Mereo BioPharma Group plc Annual Report 2019

Plain-text annual report

Company Number 09481161 MEREO BIOPHARMA GROUP PLC Annual Report and Accounts Year ended December 31, 2019 MEREO BIOPHARMA GROUP PLC CONTENTS Introduction Directors, secretary and advisers Strategic report Introduction Business strategy Chairman and CEO’s statement Financial review Principal risks and uncertainties Corporate governance Corporate Governance Report Audit and Risk Committee Report Directors’ Remuneration Report Directors’ Report Statement of Directors’ responsibilities Financial statements Independent auditors’ report Consolidated Statement of Comprehensive loss Consolidated Balance Sheet Consolidated Statement of Cash Flows Consolidated Statement of Changes in Equity Notes to the consolidated ﬁnancial statements Company Balance Sheet Notes to the Company ﬁnancial statements Page 2 3 4 7 14 20 35 46 49 72 77 78 87 88 89 90 92 144 146 1 MEREO BIOPHARMA GROUP PLC DIRECTORS, SECRETARY AND ADVISERS Directors Dr. Denise Scots-Knight (Chief Executive Ofﬁcer) Richard Jones (Chief Financial Ofﬁcer) Dr. Peter Fellner Dr. Anders Ekblom Peter Bains Paul Blackburn Kunal Kashyap Dr. Deepa Pakianathan (appointed April 23, 2019) Michael Wyzga (appointed April 23, 2019) Dr. Frank Armstrong (resigned February 8, 2019) Company Secretary Charles Sermon Registered Ofﬁce 4th Floor, One Cavendish Place London W1G 0QF Company Number 09481161 Auditors Ernst & Young LLP Apex Plaza Reading RG1 1YE Nominated Adviser and Broker Cantor Fitzgerald Europe 5 Churchill Place London E14 5HU Solicitors Mayer Brown International LLP 201 Bishopsgate London EC2M 3AF Registrars Link Asset Services PXS 1 34 Beckenham Road Beckenham Kent BR3 4ZF 2 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: INTRODUCTION The Directors present their strategic report together with the corporate governance report, audited consolidated ﬁnancial statements, audited company ﬁnancial statements and auditors’ report for the year ended December 31, 2019. This strategic report is broken down into the following sections: • • • • Business strategy; Chairman and CEO’s statement; Financial review; and Principal risks and uncertainties. 3 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: BUSINESS STRATEGY We are a biopharmaceutical company focused on the development and commercialization of innovative therapeutics that aim to improve outcomes for oncology and rare diseases. Our existing portfolio consists of six clinical stage product candidates. Our lead oncology product candidate, etigilimab (an “Anti-TIGIT”), has completed a Phase 1a dose escalation clinical trial in patients with advanced solid tumors and has been evaluated in a Phase 1b study in combination with nivolumab in select tumor types. Our second oncology product, navicixizumab for the treatment of late line ovarian cancer has completed a Phase 1 study and has been partnered with Oncologie, Inc. Our rare disease product candidates are setrusumab for the treatment of osteogenesis imperfecta (“OI”) and alvelestat for the treatment of severe alpha-1 antitrypsin deﬁciency (“AATD”) which is being investigated in an ongoing Phase 2 proof-of-concept study. We plan to complete a strategic partnership for the development of setrusumab in adults and children following the the Phase 2b study in adults and alignment with the FDA and EMA on the pivotal study design for children with OI. We plan to develop our product candidates for oncology and rare diseases through the next key clinical milestone and then partner or in selected cases to develop through regulatory approval and potentially commercialization. We plan to partner or sell our other two product candidates (which do not target oncology or rare diseases), acumapimod for the treatment of acute exacerbations of chronic obstructive pulmonary disease (“AECOPD”) and leflutrozole for the treatment of infertility and hypogonadatropic hypogonadism (“HH”) in obese men, recognizing the need for greater resources to take these product candidates to market. Our strategy is selectively to acquire and develop product candidates for oncology and rare diseases that have already received signiﬁcant investment from large pharmaceutical and biotechnology companies and that have substantial pre-clinical, clinical and manufacturing data packages. Since our formation in March 2015, we have successfully executed on this strategy by acquiring six clinical-stage product candidates, of which four were in oncology and rare diseases. Four of these six clinical-stage product candidates were acquired from large pharmaceutical companies and two of which we acquired in the merger with OncoMed Pharmaceuticals, Inc. (“OncoMed”). We aim to efﬁciently develop our product candidates through the clinic and have commenced or completed large, randomized Phase 2 clinical trials for four of our product candidates. Oncology and rare diseases represent an attractive development, and in some cases, commercialization opportunity for us since they typically have high unmet medical need and can utilize regulatory pathways that facilitate acceleration to approval and to the potential market. Development of products for oncology and rare diseases both involve close collaboration with key opinion leaders and investigators. Development of rare disease products generally involves close coordination with the patient organizations and patients are treated at a limited number of specialized sites which helps identiﬁcation of the patient population and enables a small targeted sales infrastructure to commercialize the products in key markets. Our team has extensive experience in the pharmaceutical and biotechnology sector in the identiﬁcation, acquisition, development, manufacturing and commercialization of product candidates in multiple therapeutic areas. Our senior management has long-standing relationships with senior executives of large pharmaceutical and biotechnology companies which we believe enhances our ability to form strategic partnerships on our product candidates and to identify and acquire additional product candidates. 4 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: BUSINESS STRATEGY Our Pipeline The following tables summarize our pipeline for our oncology and rare disease product candidates and our other product candidates. We have global commercial rights to etigilimab, setrusumab, alvelestat, acumapimod and leflutrozole. *Partnered with Oncologie, Inc (cid:1) (cid:1)(cid:1) We intend to become a leading biopharmaceutical company developing innovative therapeutics that aim to improve outcomes for patients with oncology and rare diseases. The key elements of our strategy to achieve this goal include: • Rapidly develop our oncology and rare disease product candidates. Etigilimab, our lead oncology program, has completed a Phase 1a dose escalating monotherapy study and has been evaluated in a Phase 1b combination study in a range of tumor types. We plan to initiate a Phase 1b study of etigilimab in combination with a PDL-1/PD-1 in Q4 2020. Our second oncology product Navicixizumab for the treatment of late line ovarian cancer has completed a Phase 1 study and has been partnered with Oncologie, Inc. We have completed and announced top-line data on a Phase 2b clinical trial of setrusumab for the treatment of OI in adults in the United States, Europe and Canada. We reported top- line data on the three blinded dose ranging arms in November 2019 with the results supporting progression of setrusumab into a pediatric pivotal study in OI. Following the completion of the dosing part of the study, patients will continue to be followed for a further twelve months to examine the off- effects of setrusumab. We have agreed on a PIP for setrusumab with the EMA and following our end of Phase 2 Type B meeting with the FDA in February 2020 have alignment on a pivotal study design for children with OI fracture as the primary end point. We plan to form a strategic partnership for setrusumab prior to initiation of the pivotal study in children with OI and believe the results from this trial, if favorable, will be sufﬁcient to support the submission of a BLA in the United States and MAA in the EU for setrusumab for the treatment of children with severe OI and a CMA for the treatment of adults with OI. We have commenced a Phase 2 proof-of-concept clinical trial of alvelestat for the treatment of severe AATD and as previously announced expect to report top-line data from this trial in the second half of 2021. If the results are favorable and pending regulatory feedback, we will assess the options for further development of alvelestat towards approval and commercialization. 5 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: BUSINESS STRATEGY Explore strategic relationships with third parties for further clinical development and/or commercialization or strategic sales or out-licensing for our other product candidates (non- oncology/non-rare disease). Based on the results from our Phase 2 clinical trial of acumapimod, we plan to enter into one or more strategic relationships with third parties for acumapimod to undertake the next phase of clinical development and, if approved, commercialization. In March 2018, we reported top-line Phase 2b data for leflutrozole for the treatment of HH and in December 2018, we reported positive results from the safety extension study for leflutrozole. We intend to explore strategic relationships with third parties for the further development and commercialization of leflutrozole. Continue to be a partner of choice for large pharmaceutical and biotechnology companies. We believe that we are a preferred partner for large pharmaceutical and biotechnology companies as they seek to unlock the potential in their development pipelines and deliver therapeutics to patients in areas of high unmet medical need. We have strong relationships with these companies, as evidenced by our agreements with Novartis and AstraZeneca, as well as by the merger with OncoMed, and a track record of structuring transactions that enable us to leverage our core capabilities while creating value for all stakeholders. We intend to continue to enter into strategic relationships that align our interests with those of large pharmaceutical and biotechnology companies and that we believe to be mutually beneﬁcial. Leverage our expertise in business development. Our senior management team has extensive relationships with large pharmaceutical and biotechnology companies. These relationships are important to us as we seek to form strategic partnerships on our product candidates and as appropriate, to grow our pipeline of product candidates in oncology and rare diseases. • • • 6 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: CHAIRMAN AND CEO’S STATEMENT Introduction The Group’s strategy continues to be to build a portfolio of oncology and rare disease products acquired from pharmaceutical and large biotechnology companies and to selectively partner or potentially develop these through regulatory approval and subsequent commercialization. During the year, we completed our acquisition of OncoMed, became a US listed company and acquired two clinical stage oncology programs, etigilimab (an “Anti-TIGIT”) and navicixizumab (or “Navi”). Successful integration of OncoMed has allowed us to broaden our asset base and signiﬁcantly strengthen our cash position, enabling us to progress beyond our key clinical milestones. We have also gained the skills and expertise of an operational base in the U.S. including highly relevant regulatory expertise. Our current portfolio consists of six clinical-stage product candidates. Etigilimab represents an attractive investment opportunity for the Company given the recent developments with other Anti-TIGIT programs. In January 2020, we announced that we had signed a global licensing deal with Oncologie, Inc. on our second oncology program, navicixizumab, for ovarian cancer. Our rare disease and orphan drug product candidates, setrusumab for the treatment of OI and alvelestat for the treatment of severe AATD, represent attractive development opportunities for us. We plan to partner setrusumab prior to initiation of the pivotal study and subsequent commercialization. Prior to our acquisition of OncoMed, each of our rare disease product candidates had generated positive clinical data for their respective target indications or for a related indication. During the year, we made signiﬁcant progress across our product development programs both in terms of clinical development and regulatory strategy. On November 11, 2019, we reported 12-month top-line data from our Phase 2b dose-ranging clinical trial for setrusumab in adults with Type I, III or IV OI. The study enrolled 112 patients in the U.S. and Europe and randomized patients originally to one of four different blinded monthly dosing regimens of setrusumab: high, medium, low and placebo. The study was subsequently revised to convert the placebo arm into an open-label arm where patients received the high dose regimen of setrusumab. The data demonstrated setrusumab to have a dose-dependent bone-building activity measured by well-established bone density scans (“DXA scans”). In the high dose arm, we also saw fewer fractures than in the medium or the low dose arms. Setrusumab was demonstrated to be safe and well-tolerated in the patients participating in the Phase 2b adult study, as well as by the 83 subjects across the four Phase 1/2 setrusumab studies completed to date. After the end of the year, on January 14, 2020, we reported additional positive data from our Phase 2b dose- ranging clinical trial. Setrusumab demonstrated a dose dependent increase in bone strength stiffness and failure load at the radius as measured by Finite Element Analysis (“FEA”). This was a second prespeciﬁed primary end point and reached statistical signiﬁcance in the high dose cohort but not in the medium and low dose cohorts. These FEA data are consistent with an effect of setrusumab at the high dose improving radius bone strength as evidenced by a better ability to resist experimental deformation and improved failure load. We announced a successful end of Phase Type B meeting on navicixizumab in July 2019 during which we agreed the outline of a Phase 2 registrational study for ovarian cancer and an accelerated approval pathway. Navicixizumab was also granted fast-track designation in the second half of 2019. In February 2020, we completed a £3.8m million convertible equity ﬁnancing with Novartis Pharma AG (“Novartis”). Also in February we completed two Securities Purchase Agreements with Boxer Capital of Tavistock Group, and Aspire Capital Fund LLC (“Aspire”) which raised a total of $6 million before expenses. The Agreement with Aspire included the ability to issue up to an additional $25 million of American Depositary Shares over a three-year period. On February 28, 2020, we announced the successful completion of a Type B End-of-Phase 2 meeting with the U.S. FDA to discuss the development of setrusumab for the treatment of children with OI. Following the review of the data from the Phase 2b study with setrusumab in adults with OI, and the design for our proposed Phase 3 study in children with OI, the U.S. FDA agreed on the design of a Phase 3 pediatric study in OI to be completed prior to the submission of a potential BLA in the U.S. This is in line with our proposed pivotal pediatric study design, which has already been agreed to in principle with the EMA in August 2018. On June 4, 2020, we announced the completion of a private placement of $70 million (£56 million) (the “Fundraising”) before commission and expenses with a number of new and existing principally U.S based institutional and accredited investors. OrbiMed led the Fundraising with participants including Vivo Capital, 7 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: CHAIRMAN AND CEO’S STATEMENT Surveyor Capital (a Citadel company), Pontifax Venture Capital, Samsara BioCapital, Commodore Capital, and funds managed by Janus Henderson Investors alongside existing investors Boxer Capital of Tavistock Group and Aspire. Update on impact of COVID-19 Coronavirus disease 2019 (“COVID-19”) is an infectious respiratory disease that was ﬁrst identiﬁed in 2019 in Wuhan, China and has since spread globally. The impact COVID-19 is evolving rapidly and its future effects are uncertain. We are actively monitoring how the effects and risks of COVID-19 impact our day-to-day operations, including our ongoing clinical trial activities: • • Our current activities on setrusumab for potential treatment of OI are focussed on completion of the ASTEROID Phase 2b extension study in adults with OI and preparations for the Phase 3 pediatric trial, which subject to partnering, we intend to start in the second half of 2020. We currently expect no change to this timeline. Our Phase 2b ASTEROID study in OI is fully recruited with topline results, as discussed above, previously announced in November 2019. Patients who enrolled in this study are in a one-year follow up post treatment extension phase. Our Phase 2 alvelestat trial recruits individuals with alpha-1 antitrypsin deﬁciency-related lung disease, who are potentially at greater risk from COVID-19 exposure. As a result, and as we announced in March 2020, recruitment into our Phase 2 alpta-1 antitrypsin study will be delayed, with topline data now expected in the second half of 2021. As a business, we have taken necessary measures across our sites in the U.K. and U.S. to ensure that our employees and other key stakeholders best adhere to the advice set out by the relevant authorities. Such measures have included the introduction of remote working arrangements, reduced face to face contact by encouraging the use of teleconferencing, a ban on domestic and international travel as well as other measures considered necessary by our recently formed COVID-19 committee which is responsible for business continuity planning during this challenging time. Organizational change On March 27, 2020, we announced that Michael Wyzga who currently serves as a Non-Executive Director, will become the Interim Chief Financial Ofﬁcer following the announced departure of Richard Jones, the Company’s current Chief Financial Ofﬁcer (“CFO”). Richard Jones will remain in his position as CFO for a transitionary period of up to ﬁve months from March 2020. Michael Wyzga previously served as President and Chief Executive Ofﬁcer and a member of the Board of Directors of Radius Health, Inc. Prior to that he served in various senior management positions at Genzyme Corporation, including as CFO from July 1999 until November 2011. Following completion of the Fundraising, we now intend to commence a search for a permanent CFO. Section 172(1) Companies Act 2006 The Directors are required by law to act in good faith to promote the success of the Group for the beneﬁt of the shareholders. As set out within the content of this annual report, the Directors have considered the following matters throughout the year and in formulating the future strategy of the business: The likely long-term consequences of any decision, as set out within our Business Strategy and Chairman and CEO’s Statement on pages 4 to 13; The interests of the Group’s employees as set out within our Corporate Governance Report on pages 35 to 45; The need to foster the Group’s business relationships with suppliers, customers and others on page 7 to 13; The impact of the Group’s operations on the community and the environment, as set out within our summary of environmental matters on pages 12-13, The desirability of the Group maintaining a reputation for high standards of business conduct on page 7 to 13; and • • • • • 8 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: CHAIRMAN AND CEO’S STATEMENT • The need to act fairly as between shareholders of the Group, as set out within our Corporate Governance Report on page 35 to 45. The Group endeavours to maintain good relationships with our suppliers by contracting, where possible, on their standard business terms and paying them in accordance with the relevant terms agreed. We meet with our signiﬁcant suppliers regularly, using the meetings to ensure that our research programs are planned and delivered and effectively in a timely and cost-efﬁcient manner. This ensures that the Group’s and our signiﬁcant suppliers’ interest are aligned. The Board recognizes the importance of maintain high standards of business conduct. The Group operates a Code of Business Conduct and Ethics, publicly available on our website, which contains general guidelines for conducting the business of the Group consistent with the highest standard of business ethics. In addition, the Group has an Employee Handbook which employees are required to read and acknowledge on an at least annual basis. Business overview Oncology Disease Product Candidates • Etigilimab (OMP-313M32): Etigilimab is an antibody against TIGIT (T-cell immunoreceptor with Ig and ITIM domains). TIGIT is a next generation checkpoint receptor shown to block T-cell activation and the body’s natural anti-cancer immune response. Etigilimab is an IgG1 monoclonal antibody which binds to the human TIGIT receptor on immune cells with a goal of improving the activation and effectiveness of T-cell and NK cell anti-tumor activity. Mereo completed a Phase 1a dose escalation clinical trial with etigilimab in patients with advanced solid tumors and enrolled patients in a Phase 1b study in combination with nivolumab in selected tumor types. 23 patients were treated in the Phase 1a dose escalation study with doses up to 20mg/kg Q2W. Tumor types included colorectal cancer, endometrial cancer, pancreatic cancer and other tumor types. No dose limiting toxicities were observed. In the Phase 1b combination study, a total of ten patients, nine of whom had progressed on prior anti-PD1/PD-L1 therapies were enrolled at doses of 3, 10, and 20 mg/kg. Tumor types included gastric cancer and six other tumor types. Eight patients were evaluable for tumor growth assessment, and all of these patients had progressed on PD1/PD-L1 therapies with best responses including two patients with a partial response and stable disease. Patients remained on study for up to 224 days. No dose limiting toxicities (DLTs) were observed. The only treatment-related adverse event in the Phase 1a portion of the study with an incidence rate greater than 20 per cent. was rash (35 per cent.), and the most common treatment-related adverse events in the Phase 1b portion of the study were rash (40 per cent.), fatigue (30 per cent.) and pruritus (20 per cent.) There was only one treatment-related serious adverse event in the Phase 1a portion (autoimmune hepatitis) and there were no treatment-related serious adverse events in the Phase 1b portion of the study. The Phase 1b study has now completed. The etigilimab program was previously subject to an exclusive license option with Celgene Corporation (“Celgene”) as part of a collaboration agreement from 2013 with OncoMed (“the Collaboration Agreement”). In June 2019, we announced that Celgene had notiﬁed OncoMed that Celgene had decided, in light of strategic product portfolio considerations, not to exercise its option to license etigilimab. The Collaboration Agreement was terminated with respect to etigilimab effective on October 11, 2019. As a result, we have worldwide rights to the etigilimab program. • Navicixizumab (OMP-305B83): Navi is a bispeciﬁc antibody that inhibits delta-like ligand 4 (DLL4) and vascular endothelial growth factor VEGF). We acquired this therapeutic product in the merger with OncoMed. This antibody is intended to have anti-angiogenic and anticancer stem cell activity. In a Phase 1a clinical trial, Navi demonstrated single agent activity. Following this we conducted a Phase 1b clinical trial in ovarian cancer, in combination with paclitaxel, in platinum-resistant ovarian cancer. A successful FDA Type B meeting was held in July 2019 and the potential for accelerated approval was discussed. Navicixizumab has also been granted Fast Track Approval by the FDA. In January 2020 we completed a global license agreement with Oncologie, Inc. (“Oncologie”) for the further development and commercialization of Navi. 9 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: CHAIRMAN AND CEO’S STATEMENT Rare Disease Product Candidates • Setrusumab (BPS-804): Setrusumab is a novel antibody we are developing as a treatment for OI, a rare genetic disease that results in bones that can break easily and is commonly known as brittle bone disease. OI is a debilitating orphan disease for which there are no treatments approved by the FDA or EMA. It is estimated that OI affects a minimum of 25,000 people in the United States and approximately 32,000 people in Germany, Spain, France, Italy, and the United Kingdom. Setrusumab is designed to inhibit sclerostin, a protein that inhibits the activity of bone-forming cells. We believe setrusumab’s mechanism of action is well suited for the treatment of OI and has the potential to become a novel treatment option for patients that could reduce fractures and improve patient quality of life. In 2016, we obtained orphan drug designation in OI for setrusumab in the United States and the EU and, in November 2017, it was accepted into the Priority Medicines scheme (“PRIME”) of the EMA. Prior to our acquisition of setrusumab, Novartis conducted four clinical trials in 106 patients and healthy volunteers. A Phase 2 clinical trial of setrusumab in OI showed statistically signiﬁcant improvements in bone formation biomarkers and bone mineral density. In April 2017, we initiated a Phase 2b clinical trial for setrusumab in adults in the United States, Europe and Canada. The trial is randomized with three blinded arms at high, medium and low doses to establish the dose response curve and an open label arm at the top dose. We reported top-line data on the three blinded dose ranging arms in November 2019 with the results supporting progression of setrusumab into a pediatric pivotal study in OI. Following the completion of the dosing part of the study, patients are continuing to be followed for a further twelve months to examine the off-effects of setrusumab. We have also agreed on a PIP for setrusumab with the EMA and in February 2020, we announced the successful completion of a Type B End-of-Phase 2 meeting with the FDA to discuss the development of setrusumab for the treatment of children with OI in the United States. We intend to partner setrusumab prior to conducting a pivotal trial of setrusumab in children with severe OI to begin in late 2020, with fracture rate as the primary endpoint. We believe that the results from this trial, if favorable, will be sufﬁcient to support the submission of an MAA to the EMA for setrusumab for the treatment of children with severe OI and a CMA for the treatment of OI in adults in the EU. • Alvelestat (MPH-966): Alvelestat is a novel, oral small molecule we are developing for the treatment of severe AATD, a potentially life-threatening, rare, genetic condition caused by a lack of effective alpha- 1 antitrypsin (“AAT”), a protein that protects the lungs from enzymatic degradation. This degradation leads to severe debilitating diseases, including early-onset pulmonary emphysema, a disease that irreversibly destroys the tissues that support lung function. There are an estimated 50,000 patients in North America and 60,000 patients in Europe with severe AATD. Alvelestat is designed to inhibit NE, a neutrophil protease, which is a key enzyme involved in the destruction of lung tissue. We believe the inhibition of NE has the potential to protect AATD patients from further lung damage. Prior to our license of alvelestat, AstraZeneca conducted 12 clinical trials involving 1,776 subjects, including trials in bronchiectasis and CF. Although these trials were conducted in diseases other than AATD, we believe the data demonstrated potential clinical beneﬁt and biomarker evidence of treatment effect for AATD patients. We have initiated a Phase 2 proof-of-concept clinical trial in patients with severe AATD in the United States and the EU and as previously announced, expect to report top-line data from this trial in the second half of 2021. Other Product Candidates for Partnering Our portfolio of non-oncology/non-rare disease products consists of the following product candidates: • Acumapimod (BCT-197): Acumapimod is a p38 MAP kinase inhibitor we are developing as an oral ﬁrst- line acute therapy for patients with AECOPD. COPD is a non-fully-reversible, progressive lung disease in which inflammation plays a central role. There are an estimated 16 million people in the United States diagnosed with COPD. Of all hospital admissions in the United States related to COPD, approximately 63 per cent. are for AECOPD patients. We believe acumapimod offers a potential new treatment for controlling inflammation by targeting pathways that drive the pathological mechanism behind AECOPD. 10 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: CHAIRMAN AND CEO’S STATEMENT Since there are currently no approved therapies in the United States or the EU to treat AECOPD, we believe that there is signiﬁcant medical need for a drug which is disease-modifying. We believe acumapimod could potentially prevent AECOPD instead of just treating the symptoms and has the potential to improve quality of life, slow the progression of the disease, and signiﬁcantly reduce direct healthcare costs. Prior to our acquisition of acumapimod, Novartis conducted ﬁve clinical trials in 459 patients and healthy volunteers, including a Phase 2a trial in AECOPD patients that showed a clinically meaningful improvement in lung function at the highest dose. We conducted a Phase 2 dose-ranging clinical trial for acumapimod in 282 patients with AECOPD to explore two different dosing regimens on top of standard of care, which included steroids, antibiotics, and bronchodilators. Both dosing regimens showed a statistically signiﬁcant change in FEV1 from baseline to Day 7, meeting the trial’s primary endpoint on an intent-to-treat patient population basis. In addition, dose-dependent, statistically signiﬁcant reductions in hsCRP and ﬁbrinogen were shown with treatment with acumapimod, with hsCRP remaining suppressed through the 26-week observation period. Treatment with acumapimod also showed a statistically signiﬁcant reduction in the number of COPD exacerbations that required hospitalization. Consistent with these results, there was a signiﬁcant reduction in the use of corticosteroid and antibiotics in the follow-up portion of the study. In addition, acumapimod was reported to be safe and well tolerated. Based on these results, we intend to explore strategic options with third parties for the further development of acumapimod. In addition, in April 2019, we announced a successful end of Phase 2 meeting with the FDA regarding acumapimod. In the meeting, we and the FDA agreed on a development plan for acumapimod. In September 2019, we had a positive SAWP meeting with the EMA. • Leflutrozole (BGS-649): Leflutrozole is a once-weekly oral therapy we are developing for the treatment of HH in obese men. HH is a clinical syndrome that results from inadequate levels of testosterone. Based on WHO estimates and scientiﬁc data, we estimate there are approximately seven million cases of HH in obese men in the United States. In these men, a decline in testosterone is exacerbated by high levels of the aromatase enzyme, which is present in fat tissue and leads to a reduction in testosterone. Leflutrozole is designed to inhibit the aromatase enzyme and is being developed to restore normal levels of testosterone without causing excessively high testosterone levels or reducing the levels of LH or FSH. Both LH and FSH play key roles in sperm formation and LH plays a key role in endogenous testosterone formation. In contrast to current therapies for HH, which involve the exogenous administration of testosterone and lead to further down regulation of LH and FSH, we believe that leflutrozole, by preserving sperm formation through LH and FSH production, may present a beneﬁt to patients. Prior to our acquisition of leflutrozole, Novartis conducted seven clinical trials exposing 131 patients and healthy volunteers to leflutrozole, including a Phase 2 proof-of-concept trial for HH in obese men in which leflutrozole normalized testosterone levels in all patients and demonstrated an increase in LH and FSH levels. In March 2018, we reported top-line data from our completed Phase 2b dose-ranging clinical trial of leflutrozole for the treatment of HH in obese men. The trial enrolled 271 patients who were administered placebo or one of three doses of leflutrozole. The trial met our primary endpoint of normalizing testosterone levels in at least 75 per cent. of subjects after 24 weeks of treatment and all of the secondary endpoints, including normalizing testosterone in at least 90 per cent. of patients after 24 weeks of treatment at the two highest doses and improvement in LH and FSH levels at all three doses. Leflutrozole was reported to be well-tolerated in the trial. A subset of 143 patients entered into a six- month safety extension study. Following the positive result of the safety extension study for leflutrozole, we convened an advisory board meeting and concluded that the future development of leflutrozole should focus on male infertility. We intend to explore strategic options with third parties for the further development of leflutrozole. 11 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: CHAIRMAN AND CEO’S STATEMENT New product opportunities To support our aim of becoming a leading oncology and rare disease company, we continue to seek and review new product opportunities to expand and grow our portfolio in oncology and rare diseases. There continues to be a good number of opportunities arising from large pharma and biotechnology companies as they continue to reappraise development pipelines on an ongoing basis to allow them to focus on a smaller number of strategically targeted therapeutic areas. Future outlook With the closing of the Fundraising with a very high-quality group of institutional and accredited investors in June 2020 and the evolution of our strategy to focus on oncology and rare diseases, 2020 is set to be an important year for the Company. We expect to initiate our phase 1b for etigilimab in a number of solid tumors, to continue to enrol the Phase 2 study for alvelestat in AATD patients and to report on the Phase 2b adult extension study for setrusumab in adults with OI. TIGIT blockade in combination with anti-PD1/PD-L1 antibodies has recently been highlighted as a potential next generation immuno-oncology target for the treatment of patients with advanced solid malignancies. We are excited to move our program forward on the back of our Phase 1a mono therapy and Phase 1b combination data. Setrusumab for OI is now Phase 3 ready as a result of the successful end of Phase 2b meeting with the FDA and the approval of a Paediatric Investigational Plan (“PIP”) by the EMA. We plan to initiate the Phase 3 study in children with OI once we have secured a strategic partnership for this program which may include regional partnerships or a global licensing deal. Following the partnership with Oncologie for Navi, we continue to focus on partnering opportunities for our other product candidates (non-oncology/non-rare disease) acumapimod and leflutrozole. Finally, we are now funded into early 2022 providing the Company sufﬁcient balance sheet strength and runway to deliver on our clinical and business development milestones. Information about the Group’s employees Within our corporate governance report on page 42, further information about the Group’s employees and gender diversity can be found. The Board has a good relationship with the Group’s employees. The Board maintains constructive dialogue with employees through the Chief Executive Ofﬁcer (“CEO”) and through regular “town hall” all-employee meetings and video conference calls where the Executive Team provides updates on strategic progress and a forum for answering questions. Appropriate remuneration and incentive schemes are maintained to align employees’ objectives with those of the Group. As set out in our Code of Business Conduct and Ethics, the Group is committed to providing a safe and healthy working environment for its employees and to avoiding adverse impact and injury to the environment and the communities in which we do business. To achieve this, Group employees must comply with all applicable external environmental, health and safety laws and other regulations as well as our own internal standards. We present our Directors’ Remuneration Report on pages 49 to 71. Environmental matters We currently outsource our research, development, testing and manufacturing activities. These activities are subject to various environmental, health and safety laws and regulations, which govern, among other things, the controlled use, handling, release and disposal of, including the maintenance of a registry for, hazardous materials and biological materials. If we or our partners fail to comply with such laws and regulations, we could be subject to ﬁnes or other sanctions. 