Annual Report 2016 Revolutionising the treatment of ARDS and activation of tumour immunity Contents fa ron pha rmaceut ic als corpor ate gover nance Saving lives Endothelial Barrier Is Everything Highlights 2016 strategi c 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 16 17 22 24 Overview Board of Directors Directors’ Report Corporate Governance Report Directors’ Remuneration Report Statement of Directors’ Responsibilities finan cial report Statement of Comprehensive Income Balance Sheet Statement of Cash Flows Statement of Changes in Equity Notes Results and dividends Auditor’s report 27 28 32 35 38 43 44 45 46 47 48 80 81 2 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Endothelial barrier is everything Faron’s pipeline is based on endothelial receptors involved in regulation of immune responses Clever-1 regulates tissue immune status CD73 controls capillary leakage and escalation of inflammation AOC3 enhances inflammation and causes vascular damage* * AOC3 inhibitor currently on hold The endothelial surface of exhaustive capillary networks control fluid and cell balance between circulation and tissues, and is a factor in many devastating diseases like organ failures and cancer metastasis. 3 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 faron pharmace ut ic als Saving lives Faron Pharmaceuticals Ltd is a clinical stage biopharmaceutical company developing novel treatments for medical conditions with significant unmet needs. The Company currently has a pipeline focusing on acute organ traumas, vascular damage and cancer immunotherapy. lead The Company’s candidate Traumakine, to prevent vascular leak- age and organ failures, is currently the only treatment for Acute Respiratory Distress Syndrome (ARDS) undergoing Phase III clinical trials. There is current- ly no approved pharmaceutical treat- ment for ARDS. An additional European Phase II Traumakine trial is underway for the Rupture of Abdominal Aorta Aneurysm (“RAAA”). Both patient groups have high mortality due to multi organ failure (MOF) caused by ischemic reper- fusion injury. Faron’s second candidate Clevegen is a ground breaking pre-clinical anti-Clev- er-1 antibody. Clevegen has the ability to switch immune suppression to immune activation in various conditions, with potential across oncology, infectious disease and vaccine development. This novel macrophage-directed immuno-on- cology switch called Tumour Immunity Enabling Technology (“TIET”) may be used alone or in combination with other immune checkpoint molecules for the treatment of cancer patients. Faron is based in Turku, Finland and is listed on London AIM under the ticker ‘FARN’. 4 ANNUAL REPORT 2016FARON PHARMACEUTICALS LTD 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 vascu- lar endothelial cells. These “homing” molecules form an essential cellular trafficking guidance system, which we all need to maintain our normal phys- iology. Unfortunately, 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 harm- ful 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 is targeting several endothelial molecules involved in this guidance sys- tem and the maintenance of the endothe- lial barrier. We believe that the control of these molecules provides a unique way of treating many life- threatening condi- tions with high unmet medical needs. Our two lead indications – acute respiratory lung injury and control of tumour immu- nity – are both based on the malfunction of the endothelial barrier, both of which we have learned to control (see page 3). We hope that our 2016 Annual Report inspires you to explore our technologies, which have originated from world-class academic laboratories and developed by Faron as novel proprietary treatments for Acute Respiratory Distress Syndrome (ARDS), and tumour immune suppression. 5 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 fa ron pha rmaceut ic als Highlights 2016 • Pivotal, pan-European, Phase III INTEREST trial for the treatment of Acute Respiratory Distress Syndrome (“ARDS”), has continued to progress as planned. • Maruishi, Faron’s Japanese licensing Partner, reported top line results from its Phase II safety study which indicated there were no safety concerns and, similarly to Faron’s phase I/II UK study, also showed reduction of 28-day mortality. • • Initiation of Maruishi’s own pivotal Phase III study in Japan which aims to recruit 120 severe and moderate ARDS patients split be- tween treatment and placebo arms. Initiated filing of a clinical trial application (CTA) for the use of Traumakine in a second indication for the prevention of mortality among operated RAAA (Rupture of Abdominal Aorta Aneurysm) patients. • Filed patent application in Finland for the intravenous formula- tion of interferon-beta and received a first allowance letter from the Finnish Patent Authorities indicating potential success in Europe and USA. • Entered into licensing agreement with Pharmbio Koreo Inc (Pharmbio) for the commercialisation of Traumakine in Korea and received a signing fee of €750,000. • Established production clones for the humanised, and de-im- munized, monoclonal antibody FP-1305 with Faron’s technology partner, Selexis. • Entered into a collaboration agreement with Abzena Corp (LSE: ABZA) to establish large scale GMP manufacturing for Clevegen. • Filed two new patent applications to seek further protection for Clevegen. If successful, Clevegen will be protected for the next 20 years. • Expansion of Clevegen’s use to include removal of local immune suppression around tumors (TIET), chronic infections (CIRT) and vaccination sites (VRET). 6 ANNUAL REPORT 2016FARON PHARMACEUTICALS LTD Financial Highlights • Raised total equity of €9.3 million (net €8.5 million) by issu- ing 3,200,000 new ordinary shares at a price of 250 pence per share. The proceeds are being used to fund Traumakine US safety trials (INTRUST), Clevegen pre-clinical and clinical de- velopment to Phase I/II for lead indication of hepatocellular carcinoma (HCC) and the RAAA European clinical develop- ment to Phase II (INFORAAA trial), as well as further R&D and operational expenses. • Generated €1.2 million (2015: €0.5 million) revenues mainly from sales of active pharmaceutical ingredient (API) and sales of medical products for trials. The €0.7 million licence agree- ment cash siging fee from Pharmbio was recorded as advance payment. In addition, the Company recorded grant income of €1.7 million (2015: €0.7 million) from the EU FP7 grant. • Drew down €0.6 million of a €1.5 million R&D loan granted by Tekes in 2015 to progress the Clevegen programme. • On 31 December 2016, the Company held cash balances of €11.5 million (2015: €11.1million). • Operating loss for the financial year ended 31 December 2016 was €9.3 million (2015: €6.2 million loss). • Net assets on 31 December 2016 were €10.9 million (2015: €11.2 million) Post-Period End Highlights • On 9 February 2017, announced a third IDMC recommenda- tion to continue the Phase III INTEREST trial as planned and also confirmed the expected read-out from the trial to be in H2 2017. • On 20 February 2017, announced recruitment of the first pa- tient in the Traumakine INFORAAA trial for the prevention of multi-organ failure and patient mortality after surgical repair of a RAAA. • On 1 March 2017, announced the successful raise of ap- proximately €5.8 million before expenses from the placing of 1,422,340 ordinary shares at a price of 350 pence per share. 7 ANNUAL REPORT 2016FARON PHARMACEUTICALS LTD strategi c report Addressing significant unmet medical needs 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 targets several endothelial molecules involved in the maintenance of the endothelial barrier which is a thin layer (membrane) of cells that lines blood and lymphatic vessels to separate blood content from tissue. The Company believes that the control of these molecules provides a unique way to treat many life-threaten- ing conditions with high unmet medical needs. Faron collaborates with its stra- tegic partners in research, manufactur- ing and drug development to bring new pharmaceutical products to market in a timely and cost-effective manner and has formed a core team of leading sci- entists in capillary biology and diseas- es arising from vascular leakage. The Company has established links with leading laboratories and clinics based at Turku University in Finland, University of Birmingham Medical School in UK and other institutions. To date, Faron has operated on a relative- ly low cost basis by employing only key members of staff and outsourcing where possible. Typically, all development work up to the proof-of-concept stage of drug development is carried out in the inno- vators’ laboratories. The Company out- sources all of its manufacturing activities in relation to its products to third parties and collaborates with Contract Research Organisations (CROs) to carry out the clinical development programmes. Faron monitors and evaluates potential com- mercial opportunities for its established drug candidates, such as Traumakine and Clevegen and its technologies, as and when they arise and will consider how best to crystallise as much value as possible for Shareholders, which may in- clude holding rights in main territories for as long as it is feasible, or, in certain cir- cumstances, up to the marketing stage. 8 ANNUAL REPORT 2016FARON PHARMACEUTICALS LTD strategi c report Chairman´s Statement 2016 was an important year for Faron. The highly experienced management team has made significant progress with Traumakine and Clevegen during its first full financial year following the successful AIM listing on the London Stock Exchange in November 2015. lead drug The Company’s novel therapies, Traumakine and Clevegen, have been developed from a thorough and deep scientific knowledge and understanding of endothelial barrier function and con- trol, and both products are delivering exciting data. Faron’s candidate, Traumakine, continues to recruit pa- tients into the pivotal, pan-European Phase III INTEREST trial, which is due to report the critical end points (e.g. mor- tality difference between placebo and active treatment) in the second half of 2017. We believe that Traumakine, as the only product in late stage clinical development for the treatment of ARDS, represents a significant opportunity to treat patients with this serious condition. The Company also believes that Traumakine could have applications across other serious indications and in early 2017, recruited the first patient in a phase II trial (INFORAAA) assessing Traumakine for the prevention of Multi- Organ Failure (MOF) and patient mortal- ity after surgical repair of a RAAA. RAAA is a medical emergency with no known treatment and an overall mortality of 30 to 50% for post-operative refusion injury for RAAA patients. Faron’s second product, its pre-clini- cal immunotherapy candidate, Clevegen, causes conversion of the immune envi- ronment around a tumour from immune suppressive to immune stimulating by reducing the number of tumour-asso- ciated macrophages (TAMs). Recent developments in the exciting field of cancer immunotherapy have been well documented with a number of important indications of clinical success. We be- lieve that Clevegen is well differentiated from other immunotherapies through its specific targeting of M2 TAMs which facilitate tumour growth, while leaving in- tact the M1 TAMs that support immune activation against tumours. In July, we were pleased to enter an agreement with Abzena for the manufacture of Clevegen for use in primate toxicity and Phase I/II clinical studies. The Company is well funded, having secured €9.3 million in a private placing in September 2016 and a further €5.8 million in February 2017. Both place- ments were executed at a premium to the Company’s share price, which indi- cates the level of confidence our inves- tors, both new and established, have in our products, our strategy and the ability of our management to deliver. Faron’s key focus for 2017 will be to prepare the business for the anticipated commercial launch of Traumakine in the event of a positive European Phase III data readout and prepare for the commencement of a Phase II safety tri- al in the US, whilst also continuing the pre-clinical and planned early-stage clin- ical development of Clevegen. As ever the Board will continue to look for opportunities to deliver and en- hance value to our Shareholders as well as patients who will benefit from the new drugs Faron is developing. The Board recognises the efforts of the management team to deliver the successes achieved in 2016 and is grateful to the investigators and pa- tients who are part of our clinical trials. We look forward to an exciting 2017 with continued support from share- holders as we progress our exciting products, Traumakine and Clevegen. Dr Frank M Armstrong – Chairman 9 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 str ategic report Operational Review When Faron listed on the London Stock Exchange’s AIM in November 2015, the Company had ambitions to deliver on its promises and exceed expectations. Faron has so far achieved its stated goals and with a lower than anticipated cash burn. We expect this momentum to continue into the coming year and our focus remains stronger than ever. We have complemented our funds raised at IPO with additional successful equity finance rounds (September 2016 and February 2017) in order to expand our pipeline development to new indica- tions and territories, as well as broaden- ing our institutional shareholder base. Traumakine® Development Our lead drug, Traumakine, progressed as planned to the full scale Phase III trial (INTEREST) during 2016 for the treatment of ARDS. ARDS is a severe, life-threatening medical condition characterised by widespread capil- lary leakage and inflammation in the lungs, most often as a result of sep- sis, pneumonia or significant trauma. Currently there are no pharmacolog- ical treatments for ARDS, an orphan disease with a 30-45% mortality rate. Traumakine has been granted Orphan Drug Designation in Europe which al- lows a period of 10 years of market ex- clusivity following marketing approval by the European Medicines Agency. The Phase III INTEREST 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 successful completion of the Phase III INTEREST trial in the second half of 2017 and achievement of regulatory approvals, Traumakine will potentially be the first effective, mechanistical- ly-targeted, disease-specific pharma- cotherapy for ARDS patients and has the potential to revolutionalise inten- sive care practices. To date, Faron has entered into agreements with three pharmaceutical companies to carry out the clinical de- velopment and commercialisation of Traumakine in Japan, Greater China and Korea. Faron owns the intellectual prop- erty and marketing rights in respect of Traumakine in all other territories. Our Japanese licensing partner, Maruishi Pharmaceutical Co., Ltd an- nounced similar positive from its Phase II Japanese study for Traumakine. Based on these results Maruishi is now conducting a pivotal phase III trial in Japan according to the advice from the Japanese FDA (PMDA). Faron continued out-licensing of Traumakine in Asia signing a profit shar- ing agreement with Pharmbio, a Korean pharmaceutical company, on rights to develop and commercialise Traumakine in Korea. Faron received a signing fee of €750,000, with additional milestones and royalty payments agreed. Parallel to completion of the European Phase III study, Faron plans to commence a Phase II US safety study (INTRUST) with Traumakine in H2 2017, which is expected to take 12 months to complete. The timing of this planned trial remains subject to regulatory ap- provals, with a pre-IND FDA meeting targeted to occur in mid 2017. Faron is currently in the process of establishing the trial structure and is recruiting PI’s, IDMC, sites and CROs in the US. Clevegen® Development One of Faron’s key areas of focus is to de- velop a cancer treatment that supports the hosts’ immune defences against tumours, as these are often suppressed in cancer patients. Faron’s second most advanced drug development project, Clevegen, revolves around Clever-1, a cell surface molecule involved in cancer growth and spread. The active pharma- ceutical ingredient of Clevegen is a hu- manised anti-Clever-1 antibody. Faron has an agreement with Geneva based Selexis to prepare high yield pro- duction clones for Clevegen (FP-1305) which was successfully completed in mid 2016. In order to obtain GMP grade antibodies, Faron contracted Abzena to build a manufacturing process for Clevegen, allowing Faron to design a fi- nal primate tox study and plan human clinical studies in several cancer groups. Abzena informed the Company at the end of 2016 that the selected clones produce more than 5 g/l, which is widely considered a commercially feasible level. During 2016, Faron has utilised €0.8 million of the €1.5 million loan funding from Tekes, the Finnish Funding Agency for Innovation, to progress the preclini- cal development of Clevegen. The fund- ing is a government loan which covers 50% of the budgeted cost of the preclin- ical development of Clevegen. 