an- cillary support such as positioning, flu- id management, and food restrictions. Extra corporeal support may also be provided depending on the severity of the condition. Complications which can also arise whilst a patient is being treat- ed for ARDS include the development of infections, pneumothorax, lung scarring and blood clots which can develop into a pulmonary embolism. Patients who recover from ARDS may suffer other consequences of ARDS after being dis- charged from the intensive care unit. A recovering patient’s quality of life may be adversely affected by permanent damage to the lungs, respiratory prob- lems, scar tissue, muscle weakness and depression, all of which can have an adverse effect on the patient’s quality of life. Treating ARDS Supply of oxygen and nutrients to indi- vidual cells of various organs are main- tained by vasculature and especially by the long and thin blood vessels called capillaries. Their integrity is sustained by endothelial cells covering the inner surfaces of these vessels and by form- ing a barrier between circulation and tissues. The breakdown of this barrier results in leakage of blood content to tis- sues. If this happens in lungs, the lung air space is filled with protein-rich fluid and blood cells preventing the normal gas exchange. The key molecule to maintain en- dothelial barrier and lung function is CD73, an endothelial ectoenzyme, which can produce local adenosine. Traumak- ine’s active pharmaceutical ingredient, interferon-beta increases CD73 expres- sion resulting in increased local adeno- sine. Subsequently high local adenosine levels reduce capillary leakage and in- crease lung function by allowing normal gas exchange to return. ”ARDS is the leading cause of respiratory failure in intensive care unit patients requiring mechanical ventilation.” ARDS • A severe, life-threatening medical condition, most often as a result of sepsis, pneumonia or significant trauma • Orphan lung disease with no available drug treatment • The leading cause of respira- tory failure in intensive care unit patients who require mechanical ventilation • Annual ARDS incidence in Europe is 170,000 and in the US nearly 200,000 patients • High mortality rate of 30 to 45% and survivors suffer long-term mental and physi- cal problems 19 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Capillary Capillary CO2 Alveolus O2 Protein-rich fluid Red blood cells Alveolus Normal CO2 O2 CO2 O2 Red blood cells Capillary leakage Leucocyte AMP Leucocyte ARDS lung Interferon β Widely used X-ray pictures can Adenosine reveal lungs filled with blood CD73 material. This shows up as white expression dense material in lung air space and for this reason the lungs of these patients are often called “white lungs”. Typically this pic- ture confirms that the patient has a condition called Acute Respira- tory Distress Syndrome (ARDS) and has a life-threatening disease. Capillary Capillary CO2 Alveolus O2 Protein-rich fluid Red blood cells Alveolus Normal CO2 O2 CO2 O2 Red blood cells Capillary leakage Leucocyte AMP Adenosine Interferon β CD73 expression Leucocyte 20 Normal lung Normally functioning lung X-ray shows no “white” material, indi- cating that lung air space is free of blood material, in contrast to the ARDS lungs above. Long term expo- sure to a respiratory syndrome like ARDS, can also cause permanent loss of lung capacity due to a fibrot- ic process that replaces lung alveoli with scar tissue. This serious side effect of ARDS results in perma- nently reduced respiratory capacity. FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Traumakine® Clinical Programme Ongoing Phase III INTEREST Study The clinical programme of Faron´s lead candidate Traumakine® addresses the treatment of Acute Respiratory Distress Syndrome ARDS. The scientific rationale for Traumakine® treatment is based on the use of interferon beta for the restoration of the endothelial barrier function in ARDS pa- tients. Traumakine® (FP-1201-lyo) is based on a patent-protected use of interferon beta to prevent leakage of vascular beds in acute lung injuries. The active pharmaceu- tical ingredient in Traumakine® is recombi- nant human IFN beta-1a. Traumakine® has commenced a pan-European Phase III trial in respect of the treatment of ARDS. The first patient in the ”INTEREST” study was enrolled in December 2015. The first clinical trial in the Traumak- ine® programme was a phase I/II open-la- bel study to assess the safety, tolerability and preliminary efficacy of interferon beta in the treatment of patients with ARDS. This study consisted of dose escalation (Phase I) and dose expansion (Phase II) phases. In the dose escalation phase, four interferon beta levels were tested. The dose expansion phase was conducted using the optimal tolerated dose. the treatment A total of 37 ARDS patients were treat- ed at nine hospitals in the UK with highly encouraging results. Interferon beta was found to be safe and well tolerated in ARDS patients and the optimal tolerated dose was established. The selected phar- macodynamic marker for interferon beta bioactivity showed clear dose response and target molecule (CD73) levels were induced during the dosing period. Most importantly, interfer- on beta treatment significantly reduced the all-cause mortality at day 28, the pri- mary end point of the study, compared to the control cohort1. Traumakine® was as- sociated with an 81% reduction in odds of 28-day mortality. Comparable results were obtained from Traumakine® Phase II Japanese study conducted by Faron´s Japanese licensing partner Maruishi Pharmaceutical Co., Ltd. in Japan, as an- nounced in January 2016. The presently ongoing, clinical trial is a Phase III double-blind, randomised, parallel-group comparison of efficacy and safety of interferon beta and pla- cebo in the treatment of patients with moderate to severe ARDS. The study named INTEREST is to be conducted in 55 hospitals in Belgium, Finland, France, Germany, Italy, Spain and UK and 300 ARDS patients in total will be recruited. INTEREST has received €6 million fund- ing from the European Union Seventh Framework Programme (FP7). Mechanism of Action The mechanism behind Traumakine’s action was invented by scientists at Tur- ku University during the period 1995 to 2003. Through extensive research and ex-vivo studies, it was identified that a molecule called CD73 is an essential entity needed to maintain the endothe- lial barrier function. CD73 is an ectoen- zyme capable of breaking down extra- cellular AMP to produce locally active adenosine. Adenosine maintains the endothelial barrier and downregulates inflammation escalation, preventing both early vascular leakage and escala- tion of inflammation, which are the two early patho-physiological events leading to Acute Respiratory Distress Syndrome (ARDS). One of the key findings that led to the development of Traumakine®, was a discovery that interferon beta could en- hance CD73 expression and therefore could be used to treat a range of vascu- lar leakage conditions including ARDS. Traumakine® works by enhancing lung CD73 expression and increasing pro- duction of anti-inflammatory adenosine such that vascular leaking and escala- tion of inflammation are reduced. Recombinant human IFN beta-1a is an approved treatment for patients with relapsing remitting MS and the safety pro- file of recombinant human IFN beta-1a in such patients is well characterised. ”Traumakine® (FP-1201-lyo) is based on a patent-protected use of interferon beta to prevent leakage of vascular beds in acute lung injuries.” 1 Bellingan et al. (2014). The effect of intravenous interferon-beta-1a (FP-1201) on lung CD73 expression and on acute respiratory distress syndrome mortality: an open-label study. The Lancet Respiratory Medicine 2014: 2: 98-107. 21 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 The INTEREST Study (protocol FPCLI002) is a Phase III clinical study to investigate efficacy and safety of FP-1201-lyo (re- combinant human interferon beta-1a) in patients with moderate or severe Acute Respiratory Distress Syndrome (ARDS). This study is planned according to our earlier results from the UK clinical trial, which demonstrated a significant reduc- tion in mortality of ARDS patients and has been published in the Lancet Res- piratory Medicine (Bellingan et al., 2014). In the double-blinded and randomised INTEREST Study pivotal effectiveness and safety of FP-1201-lyo is compared to placebo. Both treatment groups also receive standard supportive care. The primary objective of the INTER- EST Study is to demonstrate the efficacy of FP-1201-lyo in improving the clinical course and outcome based on survival and need for mechanical ventilation in patients with moderate or severe ARDS. Other study objectives are to assess the safety and efficacy of FP-1201-lyo com- pared to placebo, in regard to e.g. mor- tality, organ failure, need for mechani- cal ventilation and vasoactive support, length of the stay in ICU and hospital as well as quality of life and pharmacoeco- nomic parameters. 55 Intensive Care Units in Seven European Countries Totally about 55 hospitals in seven coun- tries within the European Union – Bel- gium, Finland, France, Germany, Italy, Spain, UK – participate in the INTEREST Study. A total of 300 adult patients with moderate or severe ARDS will be enrolled (in average six patients per hospital). Faron Pharmaceuticals runs the study in collaboration with external research INTEREST has re- service providers. ceived funding from the European Union Seventh Framework Programme (FP7) under the Traumakine® project name. First Patient Enrolled in December 2015 The first approvals from competent au- thorities and favourable opinions from in- dependent ethics committees to conduct the study were obtained during the end of 2015. The first patient was enrolled in De- cember 2015. The majority of the hospital sites are ready to start the study during the first quarter of 2016. The enrolment period is estimated to last 12–18 months. The patients enrolled in the study are screened from patients who have been PIPELINE: TRAUMAKINE ® The INTEREST Study 22 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 admitted to intensive care units (ICU) at the participating hospitals. To further ensure appropriate patient enrolment into the study across all hospitals the study design incorporates an eligibility process via the electronic data cap- ture system, involving an indepen dent medical monitor. After all screening procedures have successfully been per- formed and eligibility for inclusion in the study has been confirmed the patient can be randomised into the study. Following randomisation, the pa- tients will be treated daily with FP-1201- lyo 10 μg or placebo for 6 days and will undergo daily assessments while in the ICU for a maximum of 28 days. The patients are followed up at 3, 6 and 12 months after enrolment. Information on the need for ventilator support as well as for hospital and ICU care is collected during this follow-up period. Other col- lected data include e.g. respiratory and neurological functions and quality of life. The main analysis and clinical study report will be written on the data from the 6 months long-term follow-up. The data from the extended follow-up period from 6–12 months will be reported separately in an addendum to the clinical study report. INTEREST Study • Pivotal Phase III trial for Traumakine® in development for the treatment of Acute Respiratory Distress Syn- drome ARDS • Conducted in 55 ICUs (Intensive Care Units) in seven European countries • 300 adult patients with mod- erate to severe ARDS will be enrolled in the study • First patient enrolled in December 2015 • The enrolment period is esti- mated to last 12–18 months • Subject to the study results and achievement of regula- tory approvals Traumakine® could be the first effective, disease-specific pharmaco- therapy for patients suffering from ARDS Safety Monitoring An Independent Data Monitoring Com- mittee has been established in order to monitor safety in this study. This safety review committee will periodically con- duct an independent unblinded review of safety data generated during the study. The study also has an esteemed Steer- ing Committee that provides expert scien- tific and clinical guidance to the clinically practical study design and conduct. The rights, safety and well-being of the patients are the basis for all considerations. More details on the study can be found on www.clinicaltrialsregister.eu (reference EudraCT No. 2014-005260-15) and clinical- trials.gov (reference NCT02622724). The mode of action of FP-1201-lyo is described on the video found at Faron web pages (www.faronpharmaceuticals.com). 23 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 One of Faron’s key areas of focus is to develop a cancer treatment to support the hosts’ immune defences against tumours, as these are often suppressed in cancer patients. Our second most advanced drug development project, Clevegen®, revolves around Clever-1, a cell surface molecule involved in cancer growth and spread. The active pharmaceutical ingredient of Clevegen® is a humanised anti-Clever-1 antibody. 24 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 PIPELI NE: CL EVEG EN ® Mechanism of Action Lymphocyte Cancer cell TAM (Tumour associated macrophages) Vascular endothelium Vascular endothelium Clevegen Lymphocytes/ local immunity Cancer cell apoptosis Clever-1 TAM Clever-1 All tumours are infiltrated by immune cells, for example macrophages, neu- trophils, T cells, dendritic cells, mast cells, myeloid derived suppressor cells and natural killer cells. Depending on the immune cells stimulated and acti- vated, they can either have a protective effect for the host through suppression of tumour growth or deleterious effect by promoting tumour growth, invasion, metastasis and angiogenesis. Tumour associated macrophages (TAMs) have emerged as an essential constituent of the tumour environment, with influence over many aspects of cancer (prolifera- tion and survival) as well as interaction with surrounding elements (angiogen- esis, escape from antitumour specific immunity). When TAMs populate a tumour, one of the very significant in- fluences they exert over it, is a strong increase in immune suppression. Cle- ver-1-positive TAMs represent one ma- jor macrophage population involved in the elimination of host immune activity against the tumour cells. Clevegen® is an anti-Clever-1 antibody which targets and eliminates Clever-1-positive TAMs from cancer patients. Clevegen® has two significant ways to intervene in the TAM’s role in tumour growth and spread: prevent TAM infil- tration into a tumour and block TAM-to- Tumour cell interaction responsible for TAM transformation into tumour sup- portive cell types. “Clever-1-positive TAMs represent one major macrophage population involved in the elimination of host immune activity against the tumour cells.” ”Clevegen® has two significant ways to intervene in the TAM role in tumour growth and spread: prevent TAM infiltration into a tumour and block TAM-to-Tumour cell interaction responsible for TAM transformation into tumour supportive cell types.” 25 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Lymphocyte Clevegen Cancer cell Cancer cell TAM Blocking interaction between cancer cell and TAM. Lymphocyte Lymphocytes/ local immunity Cancer cell apoptosis Clever-1 TAM (Tumor associated macrophages) Clever-1 Clevegen Vascular endothelium Cancer cell TAM Clevegen Clever-1 Cancer cell TAM Vascular endothelium Clevegen-1 mode of action Blocking TAM Infiltration into Preventing leucocyte migration... Blocking adhesion receptor. a Tumour Blocking interaction between cancer cell Blocking TAM – Tumour Cell and TAM. Interaction TAM TAM (Tumor associated macrophages) Tumour endothelial cells are Clever-1 positive and when anti-Clever-1 antibod- ies bind to the Clever-1 receptor, the in- filtration of TAMs is prevented. Through blocking the infiltration of TAMs into the tumour, the ability of the tumour to suppress the hosts’ immune system is reduced. Vascular endothelium Clever-1 Lymphocyte Cancer cell Clever-1 TAM (Tumour associated macrophages) ”In some tumours up to 50% of the tumour mass may contain TAMs and the only way to eliminate this Vascular dominance is remove them from endothelium tumours.” Vascular endothelium Clevegen Clever-1 Clevegen-1 Clevegen® prevents tumour cells – TAM interactions as shown on the picture. Through this action, the anti-Clever-1 antibody prevents further transforma- tion of Clever-1 positive TAMs to tumour supportive phenotype. Clevegen TAM Clevegen-1 mode of action Preventing leucocyte migration... Blocking adhesion receptor. Clevegen-1 Lymphocytes/ local immunity Cancer cell apoptosis Clever-1 TAM References: Karikoski et al. (2014) Clever-1/Stabilin-1 controls cancer growth and metastasis. Clin. Cancer Res. 2014: 20: 6452-64. Palani et al. (2016). Monocyte Stabilin-1 suppresses the activation of Th1 lymphocytes. Journal of Immunology 2016: 196: 115-123. 