12 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: CHAIRMAN AND CEO’S STATEMENT As with other companies engaged in similar activities, we face a risk of environmental liability that is inherent in our current and historical activities, including liability relating to releases of or exposure to hazardous or biological materials. Environmental, health and safety laws and regulations are becoming more stringent. We may be required to incur substantial expenses in connection with future environmental compliance or remediation activities, in which case, production and development efforts being carried out by our outsourced partners relating to our products may be interrupted or delayed. As noted in our Directors’ report, a report on greenhouse gas emissions will be included in our annual report and accounts for the year ended December 31, 2020. Dr. Peter Fellner Dr. Denise Scots-Knight Chairman Chief Executive Ofﬁcer June 15, 2020 June 15, 2020 13 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: FINANCIAL REVIEW The ﬁnancial statements contained within this annual report are presented on a consolidated Group basis prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) and adopted in the E.U. for the year ended December 31, 2019. Comparative data is shown on the same basis for the year ended December 31, 2018. Financial KPIs The directors consider that our underlying cash burn, cash balances and future cash runway and our committed and planned expenditure on research and development (“R&D”) to be the Group’s key ﬁnancial KPIs at its current stage of development. Progress and performance against these key ﬁnancial KPIs are discussed further in this ﬁnancial review. The Directors consider that the most important non-ﬁnancial KPIs are: • • • Progress with our R&D pipeline including our clinical studies and related manufacturing activities; The management and development of our patent portfolio; and Business development including partnering or out-licensing activities. These activities are discussed in the Chairman and CEO’s Statement and our product overview. The following table sets forth Mereo’s results of operations for the years ended December 31, 2018 and 2019. Year Ended December 31, (in thousands of pounds) 2018 2019 Research and development expenses Administrative expenses Operating loss Net income recognized on acquisition of subsidiary Finance income Finance charge Net foreign exchange (loss)/gain Loss before tax Income tax beneﬁt Loss attributable to equity holders of the parent Net fair value gain /(loss) on investments in debt instruments held at fair value Exchange differences on translation of foreign operations Total comprehensive loss attributable to equity holders of the parent (22,703) (11,775) –––––––––– (34,478) – 307 (3,091) (44) –––––––––– (37,306) 5,277 –––––––––– (32,029) –––––––––– –––––––––– – – –––––––––– –––––––––– (32,029) –––––––––– –––––––––– (23,608) (15,909) –––––––––– (39,517) 1,035 377 (3,496) 483 –––––––––– (41,118) 6,274 –––––––––– (34,844) –––––––––– –––––––––– – (499) –––––––––– –––––––––– (35,343) –––––––––– –––––––––– 14 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: FINANCIAL REVIEW R&D expenses The following table sets forth our R&D expenses by product development program for the years ended December 31, 2018 and 2019: Year Ended December 31, (in thousands of pounds) 2018 2019 Setrusumab (BPS-804) Alvelestat (MPH-966) Leflutrozole (BGS-649) Acumapimod (BCT-197) Navicixizumab (“Navi”) Etigilimab GITR-Fc (1) Unallocated costs Total R&D expenses 11,304 3,722 5,091 2,285 – – – 301 –––––––––– 22,703 –––––––––– –––––––––– 13,734 4,976 1,089 388 1,721 767 432 501 –––––––––– 23,608 –––––––––– –––––––––– (1) Consists of R&D expenses incurred by OncoMed. Development of this candidate ceased during 2019. Total R&D expenses increased by £0.9 million, or 4%, from £22.7 million in 2018 to £23.6 million in 2019. Direct R&D expenses relating to setrusumab increased by £2.4 million, or 21%. The increase was driven primarily by the manufacture of additional drug product during 2019 which is planned to be used in upcoming clinical studies together with ongoing costs related to the adult Phase 2b study which reported top-line data in November 2019. R&D expenses relating to alvelestat increased by £1.3 million, or 34% to £5.0 million, reflecting a full year of costs for the Phase 2 proof of concept study, which commenced in the fourth quarter of 2018. In total, £2.9 million of total R&D expenses in the current year is speciﬁc to programs acquired through the acquisition of OncoMed in April 2019 for which there is no relevant prior year comparative (Navi, Etigilimab and GITR-Fc). Of this, £1.7 million relates to Navi, which was subject to a global out-licensing agreement announced in January 2020. The licensee, Oncologie, assumed all future ongoing development costs following an agreed transition period to close out the existing Phase 1b study. Following completion of the Phase 1 study in 2019, further signiﬁcant development for etigilimab has yet to be undertaken. Largely offsetting the increase, R&D expenses relating to leflutrozole and acumapimod decreased by £5.9 million, or 80%. The decrease in spend was driven by the completion of the Phase 2b clinical study on leflutrozole in early 2019 and limited activity mainly relating to regulatory activity for acumapimod following the completion of the study. Unallocated costs increased by £0.2 million to £0.5 million in 2019. This increase is attributable to certain R&D expenses incurred by OncoMed that are not allocated to a speciﬁc product development program. Administrative expenses Administrative expenses increased by £4.1 million, or 35%, from £11.8 million in 2018 to £15.9 million in 2019. The increase was primarily due to an increase in costs following the acquisition of OncoMed. In particular, payroll costs increased by £1.2 million to £3.4 million in 2019. In addition, following the Company’s listing on the Nasdaq Global Market, professional fees, including the signiﬁcantly increased costs of Directors and Ofﬁcers (“D&O”) insurance, have increased by £1.0 million in 2019. Following the adoption of IFRS 16 (Leases), right-of-use assets were recognized which are subsequently depreciated over their expected term of use. In 2019 this resulted in depreciation costs of £1.5 million in administrative expenses compared to £0.3 million in 2018 prior to the implementation of IFRS 16 (Leases). 15 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: FINANCIAL REVIEW Professional fees increased during the year from £1.5 million to £3.1 million reflecting higher costs associated with the Nasdaq listing and managing a larger business in two jurisdictions. Transaction costs relating to the acquisition of OncoMed are presented separately and are included within net income recognized on acquisition of subsidiary (see below). Net income recognized on acquisition of subsidiary As OncoMed was acquired for an amount less than the fair market value of the net assets acquired on the date that control was obtained, a gain on bargain purchase of £3.7 million was realized (recognized net against the acquisition transaction costs within the consolidated statement of comprehensive loss). Total acquisition transaction costs amounted to £2.7 million which were wholly incurred in connection with the acquisition. Therefore, the net income recognized on acquisition of OncoMed was £1.0 million. Finance income and charges Total ﬁnance income was £0.4 million in 2019, up from £0.3 million in 2018. The increase was attributable to an increase in interest income earned on additional short-term investments acquired through the acquisition of OncoMed. All short-term investments were sold by December 31, 2019. Total ﬁnance charges increased from £3.1 million in 2018 to £3.5 million in 2019. Following the adoption of IFRS 16 (Leases), interest costs on recognized lease liabilities of £1.3 million were incurred as an expense during the year. In the prior year, no such interest costs were recognized. In addition, non-cash interest costs on the bank loan increased by £0.8 million following modiﬁcations made to the terms of the bank loan following the reﬁnancing in May 2019. The increase in ﬁnance costs attributable to interest costs on lease liabilities and the bank loan was partly offset by fair value movements on outstanding warrants accounted for as a ﬁnancial liability. The overall movement was a decrease in the value of the liability by £0.9 million up from £0.7 million in 2018, which is recorded as income. The increase in ﬁnance costs was further reduced by a re-classiﬁcation of the loan modiﬁcation loss occurring in 2018 as a ﬁnance charge resulting the increase in ﬁnance charges in 2018 of £0.7 million. In 2019 there was a corresponding loan modiﬁcation gain of £0.5 million.Net foreign exchange gain / (loss). The net foreign exchange gain for the year was £0.5 million, up by £0.5 million from a £nil million loss in 2018. The net foreign exchange gain consists of a £0.1 million foreign exchange loss on the translation of cash deposits which are primarily held in U.S. dollars throughout the year. The foreign exchange loss has been offset by a foreign exchange gain of approximately £0.6 million relating to the retranslation of U.S. dollar denominated intercompany funds held by an entity in the Group with a British pound functional currency. Taxation The tax credit for the year was £6.3 million, up by £1.0 million from 2018. The tax credit represents eligible cash rebates paid or receivable from the tax authorities in the jurisdictions within which we operate. In the U.K., certain subsidiaries within the Group qualify for cash rebates for eligible types of research and development activities and associated expenditure (the “R&D tax credit”) which amounted to a total beneﬁt of £5.1 million for 2019. Further, in August 2019, OncoMed received a tax refund in respect of Alternative Minimum Tax (“AMT”) of £1.1 million from the U.S. Internal Revenue Service (“IRS”), of which approximately £0.2 million has been recognized as income tax beneﬁt during the year. It is currently estimated that an additional £1.0 million of tax refund in respect of AMT will be received in 2020 with respect to the current ﬁnancial year. As at December 31, 2019, total receivables related to tax credits previously recognized amount to £11.4 million, of which £10.4 million relates to R&D tax credit in the U.K. Included within the £10.4 million cash rebate is £5.3 million from the claim for the ﬁnancial year ended December 31, 2018 as the amount was not repaid until early 2020. The claim for the ﬁnancial year ended December 31, 2019 will be submitted around mid-2020 and the Group expects to receive an estimated claim amount of £5.1 million in the second half of 2020. 16 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: FINANCIAL REVIEW Loss per share After taking account of the £3.3 million increase in loss attributable to equity holders and an increase in weighted average number of shares from 71.1 million to 89.4 million, basic and diluted loss per share for the year was 39 pence, down from 45 pence in 2018. Adoption of IFRS 16 (Leases) Effective January 1, 2019, the Group adopted IFRS 16 (Leases). The new standard introduces new or amended requirements with respect to lease accounting. In previous years, the Group’s lease portfolio consisted of operating leases which have now been recognized on the balance sheet as a right-of-use asset, offset by a corresponding lease liability. The total impact on assets on adoption was £2.5 million, offset by a lease liability recognized for the same amount. The lease portfolio on adoption consisted of a property lease and a number of specialist equipment leases for use in clinical trial activities. Following the acquisition of OncoMed, a right-of-use asset of £10.8 million was recognized, offset by a lease liability of £10.7 million. The OncoMed lease portfolio consisted of a property lease in the U.S. During the year ended December 31, 2019, total depreciation charges of £1.5 million and interest charges of £1.3 million have been recognized under IFRS 16 (Leases). Acquisition of OncoMed Pharmaceuticals, Inc. On April 23, 2019, we completed the acquisition of OncoMed, a California-based and Nasdaq-listed company, at which time OncoMed became an unlisted U.S. subsidiary of Mereo. At completion, we acquired cash and short-term deposits and short-term investments of £39.1 million. The estimated fair value of the intangible assets acquired was £12.7 million. In connection with the acquisition, 24,783,320 ordinary shares were issued and listed on the AIM Market of the London Stock Exchange (“AIM”). On April 24, 2019, 4,956,664 American Depositary Shares (“ADSs”) were listed on the Nasdaq Global Market, with each ADS representing ﬁve ordinary shares. Following completion of the acquisition, former OncoMed shareholders owned 25.8% of the enlarged share capital of the Group. As a consequence of the license agreement with Oncologie (the “License Agreement”), and in accordance with the terms and conditions of the Contingent Value Rights Agreement (the “CVR Agreement”) for former stockholders of OncoMed, dated April 23, 2019, by and among Mereo and Computershare Inc., as rights agent, holders of contingent value rights (“CVRs”) pursuant to the CVR Agreement will be entitled to receive certain eligible cash milestone payments made to Mereo under the License Agreement . Mereo accounts for the CVR Agreement as contingent consideration at fair value. As at December 31, 2019, the fair value of the contingent consideration is estimated at £0.4 million. As at acquisition date, the fair value of the contingent consideration was estimated at £nil. The estimated contingent consideration payable is based on a risk-adjusted, probability-based scenario. Under this approach, the likelihood of future payments being made to the former shareholders of OncoMed under the CVR Agreement is considered. The estimate could materially change over time in line with the development plan and subsequent commercialization of the Navi product. 17 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: FINANCIAL REVIEW Liquidity and capital resources As of December 31, 2019, we had cash and short-term deposits and short-term investments (together “cash resources”) of £16.3 million compared to £27.5 million as at December 31, 2018. The table below summarizes our cash flows for the for the years ended December 31, 2018 and 2019: Year Ended December 31, (in thousands of pounds) 2018 2019 Net cash used in operating activities Net cash from investing activities Net cash used in ﬁnancing activities Net decrease in cash and cash equivalents (23,139) 252 (2,075) –––––––––– (24,962) –––––––––– –––––––––– (45,931) 43,295 (5,710) –––––––––– (8,346) –––––––––– –––––––––– Net cash used in operating activities for the year ended December 31, 2019 was £45.9 million, an increase of £22.8 from £23.1 million in 2018. The loss for the year increased from £37.3 million to £41.1 million due to an increase in R&D activity and administrative expenses. This was impacted by a decrease in trade payables of £8.3 million and an increase in trade payables of £1.7 million in 2019 compared to 2018. There was also an increase in tax received of £2.8 million in 2019 compared to 2018. In addition various non-cash items impacted 2019 compared to 2018 including the gain on bargain purchase on the acquisition of OncoMed of £3.7 million, a reduction in share based payment charges (including associated taxes) of £4.1 million, a modiﬁcation gain of £0.5 million on the bank loan following the reﬁnancing of debt was recorded compared to a modiﬁcation loss of £0.7 million recorded in 2018 and an increase in ﬁnance charges of £0.9 million. In previous years, the impact of tax credits has offset increase in operational expenditure. For the current year, tax credits received in cash decreased by £7.0 million to £1.1 million. Tax credits of £1.1 million received during the current year relate in part to a refund of Alternative Minimum Tax (“AMT”) in the U.S. following the acquisition of OncoMed. In addition, Tax credits received in cash during the current year in the UK decreased compared to the prior year as the Group had not yet received repayment of the 2018 R&D tax credit from the U.K. tax authorities in 2019, this being received in early 2020. As at December 31, 2019, total receivables related to tax credits previously recognized amount to £11.4 million, of which £10.4 million relates to R&D tax credit from the U.K. tax authorities being the balance due for FY 2018 and the credit recognized for FY 2019. Net cash from investing activities was £43.3 million in 2019, up from £0.3 million in 2018. The increase was due to the acquisition of OncoMed in April 2019, which provided a net cash inflow on acquisition of £10.1 million and receipt of £32.9 million of short-term investments in the form of short-dated US treasuries, all of which were sold by December 31, 2019. Net cash used in ﬁnancing activities was £5.7 million in 2019, an increase of £3.6 million from 2018. The increase is attributable to the payment of lease liabilities, now reported as a ﬁnancing activity following the adoption of IFRS 16 (Leases) and an increase in the value of treasury shares purchased in the current year compared with the prior year. Total payments of lease liabilities amounted to £2.2 million during the year of which £1.3 million related to the US facility acquired with OncoMed in April 2019.. Treasury shares of £1.0 million were purchased during 2019 compared with £0.3 million in 2018. On April 23, 2019 the Group agreed an amendment to the terms of its bank loan with the lenders. The new terms extended the interest-only period to December 31, 2019 followed by a 15-month capital and interest repayment period. 18 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: FINANCIAL REVIEW Subsequent to the end of the ﬁnancial year, the Company has entered into certain arrangements which provide additional liquidity and capital resource. Those arrangements include: • • • • • On January 13, 2020, the Company announced the License Agreement with Oncologie for the development and commercialization of Navi. Under the terms of the License Agreement, the Company received an upfront payment of £3.2 million ($4 million) with an additional payment of £1.6 million ($2 million) conditional on a Chemistry, Manufacturing and Controls (“CMC”) milestone. Additionally, the Company will be eligible to receive up to $300 million in future milestones and royalties. On February 10, 2020, the Company entered into a £3.8m million convertible equity ﬁnancing with Novartis. Under the terms of the convertible equity ﬁnancing, Novartis purchased £3.8 million in a convertible loan note. The loan note is convertible at any time at a ﬁxed price of £0.265 per ordinary share. In connection with the loan note, the Company issued a warrant instrument to Novartis to purchase up to 1,449,614 of the Company’s ordinary shares. On February 10, 2020, the Company entered into a Securities Purchase Agreement to issue up to £22.4 million ($28 million) $28 million of the Company’s ordinary shares exchangeable for American Depositary Shares, including a £2.4 million ($3 million initial purchase, with Aspire Capital Fund, LLC. In exchange for the £2.4 million ($3 million) initial purchase the Company issued 11,423,925 ordinary shares (equivalent to 2,286,585 ADSs). On February 19, 2020, the Company entered into a Securities Purchase Agreement with Boxer Capital, LLC to make an investment of £2.4 million ($ 3 million) to purchase 12,252,715 of the Company’s ordinary shares (equivalent to 2,450,543 ADSs). On June 4, 2020 the Company announced the completion of a £56 million ($70 million) fundraising, or approximately £51.4 million ($64.2 million) net from the issue of equity, loan notes and warrants to new and existing shareholders. Financial Outlook Under the current business plan and cash flow forecasts, with ongoing research and development efforts focused on etigilimab, our oncology product candidate and on our rare disease product candidates, setrusumab and alvelestat, and taking into account our recently completed fundraising which raised approximately £51.4 million ($64.2 million) of net funds, we expect that our current on-hand cash resources will extend to early 2022. Richard Jones Chief Financial Ofﬁcer June 15, 2020 19 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Risk factors We are a biopharmaceutical company focused on the development and commercialization of innovative therapeutics that aim to improve outcomes for patients with oncology and rare diseases. As such, and in common with other such companies, we face signiﬁcant risks and uncertainties relevant to our operations. The Board has adopted a strategy designed to identify, quantify, manage and mitigate the risks we face, whilst recognizing that no risk management strategy can provide absolute assurance against loss and that drug development and commercialization is inherently uncertain. The Audit and Risk Committee (“ARC”) reviews risks and receives presentations from risk owners at its regular meetings to oversee the management and mitigation of the principal risks faced by the Group and reports its ﬁndings to the Board. Members of the Executive Committee routinely attend meetings. The Board reviews risks at its regular Board meetings, including, but not limited to, an update on progress with our clinical trials and manufacturing, our patents, our ﬁnancial results and projections, and our corporate development activities. Progress against objectives is measured by ﬁnancial and non-ﬁnancial key performance indicators (“KPIs”). We set out below our key risk factors that have been identiﬁed through our risk management review process. Some of these risk factors are speciﬁc to us and others are more generally applicable to the biopharmaceutical industry in which we operate. The Board believes that it has taken all reasonable steps to satisfy itself that the risk management process is effective and ﬁt for purpose. Our control of risk is supported by an in-house quality team that has developed and implemented a fully Good Practice (GxP) compliant quality management system to mitigate risk. The Head of Quality reports to the General Counsel with appropriate escalation measures in place to review and control new and emerging risks within the business. The direction of change in the assessment of the risk during the year is illustrated by the arrow in the “Change” column. Please note that this refers to the overall change in the risk to the Group, following mitigating actions. Mitigation and Risk Description developments to date Change Health epidemics and other widespread outbreaks of contagious disease outbreaks of Signiﬁcant contagious diseases, and other adverse health public developments, could have a material impact on our business operations and operating results. In December 2019, a strain of novel coronavirus, COVID-19, which causes respiratory illness emerged in the city of Wuhan in the Hubei province of China. The Chinese government has taken certain emergency measures to combat the spread of the virus, including implementation of travel bans and closure of factories and businesses. New risk We are actively monitoring how the effects and risks of COVID-19 impact day-to-day operations, including our ongoing clinical trial activities: our • Our current activities on setrusumab for potential treatment of OI are focussed on preparations for the Phase trial, which, 3 pediatric subject to partnering, we intend to start in the second half of 2020 and this may be subject to delay. Our Phase 2b ASTEROID study in OI is fully recruited with topline results, as discussed above, in previously announced November 2019. Patients who enrolled in this study are in a one-year follow up post treatment extension phase. 20 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Mitigation and Risk Description developments to date Change Health epidemics and other widespread outbreaks of contagious disease Since that time, similar measures have extended broadly across the globe as the virus has spread. Multiple countries other throughout the world, including the U.K. and U.S., have been affected by the spread of the virus and have implemented a variety of measures aimed at reducing or halting the spread of the infection. The World Health Organisation has declared it at pandemic status. (“WHO”) We continue to monitor the global spread of COVID-19 and have put in place and will continue to put in place measures as appropriate and necessary for our business. Any prolonged deviations from normal daily operations could negatively impact our business. New risk • Our Phase 2 alvelestat trial recruits individuals with alpha-1 antitrypsin deﬁciency- related lung disease, who are potentially at greater risk from COVID-19 exposure. As a result, recruitment into our Phase 2 alpta-1 antitrypsin study will be delayed, with topline data now expected in the second half of 2021. of by • As a business, we have taken necessary measures across our sites in the U.K. and U.S. to ensure that our employees and other key stakeholders best adhere to the advice set relevant the out authorities. Such measures the have included introduction remote arrangements, working reduced face to face contact by encouraging the use of teleconferencing, a ban on domestic and international travel as well as other measures considered necessary by our newly formed COVID-19 committee for which business continuity planning during this challenging time. responsible is Any prolonged disruption of our clinical trials, suppliers or contract manufacturers, closures of facilities, such as clinical trial sites, suppliers, and manufacturers distributors, including single- source could suppliers impact our ability to advance our development programs as planned, and could have impacts such as delaying regulatory approvals or the commercialization of any current or future products. 21 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Mitigation and Risk Description developments to date Change Integration of OncoMed In April 2019, we completed the of acquisition OncoMed. Acquisitions inherently have risks, including misjudging key elements in an acquisition or failing to integrate the acquired company in an efﬁcient and timely manner which would disrupt operations. Decrease We have now completed a ﬁnancial year with OncoMed as part of the Group and have the integrated successfully and people business, development programs. a developed In January 2020, we announced a global out-licensing deal for product navicixizumab, previously by OncoMed. Our license partner, Oncologie, Inc. (“Oncologie”) has assumed future development and commercialization rights. Following the acquisition of OncoMed, we conducted a thorough assessment of the integration requirements and established an integration plan, including working methods. We Mereo restructured the fully team management integrate OncoMed the Group. From the completion of the acquisition of OncoMed, we have taken steps to align and integrate OncoMed’s quality process and procedures with those of the Group. and policies to into 22 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Mitigation and Risk Description developments to date Change Further successful development of product candidates Our clinical-stage Our existing portfolio consists of six product candidates. oncology product candidates etigilimab and navicixizumab and our rare disease, product “orphan” candidates, setrusumab and alvelestat, generated have positive clinical data for their target indications or for a related indication. We plan to partner or sell our existing non-oncology/ non-rare product disease leflutrozole and, candidates, acumapimod. substantial Our portfolio remains under development. Whilst we have progress made throughout 2019, our ability to successfully further develop our product candidates could be influenced by several factors. in including Those factors include the ability to demonstrate satisfactory safety and efﬁcacy in clinical in completing trials; delays clinical trials, which may cause us to incur additional costs; delays or difﬁculties the enrolment of patients into clinical other if trials, competing clinical trials are initiated in the same therapeutic area; unforeseen adverse events in connection with clinical trials; reliance on the completeness and accuracy of data packages provided product originator; reliance on third-party contract research organizations (“CROs”) for the conduct of clinical trials; and reliance on contract manufacturing organizations (“CMOs”) for the manufacturing product candidates in sufﬁcient quantity and to the requisite quality and in good compliance manufacturing practice (“GMP”). with the by of No change external Our highly experienced in-house team manages the control over vendors our and partners that assist us as sponsor in managing our clinical trials under GxP. In addition to quality audits of our CROs and clinical trial sites, we also undertake specialized data analytics that are designed to validate the quality of data generated from our clinical trials. 2019, During the year ended December 31, following achievements are notable across our product portfolio: the Etigilimab In 2019 we completed a Phase 1b combination study of etigilimab in selected tumor types with two patients of eight evaluable showing a partial and stable response. Navicixizumab (“Navi”) In January 2020 we announced a global license agreement with Oncologie, Inc. (“Oncologie”), for the and development commercialization of Navi. Under the terms of the global license agreement, Oncologie will receive an exclusive worldwide license to develop and commercialize Navi in return for potential milestones and royalties. 23 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Mitigation and Risk Description developments to date Change Further successful development of product candidates Setrusumab In September 2019, Dr. Arun Mistry was appointed as the Therapeutic Area Head for Setrusumab. No change 2019, November In we announced positive results from the Phase 2b dose-ranging clinical study. The study was the largest, prospectively designed, interventional clinical study to be performed in the selected patient group. The topline results from the study demonstrated a clear, dose-dependent, statistically signiﬁcant bone building effect of multiple setrusumab in adult OI anatomical sites irrespective of OI patients, subtype. data analyses continue; and further regarding results positive setrusumab effect on bone stiffness and strength were published in January 2020. Additional at and Food In February 2020 we announced positive feedback from Type B End-of-Phase 2 Meeting with the U.S. Drug Administration (“U.S. FDA”) in which the U.S. FDA agreed the design of our planned Phase 3 pediatric study. The European Medicines Agency (“EMA”) had principle already agreement in August 2018. As such, the pivotal trial is planned to commence in late-2020 subject to completion of a strategic partnership. given in doses Alvelestat In late 2018 we commenced a Phase 2, 12-week randomized, placebo-controlled Phase II proof-of-concept clinical trial evaluating of two alvelestat versus placebo that is expected to enrol approximately 165 patients. It is now expected that top line data will be reported in the second half of 2021 and, if positive, the regulatory advice on the design of a pivotal trial in the U.S. and the E.U. will be sought. results are 24 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Mitigation and Risk Description developments to date Change Further successful development of product candidates Manufacturing its The Group does not have its own manufacturing infrastructure but relies on third-party CMOs to produce its product candidates. Mereo’s ability to commence or development continue activities could be impacted by a failure of the CMOs to meet the required output in terms of quality, scheduling, scale-up, reproducibility, yield, purity, cost, potency or quality; or a failure on the part of the CMO to adhere to In regulatory addition, setrusumab is a large molecule monoclonal antibody, which, as a result, has a more complex manufacturing process than our other small molecule candidate products. requirements. cause In addition, setrusumab is of the IgG2 type subclass monoclonal antibody. The IgG2 subclass is known for having a tendency to reversibly self-associate and this can an opalescent appearance to the liquid antibody formulation, which can be protein mediated concentration, and temperature. The presence of an opalescence in the solution does not have an impact on product potency and effectiveness and does not generally correlate with the formation of aggregates or particles. pH by No change Leflutrozole Following the completion of the Phase 2 dose-ranging clinical trial, in April 2019, we announced a successful end of Phase 2 meeting with the U.S. FDA. In the meeting, a development plan for the product was agreed with the U.S. FDA. In September 2019, we had a meeting with the EMA’s Scientiﬁc Advice Working Party (“SAWP”) that resulted in positive guidance on the next development steps for the program. In August 2019, Richard Francis was appointed as Head of Pharmaceutical Development. No change of number The Group has an experienced in- house team that is working with a specialist manufacturers in respect of its drug manufacturing capabilities. We have a comprehensive in- house quality management process that covers the selection, monitoring and audit inspection of our CMOs and other associated vendors. Speciﬁc to setrusumab, studies are being conducted to in order to minimize any risk of signiﬁcant opalescence or of aggregate formation. Whilst we have recently conducted several large scale manufacturing runs of drug substance and drug product at third-party without observing any opalescence, there can be no assurances that this opalescence will not occur in future manufacturing runs. CMOs 25 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Mitigation and Risk Description developments to date Change a in operate highly We competitive and rapidly changing industry, which may result in others acquiring, developing or competing commercializing product candidates before, or more successfully than we do. Future success for the Group is dependent on obtaining a commercial return from products, either into arrangements with third parties for or commercialization commercializing certain product candidates ourselves. entering by remain At present, none of our existing portfolio is commercialized as yet, because all our candidate products under development and have yet to receive approval / marketing is an authorization, which essential to pharmaceutical and commercialization. pre-requisite launch or Our ability to obtain a commercial return on product candidates could be influenced by a number of factors in addition to receiving /marketing approval authorization including the ability to establish effective sales and marketing capabilities; the ability to enter into product divestment, licensing co- commercialization agreements with third parties; competition that may lead to third parties developing or commercializing products or more earlier successfully than Mereo; the ability to achieve commercially reasonable rates for pricing and reimbursement product candidates commercialized by Mereo; and physician and patient product acceptance for candidates commercial amongst others. approved sale, for of No change For our rare disease programs, we engage with regulators, health technology assessment (“HTA”) bodies, treating physicians and representative patient organisations at all stages of our development. Setrusumab has been designated a Priority Medicine in Europe under the EMA’s PRIME scheme. As such, we beneﬁt from ongoing advice from regulators, payers and HTA bodies on an ongoing basis. We are also in regular dialogue with the European payers through the Mechanism of Coordinated Access to Orphan Medicinal Products (“MoCA”). This work will be extended to the U.S. payers following the receipt of positive feedback from the U.S. FDA about our planned Phase 3 pivotal pediatric trial. Treating physicians, notably those in the lead Centres of Expertise are part of our development work on an ongoing basis; and we also consult patient regularly with representative organisations from the therapeutic areas we intend to address with setrusumab and alvelestat in particular. the Market research work, including pricing, has been initiated for our two rare disease candidate productsWe constantly monitor development programs from other target in companies our indications, to to allow us effectively understand and evaluate landscape for the competitive etigilimab, and alvelestat on an ongoing basis. setrusumab We have commenced licensing and/or partnering discussions for setrusumab, acumapimod and leflutrozole these discussions are ongoing. and Successful commercial- ization 26 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Mitigation and Risk Description developments to date Change Successful commercial- ization Failure to obtain regulatory approvals if addition, In etigilimab, alvelestat, setrusumab, acumapimod, or leflutrozole is approved and launched on the market, we will face intense competition from a variety of businesses, including large, fully integrated pharmaceutical companies, other rare disease pharmaceutical or biotechnology non-rare companies, pharmaceutical and biopharmaceutical companies in the U.S., Europe and other jurisdictions. risks approvals. We operate in a highly regulated industry, giving rise to a number that could affect of the and development commercialization of our product candidates, including the ability to obtain required regulatory marketing The regulatory approval processes of the U.S. FDA, the EMA and comparable foreign authorities are lengthy, time consuming, and with inherently unpredictable outcomes, because they rely on third-party decisions outside of our control. If we are ultimately regulatory unable approval product candidates, our business will be impacted. to obtain for our Even if any of our product candidates obtains regulatory approval, we will be subject to and ongoing continued review including potential additional studies or data generation, which signiﬁcant may additional time and expense. obligations regulatory result in No change Decrease Following the acquisition of OncoMed, Jill Henrich joined the management team as the U.S. Site Head and SVP of Regulatory Affairs, signiﬁcant expertise and experience to the Company. bringing To supplement our experienced in-house team, we work with several specialized regulatory advisors to give guidance on regulatory strategy for each of our candidate products. fail their that we As our programs continue through respective development plans, the relative risk to obtain regulatory approval continues to decrease. Matters that remain outside our control, e.g., the scientiﬁc performance of a compound in a clinical study, or the ultimate decision-making of a regulatory body, are mitigated by dialogue with decision- makers and rigorous study preparation and design. in which In July 2019 we announced a successful Type B meeting for Navicixizumab the outline of a Phase 2 registrational trial was agreed through an accelerated pathway. Navicixizumab was also granted Fast Track designation. 