10 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Upcoming Newsflow The Board anticipates the following pipeline progress during 2017: • Advanced Traumakine: • Read-out for the pan-European phase III trial (INTEREST) results (all-cause mortality at day 28) during H2 2017. advice IDMC Data Monitoring (Independent Committee) on the INTEREST study is expected in May 2017. Faron recently received the third recommendation from IDMC for the trial to continue without any modifications. from • The Company has established a man- ufacturing plan to build its stocks of Traumakine. Subject to a positive out- come of the INTEREST study, having manufacturing in place should facili- tate the application process for mar- ket approval of Traumakine. • The Company plans to commence a Phase II US safety study (INTRUST) with Traumakine in H2 2017. It is ex- pected that the full study will take 12- 15 months to get to D28 and D90 all cause mortality data. Timing remains subject to regulatory approvals with a pre-IND FDA meeting targeted to oc- cur in mid 2017. • The Company currently expects re- in the Japanese Phase cruitment III pivotal study for the treatment of ARDS with Traumakine, run by its Japanese licensing partner Maruishi Pharmaceutical Co., to progress to- wards completion during 2017. • Interim results from the 160 patient Traumakine clinical study (INFORAAA) for the treatment of patients with rup- ture of acute abdominal aorta (RAAA), which began recruiting in February 2017, is expected in 12 to 18 months. The aim of this trial is to reduce mortality in operated RAAA patients, which normally varies from 30 to 50% of all patients surgically operated on. The INFORAAA study will also assist in the design of Traumakine trials for single organ failures. ”Subject to the successful completion of the Phase III INTEREST trial and achievement of regulatory approvals, Traumakine will potentially be the first effective, mechanistically- targeted, disease-specific pharmacotherapy for ARDS patients.” Clevegen: • Subject to access of Clevegen’s active pharmaceutical incredient (FP-1305), Faron has contracted a toxicological pre-clinical study for Clevegen to start in mid 2017. • The Company expects to file the first CTA with the UK regulatory authori- ties (MHRA) in late 2017 / early 2018 and this study is expected to provide enough safety data for acceptance of the CTA. The first, and primarily safety focused clinical trial is expected to be conducted with liver cancer patients at the Birmingham University Liver Cancer Centre and is expected to continue into a Phase II study via an adapted trial design for HCC patients to recognise early efficacy signals. • The second set of clinical cancer trials will be conducted in parallel with the HCC trial in Scandinavia with mela- noma, pancreas and ovarian cancer patients. Commerical: Faron is exploring various commer- cial opportunities while continuing to develop the pipeline with the existing resources. Markku Jalkanen – CEO 11 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 str ategic report Financial Review Key Performance Indicator Faron is a late clinical stage drug de- velopment company with no recur- ring sales and thus the primary Key Performance Indicators (KPIs) followed by the Board focus on cash balances and other related information. During 2016, the Company was able to gen- erate positive (€0.4 million) cash flow despite strong investments in R&D. This was possible mainly due to successful fundraising and stronger than expected income, both revenues and other oper- ating income. The Board will consider the appropriateness of monitoring addi- tional KPIs as the Company’s operations advance. Revenue and Other Operating Income The Company’s revenue was €1.2 mil- lion for the year ended 31 December 2016 (2015: €0.5million), which com- prised of sale of excess API material and sales of IMP –material. The €0.7 million signing fee milestone from Korean license partner PharmBio was not recorded as revenue but as advance payment. The Company also recorded €1.7 million (2015: €0.7 million) of other operational income. This comprised of income recognised from the European Commission FP7 grant in support of the Traumakine programme as well a grant component from public loans. Research and development costs The R&D costs increased by €5.6 million (141%) from €4.0 million to €9.6 million. This was mainly due to the INTEREST –trial which recruited its first patient very late 2015 and was in full capacity dur- ing 2016. Also, Clevegen development entered a more active phase. The third contributor to the R&D cost increase was preparatory work for eventual Traumakine launch including ramp-up of production of API. Losses Loss before income tax was €9.3 mil- lion (2015 €6.2 million). Net loss for the year was €9.2 million (2015 €6.2 million) representing a loss of €0.39 per share (2015 € 0.30 per share) (adjusted for the changes in share capital). Share-based compensation Cash Flows According to the 2015 Option program a number of options were awarded to Directors and key personnel dur- ing 2016. This had no cash impact on the results for the year, however accounting standards this share based compensation to be rec- ognised in the Consolidated Statement of Comprehensive Income, resulting in a charge of €0.5 million (2015: €0.5 million.). required Taxation The Company’s tax credit for the fis- cal year 2016 can be recorded only after the Finnish tax authorities have approved the tax report and con- firmed the amount of tax-deductible losses for 2016. The total amount of cumulative tax losses carried for- ward approved by tax authorities on 31 December 2016 was €13.9 million (2014: €5.7 million). These losses can be utilised during the years 2019 to 2025 by offsetting them against prof- its. In addition, Faron has €2.8 million research and development costs in- curred in the financial years 2010 and 2011 that have not yet been deducted in its taxation. This amount can be de- ducted over an indefinite period at the Company’s discretion. The Company was able to maintain a positive net cash inflow of €0.4 million for the year ended 31 December 2016, compared to a positive cash inflow of €10.8 million for the previous year. Cash used by operating activities increased with €1.3 million to €8.5 million for the year, compared to €7.1 million for the year ended 31 December 2015. This increase was driven by €5.6 million (142%) increase in research and devel- opment costs, and was offset by a €1.7 million (142%) increase in income and a €0.9 million (29%) reduction in adminis- trative costs. Net cash inflow from financing ac- tivities €9.0 million (2015: €18.1 mil- lion) mainly due to the receipt of net proceeds of €8.5 million from an equity placing completed in September 2016 Financial Position As at 30 September 2016, total cash and cash equivalents held were €11.5 million (2015 €11.1 million). Headcount Average headcount of the Company for the year was 10 (2015:6). The increase in headcount is attributable to the com- mencement of the Phase III trial. 12 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Share Capital Based on the authorisation by the Annual General held on 26 May 2016, the Board of Directors decided to issue a total of 3,200,000 million new ordinary shares. On 23 September 2016, the num- ber of ordinary shares was increased to 26,311,704 by the issue of 3,200,000 new ordinary shares at a subscription price of £2.50. 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 Based on a the Extraordinary General Meeting held on 15 September 2015, the Company had adopted the 2015 Share Option Plan. On 18 November 2016 the Board of Directors granted the 2015B Options to the management and employees of the Company. The directors’ options are detailed in Directors´ Remuneration Report set out in the Annual Report and Accounts. resolution of Money Raised to Date Until 31 December 2016, the Company has been funded with a total of approx- imately €44 million, made up of a com- bination of equity, debt and grant fund- ing, which has been used to develop the Company’s products and intellectual property. The Company has also gen- erated revenue and cash of €4.2 million to date through the receipt of milestone payments pursuant to certain of its li- censing arrangements and the sale of surplus raw materials. Yrjö E K Wichmann – CFO 13 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 str ategic report 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 2016 are below. Research and Development Faron’s main product is in the late stag- es of clinical development however may not be successful in the clinical trials and may not be able to develop approved or marketable products. Technical risk is also present at each stage of the discov- ery and development process of other, earlier stage products with challenges in biology (including the ability to pro- duce candidate drugs with appropriate safety, efficacy and usability character- istics). Additionally, drug development is a highly regulated environment which itself presents technical risk through the need for study designs and data to be accepted by regulatory agencies. Furthermore, there can be no guarantee that the Company will be able to, or that it will be commercially advantageous for the Company to, monetize the value of its intellectual property through enter- ing into licensing or other co-operation deals with pharmaceutical companies. Commercial Faron’s industry, being biotechnology and pharmaceutical industries, are very competitive. The Company’s competi- tors include major multinational phar- maceutical companies, biotechnology companies and research institutions. Many of its competitors have substan- tially greater financial, technical and oth- er resources, such as larger research and development resources and 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 of the prod- uct candidates which the Company is currently developing or which it may de- velop and may have a material adverse impact on the Company. in- appropriately qualified personnel, cluding personnel with a high level of scientific and technical expertise. There is currently a shortage of such per- sonnel in the pharmaceutical industry, meaning that the Company is likely to face significant competition in recruit- ment. The Company may be unable to find a sufficient number of appropriately highly trained individuals to satisfy its growth rate, which could affect its ability to develop as planned. Dependence on key personnel and scientific and clinical collaborators The Company’s success is highly de- pendent on the expertise and expe- rience of the Directors and the key Management. Whilst the Company has entered into employment and oth- er agreements with each of these key personnel, the retention of such person- nel cannot be guaranteed. Should key personnel leave or no longer be party to agreements or collaborations with the Company, the Company’s business prospects, financial condition and/or results of operations may be material- ly adversely affected. To develop new products and commercialise its cur- rent pipeline of products, the Company relies, in part, on the recruitment of 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 14 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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, un- authorized third parties may attempt to copy, or obtain and use the Company’s IPR and other technology that is incor- porated into its pharmaceutical prod- ucts. In addition, alternative technolog- ical solutions similar to the Company’s products may become available to competitors or prospective competi- tors of the Company. It should be not- ed 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 material and ar- guments, which the patent office grant- ing the patent may not have seen at the time of granting the patent. Therefore, whilst a patent may be granted to the Company it could in the future be found by a court of law or by the patent of- fice 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 unfavorable outcomes in respect of patent litigation could limit the Company’s IPR and activ- ities moving forward. The Directors do not believe that its lead pharmaceutical drug candidates, future drug candidates in development, and proprietary processes for gen- erating those candidate compounds infringe the IPR of any third parties al- though 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 par- ty intellectual property. The Company’s research has included searching and reviewing certain publicly available re- sources, which are examined by senior levels of management in order to keep abreast of developments in the field. Financial The Company has incurred significant losses since its inception and does not have any approved or revenue-gener- ating products. The Company expects to incur losses for the foreseeable fu- ture, and there is no certainty that the business will generate a profit. The Company may not be able to raise addi- tional funds that will be needed to sup- port its product development programs 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 continued service of its senior manage- ment team including the Directors. The Company has invested in its manage- ment team at all levels. The Directors also believe that the senior manage- ment team is appropriately structured for the Company’s size and is not overly dependent upon any particular indi- vidual. The Company has entered into contractual arrangements with these individuals with the aim of securing the services of each of them. Retention of these services or the identification of suitable replacements, however, cannot be guaranteed. 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 finan- cial performance and reduce the value of an investment in the Ordinary Shares. This report was approved by the Board on 28 March 2017 and signed on its behalf. 15 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 PIPEL INE Revolutionising the treatment of ARDS and activation of tumour immunity 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. lead The fast evolving Faron pipeline con- sists of drug candidates (FP-1201-lyo and FP-1305) from two major Faron pro- grammes – Traumakine and Clevegen, indication of respectively. The 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. Traumakine® is Faron’s spearhead project Research Pre-clinical Phase I/II Phase III EU, ARDS Japan, ARDS (Maruishi) US, ARDS Rupture of Abdominal Aortic Aneurysm (RAAA) Single organ injury Clevegen® Research Pre-clinical Phase I/II Phase III Tumour Immunity Enabling Technology (TIET- programme) Hepatocellular carcinoma Other solid tumours (Ovarian, Pancreas, Melanoma) Anti-CD20 resistant lymphomas TAM-positive Hodgkin’s lymphomas Chronic Infection Removal Therapy (CIRT- programme) Vaccination Response Enhancement Technology (VRET- programme) D-ARDS Research Pre-clinical Phase I/II Phase III ARDS diagnostics for Traumakine® treatment efficacy 16 ANNUAL REPORT 2016FARON PHARMACEUTICALS LTD 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. 17 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 include 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 treated with ARDS are generally 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 re- cover from ARDS may suffer other con- sequences of the condition after being discharged 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 forming a barrier between circulation and tissues. The breakdown of this barrier results in leakage of blood content to tissues. If this happens in lungs, the lung air space is filled with protein-rich fluid and blood cells preventing normal gas exchange. The key molecule involved in main- taining endothelial barrier and lung func- tion is CD73, an endothelial ectoenzyme, local adenosine. which can produce Traumakine’s active pharmaceutical ingredient, increases interferon-beta, CD73 expression resulting in increased local adenosine. Subsequently, high local adenosine levels reduce capillary leakage and increase 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 c. 125,000 and in the US c. 170,000 patients • High mortality rate of 30 to 45% and survivors suffer long-term mental and physi- cal problems 18 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 CD73 ectoenzyme produces local anti-inflammatory adenosine Interferon-beta upregulates expression CD73 Loss of CD73 results in high amounts of proinflammatory ATP Inflammation reduces CD73 amounts and its adenosine production 19 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 ARDS lung Normal lung Widely used X-ray pictures can reveal lungs filled with blood material. This shows up as white dense material in lung air space and for this reason the lungs of these patients are often called “white this picture confirms that the patient has a condi- tion called Acute Respiratory Distress Syndrome (ARDS) and has a life-threat- ening disease. lungs”. Typically Normally functioning lung X-ray shows no “white” material, indicating that lung air space is free of blood material, in contrast to the ARDS lungs above. Long term exposure to a respiratory syn- drome like ARDS, can also cause per- manent loss of lung capacity due to a fi- brotic process that replaces lung alveoli with scar tissue. This serious side effect of ARDS results in permanently reduced respiratory capacity. 20 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Traumakine® Clinical Programme The first indication that Faron´s lead can- didate, Traumakine, addresses is the treat- ment of 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 en- rolled in December 2015 and the study has progressed as planned during 2016. This was also confirmed by the Independent Data Monitoring Committee twice during the year. The first clinical trial in the Traumakine programme was a phase I/II open-label 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. 