26 Change in Tumour Immunity Anti-Clever-1 antibodies change the tumour immunity by lowering the pres- ence of tumour supportive TAMs in the tumour. This will allow other immune cells to attack tumour cells and drive them to programmed cell death (apop- tosis). In some tumours up to 50% of the tumour mass may contain TAMs and the only way to eliminate this dom- inance is remove them from tumours. It is these TAM cells that are the main tar- get of the Clevegen® programme. Lymphocytes/ local immunity Cancer cell apoptosis Clever-1 Vascular endothelium TAM FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 ANNUAL REPORT 2015 FARON PHARMACEUTICALS LTD Corporate Governance The Board of Faron emphasises the importance of good corporate governance and is aware of their responsibility for overall corporate governance, and for supervising the general affairs and business of the Company. Faron is not required to comply with the UK Corporate Governance Code by virtue of being an AIM quoted company. The Board does however seek to apply the QCA´s Corporate Governance Code for Small and Medium Sized Companies (as devised by the QCA in consultation with a number of significant institutional small company investors) to the extent appropriate and practical for a Company of its nature and size. 27 corp orate governance Board of Directors Dr Frank Armstrong Non-Executive Chairman Matti Manner Non-Executive Vice- Chairman Dr Armstrong has held Chief Executive roles with five biotech- nology companies (both public and private) including Fulcrum Pharma PLC (AIM). He led Medical Science and Innovation at Merck Serono and was previously Executive Vice President of Product Development at Bayer and Senior Vice President of Medical Research and Communications at Zeneca. Dr Arm- strong is currently the Chairman of Xceleron Inc., Summit Therapeutics (AIM and NASDAQ) and Redx Pharma (AIM) and a Non-Executive Director of Actino Pharma, Juniper Therapeu- tics (NASDAQ) and Mereo Pharma. Dr Armstrong is a physician and a Fellow of the Royal Col- lege of Physicians (Edinburgh). He is also a member of the Scientific Advisory Board of Healthcare Royalty Partners. He was appointed as a Non-Executive Director of the Company in September 2015. Mr Matti Manner was appointed as a partner of Brander & Manner Attorneys Ltd in 1980 having previously sat as a judge at Turku Appeal Courts. He has significant experience in national and international business deals, corporate law and mergers and acquisitions having held a number of board memberships throughout his career. Mr Manner joined the Board of the Company as Chairman in 2007 having previously been the Chairman of Faron Ventures Oy from 2002. He is cur- rently Chairman of Turun Osuuskauppa and Ruissalo Founda- tion and a member of the board of Marva Media Ltd, Satatuote Ltd, YH VS-Rakennuttajat Ltd and Kauppakeskus Mylly Ltd. Mr Manner has experience of several trustee posts includ- ing the Presidency of the Finnish Bar (Lawyers) Association during the period of 1998 to 2004. Mr Manner obtained a Mas- ter of Laws from the University of Turku. He became an honor- ary Chief Justice in Finland in 2013. 28 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Dr Markku Jalkanen Chief Executive Officer Dr Juho Jalkanen Non-Executive Director Dr Jalkanen is currently a consultant in vascular surgery at Turku University Hospital, having previously held positions as Resident in Surgery at the Hospital District of Southwest Fin- land, General Hospitals of Raisio and Salo and at Turku Univer- sity Hospital. For the period of 2009 to 2012 Dr Jalkanen was a board member of Duodecim Medical Association on Southwest Finland and subse- quently joined the Board of the Company in 2013. Dr Jalkanen obtains degrees from both business and medicine. He has a Master’s degree in Economics and Business Administra- tion from the Turku School of Economics, a Medical Doctor’s de- gree from the University of Turku and subsequently became a fully licensed General Practitioner. At the moment Dr Jalkanen is con- ducting his PhD on the molecular mechanisms of atherosclerosis. He has published six articles in various publications including the International Journal of Biotechnology and Circulation Research. Dr Jalkanen has more than 25 years of experience within biomed- ical research, biotech development and the biopharmaceutical industry. He was a founding member of the Company and is the Company´s CEO. In addition to his role as CEO of the Company, Dr Jalkanen is an advisor for the only active Finnish life sciences fund – Inveni Capital. Between 1996 and 2002, Dr Jalkanen was the found- ing CEO and President of BioTie Therapies Corp which has since become the first publically traded Finnish biotech company to have listed on NASDAQ. Dr Jalkanen has published over 130 peer reviewed scientific publications in various highly ranked international journals. Dr Jalkanen has held several board memberships for both public and private companies. Dr Jalkanen obtained a Masters in Medical Biochemistry from the University of Kuopio and subsequently received a PhD in Med- ical Biochemistry from the University of Turku. He completed a side-laudatur examination in Mol ecular Biology from the University of Turku and completed his post-doctoral training at Stanford Uni- versity, California between 1983 and 1986. Dr Jalkanen obtained the position of docent in Biochemistry from University of Helsinki and the same qualification in Molecular and Cell Biology from the University of Turku. He became a Professor at the University of Turku in 1992 as well as Head of Turku Centre for Biotechnology. 29 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Dr Jonathan Knowles Non-Executive Director Dr Huaizheng Peng Non-Executive Director Dr Peng is a General Manager of China Medical System Holdings, a specialty pharmaceutical company listed on the Hong Kong Stock Exchange. He is in charge of international operations for the Company, including pharmaceutical asset acquisition/product licensing-in/out, international business development, outbound investment and asset management, among others. Dr Peng served as an independent Non-Exec- utive Director of China Medical System Holdings Ltd for three years, and the Company was admitted to trading on AIM (be- tween 2007 and 2010). Dr Peng was a partner of Northland Bancorp, a private equity firm. Before that, he worked as a head of life sciences and as a director of corporate finance at Seymour Pierce, a London-based investment bank and stockbroker. In addition, he was a Non-Executive Director of China Medstar, an AIM listed medical device company. Earlier in his career Dr Peng was a senior portfolio manager, specialising in global life science and Asian technology investment at Reabourne Technology Investment Management Limited. Dr Peng received his Bachelor´s degree in medicine from Hunan Medical College (now Central South University Siangya School of Medicine) in Changsha, Hunan Province, China and subsequently he obtained a Master´s degree in medicine from Hunan Medical College. Dr Peng was awarded his PhD in molecular pathology from University College London (UCL) Medical School and subsequently practiced as a clinical lecturer there. Dr Peng was appointed as a Non-Executive Director of the Company in September 2015. Dr Jonathan Knowles has a career spanning over 40 years in the biotech industry. Dr Knowles held a number of research and teaching positions in the early part of his career before founding the molecular biology group within the Biotechnical Laboratory, Helsinki in 1980. Dr Jonathan Knowles is currently the Chairman of Adaptimmune Therapeutics PLC (NASDAQ) and Immunocore Ltd and serves on the boards of a number of biotech companies in Europe and the USA. He is a trustee of CRUK and Chairman of the Genomics Eng- land Access committee. Jonathan Knowles is a visiting Professor at the University of Oxford, a Research Director at FIMM institute in University of Helsinki (20010-2014 FiDiPro Distinguished Profes- sor), and Professor Emeritus at EPFL, Lausanne. He is a member of EMBO and a member of the Board of A*Star in Singapore. Dr Knowles was appointed as the President of Global Research at F. Hoffman-La Roche Ltd and subsequently the President of Group Research. He was a member of the Genentech Board for 12 years and a member of the Chugai Board for seven years. He was also the Chairman of the Corporate Governance Committee of Genentech. Under his leadership, the company developed and implemented a strategy of highly effective therapies based on personalised health- care. Dr Knowles retired from his position at F. Hoffman-La Roche Ltd at the end of 2009. Prior to joining Roche, Dr Knowles was the Head of the Glaxo Institute for Molecular Biology in Geneva and sub- sequently the Research Director for Glaxo Wellcome Europe. Dr Knowles was, for 5 years, the Chairman of the Hever Group and the Chairman of the Research Directors’ Group of EFPIA (Euro- pean Federation of Pharmaceutical Industry Associations) and was the first Chairman of the Board of the Innovative Medicines Initia- tive, a unique public-private partnership between 28 pharmaceutical companies and the European Commission with the participation of over 200 academic institutions in Europe with a budget of more than 5 billion euros over ten years. Dr Knowles obtained a Bachelor of Science in Biological Scien- ces from the University of East Anglia, Norwich and subsequently received a PhD in Mitochondrial Genetics from the University of Ed- inburgh. Dr Knowles was appointed as a Non-Executive Director of the Company in September 2015. 30 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Leopoldo Zambeletti Non-Executive Director Yrjö E K Wichmann Chief Financial Officer During a 19-year career as an investment banker, Mr Zam- beletti led the European Healthcare Investment team at JP Morgan for eight years before taking up the same position at Credit Suisse for a further five years. Since 2013 he has been an independent strategic advisor to life science companies on merger and acquisitions, out-licencing deals and financing strategy. He is a Non-Executive Director at Advanced Acceler- ator Applications, Qardio, Summit Therapeutics PLC (NASDAQ and AIM) and Nogra Pharma. Mr Zambeletti started his career at KPMG as an auditor. Mr Zambeletti received a BA in Business from Bocconi University in Milan, Italy. He serves as a trustee to Barts and the London Charity, which helps to fund the hospitals of the Barts NHS Trust including St Bartholomew, the Royal London and the London Chest Hospitals. He is the founder of the cultural initiative 5×15 Italy. Mr Zambeletti was appointed as a Non-Executive Director of the Company in Sep- tember 2015. Mr Wichmann has a career spanning over 20 years in the fi- nancing and investment banking. He was appointed as a Chief Financial Officer of the Company in 2014. Prior to his appoint- ment at the Company, Mr Wichmann has held a number of senior positions within the life sciences and biotechnology sector, most recently at IP Finland Oy, Biohit Oyj (NASDAQ OMX Helsinki), Capman Oyj, FibroGen Europe Oyj (NASDAQ) and D. Carnegie & Co AB. Whilst carrying out these roles Mr Wichmann has participated in healthcare IPOs on the London, Stockholm and Helsinki stock exchanges as both an invest- ment banker and as a member of the board. Mr Wichmann is a member of the Investment Committee at Da- sos Timberland Fund I and II and a member of the Innovation Board of Helsinki University, which advises the rector and the board of the university in research commercialisation. The Innovation Board also oversees the venture capital portfolio of Helsinki University Funds valued at approximately €30 million. Mr Wichmann is also a mem- ber of the board of Bioretec Oy. Mr Wichmann obtained a Masters in Economics from Helsinki University. He was appointed as an Executive Director of the Com- pany in 2015. 31 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 corp orate governance Directors’ Report For the year ended 31 December 2015. Directors The Directors of the Company were: The Directors present their report together with the audited financial statements for the year ended 31 December 2015. Executive Dr Markku Jalkanen, PhD, Chief Executive Officer Mr Yrjö E K Wichmann, MSc, Chief Financial Officer (Appointed 15 September 2015) Non-Executive Dr Frank M Armstrong, FRCPE, FFPM, Chairman (Appointed 15 September 2015) Mr Matti Manner, LL.M., Vice-Chairman Dr Risto Lammintausta, MD, PhD, Vice-Chairman (Resigned 15 September 2015) Dr Juho Jalkanen, MD, MSc, Non-Executive Director Dr Jonathan Knowles, PhD, Non-Executive Director (Appointed 15 September 2015) Dr Huaizheng Peng, MD, PhD, Non-Executive Director (Appointed 15 September 2015) Mr Frans Wuite, MSc, Non-Executive Director (Resigned 15 September 2015) Mr Leopoldo Zambeletti, BA, Non-Executive Director (Appointed 15 September 2015) The Directors of the Company held the following beneficial interests in the shares and share options of Faron Pharmaceuticals Ltd on the date of this report: Executive Ordinary shares Percentage held Ordinary shares Exercise prise, pence Issued Share Capital Share options Markku Jalkanen¹ Juho Jalkanen² Matti Manner Yrjö Wichmann Leopold Zambeletti Frank Armstrong3 Jonathan Knowles Huaizheng Peng 2 873 390 1 082 570 480 900 69 440 13 461 3 846 3 846 0 12.4% 4.7% 0.3% 0.3% 0.1% 0.0% 0.0% 0.0% 80 000 20 000 20 000 30 000 20 000 40 000 20 000 20 000 4 527 453 19.6% 250 000 260 260 260 260 260 260 260 260 1 of which, 1,794,890 are held by Markku Jalkanen directly, and 1,078,500 are held by Markku Jalkanen’s wife being Sirpa Jalkanen. 2 of which, 1,078,500 are held by Juho Jalkanen directly, and 4,070 are held by Juho Jalkanen´s family being Aaro Jalkanen, Enna Jalkanen and Heikki Jalkanen. 3 held by Frank Armstrong’s company Shore Capital. For a more detailed description of the remuneration of the Directors, see page Directors´ Remuneration Report. The Company maintained Directors’ and officers’ liability insurance cover throughout the year. 32 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Principal risks and uncertainties Research and development For a discussion of the principal risks and uncertainties which face Faron please see page Risks and uncertainties. Results and dividends Details of Company’s key research and development pro- grammes can be found in the Strategic Report and the detailed programme sections. Further information is also available on the Company website, www.faronpharmaceuticals.com. The Statement of Comprehensive Income for the year is set out here. Post balance sheet events The Company’s loss for the financial year after taxation and other comprehensive losses was € 6.2 million (2014: €1.4 mil- lion loss). No events occurred after the balance sheet date that would have a material impact on the result or financial position of the Company. The Company has no distributable equity and thus the Direc- tors do not recommend the payment of a dividend (2014: nil). Financial information The Company produces budgets and cash flow projections on an annual basis for approval by the Board. These are updated during the year to meet the changing needs of the business. Detailed management accounts are produced on a monthly basis, with all significant variances investigated promptly. The management accounts are reviewed and commented on by the Board at Board meetings and are reviewed and reported to the Directors on a monthly basis by the management team. Financial Key Performance Indicators (‘KPIs’) For a review of the Company’s KPIs please see Statement of Cash Flows. Financial instruments and management of liquid resources The Company’s principal financial instrument comprises cash, and this is used to finance Company’s operations. The Compa- ny has also other financial instruments such as leasing facili- ties that arise directly from its operations. The Company has a policy, which has been consistently followed, of not trading in financial instruments and to minimise currency exposure by actively matching currency expenses and income to the extent possible. The Company’s cash is held on bank accounts in rep- utable banks in Finland and UK. The Group’s treasury policy is reviewed annually. See Note 1.16 Financial assets and Note 2 Principles of financial risk management in the Notes to the Financial Statements for IFRS disclosure regarding financial instruments. 33 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Substantial shareholdings On 31 December 2015 the Company had been notified of the following holdings of more than 3% or more of the issued share capital of the Company. Name Number of shares A&B (HK) Company Limited Marko Salmi Tom-Erik Lind Aviva Investors Global Services Limited Markku Jalkanen Juho Jalkanen* Sirpa Jalkanen Maija-Leena Hollmén** Katriina Peltola*** Timo Syrjälä**** 3,408,409 3,389,570 2,552,523 2,305,769 1,794,890 1,082,570 1,078,500 1,078,500 1,078,500 924,676 % 14.75 14.67 11.04 9.98 7.77 4.68 4.67 4.67 4.67 4.00 * Held by Juho Jalkanen and connected parties. ** Held by Maija-Leena Hollmén and connected parties. *** Held by Katriina Peltola and connected parties. **** of which, 520,830 are held directly by Timo Syrjälä and 403,846 are held by Acme Investments SPF S.