27 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Mitigation and Risk Description developments to date Change in to obtain Regulatory approval of any product candidate in a major market, such as the U.S. or E.U., does not guarantee that we are reimbursed able inclusion government healthcare systems or by private insurance providers. Regulatory approval to commercialize that product in one jurisdiction does not guarantee that we are able to receive such authorisation in other markets. We face an ever-increasing amount of corporate regulation as a dual-listed publicly traded company based both in the U.S. and U.K. We are subject to the U.K. Bribery Act, the U.S. Foreign Corrupt Practices Act and other anti- competition laws, as well as export control laws, customs laws, sanctions laws and other laws governing our operations. If we fail to comply with these laws, we could be subject to civil or criminal penalties, other remedial measures, and legal expenses, which could adversely affect our business, results of operations and ﬁnancial condition. required As a Foreign Private Issuer (“FPI”), we are required to comply with the reporting regime under the U.S. Exchange Act, and will incur signiﬁcant legal, accounting and other expenses should we deviate from this. Our management is now devote substantial additional time to new compliance initiatives, ﬁnancial controls and monitoring activities and governance matters. With respect to the 2019 ﬁnancial year, we provided attestation under Section 404(a) of the Sarbanes-Oxley Act of 2002 for the ﬁrst time. corporate to Decrease In January 2020 we announced positive feedback from a Type B End-of-Phase 2 meeting with the U.S. FDA in which the U.S. FDA also agreed the design of our planned Phase 3 pediatric study for setrusumab in OI. This is in line with our proposed pivotal paediatric study design that has in already been agreed principle with the EMA. to Increase Following our U.S. listing of our American Depository Shares (“ADSs”) in 2019, we introduced new policies and procedures to ensure that our business practices are aligned with those expected of a dual-listed Company in the U.S. and the U.K. This has included updates to the Terms of Reference for the Board Committees which are available for inspection on our website. The Group’s General Counsel and Company Secretary, who serves as an Executive Ofﬁcer, is ensuring for responsible compliance with laws and regulations. For certain matters, the Company will engage external counsel or regulatory advisors. attestation Substantial progress was made the year, ahead of during under providing Section 404(a) of the Sarbanes- Oxley Act of 2002. Measures taken included creating a Risk and Control Matrix (“RACM”) for ﬁnancial processes and controls, evaluating our internal control framework and involving our Audit and Risk Committee (“ARC”) throughout the transition process. Failure to obtain regulatory approvals Continued compliance with new laws and regulations 28 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Mitigation and Risk Description developments to date Change No change We continue to actively monitor the developments relating to the U.K.’s exit from the E.U. and will remain alert to any developments that may impact our business or the wider industry. our E.U. In 2018, we established a wholly owned Irish subsidiary that now orphan holds designation and acts as our E.U. representative for all ongoing E.U. clinical regulatory dialogue and eventual regulatory submissions. studies, Brexit The U.K. formally exited the European Union (“E.U.”) on January 31, 2020. Under the terms of the departure, the U.K. will enter a transition period during which it will continue to follow all E.U. rules and the trading relationship will remain the same. The transition period is scheduled to end on December 31, 2020. that Long-term effects of Brexit will depend on agreements and the U.K. arrangements negotiates with the E.U. following the end of the transition period, including whether and to what extent the U.K. will retain access to the E.U. markets after the transition period. This uncertainty has the potential to impact our business as we are engaged with drug development in Europe, where we are currently subject to regulation by the EMA and the E.U. Commission as well as national competent authorities in the E.U. Member States. 29 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Risk Description developments to date Change Cybersecurity risks including loss of data protection and functioning of continues importance threat to Cybersecurity to in increase to data the mitigate of privacy, the the conﬁdential data the effective Company’s infrastructure. The threat from online attacks or data breaches continues to increase, becoming more complex for all companies and we are no exception. During the year we continued to implement further controls over our cybersecurity. No change the OncoMed We Following the acquisition of OncoMed, we performed a full IT review of environment. also implemented group cybersecurity policies the U.S., which included upgrading software and hardware. Further, in early 2020 we moved our IT hardware in the U.S. into a more secure off-site specialist data centre. in We also regularly test our IT control environment and our undertake personnel and training additional employee measures where required, based on the outcome of this testing. Where relevant, we obtain external third-party support to the extent that risks evolve or require specialist consideration. Since 2019, our IT control environment is also subject to evaluation under Section 404(a) of the Sarbanes-Oxley Act of 2002, with relation to ﬁnancial accounting reporting and processes Continued maintenance of strong intellectual property (IP) portfolio No change Our ability to successfully license, divest or commercialize our product candidates depends in large part on our ability to obtain and maintain effective patent protection for our products in the U.S., Europe and other territories. If we are unable to obtain or maintain patent protection for our product candidates, or if the scope of the patent protection is not broad, competitors could develop and commercialize similar products, which would materially affect our potential commercial return from our products. sufﬁciently We have had a dedicated Head of IP since 2015 and, in addition, we utilize expert external counsel in the prosecution and maintenance of our IP portfolio. The etigilimab patent portfolio contains one core patent family that covers the product per se as well as medical uses thereof. Patents in this family will expire in 2036. The portfolio also includes a second patent family that relates to speciﬁc methods of treatment using etigilimab. Patents that issue from this family will expire in 2037 30 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Risk Description developments to date Change Continued maintenance of strong intellectual property (IP) portfolio We are subject to additional risks, including infringement of patent rights and inability to protect the conﬁdentiality of our know-how, which could have an adverse competitive the effect on advantage of our product candidates. Our key patents for setrusumab include claims directed to the antibody itself as well as the antibody’s use as a medicinal product. Patents in this family will expire in 2028. Further patent applications have been ﬁled relating to the use of anti- sclerostin antibodies the treatment of OI, which, if granted, in 2037. The will setrusumab antibody also has orphan status in both the U.S. and the E.U. expire in Two families of patents for alvelestat have been licensed under our agreement with AstraZeneca. The ﬁrst family includes claims to the alvelestat compound and its uses, and these patents will expire in 2024. The second includes claims to the speciﬁc tosylate salt the alvelestat compound and these patents will expire in 2030. Further patent applications have recently been ﬁled relating to dosage regimens for alvelestat, which, if granted, will expire in 2041. form of family The leflutrozole (BGS-649) patent portfolio includes claims directed to leflutrozole formulations and to the use of leflutrozole in treating hypogonadism according to a speciﬁc dosing regimen, with expiry dates in 2032. No change 31 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Risk Description developments to date Change No change to The ﬁrst patent family of our acumapimod patent portfolio relates the acumapimod compound and other ﬁve- membered heterocycle-based p38 kinase inhibitors and these patents will expire in 2024. The second patent family relates to the use of pyrazole derivatives in the treatment of AECOPD, and these patents will expire in 2033. Further patent applications have been ﬁled relating to dosage regimens of acumapimod, the the use of acumapimod treatment of speciﬁc patient subpopulations, methods of producing speciﬁc polymorphs of synthetic acumapimod methods of production of acumapimod, with expected expiry dates not earlier than between 2036 and 2039. and in The patent portfolio relating to Navi contains two core patent families, both of which cover the product per se as well as medical uses thereof. Patents and patent applications, if issued, in these core families are expected to expire between 2030 and 2032. includes The portfolio also several other patent families including issued U.S. and foreign patents and pending applications that relate to speciﬁc methods of treatment using Navi. Patents and patent applications, if issued, in these families are expected to expire between 2030 and 2039. Navi was licensed by the Group to Oncologie Inc. in January 2020 pursuant to the terms of a global licensing agreement. Continued maintenance of strong intellectual property (IP) portfolio 32 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Risk Description developments to date Change Availability of ﬁnance for incur We have incurred losses since our inception and do not yet have any approved or revenue- generating products. We expect to the losses foreseeable future, and there is no certainty that we will ever generate a proﬁt. We may not be able to raise the additional funds that will be needed to support or development commercialization of our product candidates, and any additional funds that are raised could cause dilution to existing investors. has Mereo signiﬁcant expenditures in US Dollars and Euros; consequently, our ﬁnancial results could be adversely impacted by foreign currency movements. Decrease As at May 31, 2020 the Group had total cash resources (being cash and short term deposits and short term investments) of £10.1 million. Taken together with the which placement private completed on June 3, 2020 and which raised net proceeds of approximately £51.4 million, the group has current total cash resources of £61.5 million. The Directors have prepared detailed cashflow forecasts for the 30- month period to December 31, 2022 based on the delivering the business plan objectives set out in the strategic report which include: • Commencement later in 2020 of a new Phase 1b study for etigilimab • Completion of extension setrusumab the adult for study • Completion of the current Phase 2 study for alvelestat These forecasts indicate that the group has a total cash runway into 2022 and will have sufﬁcient funds to meet its liabilities as they fall due for at least the next 12 months. 33 MEREO BIOPHARMA GROUP PLC STRATEGIC REPORT: PRINCIPAL RISKS AND UNCERTAINTIES Risk Description developments to date Change Constraints in the growth of the Group retain expanding difﬁculties Our future success depends upon key to our ability employees, the including executive directors and executive ofﬁcers, and to attract, retain and motivate qualiﬁed individuals. We anticipate our operational capabilities, and there is a risk that we may encounter in managing this growth, which could disrupt our business. Our growth plans are dependent upon only to our not ability and develop successfully commercialize existing our product candidates but also to successfully identify product further onboard candidates as well as to integrate such products into our business. Our operations may be adversely impacted if we are unable to successfully accomplish this; or are unable to comply with the terms of licensing or acquisition agreements and applicable laws and regulations, including data privacy, amongst others. and No change people We continue to attract highly and experienced continued to expand our team in terms of numbers and breadth of speciality industry-relevant experience. the includes During 2019 we grew from a total of 37 to 50 full-time employees, which new employees from the acquisition of OncoMed as well as an increase in our U.K. employee base. The OncoMed team is now fully integrated into the Group and we welcome the valuable additional operational capabilities and expertise that they bring to the Group, which is a critical part of our continued business growth strategy and execution. reviewed our We incentive arrangements during the year and have implemented new long- term incentives in April 2019, which will allow us to incentivize and retain employees across the Group. We granted options under these new schemes to both employees and Non-Executive Directors in 2019 and early 2020. Further details are set out in our Director’s Remuneration Report on pages 49 to 71. This strategic report, which has been prepared in accordance with Companies Act 2006, has been approved and signed by order of the Board: Dr. Peter Fellner Dr. Denise Scots-Knight Chairman Chief Executive Ofﬁcer June 15, 2020 June 15, 2020 34 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT Chairman’s governance overview I am pleased to present the Corporate Governance Report for the year ended December 31, 2019. The role of Chairman is to ensure that the Board of Mereo operates effectively in delivering the long-term success of the Company. In fulﬁlling this role, the Chairman seeks to ensure that the Board proceedings are conducted in such a way to as to allow all directors to have the opportunity to express their views openly and, in particular, the Non-Executive Directors (“NEDs”) are able to provide constructive support and challenge to the Company’s executive leadership team. Good corporate governance is a central element of the successful growth and development of the Company. The Board and its Committees play a key role in the Company’s governance by seeking to ensure that an effective system of internal controls and risk management procedures is in place. This section of the annual report describes our corporate governance structures and processes and how they have been applied throughout the year ended December 31, 2019 and up to the date of this report in 2020. The Board also takes into consideration how the Group’s growth may result in the evolution of the corporate governance framework. Following completion of the acquisition of OncoMed in April 2019, many of the Company’s corporate governance policies and procedures as well as the terms of reference for the Board Committees were updated to meet the requirements of the Nasdaq Global Market. Throughout 2019 and up to the date of this report, those terms of reference have been consistently applied in the activities performed by the Board Committees. The Board recognizes that a healthy corporate culture is important to Mereo’s business purpose and strategy. The Executive Ofﬁcers of Mereo have a key role in establishing the key elements of our culture and the behaviours we expect to see. They provide feedback to the Board on this on a regular basis. Executive Ofﬁcers of Mereo hold monthly meetings with the Company employees at which they highlight our values and approach to business integrity. In addition, we work with business management consultants at a Company and Executive team level to assess the state of our culture and to agree and embed any modiﬁcations. The Quoted Companies Alliance Code The Board complies with and reports against the standards of corporate governance prescribed by the Corporate Governance Code for Small and Mid-Sized Companies from the Quoted Companies Alliance (the “QCA Code”). The Board believes that this corporate governance framework is appropriate for the Company, having regard to its size and nature. The Board periodically reviews the QCA Code and updates the framework if necessary. A general overview of how the Company complies with the Principles of the QCA Code can be found on our website at www.mereobiopharma.com/investors-page/corporate-governance. The Nasdaq Global Market and U.S. securities laws Following completion of the acquisition of OncoMed and the listing of American Depositary Shares (“ADSs”), each representing ﬁve Mereo ordinary shares, on the Nasdaq Global Market we are required to comply with certain U.S. securities laws and Nasdaq rules that are relevant to us an Emerging Growth Company (“EGC”) (as deﬁned under US securities laws) and as a non-U.S. company with foreign private issuer status (as deﬁned under US securities laws). As an EGC, we are subject to reduced public company disclosure requirements and, as a non-U.S. company with foreign private issuer status, we are exempted from certain corporate governance provisions of U.S. securities laws and Nasdaq rules that are generally applicable to U.S. domestic public companies. Other Board reports I am pleased to include the following stand-alone reports: • • Audit and Risk Committee Report, see page 46 to 48 Directors’ Remuneration Report, see pages 49 to 71 35 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT The Board and Board changes As at the date of this report the Board comprises the Chairman, two Executive Directors and six Non- Executive Directors. The Board considers there to be sufﬁcient 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. The Board also reflects a good balance of skills, diversity and experience from ﬁnancial, operational and sector speciﬁc backgrounds as described in the Directors’ biographies on pages 43 to 45. On March 27, 2020, we announced that Michael Wyzga who currently serves as a Non-Executive Director, will become the Interim Chief Financial Ofﬁcer following the announced departure of Richard Jones, the Company’s current Chief Financial Ofﬁcer (“CFO”). Richard Jones will remain in his position as CFO for a transitionary period of up to ﬁve months. The Board has considered and concluded that the appointment of a Senior Independent Director is not necessary at this time. In recognition of OrbiMed’s participation in, and assistance with, the Fundraising, the Company has agreed to grant OrbiMed the right to nominate two persons to be appointed to the Board of Directors (out of a maximum number of nine directors), within a period of 180 days from 3 June 2020 subject to the appropriateness of the nominees. Our Non-Executive Directors currently have a limited number of equity incentive awards issued to them from the Mereo BioPharma Group Limited Share Option Plan (the “2015 Plan”) or the 2019 Non-Executive Director Equity Incentive Plan (the “NED EIP”). Equity incentive awards awarded to Non-Executive Directors are discussed in further detail in the Directors’ Remuneration Report. Considering the limited number of equity incentive awards issued to Non-Executive Directors, the Board does not consider that the awards impact the independence of the Non-Executive Directors. Dr. Peter Fellner, Peter Bains, Paul Blackburn, Kunal Kashyap, Dr. Anders Ekblom, Michael Wyzga and Dr. Deepa Pakianathan qualify as “independent” under U.S. securities laws and Nasdaq rules. Name Non-Executive Directors Dr. Peter Fellner Frank Armstrong(1) Peter Bains Paul Blackburn Dr. Anders Ekblom Kunal Kashyap Michael Wyzga Dr. Deepa Pakianathan Executive directors Dr. Denise Scots-Knight, Chief Executive Ofﬁcer Richard Jones, Chief Financial Ofﬁcer Company Secretary Charles Sermon (1) Frank Armstrong resigned from the Board on February 8, 2019 Date of appointment July 29, 2015 July 29, 2015 July 29, 2015 October 6, 2015 July 29, 2015 July 29, 2015 April 23, 2019 April 23, 2019 March 10, 2015 January 30, 2017 May 19, 2015 The Board typically has ﬁve scheduled meetings per year with additional Board meetings and Board Committee meetings as circumstances and business needs dictate. The Board is responsible to the shareholders for the proper management of the Group and meets regularly to set the overall direction and strategy of the Group and to review scientiﬁc, operational and ﬁnancial performance. The Board has also convened on an ad-hoc basis between scheduled Board meetings to review speciﬁc business opportunities and other matters that require more immediate Board input. The key responsibilities of the Board are as follows: Setting the Company’s values and standards; Approval of long-term objectives and strategy; • • 36 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT • • • • • • • Approval of budgets and plans; Oversight of operations, ensuring that adequate systems of internal controls and risk management are in place, maintenance of accounting and other records and compliance with statutory and regulatory obligations; Review of performance considering strategy and budgets, ensuring any necessary corrective actions are taken; Approval of the annual report and ﬁnancial statements and major projects such as new product acquisitions; Changes to the structure, size and composition of the Board; Determining the remuneration policy for the directors and approval of the remuneration of the Non- Executive Directors; and Approval of communications with shareholders and the market. There is a clear separation of the roles of the Chief Executive Ofﬁcer and the Chairman. The Chairman is responsible for overseeing the running of the Board, ensuring that no individual or group dominates the Board’s decision making and ensuring the Non-Executive Directors are properly briefed on matters. The Chief Executive Ofﬁcer has the responsibility for implementing the strategy of the Board and managing the day-to-day business activities of the Group. In accordance with the Company’s articles of association each of its Directors serves for a term of three years. Retiring directors are eligible for re-election at the Company’s Annual General Meeting (“AGM”) and, if no other director is elected to ﬁll his or her position, and if the director is willing, shall be re-elected by default. The current term for all our directors expires in 2021, except for Richard Jones, whose current term expires in 2020 and who will not be standing for re-election, and for Michael Wyzga and Dr. Deepa Pakianathan, whose current terms expire in 2022 following their re-appointment at our last AGM held on June 19, 2019. Directors are required to notify the Board of any conflicts of interest and a register of such interests is maintained by the Company Secretary and reviewed at Board meetings. Any planned changes to their interests, including directorships outside the Mereo Group are notiﬁed to the Board. Development, information and support Updates are given to the Board on developments in governance and regulations as appropriate, including presentations from the Company’s Nominated Advisor (“Nomad”) and ﬁnancial, legal and remuneration advisors. The Board has access to the advice of the Company Secretary, who is a qualiﬁed lawyer and acts as secretary to the Board and its committees and is responsible for ensuring that Board procedures are followed, and applicable rules and regulations are complied with. Performance evaluation The Board recognizes the need to regularly review the effectiveness of its performance as well as that of its committees and individual directors. The Nominations Committee is responsible for performance evaluation of the Board including that of its Committees and individual directors, including the Chairman. The Nomination Committee has initiated a performance effectiveness process which has yet to be completed. The Nomination Committee recognizes the need for membership of the Board to be periodically refreshed and on April 4, 2019 approved the appointment of Michael Wyzga and Dr. Deepa Pakianathan as additional Non-Executive Directors of the Company on completion of the acquisition of OncoMed. 37 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT Attendance at Board and Committee meetings There were ten Board meetings during 2019. Directors’ attendance at Board and Committee meetings was as follows: Current directors Dr. Peter Fellner Peter Bains Paul Blackburn Dr. Anders Ekblom Kunal Kashyap Michael Wyzga(3) Dr. Deepa Pakianathan(4) Dr. Denise Scots-Knight Richard Jones Past directors Frank Armstrong(5) Board (out of 10) Remuneration Audit and Risk Committee (out of 8) Committee (out of 4) R&D Committee (out of 4) Nomination Committee (out of 1) 10 10 10 10 10 7 6 10 10 1 n/a 4 n/a 4 n/a n/a 1 n/a n/a 1 n/a n/a 8 4(2) 8 4 n/a n/a n/a n/a n/a 3(1) n/a 4 n/a n/a 2 n/a n/a 1 1 1 n/a 1 n/a n/a n/a n/a n/a n/a (1) (2) (3) (4) Peter Bains was absent for one R&D Committee meeting because of personal reasons. Anders Ekblom served as a member of the Audit and Risk Committee for part of the year. Anders Ekblom has attended all scheduled meetings. Michael Wyzga was appointed to the Board of Directors on April 23, 2019. Since that date, Michael Wyzga has attended all scheduled meetings. Deepa Pakianathan was appointed to the Board of Directors on April 23, 2019. Since that date, Dr. Deepa Pakianathan has attended all scheduled meetings except one Board meeting because of personal reasons. (5) Frank Armstrong resigned from the Board on February 8, 2019 Board members’ time commitment is considered necessary for the performance of their duties and Board members are expected to attend all Board and relevant Committee meetings, unless other previous commitments have been arranged. All Board and relevant Committee meetings through 2019 were fully attended except for the two instances noted above (relating to a Board meeting and a R&D Committee meeting) due to personal reasons. Board Committees To effectively manage governance of the Group, the Board has delegated certain responsibilities to sub- committees, as detailed below. As noted above with the re-organization of the Board on completion of the acquisition of OncoMed, the composition of the sub committees was reviewed. These and other changes were implemented as noted below. Audit and Risk Committee Paul Blackburn (Chair) Kunal Kashyap Michael Wyzga (from May 1, 2019) Dr. Anders Ekblom (until May 1, 2019) Remuneration Committee Peter Bains (Chair from May 1, 2019) Dr. Anders Ekblom (Chair until May 1, 2019) Dr. Deepa Pakianathan (from May 1, 2019) Frank Armstrong (until February 8, 2019) Nomination Committee Dr. Peter Fellner (Chair) Peter Bains Dr. Anders Ekblom Frank Armstrong (until February 8, 2019) 38 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT Research and Development Committee Dr. Anders Ekblom (Chair from May 1, 2019) Frank Armstrong (Chair and member until February 8, 2019) Peter Bains Dr. Deepa Pakianathan (from May 1, 2019) The detailed charters for each of the committees can be found on the Group’s website at www.mereobiopharma.com. All the Board committees are authorized to obtain, at the Company’s expense, professional advice on any matter within their terms of reference and to have access to enough resources to carry out their duties. Audit and Risk Committee The Audit and Risk Committee, which consists of Paul Blackburn, Kunal Kashyap and Michael Wyzga, assists the Board in overseeing our accounting and ﬁnancial reporting processes and the audits of our ﬁnancial statements. Mr. Blackburn serves as Chairman of the Audit and Risk Committee. The Audit and Risk Committee consists exclusively of members of our Board who are ﬁnancially literate, and Paul Blackburn is considered an “audit committee ﬁnancial expert” as deﬁned by applicable SEC rules and has the requisite ﬁnancial sophistication as deﬁned under the applicable Nasdaq rules and regulations. Our Board has determined that all of the members of the Audit and Risk Committee satisfy the “independence” requirements set forth in Rule 10A-3 under the Exchange Act. The Audit and Risk Committee is governed by a charter that complies with Nasdaq rules. The Audit and Risk Committee’s responsibilities include: • • • • • • Recommending the appointment of the independent auditor to the general meeting of shareholders; The appointment, compensation, retention and oversight of any accounting ﬁrm engaged for the purpose of preparing or issuing an audit report or performing other audit services; Pre-approving the audit services and non-audit services to be provided by our independent auditor before the auditor is engaged to render such services; Evaluating the independent auditor’s qualiﬁcations, performance and independence, and presenting their conclusions to the full Board on at least an annual basis; Reviewing and discussing our ﬁnancial statements and our ﬁnancial reporting process with the executive ofﬁcers, the Board and the independent auditor; and Approving or ratifying any related person transaction (as deﬁned in our Related Person Transaction Policy) in accordance with our Related Person Transaction Policy. The Audit and Risk Committee meets as often as one or more members of the Audit and Risk Committee deem necessary, but in any event meets at least four times per year. The Audit and Risk Committee meets at least once per year with our independent auditor, without our senior management being present. The Audit and Risk Committee Report is presented on pages 46 to 48. Remuneration Committee The Remuneration Committee, which consists of Peter Bains, Dr. Deepa Pakianathan and Dr. Anders Ekblom, assists the Board in determining senior management compensation. Mr. Bains serves as Chairman of the committee. Under SEC and Nasdaq rules, there are heightened independence standards for members of the Remuneration Committee, including a prohibition against the receipt of any compensation from the Company other than standard board member fees. However, foreign private issuers are not required to meet this heightened standard. Nonetheless, our Board has determined that Peter Bains, Dr. Deepa Pakianathan and Dr. Anders Ekblom meet this heightened standard. The Remuneration Committee is governed by a charter that complies with Nasdaq rules. 39 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT The Remuneration Committee’s responsibilities include: • • • • • Identifying, reviewing, and proposing policies relevant to senior management compensation; Evaluating each member of senior management’s performance in light of such policies and reporting to the Board; Analyzing the possible outcomes of the variable compensation components and how they may affect the compensation of senior management; Recommending any equity long-term incentive component of each member of senior management’s compensation in line with any compensation policy and reviewing our senior management compensation and beneﬁts policies generally; and Reviewing and assessing risks arising from our compensation policies and practices. Following the Company’s listing on the Nasdaq Global Market, it is required to publish a Directors’ Remuneration Report, because the Company meets the deﬁnition of a “quoted company” as deﬁned in Section 385 of the Companies Act 2006. The Directors’ Remuneration Report for the ﬁnancial year ended December 31, 2019, is presented on pages 49 to 71. Nomination Committee The Nomination Committee, which consists of Dr. Peter Fellner, Peter Bains and Dr. Anders Ekblom, assists our Board in identifying individuals qualiﬁed to become members of our board and senior management consistent with criteria established by our Board and in developing our corporate governance principles. Dr. Peter Fellner serves as Chairman of the Nomination Committee. The Nomination Committee is governed by a charter that complies with Nasdaq rules. The Nomination Committee’s responsibilities include: • • • • • Drawing up selection criteria and appointment procedures for board members; Reviewing and evaluating the size and composition of our Board and making a proposal for a composition proﬁle of the Board at least annually; Recommending nominees for election to our Board and its corresponding committees; Assessing the functioning of individual members of the Board and senior management and reporting the results of such assessment to the Board; and Developing and recommending to the Board rules governing the Board, reviewing and reassessing the adequacy of such rules governing the Board, and recommending any proposed changes to the Board. Research and Development Committee The Research and Development Committee, which consists of Dr. Anders Ekblom, Peter Bains and Dr. Deepa Pakianathan, assists our senior management with oversight and guidance related to strategic research and development matters and provides guidance and makes recommendations to our Board regarding strategic research and development matters. Dr. Anders Ekblom serves as Chairman of the Research and Development Committee. The Research and Development Committee’s responsibilities include oversight of: • • Our strategic development plans for product candidates, taking into account any regulatory feedback; and The acquisition of new product candidates. In addition, the Research and Development Committee is tasked with keeping the Board informed of strategic issues and commercial changes affecting our development programs and potential product acquisitions. Corporate social responsibility The Board recognizes the importance of social, environmental and ethical matters and it endeavours to consider the differing interests of the Group’s stakeholders, including its investors, employees, suppliers and business partners, when operating its business. 40 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT General Data Protection Regulation (“GDPR”) Prior to the adoption of GDPR in 2018 we updated our data protection guidelines, training and processes. Throughout the year we have continued to maintain and update these guidelines, training and processes, including targeted awareness sessions delivered to our employees. Risk management and internal control The Board is responsible for the systems of internal control and for reviewing their effectiveness. Details of the Board’s review of the Company’s risk management and internal control procedures are set out in the Audit and Risk Committee Report on page 46 to 48. Details of our principal risks are set out on pages 20 to 34. Financial reporting The Board is responsible for reviewing and approving the Annual Report and Accounts and the interim ﬁnancial information and for ensuring that these reports present a fair and balanced assessment of the Group’s position. Drafts of these reports are provided to the Board in a timely manner and Directors’ feedback is discussed and incorporated, where appropriate, prior to publication. In addition, the Board ensures that controls over the ﬁnancial reporting process and preparation of the consolidated accounts include extensive reviews by qualiﬁed and experienced individuals to ensure that all elements of the ﬁnancial statements and appropriate disclosures are considered and accurately stated. With respect to the ﬁnancial year ended December 31, 2019, the Board acknowledges the steps taken by management and the Audit and Risk Committee to ensure appropriate actions are taken with respect to the requirement to provide attestation over Section 404(a) of the Sarbanes-Oxley Act of 2002. Market Abuse Regulation The Board has in place procedures to assist the Company in complying with its obligations relating to the disclosure and control of inside information under the Market Abuse Regulation and the AIM Rules. These procedures include identifying inside information, ensuring the appropriate disclosure of inside information, the maintenance of insider lists and that effective controls are in place to keep any inside information conﬁdential. Whistleblowing The Group operates a whistleblowing policy which allows all employees to raise concerns to senior management in strict conﬁdence about any unethical business practices, fraud, misconduct or wrongdoing. The Company has implemented a whistleblowing hotline through which employees can raise questions and concerns anonymously. Any concerns with the whistleblowing policy are reviewed by the Audit and Risk Committee. Relations with stakeholders and shareholders The Board recognizes the importance of communication with its shareholders to ensure that its strategy and performance are understood and that it remains accountable to shareholders and we therefore maintain a regular dialog with our institutional investors. Executive ofﬁcers of the Company also engage with stakeholders and receive feedback from a range of such stakeholders including the Company’s employees which is then shared with the Board. The Board recognizes that the Company’s employees are a valuable asset and a key driver of the Company’s success. The Board and the Board’s committees, including the R&D Committee, also receive regular feedback directly from key advisers and third-party experts. Our website, www.mereobiopharma.com, has a dedicated investor section, which is fully compliant with AIM Rule 26 and provides useful information for our shareholders including the latest announcements, press releases, published ﬁnancial information, details of our products and our current development pipeline and other information about the Company. The Board as a whole is responsible for ensuring that a satisfactory dialog with shareholders takes place, while the Chief Executive Ofﬁcer and I, as Chairman, ensure that the views of the shareholders are communicated to the Board as a whole. The Board ensures that our strategic plans have been carefully reviewed in terms of their ability to deliver long-term shareholder value. 41 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT Annual General Meeting (“AGM”) This year’s AGM of the Company will be held on June 29, 2020. The notice of AGM, which includes all proposed resolutions, has been posted to shareholders and is available on the Group’s website www.mereobiopharma.com. All shareholders will have had at least 21 days’ notice of the AGM. Due to COVID-19 and the current social distancing measures set out by the UK Government, the Company’s AGM will be a closed meeting. As iterated in the Company’s press release on May 22, 2020, this means that ordinary shareholders will not be allowed to attend the AGM in person and any ordinary shareholder seeking to attend the AGM in person will be refused entry. Under the Companies Act 2006, the directors of a public company are required to lay its annual report and accounts before the company in general meeting (an “accounts meeting”) by no later than the end of the period for the ﬁling of those reports and accounts with the Registrar of Companies. The period for ﬁling the annual report and accounts is ordinarily six months from the accounting reference date. There is a separate requirement under the Companies Act 2006 for a public company to hold an AGM within the period of six months from its accounting reference date. Ordinarily the Company’s AGM would also serve as its accounts meeting. However, in response to the COVID- 19 pandemic, Companies House has allowed companies to apply for a three-month extension of time to ﬁle their accounts. The Company has applied for, and been granted, such an extension in respect of its annual report and accounts for the ﬁnancial year ended December 31, 2019 (the “Annual Accounts”). The Company announced and published the Annual Accounts on June 16, 2020, however the extension allows until September 30, 2020 to ﬁle the Annual Accounts, if required. In light of this extension, the Company’s accounts meeting may now be held as a general meeting no later than September 30, 2020. However, the Company is currently still required to hold its AGM by June 30, 2020, hence the meeting going ahead as stated above. It is noted that the Annual Accounts will not be able to be sent out to shareholders in sufﬁcient time ahead of the AGM and therefore will not be laid before the AGM but at a general meeting of the Company to be convened and held prior to September 30, 2020. Our employees Our employee base includes key people in strategic areas including in corporate development, patient access and commercial planning, as we move our rare disease programs forward and seek to partner our speciality products. We have been fortunate to attract and retain highly experienced individuals in clinical development, clinical operations, manufacturing, intellectual property and quality assurance, supporting them with strong leadership at the executive and Board level. Our internal expertise is leveraged with external organisations, including contract research organisations (“CROs”) and contract manufacturing organisations (“CMOs”) as well as bespoke consulting agreements. This combination has allowed the Group to initiate international clinical trial studies within a relatively short period of time since acquiring products from large pharma, whilst also maintaining a lean internal infrastructure. Across the U.K. and the U.S., we now have approximately 45 employees. Mereo seeks to appoint employees with appropriate skills, knowledge and experience for the roles they undertake and thereafter to develop, incentivize and retain staff. The Board recognizes its legal responsibility to ensure the well-being, safety and welfare of the Group’s employees and maintain a safe and healthy working environment for them and for our visitors. If an employee has a concern about unsafe conditions or tasks, they are encouraged to report their concerns immediately to their manager or the General Counsel. Employees may also contact a dedicated whistleblowing hotline, independent of the Group, if anonymity is sought. The Group is fully committed to the elimination of unlawful and unfair discrimination and values the differences that a diverse workforce brings to the organization. The Group endeavours to not discriminate because of age, disability, gender reassignment, marriage and civil partnership, pregnancy and maternity, race (which includes colour, nationality and ethnic or national origins), religion or belief, sex or sexual orientation. This is captured in our Employee Handbook, which all employees are required to read and acknowledge on an at least annual basis. The Group will undertake an annual review of its policies and procedures to establish its position about compliance and best practice and monitor and promote a healthy corporate culture. 