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 treatment the were obtained from Traumakine Phase II Japanese study conducted by Faron´s licensing partner, Maruishi Japanese Pharmaceutical Co., Ltd. in Japan, as an- nounced in January 2016. Ongoing Phase III INTEREST Study adenosine such that vascular leaking and escalation 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. The Phase III ongoing, clinical trial is a double-blind, randomised, parallel-group comparison of efficacy and safety of interferon beta and placebo in the treat- ment of patients with moderate to se- vere ARDS. The study named INTEREST will be conducted in 60 hospitals across Belgium, Finland, France, Germany, Italy, Spain and the UK and 300 ARDS pa- tients in total will be recruited. INTEREST has received €6 million funding from the European Union Seventh Framework Programme (FP7). Mechanism of Action The mechanism behind Traumakine’s action was invented by scientists at Turku University during the period 1995 to 2003. Through extensive research and ex-vivo studies, it was identified that a molecule called CD73 is essential in maintaining the endothelial barrier function. CD73 is an ectoenzyme capa- ble of breaking down extracellular AMP to produce locally active adenosine. Adenosine maintains the endothelial barrier and downregulates inflamma- tion escalation, preventing both early vascular leakage and escalation of in- flammation, which are the two early patho-physiological events leading to 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 could there- fore, be used to treat a range of vascu- lar leakage conditions including ARDS. Traumakine works by enhancing CD73 expression in the lungs and increas- ing production of anti-inflammatory ”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 2016 in the Lancet Respiratory Medicine1. 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 INTEREST 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 compared to pla- cebo, in regard to mortality, organ failure, need for mechanical ventilation and vas- oactive support, length of the stay in ICU and hospital as well as quality of life and pharmacoeconomic parameters. 60 Intensive Care Units in Seven European Countries In total, approximately 60 hospitals in seven countries within the European Union – Belgium, Finland, France, Germany, Italy, Spain, UK – are partici- pating in the INTEREST Study. A total of 300 adult patients with moderate or se- vere ARDS will be enrolled (on average six patients per hospital). Faron Pharmaceuticals is running the study in collaboration with external research service providers. INTEREST has received funding from the European Union Seventh Framework Programme (FP7) under the Traumakine project name. Progressing as planned The first approvals from competent au- thorities and favourable opinions from independent ethics committees to con- duct the study were obtained towards the end of 2015 with the first patient enrolled in December 2015. The major- ity of sites were opened during the first half of 2016 and currently 60 sites are recruiting. The read-out for the primary and secondary end points is expected in the second half of 2017. The patients enrolled in the study are screened from patients who have been admitted to intensive care units (ICU) at participating hospitals. To further en- sure appropriate patient enrolment into the study across all hospitals, the study design incorporates an eligibility pro- cess via the electronic data capture sys- tem, involving an indepen dent medical monitor. After all screening procedures 22 PIPELINE: TRAUMAKINE ® The INTEREST Study Study INTEREST The (protocol FPCLI002) is a Phase III clinical study to investigate efficacy and safety of FP- 1201-lyo (recombinant human interfer- on-beta-1a) in patients with moderate or severe ARDS. This study is designed based on previous results from the UK clinical trial which demonstrated a significant reduction in mortality of ARDS patients and has been published FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 have successfully been performed, and eligibility for inclusion in the study has been confirmed, the patient can be ran- domised into the study. Following randomisation, the pa- tients will be treated daily with either 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 the need for hospi- tal and ICU care, is collected during this follow-up period. Other collected 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 clini- cal study report. Safety Monitoring An Independent Data Monitoring Committee has been established in or- der to monitor safety in this study. This safety review committee will periodically conduct an independent unblinded re- view of safety data generated during the study and provided two recommenda- tions during 2016 to continue the study as planned. The study also has an esteemed Steering Committee that provides expert scientific and clinical guidance to the practical study design and conduct. The rights, safety and well-being of the pa- tients 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 clini- caltrials.gov (reference NCT02622724). The mode of action of FP-1201-lyo is described on the video found at Faron web pages (www.faronpharmaceuticals.com). INTEREST Study • Pivotal Phase III trial for Traumakine in development for the treatment of ARDS • Conducted in 60 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 until H2 2017 • 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 INFORAAA trial initiation Ruptured Abdominal Aortic Aneurysm (RAAA) is a surgical emergency with an overall mortality of 70 to 80%. It re- quires immediate surgery and aortic re- pair. Approximately half of the deaths of RAAA patients are due to not reaching the hospital in time, and, despite imme- diate surgery and intensive care treat- ment, the second half die in hospital within 30 days post-operatively, mostly due to multi-organ failure. The cause of high post-operative mortality is mainly due to prolonged hypotension/hypoxia from the ruptured aorta and the after- math of restoring blood flow: reperfu- sion, vascular leakage and failure of vital organs. Currently, there are an estimat- ed 20,000 US and European patients per annum eligible for treatment. The high mortality rate of RAAA, which accounts for 4-5 deaths per 100,000 population2, requires new treatments to prevent post-operative reperfusion inju- ry leading to the death of RAAA patients, which exhibits a 30-50% mortality rate post-operatively. RAAA accounts for 13-14/100,000 hospital admissions an- nually3, and is the second indication for Traumakine targeted by Faron. Open surgical aortic repair to treat RAAA patients is associated with a Systemic Response Inflammatory Syndrome (SIRS) affecting vital organs, especially the heart, lungs, kidneys, and intestines. The death of approximate- ly 80% of the operated RAAA patients is caused by MOF, similar to patients with ARDS. Traumakine (FP-1201-lyo) is currently in a European Phase III clinical trial for the treatment of ARDS, with encouraging Phase I/II data. The Directors consider that data seen to date supports the rationale for extend- ing the use of Traumakine in similar con- ditions to potentially treat single, and multiple, organ failures. For example, during the Traumakine phase I/II study, there was a reduced need for haemodi- alysis (an indication of improved kidney function) among the ARDS patients on Traumakine. Soon after closing the September 2016 financing round, Faron initiated filing of a clinical trial application to open the INFORAAA study. This CTA was accepted in late 2016 and the first patient for the trial was recruited in February 2017, as announced previously. 1 Bellingan et al., 2014 2 Karthikesalingam et al., 2014 3 Anjum et al., 2012 23 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 One of Faron’s key areas of focus is to develop a cancer treatment 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, which modulate Clever-1 function to switch the immunosuppressive M2 macrophages to immune stimulating M1 macrophages. 24 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 PIPELI NE: CL EVEG EN ® Mechanism of Action 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 (angiogene- sis, escape from antitumour specific im- munity). When TAMs populate a tumour, one of the very significant influences they exert over it is a strong increase in immune suppression. Cle ver-1-positive TAMs represent one major macrophage population involved in the elimination of host immune activity against the tu- mour cells. Clevegen is an anti-Clever-1 antibody which targets and eliminates Clever-1-positive TAMs from cancer patients by converting the immune suppressive type 2 macrophages (M2) to immune stimulating type 1 (M1) macrophages. Clevegen also prevents TAM infiltra- tion into a tumour and therefore blocks their accumulation at tumour sites and can, therefore, also control the tumour content of regulatory T-cells, which are dependent on M2 macrophage support. Expansion of Clevegen’s use, to in- clude removal of local immune sup- pression in chronic infections and vac- cination sites, are also being explored alongside tumours. These platforms are called CIRT, VRET and TIET, respec- tively and are all based on the same anti-Clever-1 antibody. “Clever-1-positive TAMs represent one major macrophage population involved in the elimination of host immune activity against the tumour cells.” ”Clevegen converts immune suppressive type 2 (M2) macrophages to immune stimulating (M1) macrophages and provides new ways to stimulate host immune system to fight cancer.” 25 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Clever-1 Clever-1 Lymphocyte Clevegen Cancer cell Cancer cell TAM Blocking interaction between cancer cell and TAM. TAM (Tumor associated macrophages) Clever-1 Clevegen Vascular Lymphocyte endothelium TAM Clevegen-1 mode of action Preventing leucocyte migration... Blocking adhesion receptor. Clevegen Cancer cell 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. Clevegen-1 Cancer cell TAM About Tumor Immunity Enabling Technology (TIET) Blocking interaction between cancer cell Blocking TAM infiltration into and TAM. a Tumour TAM (Tumor associated macrophages) Vascular endothelium Clever-1 Clevegen 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. TAM The TIET technology is built around the humanised anti-Clever-1 antibody FP- 1305, which binds to a specific Clever-1 proprietary epitope. Clevegen binds to this epitope, activating conversion of type 2 tumour associated macrophages to type 1 macrophages, resulting in the transformation of the tumour environ- ment from immune suppression to im- mune activation. As the TIET technology is based on a humanised antibody, the Clevegen-1 mode of action Preventing leucocyte migration... Blocking adhesion receptor. INNATE IMMUNITY / MACROPHAGES Macrophage-Directed Cancer Immunotherapy Clevegen-1 TAM ADAPTED IMMUNITY / LYMPHOCYTES M1 Macrophage TNFα TUMOR CELL γ-Interferon Phagocytosis TH1 Cytotoxic Cell γ-Interferon Lymphocytes/ local immunity Cancer cell apoptosis Clever-1 Faron Directors believe it can be com- bined with a number of other immune therapies without a significant risk of in- creased adverse events. The TIET tech- nology could provide a significant boost for the efficacy of other immune check- point molecules, as its target is unique and represents a completely separate control of immunity. Vascular endothelium TAM ”In some tumours up to 50% of the tumour mass may contain TAMs and the only way to eliminate this dominance is remove them from tumours.” Lymphocytes/ local immunity Cancer cell apoptosis References: Karikoski et al. (2014) Clever-1/Stabilin-1 controls cancer growth and metastasis. Clin. Clever-1 Cancer Res. 2014: 20: 6452-64. Palani et al. (2016). Monocyte Stabilin-1 suppresses the activation of Th1 lymphocytes. Vascular endothelium Journal of Immunology 2016: 196: 115-123. NK Cytotoxic Cell γ-Interferon TUMOR CELL Apoptosis MHC II -receptor expression M2 Macrophage modulation to M1 M2 Macrophage Tumor antigen presentation TNFα M1 Macrophage γ-Interferon Anticlever-1 treatment γ-Interferon γ-Interferon CD8 Cytotoxic Cell 26 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Corporate Governance The Board of Faron emphasises the importance of good corporate governance and is aware of its 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 that is appropriate and practical for a Company of its nature and size. 2727 ANNUAL REPORT 2016FARON PHARMACEUTICALS LTD corpor ate gov erna nce 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 Armstrong is currently the Chairman of Xceleron Inc., Summit Therapeutics (AIM and NASDAQ) and a Non-Executive Director of Actino Pharma, Juniper Therapeutics (NASDAQ) and Mereo Pharma. Dr Armstrong is a physician and a Fellow of the Royal College 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 na- tional and international business deals, corporate law and mergers and acquisitions having held a number of board mem- berships 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 current- ly Chairman of Turun Osuuskauppa and Ruissalo Foundation 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 Master of Laws from the University of Turku. He became an honorary Chief Justice in Finland in 2013. 28 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Dr Markku Jalkanen Chief Executive Officer Dr Juho Jalkanen Non-Executive Director Dr Jalkanen has more than 25 years of experience within bi- omedical research, biotech development and the biopharma- ceutical 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 founding CEO and President of BioTie Therapies Corp which has since become the first publically trad- ed Finnish biotech company to have listed on NASDAQ. Dr Jalkanen has published over 130 peer reviewed scientific publications in various highly ranked international journals and has held several board memberships for both public and pri- vate companies. Dr Jalkanen obtained a Masters in Medical Biochemistry from the University of Kuopio and subsequently received a PhD in Medical Biochemistry from the University of Turku. He com- pleted a side-laudatur examination in Mol ecular Biology from the University of Turku and completed his post-doctoral train- ing at Stanford University, 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. 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 Finland, General Hospitals of Raisio and Salo and at Turku University Hospital. For the period of 2009 to 2012 Dr Jalkanen was a board member of Duodecim Medical Association on Southwest Finland and subsequently joined the Board of the Company in 2013. Dr Jalkanen holds degrees in both business and medi- cine. He has a Master’s degree in Economics and Business Administration from the Turku School of Economics, a Medical Doctor’s degree from the University of Turku and subsequently became a fully licensed General Practitioner. At the moment Dr Jalkanen is conducting his PhD on the molecular mechanisms of atherosclerosis. He has published six articles in various pub- lications including the International Journal of Biotechnology and Circulation Research. 29 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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- Executive Director of China Medical System Holdings Ltd for three years, and the Company was admitted to trading on AIM (between 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 medi- cal 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 lectur- er 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 England 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 Professor), 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 healthcare. 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 subsequently 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 (European Federation of Pharmaceutical Industry Associations) and was the first Chairman of the Board of the Innovative Medicines Initiative, 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 Edinburgh. Dr Knowles was appointed as a Non-Executive Director of the Company in September 2015. 30 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Leopoldo Zambeletti Non-Executive Director Yrjö E K Wichmann Chief Financial Officer During a 19-year career as an investment banker, Mr Zambeletti 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 inde- pendent strategic advisor to life science companies on merg- er and acquisitions, out-licencing deals and financing strate- gy. He is a Non-Executive Director at Advanced Accelerator 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 cultur- al initiative 5×15 Italy. Mr Zambeletti was appointed as a Non- Executive Director of the Company in September 2015. Mr Wichmann has a career spanning over 20 years in fi- nancing and investment banking. He was appointed as a Chief Financial Officer of the Company in 2014. Prior to his appointment at the Company, Mr Wichmann held a number of senior positions within the life sciences and biotechnolo- gy 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 Dasos 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 member 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 Company in 2015. 