à.r.l., an entity which is wholly owned by Timo Syrjälä. Annual General Meeting Disclosure and information to auditors The AGM will be held on 26 May 2016 and further details will be provided to Shareholders in advance of the meeting. Each of the current Directors hereby confirms that: Independent auditors (a) So far as he or she is aware, there is no relevant audit infor- mation of which the auditors are unaware; and PricewaterhouseCoopers have expressed their willingness to continue in office as auditors for the year. A resolution to reap- point them will be proposed at the forthcoming AGM. (b) He or she has taken all reasonable steps to ascertain any relevant audit information and to ensure that the auditors are aware of such information. On behalf of the Board Frank M Armstrong Chairman 9 March 2016 34 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 corpor ate gov erna nce Corporate Governance Report The Board At 31 December 2015, the Board com- prised six Non-Executive Directors, and two Executive Directors. The composition of the Board of Di- rectors as well as Directors’ biogra- phies are described on pages Board of Directors. The Board is responsible to the Shareholders for the proper manage- ment of the Company and meets regu- larly to set the overall direction and strat- egy of the Company, to review scientific, operational and financial performance, and to advise on management appoint- ments. The Board has also convened by telephone conference during the year to review the strategy and activities of the business. All key operational and investment decisions are subject to Board approval. The roles of Chief Executive Officer and Non-Executive Chairman are well defined and clearly separated. The Chairman oversees the Board´s work, ensures that the Board’s decision-mak- ing is balanced and that the Non-Exec- utive Directors have all relevant infor- mation on matters to be decided. The Chief Executive Officer is responsible for implementing the strategy of the Board and managing the day-to-day business activities of the Company. The man- agement of the Company prepares a monthly management and financial ac- counts pack, which is distributed to the Board every month in advance of Board meetings. The Board considers there to be suf- ficient independence on the Board and that all the Non-Executive Directors are of sufficient competence and calibre to add strength and objectivity to the Board, and to bring considerable experi- ence in terms of their knowledge of the scientific, operational and financial de- velopment of biopharmaceutical prod- ucts and companies. Where necessary, the Company facilitates that Non-Exec- utive Directors obtain specialist external advice from appropriate advisers. The term of office of each Director expires on the closing of the AGM immediate- ly following his/her appointment to the Board. Under the Finnish Companies Act and the Articles, the Directors are elected by the Shareholders at General Meetings annually. Under the Finnish Companies Act, Directors may be re- moved from office at any time, with or without cause, by a majority of votes cast at a General Meeting. Vacancies on the Board may only be filled by a majori- ty of Shareholder votes cast at a General Meeting. 35 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Performance evaluation Remuneration Committee The Board has a process for evaluation of its own performance, that of its com- mittees and individual Directors, includ- ing the Chairman. These evaluations are carried out at least annually. Board committees In conjunction with the being admitted to trading on AIM, the Company has established audit, nomination and re- muneration committees of the Board with formally delegated duties and responsibilities. The Remuneration Committee com- prises Frank Armstrong as Chairman together with Huaizheng Peng and Leopoldo Zambeletti. The commit- tee is responsible for the review and recommendation of the scale and structure of remuneration for senior management, including any bonus arrangements or the award of share options with due regard to the inter- ests of the Shareholders and the per- formance of the Company. The Remu- neration Committee did not hold any meetings during 2015. Attendance at Board meetings During 2015 the Board held 15 meetings. The table below lists the Directors attend- ance to the Board meetings during the year: Period Joined Board Before EGM 15 Sep 2015 After EGM 15 Sep 2015 Executive Directors Dr Markku Jalkanen 24.10.2006 11/11 Mr Yrjö E K Wichmann 15.09.2015 Non-Executive Directors Dr Frank M Armstrong 15.09.2015 Mr Matti Manner 24.10.2006 Dr Juho Jalkanen 18.06.2013 Dr Jonathan Knowles 15.09.2015 11/11 11/11 Dr Risto Lammintausta 08.05.2009 10/11 Dr Huaizheng Peng 15.09.2015 Mr Frans Wuite 30.03.2011 9/11 Mr Leopoldo Zambeletti 15.09.2015 4/4 4/4 4/4 4/4 4/4 1/4 4/4 2/4 36 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Audit Committee The Audit Committee, which comprises Leopoldo Zambeletti as Chairman togeth- er with Frank Armstrong and Huaizheng Peng, meets not less than twice a year. The committee is responsible for making recommendations to the New Board on the appointment of auditors and the au- dit fee and for ensuring that the financial performance of the Company is properly monitored and reported. In addition, the Audit Committee will receive and review reports from management and the au- ditors relating to the Interim Report, the Annual Report and accounts and the in- ternal control systems of the Company. The Audit Committee did not hold any meetings during 2015. Nomination Committee The Nomination Committee comprises of Matti Manner as Chairman together with Frank Armstrong and Jonathan Knowles. The Nomination Committee monitors the size and composition of the Board and the other Board commit- tees and is responsible for identifying suitable candidates for Board member- ship. The Nomination Committee did not hold any meetings during 2015. Risk management and internal control The Board is responsible for the sys- tems of internal control and for re- viewing their effectiveness. The inter- nal controls are designed to manage rather than eliminate risk and provide reasonable but not absolute assurance against material misstatement or loss. The Board reviews the effectiveness of these systems annually by considering the risks potentially affecting the Com- pany. The Company does not consider it necessary to have an internal audit function due to the small size of the administrative function. Instead there is a monthly review and authorisation of transactions by the Chief Financial Officer and Chief Executive Officer. A comprehensive budgeting process is completed once a year and is reviewed and approved by the Board. The Compa- ny’s results, compared with the budget, are reported to the Board on a monthly basis and discussed in detail. The Company maintains appropriate insurance cover in respect of actions taken against the Directors because of their roles, as well as against material loss or claims against the Company. The insured values and type of cover are comprehensively reviewed on a periodic basis. Corporate Social Responsibility The Company is committed to main- taining and promoting high standards of business integrity. Company values, which incorporate the principles of Cor- porate Social Responsibilities (CSR) and sustainability, guide the Company’s relationships with clients, employees and the communities and environment in which we operate. The Company’s approach to sustainability addresses both our environmental and social im- pacts, supporting the Company’s vision to remain an employer of choice, while meeting client demands for socially re- sponsible partners. The Company respects laws and customs while supporting international laws and regulations. Relations with Shareholders The Board recognises the importance of communication with its Shareholders to ensure that its strategy and performance is understood and that its remains ac- countable to Shareholders. Our website, www.faronpharmaceuticals.com, has a section dedicated to investor matters and provides useful information for the Company’s owners. 37 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Compliance with the Principles of the QCA Code The Principles of the QCA Code 1. Setting out the vision and strategy Comply/ Explain Comply Reference Strategic Report 2. Managing and communicating risk and implementing internal control Comply CGR (Risk Management and Internal Control), Risks and Uncertainties 3. Articulating strategy through corporate communication and investor relations Comply CGR (Relations with Shareholders) 4. Meeting the needs and objectives of Shareholders Comply CGR (Relations with Shareholders) 5. Meeting stakeholders and social responsibilities Comply GCR (Corporate Social Responsibility) 6. Using cost-effective and value-added arrangements Comply Strategic Report 7. Developing structures and processes 8. Being responsible and accountable 9. Having balance on the Board Comply Comply Comply Strategic Report CGR (The Board) CGR (The Board) 10. Having appropriate skills and capabilities on the Board Comply CGR (The Board) 11. Evaluating Board performance and development Comply CGR (Performance evaluation) 12. Providing information and support Comply CGR (The Board) CGR = Corporate Governance Report 38 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 corpor ate gov erna nce Directors’ Remuneration Report Audited Information Remuneration policy for Executive Directors The Remuneration Committee sets the remuneration policy that aims to align Executive Director remuneration with Shareholders’ interests and attract and retain the best talent for the benefit of the Company. The remuneration of the Executive Directors during the year 2015 is set out below. For the year ended 31 December 2015. This report sets out Faron´s remu- neration policy for the Executive and Non-Executive Directors. No Director is involved in discussions relating to their own remuneration. Basic salary Longer term incentives Basic salaries are reviewed annually. The review process is managed by the Remuneration Committee with refer- ence to market salary data, the Execu- tive’s performance and contribution to the Company during the year. Bonuses Annual bonuses are based on achieve- ment of Company’s strategic and finan- cial targets, and personal performance objectives. The Non-Executive Directors believe that bonuses are an incentive to achieve the targets and objectives, and represent an important element of the total compensation of the Executive Directors; they have established that the annual bonus potential will be up to 40% for the Executive Directors. On 9 Febuary 2016 the Chief Executive Of- ficer was awarded a bonus representing 40% and the Chief Financial Officer was awarded a bonus representing 30% of his 2015 gross basic salary. In order to further incentivise the Execu- tive Directors and employees, and align their interests with Shareholders, the Extraordinary General Meeting of the Company approved a share option plan and granted share options to the mem- bers of the Board under this option plan. Details of the option plan are in the table below. Pension Faron has a law-defined contribution plan under which Faron pays fixed con- tributions into a separate entity. The plan covers all the employees of Faron including the Executive Directors. Faron has no legal or constructive obligations to pay further contributions if the fund does not hold sufficient assets to pay all employees the benefits relating to em- ployee service in the current and prior periods. 39 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Other benefits Some employees have the possibility to take a company car allowance, which is part of their gross salary. All employees have a company mobile phone that consti- tutes a company mobile phone allowance. Executive Directors’ service contracts and termination provisions The service contracts of Executive Directors are approved by the Board and are one- year rolling contracts. The service contract may be terminated by either party giving six months’ notice to the other. The details of the Directors’ contracts are summarised below: Markku Jalkanen Yrjö E K Wichmann CEO CFO 16.09.2015 16.09.2015 6 months1 6 months1 Date of contract Notice period 1 The 6 months’ notice period starts after a fixed 12 months’ period from Admission, i.e. from 18 November 2016. Non-Executive Directors’ service contracts and remuneration The remuneration and compensation payable to the members of the Board including the Non-Executive Directors shall be approved by the Shareholders at the AGM. Any Non-Executive Director who, by request, goes or resides abroad for any purposes of the Company or who performs services which in the opinion of the Board goes beyond the ordinary duties of a Director may be paid extra remuneration or may receive such other benefits as the Remuneration Committee may approve. Non-Executive Direc- tors are entitled to be reimbursed in respect of their reasonably and properly incurred travelling, accommodation and incidental expenses for attending and returning from meetings of the Board, committee meetings or the General Meetings of Shareholders. The Non-Executive Directors do not receive any pension, or bonus or benefits from the Company. The contracts of the Non-Executive Directors, excluding remu- neration and compensation, are reviewed by the Board annually. Current contracts are summarised below: Non-Executive Directors' Contracts Contracts Date of Contract Frank M Armstrong Matti Manner Juho Jalkanen Jonathan Knowles Huaizheng Peng Leopoldo Zambeletti Chairman Vice-Chairman member member member member 16.09.2015 16.09.2015 16.09.2015 16.09.2015 16.09.2015 16.09.2015 The appointments of Non-Executive Directors are terminable with immediate effect in accordance with the Articles of Association and pursuant to the Finnish Compa- nies Act, through a resolution of Shareholders at a General Meeting on any grounds. The Non-Executive Directors may resign as a Director by delivering three months’ no- tice to the Registered Office of the Company or through tendering such resignation at a meeting of the Board, after a fixed 6 months’ period from Admission. 40 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Audited Information Directors’ remuneration The Directors received the following remuneration during the year: Executive Markku Jalkanen Yrjö E K Wichmann Non-Executive Frank M Armstrong1 Matti Manner Juho Jalkanen Jonathan Knowles1 Risto Lammintausta2 Huaizheng Peng1 Frans Wuite2 Leopoldo Zambeletti1 Salaries and fees Bonus 2015 Taxable benefits Total 150 300,00 63 512,00 12 720,00 226 532,00 126 666,00 38 202,00 674,00 165 542,00 21 400,00 25 709,90 22 123,18 10 260,27 11 862,90 10 260,27 10 862,90 11 726,03 - - - - - - - - - - - - - - - - 21 400,00 25 709,90 22 123,18 10 260,27 11 862,90 10 260,27 10 862,90 11 726,03 401 171,46 101 714,00 13 394,00 516 279,46 1 Joined the Board on 15 September 2015 2 Resigned from the Board on 15 September 2015 Directors’ share options remunerations disclosed Aggregate above do not include any amounts for the value of options to acquire Ordinary Shares in the Company granted to or held by the Directors. A share option plan was adopted by the Company at the Extraordinary General Meeting held on 15 September 2015. The option plan allows the Com- pany to offer options for subscription free of charge to members of the Board, and to such officers and employees of the Company as the Board sees fit. Each option will entitle the holder of the op- tion to subscribe for one Ordinary Share. Under the terms of the option plan, an aggregate maximum number of 1,600,000 options may be granted, such aggregate being made up of a maximum of 400,000 “A” options, the subscription period for which ends on 31 December 2015 (such options exercisable between 2 November 2015 and 30 September 2021), a maximum of 400,000 “B” options to be subscribed for between 8 October 2016 and 30 September 2019 (exercisa- ble between 8 October 2016 and 30 Sep- tember 2021), a maximum of 400,000 “C” options to be subscribed for between 8 October 2017 and 30 September 2019 (exercisable between 8 October 2017 and 30 September 2021), and a maximum of 400,000 “D” options to be subscribed for between 8 October 2018 and 30 Septem- ber 2019 (exercisable between 8 October 2018 and 30 September 2021). The exercise price for Ordinary Shares based on “A” options shall be the euro equivalent to the Placing Price. The exercise price for Ordinary Shares based on “B”, “C” and “D” options shall be determined by the euro equivalent to the average share price of the publicly traded Ordinary Shares of the Company on AIM between 1 July and 30 Septem- ber of 2016, 2017 and 2018 respectively. The exercise price will be disclosed in euros based on the exchange reference rate published by the European Central Bank on the last day of the period for determination of the subscription price, and rounded to the nearest euro cent. 41 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Details of these options are as follows: Directors' share options1 Date of grant of A options At 1 Jan 2015 Granted during the period Cancelled during the period Markku Jalkanen 16.09.2015 Yrjö E K Wichmann 16.09.2015 Frank M Armstrong2 Matti Manner Juho Jalkanen 16.09.2015 16.09.2015 16.09.2015 Jonathan Knowles2 16.09.2015 Risto Lammintausta3 Huaizheng Peng2 16.09.2015 Frans Wuite3 Leopoldo Zambeletti2 16.09.2015 0 0 0 0 0 0 0 0 0 0 80 000 30 000 40 000 20 000 20 000 20 000 20 000 20 000 0 0 0 0 0 0 0 0 0 0 At 31 Dec 2015 80 000 30 000 Price per share (p) 260 260 Expiry date Date from which exer- cisable 02.11.2015 30.09.2021 02.11.2015 30.09.2021 40 000 260 02.11.2015 30.09.2021 260 260 260 02.11.2015 30.09.2021 02.11.2015 30.09.2021 02.11.2015 30.09.2021 20 000 20 000 20 000 0 20 000 260 02.11.2015 30.09.2021 0 20 000 260 02.11.2015 30.09.2021 1 Additionally, the Directors have the right to subscribe equal amounts of “B”, “C” and “D” Options (conditional on them continuing to remain in their respective Director roles at the time of commencement of the relevant subscription period). 2 Joined the Board on 15 September 2015 3 Resigned from the Board on 15 September 2015 Directors’ shareholdings The Directors who served during the period, together with their beneficial interests in the shares of the Company, are as follows: Executive Markku Jalkanen1 Juho Jalkanen2 Matti Manner Yrjö E K Wichmann Leopoldo Zambeletti Frank M Armstrong3 Jonathan Knowles Huaizheng Peng Issued Share Capital Share options Ordinary shares Percentage held Ordinary shares Exercise price, pence 2 873 390 1 082 570 480 900 69 440 13 461 3 846 3 846 0 12,4% 4,7% 2,1% 0,3% 0,1% 0,0% 0,0% 0,0% 80 000 20 000 20 000 30 000 20 000 40 000 20 000 20 000 4 527 453 19,6% 250 000 260 260 260 260 260 260 260 260 1 of which, 1,794,890 are held by Markku Jalkanen directly, and 1,078,500 are held by Markku Jalkanen’s wife being Sirpa Jalkanen. 