42 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT A breakdown of employment statistics by gender as at December 31, 2019 is as follows: Position Female Male Total Directors of the Company (CEO, CFO and Non-Executive) Executive ofﬁcers Employees Total 2 2 18 22 7 3 18 28 9 5 36 50 Executive ofﬁcers consist of senior managers who have responsibility for planning, director or controlling the activities of the Group. As at December 31, 2019, this includes the Chief Medical Ofﬁcer, General Counsel and Company Secretary, Head of Corporate Development, Head of Patient Access and Commercial Planning and U.S. Site Head and SVP Regulatory Affairs. Our Directors have signiﬁcant operational experience in leadership positions in large and small pharmaceutical and biotechnology companies. They provide valuable strategic input into our corporate development programs and our corporate and ﬁnancing strategies. We welcomed two new Non-Executive Directors from OncoMed, brining additional skills and diversity to the Mereo Board. Biographies for our team of highly experienced directors and executive ofﬁcers can be found below: Executive Directors Dr. Denise Scots-Knight (CEO and co-founder) Dr. Scots-Knight has served as our Chief Executive Ofﬁcer since July 2015 and as a member of our Board since our formation. From 2010 until joining us, Dr. Scots-Knight was the Managing Partner of Phase4 Partners Ltd. (“Phase4”), a global life science venture capital ﬁrm. Dr. Scots-Knight is currently a board member of Elanco Animal Health Incorporated (NYSE: ELAN. Dr. Scots-Knight previously served as a member of the board of directors of Idenix Pharmaceuticals, Nabriva, Albireo and OncoMed. Dr. Scots-Knight holds a B.Sc. (Hons.) and a Ph.D. from Birmingham University. Richard Jones (CFO) Mr. Jones has served as our Chief Financial Ofﬁcer and as a member of our Board from January 2017. As a consequence of Mr. Jones serving notice in March 2020 that he will be leaving the Board of the Company and will remain in his position as Chief Financial Ofﬁcer for a transitionary period of up to 5 months, Mr. Jones is not standing for re-election to the Board at the Annual General Meeting to be held on June 29, 2020. From 2011 until joining us, Mr. Jones was the Chief Financial Ofﬁcer and Company Secretary of Shield Therapeutics plc, where he also served as a Non-Executive Director from 2010 to 2011. Mr. Jones serves as a non-executive director on the board of Alliance Pharma plc. Mr. Jones is a qualiﬁed chartered accountant (ACA) with the Institute of Chartered Accountants in England and Wales (ICAEW) and holds a B.Eng. (Hons.) from the University of Newcastle upon Tyne. Non-Executive Directors Dr. Peter Fellner (Chairman) Dr. Fellner has been Chairman of our Board since July 2015. He served as Chairman of the board of directors of Consort Medical plc from May 2009 until April 2019 and was Chairman of the board of directors of Ablynx NV from November 2013 until January 2018 and Vernalis plc until October 2018. Dr. Fellner was previously Chairman of the board of directors of Acambis plc from 2006 until its acquisition by Sanoﬁ Pasteur and Optos plc from 2000 until its acquisition by Nikon Corporation, and Vice Chairman of Astex Pharmaceuticals Inc. until its acquisition by Otsuka Pharmaceutical Company. He also served as a Director of UCB S.A. and was CEO and then Chairman of Celltech Group plc. Dr. Fellner holds a B.Sc. (Hons.) from the University of Shefﬁeld and a Ph.D. from the University of Cambridge. Dr. Fellner serves as Chair of the Nomination Committee. Paul Blackburn Mr. Blackburn has served on our Board since October 2015. Mr. Blackburn was Senior Vice President Strategic Finance Projects and Financial Controller at GlaxoSmithKline. Mr. Blackburn currently serves on the Board of Directors of Syngene. Mr. Blackburn is a member of the Chartered Institute of Management Accountants. Mr. Blackburn holds a B.Sc. from Warwick University. 43 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT Mr. Blackburn serves as Chair of the Audit and Risk Committee. Dr. Anders Ekblom Dr. Ekblom has served on our Board since July 2015. Dr. Ekblom has held a number of executive positions at AstraZeneca, including Executive Vice President Global Drug Development, Executive Vice President Global Medicines Development, Global Head Clinical Development, and Chief Executive Ofﬁcer of AstraZeneca AB Sweden. He currently serves as Chairman of the Board of Elypta AB, as Vice Chairman of the Board of LEO Pharma A/S, and on the boards of directors of Alligator Bioscience AB and AnaMar AB. Dr. Ekblom is a board- certiﬁed medical doctor and an Associate Professor at the Karolinska Institutet. Dr. Ekblom holds a M.D., Ph.D. and a D.D.S from Karolinska Institutet. Dr. Ekblom serves as Chair of the R&D Committee and is a member of the Remuneration Committee and Nomination Committee. Kunal Kashyap Mr. Kashyap has served on our Board since July 2015. Mr. Kashyap is Chairman and Managing Director of Allegro Capital Advisors. He had also served as an Independent Director of GlaxoSmithKline Consumer Healthcare Ltd until June 2019. Mr. Kashyap was a partner with Arthur Andersen responsible for establishing and managing their operations in South India. Mr. Kashyap is also the Founder and was the Executive Director of Celstream Technologies Private Limited. Mr. Kashyap is a Chartered Accountant from the Institute of Chartered Accountants of India. Mr. Kashyap is a member of the Audit and Risk Committee. Peter Bains Mr. Bains has served on our Board since July 2015. Mr. Bains was a Representative Executive Ofﬁcer and Chief Executive Ofﬁcer of Sosei Group Corporation, a Japanese listed biotechnology company until 31 December 2018. Previously, he was Chief Executive Ofﬁcer and Executive Director of Syngene International Ltd, a BSE listed contract research organization, where he served as a Non-Executive Director until 2016. Mr. Bains also served as Non-Executive Chairman of Fermenta Biotech Ltd, an Indian speciality manufacturing company until April 2018. Mr. Bains currently serves as a Non-Executive Director for MiNA Therapeutics Ltd and Apterna Ltd, both privately held UK biotechnology companies, and Indivior PLC, a FTSE listed speciality pharmaceuticals company. Mr. Bains holds a B.Sc. (Hons.) from Shefﬁeld University. Mr Bains serves as Chair of the Remuneration Committee and is a member of the Nomination Committee and R&D Committee. Michael Wyzga Mr. Wyzga has served on our Board since April 2019 following completion of the Merger and had served as a director of OncoMed since October 2013 until the closing of the Merger. On May 14, 2020, we entered into the Consulting and Interim Chief Financial Ofﬁcer Agreement with MSW Consulting Inc. and Michael Wyzga by which Mr. Wyzga will serve as Interim Chief Financial Ofﬁcer following the departure of Mr. Jones. Mr. Wyzga is currently the President of MSW Consulting Inc., a strategic consulting group focused in the life sciences area. From December 2011 until November 2013, Mr. Wyzga served as President and Chief Executive Ofﬁcer and a member of the board of directors of Radius Health, Inc. Prior to that, Mr. Wyzga served in various senior management positions at Genzyme Corporation, including as Chief Financial Ofﬁcer from July 1999 until November 2011. Mr. Wyzga is a member of the boards of directors of Exact Sciences Corporation and LogicBio, and is Chairman of the board of directors of GenSight Biologics S.A. and of X4 Biologics. Mr. Wyzga previously served as a member of the boards of directors of Idenix Pharmaceuticals, Inc. and Altus Pharmaceuticals, Inc., and as a member of the supervisory board of Prosensa Holding B.V. He received an M.B.A. from Providence College and a B.S. from Suffolk University. Mr. Wyzga is a member of the Audit and Risk Committee. 44 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: CORPORATE GOVERNANCE REPORT Dr. Deepa Pakianathan Dr. Pakianathan has served on our Board since April 2019 following completion of the Merger and served as a director of OncoMed since December 2008 until the closing of the Merger. Since 2001, Dr. Pakianathan has been a Managing Member at Delphi Ventures, a venture capital ﬁrm focused on biotechnology and medical device investments. Dr. Pakianathan serves on the boards of directors of Karyopharm Therapeutics, Inc., and Calithera Biosciences, Inc. Dr. Pakianathan previously served on the boards of directors of Alexza Pharmaceuticals, Inc., Alder Biopharmaceuticals, Inc., PTC Therapeutics, Inc. and Relypsa, Inc. Dr. Pakianathan received a B.Sc. from the University of Bombay, India, a M.Sc. from The Cancer Research Institute at the University of Bombay, India, and an M.S. and Ph.D. from Wake Forest University Dr. Pakianathan is a member of the Remuneration Committee and the R&D Committee. Executive Ofﬁcers Dr. Alastair Mackinnon (Chief Medical Ofﬁcer, co-founder) Dr. MacKinnon has served as our Chief Medical Ofﬁcer since July 2015. From 2010 until joining us, Dr. MacKinnon was a Partner of Phase4. Dr. MacKinnon holds a B.Sc. and a MBBS from King’s College London and is a Member of the Royal College of Surgeons in Edinburgh. . John Richard (Head of Corporate Development, co founder) Mr. Richard has served as our Head of Corporate Development since July 2015. Prior to joining us, he was a consultant for Nomura, a global investment bank, and Phase4, and previously served as the head of business development for Sequus Pharmaceuticals Inc., VIVUS Inc. and Genome Therapeutics Corporation. Mr. Richard serves on the boards of QUE Oncology, and previously served on the boards of Catalyst Biosciences, Vaxart, Inc., Aviragen Therapeutics, Inc., and Targacept, Inc. Mr. Richard holds a B.S. from Stanford University and an MBA from Harvard Business School. Charles Sermon (General Counsel, Company Secretary, co-founder) Mr. Sermon has served as our General Counsel and Company Secretary since July 2015. From 2010 until joining us, Mr. Sermon was a Partner of Phase4, where he currently serves as a member of the board of directors. Mr. Sermon trained and qualiﬁed as a lawyer with Freshﬁelds after completing the Law Society’s Final Examination. Mr. Sermon holds an LL.B. (Hons.) from Hull University. Wills Hughes-Wilson (Head of Patient Access and Commercial Planning) Ms. Hughes-Wilson has served as our Head of Patient Access and Commercial Planning since March 2018. Prior to joining us, Ms. Hughes-Wilson was Senior Vice President, Chief Patient Access Ofﬁcer at Swedish Orphan Biovitrum (publ.) AB, a biotechnology company, from 2012 to 2018, and prior to that served as Vice President Health & Market Access Policy EMEA at Genzyme (now Sanoﬁ Genzyme), a biotechnology company. Ms. Hughes-Wilson holds a bachelor’s degree in Law and Politics (Hons.) from the University of Durham, U.K. Jill Henrich (U.S. Site Head and SVP of Regulatory Affairs) Ms. Henrich serves as our U.S. Site Head and Senior Vice President of Regulatory Affairs. Prior to the Merger she was Senior Vice President of Regulatory Affairs and QA at OncoMed Pharmaceuticals Inc. Prior to joining OncoMed, Ms. Henrich was at PDL BioPharma, Inc. (Facet Biotech, acquired by Abbott) as Executive Director of Regulatory Affairs with additional responsibility for Regulatory Operations, Corporate Document Control, Medical Writing and Quality Assurance Compliance. She was Senior Director of Regulatory Affairs at Corixa Corporation (formerly Coulter Pharmaceutical, Inc.), and held various positions in Research (Cell Genetics/Molecular Biology) and Regulatory Affairs at Genentech. Ms. Henrich received her Bachelor of Science degree in Biological Sciences/Microbiology from the University of Connecticut. Dr. Peter Fellner Chairman June 15, 2020 45 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: AUDIT AND RISK COMMITTEE REPORT The Board has delegated certain responsibilities to the Audit and Risk Committee (“ARC”), as more fully explained within the Corporate Governance Report on pages 35 to 45. Those responsibilities include oversight for the ﬁnancial accounting and reporting process, internal control, risk management, and management and evaluation of the independent external auditor. The ARC met eight times in 2019. A summary of the Committee’s key activities during 2019 is as follows: Review of the independent external auditor and tax adviser The ARC monitors the relationship with the independent external auditor, Ernst & Young LLP, which was appointed in 2015 and reappointed at the 2019 AGM, to ensure that auditor independence and objectivity are maintained. We also reviewed and approved the 2019 audit plan and fee schedule. We have also assessed the performance of the independent external auditor during the year. As part of its review we monitor the provision of non-audit services by the independent external auditor. The breakdown of fees between audit and non-audit services for 2019 is provided in Note 7 of the consolidated ﬁnancial statements. During the year, Ernst & Young LLP provided certain non-audit services. These non-audit services were in relation to: • • Regulatory requirements relating to the audit of the ﬁnancial information contained within Registration Statements ﬁled with the U.S. Securities and Exchange Commission (“SEC”); Contractual requirements relating to one-off agreed upon procedure assignments which require completion by the Company’s independent external auditor. During the year this included an opinion relating to the issue of warrants to our lenders. The audit to non-audit fee ratio is impacted by the volume of additional work required as part of the audit of ﬁnancial information contained within the Registration Statement (on Form F-4) ﬁled with the SEC in early 2019 relating to the initial registration of the Company’s American Depository Shares (“ADSs”) onto the Nasdaq Global Market and subsequently as part of a review of information incorporated by reference within a Securities Registration Statement (on Form S-8). In addition to the Registration Statements, the independent external auditor has also reviewed similar ﬁnancial information contained within other documents proposed to be ﬁled with the SEC throughout the year. We expect that the audit to non-audit fee ratio will improve in future years and do not consider the ratio at present to impact auditor independence or objectivity given the regulatory and contractual requirement that the independent external auditor performs the relevant service, as well as the nature of work performed. Having reviewed the independent external auditor’s independence and performance, we recommended to the Board that the appointment of Ernst & Young LLP as auditors from the conclusion of the Company’s Annual General Meeting on June 19, 2019 be conﬁrmed to continue until the conclusion of the next general meeting at which the Company’s annual report and accounts are presented. During the year we also reviewed our advisors for corporate tax and agreed the appointment of Deloitte LLP as our corporate tax advisors for our tax compliance and any ad-hoc taxation advice. We also agreed the appointment of Moss Adams for routine US based tax compliance. Auditor rotation After the year end, the audit and risk committee considered the Ethical Standards in respect of audit partner rotation as the Ernst and Young engagement partner, D Hales, will complete his ﬁve year term for the UK audit when Mereo ﬁles its 2019 Annual report. The committee considered the extenuating circumstances arising from the impact of Covid19 on the ongoing business activity, the impact of recent corporate deals and fundraising on our business, and the resignation of our CFO. We concluded that there is a need for continuity when completing the 2020 audit including the additional audit and related work in respect of the recently completed ﬁnancing and concluded that the integrity, objectivity or independence of the audit would not be compromised. Consequently, the committee approved an extension of up to one year. Ernst and Young will work on succession plans to identify a partner to take over after 2020. 46 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: AUDIT AND RISK COMMITTEE REPORT Financial statements During the year we met with the Chief Financial Ofﬁcer (“CFO”), wider ﬁnance team and the independent external auditor to agree the scope of the 2019 audit plan. We also reviewed and approved the FY 2018 ﬁnancial statements, the FY 2019 interim statements, the FY 2016 and FY 2017 ﬁnancial statements audited under U.S. PCAOB standards and the proforma consolidated combined ﬁnancial statements for FY 2017 and FY 2018 and H1 2019 and the proforma consolidated combined balance sheets as at June 30, 2018 and December 31, 2018. As a dual-listed organization, the Company has reporting requirements in both the U.K. and U.S. Throughout the year, the ARC has monitored the progress made by the Company to ensure those reporting requirements are met on a timely basis through holding regular discussions with the CFO and wider ﬁnance team as well as reviewing internal action plans. As part of our review of the ﬁnancial statements for the current accounting period, the ARC considered and approved existing and new accounting policies as well as updated judgments and estimates. Speciﬁcally, we considered: • • • • The sufﬁciency and adequacy of disclosures made by management with respect to the Group’s liquidity and funding position as at the date of this report. The acquisition of OncoMed in April 2019 which required the Company to account for a transaction for the ﬁrst time under IFRS 3 (Business Combinations). As part of the review of the proposed accounting treatment, the ARC challenged the assumptions made by management within the purchase price allocation (“PPA”) assessment and other considerations made throughout the one-year measurement period within which certain changes to the PPA are permissible. The adoption of IFRS 16 (Leases), effective January 1, 2019. The adoption of this new standard had a material impact on the statement of ﬁnancial position as it established a right-of-use asset offset by a lease liability whereas previously no such asset or liability was recognized under IAS 17 (Leases). The materiality of IFRS 16 (Leases) was further impacted by the acquisition of OncoMed through which the Group acquired an operating lease over OncoMed’s operational facility in Redwood City, California. Management’s impairment assessment, which is required annually under IAS 36 (Impairment of Assets) given all intangible assets held by the Group, are not yet amortized as they remain under development. As part of our review of the impairment assessment, the ARC understood the rationale for key changes in the valuation methodology and inputs used in determining the recoverable value of the respective intangible assets. Internal controls The Board and ARC are responsible for ensuring systems of internal control are appropriate and hold ultimate responsibility for reviewing their effectiveness. The internal controls are designed to manage rather than eliminate risk and provide reasonable but not absolute assurance against material misstatement or loss. The Board and ARC review the effectiveness of these systems annually by considering the risks potentially affecting the Group. Following the listing on the Nasdaq Global Market in April 2019, the Group is required by December 31, 2019, to adhere to Section 404(a) of the Sarbanes-Oxley Act of 2002 which holds management responsible for establishing and maintaining adequate internal controls and ﬁnancial reporting procedures. As an Emerging Growth Company (“EGC”), as deﬁned in the Jumpstart Our Business Start-Ups Act of 2012, our independent external auditor is not required to attest our assessment of internal control. This exemption will be lost either when the Group fails to qualify as an EGC, or at the conclusion of the ﬁnancial year ended December 31, 2014, whichever occurs earlier. 47 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: AUDIT AND RISK COMMITTEE REPORT During the year the ARC noted that the Company: • • • • Appointed an experienced individual within the ﬁnance team to hold internal responsibility for the transition to compliance with Section 404(a) requirements; Established a Risk and Control Matrix (“RACM”) which was reviewed by the ARC. The RACM establishes baseline controls across the Group’s ﬁnancial processes with consideration for differences in practice following the acquisition of OncoMed; Documented a full assessment of identiﬁed control deﬁciencies relating to control design and operating effectiveness which included, where relevant, the measures taken by management to mitigate the deﬁciency. The assessment was reviewed and approved by the ARC; and Engaged a third party to independently validate key evaluations by management with respect to design and operating effectiveness testing performed during the year. At each meeting of the ARC throughout 2019, the CFO and wider ﬁnance team provided the ARC with a status update of the roll-out and implementation of the RACM and other control procedures to ensure attestation under Section 404(a) of the Sarbanes-Oxley Act of 2002 can be provided. The ARC considers that in 2019 the Company had an effective internal control environment during the year. This consideration is based on a detailed testing plan which considered the design and operating effectiveness of internal control and a completed assessment of the severity and subsequent mitigation of control deﬁciencies identiﬁed during the year. At present, the ARC does not consider it necessary for the Group to have an internal audit function due to the small size of the ﬁnance function. This need will be evaluated annually. Treasury management During the year we reviewed the treasury management policy and procedures to ensure that the oversight of cash balances and the translation of currencies were appropriate for the business needs. We have ensured that appropriate levels of foreign currency cash balances are held to meet business requirements and appropriate policies are in place in respect of the investment of cash balances surplus to immediate working capital requirements. Risk management During the year we agreed the principal risks in the business and reviewed a number of principal risk mitigation plans presented by individual risk owners. Principal risks identiﬁed are set out in the Strategic Report on pages 20 to 34. Paul Blackburn Chairman of the Audit and Risk Committee June 15, 2020 48 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: LETTER Dear Shareholder, Introduction As Chair of the Remuneration Committee (the “Committee”), I am pleased to present, on behalf of the Board of Directors of Mereo BioPharma Group plc (the “Company”) the ﬁrst Directors’ Remuneration Report for the year ended December 31, 2019 (the “Report”). The requirement to prepare this report follows the Company’s listing in the U.S. on the Nasdaq Global Market in April 2019. This Report will be subject to an advisory vote and our Remuneration Policy (the “Policy”) will be subject to a binding vote under resolutions to be proposed at a general meeting of the Company to be convened later this year (“the General Meeting”). The outcome of these votes will be considered carefully by the Committee in the formulation and approval of the Company’s future remuneration strategy. Remuneration policy This is the ﬁrst year that the Company has been required to put the Policy to shareholders for approval. The Policy is set out in full within this Report and will be proposed at a General Meeting of the Company, a notice of which will be sent out in due course setting out the time, date and location of such General Meeting, together with resolutions to be proposed at such meeting. The Committee considers that the Policy provides a fair basis for the remuneration of Executive Directors, rewarding performance against short-term objectives which provide the foundations for the achievement of longer-term corporate goals. In addition, the Policy allows for the use of equity incentives to encourage longer-term commitment and sustainable performance. The Committee has also considered Non-Executive Directors within the Policy and considers that the current remuneration strategy provides an appropriate level of remuneration for their services. Key decision and activities in the year ended December 31, 2019 Since January 1, 2019, the Committee has undertaken the following key decisions and activities: • • • • • • In the ﬁrst half of the year, we engaged an external consultant to support the Committee to conduct a benchmarking exercise over the remuneration structure and strategy following completion of the Company’s acquisition of OncoMed Pharmaceuticals, Inc. (“OncoMed”) and the Company’s subsequent U.S. listing on the Nasdaq Global Market. This benchmarking exercise covered both Executive and Non- Executive Directors and considered a comparator group of companies that were at a similar development stage to Mereo and that had a range of market capitalisations. The comparator group also included companies with dual listings (London and the U.S.) and market capitalisation similar to that of Mereo. The overall conclusion from the benchmarking exercise was that the remuneration structure is in line with the increased size and complexity of the Group and that the remuneration strategy is aligned to the Group’s industry and location; Adopted a new equity incentive award plan for both employees (including Executive Directors) and Non- Executive Directors. The new equity incentive award plan allows the Committee to grant equity-based incentive awards to eligible individuals in order to retain, recruit and reward the workforce required to create sustainable growth and progress the development of our products; Awarded both employees (including Executive Directors) and Non-Executive Directors with market value share options under the newly adopted equity incentive award plan; Considered, reviewed and approved the short-term objectives for the annual bonus for the ﬁnancial year ended December 31, 2019 for the Executive Directors; Assessed performance against the short-term objectives established for the ﬁnancial year ended December 31, 2019 for the Executive Directors. The Committee approved the level of bonuses to be paid to the Executive Directors and other Executive Ofﬁcers, determined according to performance against the short-term annual objectives. Such amounts are included as a liability within ﬁnancial statements for the year ending December 31, 2019; and Considered and agreed the short-term objectives for the annual bonus for the ﬁnancial year ending December 31, 2020 for the Executive Directors. 49 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: LETTER Achievements The Policy for the remuneration of the Executive Directors ensures that variable incentives are structured to align with the achievement of both short-term and long-term corporate objectives to deliver sustainable growth and value. During the 2019 performance period, the performance of our Executive Directors and employees was evaluated against the criteria set at the start of the ﬁnancial year, which outlined the relevant objectives to be met. The Committee considers that the Company has made substantial progress and delivered on many operational objectives during the performance period, reflective of the dedication, hard work and support provided by the Company’s employees. Key achievements during the 2019 performance period include: • • • • Progressed activities to deliver positive data readouts on the Setrusumab Phase 2b clinical trial in adults. Whilst the primary endpoint from the Phase 2b trial was not met, the secondary endpoint was achieved and the topline 12-month results from the study demonstrated a clear, dose-dependent, statistically signiﬁcant bone-building effect of Setrusumab and supported further progression into Phase 3. Alongside this positive data readout, the management team and wider employee base have further progressed the late-stage development and commercialisation plans for this product candidate. On Acumapimod, a successful End of Phase 2 meeting with the U.S. FDA was held in April 2019 which provided the outline for pivotal trial design for the drug in patients with acute exacerbations of chronic obstructive pulmonary disease (“AECOPD”). On Navicixizumab (“Navi”), a successful Type B meeting was held with the U.S. FDA in July 2019 which outlined an accelerated approval pathway for Navi in patients with advanced ovarian cancer. In addition, the Company received U.S. FDA Fast Track designation for the treatment of patients with heavily pre- treated ovarian cancer. Subsequent to the year end, a global license agreement was signed with Oncologie, Inc. (“Oncologie”) for the development and commercialization of Navi. Following the Company’s acquisition of OncoMed in April 2019, we have successfully integrated a new business into Mereo which included the retention of a number of employees who continue to deliver on our ongoing development programmes. In addition, the Company is now listed on the Nasdaq Global Market and has delivered its ﬁrst ﬁnancial year as dual-listed company. Subsequent to the 2019 performance period, the Company announced positive feedback following a successful Type B End-of-Phase 2 meeting with the U.S. FDA with an outline of the pivotal Phase 3 pediatric study design for setrusumab in OI patients. This combined with the previously approved E.U. Pediatric Investigational Plan (“PIP”) allows a single global Phase 3 study. Whilst this event falls outside the 2019 performance period, it nonetheless provides testament to the success and achievements of the Executive Directors and employees. With consideration for the achievement of objectives during the performance period, the Committee has decided to award both Executive Directors a bonus which will pay out at 75% of annual base salary. The maximum potential pay out of 100% of annual base salary was not met, because certain objectives, related to a clinical milestone for the ongoing Phase 2 study of alvelestat in alpha-1 antitrypsin deﬁciency (“AATD”) and a speciﬁc corporate development target relating to acumapimod, were either not met or not fully achieved during the performance period. As the bonuses are now approved, such amounts are included as a liability within ﬁnancial statements for the year ending December 31, 2019. The level of pay out achieved is the result of strong performance against the short-term objectives, which were considered, reviewed and approved by the Committee at the start of the 2019 performance period. Further details are discussed within this Report. During the 2019 performance period no long-term incentives with performance conditions were awarded to Executive Directors. Termination arrangements for Richard Jones (Chief Financial Ofﬁcer) In March 2020 we announced that Richard Jones had informed the Board of his intention to leave the Company to pursue other opportunities. It is anticipated that Richard will leave the Board and the Company no later than early September 2020. 50 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: LETTER In light of Richard’s contribution to the Company over the last three years, the Committee has exercised its discretion to award him a reduced bonus payment in respect of his services which is due to be paid out in the current year. Payment of this bonus is subject to certain conditions to be achieved prior to Richard’s departure. The Committee has also exercised its discretion to allow exercise of Richard’s share options held under The Mereo BioPharma Group plc Share Option Plan and the 2019 EIP for a period of two years following his departure in light of Richard’s contribution to the Company over the last three years including over his notice period. All other unvested long-term incentives at the point of departure will lapse. Corporate Governance Mereo is a dual-listed Company whose shares are traded on the AIM Market of the London Stock Exchange (“AIM”) and Nasdaq Global Market. Therefore, we are subject to corporate governance standards and regulations applicable in both the U.S. and U.K. It is the Committee’s belief that the Policy ensures relevant corporate governance standards and regulations with regard to ensuring that remuneration practices are met. The Committee comprises three members who are all independent Non-Executive Directors under the Corporate Governance Code as published by the Quoted Companies Alliance (the “QCA Code”), under U.S. securities laws and Nasdaq listing rules. Summary The Committee believes that this Report and the Policy contained within the Report provides a remuneration philosophy that encourages both Executive and Non-Executive Directors to serve in the best interests of the Company to support the delivery of value to shareholders in the future in a sustainable way. Further, the Committee trusts that the both the Report and the Policy is helpful and looks forward to the Company’s General Meeting where we hope to have your support. Yours sincerely, Peter Bains Chair of the Remuneration Committee June 15, 2020 51 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY The following section of this Report describes the formal remuneration policy applying to the Company’s Executive and Non-Executive Directors. This Policy will be put to a binding shareholder vote at the Company’s General Meeting, and if approved, will become effective from the date of such General Meeting It is intended that the Policy will remain in place for a period of three years, unless the Remuneration Committee (the “Committee”) determines that it is necessary to seek approval for an amended Policy during that period. The Policy, which is maintained by the Committee, is designed to: • • • • Attract, retain and motivate outstanding individuals who have the potential to support the growth of the Company and to attract and retain Non-Executive Directors who can substantially contribute to our success; Align Executive Directors’ incentives with shareholder value creation; Tie short- and long-term cash and equity incentives to the achievement of measurable corporate objectives; and Consider practices for comparable companies that are dual-listed in the U.K. and U.S. 1.1 Remuneration policy table – Executive Directors The total remuneration for Executive Directors is made up of the following elements: • • • • • Base salary; Beneﬁts; Pension; Annual bonus (short-term beneﬁt); Equity incentives (long-term beneﬁt). The following section of this report describes the formal remuneration policy applying to the Company’s Executive Directors: Base salary Purpose and link to strategy Provides a core level of reward for the completion of duties by the Executive Directors. Set at a level to attract and retain employees of a sufﬁcient calibre to drive the Company’s success, taking into account the global nature of the business and the key talent markets (including the U.K. and U.S.) in which we must compete. Maximum opportunity There is no maximum salary limit. When considering salary levels, the Committee will consider the speciﬁc nature and responsibilities of the role held by the Executive Director, the capabilities and experience of the individual, as well as pay levels in the wider market. Operation Salaries are typically reviewed annually, with any increases normally taking effect from 1 January. When awarding salary increases, the Committee will consider the level of increase proposed for the wider workforce, as well as employee pay conditions more broadly and inflation. Where there has been a change in the role, or if the individual is new to the role, increases could be higher. The Committee retains discretion to retrospectively increase salaries for Executive Directors. Performance framework A broad assessment of individual and corporate performance is considered as part of the annual review process. 