31 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 corpor ate gov erna nce Directors’ Report For the year ended 31 December 2016. Directors The Directors present their report together with the audited financial statements for the year ended 31 December 2016 During the year ended 31 December 2016 following persons have been members of Board of Directors of the Company: Executive Dr Markku Jalkanen, PhD, Chief Executive Officer Mr Yrjö Wichmann, MSc, Chief Financial Officer Non-Executive Dr Frank Armstrong, FRCPE, FFPM, Chairman Mr Matti Manner, LLM, Vice-chairman Dr Juho Jalkanen, MD, MSc, Non-Executive Director Dr Jonathan Knowles, PhD, Non-Executive Director Dr Huaizheng Peng, MD, PhD, Non-Executive Director Mr Leopoldo Zambeletti, Non-Executive Director 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 Avergare exercise price, euro cent Issued Share Capital Share options Markku Jalkanen¹) Juho Jalkanen²) Matti Manner Yrjö Wichmann Jonathan Knowles Leopold Zambeletti Frank Armstrong3) Huaizheng Peng 2 873 390 1 082 570 484 900 69 440 27 712 17 461 7 846 4 000 10.9% 160 000 4.1% 1,8% 0.3% 0.1% 0.1% 0.0% 0.0% 40 000 40 000 60 000 40 000 40 000 80 000 40 000 4 567 319 17,4% 500 000 3,31 3,31 3,31 3,31 3,31 3,31 3,31 3,31 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 2016 Principal risks and uncertainties Post balance sheet events For a discussion of the principal risks and uncertainties which face Faron please see page Risks and uncertainties. Results and dividends The Consolidated Statement of Comprehensive Income for the year is set out on here. The Company’s loss for the financial year after taxation and other comprehensive losses was € 7.9 million (2015: € 6.2 million). The Company has no distributable equity and thus the Directors do not recommend the payment of a dividend (2015: nil). Financial information The Company produces budgets and cash flow projections on an annual basis for approval by the Board. These are reviewed during the year and updated if needed to reflect any changes in the business. Detailed management accounts are produced on a monthly basis, with all significant variances investigated promptly. The management accounts are reviewed and com- mented on by the Board at Board meetings and are reviewed and reported to the Directors on a monthly basis by the man- agement team. Financial Key Performance Indicators (‘KPIs’) The For a review of the Group’s KPIs please see page Financial Review. Research and development Details of Company’s key research and development pro- grams can be found in the Strategic Report and the detailed program sections. Further information is also available on the Company website, www.faronpharmaceuticals.com. • On February 9th Faron announced that it had received a third Independent Date Monitoring Committee recommen- dation to continue the INTEREST trial as planned. • On 20 February 2017, Faron announced a first patient re- cruited in the Traumakine INFORAAA trial. • On 28 February 2017, Faron announced a proposed plac- ing of up to 1,422,340 new ordinary shares in the capital of the Company at a price of 350 pence per share (the “Issue Price”) to raise, in aggregate, up to approximately €5.8 mil- lion before expenses. • On 1 March 2017, Faron announced that it had issued and placed 1,422,340 new ordinary shares at the Issue Price of 350 pence per share raising approximately €5.8 million new capital before expenses. 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 Company has also other financial instruments such as leasing facilities that arise directly from its operations. The Company has a policy, which has been consistently fol- lowed, of not trading in financial instruments and to minimize currency exposure by actively matching currency expenses and income to the extent possible. The Company’s cash is held on bank accounts in reputable bank in Finland. The Group’s treasury policy is reviewed annually. See Note 1.16 ‘Financial instruments’ and Note 2, Principles of financial risk manage- ment in the Notes to the Financial Statements for IFRS disclo- sure regarding financial instruments. 33 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Substantial shareholdings On 31 December 2016 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 Markku Jalkanen Legal & General Investment Management Juho Jalkanen* Sirpa Jalkanen Maija-Leena Hollmén** Katriina Peltola*** City Financial Timo Syrjälä**** 3,408,409 3,389,570 2,552,523 1,983,321 1,794,890 1,365,000 1,082,570 1,078,500 1,078,500 1,078,500 1,000,000 936,076 % 12.95 12.88 9.70 7.54 6.82 5.19 4.11 4.10 4.10 4.10 3.80 3.56 * 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 415,246 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 in 16 May 2017 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 28 March 2017 34 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 corpor ate gov erna nce Corporate Governance Report The Board At 31 December 2016, the Board com- prised six Non-Executive Directors, and two Executive Directors. The composition of the board of directors as well as Directors’ biogra- phies are described on pagesBoard of Directors. The Board is responsible to the share- holders for the proper management of the Company and meets regularly to set the overall direction and strategy 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- Executive Directors have all relevant information on matters to be decided. The Chief Executive Officer is respon- sible for implementing the strategy of the Board and managing the day-to-day business activities of the Company. The management of the Company prepares a monthly management and financial accounts pack, which is distributed to the Board every month and 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 experience in terms of their knowledge of the scien- tific, operational and financial develop- ment of biopharmaceutical products and companies. Where necessary, the Company facilitates that Non-Executive Directors obtain specialist external ad- vice 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. Performance Evaluation 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. Remuneration Committee The Remuneration Committee com- prises Frank Armstrong as Chairman together with Huaizheng Peng and Leopoldo Zambeletti. The committee is responsible for the review and recom- mendation of the scale and structure of remuneration for senior management, including any bonus arrangements or the award of share options with due re- gard to the interests of the Shareholders and the performance of the Company. The Remuneration Committee held four meetings during 2016. Audit Committee The Audit Committee, which compris- es Leopoldo Zambeletti as Chairman together with Frank Armstrong and Huaizheng Peng, meets not less than twice a year. The committee is respon- sible for making recommendations to the New Board on the appointment of auditors and the audit fee and for ensur- ing that the financial performance of the Company is properly monitored and re- ported. In addition, the Audit Committee will receive and review reports from man- agement and the auditors relating to the interim report, the annual report and ac- counts and the internal control systems of the Company. The audit committee held one meeting during 2016. 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 held one meeting during 2016. 35 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Risk management and Internal control Corporate Social Responsibility Attendance at Board meetings The Board is responsible for the systems of internal control and for reviewing their effectiveness. The internal controls are designed to manage rather than elim- inate risk and provide reasonable but not absolute assurance against mate- rial misstatement or loss. The Board reviews the effectiveness of these sys- tems annually by considering the risks potentially affecting the Company. The Company does not consider it neces- sary to have an internal audit function due to the small size of the administra- tive 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 Company’s results, com- pared with the budget, are reported to the Board on a monthly basis and dis- cussed 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. The Company is committed to main- taining and promoting high standards of business integrity. Company values, which incorporate the principles of Corporate 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, has www.faronpharmaceuticals.com, a section dedicated to investor matters and provides useful information for the Company’s owners. During 2016 the Board held 10 meet- ings. The table below lists the Directors attendance to the Board meetings dur- ing the year: Faron Board Attendance to meetings Executive Directors Markku Jalkanen Yrjö E K Wichmann Non-Executive Directors Frank M Armstrong Matti Manner Juho Jalkanen Jonathan Knowles Huaizheng Peng Leopoldo Zambeletti 10/10 10/10 10/10 10/10 9/10 8/10 10/10 8/10 36 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Compliance with the Principles of the QCA Code The Principles of the QCA Code 1. Setting out the vision and strategy 2. Managing and communicating risk and implementing internal control 3. Articulating strategy through corporate communication and investor relations Comply/ Explain Comply Comply Reference Strategic Report CGR (Risk Management and Internal Control), Risks and Uncertainties 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 7. Developing structures and processes 8. Being responsible and accountable 9. Having balance on the Board 10. Having appropriate skills and capabilities on the Board 11. Evaluating Board performance and development 12. Providing information and support Comply Comply Comply Comply Comply Comply Comply Strategic Report Strategic Report CGR (The Board) CGR (The Board) CGR (The Board) CGR (Performance evaluation) CGR (The Board) CGR = Corporate Governance Report 37 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 ended 31 December 2016 is set out below: For the year ended 31 December 2016 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 Executive Director’s performance and contribution to the Company during the year. Bonuses Annual bonuses are based on the achievement of Company strategic and financial targets and personal perfor- mance 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 estab- lished that the annual bonus potential will be 40% for the Executive Directors. On 15 February 2017 the Chief Executive Officer was awarded a bonus represent- ing 40% and the Chief Financial Officer was awarded a bonus representing 35% of their 2016 gross basic salaries. In order to further incentivise the Executive 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 members 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 it pays fixed contri- butions into a separate entity. The plan covers all the employees of Faron in- cluding 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. 38 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 constitutes 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 Executive Directors’ contracts are summarised below: Markku Jalkanen Yrjö E K Wichmann CEO CFO 16.09.2015 6 months1 16.09.2015 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 be- yond 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 Directors are entitled to be reimbursed in respect of their reasonably and properly incurred travelling, accommodation and incidental expenses for attending and re- turning from meetings of the Board, committee meetings or the general meetings of Shareholders. The Non-Executive Directors do not receive any pension, bonus or benefits from the Company. The contracts of the Non-Executive Directors, excluding remuneration and compensation, are reviewed by the Board annually. Current contracts are summarised below: Non-Executive Directors' Contracts Contract Date of Contract Frank M Armstrong Chairman 16.09.2015 Matti Manner Juho Jalkanen Jonathan Knowles Huaizheng Peng Leopoldo Zambeletti Vice-chairman 16.09.2015 member 16.09.2015 member 16.09.2015 member 16.09.2015 member 16.09.2015 39 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 The appointments of Non-Executive Directors are terminable with immediate ef- fect in accordance with the Articles of Association and pursuant to the Finnish Companies 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’ notice to the Registered Office of the Company or through tendering such resignation at a meeting of the Board, after a fixed 6 month’s period from Admission. Audited Information Directors’ remuneration The Directors received the following remuneration during the year: Executive Markku Jalkanen Yrjö E K Wichmann Non-Executive Frank M Armstrong Matti Manner Juho Jalkanen Jonathan Knowles Huaizheng Peng Leopoldo Zambeletti Salaries and fees Bonus 2016 Taxable benefits Total 188 244,00 80 000,00 12 720,00 280 964,00 148 800,00 52 340,00 744,00 201 884,00 73 000,00 40 000,00 35 000,00 35 000,00 35 000,00 40 000,00 - - - - - - - - - - - - 73 000,00 40 000,00 35 000,00 35 000,00 35 000,00 40 000,00 595 044,00 132 340,00 13 464,00 740 848,00 Directors’ share options Aggregate remunerations disclosed 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 Company to offer options for subscrip- tion free of charge to members of the Board, and to such officers and employ- ees of the Company as the Board sees fit. Each option will entitle the holder of the option 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 maxi- mum of 400,000 “A” options, the sub- scription period for which ended on 9 May 2016 (such options exercisable between 9 May 2016 and 30 September 2021), a maximum of 400,000 “B” op- tions 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 maximum 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 exercise price for Ordinary Shares based on “A” options shall be €3.71. The exercise price for Ordinary Shares based on “B” options shall be €2.90. The exercise price for Ordinary Shares based on “C” and “D” options shall be de- termined by the Euro equivalent to the average share price of the publicly trad- ed Ordinary Shares of the Company on AIM between 1 July and 30 September of 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. 40 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Details of these options are as follows: 2015A Options Date of grant of A options 1) At 1 Jan 2016 Granted during the period Cancelled during the period At 31 Dec 2016 Subscription Price per share, € Date from which exer- cisable Expiry date of A options Markku Jalkanen 16.09.2015 80 000 Yrjö E K Wichmann Frank M Armstrong 16.09.2015 30 000 16.09.2015 40 000 Matti Manner 16.09.2015 20 000 Juho Jalkanen 16.09.2015 20 000 Jonathan Knowles 16.09.2015 20 000 Huaizheng Peng 16.09.2015 20 000 Leopoldo Zambeletti 16.09.2015 20 000 0 0 0 0 0 0 0 0 80 000 30 000 40 000 20 000 20 000 20 000 20 000 20 000 3,71 02.11.2015 30.09.2021 3,71 02.11.2015 30.09.2021 3,71 02.11.2015 30.09.2021 3,71 02.11.2015 30.09.2021 3,71 02.11.2015 30.09.2021 3,71 02.11.2015 30.09.2021 3,71 02.11.2015 30.09.2021 3,71 02.11.2015 30.09.2021 250 000 250 000 2015B Options Date of subscrip- tion of B options1) At 1 Jan 2016 Granted during the period Cancelled during the period At 31 Dec 2016 Subscription Price per share, € Date from which exer- cisable Expiry date of A options Markku Jalkanen 18.11.2016 Yrjö E K Wichmann Frank M Armstrong 18.11.2016 18.11.2016 Matti Manner 18.11.2016 Juho Jalkanen 18.11.2016 Jonathan Knowles 18.11.2016 Huaizheng Peng 18.11.2016 Leopoldo Zambeletti 18.11.2016 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 80 000 30 000 40 000 20 000 20 000 20 000 20 000 20 000 2,90 02.11.2015 30.09.2021 2,90 02.11.2015 30.09.2021 2,90 02.11.2015 30.09.2021 2,90 02.11.2015 30.09.2021 2,90 02.11.2015 30.09.2021 2,90 02.11.2015 30.09.2021 2,90 02.11.2015 30.09.2021 2,90 02.11.2015 30.09.2021 250 000 250 000 1) Additionally, the Directors have the right to subscribe equal amounts of “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). 41 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Total Options At 1 January 2016 Granted during the period Cancelled during the period Markku Jalkanen Yrjö E K Wichmann Frank M Armstrong Matti Manner Juho Jalkanen Jonathan Knowles Huaizheng Peng Leopoldo Zambeletti 80 000 30 000 40 000 20 000 20 000 20 000 20 000 20 000 80 000 30 000 40 000 20 000 20 000 20 000 20 000 20 000 250 000 250 000 0 0 0 0 0 0 0 0 Average subs.price per shares, € 3,31 3,31 3,31 3,31 3,31 3,31 3,31 3,31 At 31 December 2016 160 000 60 000 80 000 40 000 40 000 40 000 40 000 40 000 500 000 Directors’ shareholdings The Directors who served during the period, together with their beneficial interests in the shares of the Company, are as follows: Executive Ordinary shares Percentage held Ordinary shares Avergare exercise price, euro cent Issued Share Capital Share options Markku Jalkanen¹) Juho Jalkanen²) Matti Manner Yrjö Wichmann Jonathan Knowles Leopold Zambeletti Frank Armstrong3) Huaizheng Peng 2 873 390 1 082 570 484 900 69 440 27 712 17 461 7 846 4 000 10.9% 160 000 4.1% 1,8% 0.3% 0.1% 0.1% 0.0% 0.0% 40 000 40 000 60 000 40 000 40 000 80 000 40 000 4 567 319 17,4% 500 000 3,31 3,31 3,31 3,31 3,31 3,31 3,31 3,31 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’s Jalkanens’ family being Aaro Jalkanen, Enna Jalkanen and Heikki Jalkanen. 3) held by Frank Armstrongs’ company Shore Capital. 42 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 corpor ate gov erna nce Statement of Responsibilities Under the Finnish Companies Act and the Finnish Accounting Act the Company must prepare an Annual Report and fi- nancial statements in accordance with applicable law and regulations. The Board of Directors and the responsible Managing Director are for the preparation of financial state- ments that give a true and fair view in accordance with International Financial Reporting Standards (IFRS) as adopted by the EU, as well as for the preparation of financial statements and the report of the Board of Directors that give a true and fair view in accordance with the laws and regulations governing the preparation of the financial statements and the report of the Board of Directors in Finland. The Board of Directors is re- sponsible for the appropriate arrange- ment of the control of the company’s ac- counts and finances, and the Managing Director 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 Alternative Investment Market, the Company is also required to prepare annual accounts and financial statements under IFRS. In preparing these financial statements, the Board of Directors is required to: Website publication 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 Corporate Governance Code for Small and Medium Sized Companies. On behalf of the Board Frank Armstrong Chairman 28 March 2017 • select suitable accounting policies and then apply them consistently; • make judgements and accounting estimates that are reasonable and prudent; • state whether they have been pre- pared in accordance with IFRSs as adopted by the European Union, sub- ject to any material departures dis- closed and explained in the financial statements; • prepare the financial statements on the going concern basis unless it is in- appropriate to presume that the com- pany will continue in business. The Board of Directors and the Managing Director are responsible for keeping adequate accounting records that are sufficient to show and explain the company’s transactions and dis- close with reasonable accuracy at any time the financial position of the com- pany and enable them to ensure that the financial statements comply with the requirements of the Finnish Accounting Act. They are also responsible for safe- guarding the assets of the company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. 