2 of which, 1,078,500 are held by Juho Jalkanen directly, and 4,070 are held by Juho Jalkanen´s family being Aaro Jalkanen, Enna Jalkanen and Heikki Jalkanen. 3 held by Frank Armstrong’s company Shore Capital. 42 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 corpor ate gov erna nce Statement of Directors’ Responsibilities Under the Finnish Companies Act and the Finnish Accounting Act the Compa- ny must prepare an Annual Report and financial statements in accordance with applicable law and regulations. The Board of Directors and the CEO are responsible for the preparation of financial statements that give a true and fair view in accordance with Inter- national Financial Reporting Standards (IFRS) as adopted by the EU, as well as for the preparation of financial state- ments and the report of the Board of Directors that give a true and fair view in accordance with the laws and regu- lations governing the preparation of the financial statements and the report of the Board of Directors in Finland. The Board of Directors is responsible for the appropriate arrangement of the control of the Company’s accounts and finances, and the CEO shall see to it that the accounts of the Company are in compliance with the law and that its financial affairs have been arranged in a reliable manner. In accordance with the rules of the London Stock Exchange for companies trading securities on the AIM, the Com- pany is also required to prepare annual accounts and financial statements un- der IFRS. In preparing these financial statements, the Board of Directors is required to: Website publication • select suitable accounting policies and then apply them consistently; • make judgements and accounting esti- mates that are reasonable and prudent; • state whether they have been prepared in accordance with IFRSs as adopted by the European Union, subject to any material departures disclosed and ex- plained in the financial statements; • prepare the financial statements on the going concern basis unless it is inap- propriate to presume that the Compa- ny will continue in business. The Board of Directors and the CEO are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reason- able accuracy at any time the financial position of the Company and enable them to ensure that the financial state- ments comply with the requirements of the Finnish Accounting Act. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the pre- vention and detection of fraud and other irregularities. The Directors are responsible for en- suring that the Annual Report and the financial statements are made available on a website. Financial statements are published on the Company’s website in accordance with the AIM rule 26 and the recommendations of the QCA´s Cor- porate Governance Code for Small and Medium Sized Companies. On behalf of the Board Frank M Armstrong Chairman 9 March 2016 43 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 financial statements Statement of Comprehensive Income Note Year ended 31 Dec 2015 €’000 Year ended 31 Dec 2014 €’000 Stated in euro Revenue Cost of sales Gross profit Other operating income Administrative expenses Research and development expenses Operating result Financial income Financial expenses Net financial costs 3; 4 5 6; 7 6; 7 2; 8 2; 8 Loss before income taxes Income tax expense 9 Total comprehensive income for the financial year Total comprehensive income, attributable to: 520 (25) 496 701 (3 061) (3 971) (5 835) 0 (311) (311) (6 146) (42) (6 188) 906 (425) 481 111 (349) (1 471) (1 228) 15 (146) (130) (1 358) (6) (1 364) Equity holders of the Company (6 188) (1 364) Loss per share attributable to equity holders of the Company 10 Basic and diluted loss per share, euro (0,30) (0,09) 44 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 financia l statem en ts Balance Sheet Stated in euro Assets Non-current assets Property, plant and equipment Intangible assets Current assets Inventories Trade and other receivables Cash and cash equivalents 11 11 12 13 14 Total assets Equity and liabilities Capital and reserves attributable to equity holders of the Company Share capital Unregistered share capital Reserve for invested non-restricted equity Retained earnings Total equity Non-current liabilities Interest-bearing financial liabilities Current liabilities Interest-bearing financial liabilities Non-interest-bearing financial liabilities Other current liabilities Total liabilities Total equity and liabilities 15; 16 17 18 18 18 Note Year ended 31 Dec 2015 €’000 Year ended 31 Dec 2014 €’000 28 1 001 1 029 649 2 074 11 068 13 791 14 821 2 691 1 275 24 533 (16 046) 11 178 1 446 1 446 245 436 1 517 2 197 3 643 14 821 0 1 184 1 184 699 40 242 980 2 165 1 416 (1 364) 6 453 (10 332) (1 188) 1 691 1 691 - 9 1 652 1 662 3 352 2 165 45 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 financial statements Statement of Cash Flows Stated in euro Year ended 31 Dec 2015 €’000 Year ended 31 Dec 2014 €’000 (6 188) (1 364) Cash flow from operating activities Loss(-) / profit(+) attributable to equity holders of the Company Adjustments for Depreciation and amortisation Financial items Income taxes Non-cash items (options granted) Change in net working capital: Trade and other receivables Inventories Trade and other current liabilities Interest and other financial costs paid Interest and other financial income received Income taxes paid Net cash used in/from operating activities (A) Cash flow from investment activities Investments in machinery and equipment and intangible assets Net cash from/used in investing activities (B) 262 298 42 474 (2 035) 50 278 (285) 0 (42) (7 146) (107) (107) Cash flow from financing activities Proceeds from issue of share capital/issue, net 18 080 Proceeds from issue of convertible notes Proceeds from current borrowings Proceeds from non-current borrowings Repayment of current borrowings Net cash used in financing activities (C) Net increase(+) / decrease (-) in cash and cash equivalents (A+B+C) Cash and cash equivalents at 1 January Cash and cash equivalents at 31 December 46 18 080 10 827 242 11 068 60 130 6 6 400 510 (146) 15 (6) (389) (152) (152) 1 126 245 (588) 783 242 (0) 242 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 financia l statem en ts Statement of Changes in Equity Stated in euro Share capital €’000 Unregistered share capital €’000 Reserve for invested non-restricted equity €’000 Retained earnings €’000 Total equity €’000 Balance at 31 December 2012 1 296 5 328 (7 460) (837) Total comprehensive income for the financial year 2013 Transactions with equity holders of the Company, recognised directly in equity Conversion of convertible debt Issue of ordinary shares for cash 120 120 1 275 1 275 (1 515) (1 515) 7 (1 508) 7 1395 (112) Balance at 31 December 2013 1 416 1 275 5 328 (8 968) (949) Total comprehensive income for the financial year 2014 Transactions with equity holders of the Company, recognised directly in equity (1 364) (1 364) Increase of share capital1 1 275 (1 275) Conversion of convertible notes 1 275 (1 275) 1 126 1 126 1 126 Balance at 31 December 2014 2 691 6 453 (10 332) (1 188) Total comprehensive income for the financial year 2015 Transactions with equity holders of the Company, recognised directly in equity Share base payment Increase of share capital Transaction costs on share capital issued Conversion of convertible notes (6 188) (6 188) 19 261 (1 181) 474 474 19 261 (1 181) 18 080 (5 714) 12 366 Balance at 31 December 2015 2 691 24 533 (16 046) 11 178 For further information on the convertible notes and other equity transactions see Note 15 Equity and reserves. 1Unregistered increase in share capital at 31 December 2013. 47 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 financial statements Notes NOTE 1 1. Summary of significant accounting policies 1.2 Basis of preparation 1.1 Corporate information Faron Pharmaceuticals Ltd (”Faron” or the ”Company”) is a Finnish limited liability company organised under the laws of Finland and domiciled in Turku, Finland. The Company’s registered address is Joukahaisenkatu 6 B, 20520 Turku, Finland. The former parent company of Faron Pharmaceuticals Ltd, Faron Ventures Ltd, merged into Faron Pharmaceuti- cals Ltd as at 31 December 2013. Faron has no interests in other entities. The shares of Faron are held by multiple Shareholders. Faron is a privately owned clinical stage drug discovery and development company. Currently Faron has three major drug development projects focusing on: • acute trauma • inflammatory diseases; and • cancer growth and spread. Faron’s lead product FP-1201, also known as Traumakine®, successfully completed a Phase I/II trial in the UK to treat vascular leakage in ARDS1 patients, and has subsequently commenced a pan-European pivotal Phase III study (INTER- EST) during 2015. INTEREST recruited its first patient in late December 2015. Faron has been granted orphan drug status for the treatment of ARDS with interferon-beta by the EU Com- mission and European Medicines Agency (EMA) under the reg- istration number EU/3/07/505. Faron has also been granted several patents in the USA, Europe and Japan, and has several pending applications in other territories for the use of interfer- on-beta to treat various ischemic conditions. The Board of Directors of Faron approved the publishing of these financial statements in its meeting on 9 March 2016. According to the Finnish Limited Liability Companies’ Act, Shareholders have the right to approve or reject the financial statements at the Annual General Meeting held after the publi- cation of the financial statements. The principal accounting policies applied in the preparation of these financial statements are set out below. 48 These are Faron’s full year financial statements prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union and as published by the International Accounting Standards Board (IASB) and in force as at 31 December 2015. In the EU IFRS standards and their interpretations are adopted in accordance with the procedure laid down in regulation (EC) No 1606/2002 of the European Parliament and of the Council. Faron has consist- ently applied these policies to each year presented, unless otherwise stated. The Company has not applied any standard, interpretation or amendment thereto before its effective date. Faron’s date of transition to IFRS is 1 January 2012. The Company has applied IFRS 1 First-time Adoption of Interna- tional Financial Reporting Standards in preparing these finan- cial statements. Until 31 December 2011 Faron’s separate fi- nancial statements were prepared in accordance with Finnish Accounting Standards (FAS). The financial statements are prepared under the historical cost convention, except as disclosed in the accounting poli- cies below. The financial year of Faron is the calendar year ending 31 De- cember. The figures in the financial statements are presented in thousands of euro unless otherwise stated. All figures present- ed have been rounded, and consequently the sum of individual figures may deviate from the presented aggregate figure. The Company has not had any other comprehensive in- come in those years presented in these financial statements. Faron’s financial statements are prepared on a going con- cern basis. It is the intention of the Company to continue the development of the products to the point where they can be either licensed at attractive terms to internationally active pharmaceutical companies who have the means to further develop these products, or to develop the products in-house until receipt of marketing approval from the relevant regulato- ry agencies is obtained. After such approval, Faron would pri- marily seek to form partnerships with strong global, regional or local pharmaceutical companies that have the necessary marketing and distribution capabilities and resources. In such partnerships, Faron will typically grant geographically limited licenses for products in exchange for contractually agreed payments, license fees and royalties on future product sales. In some cases, one element of such an agreement may in- clude a collaboration in which Faron will also receive funding FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 for R&D services provided at a cost plus basis. In addition to its normal R&D and corporate activities, Faron seeks, as a clinical stage drug discovery and development company, to advance the development of its lead compounds through clin- ical trials. The Company conducts these clinical trials either together with development partners or by itself, however, in both cases these activities require substantial funding. Faron primarily relies upon financing its activities through equity fi- nancing, license agreements and public R&D loans and grants. The preparation of financial statements under IFRS requires management to make judgments, estimates and assump- tions that affect the reported amounts of assets and liabili- ties, and disclosure of contingent assets and liabilities at the end of the reporting period as well as the reported amounts of income and expenses during the reporting period. These es- timates and assumptions are based on historical experience and other justified assumptions that are believed to be reason- able under the circumstances at the end of the reporting pe- riod and the time when they were made. Although these esti- mates are based on management’s best knowledge of current events and actions, actual results may ultimately differ from those estimates. The estimates and underlying assumptions are reviewed on an ongoing basis and when preparing the fi- nancial statements. Changes in accounting estimates may be necessary if there are changes in the circumstances on which the estimate was based, or as a result of new information or more experience. Such changes are recognised in the period in which the estimate is revised. The key assumptions about the future and key sources of estimation uncertainty that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next 12 months are described in more de- tail in Note 1.20 below. sales and milestone payments in accordance with the license agreements in place. Revenue is recognised when the amount of revenue can be measured reliably; when it is probable that the future economic benefits will flow to the Company; and when specific criteria have been met for each of the Company’s activities as described below. 1.4.1 Revenue from sales of goods Revenue from the sale of goods is recognised when the signif- icant risks, rewards and control usually associated with own- ership of the goods have been transferred to the buyer. In the period 1 January 2013 to 31 December 2015 Faron has gener- ated revenues from sales of excess inventory (interferon-beta). 1.4.2 Recognition of revenue from upfront payments Upfront license fees, including signing fees, are usually re- ceived when a license is granted. They are deferred and recog- nised as revenue over the relevant contract period on a basis that is consistent with the services delivered over the relevant contract period. 1.4.3 Recognition of revenue from milestone payments Revenue associated with performance milestones is recog- nised based on achievement of the deliverables as defined in the respective agreements. Refundable milestone payments are recorded as deferred income and recognised as revenue at the point of time when the underlying performance obliga- tions have been fulfilled. Non-refundable milestone payments are recognised as revenue when: • the customer has verifiably accepted that the milestone 1.3 Foreign currency transactions and balances has been reached; The Company’s presentation and functional currency is euro. Foreign currency transactions are translated into the function- al currency using the exchange rates prevailing at the dates of the transactions or valuation where items are re-measured. Foreign exchange gains and losses resulting from the settle- ment of such transactions and from the translation at peri- od-end exchange rates of monetary assets and liabilities de- nominated in foreign currencies are recognised in the income statement within financial items. • Faron has no further performance obligations; and • there is a reasonable assurance that these receivables can and will be collected. 1.5 Other operating income Other operating income includes income from activities out- side the ordinary business of Faron, such as recognition gov- ernment grants, service charge income and gains from dis- posals of non-current assets. 1.4 Revenue recognition 1.6 Research and development costs Pharmaceutical companies collect revenues in many ways depending on the stage of the drug development process. The Company’s main sources of revenue have been upfront payments (one-off license payments), revenues from product All costs related to research activities are presented under the heading research and development expenses in the income statement. Research and development expenses include salaries and other expenditure directly attributable to Faron’s 49 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 research and development activities. Furthermore, costs at- tributable to supporting the research and development activ- ities, such as rental expenses for facilities, are included. Re- search and development expenses are directly related to the development phases of Faron’s projects and may therefore fluctuate strongly from year to year. No internal development expenses related to Company’s products and product candidates have yet been capitalised as management considers that the uncertainties inherent in developing pharmaceutical products prohibits the capitalisa- tion of internal development expense as an intangible asset until marketing approval has been received from the relevant regulatory agencies. Costs incurred on internal development projects are re- cognised as intangible assets as at the date that the internal development project meets the criteria for recognition. See 1.12.2 Intangible assets. 