52 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY Beneﬁts Purpose and link to strategy Provides market-competitive and cost-effective employment beneﬁts Maximum opportunity There is no formal maximum limit as the value of insured beneﬁts will vary from year-to-year based on the cost quoted by third party providers. Operation For Executive Directors, this includes private medical insurance and life insurance. Other employment beneﬁts may be provided from time to time on similar terms as those of other employees. In the event that an Executive Director is required to relocate, reasonable expenses or an allowance may be payable. Any reasonable business-related expenses can be reimbursed, including tax Performance framework Not applicable. thereon. Pension Purpose and link to strategy Provides employees with long-term savings for their future. Maximum opportunity The Company operates a deﬁned contribution pension plan and has a policy of encouraging all employees to plan responsibly for their retirement, including the Executive Directors. The policy also complies with the provisions of auto-enrolment. The Company makes payments of 15% of basic salary for the Chief Executive Ofﬁcer and 10% of basic salary for the Chief Financial Ofﬁcer into any pension scheme or similar arrangement as the individual may reasonably request (or a payment in lieu). Such payments are not counted for the purposes of determining bonuses. Operation Payments are made directly to a nominated pension scheme or, where payments are made in cash, delivered monthly through payroll. Only base salary is pensionable. Performance framework Not applicable. Annual bonus (short-term beneﬁt) Purpose and link to strategy To focus attention on the achievement of short-term corporate objectives and incentivize successful delivery of the Company’s strategic goals. Further, the annual bonus creates a tangible link between annual performance and individual pay opportunity. Maximum opportunity Executive Directors are eligible for a maximum annual bonus of 100% of base salary per annum. The Committee will determine an appropriate award size each year within this parameter based on achievement against annual performance. Operation Annual performance is measured through short-term corporate objectives which are set at the start of each year and reflect the key milestones and other objectives for that year that make progress towards the Company’s strategic goals. The target annual cash bonus is based on a percentage of salary and is payable in cash after the award has been approved by the Committee, usually at the end of the ﬁnancial year. 53 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY Under the Deferred Bonus Plan (“2019 DBSP”), 100% of the annual bonus is paid in cash, of which 30% net of amounts granted to executive ofﬁcers (after deduction of income tax and the relevant employee’s national insurance contributions) is normally required to be utilized by the executive to acquire Mereo shares in the open market within 12 months of the grant of the award. Performance framework Short-term corporate objectives are set annually and approved by the Committee. In any given year they typically include targets relating to clinical development, corporate development, ﬁnance, manufacturing and intellectual property / legal. Once set, short-term corporate objectives can be revised during the performance period but require pre-approval by the Committee. In accordance with the regulations, any changes would be disclosed in the relevant year’s report and accounts. At the end of the performance period (typically the end of a ﬁnancial year) short-term corporate objectives are reviewed and their achievement is evaluated by the Committee. Short-term corporate objectives can be fully achieved, partially achieved or lapse under poor performance. Once the evaluation is complete, an overall proposal of bonus payment (against a maximum annual bonus of 100% of base salary per annum) is approved by the Committee. The minimum potential level of bonus opportunity is 0% of the maximum. Equity incentives (long-term beneﬁt) Purpose and link to strategy Historically, equity incentive awards have been granted to Executive Directors under The Mereo 2015 Plan (the “2015 Plan”), the Mereo BioPharma Group plc Share Option Plan (the “Share Option Plan”) and, following the IPO on the AIM Market of the London Stock Exchange (“AIM”), a long-term incentive plan (the “LTIP”). Following the implementation of the 2019 Equity Incentive Plan (the “2019 EIP”), equity incentive awards from the start of 2019 are granted to Executive Directors under the 2019 EIP. The Committee envisages further grants under the 2019 EIP to motivate and reward employees, including Executive Directors, to perform at the highest level and to further the best interest of the Company and its shareholders. In addition, the 2019 EIP is designed to align the interests of Executive Directors with those of shareholders and also encourage retention, as the beneﬁts accrue over a period of years. The Committee does not anticipate further issuances of other types of equity incentive awards but reserves the right to make such awards. Maximum opportunity There is no maximum opportunity under the 2019 EIP. However, the Committee will generally work within the benchmarking guidelines provided by our external compensation consultants. Operation The 2019 EIP provides for the grant of market value options, share appreciation rights, restricted stock unit awards, performance awards (subject to performance conditions) and other share-based awards. Further, subject to the terms of the award agreement, awards can be granted in respect of ordinary shares, American Depository Shares (“ADSs”), cash or a combination thereof. 54 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY Awards vest in accordance with the vesting schedule set for the relevant award in its award agreement. The Committee maintains discretion over the type and terms of equity awards granted. The 2019 EIP is administered by the Committee. The Board may also choose to administer the 2019 EIP itself. Performance framework In the determination of the award agreement, the Committee will select the most appropriate form of award to be granted. Rights, payments and beneﬁts which accrue to Executive Directors under the 2019 EIP are subject to repayment or to recoupment (“clawback”) by the Company in accordance with policies and procedures that the Committee or Board may adopt from time to time. 1.2 Remuneration policy table – Non-Executive Directors The total remuneration for Non-Executive Directors is made up of the following elements: • • Fees; and Equity incentives (long-term beneﬁt). The following section of this report describes the formal remuneration policy applying to the Company’s Non-Executive Directors: Fees Purpose and link to strategy Supports the recruitment and retention of Non-Executive Directors with the required skills and experience to support the growth of the Company. Maximum opportunity Aggregate fees are subject to the amount per the letter of appointment with the Non-Executive Director, subject to periodic review by the Board of Directors. Non-Executive Directors are excluded from any discussions relating to their own fees. Operation Non-Executive Directors receive a base fee for performance of their duties. The Company may also pay additional fees in recognition of any additional responsibilities. Fees paid to Non-Executive Directors are reviewed on a regular basis with reference to pay levels in relevant markets, taking into account the speciﬁc roles and responsibilities, as well as expected time commitment. The Company reserves the right to pay additional fees in any given year to reflect a material, but temporary, increase in time commitment during the period. Any reasonable business-related expenses may be reimbursed, including any taxes payable thereon if determined to be a taxable beneﬁt. Business- related expenses are only reimbursable where they relate to the Non- Executive Directors’ discharge of responsibilities in relation to the Company. Performance framework Not applicable. 55 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY Equity incentives (long-term beneﬁt) Purpose and link to strategy Historically, equity incentive awards have been granted to Non-Executive Directors under The Mereo 2015 Plan (the “2015 Plan”). Following the implementation of the 2019 Non-Executive Director Equity Incentive Plan (the “2019 NED EIP”), equity incentive awards from the start of 2019 are granted to Non-Executive Directors under the 2019 NED EIP. The Committee envisages further grants under the 2019 NED EIP to facilitate share ownership by Non-Executive Directors in the Company. Maximum opportunity There is no maximum opportunity under the 2019 NED EIP. However, the Committee will generally work within the benchmarking guidelines provided by our external compensation consultants. Operation The 2019 NED EIP provides for the grant of market value options, share appreciation rights, restricted stock unit awards, performance awards (subject to performance conditions) and other share-based awards. Further, subject to the terms of the award agreement, awards can be granted in respect of ordinary shares, ADSs, cash or a combination thereof. However, performance awards (subject to performance conditions) are not intended to be issued to Non-Executive Directors. Awards vest in accordance with the vesting schedule set for the relevant award in its award agreement. The Committee maintains discretion over the type and terms of equity awards granted. The 2019 NED EIP is administered by the Committee. The Board may also choose to administer the 2019 NED EIP itself. Performance framework In the determination of the award agreement, the Committee will select the most appropriate form of award to be granted. Rights, payments and beneﬁts which accrue to Non-Executive Directors under the 2019 NED EIP are subject to repayment or to recoupment (“clawback”) by the Company in accordance with policies and procedures that the Committee or Board may adopt from time to time. Notes to the Remuneration Policy tables Legacy arrangements For the duration of this Remuneration Policy, the Company will honour any commitments made in respect of current or former Directors before the date on which either: (i) the Remuneration Policy becomes effective; or (ii) an individual becomes a Director, even where not consistent with the Remuneration Policy set out in this report or prevailing at the time such commitment is fulﬁlled. Through approval of this Remuneration Policy, approval is given to the Company to honour any such commitments. Details of any legacy arrangements made outside this Policy will be disclosed in future Directors’ Remuneration Reports as and when they arise. Performance conditions The Committee’s discretion over the determination, review and appraisal of short-term objectives linked to the annual bonus reflects the Committee’s belief that any incentive-based remuneration should be appropriately challenging and tied to the delivery of key ﬁnancial and strategic targets intended to ensure that Executive Directors are incentivized to deliver across a range of objectives for which they are accountable. The Committee has retained some flexibility on the speciﬁc measures that will be used to ensure that any measures are fully aligned with the strategic imperatives prevailing at the time they are set. 56 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY The targets for the bonus scheme for the forthcoming year will be set out in general terms, subject to limitations with regards to commercial sensitivity. Short-term corporate objectives in any given year typically include targets relating to clinical development, corporate development, commercial planning, ﬁnance, manufacturing and intellectual property / legal. The Committee will determine appropriate performance conditions for EIP awards granted to Executive Directors at the time each EIP award grant is made. With respect to the 2019 performance period, no EIP awards granted to Executive Directors had performance conditions attached. As at December 31, 2019, the only equity incentive awards outstanding subject to performance conditions are the Long-Term Incentive Plan (“LTIP”) awards granted to the Chief Executive Ofﬁcer and Chief Financial Ofﬁcer in 2016 and 2017 respectively. 1.3 Committee discretion in operation of variable pay schemes The Committee operates under the powers it has been delegated by the Board. In addition, it complies with rules that are either subject to shareholder approval or by approval from the Board. These rules provide the Committee with certain discretions which serve to ensure that the implementation of the Policy is fair and in the interests of shareholders. To ensure the efﬁcient administration of the variable pay schemes outlined above, the Committee will apply certain operational discretions. These operational discretions include the following: i. ii. iii. iv. v. The eligibility of participants to participate in variable pay schemes operated by the Company; The timing of grant of awards and relevant payments made relating to variable pay schemes; The size of awards and payments (subject to maximum limits set out in the respective plan rules); The determination of whether any performance conditions have been met relating to variable pay schemes with a performance condition; Discretion to override formulaic outcomes of incentive schemes where the payment would otherwise be inappropriate; vi. Determination of whether an employee is to be considered a ‘good’ or ‘bad’ leaver for the purposes of exit payments made under this Policy and the relevant terms of any variable pay schemes; vii. Whether recovery and / or withholding shall be applied to any award and, if so, the extent to which they shall apply; viii. Adjustments required in certain capital events such as rights issues, corporate restructuring, other events and special dividends; and ix. The setting and annual review of short-term corporate objectives. The Committee also retains the ability to adjust the targets (up or down) and / or set different measures and alter weightings for the annual bonus plan and to adjust targets for the bonus if events occur (e.g., material divestment of a Group business or events relating to the Company’s issued share capital) which cause it to determine that the conditions are no longer appropriate in the circumstances and the amendment is required so that the conditions achieve their original purpose and are not, in the opinion of the Committee, materially more or less challenging to satisfy in the circumstances. 1.4 Shareholder and other stakeholder views The Board is committed to dialogue with shareholders. The Committee will consider shareholder feedback received following the General Meeting, as well as any additional feedback and guidance received from time to time. This feedback will be considered by the Committee as it develops the Company’s remuneration framework and practices going forward. The Committee’s independent advisor actively monitors developments within comparator companies and provides feedback to the Committee. Where relevant, such developments are considered in the structure of remuneration for both Executive Directors and Non-Executive Directors. 57 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY The Company operates a coherent approach to remuneration across the organisation. Annual bonuses for Executive Directors are subject to the same performance criteria as all employees in the bonus scheme, with additional personal objectives set for other participants where relevant. Employees are also eligible to participate in the equity incentive awards, to encourage broad employee share ownership and alignment with the Company’s success. Although the Committee does not consult with employees directly, it is appraised of any decisions relating to pay for the broader workforce and will consider pay conditions throughout the Group when making decisions on Executive Directors’ remuneration. 1.5 Executive Directors’ service agreements and payments for loss of ofﬁce Executive Directors are employed under rolling service agreements with a notice period of twelve months (in the case of the Chief Executive Ofﬁcer) and six months (in the case of the Chief Financial Ofﬁcer) from either party. A copy of these contracts may be viewed at the Company’s head ofﬁce or may be requested from the Company Secretary at the General Meeting. Executive Directors retire from their position upon the third AGM following the AGM at which they were elected or last re-elected. They are eligible for re-election at the AGM at which the retire. Executive Director Denise Scots-Knight Richard Jones Date of contract July 29, 2015 November 7, 2016 The Company shall be entitled at its sole and absolute discretion lawfully to terminate the employment of an Executive Director at any time and with immediate effect by written notiﬁcation to the Executive Director and pay, within one month following the date of such termination, a payment in lieu of notice. The total payment in lieu of notice will be equal to the basic salary due to the Executive Director during the notice period. In the event of a breach of service agreement or other summary termination of employment, no such payments will be made. 1.6 Non-Executive Directors’ service agreement and payments for loss of ofﬁce Each of the Non-Executive Directors is engaged under a Non-Executive Director letter of appointment. A copy of these letters of appointment may be viewed at the Company’s head ofﬁce or may be requested from the Company Secretary at the General Meeting. Non-Executive Directors retire from their position upon the third AGM following the AGM at which they were elected or last re-elected. They are eligible for re-election at the AGM at which the retire. Each Non-Executive Director appointment is terminable by either party on not less than three months written notice. Non-Executive Directors are only entitled to fees accrued to the date of termination. The dates of appointment of each of the Non-Executive Directors serving at December 31, 2019, are summarized in the table below: Non-Executive Director Dr Peter Fellner Dr Anders Ekblom Peter Bains Kunal Kashyap Paul Blackburn Michael Wyzga Dr Deepa Pakianathan Date of appointment July 29, 2015 July 29, 2015 July 29, 2015 July 29, 2015 October 6, 2015 April 23, 2019 April 23, 2019 1.7 Treatment of leavers The default treatment of outstanding incentive awards on termination of employment is described in the relevant plan rules and related policy documents, but the Committee retains the discretion to adopt any treatment that it determines fair and appropriate given the circumstances applicable to individual leavers. 58 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY Generally, in the event of termination, the Executive Directors’ service contracts may provide for payment of basic salary and beneﬁts over the notice period. The Company may elect to make a payment in lieu of notice equivalent in value to basic salary for any unexpired portion of the notice period. The notice period for exiting the Executive Directors service contract is twelve months (for the CEO) and six months (for the CFO). The Committee’s approach to payments in the event that an Executive Director’s employment is terminated is to take account of the individual circumstances, including the reason for termination, individual performance, contractual obligations and the terms of any remaining or outstanding equity awards in which the Executive Director participates. Annual bonus (short-term incentives) If an Executive Director is working a period of notice at the date any bonus is payable to the Executive Director, no bonus or pro-rata bonus is contractually payable. However, the Committee may consider a payment at its discretion in the case of good leavers. Any bonus paid to a good leaver would normally be paid in cash and would not normally be subject to the requirement that part of the proceeds are used to acquire shares. Equity awards (long-term incentives) Whether any equity awards, which are long-term incentives, would vest and be exercisable upon loss of ofﬁce would be subject to the relevant plan rules. These allow for vesting and exercise of awards in the event of death, retirement, ill-health, injury, redundancy and any other reason at the discretion of the Committee. The Committee retains discretion to determine the extent to which the award will vest, taking into consideration the circumstances. Unvested awards will normally lapse, although the Committee retains the power to determine, in accordance with the ‘good leaver’ provisions of the relevant plan rules, what proportion of unvested awards will be retained and what proportion will lapse and whether to impose or vary any conditions on vesting or exercise. In determining this, the Committee will give consideration to the reason for leaving, the extent of achievement of performance objectives at the date of leaving and may decide to time pro-rate awards. Additional payments The Committee reserves the right to make payments it considers reasonable under a compromise or settlement agreement, including payment or reimbursement of reasonable legal and professional fees, accrued holiday and any payment in respect of statutory rights under employment law in the U.K. and other jurisdictions. 1.8 Remuneration on recruitment The remuneration package for any new Executive Director will be determined by the Remuneration Committee in accordance with the terms of the Policy at the time of appointment (including salary, beneﬁts, annual bonus, long-term incentive awards and pension). It is recognized that in order to attract and recruit talented individuals the Policy needs to allow for sufﬁcient flexibility with respect to remuneration on recruitment. The following policies apply to the remuneration of recruitment of new Executive Directors: Salary Base salary levels will be set in accordance with our remuneration policy, taking into account the experience and calibre of the individual and the relevant market rates at the time of appointment. Where it is appropriate to offer a lower salary initially, progressive increases may be offered to achieve the desired salary positioning over the following years subject to individual performance and continued development in the role. Pension Pension contributions or a cash supplement up to the maximum level indicated in the policy table may be provided, although the Committee retains discretion to structure any arrangements as necessary to comply with the relevant legislation and market practice if an overseas Executive Director is appointed. 59 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY Beneﬁts Beneﬁts will be provided in line with those offered to other employees, with relocation expenses and other arrangements provided for if necessary. Should it be appropriate to recruit an Executive Director from overseas, flexibility is retained to provide beneﬁts that take account of those typically provided in their country of residence (e.g., it may be appropriate to provide beneﬁts that are tailored to the unique circumstances of such an appointment). Annual bonus (short-term incentives) In the year of appointment, the annual bonus opportunity will be the subject to the same performance conditions as offered to existing Executive Directors, pro-rated for the period of service. The Committee retains the discretion to set different performance measures, taking into account the responsibilities of the individual, and the point in the ﬁnancial year that they joined the Company. For internal appointments, annual bonuses award in respect of the prior role will be allowed to pay out according to their existing terms. In addition, any other contractual remuneration obligations existing prior to appointment may continue. Equity awards (long-term incentives) Equity awards will be granted to new Executive Directors in line with the policy outlined for existing Executive Directors. An award may be made shortly following an appointment. The Committee maintains discretion over the type and terms of equity awards granted to new Executive Directors, as well as the timing of grant. For internal appointments, existing equity awards will continue on their original terms. Buy-out awards The Committee may offer additional cash and/or share-based elements to compensate an individual for remuneration forfeited on leaving a former employer, in connection with an executive joining the company following merger and acquisition activity or for any other reason at the discretion of the Committee, if it considers these to be in the best interests of the company and its shareholders. Depending on individual circumstances at the time, the Committee has the discretion to determine the type of award (i.e., cash, shares, options, vesting and holding periods and whether or not performance conditions would apply). When exercising its discretion, the Committee will carefully consider the balance between the need to secure an individual in the best interests of the company against the concern of shareholders about the quantum of remuneration. Any use of discretion would be disclosed to shareholders if considered appropriate. Non-Executive Directors On the appointment of a new Non-Executive Director, the fees will be set taking into account the experience and calibre of the individual and the expected time commitments of the role. Equity awards will be granted to new Non-Executive Directors in line with the policy outlined for existing Non-Executive Directors. 1.9 Policy on external appointments Executive Directors may, subject to approval from the Board of Directors, accept appropriate external Non- Executive Director appointments, so long as this commitment is not thought to interfere with the business of the Company or the individual’s ability to carry out their duties. Any fees payable for such appointments may be retained by the individual. As at December 31, 2019, both Executive Directors serve as a Non-Executive Director for public companies. Dr. Denise Scots-Knight (CEO) is currently a Non-Executive Director of Elanco Animal Health Incorporated (“Elanco”) (NYSE: ELAN) and Richard Jones (CFO) is currently a Non-Executive Director of Alliance Pharma Plc (“Alliance”) (LSE: APH). 1.10 Illustration of application of the policy The charts set out for illustrative purposes only, what the annual remuneration the Company expects the Chief Executive Ofﬁcer (“CEO”) will obtain if performance levels are below threshold (minimum), meet expectations (target) or exceed the maximum targets (maximum) in the 2020 performance period. 60 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: POLICY The assumptions used in the calculations are set out below: – Minimum: ﬁxed pay; – Target: ﬁxed pay, annual bonus at threshold level (50% of annual salary) and 50% of the fair value of equity incentive awards granted in 20191; – Maximum: ﬁxed pay, annual bonus at maximum pay-out (100% of annual salary) and 100% of the fair value of equity incentive awards granted in 2019; – Maximum plus 50% share price growth scenario: For the equity incentive award this results in a lower amount than the fair value used in the maximum scenario as the fair value at maximum includes all possible future outcomes. Fixed pay comprises: – – – Salaries: salary effective as at January 1, 2020; Beneﬁts: value of all beneﬁts received in the 2019 ﬁnancial year; Pension: 15% and 10% of salary respectively for the CEO. (cid:14)(cid:13)(cid:12)(cid:11)(cid:10)(cid:9)(cid:8)(cid:7)(cid:11)(cid:6)(cid:5)(cid:4)(cid:12)(cid:3)(cid:11)(cid:9)(cid:2)(cid:10)(cid:10)(cid:12)(cid:6)(cid:11)(cid:1) (cid:3) (cid:1) (cid:2) (cid:2) (cid:2) (cid:4) (cid:5) (cid:6) (cid:12) (cid:7) (cid:8) (cid:9) (cid:10) (cid:11) (cid:15) (cid:12) (cid:13) (cid:14) (cid:15) (cid:16) (cid:31)(cid:15)(cid:12)(cid:1)(cid:11)(cid:28)(cid:28) (cid:31)(cid:15)(cid:12)(cid:1)(cid:13)(cid:28)(cid:28) (cid:31)(cid:15)(cid:12)(cid:1)(cid:28)(cid:28)(cid:28) (cid:31)(cid:15)(cid:3)(cid:28)(cid:28) (cid:31)(cid:15)(cid:2)(cid:28)(cid:28) (cid:31)(cid:15)(cid:11)(cid:28)(cid:28) (cid:31)(cid:15)(cid:13)(cid:28)(cid:28) (cid:31)(cid:15)(cid:14) (cid:13)(cid:29)(cid:27) (cid:13)(cid:5)(cid:27) (cid:29)(cid:5)(cid:27) (cid:12)(cid:28)(cid:28)(cid:27) (cid:5)(cid:5)(cid:27) (cid:5)(cid:12)(cid:27) (cid:5)(cid:2)(cid:27) (cid:5)(cid:28)(cid:27) (cid:5)(cid:13)(cid:27) (cid:5)(cid:3)(cid:27) (cid:43)(cid:42)(cid:41)(cid:42)(cid:40)(cid:39)(cid:40) (cid:38)(cid:37)(cid:36)(cid:35)(cid:34)(cid:33) (cid:43)(cid:37)(cid:32)(cid:42)(cid:40)(cid:39)(cid:40) (cid:21)(cid:20)(cid:39)(cid:42)(cid:33)(cid:19)(cid:31)(cid:42)(cid:41)(cid:23)(cid:34)(cid:41)(cid:33)(cid:42)(cid:18)(cid:34)(cid:31)(cid:37)(cid:17)(cid:37)(cid:36)(cid:16) (cid:9)(cid:41)(cid:41)(cid:39)(cid:37)(cid:8)(cid:31)(cid:7)(cid:6)(cid:41)(cid:39)(cid:26) (cid:4)(cid:42)(cid:32)(cid:34)(cid:16)(cid:31)(cid:24)(cid:37)(cid:19) (cid:15)(cid:14) (cid:15)(cid:14) (cid:15)(cid:11)(cid:29)(cid:3) (cid:15)(cid:13)(cid:12)(cid:13) (cid:15)(cid:12)(cid:10)(cid:29) (cid:15)(cid:11)(cid:29)(cid:3) (cid:15)(cid:11)(cid:13)(cid:29) (cid:15)(cid:5)(cid:10)(cid:12) (cid:15)(cid:11)(cid:29)(cid:3) (cid:43)(cid:37)(cid:32)(cid:42)(cid:40)(cid:39)(cid:40)(cid:31)(cid:30)(cid:29)(cid:28)(cid:27) (cid:26)(cid:25)(cid:37)(cid:36)(cid:34)(cid:31)(cid:24)(cid:36)(cid:42)(cid:23)(cid:34) (cid:42)(cid:41)(cid:23)(cid:36)(cid:34)(cid:37)(cid:26)(cid:34)(cid:22) (cid:15)(cid:13)(cid:10)(cid:12) (cid:15)(cid:5)(cid:10)(cid:12) (cid:15)(cid:11)(cid:29)(cid:3) (cid:1) With respect to the maximum scenario which assumes a 50% share price increase in share price, we have included an outcome for the equity incentive award which reflects the share price at the time of grant increasing by 50% over the service period. The share price at the time of grant is equal to the exercise price. 1 The Committee has not determined a set number of equity incentive awards to be granted to the CEO in the 2020 performance period, nor is there a guided minimum or maximum level of equity incentive awards issuable. Therefore, for the purposes of this illustrative disclosure, the fair value of equity incentive awards granted in 2019 has been used a guide. 61 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT 2.1 Single total ﬁgure of remuneration of each Director (audited) The Directors proportion of ﬁxed and variable remuneration is shown in the below table for the years ended December 31, 2019 and 2018. Fixed remuneration is the sum of salary, taxable beneﬁts and pension (columns a, b and e of the single total ﬁgure table). Variable remuneration is the sum of any annual bonus, share options or other types of remuneration (columns c, d and other of the single total ﬁgure table). Year Ended (a) (b) December 31, 2019 Salary/fees Beneﬁts (i) Variable Fixed remuneration (c, d (d) Share Other remuneration and other) (c) Bonus options (v) (e) Pensions (ii)/(iii) 2019 Total (a, b and e) (in £) Executive Dr. Denise 718,054 Scots-Knight 390,988 8,497 Richard Jones 291,200 8,168 133,513 ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– 293,241 – 58,648 424,813 1,176,187 458,133 – – 29,120 133,513 462,001 328,488 Non-Executive 26,703 Dr. Peter Fellner 100,000 – 26,703 Dr. Anders Ekblom 48,000 – 26,703 Peter Bains 46,667 — 26,703 Kunal Kashyap 40,000 – 26,703 Paul Blackburn 48,000 – 26,703 Michael Wyzga (1) 27,590 – 26,703 Dr. Deepa Pakianathan (1) 30,349 – Dr. Frank Armstrong (2) 19,959 – – ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– – – – 26,703 126,703 100,000 – – – 26,703 74,703 48,000 – – – 26,703 73,370 46,667 – – – 26,703 66,703 40,000 – – – 26,703 74,703 48,000 – – – 26,703 54,293 27,590 – – – 26,703 57,052 30,349 – – – – 19,959 19,959 (1) Michael Wyzga and Dr. Deepa Pakianathan were appointed on April 23, 2019 (2) Dr. Frank Armstrong resigned on February 8, 2019 Year Ended (a) (b) December 31, 2018 Salary/fees Beneﬁts (i) Variable Fixed remuneration (c, d (d) Share Other remuneration and other) (c) Bonus options (v) (e) Pensions (iv) 2018 Total (a, b and e) (in £) Executive 408,021 Dr. Denise Scots-Knight 379,600 7,620 Richard Jones 260,000 7,481 279,446 ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– 303,680 – 59,640 – 854,881 446,860 208,000 – 26,000 – 572,927 293,481 Non-Executive – Dr. Peter Fellner 100,000 – – Dr. Anders Ekblom 48,000 – – Peter Bains 44,000 — – Kunal Kashyap 40,000 – – Paul Blackburn 48,000 – Dr. Frank Armstrong 56,000 – – ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– – – – – 100,000 100,000 – – – – 48,000 48,000 – – – – 44,000 44,000 – – – – 40,000 40,000 – – – – 48,000 48,000 – – – – 56,000 56,000 Beneﬁts represent private medical insurance during the years ended December 31, 2019 and 2018. (i) (ii) During the year ended December 31, 2019, market value options were granted as an equity incentive award to both Executive Directors. The market value options do not have performance conditions and are therefore presented as other variable remuneration. The value of the market value options granted to both Executive Directors included in the single ﬁgure table is the grant date fair value as computed in accordance with IFRS 2 (Share Based Payments) using a Black-Scholes option pricing model. No outstanding equity incentive awards with performance conditions vested during the year ended December 31, 2019. (iii) During the year ended December 31, 2019, other share-based awards were granted as an equity incentive award to Non-Executive Directors. The other share-based awards do not have performance conditions and are therefore presented as other variable remuneration. The value of the other share-based awards granted to Non-Executive Directors included in the single ﬁgure table is the grant date fair value as computed in accordance with IFRS 2 (Share Based Payments) using a Black-Scholes option pricing model. (iv) During the year ended December 31, 2018, no equity incentive awards were granted to Executive or Non-Executive Directors. No outstanding equity incentive awards with performance conditions vested during the year ended December 31, 2018. (v) During the years ended December 31, 2019 and 2018, no equity incentive awards with performance conditions or measures were granted or vested. Annual performance bonus The Company has a discretionary bonus scheme for all employees and the Executive Directors. Bonus payments for employees are a percentage of base salary based on performance-based measures against personal and Company-wide target objectives. Bonus payments for Executive Directors are a percentage of base salary, based on performance-based measures against Company-wide target objectives. 62 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT For the 2019 performance period the CEO was entitled to an annual performance bonus of 100% of base salary. The agreed Company wide target objectives were met at 75%, meaning the bonus pay-out for the 2019 performance period will be 75% of the base salary for the CEO. As a result of his departure, Richard Jones is not automatically eligible to receive a bonus in respect of 2019. In light of his contribution and performance over the past three years, the Committee has exercised its discretion to award Richard Jones a bonus of £100,000. This bonus will be payable in instalments in the current year, subject to certain additional conditions which are disclosed later in this report. The bonus will be paid in cash and not subject to a requirement to purchase shares out of the proceeds of the bonus. This amount is not included within the single total ﬁgure of remuneration table, disclosed above, as it is not considered to be a form of remuneration directly attributable to the 2019 performance period. Non-Executive Directors are not entitled to a bonus payment. The annual performance bonus for 2019 was paid in June 2020. Speciﬁc details of the actual Company wide target objectives are considered commercially sensitive and therefore not disclosed in detail. However, the objectives used to measure the performance of the Executive Directors included the following: – – – – Clinical milestone targets relating to products under development; Corporate-related objectives (including the successful integration of OncoMed); Corporate development targets; and Financial goals. From January 1, 2018, under the new Deferred Bonus Plan (“2019 DBP”), 100% of the annual bonus is paid in cash, of which 30% of amounts granted to Executive Directors (after deduction of income tax and the relevant employee’s national insurance contributions) is required to be utilized to acquire shares in the Company in the open market within 12 months of the grant of the award. With respect to the 2018 performance period, Executive Directors have satisﬁed the condition to acquire shares under the 2019 DBP. Executive Directors are required to hold the shares purchased subject to the 2019 DBP for a period of two years from the date of purchase. With respect to the 2019 performance period, the Committee has not yet ﬁnalized the conditions relating to the annual bonus and the 2019 DBP for Dr. Denise Scots-Knight. Prior to January 1, 2018, under the old Deferred Bonus Share Plan (“DBSP”), 30% of the annual bonus awarded to Executive Directors was deferred into rights to acquire shares equal in value to the amount deferred, free of charge. The DBSP vests three years after the date of grant with no performance conditions nor any service conditions attached (including no requirement for continued employment once the awards have been made). Long-term incentive awards during the ﬁnancial year (audited) Directors may be granted long-term incentive awards at the discretion of the Committee. During the year ended December 31, 2019: – – Both Executive Directors were awarded options under the Company’s 2019 Equity Incentive Plan (“EIP”) to subscribe for market value options over a four-year vesting period. The awards vest 25% after one year and in 36 equal monthly instalments thereafter. The options awarded under the EIP were in respect of ADSs and do not have performance conditions. All Non-Executive Directors were awarded options under the Company’s 2019 Non-Executive Director Equity Incentive Plan (“NED EIP”) to subscribe for other-share based awards over a one-year vesting period. The awards vest monthly over an annual period from the grant date. The other-share based awards granted under the NED EIP were in respect of ADSs and do not have performance conditions. All awards granted under the EIP and NED EIP during the year ended December 31, 2019, are subject to a service condition and may be exercised at any time between the relevant vesting date and the tenth anniversary of the date of grant. Awards which do not vest at the end of the vesting period will lapse permanently. 