43 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 financia l statem en ts Statement of Comprehensive Income 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 Loss before income taxes Income tax expense Total comprehensive income for the financial year Total comprehensive income, attributable to: Note 3; 4 5 6; 7 6; 7 2; 8 2; 8 9 Year ended 31 Dec 2016 €’000 Year ended 31 Dec 2015 €’000 1 153 1 153 1 742 (2 161) (9 592) (8 858) 0 (361) (361) (9 219) (75) (9 294) 520 (25) 496 701 (3 061) (3 971) (5 835) 0 (311) (311) (6 146) (42) (6 188) Equity holders of the Company (9 294) (6 188) Loss per share attributable to equity holders of the Company 10 Basic and diluted loss per share, euro (0,39) (0,30) 44 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 Total assets Equity and liabilities 11 11 12 13 14 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 2016 €’000 Year ended 31 Dec 2015 €’000 21 933 954 1 451 3 404 11 478 16 333 17 287 28 1 001 1 029 649 2 074 11 068 13 791 14 821 2 691 2 691 34 006 (25 814) 10 884 2 033 2 033 93 1 874 2 403 4 371 6 404 17 287 24 533 (16 046) 11 178 1 446 1 446 245 436 1 517 2 197 3 643 14 821 45 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 financia l statem en ts Statement of Cash Flows Stated in euro Cash flow from operating activities Loss(-) / profit(+) attributable to equity holders of the Company Adjustments for Depreciation and amortisation Financial items Income taxes Expensed R&D 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) Cash flow from financing activities Proceeds from issue of share capital/issue, net Proceeds from issue of convertible notes Proceeds from current borrowings Proceeds from non-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 Year ended 31 Dec 2016 €’000 Year ended 31 Dec 2015 €’000 (9 294) (6 188) 168 361 75 480 (1 330) (802) 2 325 (361) 0 (75) (8 452) (92) (92) 8 519 (151) 587 8 955 410 11 068 11 478 184 298 42 78 474 (2 035) 50 278 (285) 0 (42) (7 146) (107) (107) 18 080 18 080 10 827 242 11 068 46 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 financia l statem en ts Statement of Changes in Equity Stated in euro Share capital €’000 Un-registered share capital €’000 Reserve for invested non-restricted equity €’000 Retained earnings €’000 Total equity €’000 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 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 Total comprehensive income for the financial year 2016 Transactions with equity holders of the Company Share base payment Increase of share capital Transaction costs on share capital issued Conversion of convertible notes (9 294) (9 294) 9 330 (811) 480 480 9 330 (811) 8 519 (8 814) (295) Balance at 31 December 2016 2 691 33 052 (24 860) 10 884 For further information on equity transactions see Note 15. Equity and reserves. 47 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 financia l statem en ts Notes NOTE 1 1. Summary of significant accounting policies 1.1 Corporate information Faron Pharmaceuticals Ltd. (hereafter ”Faron” or ”Company”) is a Finnish limited liability company organized under the laws of Finland and domiciled in Turku, Finland. The Company’s reg- istered address is Joukahaisenkatu 6 B, 20520 Turku, Finland. The former parent company of Faron Pharmaceuticals Ltd., Faron Holding Ltd., merged into Faron Pharmaceuticals Ltd. as at 31 December 2013. Faron has no interests in other entities. The shares of Faron Pharmaceuticals Ltd. are held by multiple shareholders. Faron Pharmaceuticals Ltd. 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, which passed successfully a phase I/II trial in the UK to treat vascular leakage in ARDS1 patients, moved to a pan-Europe- an pivotal phase III study (INTEREST –study) during 2015. INTEREST recruited its first patient in late December 2015. Faron has been granted an orphan drug status for the treat- ment of ARDS with interferon-beta by the EU Commission and European Medicines Agency (EMA) under the registration number EU/3/07/505. Faron has also been granted several patents both in USA, Europe and Japan, and has several pend- ing applications in other territories for the use of interferon-be- ta to treat various ischemic conditions. Faron’s second product FP-1305, also known as Clevegen, is in pre-clinical stage and will be taken into clinical trials aim- ing to prove its safety and efficacy in reduction of tumour immunosuppression and macrophage activation. Also for Clevegen Faron has been granted several patents both in USA, Europe and Japan, and has several pending applications in other territories for the molecule, the antibody as well as other key characteristics related to their use and efficacy. In its meeting on 28 March 2017 the Board of Directors of Faron Pharmaceuticals Ltd. approved the publishing of these financial statements. According to the Finnish Limited Liability Companies’ Act, shareholders have the right to approve or re- ject the financial statements in the Annual General Meeting held after the publication of the financial statements. The principal accounting policies applied in the preparation of these financial statements are set out below. 1.2 Basis of preparation These are Faron’s third full year financial statements pre- pared 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 2016. In the EU IFRS are standards and their interpretations adopted in accordance with the procedure laid down in regulation (EC) No 1606/2002 of the European Parliament and of the Council. Faron has consistently applied these policies to all the years presented, unless otherwise stated. The Company has not applied any standard, interpretation or amendment thereto before its ef- fective date. Faron’s date of transition to IFRS is 1 January 2012. The Company has applied IFRS 1 First-time Adoption of International Financial Reporting Standards in preparing these financial statements. Until 31 December 2011 Faron’s sepa- rate financial statements have been 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 December. The figures in the financial statements are present- ed in thousands of euro unless otherwise stated. All figures presented 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 48 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 until receipt of marketing approval from the relevant regula- tory agencies. After such approval, Faron would either seek to form partnerships with global, regional or local pharma- ceutical companies that have the necessary marketing and distribution capabilities and resources or take the approved product to the markets itself. In the case of partnership, Faron would typically grant geographically limited licenses to prod- ucts in exchange for contractually agreed payments, license fees and royalties on future product sales. In some cases, one element of such agreements may include a collaboration in which Faron will also receive funding for R&D services pro- vided at a cost plus basis. In case of choosing to market the product itself, Faron would need to secure necessary funding to cover the costs of taking the product through the approval, pricing and regional registering process in addition to required marketing costs. In absence of collaboration agreement such funding would mainly come in form of equity funding. 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 clinical trials. The Company conducts these either to- gether with development partners or by itself. In both cases these activities require substantial amounts of funds. 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 estimates and assumptions are based on historical experi- ence and other justified assumptions that are believed to be reasonable under the circumstances at the end of the report- ing period and the time when they were made. Although these estimates are based on management’s best knowledge of current events and actions, actual results may ultimately differ from those estimates. The estimates and underlying assump- tions are reviewed on an on-going basis and when preparing 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 detail in chapter 1.20. 1.3 Foreign currency transactions and balances 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. 1.4 Revenue recognition 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 sales and milestone payments. 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 group’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 actual control usually associated with ownership of the goods have been transferred to the buyer. From 2013 to 2016 Faron has generated revenues from sales of 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 recognized 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: 49 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 • customer has verifiably accepted that the milestone has been reached • Faron has no further performance obligations related to the milestone in question; 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. 1.6 Research and development costs All costs related to research activities are presented under the caption research and development expenses in the income statement. Research and development expenses include sal- aries and other expenditure directly attributable to Faron’s re- search and development activities. Furthermore, costs attrib- utable to supporting the research and development activities, such as rental expenses for facilities, are included. Research and development expenses are directly related to the develop- ment phases of Faron’s projects and may therefore fluctuate strongly from year to year. No internal development expenses related to Company’s un- approved product candidates have yet been capitalized as management considers that the uncertainties inherent in de- veloping pharmaceutical products prohibits the capitalization of internal development expense as an intangible asset until marketing approval has been received from the relevant reg- ulatory agencies. Costs incurred on internal development projects are rec- ognised as intangible assets as of 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 external entity. 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 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 programs under which board mem- bers and 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 valuation model. The cost is recognized together with a corresponding increase in equity over the period in which the performance and service conditions are fulfilled, the vesting period. The fair value determined at the grant date of the equity-settled share- based payment is expensed on a straight line basis. No expense is recognized 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 allow the use of additional line items and subtotals in the income statement. Faron has defined operating result to be a relevant subtotal in understanding the Company’s financial performance. In Faron, 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, if any. 50 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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. 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 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. Deferred tax liability tax is generally provided for in full. Deferred tax assets are recorded up to the amount that rep- resents probable taxable income received in the future and against which temporary differences can be utilized. The amount and probability of the utilization 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 realized 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. Equipment that Faron owns comprises mainly office equipment and per- sonal computers. Equipment is stated at historical cost less depreciation and any impairment losses. Historical cost in- cludes expenditure that is directly attributable to the acqui- sition of the items. Repairs and maintenance costs are ex- pensed as incurred. 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 amortization 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- ate probable future economic benefits, • adequate technical, financial and other resources to com- plete 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 ingredient, API (“API documentation”) The development activities and documentation relate to stability testing of a drug substance (API), that is sellable as such, but the usage value of which im- proves as the prolonged stability is proven and documented. In addition to its own use, Faron may also, for a fee, license the documentation to companies that can utilise documen- tation in their own drug candidate approval and registration documentation. Provision of such access does in no way limit Faron’s ability to use the documentation 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 estimated useful lives of intangible assets are regularly 51 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 reviewed. The estimated useful life for intangible assets is cur- rently 10 years. The effect of any adjustment to useful lives is recognised prospectively 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 capitalized. Before this trigger point all drug product related development costs are typically expensed as incurred. Faron has not capitalized 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 capitalized at a later date. 1.13 Impairment of non-financial assets Assets that are subject to depreciation/amortisation are re- viewed for impairment whenever there are any indications that the carrying amount may not be recoverable. As a clinical stage drug discovery and development company Faron pays attention on the following factors, among others: changes 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 amortization 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 (Commission’s FP7 program). the EU Grants from governments or similar organizations to sup- port certain projects are accounted for as grants related to income. They are initially recognised at their fair value. 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 management has rea- sonable assurance that the grant will be received 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 Inventories are stated at the lower of cost and net realizable value. Cost is determined using average cost method instead of FIPO –method. The change of method had no impact on the inventory value. The cost of finished goods comprises pur- chase 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 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. 52 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 (in- cluding reimbursable costs) in the ordinary course of busi- ness. Trade receivables are carried at the original invoice amount less allowances made for doubtful receivables, dis- counts and rebates and similar allowances, when applicable. Impairment is recognised on doubtful receivables 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 financial 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. 1.17 Financial liabilities and equity Faron classifies an instrument, or its component parts, on in- itial 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 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 three government loans with a below-market rate of interest from Tekes (The Finnish Funding Agency for Technology and Innovation). Two of 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 accounted for the below-market grant separately. Subsequently, these loans are carried at amortised cost using the effective interest rate. In January 2016 the Company raised first instalment of a new €1.5 million Tekes development loan for funding of the pre-clinical development of Clevegen. As the third loan was draw down after the date to transition to IFRS (i.e. after 1 January 2014) it is therefore treated according to IAS 20 and IAS 39. The benefit of a government loan at a below market rate of interest is treated as a government grant and account- ed for in accordance with IAS 20. The loan component is recognized and measured in ac- cordance with IAS 39 initially at fair value and subsequently at amortised cost over the loan period by using the effective interest method. The benefit of the below market rate is meas- ured as the difference between the initial carrying value of the loan, i.e. the fair value, and the proceeds received from the government. Government grants are recognised as profit or loss on a systematic basis over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate. 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 contractual obligation to deliver cash or other financial assets, and it can be converted to fixed amount of the Company’s shares, it is classified as equity. If the conversion option is to variable amount of the Company’s shares, and it includes contractual obligation to deliver cash, the instrument is a liability that contain embed- ded derivatives, and it is 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 53 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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. As of 31 December 2016, Faron had no outstanding con- vertible loans. 