1.7 Employee benefits Faron’s employee benefits currently consist of short-term em- ployee benefits and post-employment benefits (defined contri- bution pension plans). Short-term employee benefits, i.e. salaries, social security contributions, paid annual leave and sick leave, bonuses and non-monetary benefits, are accrued in the year in which the related service is provided. A liability is recognised for the amount expected to be paid if Faron has a present legal or constructive obligation to pay this amount as a result of past service provided by the employee and the obligation can be estimated reliably. A defined contribution plan is a pension plan under which Faron pays fixed contributions into a separate entity. Faron has no legal or constructive obligations to pay further contri- butions if the fund does not hold sufficient assets to pay all employees the benefits relating to employee service in the current and prior periods. The contributions are recognised as employee benefit expense when they are due. Prepaid contri- butions are recognised as an asset to the extent that a cash refund or a reduction in the future payments is available. 1.8 Share based payments Share-based incentive programmes under which Board mem- bers and Key employees have the option to purchase shares in the Company (equity-settled share-based payment arrange- ments) are measured at the equity instrument’s fair value at the grant date. The cost of equity-settled transactions is determined by the fair value at the date of grant using the Black-Scholes valua- tion model. The cost is recognised together with a correspond- ing increase in equity over the vesting period being the period in which the performance and service conditions are fulfilled. The fair value determined at the grant date of the equity-set- tled share-based payment is expensed on a straight line basis. No expense is recognised for grants that do not ultimately vest. The assumptions and best estimates for calculating the fair value of share-based payment transactions are disclosed in the notes. 1.9 Operating result IFRS allows the use of additional line items and subtotals in the income statement. Faron has defined its operating result to be a relevant subtotal in understanding the Company’s fi- nancial performance. Faron’s, operating result is the net sum which is formed by adding other operating income to revenue and then deducting research and development expenses as well as administrative expenses. All other items of the income statement are presented below the operating result. 1.10 Loss per share Basic loss per share is calculated by dividing the net loss at- tributable to Shareholders by the weighted average number of ordinary shares in issue during the year, excluding ordi- nary shares purchased by the Company and held as treasury shares. Diluted loss per share is calculated by adjusting the weight- ed average number of ordinary shares outstanding assuming conversion of all dilutive potential ordinary shares. 1.11 Income taxes The income tax expense for the period consists of current and deferred taxes. Tax is recognised in the income state- ment, except for the income tax effects of items recognised in other comprehensive income or directly in equity, which is similarly recognised in other comprehensive income or equi- ty. The current income tax charge is calculated on the basis of the tax rates and laws enacted or substantively enacted in the countries where Faron operates and generates taxable income. Management establishes provisions where appropri- ate on the basis of amounts expected to be paid to the tax authorities. Deferred tax is provided using the liability method on temporary differences arising between the tax bases of as- sets and liabilities and their carrying amounts in the financial statements. However, deferred tax is not accounted for if it arises from initial recognition of an asset or liability in a trans- action other than a business combination that at the time of the transaction affects neither accounting nor taxable profit nor loss. Faron’s major temporary differences arise from tax losses carried forward and research expenditure incurred not yet deducted for tax purposes. 50 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Deferred tax liability tax is generally provided for in full. De- ferred tax assets are recorded up to the amount that repre- sents probable taxable income received in the future and against which temporary differences can be utilised. The amount and probability of the utilisation of deferred tax assets are reviewed at the end of each reporting period. Deferred taxes are determined using tax rates (and laws) enacted or substantively enacted by the balance sheet date in the respective countries and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled. 1.12 Equipment and intangible assets 1.12.1 Equipment Currently Faron does not own any land or buildings. Equip- ment that Faron owns comprises of mainly office equipment and personal computers. Equipment is stated at historical cost less depreciation and any impairment losses. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Repairs and maintenance costs are expensed as incurred. Depreciation is calculated using the straight-line method to allocate each item’s cost to its residual value over its estimat- ed useful life. The depreciation expense is included in the costs of the functions using the asset. 1.12.2 Intangible assets Faron’s intangible assets include patents and internally devel- oped intellectual property (“documentation-related assets”). An intangible asset is recognised only if it is probable that the future economic benefits attributable to the asset will flow to Faron and the cost of the asset can be measured reliably. All other expenditure is expensed as incurred. These intangible assets are initially recognised at cost. Cost comprises the purchase price and all costs directly attributable to bringing the asset ready for its intended use. Subsequently intangible assets are carried at cost less amortisation and any accumu- lated impairment losses. Internally generated intangible assets arising from develop- ment are recognised if, and only if, all the criteria for recogni- tion are fulfilled: • it is technically feasible to complete the intangible asset so that it will be available for use; • there is an ability to use or sell the intangible asset; • it can be demonstrated how the intangible asset will gener- complete the development and to use or sell the intangible asset are available; and • the expenditure attributable to the intangible asset during its development can be reliably measured. • The internally developed documentation asset is related to the re-development of the Active Pharmaceutical Ingredi- ent, API (“API documentation”) The development activities and documentation relate to stability testing of a drug sub- stance (API), that is sellable as such, but the quality and value of which improves as the stability is proven and doc- umented. In addition to its own use, Faron may also, for a fee, license the documentation to companies that can uti- lise documentation in their own drug candidate approval and registration documentation. Provision of such access does in no way limit Faron’s ability to use the documenta- tion in its own application processes or ability to give such access to additional users. Intangible assets are amortised over their expected or known useful lives on a straight-line basis beginning from the point they are available for use. The estimated useful life is the lower of the legal duration and the economic useful life. The estimat- ed useful lives of intangible assets are regularly reviewed. The estimated useful life for intangible assets is currently 10 years. The effect of any adjustment to useful lives is recognised pro- spectively as a change of accounting estimate. Intellectual property-related costs for patents are part of the expenditure for the research and development projects. The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at the end of each financial year. Internal research costs are those costs incurred for the purpose of gaining new scientific or technical knowledge and understanding. Such costs are always expensed as incurred. Internal development costs are those costs incurred for the application of research findings or other knowledge to plan and develop new products for commercial production. As the drug product development projects undertaken by Faron are subject to technical feasibility, regulatory approval and other uncertainties, these criteria are considered to be met only after Faron has filed its submission to the regulatory authority for final approval after which all subsequent development costs will be capitalised. Before this trigger point all drug product related development costs are typically expensed as incurred. Faron has not capitalised any drug product related develop- ment expenditure as the related criteria have not been met yet. Development costs expensed in prior financial years are not capitalised at a later date. 1.13 Impairment of non-financial assets ate probable future economic benefits; • adequate technical, financial and other resources to Assets that are subject to depreciation/amortisation are re- viewed for impairment whenever there are any indications 51 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 that the carrying amount may not be recoverable. As a clin- ical stage drug discovery and development company Faron pays attention to the following factors, among others: chang- es in the legal framework covering patents, rights or licences, change in the useful lives of similar assets, relationship with other intangible or tangible assets and, other factors that in- dicate that the value of a tangible or an intangible asset has been impaired. Intangible assets that have an indefinite useful life or intan- gible assets not ready for use are not subject to amortisation and are tested for impairment annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use. The value in use represents the discounted future net cash flows expected to be derived from an asset. Any reductions are reported in the income statement as an impairment loss. 1.14 Government grants Faron has received government grants from the EU (Commis- sion’s FP7 programme). Grants from governments or similar organisations to support certain projects are accounted for as grants relat- ed to income. They are initially recognised at their fair val- ue. Those grants are deferred and recognised in the income statement over the period necessary to match them with the costs that they are intended to compensate, when man- agement has reasonable assurance that the grant will be re- ceived and Faron will comply with the conditions attached to that grant. Such grants are presented as other operating income. Grants for the acquisition of equipment and intangible as- sets would be deducted from the cost of the asset in question. So far Faron has not received any such grants. If, at the balance sheet date, the conditions are believed to be fulfilled and the related grant payments are outstanding, grant receivables are shown in the balance sheet. 1.15 Inventories research and development purposes to be processed into IMP (Investigational Medicinal Product). However, it also has alter- native use, i.e. the ingredient is traded by other companies and consequently may be sold in the market. Faron has sold API over the reporting periods to pharmaceutical companies. 1.16 Financial assets Faron’s financial assets consist principally of cash and cash equivalents. The classification of a financial asset depends on the pur- pose for which the financial asset was acquired. Management determines the classification of its financial assets at initial recognition. Cash and cash equivalents are recognised at cost. They include cash in hand and bank balances if they are readily con- vertible to known amounts of cash, are not subject to signif- icant changes in value and have a maturity of three months or less from the date of acquisition. Any bank overdrafts are shown within borrowings in current financial liabilities. Receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active mar- ket nor held by the Company for trading. Trade receivables and other financial receivables are included in this category. They are included in current assets, except for maturities greater than 12 months after the end of the reporting period. Trade receivables are amounts due from customers for signing fees, milestone payments or services performed (including reimbursable costs) in the ordinary course of business. Trade receivables are carried at the original in- voice amount less allowances made for doubtful receiva- bles, discounts and rebates and similar allowances, when applicable. Impairment is recognised on doubtful receiva- bles based on individual assessment of potential identified credit risk where there is objective evidence that Faron will not be able to collect all amounts due. Credit losses are recognised in the income statement and presented under costs allocated to functions. Interest income is recognised using the effective interest method and recorded in finan- cial income. Financial assets are derecognised when Faron loses the rights to receive the contractual cash flows on the financial asset or it transfers substantially all the risks and rewards of ownership outside Faron. Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first-in, first-out (FIFO) method. The cost of finished goods comprises purchase price and other directly attributable costs. Net realisable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses. Inventories consist of GMP2 manufactured drug ingredient API (Active Pharmaceutical Ingredient), acquired primarily for 1.17 Financial liabilities and equity Faron classifies an instrument, or its component parts, on ini- tial recognition as a financial liability or an equity instrument in accordance with the substance of the contractual arrange- ment and the definitions of a financial liability and an equity instrument. 52 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 1.17.1 Bank borrowings Borrowings are initially recognised at fair value, less any direct- ly attributable transaction costs. Subsequently borrowings are carried at amortised cost using the effective interest method. Borrowings are presented as current liabilities unless Faron has an unconditional right to defer settlement of the liability for at least 12 months after the end of the reporting period. Borrowings (or part of the liability) is not derecognised until the liability has ceased to exist, that is, when the obligation identified in a contract has been fulfilled or cancelled or is no longer effective. Fees paid on the establishment of loan facilities are recog- nised as transaction costs of the loan to the extent that it is probable that some or all of the facility will be drawn down. In this case, the fee is deferred until the draw-down occurs. To the extent there is no evidence that it is probable that some or all of the facility will be drawn down, the fee is capitalised as a pre-payment for liquidity services and amortised over the period of the facility to which it relates. 1.17.2 Government loans Faron has two government loans with a below-market rate of interest from Tekes (The Finnish Funding Agency for Technol- ogy and Innovation). The loans have been withdrawn before the date to transition to IFRS (i.e. prior to 1 January 2012). Based on the exemption under IFRS 1, Faron has measured the government loans using the previous FAS book value as the carrying amount of the loan and as such has not account- ed for the below-market grant separately. Subsequently, the loans are carried at amortised cost using the effective inter- est rate. In December 2015 Tekes made a positive decision regarding a €1.5 million development loan for funding of the pre-clinical development of Clevegen®. As at 31 December 2015 the loan agreement was not signed. 1.17.3 Convertible notes Faron analyses the contractual terms and substance of con- vertible notes to classify each instrument, or its component parts, as a financial liability or an equity instrument. If the instrument does not contain a contractual obligation to deliver cash or other financial assets, and it can be convert- ed to a fixed amount of the Company’s shares, it is classified as equity. If the conversion option is to a variable amount of the Company’s shares, and it includes contractual obligation to deliver cash, the instrument is a liability that contains em- bedded derivatives, and it is therefore classified as a financial liability at fair value through profit or loss in its entirety. If the instrument is classified as equity, it is recognised at cost and it is not re-measured subsequently. If the instrument is classified as a financial liability at fair value through profit or loss, it is measured initially and subsequently at fair value, and fair value changes are recognised in the income statement as finance income or costs in the period in which they occur. On conversion to equity, the liability is transferred to equity. All convertible notes have been converted into ordinary shares by the end of January 2015. 