63 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT As at December 31, 2018, both Executive Directors and Non-Executive Directors had outstanding long-term incentive awards under the following equity award plans: Equity award plan Granted to Vesting condition The Mereo 2015 Plan (the “2015 Plan”) Executive Directors Service only Non-Executive Directors The Mereo BioPharma Group Executive Directors Service only lc Share Option Plan Non-Executive Directors (the “Share Option Plan”) Long-term incentive plan (“LTIP”) Executive Directors Performance conditions linked to share price appreciation and strategic objectives Deferred Bonus Share Plan (“DBSP”) Executive Directors No vesting conditions All equity award plans granted prior to December 31, 2018 were in respect of ordinary shares. Awards granted during the year to December 31, 2019 (audited) During the year to December 31, 2019, Executive Directors were granted options under the Company’s 2019 EIP, those awards vest based on continued employment only with no performance conditions. The awards vest 25% after one year and in 36 equal monthly instalments thereafter. Director Dr. Denise Scots-Knight Richard Jones Grant date May 20, 2019 July 23, 2019 May 20, 2019 July 23, 2019 ADSs Underlying Grant 87,500 87,500 27,500 27,500 Exercise Price per ADS ($) Face value ($) Expiration Date 5.40 3.00 5.40 3.00 472,500 May 20, 2029 262,500 July 23, 2029 148,500 May 20, 2029 July 23, 2029 82,500 During the year to December 31, 2019, Non-Executive Directors were granted other share-based awards under the Company’s 2019 NED EIP, those awards vest based on continued service only with no performance conditions. The awards vest monthly over an annual period from the grant date. Director Peter Fellner Peter Bains Paul Blackburn Dr. Anders Ekblom Kunal Kashyap Dr. Deepa Pakianathan Michael Wyzga Grant date May 20, 2019 July 23, 2019 May 20, 2019 July 23, 2019 May 20, 2019 July 23, 2019 May 20, 2019 July 23, 2019 May 20, 2019 July 23, 2019 May 20, 2019 July 23, 2019 May 20, 2019 July 23, 2019 ADSs Underlying Grant Exercise Price per ADS ($) Face value ($) Expiration Date 5,500 5,500 5,500 5,500 5,500 5,500 5,500 5,500 5,500 5,500 5,500 5,500 5,500 5,500 5.40 3.00 5.40 3.00 5.40 3.00 5.40 3.00 5.40 3.00 5.40 3.00 5.40 3.00 29,700 May 20, 2029 July 23, 2029 16,500 29,700 May 20, 2029 16,500 July 23, 2029 29,700 May 20, 2029 16,500 July 23, 2029 29,700 May 20, 2029 16,500 July 23, 2029 29,700 May 20, 2029 16,500 July 23, 2029 29,700 May 20, 2029 16,500 July 23, 2029 29,700 May 20, 2029 July 23, 2029 16,500 64 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT The exercise price of all options granted during the year under the 2019 EIP and 2019 NED EIP was the market value of the shares upon closing on the day before the grant. Awards lapsed during the year to December 31, 2019 (audited) During the year to December 31, 2019, certain awards previously made to Dr. Denise Scots-Knight under the LTIP were eligible to vest, however they lapsed as they did not meet the relevant vesting criteria (a share price performance condition). The LTIP awards vest over a ﬁve-year period with 75% of the total award based upon the achievement of share price targets and 25% of the total award based upon the achievement of strategic targets. Director Form of award Grant date Options outstanding (December 31, 2018) Options lapsed Options outstanding (December 31, 2019) Dr. Denise Scots-Knight LTIP June 9, 2016 461,538 (115,385) 346,154 There were no LTIP awards granted during the year to December 31, 2019. No other awards lapsed during the year to December 31, 2019. On January 1, 2020, a further 115,383 options awarded to Dr. Denise Scots-Knight lapsed as they did not meet the relevant vesting criteria (a share price performance condition). As at the date of this Report, Dr. Denise Scots-Knight has 230,860 options outstanding under the LTIP. On the same date, 46,487 options awarded to Richard Jones lapsed as they did not meet the relevant vesting criteria (a share price performance condition). As at the date of this Report, Richard Jones has 139,463 options outstanding under the LTIP. 2.2 Payments to past Directors (audited) There were no payments to past Directors made during the ﬁnancial year ending December 31, 2019. 2.3 Payments for Loss of Ofﬁce (audited) There were no payments made to Directors for Loss of Ofﬁce during the ﬁnancial year ending December 31, 2019. In accordance with his contract and the terms agreed for his departure, Richard Jones will receive the following remuneration in 2020: • • • • • Salary, beneﬁts and pension up to the termination date; An amount in respect of accrued untaken annual leave; Payment of a bonus of £100,000, payable in three instalments on: the earlier of 15 May 2020 and the ﬁling of the Company’s Annual Report on Form 20-F; the earlier of the date of cessation and 15 June 2020; the payment of the 2019 bonuses to other executives of the Company. In light of his departure, the Committee has determined that Richard will not be required to purchase shares using the proceeds of the bonus; Vested options granted under the Share Option Plan and the 2019 EIP at the time of cessation of employment will be allowed to be exercised for a period of two years following termination in light of Richard’s contribution to the Company over the last three years including over his notice period. Richard’s other unvested share awards will lapse on cessation; and A contribution towards legal fees of £1,500. In accordance with the Companies Act, full details of these payments will be disclosed to shareholders via the Company’s website at the time Richard Jones ceases to be a Director and in next year’s remuneration report. 65 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT 2.4 Statement of Directors’ Shareholding and Share Interests (audited) The table below sets out, as at December 31, 2019, the beneﬁcial interest in the Company’s shares of the Directors (together with interests held by his or her connected persons). In addition, the table below also sets out the total number of shares held by Directors which are unvested, the total number of options held by Directors which are vested but not yet exercised and the total number of options held by Directors which are unvested. The total number of shares which are unvested are disclosed by those with and without performance conditions. Shares Vested Shares Unvested Awards Vested Unvested Beneﬁcially LTIP DBSP (Unvested, (Unvested, without with owned performance performance conditions) shares(1) conditions) 2015 Plan/ Share Option Plan (ordinary shares vested but not yet exercised) 2019 NED EIP (ADSs, vested but not yet exercised) 2019 2015 Plan (ordinary EIP/NED EIP (ADSs, unvested) shares, unvested) 935,999(2) 66,915 57,524 22,058 346,154 1,544,745 – 185,950 – – – 650,000 175,000 55,000 65,500 189,702 206,796 1,497,735 22,624 1,283,670(3) – – – – – – – – – 1,692,673 216,264 – 710,583 – 216,264 – 236,974 – – – – – 5,496 5,496 5,496 5,496 5,496 5,496 5,496 – – – – – – – 5,504 5,504 5,504 5,504 5,504 5,504 5,504 Director Executive Dr. Denise Scots-Knight Richard Jones Non-Executive Dr. Peter Fellner Dr. Anders Ekblom Peter Bains Kunal Kashyap Paul Blackburn Dr. Deepa Pakianathan Michael Wyzga Includes 6,300 ordinary shares held by Dr. Denise Scots-Knight’s husband. (1) Ordinary shares (each ADS held has been converted into ﬁve ordinary shares) (2) (3) Delphi Ventures VIII, L.P. (“Delphi VIII”) directly holds 254,327 ADSs. Delphi Bio Investments VIII, L.P. (“DBI VIII”) directly holds 2,407 ADSs. Delphi Management Partners VIII, L.L.C. (“DMP VIII”) is the general partner of Delphi VIII and DBI VIII (together, the “Delphi VIII Funds”), and may be deemed to have sole voting and dispositive power over the ADSs held by the Delphi VIII Funds. DMP VIII and each of James J. Bochnowski, David L. Douglass, Douglas A. Roeder and Deepika R. Pakianathan, Ph.D., the Managing Members of DMP VIII who may be deemed to share voting and dispositive power over the reported securities, disclaim beneﬁcial ownership of the reported securities held by the Delphi VIII Funds except to the extent of any pecuniary interest therein. The Company does not have a formal policy on Executive or Non-Executive Director shareholdings. 66 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT As at December 31, 2019, no unvested equity incentive awards are subject to performance conditions. The interests of the Directors in the Company’s share options as at December 31, 2019, is as follows: Exercise Price Ordinary Per Exercise Shares Ordinary ADSs Price Equity Underlying Share Underlying Per ADS Director Award Plan Grant (£) Grant ($) Grant Date Expiration Date Executive Dr. Denise 2015 Plan 1,544,745 1.29 – – September 25, 2015 June 9, 2016 Scots-Knight LTIP 346,154 nil – – April 4, 2017 DBSP 25,319 nil – – April 26, 2018 DBSP 32,205 nil – – May 20, 2019 2019 EIP – – 87,500 5.40 July 23,2019 2019 EIP – – 87,500 3.00 Richard Share Option Plan 650,000 3.03 – – Jones LTIP 185,950 nil – – DBSP 22,058 nil – – 2019 EIP – – 27,500 5.40 2019 EIP – – 27,500 3.00 April 4, 2017 April 4, 2017 April 26, 2018 May 20, 2019 July 23,2019 Non-Executive Peter Fellner 2015 Plan 1,692,673 1.29 – – September 29, 2015 May 20, 2019 2019 NED EIP – – 5,500 5.40 July 23,2019 2019 NED EIP – – 5,500 3.00 Peter Bains 2015 Plan 710,583 1.29 – – September 29, 2015 May 20, 2019 2019 NED EIP – – 5,500 5.40 July 23,2019 2019 NED EIP – – 5,500 3.00 Paul Blackburn 2015 Plan 236,974 1.84 – – 2019 NED EIP – – 5,500 5.40 2019 NED EIP – – 5,500 3.00 May 11, 2016 May 20, 2019 July 23,2019 Dr. Anders 2015 Plan 216,264 1.29 – – September 29, 2015 May 20, 2019 Ekblom 2019 NED EIP – – 5,500 5.40 July 23,2019 2019 NED EIP – – 5,500 3.00 Kunal Kashyap 2015 Plan 216,264 1.29 – – September 29, 2015 May 20, 2019 2019 NED EIP – – 5,500 5.40 July 23,2019 2019 NED EIP – – 5,500 3.00 Dr. Deepa 2019 NED EIP – – 5,500 5.40 Pakianathan 2019 NED EIP – – 5,500 3.00 Michael Wyzga 2019 NED EIP – – 5,500 5.40 2019 NED EIP – – 5,500 3.00 May 20, 2019 July 23,2019 May 20, 2019 July 23,2019 September 25, 2025 June 9, 2026 April 4, 2021 January 31, 2022 May 20, 2029 July 23, 2029 April 4, 2027 June 9, 2026 January 31, 2022 May 20, 2029 July 23, 2029 September 29, 2025 May 20, 2029 July 23, 2029 September 29, 2025 May 20, 2029 July 23, 2029 May 11, 2026 May 20, 2029 July 23, 2029 September 29, 2025 May 20, 2029 July 23, 2029 September 29, 2025 May 20, 2029 July 23, 2029 May 20, 2029 July 23, 2029 May 20, 2029 July 23, 2029 Executive Directors – Under the 2019 EIP, we have granted market value options to our Executive Directors. These market value options vest over four years with 25% vesting 12 months after the grant date and the balance vesting equally over the next 36 months. There are no performance conditions attached to share options granted under the 2019 EIP. Subject to the terms of the grant, awards under the 2019 EIP can be granted in respect of ordinary shares, ADSs, cash or a combination thereof. All grants to Executive Directors during the 2019 performance period were in respect of ADSs. – – Under the 2015 Plan, we have granted market value options to our Executive Directors. These market value options vest over four years with 25% vesting 12 months after the grant date and the balance vesting equally over the next 36 months. There are no performance conditions attached to share options granted under the 2015 Plan. Under the Share Option Plan, we have granted share options to our Executive Directors. These share options vest over three years. There are no performance conditions attached to share options granted under the Share Option Plan. 67 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT – – Under the DBSP, we have granted share awards to our Chief Executive Ofﬁcer. These share awards vest three years from grant date and are exercisable within one year of vesting. There are no performance conditions, nor any service conditions attached to share options granted under the DBSP. Under the LTIP, we have granted share awards to our Executive Directors. 75% of these share awards have speciﬁc performance conditions and vest depending on achieving share price appreciation relative to the share price on speciﬁed future dates against the share price at admission to the AIM Market of the London Stock Exchange (“AIM”) (75% of the grant) and the achievement of strategic operational targets (25% of the total grant). Non-Executive Directors – Under the 2015 Plan, we have granted share options to our Non-Executive Directors. These share options vested over three years from grant date in three equal annual instalments. There are no performance conditions attached to share options granted under the 2015 Plan. – Under the 2019 NED EIP, we have granted other share-based awards to our Non-Executive Directors. These other share-based awards vest in equal monthly instalments over the one-year period following their grant date. There are no performance conditions attached to the other share-based awards granted under the 2019 NED EIP. Subject to the terms of the grant, awards under the 2019 NED EIP can be granted in respect of ordinary shares, ADSs, cash or a combination thereof. All grants to Non- Executive Directors during the 2019 performance period were in respect of ADSs, however the award may be cash settled at the Company’s sole discretion. 2.5 Performance Graph and Table (audited) The graph below shows the Company’s performance, measured by total shareholder return, for U.K. ordinary shares listed on AIM Market of the London Stock Exchange (“AIM”) against the AIM All Share Index. The AIM All Share Index has been selected for this comparison because the Company has been trading on this exchange since 2016 and is therefore considered to be the most suitable comparator index. (cid:1) (cid:4) (cid:17) (cid:12) (cid:11) (cid:5) (cid:12) (cid:14) (cid:2) (cid:3) (cid:8) (cid:4) (cid:12) (cid:14) (cid:8) (cid:5) (cid:6) (cid:7) (cid:10) (cid:14) (cid:8) (cid:14) (cid:9) (cid:10) (cid:11) (cid:12) (cid:15) (cid:14) (cid:13) (cid:14) (cid:15) (cid:16) (cid:17) (cid:12) (cid:12) (cid:13)(cid:5)(cid:7)(cid:10)(cid:9)(cid:10)(cid:10) (cid:13)(cid:5)(cid:8)(cid:10)(cid:9)(cid:10)(cid:10) (cid:13)(cid:5)(cid:11)(cid:10)(cid:9)(cid:10)(cid:10) (cid:13)(cid:5)(cid:10)(cid:10)(cid:9)(cid:10)(cid:10) (cid:13)(cid:6)(cid:10)(cid:9)(cid:10)(cid:10) (cid:13)(cid:7)(cid:10)(cid:9)(cid:10)(cid:10) (cid:13)(cid:8)(cid:10)(cid:9)(cid:10)(cid:10) (cid:13)(cid:11)(cid:10)(cid:9)(cid:10)(cid:10) (cid:13)(cid:12) (cid:7)(cid:4)(cid:3)(cid:4)(cid:11)(cid:10)(cid:5)(cid:7) (cid:5)(cid:11)(cid:4)(cid:2)(cid:5)(cid:4)(cid:11)(cid:10)(cid:5)(cid:7) (cid:5)(cid:11)(cid:4)(cid:2)(cid:5)(cid:4)(cid:11)(cid:10)(cid:5)(cid:1) (cid:5)(cid:11)(cid:4)(cid:2)(cid:5)(cid:4)(cid:11)(cid:10)(cid:5)(cid:6) (cid:5)(cid:11)(cid:4)(cid:2)(cid:5)(cid:4)(cid:11)(cid:10)(cid:5)(cid:3) (cid:23)(cid:22)(cid:21)(cid:22)(cid:20)(cid:19)(cid:18)(cid:17)(cid:20)(cid:16)(cid:15)(cid:14)(cid:21)(cid:13)(cid:14)(cid:19)(cid:12)(cid:21)(cid:20)(cid:11)(cid:10)(cid:19)(cid:10)(cid:9)(cid:8) (cid:7)(cid:6)(cid:5)(cid:4)(cid:19)(cid:3)(cid:2)(cid:23)(cid:19)(cid:3)(cid:9)(cid:9)(cid:1)(cid:5)(cid:15)(cid:14)(cid:21)(cid:22) (cid:1) The graph shows the value, by December 31, 2019, of £100 invested in the Company on June 6, 2016, compared with the value of £100 invested in the FTSE AIM All-Share on the same date. Chief Executive Ofﬁcer Total Remuneration History As this is the Company’s ﬁrst Directors’ Remuneration Report, the exemption not to disclose the history of remuneration for the Chief Executive Ofﬁcer prior to 2019 has been taken. The Company has chosen to disclose remuneration history from 2019 onwards. 68 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT Total CEO remuneration CEO bonus (as a % of maximum available) CEO LTIP(1) vesting (as a % of maximum available) 2019 £1,176,187 75% 0% (1) During the 2019 performance period the only long-term incentive award to potentially vest with a performance condition attached was the LTIP. 2.6 Percentage Change in Remuneration of Directors and Employees (audited) As this is the Company’s ﬁrst Directors’ Remuneration Report, there has been no change in the remuneration of Directors and employees. It is therefore not possible to provide meaningful comparative data. However, full disclosure of the year-on-year movement will be provided in future remuneration reports. 2.7 Relative Importance of Spend on Pay (audited) The Remuneration Committee considers the Company’s research and development (“R&D”) expenditure relative to salary expenditure for all employees, to be the most appropriate metric for assessing overall spend on pay due to the nature and stage of the Company’s business. Dividend distribution and share buy-back comparators have not been included because the Company has no history of such transactions. The table below illustrates the gross pay to all employees, per year, as compared to R&D expenditure and illustrates the year-on-year change. Gross pay to all employees* R&D expenditure 2019 (£’000) 2018 (£’000) % change £8,221 £23,608 £6,198 £22,703 33% 4% Gross pay to all employees, up by £2.0 million (or 33%) on the prior year, increased following the acquisition of OncoMed on April 23, 2019. As a result of the acquisition, the Group’s headcount increased, which had an impact on employee costs. Further information can be found within the Financial Review (Strategic Report). 2.8 Membership of the Remuneration Committee and its Advisors (audited) The Remuneration Committee currently comprises of three independent Non-Executive Directors: Peter Bains (Chair), Dr. Anders Ekblom and Dr. Deepa Pakianathan. On May 1, 2019, Peter Bains assumed the role of Chair of the Committee from Dr. Anders Ekblom. The Chief Executive Ofﬁcer, Chief Financial Ofﬁcer and General Counsel, as well as others, are invited to attend Remuneration Committee meetings as required to provide advice and assistance. The terms of reference of the Committee can be found on our website at www.mereobiopharma.com. During the year, the Remuneration Committee engaged Radford (part of Aon plc) to provide advice on certain remuneration matters, including: – – – – – Support in the preparation of the Group’s ﬁrst Directors’ Remuneration Policy; An evaluation of the compensation provided to the non-executive directors during the ﬁnancial year and recommendations for a go-forward compensation program; A cash compensation benchmarking analysis (competitive assessment) for the U.K. and U.S. workforce; A further review of cash compensation provided to Executive Directors and other members of the senior management team, with recommendations for a go-forward compensation program; and Strategic review of equity compensation practices in the U.K. and U.S. given the Company’s acquisition of OncoMed in April 2019 and subsequent listing on the Nasdaq Global Market. The Remuneration Committee is satisﬁed that Radford (part of Aon plc) provides independent and objective advice. During 2019, total fees of approximately £0.1 million were paid to Radford (part of Aon plc). 2.9 Statement of Voting at a general meeting of the Company The Company will hold a general meeting on a date to be announced in due course. At this general meeting, shareholders will be asked to approve the remuneration policy through a binding vote, and the annual report on remuneration through an advisory vote. Results of these two votes will be included in next year’s Directors’ Remuneration Report. 69 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT 2.10 Statement of Implementation of Remuneration Policy in Current Financial Year (audited) Annual salary As at the date of this report, there has been no change in the annual base salary for both Executive Directors against the 2019 performance period. The Committee has deferred the decision to review a change in annual base salary for both Executive Directors, however the Committee reserves the right to apply any subsequent review with effect from January 1, 2020, at a point later in the year. The outcome of this will be reported to shareholders in next year’s report. Any increase is expected to be in line with that of the general workforce. Beneﬁts and pension Both Executive Directors will continue to receive pension contributions (or cash payments in lieu) to the value of 15% (in respect of the CEO) and 10% (in respect of the CFO) of basic salary. No changes will be made to the provision of other beneﬁts. Bonus In line with the Policy provided within this Directors’ Remuneration Report, the CEO will be eligible for a maximum annual bonus of 100% of basic salary for the 2020 ﬁnancial year. The bonus will be subject to the achievement of short-term corporate objectives which have been set by the Committee with respect to the current performance period. The short-term objectives cover key objectives that relate to the achievement of the Group’s wider strategic goals. For the current performance period, short-term corporate objectives include measures relating to clinical development, corporate development, commercial planning, ﬁnance, manufacturing and intellectual property /legal. The amount of bonus payable is at the discretion of the Committee subject to review of performance against the short-term corporate objectives at the end of the performance period (which is aligned with the ﬁnancial year). Long-term incentive plan In line with the Policy, the Committee reserves the right to issue market value options to Executive Directors during 2020. The Committee may also, with discretion, consider the issuance of other option types to Executive Directors in line with the 2019 EIP. On February 20, 2020, equity incentive awards were granted to Executive Directors under the 2019 EIP. These equity incentive awards were market value options over ADSs, and the vesting period is four years; 25% of the award vesting on the ﬁrst anniversary of the grant date and the balance vesting in equal monthly instalments over the following three years. No performance conditions were attached to the awards. Dr. Denise Scots-Knight Richard Jones ADS options granted February 20, 2020 Exercise Price per ADS ($) Face value ($) 175,000 85,000 $1.84 $1.84 322,000 156,400 Non-Executive Directors’ fees No changes are foreseen to the fees paid to Non-Executive Directors during the 2020 ﬁnancial year. In addition to fees paid, the Committee foresees the issuance of market value options to Non-Executive Directors during 2020. In line with the Policy, the Committee reserves the right to issue other share-based awards to Non-Executive Directors during 2020. The Committee may also, with discretion, consider the issuance of other option types to Non-Executive Directors in line with the 2019 NED EIP. 70 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REMUNERATION REPORT: REPORT On February 20, 2020, equity incentive awards were granted to Non-Executive Directors in line with the 2019 EIP. These equity incentive awards were market value options over ADSs, and the vesting period is one year; vesting in equal monthly instalments over the one-year period following grant date. No performance conditions were attached to the awards. ADS options granted February 20, 2020 Exercise Price per ADS ($) Face value ($) 11,000 11,000 11,000 11,000 11,000 11,000 11,000 1.84 1.84 1.84 1.84 1.84 1.84 1.84 20,240 20,240 20,240 20,240 20,240 20,240 20,240 Dr. Peter Fellner Dr. Anders Ekblom Peter Bains Kunal Kashyap Paul Blackburn Dr. Deepa Pakianathan Michael Wyzga On behalf of the Board, Peter Bains Chair of the Remuneration Committee June 15, 2020 71 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REPORT The Directors present their report together with the audited ﬁnancial statements for the year ended December 31, 2019. Principal activities The Strategic Report on pages 4 to 34 describes the Group’s principal development activities and strategy. We are a biopharmaceutical company focused on the development and commercialization of innovative therapeutics that aim to improve outcomes for oncology and rare diseases. On April 23, 2019 we completed the acquisition of OncoMed, Pharmaceuticals, Inc, (“OncoMed”) and a new listing of American Depository Shares (“ADSs”) on the Nasdaq Global Market (NASDAQ: MREO) whilst retaining our AIM listing (AIM: MPH). Since completing the acquisition, we now operate from sites in the U.K. and the U.S. Results and dividends The Group recorded a total comprehensive loss for the year attributable to equity holders of the parent of £35.3 million (2018: £32.0 million). Further details are given in the Strategic Report and in the consolidated ﬁnancial statements. The Directors do not recommend payment of a dividend. Research and development For the ﬁnancial year ended December 31, 2019, we spent £23.6 million (2018: £22.7 million) on research and development activity. Research and development spend primarily reflects the underlying activity on clinical trials for our products as well as the manufacturing of drug product together with the internal costs, including payroll directly attributable to these activities. In addition, we acquired additional product programs through our acquisition of OncoMed. Further details of our product programs and research and development spend can be found within the Strategic Report. Statement of corporate governance arrangements The Board of Directors of the Company recognises the importance of corporate governance and, since 2018, has decided to apply the Corporate Governance Code published by the Quoted Companies Alliance (the “QCA Code”). The QCA Code sets out a standard of minimum best practice for small and mid-size quoted companies. The QCA’s ten principles of corporate governance are set out in the content on our website, which links each principle of corporate governance to our annual report and / or other location on the website. The Company has not departed from the QCA Code during the year. Information on environmental matters The Company is required to measure and report its greenhouse gas emissions. Our greenhouse gas emissions report period will be aligned to the ﬁnancial reporting year and, as such, the ﬁrst year will be reported as the baseline year against which future performance will be measured. Therefore, no greenhouse gas emissions report is included in this Directors’ report for the period between April 2019 and December 2019. 72 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REPORT Post-balance sheet events Further information on post-balance sheet events is provided in Note 30 within the consolidated ﬁnancial statements contained within this report. • • • • • • • • On January 13, 2020, the Company announced a global licensing agreement with Oncologie, Inc. (“Oncologie”) for the development and commercialization of navicixizumab. On February 10, 2020, the Company entered into a $3.8 million convertible equity ﬁnancing with Novartis Pharma (AG) (“Novartis”). Under the terms of the convertible equity ﬁnancing, Novartis invested £3.8 million through a convertible loan note. The loan note is convertible at any time at a ﬁxed price of £0.265 per ordinary share. In connection with the loan note, the Company issued a warrant instrument to Novartis to purchase up to 1,449,614 of the Company’s ordinary shares. On February 10, 2020, the Company entered into a Securities Purchase Agreement to issue up to $28 million of the Company’s ordinary shares exchangeable for American Depositary Shares, including a $3 million initial purchase, with Aspire Capital Fund, LLC. In exchange for the $3 million initial purchase the Company issued 11,423,925 ordinary shares (equivalent to 2,286,585 ADSs). On February 19, 2020, the Company entered into a Securities Purchase Agreement with Boxer Capital, LLC to make an investment of $3 million to purchase 12,252,715 of the Company’s ordinary shares (equivalent to 2,450,543 ADSs). On February 20, 2020, the Company granted 962,836 market value options over ADSs under the Mereo 2019 Equity Incentive Plan to certain Executive Directors and other employees at an exercise price of $1.84 per ADS. On the same date, the Company granted 77,000 market value options over ADSs under the Mereo 2019 Non-Executive Director Equity Incentive Plan to certain Non-Executive Directors at an exercise price of $1.84 per ADS. Following the transactions noted above, it is anticipated that a further 362,534 additional warrants will be issued to the lenders of the bank loan facility giving them the right to subscribe for ordinary shares at an exercise price of £2.95. On March 27, 2020, we announced the resignation of Richard Jones. Michael Wyzga, a Non-Executive Director, will assume the role of Interim Chief Financial Ofﬁcer following the departure of Richard Jones. Richard Jones will remain in his position as CFO for a transitionary period of up to ﬁve months. On 4 June 2020, we announced completion of a private placement offering of $70 million (£56 million) (the “Fundraising”) before commission and expenses with a number of new and existing principally U.S based institutional and accredited investors. OrbiMed led the Fundraising with participants including Vivo Capital, Surveyor Capital (a Citadel company), Pontifax Venture Capital, Samsara BioCapital, Commodore Capital, and funds managed by Janus Henderson Investors alongside existing investors Boxer Capital of Tavistock Group and Aspire Capital Fund, LLC. Going concern As at May 31, 2020 the group had total cash resources(1) £10.1 million. Taken together with the private placement which completed on June 3, 2020 and which raised net proceeds of approximately £51.4 million, the group has current total cash resources of £61.5 million. The Directors have prepared detailed cashflow forecasts for the 30-month period to December 31, 2022 based on the delivering the business plan objectives set out in the strategic report which include: • • • Completion of the adult Phase 2b extension study for setrusumab Completion of the current Phase 2 study for alvelestat Commencement later in 2020 of a new Phase 1b study for etiligimab These forecasts indicate that the group has a total cash runway into 2022 and will have sufﬁcient funds to meet its liabilities as they fall due for at least the next 12 months. 73 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REPORT In preparing these forecasts the directors have considered the impact of COVID-19 and in particular the unprecedented burden on health systems in impacted countries around the world. As a result, clinical centres have diverted resources away from the performance of clinical trials and because of that and the vulnerability of patients in the Company’s setrusumab clinical development program for osteogenesis imperfecta (OI) and its Phase 2 alvelestat program for patients with alpha-1 antitrypsin deﬁciency (AATD), the Company’s clinical activities will face some delays. AATD patients, in particular, are at greater risk from COVID-19 given that the condition is a respiratory and lung condition, for this reason, our Phase 2 alvelestat trial will be delayed with topline data now expected in 2021. Subject to a partnership, we are also currently planning to initiate a Phase 3 study in children with OI in late 2020, however, the initiation of the study may also be delayed. In addition, the Directors have considered a downside scenario involving an increase in operating overheads, an increase in the costs of setting up and running the planned Phase 1b study for etiligimab when this study is contracted out to third parties and increased investment in manufacturing development costs for setrusumab. In addition, In this scenario the forecasts also indicate that the group will have sufﬁcient funds to meet its liabilities as they fall due for at least the next 12 months. In both scenarios the Directors have not taken into account potential income from partnering one or more of its assets which would increase the cash resources available to the Group. In conclusion, although the Group continues to make losses, the directors believe it is appropriate to prepare the ﬁnancial information on the going concern basis. This is because the Group’s development into new products continues to progress according to plan and the funding secured to date, together with the funds that have come into the Group since the year end (as described more fully in Note 30) will allow it to meet its liabilities as they fall due for at least 12 months from the date of authorization for the issue of these consolidated ﬁnancial statements. (1) Total cash resources are a non-GAAP measure being cash and short-term deposits and short-term investments. Directors The directors of the Company who held ofﬁce during the year and up to the date of this report, unless otherwise noted, were: Executive directors Dr. Denise Scots-Knight – Chief Executive Ofﬁcer Richard Jones – Chief Financial Ofﬁcer Non-executive directors Dr. Peter Fellner Peter Bains Paul Blackburn Dr. Anders Ekblom Kunal Kashyap Michael Wyzga appointed April 23, 2019 Dr. Deepa Pakianathan appointed April 23, 2019 Frank Armstrong resigned February 8, 2019 On March 27, 2020, we announced the resignation of Richard Jones. Michael Wyzga, a Non-Executive Director, will assume the role of Interim Chief Financial Ofﬁcer following the departure of Richard Jones. Richard Jones will remain in his position as CFO for a transitionary period of up to ﬁve months. Brief biographical details of the current directors of the Company are provided within the Corporate Governance report on pages 43 to 45. As at the date of this report, the directors held shares representing 2.0%% of the equity of the Company. Details of the directors’ shareholdings and their options over shares in the Company are disclosed in the Directors’ Remuneration Report on pages 49 to 71. 74 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REPORT Financial risk management objectives and policies (including information on exposure to price risk, credit risk, liquidity risk and cash flow risk) Refer to Note 25 of the consolidated ﬁnancial statements for further details on our ﬁnancial risk management objectives and policies. Health, safety and environment The directors are committed to ensuring the highest standards of health and safety, both for their employees and for the communities within which the Group operates. The directors are also committed to minimizing the impact of the Group’s operations on the environment. Political contributions Neither the Company nor any of its subsidiaries made any political donations or incurred any political expenditure during the years ended December 31, 2019 and December 31, 2018. Share capital As at the date of this report, the Company had total issued and fully paid up share capital of £640,957.46 representing 213,652,487 ordinary shares of £0.003, all of which rank pari passu. All shares are admitted to trading on the AIM Market of the London Stock Exchange (“AIM”) and each share carries the right to one vote at general meetings of the Company. No shareholder holds shares carrying special rights with regard to control of the Company. ADSs are traded on the Nasdaq Global Market. Each ADS represents ﬁve ordinary shares. Purchases of own shares during the year During the year ended December 31, 2019, the Group purchased £1.0 million of its own shares through an Employee Beneﬁt Trust (“EBT”), which is controlled by the Group. As at December 31, 2019, a total of 1,237,274 own shares were held by the EBT. Branches outside the U.K. As at December 31, 2019, the Group consists of certain subsidiaries which are incorporated outside the United Kingdom. Further information can be found in Note 6 of consolidated ﬁnancial statements. Substantial interests As at June 8, 2020, on the basis of the best information available to the Company, derived from the register of members as at May 29, 2020, the details of the Fundraising and notiﬁcations of Shareholders' voting rights received by the Company up to June 8, 2020, the following investors are currently believed to have interests of 3 per cent. or more of the issued share capital of the Company: Name and address of beneﬁcial owner 3% or Greater Shareholders: Tavistock Group OrbiMed funds Baker Brothers Link Fund Solutions Aspire Capital Fund, LLC Novartis Pharma AG Vivo funds Schroders plc Invesco Ltd Number of Ordinary Percentage of Ordinary Shares Beneﬁcially Owned Shares Beneﬁcially Owned as of June 8, 2020 21,151,595 20,061,437 20,061,437 19,031,915 16,970,378 15,703,871 13,374,291 7,845,873 7,620,000 9.9% 9.4% 9.4% 8.9% 7.9% 7.4% 6.3% 3.7% 3.6% Website publication The Directors are responsible for ensuring that the annual report, including the ﬁnancial statements, are made available on our website. 75 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: DIRECTORS’ REPORT Annual general meeting (“AGM”) The 2019 AGM of the Company will be held on June 29, 2020. The notice of the meeting, together with an explanation of the business to be dealt with including proposed resolutions, has been prepared as a separate document and was distributed to shareholders and posted to our website. Disclosure of information to the Auditor Each of the persons who is a director at the date of approval of this report conﬁrms that: • • So far as the director is aware, there is no relevant audit information of which the Group’s Auditor is unaware; and The director has taken all the steps that they ought to have taken as a director in order to make themselves aware of any relevant audit information and to establish that the Group’s Auditor is aware of that information. Directors’ and ofﬁcers’ liability insurance The Company has, as permitted by the Companies Act 2006, purchased and maintained throughout the ﬁnancial year suitable insurance cover on behalf of the directors, indemnifying them against certain liabilities which may be incurred by them in relation to the Group. We have also entered into a deed of indemnity with each of our directors and executive ofﬁcers. Effective date This report was approved by the Board of Directors by written resolution and signed on its behalf by: Peter Fellner Charles Sermon Chairman General Counsel and Company Secretary June 15, 2020 June 15, 2020 76 MEREO BIOPHARMA GROUP PLC CORPORATE GOVERNANCE: STATEMENT OF DIRECTORS’ RESPONSIBILITIES The Directors are responsible for preparing the annual report and the ﬁnancial statements in accordance with applicable laws and regulations. Company law requires the directors to prepare ﬁnancial statements for each ﬁnancial year. Under the AIM Rules of the London Stock Exchange we are required to prepare our Group ﬁnancial statements in accordance with International Accounting Standards. For the ﬁnancial year ended December 31, 2019, we have chosen to prepare our Group and Company accounts according to International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) and adopted by the E.U. and in accordance with Companies Act 2006. Under company law the directors must not approve the ﬁnancial statements unless they are satisﬁed that they give a true and fair view of the state of affairs of the Group and parent company and of their proﬁt or loss for that period. In preparing each of the Group and parent company ﬁnancial statements, the directors are required to: • • • • Select suitable accounting policies and then apply them consistently; Make judgments and accounting estimates that are reasonable and prudent; State whether they have been prepared in accordance with IFRS as issued by the IASB or as adopted by the E.U.; and Prepare the ﬁnancial statements on the going concern basis unless it is inappropriate to presume that the Group and the parent company will continue in business. The directors are responsible for safeguarding the assets of the Group and parent company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. The directors are responsible for keeping adequate accounting records that are sufﬁcient to show and explain the parent company’s and Group’s transactions and disclose with reasonable accuracy at any time the ﬁnancial position of the parent company and the Group and to enable them to ensure that its ﬁnancial statements and Directors’ Remuneration Report comply with the Companies Act 2006. The Directo rs are responsible for the maintenance and integrity of the corporate and ﬁnancial information included on the Company’s website. Legislation in the U.K. governing the preparation and dissemination of ﬁnancial statements may differ from legislation in other jurisdictions. Directors’ conﬁrmations In the case of each Director in ofﬁce at the date the Directors’ Report is approved: • • So far as the director is aware there is no relevant audit information of which the Group and parent company’s Auditor is unaware; and They have taken all the steps that they ought to have taken as a director in order to make themselves aware of any relevant audit information and to establish that the Group and parent company’s Auditor is aware of that information. On behalf of the Board: Charles Sermon General Counsel and Company Secretary June 15, 2020 77 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: INDEPENDENT AUDITORS’ REPORT Opinion In our opinion: • • • • Mereo BioPharma Group plc’s group ﬁnancial statements and parent company ﬁnancial statements (the “ﬁnancial statements”) give a true and fair view of the state of the group’s and of the parent company’s affairs as at 31 December 2019 and of the group’s loss for the year then ended; the group ﬁnancial statements have been properly prepared in accordance with IFRSs as adopted by the European Union; the parent company ﬁnancial statements have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice; and the ﬁnancial statements have been prepared in accordance with the requirements of the Companies Act 2006. We have audited the ﬁnancial statements of Mereo BioPharma Group plc which comprise: Group Parent company Consolidated balance sheet as at 31 December 2019 Balance sheet as at 31 December 2019 Consolidated statement of comprehensive loss for the year then ended Statement of changes in equity for the year then ended Consolidated statement of changes in equity for the year then ended Related notes 1 to 12 to the ﬁnancial statements including a summary of signiﬁcant accounting policies Consolidated statement of cash flows for the year then ended Related notes 1 to 30 to the ﬁnancial statements, including a summary of signiﬁcant accounting policies The ﬁnancial reporting framework that has been applied in the preparation of the group ﬁnancial statements is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union, and, as regards to the parent company ﬁnancial statements, United Kingdom Accounting Standards, including FRS 101 “Reduced Disclosure Framework” (United Kingdom Generally Accepted Accounting Practice). 