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 issuance of new shares to the stock market in September 2015, or are other- wise 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 capitalized 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 ex- pensed. An asset recognised under a finance lease is depre- ciated 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. 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 recognized when the criteria for revenue recognition is met for each component. Non- refundable milestones are recognized as revenue when the milestone has been achieved and the Company does not have future obligations related to that milestone. This is normal- ly 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 deferred revenue in the balance sheet/statement of financial position and recognized as revenue when the service/goods has been delivered and there are no remaining obligations or contingencies. For some transactions this may result in recognizing cash receipts in- itially as deferred income and then released to income over subsequent financial years on the basis of meeting the condi- tions 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 capitalization. This determination re- quires significant judgement. When an internal development project fulfils the criteria for capitalization, costs incurred are capitalized from that point forward. The in-process devel- opment 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 capitalized until marketing approval has been received from 54 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 the relevant regulatory agencies, as this is considered to be the first point at which it may be concluded that that future revenues 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”), fulfils the criteria of IFRS for capitalizing costs of internally developed intangible assets despite the nature of the Company’s operations where capitalization 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 usage val- ue of the drug substance improves as the prolonged stability is proven and documented. In addition to its own use, Faron may also, for a fee, license the documentation to companies that can utilise documentation in their drug candidate approv- al and registration documentation. The costs of this internally developed intangible asset have been capitalized as of the cri- teria for capitalization 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 differenc- es can be utilized. Various internal and external factors may have favourable or unfavourable effects on the deferred tax assets 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- izable value. Net realizable 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 sale. Net realizable 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 realized from their sale or use. Management has assessed, that GMP3 manufactured drug ingredient also fulfils 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 inter- pretations applicable in future financial years New and forthcoming IFRS standards, effective 1 January 2016 or period thereafter In preparing these financial statements, Faron has followed the same accounting policies as in the annual financial state- ments for 2015 except for the effect of changes required by the adoption of the following new standards, interpretations and amendment to existing standards and interpretations on 1 January 2016. Clarification of Acceptable Methods of Depreciation and Amortisation – Amendments to IAS 16 and IAS 38 (Effective date 1 January 2016) The amendments clarify that a revenue-based method of de- preciation or amortisation is generally not appropriate. The IASB has amended IAS 16 Property, Plant and Equipment to clarify that a revenue-based method should not be used to calculate the depreciation of items of property, plant and equipment. IAS 38 Intangible Assets now includes a rebuttable pre- sumption that the amortisation of intangible assets based on revenue is inappropriate. This presumption can be overcome if either • The intangible asset is expressed as a measure of revenue (ie where a measure of revenue is the limiting factor on the value that can be derived from the asset), or • It can be shown that revenue and the consumption of eco- nomic benefits generated by the asset are highly correlated. None of the above-listed annual improvements had any effect on the financial statements for 2016. 55 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Annual Improvements to IFRSs 2012-2014 cycle (Effective date 1 January 2016) The latest annual improvements clarify: • IFRS 5 – when an asset (or disposal group) is reclassified from ‘held for sale’ to ‘held for distribution’ or vice versa, this does not constitute a change to a plan of sale or distribution and does not have to be accounted for as such; • IFRS 7 – specific guidance for transferred financial assets to help management determine whether the terms of a ser- vicing arrangement constitute ‘continuing involvement’ and, therefore, whether the asset qualifies for derecognition; • IFRS 7 – that the additional disclosures relating to the off- setting of financial assets and financial liabilities only need to be included in interim reports if required by IAS 34 • IAS 19 – that when determining the discount rate for post-employment benefit obligations, it is the currency that the liabilities are denominated in that is important and not the country where they arise • IAS 34 – what is meant by the reference in the standard to ‘information disclosed elsewhere in the interim financial re- port’; entities taking advantage of the relief must provide a cross-reference from the interim financial statements to the location of that information and make the information avail- able to users on the same terms and at the same time as the interim financial statements. None of the above-listed annual improvements had any effect on the financial statements for 2016. Disclosure Initiative - Amendments to IAS 1 (Effective date 1 January 2016) The amendments to IAS 1 Presentation of Financial Statements are made in the context of the IASB’s Disclosure Initiative, which explores how financial statement disclosures can be improved. The amendments provide clarifications on a number of issues, including: • Materiality – an entity should not aggregate or disaggregate information in a manner that obscures useful information. Where items are material, sufficient information must be provided to explain the impact on the financial position or performance. • Disaggregation and subtotals – line items specified in IAS 1 may need to be disaggregated where this is relevant to an understanding of the entity’s financial position or perfor- mance. There is also new guidance on the use of subtotals. • Notes – confirmation that the notes do not need to be pre- sented in a particular order. • OCI arising from investments accounted for under the equi- ty method – the share of OCI arising from equity-accounted investments is grouped based on whether the items will or will not subsequently be reclassified to profit or loss. Each group should then be presented as a single line item in the statement of other comprehensive income. According to the transitional provisions, the disclosures in IAS 8 regarding the adoption of new standards/accounting poli- cies are not required for these amendments. None of the above-listed annual improvements had any ef- fect on the financial statements for 2016. Forthcoming requirements of IFRS standards, interpreta- tions and amendments IFRS 9 Financial Instruments and associated amend- ments to various other standards (Effective date 1 January 2018) IFRS 9 “Financial Instruments” replaces the multiple classifi- cation and measurement models in IAS 39 and it will bring changes to classification and measurement of financial as- sets their impairment assessment hedge accounting. A debt instrument is measured at amortised cost only if the objective of the business model is to hold the financial asset for the collection of the contractual cash flows, and the con- tractual cash flows under the instrument solely represent pay- ments of principal and interest. All other debt and equity instruments, including invest- ments in complex debt instruments and equity investments, must be recognised at fair value. All fair value movements on financial assets are taken through the statement of prof- it or loss, except for equity investments that are not held for trading, which may be recorded in the statement of profit or loss or in reserves (without subsequent recycling to profit or loss). In addition debt instruments can be classified at fair val- ue through other comprehensive income according to entity’s business model. As of the date of these financial statements Faron is still to assess the impacts of the standard. IFRS 15 Revenue from contracts with customers and associ- ated amendments to various other standards (Effective date 1 January 2018) The IASB has issued a new standard for the recognition of revenue. This will replace IAS 18 which covers contracts for goods and services and IAS 11 which covers construction contracts. The new standard is based on the principle that revenue is recognised when control of a good or service transfers to a customer – so the notion of control replaces the existing notion of risks and rewards. A new five-step process must be applied before revenue can be recognised: 56 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 • identify contracts with customers • identify the separate performance obligation • determine the transaction price of the contract • allocate the transaction price to each of the separate perfor- mance obligations, and • recognise the revenue as each performance obligation is satisfied. Key changes to current practice are: The Company is still to assess the impacts of the standard. IFRS 16 Leases (effective for financial years beginning on or after 1 January 2019) IFRS 16 will affect primarily the accounting by lessees and will result in the recognition of almost all leases on balance sheet. The standard removes the current distinction between operat- ing and financing leases and requires recognition of an asset (the right to use the leased item) and a financial liability to pay rentals for virtually all lease contracts. An optional exemption exists for short-term and low-value leases. The income statement will also be affected because the total expense is typically higher in the earlier years of a lease and lower in later years. Additionally, operating expense will be replaced with interest and depreciation, so key metrics like EBITDA will change. Operating cash flows will be higher as cash payments for the principal portion of the lease liability are classified within financing activities. Only the part of the payments that reflects interest can continue to be presented as operating cash flows. The accounting by lessors will not significantly change. Some differences may arise as a result of the new guidance on the definition of a lease. Under IFRS 16, a contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The Company is still to assess the impacts of the standard. Recognition of Deferred Tax Assets for Unrealised Losses – Amendments to IAS 12 (effective for financial years begin- ning on or after 1 January 2017) Amendments made to IAS 12 in January 2016 clarify the accounting for deferred tax where an asset is measured at fair value and that fair value is below the asset’s tax base. Specifically, the amendments confirm that: • A temporary difference exists whenever the carrying amount of an asset is less than its tax base at the end of the report- ing period. • An entity can assume that it will recover an amount higher than the carrying amount of an asset to estimate its future taxable profit. • Where the tax law restricts the source of taxable profits against which particular types of deferred tax assets can be recovered, the recoverability of the deferred tax assets can only be assessed in combination with other deferred tax assets of the same type. • Tax deductions resulting from the reversal of deferred tax assets are excluded from the estimated future taxable profit that is used to evaluate the recoverability of those assets. The Company is still to assess the impacts of the standard. Disclosure Initiative – Amendments to IAS 7(effective for fi- nancial years beginning on or after 1 January 2017). Going forward, entities will be required to explain changes in their liabilities arising from financing activities. This includes changes arising from cash flows (e.g. drawdowns and repay- ments of borrowings) and non-cash changes such as acquisi- tions, disposals, accretion of interest and unrealised exchange differences. Changes in financial assets must be included in this disclo- sure if the cash flows were, or will be, included in cash flows from financing activities. This could be the case, for example, for as- sets that hedge liabilities arising from financing liabilities. Entities may include changes in other items as part of this disclosure, for example by providing a ‘net debt’ reconciliation. However, in this case the changes in the other items must be disclosed separately from the changes in liabilities arising from financing activities. The information may be disclosed in tabular format as recon- ciliation from opening and closing balances, but a specific format is not mandated. The Company is still to assess the impacts of the standard. Sale or contribution of assets between an investor and its as- sociate or joint venture – Amendments to IFRS 10 and IAS 28 (effective date has not been established yet, not yet endorsed by EU). The IASB has made limited scope amendments to IFRS 10 Consolidated financial statements and IAS 28 Investments in associates and joint ventures. The amendments clarify the accounting treatment for sales or contribution of assets be- tween an investor and its associates or joint ventures. They confirm that the accounting treatment depends on whether the non-monetary assets sold or contributed to an associate or joint venture constitutes a ‘business’ (as defined in IFRS 3 Business Combinations). Where the non-monetary assets constitute a business, the investor will recognise the full gain or loss on the sale or con- tribution of assets. If the assets do not meet the definition of a business, the gain or loss is recognised by the investor only to 57 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 ‘‘Share-based Payment Transactions’ – Amendments to IFRS 2 (effective date 1 January 2018, not yet endorsed by EU). Clarifies how to account for certain types of share-based pay- ment transactions and provide requirements on the account- ing for: • the effects of vesting and non-vesting conditions on the measurement of cash-settled share-based payments; • share-based payment transactions with a net settlement feature for withholding tax obligations; and • a modification to the terms and conditions of a share-based payment that changes the classification of the transaction from cash-settled to equity-settled The Company is still to assess the impacts of the standard. IFRIC 22: Foreign Currency Transactions and Advance Considerations 2 (effective date 1 January 2018, not yet en- dorsed by EU). IFRIC 22 provides requirements about which exchange rate to use in reporting foreign currency transactions (such as revenue transactions) when payment is made or received in advance. The Company is still to assess the impacts of the standard. Transfers of Investment Property – Amendments to IAS 40 (effective date 1 January 2018, not yet endorsed by EU). Clarification. The amendment was made to reinforce the principle for transfers into, or out of, investment property in respect of properties under construction or development. The Company is still to assess the impacts of the standard. the extent of the other investor’s investors in the associate or joint venture. The amendments apply prospectively. The Company is still to assess the impacts of the standard. Clarifications to IFRS 15 Revenue from Contracts with Customers (effective date 1 January 2018, not yet endorsed by EU) The amendments comprise clarifications of the guidance on identifying performance obligations, accounting for licenses of intellectual property and the principal versus agent as- sessment (gross versus net revenue presentation). New and amended illustrative examples have been added for each of these areas of guidance. The IASB has also included addition- al practical expedients related to transition to the new revenue standard. The Company is still to assess the impacts of the standard . Annual improvements to IFRSs 2014-2016 cycle (effective date 1 January 2017, not yet endorsed by EU). These annual improvements clarify: • IFRS 12 – that the disclosure requirements in IFRS 12, other than those relating to summarised financial information for subsidiaries, joint ventures and associates, apply to an en- tity’s interests in other entities that are classified as held for sale or discontinued operations in accordance with IFRS 5. IAS 28 – that an entity has an investment-by-investment choice for measuring investees at fair value in accordance with IFRS 9 by a venture capital organisation, or a mutual fund, unit trust or similar entities including investment linked insur- ance funds. Additionally, an entity that is not an investment entity may have an associate or joint venture that is an invest- ment entity. IAS 28 permits such an entity the choice to retain the fair value measurements used by that investment entity associate or joint venture when applying the equity method. The amendments clarify that this choice is also available on an investment-by-investment basis. The Company is still to assess the impacts of the standard. ‘Insurance Contracts’ – Amendments to IFRS 4 (effective date 1 January 2018, not yet endorsed by EU). The amendment provides exceptions in applying IFRS 9 with IFRS 4 Insurance Contracts when entity has issued insurance contracts. 