1.17.4 Equity Ordinary shares are classified as equity. Incremental costs di- rectly attributable to the issue of new shares are shown in eq- uity as a deduction, net of tax, from the proceeds of the share issue. The portion of costs attributable to the stock market listing in November 2015, or are otherwise not incremental and directly attributable to issuing new shares, are recorded as an expense in the income statement. Reserve for invested unrestricted equity is credited with other equity inputs as well as that part of the subscription price of the shares that according to the explicit decision is not to be credited to the share capital. 1.18 Leases Faron as a lessee Leases of equipment, where Faron has substantially all the risks and rewards of ownership, are classified as finance leases. Assets leased under finance leases are capitalised at the inception of the lease at the lower of the fair value of the leased property and the present value of the minimum lease payments. Lease obligations are included in current and non-current financial liabilities based on their maturity, net of finance charges. The interest element of the payments is expensed. An asset recognised under a finance lease is depreciated over its useful life. Faron’s assets leased under finance leases were insignificant during the financial years presented. Leases where a significant portion of the risks and rewards of ownership are retained by the lessor are classified as op- erating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the lease term. 1.19 Provisions and contingent liabilities A provision is recognised when Faron has a present legal or constructive obligation as a result of past events, it is proba- ble that an outflow of resources will be required to settle the obligation, and a reliable estimate of the amount can be made. Faron had no provisions at the end of the reporting periods presented in these financial statements. 53 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 A contingent liability is a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence of uncertain future events not wholly within the control of the entity. Such present obligation that probably does not require settlement of a payment obligation and the amount of which cannot be reliably measured is also consid- ered to be a contingent liability. Contingent liabilities are dis- closed in the notes to the financial statements. 1.20 Critical accounting estimates and management judgments made in applying accounting policies 1.20.1 Revenue recognition Due to the nature of the pharmaceutical development busi- ness, Faron’s collaboration and licence contracts are complex and these contracts often require significant analysis and judgement by management in order to determine the appro- priate method of revenue recognition. Contracts may consist of multiple components with the un- derlying services and goods delivered at different times over a contract’s lifetime representing separate earnings processes. Revenue is allocated to the separate components on a relative fair value basis and revenue is recognised when the criteria for revenue recognition is met for each component. Non-refunda- ble milestones are recognised as revenue when the milestone has been achieved and the Company does not have future ob- ligations. This is normally when the Company is informed by the contract party that the milestone has been achieved. Any milestone payments that have been received but for which earnings process has not been completed are reported as de- ferred revenue in the balance sheet/statement of financial po- sition and recognised as revenue when the service/goods has been delivered is complete and there are no remaining obliga- tions or contingencies. For some transactions this may result in recognising cash receipts initially as deferred income and then released to income over subsequent financial years on the basis of meeting the conditions further specified in each individual agreement. 1.20.2 Research and development expenses Faron follows IFRS guidance to determine whether develop- ment costs qualify for capitalisation. This determination re- quires significant judgement. When an internal development project fulfills the criteria for capitalisation, costs incurred are capitalised from that point forward. The in-process de- velopment project is then tested for impairment annually and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. It is Faron’s view that drug product related development expenses may not be capitalised until marketing approval has been received from the relevant regulatory agencies, as this is considered to be the first point at which it may be concluded that future reve- nues can be generated. According to management’s judgement, the internally de- veloped documentation asset that is related to the re-develop- ment of the Active Pharmaceutical Ingredient, API (“API doc- umentation”), fulfills the criteria of IFRS for capitalising costs of internally developed intangible assets despite the nature of the Company’s operations where capitalisation criteria is tradi- tionally met at the receipt of regulatory approval. The develop- ment activities and documentation relate to stability testing of a drug substance (API) that is sellable as such, even though it is primarily used in the development process. The quality and value of the drug substance improves as the stability is proven and documented. In addition to its own use, Faron may also, for a fee, license the documentation to companies that can uti- lise documentation in their own drug candidate approval and registration documentation. The costs of this internally devel- oped intangible asset have been capitalised as of the criteria for capitalisation was fulfilled. 1.20.3 Deferred taxes Recognition and measurement of deferred tax assets and de- ferred tax liabilities include management estimates, especially for deferred tax assets arising from tax losses carried forward. Deferred tax assets are recognised for deductible temporary differences to the extent that it is probable that taxable profit will be available against which deductible temporary differen- ces can be utilised. Various internal and external factors may have favorable or unfavorable effects on the deferred tax as- sets and liabilities. These factors include, but are not limited to, available tax strategies, changes in tax laws, regulations and/or rates dealing with e.g. recoverability periods for tax loss carry-forwards, changing interpretations of existing tax laws or regulations, future levels of research and development spending and changes in overall levels of pre-tax earnings. Such changes that arise could impact the assets and liabili- ties recognised in the balance sheet in future periods. All tax liabilities and assets are reviewed at the end of the reporting period and changes are recognised in the income statement. Faron has not recorded any deferred tax assets on tax losses carried forward. 1.20.4 Inventories Measurement of inventories includes some management esti- mates. Inventories are measured at lower of cost and net real- isable value. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the 54 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 sale. Net realisable value is used in testing the recoverable amount of inventories in order to avoid the inventories being carried in excess of amount expected to be realised from their sale or use. Management has assessed, that GMP3 manufactured drug ingredient also fulfills the criteria of IFRS to be classified as in- ventory. Even though it has been acquired mainly for research and development purposes to be processed into API (Active Pharmaceutical Ingredient) and it is not currently Faron’s core business to actively market the ingredient, as it also has alter- native use, i.e. the ingredient is traded by other companies and Faron has also traded API, management has recorded the API in its inventory. 1.20.5 Adoption of new and amended standards and interpretations applicable in future financial years Faron has not yet adopted the new and amended standards and interpretations already issued by the IASB but that are not effective for financial year 2015. The Company will adopt them as of the effective date or, if the date is other than the first day of the financial year, from the beginning of the subsequent financial year. The Company has presented below only the standards that are relevant to the Company and might have impact on its financial statements in its current operations. *= not yet endorsed for use by the EU as of 31 December 2015. • IFRIC 21 Levies (effective for financial years beginning on or after 17 June 2014): The interpretation addresses the accounting for a liability to pay a levy recognised in ac- cordance with IAS 37 Provisions, and the liability to pay a levy whose timing and amount is certain. The amendment does not have a material impact on the Company’s finan- cial statements. • Annual Improvements to IFRSs (2010-2012 and 2011-2013 cycles*) (effective for financial years beginning on or after 1 July 2014): The annual improvements process provides a mechanism for minor and non-urgent amendments to IFRSs to be grouped together and issued in one package annually. These amendments cover several standards and their impacts vary standard by standard but the Company considers that they do not have a significant impact on the financial statements of Company. • Amendments to IAS 1 Presentation of financial statements (effective for financial years beginning on or after 1 Janu- ary 2016): The amendments clarify guidance in IAS 1 on materiality and aggregation, the presentation of subtotals, the structure of financial statements and the disclosure of accounting policies. The Company is still assessing the possible impact of the amendments to its financial statements. • IFRS 15 Revenue from contracts with customers* (effec- tive for financial years beginning on or after 1 January 2017): The standard covers revenue recognition and will supersede current revenue recognition standards, IAS 18 and IAS 11. The Company is still to assess the impacts of the standard. • IFRS 9 Financial Instruments* (effective for financial years beginning on or after 1 January 2018): The standard will replace IAS 39 fully (even though some areas are moved from IAS 39 to IFRS 9 unchanged). Main changes are: Fi- nancial assets are classified based on entity’s business model. Impairment will be recognised based on expected losses from the first reporting date that the assets mea- sured at amortised cost are on the balance sheet. Hedge accounting will be aligned more closely with risk manage- ment. The Company is still to assess the impacts of the standard. 1 Acute Respiratory Distress Syndrome, ARDS. 2 GMP = Good Manufacturing Practice. 3 GMP = Good Manufacturing Practice. 55 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 following the general terms of the loans. The loans do not in- clude any covenants. The Company has negotiated with Tekes a two-year extension to the loan and an equal postponement of the installments of the first loan. B) Convertible notes Faron issued convertible notes in 2014 to strengthen its finan- cial position. These convertible notes were classified in equity, because they contained contractual obligation to deliver cash to the holder only in an event of liquidation of Faron, and the actual conversion rate determined in the contract was fixed. The loan was fully converted to shares in January 2015. NOTE 2 2.1 Principles of financial risk management Faron’s activities expose it to a variety of financial risks as follows: In 2015 Faron received new equity, less direct costs, to the amount of EUR 18,080,000. This new capital significantly re- duced the liquidity risk for the Company in the near future. In 2012 the European Commission awarded a EUR 5,963,000 grant to the Faron network (Consortium) to support the FP-1201-lyo clinical Phase III programme (“Traumakine®”). The Consortium consists of the European Commission as a granting agency, Faron as a coordinator and three other par- ticipating partners of the Traumakine® programme; University College London Hospital (UCLH), University of Torino and Uni- versity of Turku. The first payment under the grant, received in 2013, amounted to EUR 1,693,000, of which EUR 660,000 has been recognised as other operating income. The second grant payment, EUR 1,018,000 was received at the end of 2014, of which EUR 110,000 has been recognised as other operating income. In 2015, EUR 701,000 was recognised as other oper- ating income. During 2014 the Company negotiated a two-year extension to the loan and an equal postponement of the instalments of the first government R&D loan from Tekes, for which the first instalment was originally now due in 2014. Tekes provided Fa- ron with an additional two years to make payment in respect to the first instalment which is now therefore due in 2016. Faron also has had a committed credit limit available, up to EUR 800,000, which was ended in 31 December 2015. The management believes that this credit limit can be reopened if required. These above mentioned funds and financing sources, in ad- dition to expected milestone payments from Maruishi, in 2016 and income from other commercial agreements, will enable Faron to fund its operating expenses as planned during 2016. A) Goverment loans (R&D loans from Tekes) The Finnish Funding Agency for Technology and Innovation (Tekes) has granted two loans to the Company. The total amount had been drawn down by the Company by the end of the year 2011. Both loans are government loans with a be- low-market rate of interest. The total loan periods are 10 years from the draw-down. The interest rate for these loans is the base rate set by the Finnish Ministry of Finance less 1%, how- ever, the interest rate will not fall below a 3% minimum. Repay- ment of these loans shall be initiated after 5 years, thereafter loan principals shall be paid back in equal installments over the remaining loan period. In certain circumstances Tekes may, at its own discretion, extend the loan terms, convert the loans into capital loans or exempt the Company from repayment 56 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 C) Loans Stated in euro Contractual maturity of loans and their interest payments at 31 Dec Non-current financial liabilities Government loans Repayment of loans Interest expenses Current financial liabilities Government loans, current portion Interest expenses Bank overdraft facility Trade payables 2015 €’000 2016 €’000 2017 €’000 2018 €’000 Later years €’000 Total €’000 0 18 245 16 338 13 338 9 770 1 691 9 64 436 453 260 351 348 779 2 191 436 The Company intends to finance the repayment of the loans from future cash sources including among others milestone payments from existing agreements, equity issuances and revenue from future lisencing agreements. The loans contain a provision, that if the projects related to the loans turn out to be unsuccesful the lender can forgive the loans either partially or fully. Credit risk Credit risk is the risk that one party to a financial instrument will cause a financial loss for Faron by failing to discharge an obligation. Credit risk arises from cash and cash equivalents as well as credit exposures to external parties, including amounts to be invoiced and outstanding receivables. and is considered the main area of credit risk. However, this risk is partly mitigated by the fact that Faron’s current collab- oration partner is a large and internationally reputable phar- maceutical company that is financially solid. These collabo- rations are normally governed by contractual relationships that typically address and describe remedies for situations in which interests of Faron and the partner are not longer in line. Faron’s cash and cash equivalents are invested primari- ly in saving and deposit accounts with original maturities of three months or less. These accounts generate a very small amount of interest income. The banks that Faron works with have good (Moody’s Aaa) credit ratings. The Company has not incurred any credit losses over the reporting periods 2012-2015, and management does not ex- pect losses from non-performance by counterparties (for ex- ample, Maruishi). Therefore, at present, credit risk is limited. Currently Faron does business with one external coun- terparty, Maruishi. Over the coming years, Maruishi funding (milestone payments and reimbursable research expenses) remains critical to Faron’s product development programmes Faron had no trade receivables by year-end 2012-2014. In the year ended 31 December 2015 there is one invoice which has been outstanding for 2.5 months. No further ageing anal- ysis of trade receivables is presented. 