78 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: INDEPENDENT AUDITORS’ REPORT Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (ISAs (UK)) and applicable law. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the ﬁnancial statements section of our report below. We are independent of the group and parent company in accordance with the ethical requirements that are relevant to our audit of the ﬁnancial statements in the UK, including the FRC’s Ethical Standard as applied to listed entities, and we have fulﬁlled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufﬁcient and appropriate to provide a basis for our opinion. Conclusions relating to going concern We have nothing to report in respect of the following matters in relation to which the ISAs (UK) require us to report to you where: • • the directors’ use of the going concern basis of accounting in the preparation of the ﬁnancial statements is not appropriate; or the directors have not disclosed in the ﬁnancial statements any identiﬁed material uncertainties that may cast signiﬁcant doubt about the group’s or the parent company’s ability to continue to adopt the going concern basis of accounting for a period of at least twelve months from the date when the ﬁnancial statements are authorised for issue. Overview of our audit approach Key audit matters • Assessment of carrying value of intangible assets • • • • • • Acquisition accounting, including purchase price allocation Going concern assessment and impact of COVID-19 Investment in subsidiaries (parent) We performed an audit of the complete ﬁnancial information of four components and audit procedures on speciﬁc balances of one component The components where we performed full or speciﬁc audit procedures accounted for 100% of group operating costs and 100% of total assets Overall group materiality of £0.8 million which represents 2% of operating costs excluding share-based payment expenses Audit scope Materiality 79 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: INDEPENDENT AUDITORS’ REPORT Key audit matters Key audit matters are those matters that, in our professional judgment, were of most signiﬁcance in our audit of the ﬁnancial statements of the current period and include the most signiﬁcant assessed risks of material misstatement (whether or not due to fraud) that we identiﬁed. These matters included those which had the greatest effect on: the overall audit strategy, the allocation of resources in the audit; and directing the efforts of the engagement team. These matters were addressed in the context of our audit of the ﬁnancial statements as a whole, and in our opinion thereon, and we do not provide a separate opinion on these matters. Key observations communicated to the Audit Risk Our response to the risk Committee Assessment of carrying value of intangible assets to Refer the Accounting policies (pages 92 to 100); and Note 13 of the Consolidated Financial Statements (pages 114 to 116) £44.5 million (2018 – £32.6 million) The Group has signiﬁcant intangible assets arising from the acquisition of products in development. Recoverability of these assets is based on forecasting and discounting future cash flows, which are inherently highly judgemental. For products in development the key assumptions include; development costs, launch dates of products, probability of successful development, sales price and projections, flow expense and projections and discount rate. The risk is that there may be errors judgments resulting in the misstatement of the carrying value of intangible assets. in these cash We have concluded that the assumptions made by management are reasonable and we concurred with management no impairments were required at year-end. that Management describes the sensitivities appropriately in the intangible assets notes to the ﬁnancial in accordance statements with IAS 36 Impairment of assets. Group Our principal audit procedures included: • We understood the methodology applied by management in performing its impairment test and walked through the controls over the process. • We performed audit procedures to test the arithmetic accuracy and assess the integrity of the model. We evaluated, including the key assumptions being used, such as the reasonableness of future revenues, development costs the and cash probability of obtaining regulatory approvals, launch dates of products and the discount rate. We considered comparable drug development projects and corroborated third party assessments. flow projections, to • Performed sensitivity analyses over individual intangible asset models, to assess the level of sensitivity to the key assumptions and focused our work in those areas. • Assessed the reasonableness of the Group’s regarding assumptions probability of obtaining regulatory approval through consideration of the current phase of development and comparison to industry practice. • key Interviewed and development personnel to corroborate the assumptions used. research • We engaged EY valuations specialists who tested the Group’s discount rate. Their procedures included using independent data sources to assess the key assumptions including the Group speciﬁc risk premium and comparison with peer companies. We recalculated the discount rate to ensure management’s discount rate was within an acceptable range. 80 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: INDEPENDENT AUDITORS’ REPORT Key observations communicated to the Audit Risk Our response to the risk Committee • Challenged management’s key assumptions regarding the size of the therapeutic area market and the product’s projected share of this market through comparison to external scientiﬁc and market research. literature • Analysed the historical accuracy of budget to actual results to determine whether the forecasts are reliable based on past performance and considering commentary in analyst forecasts to identify any contrary views. Acquisition accounting, including purchase price allocation to Refer the Accounting policies (pages 92 to 100); and Note 5 of the Consolidated Financial Statements (pages 104 to 106). On 23 April 2019 the Group acquired 100% of OncoMed Pharmaceuticals Inc. for a total consideration of £40.9 million settled through the issue of shares. We have determined this to be a key the audit matter in management determining this transaction met the deﬁnition of a business combination, the estimates made on the the provisional PPA and adjustments made to align accounting policies with those of the Group. given judgement that with • Discussed the post year-end change in business key strategy management and conﬁrmed this has not underlying assumptions within the impairment models, validating to market data as appropriate. impacted the • Assessed the adequacy of related disclosures in the Group’s ﬁnancial statements. Our principal audit procedures included: • Obtained and evaluated the accounting analysis Business IFRS Combinations prepared by management. of 3 • Veriﬁed the paid (including contingent consideration) to supporting evidence. consideration • Tested the professional fees incurred and veriﬁed appropriate classiﬁcation between capitalised and expensed fees. • Selected a sample of items from the opening balance sheet of OncoMed Pharmaceuticals, Inc. and corroborated the supporting documentation, including invoices and third party support to ensure they have been appropriately recognised in line with Group accounting policies. amounts to made We have concluded that the judgements by management in accounting for the acquisition as a business combination are reasonable, and that the fair values ascribed the acquired assets and liabilities are appropriate. to in We are satisﬁed that the additional disclosures relating to the acquisition the ﬁnancial included statements are consistent with our knowledge from the audit and are in compliance with business combinations. IFRS 3 • Engaged our EY valuation specialists to test the methodology and discount rate used in the valuation of the acquired identiﬁed intangible assets, comparing key assumptions to comparable biotechs including the risk beta and market data. 81 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: INDEPENDENT AUDITORS’ REPORT Key observations communicated to the Audit Risk Our response to the risk Committee Under business combination accounting, a gain on bargain purchase of £3.7 million was recognised and a separately identiﬁable intangible asset of £12.7 million was recognised. There is a risk for the ﬁnancial statements that the fair value of the intangible asset has not been determined appropriately. • We assessed the appropriateness of the valuation model used through discussions with management and comparison to market data. Tested the cash flow forecasts and assumptions included within, notably the future revenues, development costs and cash flow projections, the probability of obtaining regulatory approvals and launch dates of products, in respect of the acquired intangible assets. • Assessed the availability of information at acquisition date and management’s conclusions that no revisions to the initial purchase price allocation were required at year end. • Assessed and appropriateness of the disclosures in the ﬁnancial statements. adequacy Our principal audit procedures included: • We analysed management’s assessment of going concern to gain an understanding of the inputs and process underpinning the cash flow model prepared for the purpose of the going concern conclusion. • We veriﬁed that the cash flow model accurately reflects the post balance sheet events by agreeing all proceeds received to bank statements and reviewing executed deal documents. • We obtained an understanding of the terms included within the private placement and ensured the cashflow model was prepared on a consistent basis. The disclosures in note 2 and note 30 appropriately reflect the basis for the Directors’ going concern assessment including the impact of the change in business strategy and COVID-19. We conclude concern the remains assumption the appropriate, disclosures appropriately reflect the key assumptions and uncertainties inherent in the forecasts upon which that conclusion relies. going and • We challenged the inputs and assumptions within the going concern model including the level of forecast research and development (R&D) and general and administrative expenditure, particularly those updated for the changes in R&D activity and COVID-19 impact. We compared the assumptions and estimates used to those applied elsewhere in the preparation of the ﬁnancial statements and corroborated amounts to supporting evidence Going concern assessment and impact of COVID-19 to Refer the Accounting policies (pages 92 to 100); and the Note 2 and 30 of Consolidated Financial Statements. identiﬁed We have the the going assessment of concern basis of accounting as a key audit matter as the Group had £16.4 million cash as at 31 December 2019 and required a future fundraising event to continue as a going concern. On [4] June 2020 the Group completed a £56 million ($70 million) private placement resulting in a revised cash flow in forecast and a change business strategy the Group. for The revised forecast reflects management’s assessment of the COVID-19 impact on the Group which is disclosed in the going concern Note 2 and the post balance sheet Note 30. 82 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: INDEPENDENT AUDITORS’ REPORT Key observations communicated to the Audit Risk Our response to the risk Committee The Group believes it has sufﬁcient liquidity to meet its ﬁnancial obligations as they fall due for the twelve months subsequent to the approval of the ﬁnancial statements. • Analysed the historical accuracy of budget to actual results to determine whether the forecasts are reliable based on past performance and considering commentary in analyst forecasts to identify any contrary views. • We held meetings with key clinical personnel to validate the planned R&D spend proﬁle included within the forecast. testing • We challenged the sensitivities and that management stress performed on the going concern forecast and agreed with the sensitivities applied. • We evaluated the appropriateness of management’s conclusions in light of the revised forecast and executed private placement agreement. Investment in subsidiaries (parent) to Refer the Accounting policies (pages 92 to 100); and Note 4 of the parent Financial Statements (page148). £156 million (2018 – £123 million). the being Parent Company’s The principal activity is to manage and support the investment in a number of subsidiaries intangible which hold assets progressed through clinical trials. There is judgement in recoverable the assessing amount of the investments which involves signiﬁcant judgement over the future activities of each subsidiary. the There investments may be impaired below their carrying value. is a risk involved that • Assessed and appropriateness of the disclosures in the ﬁnancial statements. adequacy that of the We concluded the carrying value investments recognised in the parent company balance sheet is supportable, and the impairment of £19.2 million recognised is appropriate. We are satisﬁed that the disclosures are appropriate. Our principal audit procedures included: • We obtained details of the investment carrying amounts in subsidiaries and compared this to the net assets of those entities. • We compared the market capitalisation of the group to the carrying value of the investments to identify if any indicators of impairment existed. • We leveraged the intangible asset impairment work to test whether the carrying value of is supportable at year end by comparing it to the investment carrying value. investments • We assessed that management’s impairment was conclusion required in respect of one subsidiary. • Analysed the historical accuracy of budgets to actual results to determine whether the forecasts are reliable based on past performance and considering commentary in analyst forecasts to identify any contrary views. • Assessed the adequacy of related disclosures in the parent company’s ﬁnancial statements. 83 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: INDEPENDENT AUDITORS’ REPORT An overview of the scope of our audit Tailoring the scope Our assessment of audit risk, our evaluation of materiality and our allocation of performance materiality determine our audit scope for each entity within the Group. Taken together, this enables us to form an opinion on the consolidated ﬁnancial statements. We take into account size, risk proﬁle, the organisation of the group, changes in the business environment and other factors such as local statutory reporting requirements when assessing the level of work to be performed at each entity. In assessing the risk of material misstatement to the Group ﬁnancial statements, and to ensure we had adequate quantitative coverage of signiﬁcant accounts in the ﬁnancial statements, we selected 5 components of the 8 components in total covering entities within the United Kingdom and United States, which represent the principal business units within the Group. Of the ﬁve components, we performed an audit of the complete ﬁnancial information of four components (“full scope components”) which were selected based on their size or risk characteristics. For the remaining one component (“speciﬁc scope component”), we performed audit procedures on speciﬁc accounts within that component that we considered had the potential for the greatest impact on the signiﬁcant accounts in the ﬁnancial statements either because of the size of these accounts or their risk proﬁle. We performed audit procedures accounting for 100% (2018: 100%) of the Group’s operating costs and 100% (2018: 100%) of the Group’s Total assets. All audit procedures were undertaken by the central UK audit team. For the current year, the full scope components contributed 85% (2018: 100%) of the Group’s operating costs and 58% (2018: 100%) of the Group’s Total assets. The speciﬁc scope component contributed 15% (2018: 0%) of the Group’s operating costs and 42% (2018: 0%) of the Group’s Total assets. Changes from the prior year Pursuant to the Group completing the acquisition of OncoMed Pharmaceuticals Inc. during the year, we included this as a speciﬁc scope component. Involvement with component teams All audit work performed for the purposes of the audit was undertaken by the Group audit team. Our application of materiality We apply the concept of materiality in planning and performing the audit, in evaluating the effect of identiﬁed misstatements on the audit and in forming our audit opinion. Materiality The magnitude of an omission or misstatement that, individually or in the aggregate, could reasonably be expected to influence the economic decisions of the users of the ﬁnancial statements. Materiality provides a basis for determining the nature and extent of our audit procedures. We determined materiality for the Group to be £0.8 million (2018: £0.7 million), which is 2% (2018: 2%) of operating costs excluding share-based payment expense. We believe that operating costs provides us with an appropriate basis upon which to set materiality, since the Group is in the development stage of its life cycle and is investing in research and development, with no operating income to date. 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Materiality for the Parent Company is higher than for Group, due to the underlying basis on which it is calculated. The Parent Company’s purpose is to raise funds to ﬁnance the Group’s operations, and therefore we believe Equity is the most suitable basis on which to calculate materiality. Performance materiality The application of materiality at the individual account or balance level. It is set at an amount to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality. On the basis of our risk assessments, together with our assessment of the Group’s overall control environment, our judgement was that performance materiality was 50% (2018: 50%) of our planning materiality, namely £0.38 million (2018: £0.35 million). We have set performance materiality at this percentage due to the rate of change in the business. Audit work at component locations for the purpose of obtaining audit coverage over signiﬁcant ﬁnancial statement accounts is undertaken based on a percentage of total performance materiality. The performance materiality set for each component is based on the relative scale and risk of the component to the Group as a whole and our assessment of the risk of misstatement at that component. In the current year, the range of performance materiality allocated to components was £0.08 million to £0.23 million (2018: £0.1 million to £0.35 million). Reporting threshold We agreed with the Audit Committee that we would report to them all uncorrected audit differences in excess of £0.038 million (2018: £0.035 million), which is set at 5% of planning materiality, as well as differences below that threshold that, in our view, warranted reporting on qualitative grounds. We evaluate any uncorrected misstatements against both the quantitative measures of materiality discussed above and in light of other relevant qualitative considerations in forming our opinion. Other information The other information comprises the information included in the annual report set out on pages 1 to 77, other than the ﬁnancial statements and our auditor’s report thereon. The directors are responsible for the other information. Our opinion on the ﬁnancial statements does not cover the other information and, except to the extent otherwise explicitly stated in this report, we do not express any form of assurance conclusion thereon. In connection with our audit of the ﬁnancial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the ﬁnancial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If we identify such material inconsistencies or apparent material misstatements, we are required to determine whether there is a material misstatement in the ﬁnancial statements or a material misstatement of the other information. If, based on the work we have performed, we conclude that there is a material misstatement of the other information, we are required to report that fact. We have nothing to report in this regard. Opinions on other matters prescribed by the Companies Act 2006 In our opinion, the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006. In our opinion, based on the work undertaken in the course of the audit: • • the information given in the strategic report and the directors’ report for the ﬁnancial year for which the ﬁnancial statements are prepared is consistent with the ﬁnancial statements; and the strategic report and directors’ report have been prepared in accordance with applicable legal requirements. 85 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: INDEPENDENT AUDITORS’ REPORT Matters on which we are required to report by exception In the light of the knowledge and understanding of the group and the parent company and its environment obtained in the course of the audit, we have not identiﬁed material misstatements in the strategic report or the directors’ report. We have nothing to report in respect of the following matters in relation to which the Companies Act 2006 requires us to report to you if, in our opinion: • • • • adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or the parent company ﬁnancial statements and the part of the Directors’ remuneration report to be audited are not in agreement with the accounting records and returns; or certain disclosures of directors’ remuneration speciﬁed by law are not made; or we have not received all the information and explanations we require for our audit. Responsibilities of directors As explained more fully in the directors’ responsibilities statement set out on page 77, the directors are responsible for the preparation of the ﬁnancial statements and for being satisﬁed that they give a true and fair view, and for such internal control as the directors determine is necessary to enable the preparation of ﬁnancial statements that are free from material misstatement, whether due to fraud or error. In preparing the ﬁnancial statements, the directors are responsible for assessing the group and parent company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the group or the parent company or to cease operations, or have no realistic alternative but to do so. Auditor’s responsibilities for the audit of the ﬁnancial statements Our objectives are to obtain reasonable assurance about whether the ﬁnancial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these ﬁnancial statements. A further description of our responsibilities for the audit of the ﬁnancial statements is located on the Financial Reporting Council’s website at https://www.frc.org.uk/auditorsresponsibilities. This description forms part of our auditor’s report. Use of our report This report is made solely to the company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed. David Hales (Senior statutory auditor) for and on behalf of Ernst & Young LLP, Statutory Auditor Reading June 15, 2020 Notes: The maintenance and integrity of the Mereo BioPharma Group plc web site is the responsibility of the directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the ﬁnancial statements since they were initially presented on the web site. Legislation in the United Kingdom governing the preparation and dissemination of ﬁnancial statements may differ from legislation in other jurisdictions. 1. 2. 86 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS for the years ended December 31, 2017, 2018 and 2019 Year ended December 31, 2018 (in £’000) Notes 2017 Research and development expenses Administrative expenses Operating loss Net income recognized on acquisition of subsidiary Finance income Finance charge Net foreign exchange (loss)/gain Loss before tax Taxation Loss attributable to equity holders of the parent Other comprehensive income – items that may be reclassiﬁed to proﬁt or loss Net fair value gain/(loss) on investments in debt instruments held at fair value Exchange differences on translation of foreign operations Other comprehensive income, net of tax Total comprehensive loss attributable to equity holders of the parent Basic and diluted loss per share 11 (34,607) (10,697) –––––––––– (45,304) — 827 (1,090) (1,384) –––––––––– (46,951) 8,152 –––––––––– (38,799) (22,703) (11,775) –––––––––– (34,478) – 307 (3,091) (44) –––––––––– (37,306) 5,277 –––––––––– (32,029) 5 9.1 9.2 7 10 2019 (23,608) (15,909) –––––––––– (39,517) 1,035 377 (3,496) 483 –––––––––– (41,118) 6,274 –––––––––– (34,844) 25 – – – – –––––––––– – –––––––––– — –––––––––– – –––––––––– (499) –––––––––– (499) –––––––––– (38,799) –––––––––– (0.56) –––––––––– –––––––––– (32,029) –––––––––– (0.45) –––––––––– –––––––––– (35,343) –––––––––– (0.39) –––––––––– –––––––––– The accompanying notes form an integral part of these consolidated ﬁnancial statements. 87 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: CONSOLIDATED BALANCE SHEET as at December 31, 2018 and 2019 Year Ended December 31, 2019 Notes 2018 Assets (in £’000) Non-current assets Property, plant and equipment Intangible assets 12 13 Current assets Prepayments R&D tax credits Other taxes recoverable Other receivables Short-term investments Cash and short-term deposits Total assets Equity and liabilities Equity Issued capital Share premium Other capital reserves Employee Beneﬁt Trust shares Other reserves Accumulated loss Translation reserve Total equity Non-current liabilities Provisions Interest-bearing loans and borrowings Warrant liability Other liabilities Lease liability Current liabilities Trade and other payables Accruals Provisions Interest-bearing loans and borrowings Contingent consideration liability Lease liability Total liabilities Total equity and liabilities 149 32,632 –––––––––– 32,781 11,558 44,456 –––––––––– 56,014 10 10 15 17 16 18 18 18 28 18 18 18 20 19 21 22 4 23 23 20 19 25 4 1,067 5,277 – 609 2,500 25,042 –––––––––– 34,495 –––––––––– 67,276 –––––––––– –––––––––– 214 118,492 18,593 (307) 7,000 (111,221) – –––––––––– 32,771 –––––––––– 2,641 14,647 1,006 34 – –––––––––– 18,328 4,570 4,437 332 6,838 — – –––––––––– 16,177 –––––––––– 34,505 –––––––––– 67,276 –––––––––– –––––––––– 2,111 10,426 979 572 – 16,347 –––––––––– 30,435 –––––––––– 86,449 –––––––––– –––––––––– 294 121,684 59,147 (1,305) 7,000 (146,065) (499) –––––––––– 40,256 –––––––––– 1,449 5,373 131 44 9,318 –––––––––– 16,315 6,352 5,138 309 15,139 354 2,586 –––––––––– 29,878 –––––––––– 46,193 –––––––––– 86,449 –––––––––– –––––––––– The accompanying notes form an integral part of these consolidated ﬁnancial statements. Approved by the Board on June 14, 2020 and signed on its behalf by: Dr. Denise Scots-Knight Richard Jones Director Director Company number: 09481161 (England and Wales) 88 2019 (41,118) 1,577 1,636 (483) (738) 221 (377) 3,731 (456) – (3,681) 354 (936) (6,730) 1,069 –––––––––– (45,931) –––––––––– 10,074 (21) – – MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: CONSOLIDATED STATEMENT OF CASH FLOWS for the years ended December 31, 2017, 2018 and 2019 Year ended December 31, 2017 12 26 Notes (37,306) (46,951) 36 3,652 1,384 2018 (in £’000) Operating activities Loss before tax Adjustments to reconcile loss before tax to net cash flows: Depreciation of property, plant and equipment Share-based payment expense Net foreign exchange loss/(gain) Provision for social security contributions on employee share options Provision for deferred cash consideration Interest earned Finance charges Modiﬁcation gain on bank loan Modiﬁcation loss on bank loan Gain on bargain purchase Fair value remeasurement on contingent consideration Working capital adjustments: (Increase)/decrease in trade and other receivables Increase/(decrease) in trade and other payables Tax received 20 9.1 & 20 9.1 9.2 9.2 & 19 9.2 & 19 5 1,116 – (827) 1,090 – – – (1,446) 443 (307) 1,916 – 730 — 39 2,190 44 10 25 – – Net cash flows (used in) operating activities Investing activities Cash acquired from acquisition Purchase of property, plant and equipment Disposal of property, plant and equipment Purchase of license (Investments)/proceeds from sale of short-term investments Interest earned Net cash flows (used in)/from investing activities Financing activities Proceeds from issue of ordinary shares Transaction costs on issue of shares Proceeds from issue of bank loan Transaction costs on bank loan Interest paid on bank loan Proceeds from TAP agreement Purchase of treasury shares Payment of lease liabilities Net cash flows from/(used in) ﬁnancing activities 5 12 12 13 17 18 18 19 22 28 4 Net (decrease) in cash and cash equivalents Cash and cash equivalents at January 1 Effect of exchange rate changes on cash and cash equivalents Cash and cash equivalents at December 31 16 (840) 3,860 5,331 –––––––––– (32,149) –––––––––– 804 1,602 8,152 –––––––––– (23,139) –––––––––– – (16) — (2,280) – (36) 2 – (2,500) 1,052 –––––––––– – 286 –––––––––– 32,865 377 –––––––––– (3,744) –––––––––– 252 –––––––––– 43,295 –––––––––– 15,000 (730) 20,000 (200) (327) — – – –––––––––– 33,743 –––––––––– (2,150) 53,578 273 (8) 455 (921) (1,645) 78 (307) – –––––––––– (2,075) –––––––––– (24,962) 50,045 – (761) – – (1,739) – (998) (2,212) –––––––––– (5,710) –––––––––– (8,346) 25,042 (1,383) –––––––––– 50,045 –––––––––– –––––––––– (41) –––––––––– 25,042 –––––––––– –––––––––– (349) –––––––––– 16,347 –––––––––– –––––––––– The accompanying notes form an integral part of these consolidated ﬁnancial statements. 89 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: CONSOLIDATED STATEMENT OF CHANGES IN EQUITY for the years ended December 31, 2017, 2018 and 2019 Other Employee Accum- Issued Share capital Beneﬁt Other ulated Translation Total capital premium reserves Trust reserves losses reserve equity (in £’000) At December 31, 2016 193 99,975 12,666 – 7,000 (40,579) – 79,255 ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– Loss for the year to December 31, 2017 – – – – – (38,799) – (38,799) Share-based payments – share options (Note 26) – – 3,028 – – – – 3,028 Share-based payments – LTIPs (Note 26) – – 298 – – – – 298 Share-based payments – deferred bonus shares (Note 26) – – 326 – – – – 326 Share-based payments – deferred equity consideration (Note 26) – – 1,331 – – – – 1,331 Issue of share capital on April 4, 2017 (Note 18) 15 14,985 – – – – – 15,000 Issue of share capital on conversion of loan note (Note 18) 2 1,397 – – – – – 1,399 Issue of share capital for Novartis bonus shares (Note 18) 2 1,081 (1,083) – – – – – Equity element of convertible loan (Note 19) – – (207) – – – – (207) Conversion of convertible loan (Note 19) – – — – – 62 – 62 Issue of share capital on October 31, 2017 (Note 18) 1 1,519 – – – – – 1,520 Transaction costs on issuance of share capital (Note 18) – (730) – – – – – (730) ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– At December 31, 2017 213 118,227 16,359 – 7,000 (79,316) – 62,483 ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– Loss for the year to December 31, 2018 – – – – – (32,029) – (32,029) Adoption of IFRS 9 (Note 4) – – – – – 124 – 124 Share-based payments – share options (Note 26) – – 1,871 – – – – 1,871 Share-based payments – LTIPs (Note 26) – – 319 – – – – 319 Issue of share capital on June 1, 2018 (Note 18) – 150 – – – – – 150 Issue of share capital on August 3, 2018 on exercise of options (Note 18) – 13 – – – – – 13 Issue of share capital on October 22, 2018 on exercise of options (Note 18) 1 110 – – – – – 111 Issue of warrants for TAP agreement (Note 18) – – 44 – – – – 44 Transaction costs on issuance of share capital (Note 18) – (8) – – – – – (8) Purchase of treasury shares (Note 28) – – — (307) – – – (307) ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– At December 31, 2018 214 118,492 18,593 (307) 7,000 (111,221) – 32,771 ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– 90 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (CONTINUED) Other Employee Accum- Issued Share capital Beneﬁt Other ulated Translation Total capital premium reserves Trust reserves losses reserve equity (in £’000) Loss for the year to December 31, 2019 – – – – – (34,844) – (34,844) Currency translation of foreign operations – — – – – – (499) (499) Net fair value gain/(loss) on investments in debt instruments held at fair value (Note 25) – – — – – – – – Share-based payments – share options (Note 26) – – 1,543 – – – – 1,543 Share-based payments – LTIPs (Note 26) – – 93 – – – – 93 Issue of share capital on April 23, 2019 (Note 18) 74 – 40,818 – – – – 40,892 Transaction costs related to issuance of share capital on April 23, 2019 (Note 18) – (761) – – – – – (761) Issue of share capital on conversion of loan note (Note 18) 3 2,366 – – – – – 2,369 Issue of share capital on Novartis bonus shares (Note 18) 3 1,587 (1,590) – – – – – Equity element of convertible loan note (Note 18) – – (310) – – – – (310) Purchase of treasury shares (Note 28) – – — (998) – – – (998) ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– At December 31, 2019 294 121,684 59,147 (1,305) 7,000 (146,065) (499) 40,256 ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– 91 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1. Corporate information Mereo BioPharma Group plc (the “Company”) is a clinical-stage, U.K.-based biopharmaceutical company focused on oncology and rare diseases. The Company is a public limited company incorporated and domiciled in the U.K., and registered in England, with our shares publicly traded on the Alternative Investment Market of the London Stock Exchange under the ticker symbol MPH. The Company is also listed on the Nasdaq Global Market via American Depositary Shares (“ADSs”) under the ticker symbol MREO. The Company’s registered ofﬁce is located at Fourth Floor, 1 Cavendish Place, London, W1G 0QF, United Kingdom. The consolidated ﬁnancial statements of Mereo BioPharma Group plc and its subsidiaries (collectively, the “Group”) for the year ended December 31, 2019 were authorized for issue in accordance with a resolution of the Directors on June 14, 2020. The principal activities of the Group is the research and development of novel pharmaceutical products. On April 23, 2019, the Group completed the acquisition of OncoMed Pharmaceuticals, Inc. (“OncoMed”), a company which is based in California and was previously a public company listed on the Nasdaq Global Market in the U.S. 2. Signiﬁcant accounting policies 2.1 Basis of preparation The Group’s consolidated ﬁnancial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and adopted by the E.U. and in accordance with the Companies Act 2006. The ﬁnancial statements are presented in pound sterling (“£’000”), which is the functional and presentational currency of the Group. All amounts disclosed in the ﬁnancial statements and notes have been rounded off to the nearest thousand currency units, unless otherwise stated. 2.2 Revision of previously issued ﬁnancial statements During 2019, we identiﬁed a classiﬁcation error in our statement of comprehensive loss for the year ended December 31, 2018 related to loan modiﬁcation expense. In correcting the error, administrative expenses reduced by £0.7 million and ﬁnance charges increased by an equivalent amount. There was no impact on net loss. We evaluated the materiality of the error quantitatively and qualitatively and concluded it was not material to our previously issued Consolidated Financial Statements as a whole for the year ended and as of December 31, 2018. Please refer to Financial statement notes 9 and 19. 2.3 Basis of consolidation The consolidated ﬁnancial information comprises the ﬁnancial statements of Mereo BioPharma Group plc and its subsidiaries as at December 31, 2019. Subsidiaries are all entities over which the Group has control. The Group controls an entity when the Group is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Group. They are deconsolidated from the date that control ceases. Intercompany transactions, balances and unrealized gains on transactions between Group companies are eliminated in preparing the consolidated ﬁnancial statements. Accounting policies of subsidiaries are consistent with the policies adopted by the Group. The Company has an employee share trust to facilitate share transactions pursuant to employee share schemes. Although the trust is a separate legal entity from the Group, it is consolidated into the Group’s results in accordance with the IFRS 10 rules on special purpose vehicles. The Company is deemed to control the trust principally because the trust cannot operate without the funding the Group provides. 2.4 Segmental information Management views the Group as a single portfolio of product candidates. Only research and development expenses are monitored at a product candidate level, however the Chief Operating Decision Maker (“CODM”) makes decisions over resource allocation at an overall portfolio level. The Group’s ﬁnancing is managed and monitored on a consolidated basis. 92 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Following the acquisition of OncoMed during the year, non-current assets held by the Group are located in the United Kingdom and United States. As at December 31, 2019, approximately £22.4 million of non-current assets are located in the United States. The Group’s CODM is the executive leadership team which is comprised of several individuals including the Chief Executive Ofﬁcer (“CEO”) and Chief Financial Ofﬁcer (“CFO”). The executive leadership team is responsible for managing the operating results of the business. The operations of the Group are mostly influenced by the timing of progression on underlying clinical development programmes across product candidates which remain under development. 