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. 58 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 NOTE 2 2.1 Principles of financial risk management Faron’s activities expose it to a variety of financial risks as follows: - liquidity risk - credit risk, and - market risk Faron’s overall risk management seeks to minimise potential adverse effects on the Company’s financial performance. Risk management is carried out by the financial management of Faron. The financial management identifies, evaluates and hedges financial risks. So far Faron has not used derivative financial instruments to hedge any risk exposures. Faron’s risk management focuses on liquidity and market risks. Liquidity risk Liquidity risk is the risk that Faron will encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or another financial asset. Management forecasts the Company’s liquidity require- ments to ensure it has sufficient cash to meet operational needs. Such forecasting takes into consideration Faron’s fi- nancing plans and expected cash flow. In 2016, Company is- sued new shares to institutional investors on AIM market and received new equity, less direct costs, to the amount of EUR 8,519 thousands. This new capital significantly reduced the liquidity risk for the Company in the near future. In 2012 the European Commission awarded a EUR 5,963 thousand grant to the Faron network (“Consortium”) to sup- port the FP-1201-lyo clinical phase III program (“Traumakine”). The Consortium consists of the European Commission as a granting agency, Faron as a coordinator and three other partic- ipating partners of the Traumakine program; University College London Hospital (UCLH), University Sapienza Roma and University of Turku. The first pre-payment for the Consortium under the grant was received in 2013, amounted to EUR 2,299 thousand, and Faron recognised EUR 660 thousand as other operating income. The second Consortium pre-payment, EUR 1,018 thousand was received at the end of 2014 and Faron recognised EUR 111 thousand as other operating income. In 2015, Faron recognised EUR 701 thousand as other operating income.The third pre-payment, EUR 1,781 thousand was re- ceived in 2016, and Faron recognised EUR 1,502 thousand as other operating income. In conjunction to each pre-payment Faron has forwarded each Consortium member their respec- tive shares of pre-payments. During 2016 the Company negotiated a further two year extension to the loan and an equal postponement of the in- stallments of the first R&D loan from Tekes, for which the first installment was due in 2016. Tekes provided Faron with an ad- ditional two years to make in respect to first installment which is now therefore due in 2018. Faron also has had a committed credit limit available, up to EUR 800 thousand, which was end- ed 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 Maruish in 2017 and income from other commercial agreements, will enable Faron to fund its operating expenses as planned during 2017. A) Goverment loans (R&D loans from Tekes) The Finnish Funding Agency for Technology and Innovation (Tekes) has granted three loans to the Company. The total amount of the first two loans had been drawn down by the Company by the end of the year 2011. Both loans are govern- ment loans with a below-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%, however, the interest rate will not fall below a 3% minimum. Repayment 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 following the general terms of the loans. The loans do not include any covenants. The Company has negotiated with Tekes four year extension to the first loan and an equal postponement of the installments. The first in- stalment of the third loan have been drawn down during 2016. 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 oblication 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. 59 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 C) Loans Stated in euro Contractual maturity of loans and their interest payments at 31 Dec 2016 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 2016 €’000 2017 €’000 2018 €’000 2019 €’000 Later years €’000 Total €’000 0 26 93 26 338 24 338 20 1 847 55 2 617 150 1824 1850 119 362 358 1 902 1 824 4 591 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 would turn out to be unsuccesfull the lender can forgive the loans either partially or fully. address and describe remedies for situations in which inter- ests 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. 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. Currently Faron does business with only few external coun- terparties, which all are licensees of Company’s technology and products. Over the coming years, funding (milestone pay- ments and reimbursable research expenses ) from licensees remain important to Faron’s product development programs and are considered the main area of credit risk. However, this risk is partly mitigated by the fact that Faron’s current licen- sees are large and internationally reputable pharmaceutical companies that are financially solid. These collaborations are normally governed by contractual relationships that typically The Company has not incurred any credit losses over the re- porting periods 2012-2016, and management does not expect losses from non-performance by counterparties. Therefore, at present, credit risk is limited. Faron has historically had very little trade receivables by year-end 2012-2015, In the year ended 31 Dec 2016 the trade receivables were EUR 579 thousand and they are all from Maruishi and one client which is a very large international pharmaceuticals company. There has not been any irregulari- ties in the payments of these clients. All the trade receivables are due in 30 days. Thus no further ageing analysis of trade receivables is presented. 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: 60 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 • 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 English Pound. 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 Ph III clinical trials with a UK -based Clinical Research Organisation as main service provider, the Companys’ sterling denominated expensess and trade payables have become significant. The Company convert- ed most of the pound -denominated IPO -proceeds into euros immediatelly after the IPO, but held- and still holds - a sizeable amounts of pounds on its pound -bank accounts. This forms a natural hedge against euro-pound exchange rate changes, as the funds held in pounds roughly match with the estimated pound expenses during 2017. As a result of the sizeable pound -holdings, the depreciation of english pound against euro had a negative effect on the financial statements. As the exchange rate may move also to other direction during 2017, the man- agement believes that natural hedge strategy best protects the Company from adverse exchange rate changes and this protec- tion overweights 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 changes in market interest rates. The Company’s interest rate risk arises from long-term borrowings. 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 partially offset by cash held at variable rates which, on the other 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 programs into commer- cialised pharmaceutical products requires significant financial resources. Faron relies on its ability to fund its operations through three major sources of financing: 1) Equity financing: Faron’s funding is partly organised through equity financing. Management monitors li- quidity 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 re- ceive upfront and milestone-dependent payments from these partners. Activities in the area of business development are targeted at securing such agree- ments. These activities are integral part of the duties of the management and are monitored by the Board of Directors, which ultimately 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 econom- ic and technological progress in the region in which Faron operates. Such funds have been historically available to Faron at substantial levels. Faron is in reg- ular contact with the funding agencies. The availability of such funds in the future cannot be guaranteed. 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. 61 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 2.3 Fair value estimation NOTE 5 Other operating income Some of Faron’s accounting policies and disclosures require the measurement of fair values. For Faron this applies primar- ily to financial assets and liabilities. For financial instruments that are measured in the balance sheet at fair value, IFRS requires disclosure of fair value meas- urements 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 indi- rectly (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 meas- urement 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 2015 revenue consisted of milestone income from Maruishi and sales of API reference material as well as analyse material sales. In 2016 revenue consisted of sale of API and sale of clinical material to Maruishi. NOTE 4 Segment reporting Faron is a late clinical stage biotechnology company. It’s op- erations have been focused on the development of its main drug candidate, Traumakine. Faron’s chief operating decision 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. Faron’s country of operation is Finland. Stated in euro Grants from EU Grant component of goverment loans Other items 2015 €’000 701 2016 €’000 1 502 237 4 Total other operating income 1 742 701 In 2012 the European Commission awarded a EUR 5,963 thousand grant to the Faron network (“Consortium”) to sup- port the FP-1201-lyo clinical phase III program (“Traumakine”). The Consortium consists of the European Commission as a granting agency, Faron as the funds receiving and further dis- tributing coordinator and three other participating partners of the Traumakine program; University College London Hospital (UCLH), University Sapienza Roma and University of Turku. The first pre-payment for the Consortium under the grant was received in 2013, amounted to EUR 2,299 thousand, and Faron recognised EUR 660 thousand as other operating income. The second Consortium pre-payment, EUR 1,018 thousand was received at the end of 2014 and Faron recognised EUR 111 thousand as other operating income. In 2015, Faron recog- nised EUR 701 thousand as other operating income.The third pre-payment, EUR 1,781 thousand was received in 2016, and Faron recognised EUR 1,502 thousand as other operating income. In conjunction to each pre-payment Faron has for- warded each Consortium member their respective shares of pre-payments. According to IFRS 39 below-market level goverment loans must be divided into Fair-value -component and Grant com- ponent. Thus the Tekes -loans raised during 2016 have been decomposed and the grant component of 237 thousand euro is recorded in Other operating income. The Other items are 4 thousand euro legal costs returned to the Company. 62 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 NOTE 6 NOTE 7 Employee benefit expense Depreciation and amortisation Stated in euro 2016 €’000 2015 €’000 Stated in euro 2016 €’000 2015 €’000 Salaries (1 636) (940) Depreciation and amortisation allocated to functions Research and development (219) (90) (480) (115) (63) (474) Administration Total depreciation and amortisation (161) (7) (175) (9) (168) (184) (2 426) (1 591) Depreciation and amortisation by asset categories Contributions to defined contribution post-employment plans Social security contributions Share based payments Total employee benefit expenses Average number of personnel Finland Total 10 10 6 6 For further information on management remuneration see Note 21 related party transactions. Share based payments are further explained in Note 16. Machinery and equipment Total depreciation Intangible assets Patents Other intangible assets IFRS depreciation adjustment (7) (7) (71) (90) (9) (9) (65) (90) (20) Total amortisation (161) (175) Total depreciation and amortisation (168) (184) The Company has not recorded any impairment losses for the years ended 31 December 2012 to 2016. 63 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 NOTE 8 Financial income and expenses Faron has received three goverment loans for research and development purposes with below-market interest rate from Tekes (The Finnish Funding Agency for Technology and Innovation). Two of theses loans were drawn down before the date to transition to IFRS (i.e. prior to 1 January 2014). 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 amortized cost using the effective interest rate. 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%, however, the interest rate will not fall below a 1% minimum. Repayment 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, ex- tend the loan terms, convert the loans into capital loans or exempt the Company from repayment following the general terms of the loans. The loans do not include any covenants. The Company has negotiated with Tekes four years extension to the first loan and an equal postponement of the install- ments and a years extension to the first loan and an equal postponement of the installments. Therefore the first instal- ment of the first loan is due in April 2018 and for the second loan in February 2019. The third Tekes loan has been partially drawn down during 2016. Its loan period is also 10 years from first draw down with first repayment after 5 years. Therefore the first instalment of the third loan is due in April 2022. In all other material respact the terms of the third loan are identical to those of the first two loans. As the third loan was draw down after the date to transition to IFRS (i.e. after 1 January 2014) and therefore it is treated according to IAS 20 and IAS 39. The benefit of a government loan at a below market rate of interest is treated as a government grant and accounted for in accordance with IAS 20. The loan component is recognized and measured in ac- cordance with IAS 39 initially at fair value and subsequently at amortised cost over the loan period by using the effective interest method. The benefit of the below market rate is meas- ured as the difference between the initial carrying value of the loan, i.e. the fair value, and the proceeds received from the government. Government grants are recognised in profit or loss on a systematic basis over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate. Other significant financial expense items are the exchange rate losses when transfering GBP to Euro, when issuing the new shares entering London stock exchange, expenses on loan guarantees, interest on convertible loans and credit limit interest from bank. See also Note 2 Financial risk management. Stated in euro 2016 €’000 2015 €’000 Financial income Interest from bank balances Interest from account receivables Exchage rate profit Total financial income Financial expenses 0 0 0 Interest on government loans (Tekes) (19) Interest on bank loans Interest on accounts payables (5) (1) 0 0 (18) (19) (1) Exchange rate losses (333) (247) Bank guarentee costs and provisions Other financial expenses (2) (1) (9) (17) Total financial expenses (361) (311) Total financial income and expenses (361) (311) 64 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 NOTE 9 Income taxes Stated in euro Withholding tax Total income taxes 2016 €’000 (75) (75) 2015 €’000 (42) (42) Stated in euro 2016 €’000 2015 €’000 Reconciliation of effective tax rate The Finnish corporate tax rate applied was 20%. Loss before income tax (9 294) (6 188) Taxes paid in the year ended 31 December 2015 and 2016 re- late to milestone payment from Maruishi and signing fee from PharmBio. Tax using Faron’s domestic corporate tax rate Current-year losses for which no deferred tax asset is recognised Taxes in the income statement 1 859 1 238 (1 859) (1 238) 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 13 928 5 434 16 744 8 250 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 2025. The amount presented for the year ended 31 December 2016 does not include the deductible temporary difference arisen from the net loss for the financial year 2016 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 in the balance sheet due to the uncertainty as to whether they can be utilised. 