57 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Market risk Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises three types of risk: • currency risk • interest rate risk; and • other price risk A) Currency risk Currency risk is the risk that the fair value or future cash flows of a financial instrument, e.g. a trade receivable, will fluctuate because of changes in foreign exchange rates. Faron’s functional currency is the euro and Faron is ex- posed to foreign exchange risk arising from currency expo- sure, currently mainly with respect to the Japanese Yen and pound sterling. The Company receives payments from its main licence partner Maruishi (based in Japan) in Japanese Yen. However, the impact of the foreign exchange risk arising from the Yen exposure is not considered significant in average. Due to the commencement of the Phase III clinical trials with a UK based Clinical Research Organisation as the main service provider, the Companys’ pound sterling denominated expens- es and trade payables have become significant. The Company converted most of the pound sterling denominated IPO pro- ceeds into euros immediatelly after the IPO, but held and still holds a sizeable amounts of pound sterling in its pound sterling bank accounts. This forms a natural hedge against euro-pound exchange rate changes, as the funds held in pound sterling roughly match with the estimated pound sterling expenses during 2016. As a result of the sizeable pound sterling holdings, the depreciation of pound sterling against euro had a negative effect on the financial statements. As the exchange rate may move also to other direction during 2016, the management be- lieves that natural hedge strategy best protects the Company from adverse exchange rate changes and this protection over- weights short-term currency rate losses. Other foreign currency denominated trade receivables (and trade payables, if any) are small and short term in nature.The borrowings and other liabilities of Faron are denominated in euro. As the currency exposure and risk is considered signif- icant, the Company established a natural hedging policy to manage the foreign exchange risk against the functional cur- rency of the Company. B) Interest rate risk Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of chang- es in market interest rates. 58 The Company’s interest rate risk arises from long-term bor- rowings. Faron’s borrowings are denominated in euro. The non-current borrowings issued at fixed rates expose the Company to fair value interest rate risk. Interest rate is par- tially offset by cash held at variable rates which, on the oth- er hand, expose Faron to cash flow interest rate risk. Given that most of the borrowings are government loans with a below-market rate of interest, cash and cash equivalents are very short-term, the impact of interest rate risk on Faron is currently minor, and consequently Faron does not hedge the interest rate risk. 2.2 Capital management Faron’s objectives when managing capital are to safeguard the Company’s ability to continue as a going concern and to maintain an optimal capital structure to reduce the cost of capital. The total amount of equity as recognised in the bal- ance sheet is seen and managed as capital by Faron. In order to maintain or adjust the capital structure, Faron may issue new shares or other equity, liability or compound instruments, or sell assets to reduce debt. To advance the drug development programmes into com- mercialised pharmaceutical products requires significant fi- nancial resources. Faron relies on its ability to fund its opera- tions through three major sources of financing: 1) Equity financing: Faron’s funding is partly organised through equity financing. Management monitors liquidity on the basis of the amount of funds. These are reported to the Board regularly. 2) Commercialisation, collaboration and licensing agree- ments: by entering into said agreements with larger pharmaceutical companies Faron is entitled to receive upfront and milestone-dependent payments from these partners. Activities in the area of business development are targeted at securing such agreements. These activ- ities are integral part of the duties of the management and are monitored by the Board of Directors, which ulti- mately decides on entering into such agreements. 3) Research and development grants and loans: In addi- tion to the sources of funding described above. Faron also relies on different sources of R&D grants and loans. Various regional, national or EU level institutions provide these funds with the aim of fostering economic and technological progress in the region in which Faron op- erates. Such funds have been historically available to Fa- ron at substantial levels. Faron is in regular contact with the funding agencies. The availability of such funds in the future cannot be guaranteed. FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Faron’s Board of Directors approves the operational plans and budget. The Board regularly follows up the implementation of these plans and the financial status. NOTE 5 Other operating income 2.3 Fair value estimation Stated in euro 2015 €’000 2014 €’000 Some of Faron’s accounting policies and disclosures re- quire the measurement of fair values. For Faron this applies primarily to financial assets and liabilities. For financial instruments that are measured in the balance sheet at fair value, IFRS requires disclosure of fair value mea- surements by level of the fair value measurement hierarchy. Fair value hierarchy is based on the source of inputs used in determining fair values (used in the valuation techniques) as follows: • Level 1: fair values are based on quoted prices (unadjusted) in active markets for identical assets or liabilities. • Level 2: fair values are based on market rates and prices, discounted future cash flows etc. Thus inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (that is, as prices) or indirectly (that is, derived from prices) are used. • Level 3: for assets and liabilities in level three, there is no reliable market source available and thus fair value mea- surement cannot be based on observable market data (un- observable inputs). When measuring the fair value of an asset or a liability, Faron uses market observable data as far as possible. NOTE 3 Revenue In 2014 revenue consisted of income generated from sale of both API and IMP reference materials. In 2015 revenue con- sisted of milestone income from Maruishi as well as sales of API material samples and analyses materials. NOTE 4 Segment reporting Faron is a late clinical stage biotechnology company. Its op- erations have been focused on the development of its lead drug candidate, Traumakine®. Faron’s chief operating deci- sion maker has been identified as the Chief Executive Officer (CEO). The CEO manages Faron as one integrated business and hence Faron has one operating and reportable segment. Fa- ron’s country of operation is Finland. Grants from EU 701 111 Grant from Tekes Other items Total other operating income 701 111 In the year ended 2012, the pan-European “Traumakine®” con- sortium where Faron Pharmaceuticals is a Coordinator, signed a grant agreement of the EUR 5,963,000 research grant award- ed by the European Commission from the Seventh Framework Programme (FP7) to support the FP-1201-lyo clinical Phase III Programme (“Traumakine®”), focusing on a first pharma- cological treatment for Acute Respiratory Distress Syndrome (ARDS). The first payment under the grant, received in 2013, amounted to EUR 1,693,000, of which EUR 660,000 has been recognised as other operating income. The second grant pay- ment of EUR 1,018,000 was received at the end of 2014, of which EUR 110,000 has been recognised as other operating income. In 2015, EUR 701,000 was recognised as other oper- ating income. The Company will defer elements of the grant to the point in which the respective milestones are completed (i.e. the milestones which are set out within the EU Grant agreement). Once these milestones are met, the amount due to the Com- pany is recognised as other operating income. 59 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 6 NOTE 7 Employee benefit expense Depreciation and amortisation Stated in euro 2015 €’000 2014 €’000 Stated in euro 2015 €’000 2014 €’000 Salaries (940) (446) Depreciation and amortisation allocated to functions Contributions to defined contribution post-employment plans Social security contributions Share based payments Total employee benefit expenses Average number of personnel Research and development (69) (15) Administration Total depreciation and amortisation (175) (9) (60) (0) (184) (60) (115) (63) (474) (1,591) (530) Depreciation and amortisation by asset categories Machinery and equipment Total depreciation (9) (9) (0) (0) Finland Finland 6 6 5 5 Intangible assets For further information on management remuneration see Note 21 related party transactions. Share based payments are further explained in Note 16. Patents (65) (60) Other intangible assets (110) Total amortisation (175) (60) Total depreciation and amortisation (184) (60) The Company has not recorded any impairment losses for the years ended 31 December 2012 to 2015. 60 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 8 Financial income and expenses Faron has received two goverment loans for research and development purposes with below-market interest rate from Tekes (The Finnish Funding Agency for Technology and Inno- vation). Both loans were withdrawn before the date of transi- tion to IFRS (i.e. prior to 1 January 2012). Thus, based on the exemption under IFRS 1, Faron has measured the government loans using the previous FAS carrying amount as the carrying amount of the loan. Subsequently, both loans are carried at amortised cost using the effective interest rate. Other significant financial expense items are the exchange rate losses when transferring GBP to euro, when issuing the new shares upon Admission to AIM, expenses on loan guar- antees, interest on convertible loans and credit limit interest from bank. See also Note 2 Financial risk management. Stated in euro Financial income 2015 €’000 2014 €’000 Interest from bank balances Interest from account receivables Total financial income 0 0 0 15 15 Financial expenses Interest on government loans (Tekes) (18) (15) Fair value changes of convertible bonds Interest expenses on convertible bonds (9) (67) Interest on bank loans (10) (26) Interest on accounts payables Exchange rate losses (1) (247) (1) (1) Bank guarentee costs and provisions (27) (35) Total financial expenses (311) (146) Total financial income and expenses (311) (131) 61 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 9 Income taxes Stated in euro Withholding tax Total income taxes 2015 €’000 2014 €’000 Stated in euro 2015 €’000 2014 €’000 (42) (42) (6) (6) Reconciliation of effective tax rate The Finnish corporate tax rate applied was 20%. Loss before income tax (6 188) (1 358) Withholding taxes paid in the year ended 31 December 2014 relate to payments of advisory fees to the non-Finnish mem- bers of the Clinical trial Steering Group. Taxes paid in the year ended 31 December 2015 relate to milestone payment from Maruishi. Tax using Faron's domestic corporate tax rate Current-year losses for which no deferred tax asset is recognised Taxes in the income statement 1 238 272 (1 238) (272) Items for which Faron has not recognised a deferred tax asset R&D expenses not yet deducted in taxation1 The tax losses carried forward approved by tax authorities2 Deductible temporary differences for which no deferred assets have been recognised 2 816 2 816 5 663 3 164 8 479 5 979 1 Faron has incurred research and development costs in the financial years ended 31 December 2010 and 2011 that have not yet been deducted in its taxation. The amount can be deducted over an indefinite period with amounts that the Company may freely decide. 2 These losses expire over the years 2019 to 2024. The amount presented for the year ended 31 December 2015 does not include the deductible temporary difference arisen from the net loss for the financial year 2015 as the related loss has not yet been approved by tax authorities by the time of prepara- tion of these financial statements. The related deferred tax assets have not been recognised due to the uncertainty as to whether they can be utilised. 62 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 10 Loss per share Basic Basic loss per share is calculated by dividing the loss attributable to equity holders of the Company by the weighted average number of ordinary shares in issue during the year. Loss attributable to equity holders of the Company (EUR 1,000) 2015 (6 188) 2014 (1 364) Weighted average number of ordinary shares in issue 20 686 854 15 012 262 Basic (and dilutive) loss per share, EUR (0,30) (0,09) Weighted-average number of ordinary shares Issued ordinary shares at 1 January 15 456 250 14 570 680 Effect of shares issued 5 230 604 441 582 Weighted-average number of ordinary shares at 31 December 20 686 854 15 012 262 Diluted Diluted loss per share is calculated by adjusting the weighted average number of ordinary shares outstanding to assume con- version of all dilutive potential ordinary shares. Loss attributable to equity holders of the Company (EUR 1,000) Interest adjustment 2015 (6 188) 9 2014 (1 364) 67 Convertible loan interest adjusted loss attributable to equity holders (6 179) (1 297) Diluted weighted average number of ordinary shares in issue 20 686 854 15 406 329 Basic loss per share, EUR (0,30) (0,09) Weighted-average number of ordinary shares Issued ordinary shares at 1 January 15 456 250 14 570 680 Effect of shares issued 5 230 604 441 582 Weighted-average number of ordinary shares at 31 December 20 686 854 15 012 262 Dilution effect of convertible loans - 394 067 Diluted weighted-average number of ord. shares at 31 December 20 686 854 15 406 329 63 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 11 Machinery and equipment and intangible assets Machinery and equipment Stated in euro Cost Balance at 1 January Cost Additions Disposals Transfers Balance at 31 December Accumulated depreciation / amortisation and impairment Balance at 1 January Depreciation / amortisation (Note 7) Balance at 31 December Net book value at 1 January Net book value at 31 December Patents Stated in euro Cost Balance at 1 January Cost Additions Disposals Transfers Balance at 31 December Accumulated depreciation / amortisation and impairment Balance at 1 January Depreciation / amortisation (Note 7) Balance at 31 December Net book value at 1 January Net book value at 31 December 64 2015 €’000 2014 €’000 2 37 39 (1) (9) (11) 0 28 2 2 (1) (0) (1) 1 0 2015 €’000 2014 €’000 646 70 716 (369) (65) (434) 277 283 602 44 646 (309) (60) (369) 293 277 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Documentation assets in process Stated in euro Cost Balance at 1 January Cost Additions Disposals Transfers 2015 €’000 907 2014 €’000 800 107 Balance at 31 December 907 907 Accumulated depreciation / amortisation and impairment Balance at 1 January Depreciation / amortisation (Note 7) Balance at 31 December Net book value at 1 January Net book value at 31 December Total intangible assets Stated in euro Cost Balance at 1 January Cost Additions Disposals Transfers Balance at 31 December Accumulated depreciation / amortisation and impairment Balance at 1 January Depreciation / amortisation (Note 7) Balance at 31 December Net book value at 1 January Net book value at 31 December (188) (188) 907 719 2015 €’000 1 553 70 1 623 (369) (253) (622) 1 922 1 001 800 907 2014 €’000 1 403 152 1 555 (310) (60) (370) 1 714 1 184 65 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Total machinery and equipment and intangible assets Stated in euro Cost Balance at 1 January Cost Additions Disposals Transfers 2015 €’000 1 555 107 2014 €’000 1 405 152 Balance at 31 December 1 662 1 557 Accumulated depreciation / amortisation and impairment Balance at 1 January Depreciation / amortisation (Note 7) Balance at 31 December Net book value at 1 January Net book value at 31 December (370) (262) (632) 1 925 1 029 (312) (60) (372) 1 717 1 185 Finance leases Orphan drug status The company does not have any finance leases. Documentation assets The cost of the documentation arisen in conjunction to the development work of Faron is recorded in intangible assets. This documentation consists of API documentation1 (see Note 1, 1.12.2 Intangible assets for further details). Faron has completed these assets in 2014. Faron has been granted an orphan drug status for the treatment of ALI/ARDS with interferon beta by the European Commission and the European Medicines Agency (EMA) under the registra- tion number EU/3/07/505. The orphan drug status granted by the EMA entitles the holder an exclusive right for the marketing and sales of drugs within the European Union for 10 years as from the grant date of the approval. This status is transferable. No costs related to this status have been capitalised. Thus the orphan drug status represents an off-balance sheet asset. 