65 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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. Stated in euro Loss attributable to equity holders of the Company (EUR 1,000) 2016 €’000 (9 294) 2015 €’000 (6 188) Weighted average number of ordinary shares in issue 23 979 650 20 686 854 Basic (and dilutive) loss per share, EUR (0,39) (0,30) Weighted-average number of ordinary shares Issued ordinary shares at 1 January Effect of shares issued Weighted-average number of ordinary shares at 31 December 23 111 704 867 945 23 979 650 15 456 250 5 230 604 20 686 854 Diluted Diluted lossper share is calculated by adjusting theweighted average number of ordinary shares outstanding to assume conver- sion of all dilutive potential ordinary shares. Stated in euro Loss attributable to equity holders of the Company (EUR 1,000) Interest adjustment Convertible loan interest adjusted loss attrib to equity holders 2016 €’000 (9 294) (9 294) 2015 €’000 (6 188) 9 (6 179) Diluted weighted average number of ordinary shares in issue 23 979 650 20 686 854 Basic loss per share, EUR (0,39) (0,30) Weighted-average number of ordinary shares Issued ordinary shares at 1 January Effect of shares issued Weighted-average number of ordinary shares at 31 December Dilution effect of convertible loans’ 23 111 704 867 945 23 979 650 15 456 250 5 230 604 20 686 854 - Diluted weighted-average number of ord. shares at 31 December 23 979 650 20 686 854 66 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 2016 €’000 2015 €’000 39 39 (11) (7) (18) 28 21 2 37 39 (1) (9) (11) 0 28 2016 €’000 2015 €’000 716 92 646 70 Balance at 31 December 809 716 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 (434) (71) (505) 283 304 (369) (65) (434) 277 283 67 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Documentation assets in process Stated in euro Cost Balance at 1 January Cost Additions Disposals Transfers 2016 €’000 2015 €’000 907 907 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 (188) (90) (278) 719 629 2016 €’000 1 623 92 (188) (188) 907 719 2015 €’000 1 553 70 Balance at 31 December 1 716 1 623 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 (622) (161) (783) 1 001 933 (369) (253) (622) 1 184 1 001 68 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Total machinery and equipment and intangible assets Stated in euro Cost Balance at 1 January Cost Additions Disposals Transfers 2016 €’000 1 662 92 2015 €’000 1 555 107 Balance at 31 December 1 754 1 662 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 (632) (168) (800) 1 029 954 (370) (262) (632) 1 185 1 029 Finance leases Orphan drug status On 31 December 2016 the company had finance leases a total of 49 thousand euros. The Interest charges related to the financial leases are re- corded in the financial expenses. See note 8. Documentation assets The cost of the documentation arisen in conjunction to the de- velopment work of Faron is recorded in intangible assets. This documentation consists of API documentation1 (see Note 1, 1.10.2 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 a drug 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. 69 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 NOTE 12 Inventories Stated in euro Pre-payment of unfinnished products Finished goods Inventories total 2016 €’000 952 499 1 451 2015 €’000 649 649 Inventories consists of pre-payments of unfinnished materials and finnished goods. The unfinnished materials consists of an on-going production lot of active pharmaceutical ingredient (API) used in production of FP-1201-lyo. The finnished goods con- sists of deep-frozen bags of API which have a limited expiry time but which can be extended by conducting additional stability studies. The cost of inventories recognised as an expense and included in the line item “Cost of sales” amounted to EUR 100,000 (2016: zero; 2015: zero). The Company has not recorded any impairment losses in years from 2012 to 2016. NOTE 13 Current receivables Stated in euro Trade receivables Prepayments Accrued items Other receivables Total trade and other receivables 2016 €’000 579 1 250 134 1 441 3 404 2015 €’000 37 1 248 17 772 2 074 The majority of prepayments relate to the Clinical Service Agreement with the clinical research organisation (CRO), 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 2016 €’000 11 478 11 478 2015 €’000 11 068 11 068 70 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 NOTE 15 Equity and reserves Equity and reserves In issue at 1 January 2013 Conversion of convertible notes to 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 31 December 2015 Share base payments Emission of new shares 31 December 2016 Number of shares (pcs) Share capital (1,000 €) Reserve for invested non-restricted equity (1,000 €) Total (1,000 €) 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 23 111 704 1 296 120 0 0 1 416 1 275 0 0 2 691 0 2 691 0 0 5 328 0 0 0 6 624 120 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 13 030 24 533 0 0 13 030 27 224 0 3 200 000 26 311 704 8 519 8 519 2 691 33 052 35 743 Faron Pharmaceuticals Ltd. has one class of shares. The shares amounted to 23,111,704 at 1 January 2016. The fol- lowing increases were made during 2016: By a resolution of a Board Meeting held on 21 September 2016 made pursuant to an authority granted to the Board of Directors at the Annual General Meeting held on 26 May 2016, the Company resolved to issue a total of 3,200,000 Ordinary Shares. The company was listed on the London Stock Exchange in November 2015. The share has no nominal value. Each share entitles the holder to one vote at the Annual General Meeting. All shares entitle holders to an equal dividend. At the 31 December 2016 Faron’s share capital, entered in the Finnish trade register, amounted to EUR 2,691 thousand. The number of Ordinary Shares at 31 December 2015 was 26,311,704. Details on the management shareholding are disclosed in Note 21. Transactions with Related Parties. 71 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Nature and purpose of reserves Share capital The subscription price of a share received by the company in connection with share issues is recorded 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. 72 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 Admission 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 ended on 9 May 2016 (exercisable between 9 May 2016 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 September 2021), a max- imum 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 September 2019 (exercisable between 8 October 2018 and 30 September 2021). The terms of the 2015 option plan require that the option holder remain 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 and the exercise price for Ordinary Shares based on “A” Options is €2.90. The exer- cise price for ordinary shares based on tranches “C” and “D” Options shall be determined by the Euro equivalent to the av- erage share price of the publicly traded ordinary shares of the Company on AIM between 1 July and 30 September of 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 2016 Option under the 2015 Option Plan Option tranche A B C D Total Status Granted Granted Allocated* Allocated* Outstanding at 1 Jan. 250 000 250 000 250 000 250 000 1 000 000 Amount Forfeited Exercised 150 000 150 000 0 0 0 0 0 0 0 0 0 0 300 000 0 0 Average exercise price in € 3.31 3.31 Outstanding at 31 Dec. 400 000 400 000 250 000 250 000 1 300 000 3.31 *Subscription for these options is conditional on the Director/employee remaining in their role at the time of commencement of the relevant subscription period. 73 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 The Company has granted warrants over 151,400 ordinary shares in 2015. 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. 74 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 1,451,400 granted and allocated options and warrants, 951,400 were exercisable as at 31 December 2016. None were exercised by year end 2016. 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 us- ing 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/ allocation Years of vesting Share price € Contractual months remaining Estimated excercise price € Volatility Risk-free interest rate A Options - Sept 2015 2015-2021 B Options - Sept 2015 2016-2021 C Options - Sept 2015 2017-2021 D Options - Sept 2015 2018-2021 Warrants A - Sept 2015 2015-2018 Warrants B - Sept 2015 2015-2018 57 57 57 57 17 14 2.88 2.78 2.69 2.69 2.69 2.69 3.71 2.90 4.51 4.96 1.55 2.01 50-53% 50-53% 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 480,256 in 2016. 2015 is Companies 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. Measuring 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 liabilities 2016 €’000 2015 €’000 2 033 1 446 2 033 1 446 2 033 1 446 The “Prepayments” above contains the residual of the EU grant prepayments paid to Company in 2014, 2015 and 2016 deduct- ed with the amounts that are recorded as Other operational income. (See Note 5, Other operational income). In addition the Prepayments include the 750 thousand euro signing fee paid by PharmBio. Further information on Faron’s financial liabilities and related arrangements is presented in Note 2. Financial risk manage- ment. See also Note 18. Current financial liabilities and other liabilities below. 75 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 2016 €’000 2015 €’000 93 93 1 874 1 874 1 718 620 65 2 403 4 371 245 245 436 436 973 515 29 1 517 2 197 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 were a major portion of the accrued expenses. 76 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 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 Faron 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. 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 is presented below. The third Tekes loan has been partially drawn down during 2016. As the third loan was draw down after the date to transition to IFRS (i.e. after 1 January 2014) and therefore it is treated according to IAS 20 and IAS 39. See note 8. for more details Stated in euro Carrying amount1 2016 €’000 2 126 2015 €’000 1 691 1 Includes both the non-current and current portions Stated in euro Corporate mortgages 2016 €’000 800 800 2015 €’000 800 800 The corporate mortage was 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-can- cellable operating leases are as follows Stated in euro No later than 1 year Later than 1 year and no later than 5 years Later than 5 years Total 2016 €’000 144 261 405 2015 €’000 82 14 96 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 long-term operating lease. 77 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 NOTE 21 Transactions with related parties Related parties of the Company Stated in euro 2016 €’000 2015 €’000 Faron’s related party comprise of the following: Remuneration of key management personnel* Faron had no interests in other entities at the end of the report- ing periods presented in these financial statements. Remuneration to the Board of Directors ** Salaries and other short-term benefits • A&B (HK) Company Limited, an investment company exist- ing under the laws of Hong Kong having significant influ- ence in Faron Pharmaceuticals Oy, given their shareholding of 12.9%, as at 31 December 2015. • Marko Salmi, a private person having significant influence over Faron Pharmaceuticals Oy, given his shareholding of 12.9%, as at 31 December 2016. • Board of Directors; and • the Company’s key management personnel (see below) Key management personnel The Company’s key management personnel consist of the following: • members of the Board of Directors • Management Team comprising CEO Markku Jalkanen, PhD; VP Ilse Piippo, MD, MSc (Pharm), Operations director. Mikael Maksimow, PhD, Medical director Matti Karvonen, MD, PhD and CFO Yrjö Wichmann, MSc (Econ) Salaries and other short-term employee benefits Share based payment Post-employment benefits (defined contribution plans) 832 769 274 122 Total 1 106 891 Stated in euro Share based payment Total 2016 €’000 2015 €’000 258 38 296 124 155 279 *Presented information for the Management Includes the ex- ecutive directors of the Board **Presented information for the Board includes only non-exec- utive directors. 78 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Management and Board shareholding Management* shareholding, 31 December 2016 Number of shares (pcs) Shareholding, percentage Board** shareholding, 31 December 2016 (excluding the shareholding of CEO and CFO) Number of shares (pcs) Shareholding, percentage Total number of shares outstanding at 31 December 2016 (pcs) 2 965 170 11,3% 1 607 489 6.1% 26 311 704 *Presented information for the Management Includes the ex- ecutive directors of the Board **Presented information for the Board includes only non-exec- utive directors. Transactions with related parties Faron has not carried out any transactions with related par- ties in the financial years presented in these financial state- ments, except that the former parent company of Faron Pharmaceuticals Ltd., Faron Holding Ltd., merged into its sub- sidiary Faron Pharmaceuticals Ltd. on 31 December 2013. NOTE 22 Events after the balance sheet date On 1 March 2017, Faron announced that the Company raised €5.8 million before expenses by way of the placing of 1,422,340 ordinary shares at the Issue Price of 350 pence per share. 79 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 Results and dividends The Statement of Comprehensive Income for the year is set out on page 44. The Company’s loss for the financial year after taxation and other comprehensive losses was € 9,293,930.28 (2015:€6,187,917.23). The Directors do not recommend the payment of a dividend (2015: nil). Board signatures Turku, 28 March 2017 Frank Armstrong, Chairman Markku Jalkanen Juho Jalkanen Yrjö Wichmann Jonathan Knowles Huaizheng Peng Leopoldo Zambeletti Matti Manner The Auditor’s Note Our auditor’s report has been issued today Turku, 28 March 2017 PricewaterhouseCoopers Kalle Laaksonen Authorized Public Accountant 80 FARON PHARMACEUTICALS LTDANNUAL REPORT 2016 1 (3) Auditor’s Report (Translation of the Finnish Original) To the Annual General Meeting of Faron Pharmaceuticals Ltd. Report on the Audit of the Financial Statements Opinion In our opinion, the financial statements give a true and fair view of the company’s financial performance and financial position in accordance with International Financial Reporting Standards (IFRS) as adopted by the EU. What we have audited We have audited the financial statements of Faron Pharmaceuticals Ltd (business identity code 2068285-4) for the year ended 31 December 2016. The financial statements comprise the balance sheet, income statement, statement of comprehensive income, statement of changes in equity and statement of cash flow and notes to the financial statements. Basis for Opinion We conducted our audit in accordance with good auditing practice in Finland. Our responsibilities under good auditing practice are further described in the Auditor’s Responsibilities for the Audit of Financial Statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Independence We are independent of the company in accordance with the ethical requirements that are applicable in Finland and are relevant to our audit, and we have fulfilled our other ethical responsibilities in accordance with these requirements. Responsibilities of the Board of Directors and the Managing Director for the Financial Statements The Board of Directors and the Managing Director are responsible for the preparation of financial statements that give a true and fair view in accordance with International Financial Reporting Standards (IFRS) as adopted by the EU. The Board of Directors and the Managing Director are also responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, the Board of Directors and the Managing Director are responsible for assessing the company’s ability to continue as going concern, disclosing, as applicable, matters relating to going concern and using the going concern basis of accounting. The financial statements are prepared using the going concern basis of accounting unless there is an intention to liquidate the company or cease operations, or there is no realistic alternative but to do so. PricewaterhouseCoopers Oy, Authorised Public Accountants, P.O. Box 1015 (Itämerentori 2), FI-00101 HELSINKI Phone +358 20 787 7000, fax +358 20 787 8000, www.pwc.fi Reg. Domicile Helsinki, Business ID 0486406-8 2 (3) Auditor’s Responsibilities for the Audit of the Financial Statements Our objectives are to obtain reasonable assurance on whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with good auditing practice will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. As part of an audit in accordance with good auditing practice, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: • Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. • Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control. • Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. • Conclude on the appropriateness of the Board of Directors’ and the Managing Director’s use of the going concern basis of accounting and based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the company to cease to continue as a going concern. • Evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events so that the financial statements give a true and fair view. We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. Other Reporting Requirements Other Information The Board of Directors and the Managing Director are responsible for the other information. The other information comprises of the strategic report, director’s report, director´s remuneration report and the statement of director´s responsibilities. Our opinion on the financial statements does not cover the other information. 3 (3) In connection with our audit of the financial statements, our responsibility is to read the reports mentioned above and, in doing so, consider whether the information included in the reports are materially inconsistent with the financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. In our opinion the information given in the strategic report, director’s report, director´s remuneration report and the statement of director´s responsibilities are prepared are consistent with the financial statements. If, based on the work we have performed, we conclude that there is a material misstatement in the reports mentioned above, we are required to report that fact. We have nothing to report in this regard. Turku 28th of March 2017 PricewaterhouseCoopers Oy Authorised Public Accountants Kalle Laaksonen Authorised Public Accountant (KHT) Faron Pharmaceuticals Ltd Joukahaisenkatu 6, Intelligate FI-20520 TURKU Finland Phone: +358 2 469 5151 Fax: +358 2 469 5152 Email: info@faron.com