66 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 12 Inventories Stated in euro Finished goods Inventories total 2015 €’000 649 649 2014 €’000 699 699 Inventories consists of deep-frozen bags of active pharmaceutical ingredient used in production of FP-1201-lyo, which have a limited expiry time, which can be extended by conducting additional stability studies. The cost of inventories is recognised as an expense and included in the line item “Cost of sales” amounted to EUR 100,000 (2014: zero; 2013: zero). The Company has not recorded any impairment losses in years from 2012 to 2015. NOTE 13 Current receivables Stated in euro Trade receivables Prepayments Accrued items Other receivables Total trade and other receivables 2015 €’000 37 1 248 17 773 2 074 2014 €’000 23 16 40 The majority of prepayments relate to the Clinical Service Agreement with the clinical research organisation (CRO) GAEA Clinical, which is the main service provider for the INTEREST Study. The other receivables consist mainly of the EU FP7 grant income as described in Note 4. NOTE 14 Cash and cash equivalents Stated in euro Bank balances Total cash and cash equivalents 2015 €’000 11 068 11 068 2014 €’000 242 242 67 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 15 Equity and reserves Equity and reserves Number of shares (pcs) Share capital (1,000 €) In issue at 1 January 2013 Conversion of convertible notes to shares Issued for merger consideration Cancelled in merger 31 December 2013 Share issues, issued for cash Issue of convertible equity instrument Warrants issue 31 December 2014 Share base payments Convertible issue Share issues for cash Total Split 1:10 Emission of new shares 1 453 380 3 688 1 000 000 -1 000 000 1 457 068 35 424 0 53 133 1 545 625 0 78 166 302 764 1 926 555 19 265 550 3 846 154 1 296 120 0 0 1 416 1 275 0 0 2 691 0 31 December 2015 23 111 704 2 691 Reserve for invested non-restricted equity (1,000 €) Total (1,000 €) 5 328 6 624 0 0 0 120 0 0 5 328 6 744 0 1 126 0 6 453 1 275 1 126 0 9 144 0 0 5 050 5 050 0 0 13 030 27 224 13 030 24 533 Faron Pharmaceuticals Ltd has one class of shares. The shares amounted to 1,545,625 at 1 January 2015. The follow- ing increases were made during 2015: unrestricted equity, and the share capital of the Company was not increased; a) On 24 February 2015, the number of Ordinary Shares was increased to 1,623,791 by the issue of 78,166 new Ordinary Shares at a subscription price of €14.40. The shares were is- sued due to conversion of the 2014 convertible loan, which so became fully converted. The subscription price was credited in full to the Company’s reserve for invested unrestricted eq- uity, and the share capital of the Company was not increased. The conversion did not have a cash effect in 2015; On 19 May 2015, the number of Ordinary Shares was in- creased to 1,843,356 by the issue of 219,565 new Ordinary Shares at a subscription price of €15.41. The subscription price was credited in full to the Company’s reserve for invested b) By a Board resolution on 6 May 2015 and pursuant to an authority granted to the Board at the Annual General Meeting held on 16 March 2015, on 19 May 2015 the number of Ordi- nary Shares was increased to 1,843,356 Ordinary Shares by the issue of 219,565 new Ordinary Shares at a subscription price of €15.41 per Ordinary Share. The subscription price was credited in full to the Company’s reserve for invested un- restricted equity, and the share capital of the Company was not increased; c) By a Board resolution on 28 May 2015 and pursuant to an authority granted to the Board at the Annual General Meeting held on 16 March 2015, on 9 June 2015 the number of Ordinary 68 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Shares was increased to 1,926,555 Ordinary Shares by the is- sue of 83,199 new Ordinary Shares at a subscription price of €20.03 per Ordinary Share. The subscription price was credited in full to the Company’s reserve for invested unrestricted equity, and the share capital of the Company was not increased; entitles the holder to one vote at the Annual General Meeting. All shares entitle holders to an equal dividend. At the 31 December 2015 Faron’s share capital, entered in the Finnish trade register, amounted to EUR 2,691,000. Details on the management shareholding are disclosed in d) by a resolution of the Extraordinary General Meeting held on 15 September 2015, on 17 September 2015 the number of Ordinary Shares was increased to 19,265,550 by the issue of 17,338,995 new Ordinary Shares to the Shareholders with- out payment in proportion to their holdings so that nine Ordi- nary Shares were issued for each existing Ordinary Share (the “Share Split”); e) by a resolution of a Board Meeting held on 16 September 2015 made pursuant to an authority granted to the Board of Directors at the Extraordinary General Meeting held on 15 September 2015, on 16 September 2015 the Company issued 151,400 warrants (each warrant representing an entitlement to subscribe for one Ordinary Share) to Whitman Howard (which were subscribed for by and issued to Whitman Howard on 16 September 2015). The warrants are divided into two tranches: in the first tranche, 109,800 warrants with a subscription price of [£0.87] (“A Warrants”), and in the second tranche, 41,600 warrants with a subscription price of [£1.43] (“B Warrants”). Any “A” Warrants shall be exercised during the subscription pe- riod commencing on 2 November 2015 and ending on 7 May 2018. Any “B” Warrants shall be exercised during the subscrip- tion period commencing on 2 November 2015 and ending on 28 May 2018; f) by a resolution of the Extraordinary General Meeting held on 15 September 2015, the Company adopted the 2015 Share Option Plan and granted the Options detailed in paragraph 5.5 below to the Directors; g) by a resolution of a Board Meeting held on 11 November 2015 made pursuant to an authority granted to the Board of Directors at the Extraordinary General Meeting held on 15 Sep- tember 2015, the Company resolved to issue (i) 2,417,113 Or- dinary Shares without payment into treasury, in order for such Ordinary Shares to be transferred to Placees pursuant to the Placing on a delivery versus payment basis on Admission, (ii) 44,044 Ordinary Shares as VCT Shares and EIS Shares pursu- ant to the Placing, and (iii) 1,384,997 Ordinary Shares as Sub- scription Shares pursuant to the Subscription. The Company was listed on the London Stock Exchange in November 2015. The share has no nominal value. Each share Note 21 Related party transactions. Nature and purpose of reserves Share capital The subscription price of a share received by the Company in connection with share issues is credited to the share capital, unless it is provided in the share issue decision that a part of the subscription price is to be recorded in the fund for invest- ed non-restricted equity. The proceeds received by Faron from the conversion of the convertible bonds have been credited to share capital. Fund for invested non-restricted equity The fund for invested non-restricted equity includes other equi- ty investments, for which part of the subscription price of the shares according to the related decision is not to be credited to the share capital and issuance of convertible capital loans. Faron has not paid any dividends over the years. 69 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 16 Share options The Company adopted its 2015 option plan on 15 September 2015 (“Option Plan”) as described in full in the Company’s Ad- mission Document. Under the Option Plan, options may be granted in four different tranches (A, B, C and D), each of which may be subscribed for and exercised in different periods. Each option will entitle the holder of the option to subscribe for one ordinary share in the Company. An aggregate maximum number of 1,600,000 options may be granted under this plan, such aggregate being made up of a maximum of 400,000 “A” Options, the subscription period for which ends on 31 De- cember 2015 (exercisable between 2 November 2015 and 30 September 2021), a maximum of 400,000 “B” Options to be subscribed for between 8 October 2016 and 30 September 2019 (exercisable between 8 October 2016 and 30 September 2021), a maximum of 400,000 “C” Options to be subscribed for between 8 October 2017 and 30 September 2019 (exercisable between 8 October 2017 and 30 September 2021), and a max- imum of 400,000 “D” Options to be subscribed for between 8 October 2018 and 30 September 2019 (exercisable between 8 October 2018 and 30 September 2021). The terms of the 2015 option plan require that the option holder remains in the Company’s service until the beginning of the subscription period. The exercise price for Ordinary Shares based on “A” Options is €3.71. The exercise price for ordinary shares based on tranches “B”, “C” and “D” Options shall be de- termined by the euro equivalent to the average share price of the publicly traded ordinary shares of the Company on AIM between 1 July and 30 September of 2016, 2017 and 2018 respectively. Faron has no legal or constructive obligation to repurchase or settle the options in cash, accordingly, the arrangements have been classified as equity settled share-based payments. Transactions during 2015 Option under the 2015 Option Plan Option tranche A B C D Total Average exercise price in € Status Granted Allocated* Allocated* Allocated* Outstanding at 1 Jan. 0 0 0 0 0 Amount Forfeited Exercised 250 000 250 000 250 000 250 000 1 000 000 4.32 0 0 0 0 0 0 0 0 0 0 Outstanding at 31 Dec. 250 000 250 000 250 000 250 000 1 000 000 4.32 * Subscription for these options is conditional on the Director/employee remaining in their role at the time of commencement of the relevant subscription period. 70 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Warrants Warrant tranche A B Total Average exercise price in € Status Granted Granted Outstanding at 1 Jan. 0 0 0 Granted Forfeited Exercised 109 800 41 600 151 400 1.68 0 0 0 0 0 0 Outstanding at 31 Dec. 109 800 41 600 151 400 1.68 During 2015 the Company granted warrants over 151,400 ordinary shares. The warrants are divided into two tranches: in the first tranche, 109,800 warrants with a subscription price of €1.55 (“A Warrants”), and in the second tranche, 41,600 warrants with a subscription price of €2.01 (“B Warrants”). Any “A” Warrants shall be exercised during the subscription period commencing on 2 November 2015 and ending on 7 May 2018. Any “B” Warrants shall be exercised during the subscription period commencing on 2 November 2015 and ending on 28 May 2018. 71 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Calculation of the share-based payment expense in the income statement Accounting for share-based payments under IFRS 2 requires Faron to take into account all the options and warrants, both granted and allocated. In the calculation of the share-based payment expense the options and warrants were treated as one pool. The estimated average fair value of options and warrants granted and allocated during the period was €0.96 per option. Out of 1,151,400 granted and allocated options and warrants, 401,400 were exercisable as at 31 December 2015. None were exercised in 2015. The maximum number of ordinary shares which could be issued in the event of all options under the 2015 option plan being allocated, subscribed for and exer- cised together with exercise of the outstanding warrants out- standing, amounts to 1,751,400 shares. The grant date fair value of the options were determined using the Black-Scholes valuation model.The significant inputs into the model were share price, exercise price, volatility and the annual risk-free interest rate as shown in the table below. Plan and month of grant Years of vesting Contractual months remaining Share price € Estimated excercise price € Volatility Risk-free interest rate A Options - Sept 2015 B Options - Sept 2015 C Options - Sept 2015 D Options - Sept 2015 2015-2021 2016-2021 2017-2021 2018-2021 Warrants A - Sept 2015 2015-2018 Warrants B - Sept 2015 2015-2018 69 69 69 69 29 29 2.69 2.69 2.69 2.69 2.69 2.69 3.71 4.10 4.51 4.96 1.55 2.01 50% 50% 50% 50% 50% 50% 0.01%. 0.01% 0.01% 0.01% 0.01% 0.01% The total expense recognised in the income statement for share options is EUR 474,000 in 2015. 2015 is the Company’s first year to issue options. Accounting for share-based payments under IFRS 2 requires Faron management to use judgment in determining whether a transactions settled in entity’s own equity instruments include share-based payments. In addition, management uses judgment in determining the attribution model in the financial statements, including, for example, estimates of future forfeitures. Measur- ing the fair value of equity instruments granted requires management to use judgment on appropriate inputs into option pricing model, e.g. share price at grant date, volatility and interest rates. NOTE 17 Non-current financial liabilities and other liabilities Stated in euro Interest-bearing financial liabilities Tekes loan Convertible notes Total non-current financial liabilities Other non-current liability Total other non-current liabilities Total non-current financial liabilities 2015 €’000 2014 €’000 1 446 1 691 1 446 1 691 1 446 1 691 Further information on Faron’s financial liabilities and related arrangements is presented in Note 2 Financial risk management. See also Note 18 Current financial liabilities and other liabilities below. 72 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 18 Current financial liabilities and other liabilities Stated in euro Interest-bearing financial liabilities Convertible notes Goverment loans (current portion) Bank overdraft facility Non-interest-bearing financial liabilities Trade payables Other liabilities Prepayment Accrued expenses Other liabilities Total current financial liabilities and other liabilities 2015 €’000 2014 €’000 245 245 436 436 973 515 29 1 517 2 198 9 9 1 456 150 46 1 652 1 662 The item “Prepayments” above comprises portions of the awarded EU grant, received in 2013 and 2014. For further information, see Note 5 Other operating income. For the years 2014 and 2015 the major item under “Accrued expenses” are personnel related (short-term employee benefits). In 2014 in addition to the before mentioned, the accrued interest of the convertible notes contributed to the increase of the accrued expenses. 73 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 19 Carrying amounts and fair values of financial liabilities by measurement categories NOTE 20 Contingencies and commitments During the years presented in these financial statements Fa- ron mainly had financial instruments classified as financial liabilities measured at amortised cost. Fair value information of those measured at fair value is included in note 2.3. The carrying amounts of Faron’s financial liabilities are considered to equal their fair values, except for the following: Faron has elected to apply the exemption provided under IFRS 1 to both goverment loans (Tekes), drawn in 2008 and 2010. The loans are stated at the carrying amount measured using the previous GAAP. The carrying amount and the respec- tive fair value are presented below. Stated in euro Carrying amount1 2015 €’000 2014 €’000 1 691 1 691 Stated in euro 2015 €’000 2014 €’000 Financial liabilities, for which mortgages have been issued Corporate mortgages 800 800 Corporate mortgages 800 800 The corporate mortgage is a guarantee for the EUR 800,000 credit limit. The credit limit was not renewed after it expired on 31 December 2015. Operating lease – Faron as a lessee The future aggregate minimum lease payments under non- cancellable operating leases are as follows 1 Includes both the non-current and current portions The fair values of all financial liabilities are within level 2 of the fair value hierarchy. Description of the hierarchy levels are included in note 2.3 Stated in euro No later than 1 year Later than 1 year and no later than 5 years Later than 5 years 2015 €’000 2014 €’000 82 14 46 2 Total 96 48 Faron leases equipment under non-cancellable operating leases. The lease terms at the time of the start of the lease agreement are between 3 and 4 years. The operating facilities used currently are leased under a cancellable operating lease. Faron is required to give a three- month notice for the termination of this agreement. 74 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 NOTE 21 Transactions with related parties Related parties of the Company Stated in euro 2015 €’000 2014 €’000 Faron’s related party comprise of the following: Remuneration of key management personnel* • Marko Salmi, a private person having significant influence over Faron Pharmaceuticals Oy, following from the sharehold- ing of 17.6%, as at 31 December 2015; • A&B (HK) Company Limited, an investment company existing under the laws of Hong Kong having significant influence in Faron Pharmaceuticals Oy, given their shareholding of 15.2%, as at 31 December 2015; • Board of Directors; and • the Company’s key management personnel (see below) • Faron had no interests in other entities at the end of the re- porting periods presented in these financial statements. Key management personnel Salaries and other short-term employee benefits 769 472 Share-based payment 122 Post-employment benefits (defined contribution plans) Total 891 472 Stated in euro 2015 €’000 2014 €’000 Remuneration to the Board of Directors ** The Company’s key management personnel consist of the following: Salaries and other short-term benefits 124 50 • members of the Board of Directors; and • Management Team comprising CEO Markku Jalkanen, PhD; VP Ilse Piippo, MD, MSc (Pharm); VP Mikael Maksimow, PhD; CFO Yrjö Wichmann MSc (Econ) Share-based payment 155 Total 279 50 * Presented information for the Management includes the Executive Directors of the Board. ** Presented information for the Board includes only Non- Executive Directors. 75 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Management and Board shareholding Management* shareholding, 31 December 2015 Number of shares (pcs) Shareholding, percentage Board** shareholding, 31 December 2015 (excluding the shareholding of CEO) Number of shares (pcs) Shareholding, percentage Total number of shares outstanding at 31 December 2015 (pcs) * Presented information for the Management includes the Executive Directors of the Board. ** Presented information for the Board includes only Non-Executive Directors. 2 942 830 12.7% 1 584 623 6.9% 23 111 704 Transactions with related parties Faron has not carried out any transactions with related parties in the financial years presented in these financial statements, except that the former parent company of Faron Pharmaceuticals Ltd, Faron Holding Ltd, merged into its subsidiary Faron Phar- maceuticals Ltd on 31 December 2013. NOTE 22 Events after the balance sheet date No events occurred after the balance sheet date that would have a material impact on the result or financial position of the Company. 76 FARON PHARMACEUTICALS LTDANNUAL REPORT 2015 Faron Pharmaceuticals Ltd Joukahaisenkatu 6, Intelligate FIN-20520 TURKU Finland Phone: +358 2 469 5151 Fax: +358 2 469 5152 Email: info@faronpharmaceuticals.com