2.5 Going concern As at May 31, 2020 the group had total cash resources ¹£10.1 million. Taken together with the private placement which completed on June 3, 2020 and which raised net proceeds of approximately £51.4 million, the group has current total cash resources of £61.5 million. The Directors have prepared detailed cashflow forecasts for the 30-month period to December 31, 2022 based on the delivering the business plan objectives set out in the strategic report which include: • • • Completion of the adult Phase 2b extension study for setrusumab Completion of the current Phase 2 study for alvelestat Commencement later in 2020 of a new Phase 1b study for etiligimab These forecasts indicate that the group has a total cash runway into 2022 and will have sufﬁcient funds to meet its liabilities as they fall due for at least the next 12 months. In preparing these forecasts the directors have considered the impact of COVID-19 and in particular the unprecedented burden on health systems in impacted countries around the world. As a result, clinical centres have diverted resources away from the performance of clinical trials and because of that and the vulnerability of patients in the Company’s setrusumab clinical development program for osteogenesis imperfecta (OI) and its Phase 2 alvelestat program for patients with alpha-1 antitrypsin deﬁciency (AATD), the Company’s clinical activities will face some delays. AATD patients, in particular, are at greater risk from COVID-19 given that the condition is a respiratory and lung condition, for this reason, our Phase 2 alvelestat trial will be delayed with topline data now expected in 2021. Subject to a partnership, we are also currently planning to initiate a Phase 3 study in children with OI in late 2020, however, the initiation of the study may also be delayed. In addition, the Directors have considered a downside scenario involving an increase in operating overheads, an increase in the costs of setting up and running the planned Phase 1b study for etiligimab when this study is contracted out to third parties and increased investment in manufacturing development costs for setrusumab. In addition, In this scenario the forecasts also indicate that the group will have sufﬁcient funds to meet its liabilities as they fall due for at least the next 12 months. In both scenarios the Directors have not taken into account potential income from partnering one or more of its assets which would increase the cash resources available to the Group. In conclusion, although the Group continues to make losses, the directors believe it is appropriate to prepare the ﬁnancial information on the going concern basis. This is because the Group’s development into new products continues to progress according to plan and the funding secured to date, together with the funds that have come into the Group since the year end (as described more fully in Note 30) will allow it to meet its liabilities as they fall due for at least 12 months from the date of authorization for the issue of these consolidated ﬁnancial statements. ¹Total cash resources are a non-GAAP measure being cash and short-term deposits and short-term investments 93 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 2.6 Summary of signiﬁcant accounting policies a) Taxes Tax expense recognized in the statement of comprehensive income comprises the sum of deferred tax and current tax not recognized in other comprehensive income or directly in equity. Current income tax Current income tax assets and / or liabilities are measured at the amount expected to be recovered from or paid to the taxation authorities that are unpaid at the reporting date. Current tax is payable on taxable proﬁt, which differs from proﬁt or loss in the ﬁnancial statements. Calculation of current tax is based on tax rates and tax laws that have been enacted or substantively enacted by the end of the reporting period within the jurisdictions that the Group operates in. Amounts receivable in respect of research and development tax credits are recognized in the ﬁnancial statements provided there is sufﬁcient evidence that the amounts are recoverable. These credits are recognized within income tax in the consolidated statement of comprehensive loss. Deferred tax Deferred tax is provided using the liability method on temporary differences between the tax bases of assets and liabilities and their carrying amounts for ﬁnancial reporting purposes at the reporting date. Deferred income tax assets are recognized for all deductible temporary differences, carry-forward of unused tax credits and unused tax losses, to the extent that it is probable that taxable proﬁt will be available against which the deductible temporary differences and the carry-forward of unused tax credits and unused tax losses can be utilized. The carrying amount of deferred income tax assets is reviewed at the end of each reporting period and reduced to the extent that it is no longer probable that sufﬁcient taxable proﬁt will be available to allow all or part of the deferred income tax asset to be utilized. Unrecognized deferred income tax assets are reassessed at the end of each reporting period and are recognized to the extent that it has become probable that future taxable proﬁt will allow the deferred tax asset to be recovered. Deferred tax assets and liabilities are measured on an undiscounted basis at the tax rates that are expected to apply to the year when the asset is realized, based on tax rates (and tax laws) enacted or substantively enacted at the end of the reporting period. IFRIC 23, Uncertainty over Income Tax Treatments In June 2017, the IASB issued IFRIC Interpretation 23, Uncertainty over Income Tax Treatments (IFRIC 23), which addresses how uncertain tax positions should be accounted for under IFRS. IFRIC 23 requires that, where acceptance of the tax treatment by the relevant tax authority is considered probable, it should be assumed as an accounting recognition matter that treatment of the item will ultimately be accepted. Therefore, no tax provision would be required in such cases. However, if acceptance of the tax treatment is not considered probable, the entity is required to reflect that uncertainty using an expected value (i.e., a probability-weighted approach) or the single most likely amount. IFRIC 23 is mandatorily effective for accounting periods beginning on or after 1 January 2019 and any resulting change to the tax provisions should be recognized in retained earnings. Mereo has recognized a net tax expense of nil in retained earnings on 1 January 2019 in respect of the adoption of IFRIC 23. b) Foreign currencies Items included in the ﬁnancial statements are measured using the currency of the primary economic environment in which the entity operates (“the functional currency”). The consolidated ﬁnancial statements are presented in pound sterling (“£”), which is the functional and presentational currency of the Group. Transactions in foreign currencies are initially recorded by the Group’s entities at the rate ruling on the date the transaction ﬁrst qualiﬁes for recognition. Differences arising on settlement or translation of monetary items are recognized in the consolidated statement of comprehensive loss, as well as gains or losses on the retranslation of foreign currency balances at the year end. The results and ﬁnancial position of Group entities that have a functional currency different from the presentational currency of the Group are translated into the presentational currency (pound sterling). The assets and liabilities of such entities are translated into pound sterling at the rate of exchange ruling at the 94 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS balance sheet date. Income and expenses are translated at the average rate for the period. Fair value adjustments arising on acquisition of such entities are treated as assets and liabilities of the relevant entity and translated into pound sterling at the closing rate. The exchange differences arising on translation for consolidation are recognized in other comprehensive income. c) Property, plant and equipment Property, plant and equipment is stated at cost, net of accumulated depreciation and accumulated impairment losses, if any. Such cost includes the cost of replacing part of the plant and equipment if the recognition criteria are met. All other repair and maintenance costs are recognized in proﬁt or loss as incurred. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets, as follows: • • • Leasehold improvements ten years Ofﬁce equipment ﬁve years IT equipment three years The right-of-use assets are presented within the same line item as that within which the corresponding underlying assets would be presented if they were owned – for the Group this is property, plant and equipment. Right-of-use assets are depreciated over the shorter period of lease term and useful life of the underlying asset: • • Right-of-use asset (building) six to nine years Right-of-use asset (equipment) one to two years An item of property, plant and equipment and any signiﬁcant part initially recognized is derecognized upon disposal or when no future economic beneﬁts are expected from its use or disposal. Any gain or loss arising on derecognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the asset) is included in the statement of comprehensive loss when the asset is derecognized. The residual values, useful lives and methods of depreciation of property, plant and equipment are reviewed at each ﬁnancial year end and adjusted prospectively, if appropriate. d) Business combinations Business combinations are accounted for using the acquisition method of accounting. At the date of the acquisition, the Group initially recognizes the fair value of the identiﬁable assets acquired, the liabilities assumed and any non-controlling interest in the acquired business. The consideration transferred is measured at fair value at the date acquisition. The excess of the consideration transferred over the fair value of net identiﬁable assets of the business acquired is recorded as goodwill, unless the amount of consideration transferred is less than the fair value of net identiﬁable assets of the business acquired in which case the difference is recognized directly in the consolidated statement of comprehensive loss as a bargain purchase. A valuation is performed of assets and liabilities assumed on each acquisition accounted for as a business combination based on our best estimate of fair value. Where the settlement of any part of cash consideration is deferred, the amounts payable in the future are discounted to their present value. Contingent consideration is classiﬁed either as equity or a ﬁnancial liability and is recognized at fair value on the acquisition date. Amounts classiﬁed as a ﬁnancial liability are subsequently remeasured to fair value in accordance with IFRS 9 (Financial Instruments), with changes in fair value recognized in the consolidated statement of comprehensive loss as an administrative expense. Directly attributable acquisition-related costs are expensed as incurred within the consolidated statement of comprehensive loss. 95 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS d) Leases (IFRS 16) Effective January 1, 2019, the Group implemented IFRS 16 (Leases). IFRS 16 (Leases) replaces existing guidance, including IAS 17 (Leases), and sets out the principles for recognition and measurement of leases. The new standard results in an increased volume of disclosure information in these consolidated ﬁnancial statements. For further information, refer to Note 4. e) Intangible assets Intangible assets are initially recorded at cost which has been determined as the fair value of the consideration paid and payable. Assets that have been acquired through a business combination are initially recorded at fair value. The fair value of consideration is regularly reviewed based on the probability of achieving contractual milestones. Intangible assets are reviewed for impairment at each reporting date by allocating the assets to the cash- generating units to which they relate. The estimated useful life is the lower of the legal duration and economic useful life. The estimated useful lives of intangible assets are reviewed on an at least annual basis. Where the consideration paid or payable is in shares, the cost is measured in accordance with IFRS 2 (Share Based Payments). Amortization would commence when product candidates underpinned by the intangible asset become available for commercial use. No amortization has been charged to date, as the product candidates underpinned by the intellectual property rights are not yet available for commercial use. f) Financial instruments Financial assets and liabilities are recognized in the consolidated balance sheet only when the Group becomes party to the contractual provisions of the instrument. Financial assets On initial recognition, a ﬁnancial asset is classiﬁed into one of three primary measurement categories: • • • Amortized cost; Fair value through OCI (“FVOCI”); or Fair value through proﬁt or loss (“FVTPL”). The initial classiﬁcation into a primary measurement category depends on the nature and purpose of the ﬁnancial asset. For each reporting period covered herein, the Group’s ﬁnancial assets were restricted to ﬁnancial assets held at FVOCI. This relates to short-term investments which are not classiﬁed as cash and short-term deposits and are held in a business model whose objective is achieved by both collecting contractual cash flows and selling the short-term investment on maturity. For short-term investments, interest income and impairment gains or losses are recognized directly in the consolidated statement of comprehensive loss. The difference between cumulative fair value gains or losses and the cumulative amounts recognized in the consolidated statement of comprehensive loss is recognized in other comprehensive income until derecognition, when the amounts in other comprehensive income are reclassiﬁed to the consolidated statement of comprehensive loss. g) Fair value measurement Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value measurement is based on the presumption that the transaction to sell the asset or transfer the liability takes place either: In the principal market for the asset or liability; or In the absence of a principal market, in the most advantageous market for the asset or liability. • • 96 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The principal or the most advantageous market must be accessible by the Group. The fair value of an asset or a liability is measured using the assumptions that market participants would use when pricing the asset or liability, assuming that market participants act in their economic best interest. The Group uses valuation techniques that are appropriate in the circumstances and for which sufﬁcient data are available to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs. All assets and liabilities for which fair value is measured or disclosed in the ﬁnancial statements are categorized within the fair value hierarchy, described as follows, based on the lowest level input that is signiﬁcant to the fair value measurement as a whole: • • • Level 1 — quoted (unadjusted) market prices in active markets for identical assets or liabilities. Level 2 — valuation techniques for which the lowest level input that is signiﬁcant to the fair value measurement is directly or indirectly observable. Level 3 — valuation techniques for which the lowest level input that is signiﬁcant to the fair value measurement is unobservable. For assets and liabilities that are recognized in the ﬁnancial statements on a recurring basis, the Group determines whether transfers have occurred between levels in the hierarchy by reassessing categorization (based on the lowest level input that is signiﬁcant to the fair value measurement as a whole) at the end of each reporting period. h) Impairment of non-ﬁnancial assets Further disclosures relating to impairment of non-ﬁnancial assets are also provided in the following notes: • • • Disclosures for signiﬁcant assumptions Note 3 Property, plant and equipment Note 12 Intangible assets not yet available for use Notes 13 and 14 The Group assesses, at each reporting date, whether there is an indication that an asset may be impaired. If any indication exists, or when annual impairment testing for an asset is required, the Group estimates the asset’s recoverable amount. An asset’s recoverable amount is the higher of an asset’s or cash-generating unit’s fair value less costs of disposal and its value in use. The recoverable amount is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. When the carrying amount of an asset or cash-generating unit exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre- tax discount rate that reflects current market assessments of the time value of money and the risks speciﬁc to the asset. In determining fair value less costs of disposal, recent market transactions are taken into account. If no such transactions can be identiﬁed, an appropriate valuation model is used. These calculations are corroborated by valuation multiples, quoted share prices for publicly traded companies or other available fair value indicators. Impairment losses are recognized in the statement of comprehensive loss in expense categories consistent with the function of the impaired asset. An assessment is made at each reporting date to determine whether there is an indication that previously recognized impairment losses no longer exist or have decreased. If such indication exists, the Group estimates the asset’s or cash-generating unit’s recoverable amount. A previously recognized impairment loss is reversed only if there has been a change in the assumptions used to determine the asset’s recoverable amount since the last impairment loss was recognized. The reversal is limited so that the carrying amount of the asset does not exceed its recoverable amount, nor exceed the carrying amount that would have been determined, net of depreciation, had no impairment loss been recognized for the asset in prior years. Such reversal is recognized in the statement of comprehensive loss unless the asset is carried at a revalued amount, in which case the reversal is treated as a revaluation increase. 97 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS i) Cash and short-term deposits Cash and short-term deposits in the balance sheet comprise cash at banks and on hand and short-term deposits with a maturity of three months or less, which are subject to an insigniﬁcant risk of changes in value. j) Short-term investments Cash held on deposit for terms greater than three months are recognized at fair value in the balance sheet with fair value changes recognized in other comprehensive income. Interest revenue, impairment gains and losses, and a portion of foreign exchange gains and losses, are recognized in proﬁt and loss. When the short-term investment is derecognized or reclassiﬁed, changes in fair value previously recognized in other comprehensive income and accumulated in equity are reclassiﬁed to proﬁt and loss. k) Provisions Provisions are recognized when the Group has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic beneﬁts will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. When the Group expects some or all of a provision to be reimbursed, for example, under an insurance contract, the reimbursement is recognized as a separate asset, but only when the reimbursement is virtually certain. The expense relating to a provision is presented in the statement of comprehensive loss net of any reimbursement. If the effect of the time value of money is material, provisions are discounted using a current pre-tax rate that reflects, when appropriate, the risks speciﬁc to the liability. When discounting is used, the increase in the provision due to the passage of time is recognized as a ﬁnance cost. l) Share-based payments Employees (including executives) of the Group receive remuneration in the form of share-based payments, whereby employees render services as consideration for equity instruments (equity settled transactions). Incentives in the form of shares are provided to employees under various plans (Note 26). Executive ofﬁcer have outstanding shares under a deferred bonus share plan (“DBSP Plan”) and a long-term incentive plan (“LTIP Plan”). In accordance with IFRS 2 Share-based Payment (“IFRS 2”), charges for these incentives are expensed through the consolidated statement of comprehensive loss on a straight-line basis over their vesting period, based on the Group’s estimate of shares that will eventually vest. The total amount to be expensed is determined by reference to the fair value of the options or awards at the date they were granted. For LTIP shares, the fair value on grant date excludes the impact of any non-market vesting conditions – these are instead taken into account by adjusting the number of equity instruments included in the measurement of the share-based payment transaction and are adjusted each period until such time as the equity instruments vest. Share options awarded to non-employees are accounted for as options awarded to employees as the value of non-employee services could be readily determined. In accordance with IFRS 2, the cancellation of share options is accounted for as an acceleration of the vesting period and therefore any amount unrecognized that would otherwise have been charged in future accounting periods is recognized immediately. When options are forfeited, the accounting expense for any unvested awards is reversed. Purchases, where consideration is satisﬁed by issuing equity shares, is accounted for as equity settled share- based payment transactions in accordance with IFRS 2. Fair value is determined by the share price at the date of purchase. m) Costs of issuing capital Incremental costs incurred and directly attributable to the offering of equity securities are deducted from the related proceeds of the offering. The net amount is recorded as share premium in the period when such shares are issued. Where such expenses are incurred prior to the offering they are recorded in prepayments 98 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS until the offering completes. Other costs incurred in such offerings are expensed as incurred and included in general and administrative expenses. n) Convertible loan instrument Convertible loan notes are regarded as compound instruments consisting of a liability component and an equity component. At the date of issue, the fair value of the liability component is estimated using a discount rate for an equivalent liability without the conversion feature. The difference between the proceeds of issue of the convertible loan note and the fair value assigned to the liability component is included in equity. o) Employee Beneﬁt Trust The Group operates an Employee Beneﬁt Trust (“EBT”), the Mereo BioPharma Group plc Employee Beneﬁt Trust. The EBT has been established to fulﬁl awards made under the DBSP Plan and the LTIP Plan. The EBT is a Jersey-based trust which is funded by a loan from the Company, which it will utilize to buy shares at nominal value from the Company in sufﬁcient quantity to fulﬁl the envisaged awards. The EBT will acquire shares in the Company and these will be deducted from the shareholders’ funds on the consolidated balance sheet at the cost of acquisition less proceeds on disposal. Shares held by the EBT are included in the consolidated balance sheet as a reduction in equity. The Group treats the EBT as an extension of the Group and the Company as it is ultimately controlled by the Company and therefore consolidated. p) R&D costs Expenditure on product development is capitalized as an intangible asset and amortized over the expected useful economic life of the product candidate concerned. Capitalization commences from the point at which technical feasibility and commercial viability of the product candidate can be demonstrated and the Group is satisﬁed that it is probable that future economic beneﬁts will result from the product candidate once completed. Capitalization ceases when the product candidate receives regulatory approval for launch. No such costs have been capitalized to date. Expenditure on R&D activities that do not meet the above criteria, including ongoing costs associated with acquired intellectual property rights and intellectual property rights generated internally by the Group, is charged to the statement of comprehensive loss as incurred. Intellectual property and in-process R&D from asset acquisitions are recognized as intangible assets at cost. q) Provision for deferred cash consideration Provision for deferred cash consideration consists of future payments which are contractually committed but not yet certain. In respect of products which are not yet approved, such deferred cash consideration excludes potential milestones, royalties or other payments that are deemed to be so uncertain as to be unquantiﬁable. Deferred cash consideration is recognized as a liability with the amounts calculated as the risk adjusted net present value of anticipated deferred payments. The provision is reviewed at each balance sheet date and adjusted based on the likelihood of contractual milestones being achieved and therefore the deferred payment being settled. Increases in the provision relating to changes in the probability are recognized as an intangible asset. Increases in the provision relating to the unwinding of the time value of money are recognized as a ﬁnance expense. r) Bank loan Borrowings (including interest-bearing loans) are initially recognized at fair value, net of transaction costs incurred. Borrowings are subsequently measured at amortized cost. Any difference between the proceeds (net of transaction costs) and the redemption amount is recognized in proﬁt or loss over the period of the borrowings using the effective interest method. Under the effective interest method, amortization is included as a ﬁnance charge in the consolidated statement of comprehensive loss. The Group’s policy is to account for non-substantial modiﬁcations to ﬁnancial liabilities measured at amortized cost through a gain or loss which is recorded in the consolidated statement of comprehensive 99 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS loss. The gain or loss is calculated as the difference between the original contractual cash flows and the modiﬁed cash flows, discounted at the original effective interest rate. For substantial modiﬁcations, the Group’s policy is to derecognize the existing ﬁnancial liability and in turn recognize a new ﬁnancial liability. Borrowings are removed from the balance sheet when the obligation speciﬁed in the contract is discharged, cancelled or expired. s) Associated warrants The Group has issued certain warrant instruments to its lenders (Note 19). As the terms of the warrant instruments allow for a cashless exercise, the Group’s policy is to account for the associated warrant instruments at fair value with changes in the fair value recognized in the consolidated statement of comprehensive loss (see Note 21). t) The Alpha-1 Project (TAP) funding agreement and associated warrants The agreement is accounted for as a compound instrument which includes both debt and equity components. The liability is measured ﬁrst at fair value and the residual value allocated to the equity component. The difference between the funding payment amount received and the measurement of the liability will be allocated to the warrants and recognized in equity. The value of warrants in equity will not be subsequently remeasured as the warrants will be settled by providing a ﬁxed number of shares for a ﬁxed amount of cash. 3. Signiﬁcant judgments, estimates and assumptions The preparation of these ﬁnancial statements requires the management of the Group to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Group bases its estimates and judgments on historical experience and on various other assumptions that it considers to be reasonable. Actual results may differ from these estimates under different assumptions or conditions. 3.1 Judgments a) Share-based compensation Incentives in the form of shares are provided to employees under certain equity award plans (which consist of both share awards and option grants). The fair value of the employee services received in exchange for equity award plans is recognized as an expense. The expense is based upon a number of assumptions disclosed in Note 26. The selection of different assumptions in the measurement of fair value of the equity award plans could affect the results of the Group. b) Business combination On April 23, 2019, the Group obtained a 100% controlling interest in OncoMed, a Company based in the U.S. which was previously listed on the Nasdaq Global Market. Judgement is applied under IFRS 3 (Business Combinations) in determining whether a transaction meets the deﬁnition of a business combination, and so accounted for in accordance with its requirements. In applying this judgement, management has considered the underlying economic substance of the transaction in addition to the contractual terms. Our assessment is that OncoMed meets the deﬁnition of a ‘business’ and the transaction has therefore been accounted for as a business combination. Please refer to Note 5 for further details regarding the OncoMed acquisition. c) Impairment of intangible assets and property, plant and equipment An assessment was made in respect of indicators of impairment in the carrying value of the Group’s intangible assets (see Note 14), right-of-use assets, leasehold improvements, ofﬁce equipment and IT equipment as at December 31, 2019. If such an indication exists, the recoverable amount of the asset, being the higher of the asset’s fair value less costs to sell and value in use, is compared to the asset’s carrying value. Any excess of the asset’s carrying value over its recoverable amount is expensed to the income statement. The assessment of intangible assets involves a number of signiﬁcant judgments regarding the likelihood of successful product 100 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS approval, the costs of reaching approval, the estimated useful life of intangible assets following commercialization and the subsequent commercial proﬁtability of the product once approved. d) IFRS 16 (Leases) discount rate Following the adoption of IFRS 16 (Leases) on January 1, 2019, the Group is required discount future lease payments using the interest rate implicit in the lease, or, if that rate cannot be readily determined, the incremental borrowing rate. IFRS 16 (Leases) deﬁnes the incremental borrowing rate as the rate of interest a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of similar value to the right-of-use assets in a similar economic environment. For the year ended December 31, 2019, the determination of an appropriate discount rate has a signiﬁcant effect on the lease liabilities recognized (see Note 4). For the current lease portfolio, the Group has determined an incremental borrowing rate based on relevant and available information as the interest rate implicit in the lease arrangements cannot be readily determined. In addition to the determination of an appropriate discount rate, the Group was also required to assess the lease term for qualifying leases. The determination of the lease term is judgmental as for certain qualifying leases held by the Group, the contract includes an extension option beyond the non-cancellable period for which the Group has the right to use the underlying asset. In applying this judgment, the Group considered the period over which it was reasonably certain to make use of the extension option. 3.2 Estimates a) Fair value of intangible assets acquired in business combination The Group performed a full valuation of the fair value of assets acquired and liabilities assumed following the acquisition of OncoMed. Based on the assets acquired and liabilities assumed, speciﬁc consideration was applied to the valuation of the intangible asset acquired which required an estimation of the expected useful life and future cash flows of the intangible asset alongside the determination of an appropriate discount rate. The intangible asset acquired was valued using a risk adjusted net present value model. b) Contingent consideration The Group makes provision for the estimated fair value of amounts payable to the former shareholders of OncoMed under the Contingent Value Rights Agreement (“CVR”), which is accounted for as a contingent consideration liability. At December 31, 2019, the Group estimates the fair value of the contingent consideration liability to be £0.4 million ($0.5 million), which is an increase from £nil on the date of acquisition (see Note 5). The increase in the fair value of the contingent consideration liability reflects the terms subsequently agreed with Oncologie, Inc. (“Oncologie”) with respect to the global licensing agreement of navicixizumab (“Navi”) (see Note 30). Total potential payments under the CVR on a gross, undiscounted basis, are approximately $80.0 million (see Note 5). The estimated contingent consideration payable is based on a risk-adjusted, probability-based scenario. Under this approach the likelihood of future payments being made to the former shareholders of OncoMed under the CVR is considered. The estimate could materially change over time in line with the development plan and subsequent commercialization of the Navi product. c) Deferred license consideration Deferred consideration in the form of cash is recognized as a provision at each balance sheet date, to the extent its amount is quantiﬁable at the inception of the arrangement (see Note 20). The amount provided is based on a number of estimates regarding the timing and progress of the related research. Deferred consideration in the form of shares is recognized as a share-based payment when it is probable that shares will be transferred. 101 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 4. Changes in accounting policies 4.1 Changes in accounting policies 2019 Effective January 1, 2019, the Group has adopted IFRS 16 (Leases). IFRS 16 (Leases) replaces existing guidance, including IAS 17 (Leases), and sets out the principles for the recognition and measurement of leases. The new standard has resulted in an increased volume of disclosure information within these consolidated ﬁnancial statements. The Group has also implemented other minor amendments to existing standards and interpretations, which have no material impact on the Group’s overall results and ﬁnancial position. a) General impact of application of IFRS 16 (Leases) The date of initial application of IFRS 16 for the Group is January 1, 2019. The Group has applied IFRS 16 using the modiﬁed retrospective approach, without restatement of the comparative information. IFRS 16 introduces new or amended requirements with respect to lease accounting. It introduces signiﬁcant changes to the lessee accounting by removing the distinction between operating and ﬁnance lease, requiring the recognition of a right-of-use asset and a lease liability at commencement for all leases, except for short- term leases and leases of low value assets. In contrast to lessee accounting, the requirements for lessor accounting have remained largely unchanged. b) Deﬁnition of a lease Previously, the Group determined at contract inception whether an arrangement was or contained a lease under IFRIC 4 (Determining Whether an Arrangement contains a Lease). The Group now assesses whether a contract is or contains a lease based on the new deﬁnition of a lease under IFRS 16 (Leases). Under IFRS 16 (Leases), a contract is or contains a lease, if the contract conveys a right to control the use of an identiﬁed asset in exchange for consideration. On transition to IFRS 16 (Leases), the Group elected to apply the practical expedient to grandfather the assessment of which transactions are leases. It applied IFRS 16 (Leases) only to contracts that were previously not identiﬁed as leases. Contracts that were identiﬁed as leases under IAS 17 and IFRIC 4 were not reassessed. In preparation for the ﬁrst-time application of IFRS 16, the Group has carried out an implementation project. The new deﬁnition in IFRS 16 will not signiﬁcantly change the scope of contracts that meet the deﬁnition of a lease for the Group. At inception or on reassessment of a contract that contains a lease component, the Group allocates the consideration in the contract to each lease and non-lease component based on their relative stand-alone prices. c) Practical expedients adopted on transition Certain practical expedients permitted by IFRS 16 are used by the Group, notably: 1) 2) 3) To not reassess, upon transition, whether an existing contract contains a lease (grandfather the previous assessment of whether a transaction was a lease under IAS 17 or IFRIC 4). The deﬁnition of a lease under IFRS 16 has been applied only to contracts entered into or changed on or after January 1, 2019; The recognition exemptions for short-term leases (less than 12 months of lease term) and the leases of low-value assets; and Used hindsight when determining the lease term, if the contract contains options to extend or terminate the lease. d) Financial impact The application of IFRS 16 to leases previously classiﬁed as operating leases under IAS 17 resulted in the recognition of right-of-use assets and lease liabilities. The table below sets out the adjustments recognized at the date of initial application of IFRS 16 which does not include the lease acquired as part of the OncoMed acquisition. 102 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS As at December 31, 2018 Impact of IFRS 16 Non-current assets Property, plant and equipment Prepayments and other Total impact on assets Current liabilities Trade and other payables Lease liabilities Non-current liabilities Lease liabilities Accruals Total impact on liabilities Total impact on retained earnings 149 1,067 ––––––––– 4,570 – — 4,437 ––––––––– Restated as at January 1, 2019 2,701 1,017 ––––––––– 2,552 (50) ––––––––– 2,502 ––––––––– – 607 4,570 607 1,927 4,405 ––––––––– 1,927 (32) ––––––––– (2,502) ––––––––– – ––––––––– ––––––––– As at January 1, 2019, right-of-use assets related to a leased property (£1.2 million) and a lease of medical equipment used in ongoing clinical trials (£1.3 million). Following the acquisition of OncoMed on April 23, 2019, the Group acquired an additional right-of-use asset related to a leased property in Redwood City, U.S. (£10.8 million). The table below presents a reconciliation from operating lease commitments disclosed as at December 31, 2018 to lease liabilities recognized as at January 1, 2019. Operating lease commitments disclosed under IAS 17 (at December 31, 2018) Effect of discounting Reassessment of lease term under IFRS 16 Lease liabilities recognised under IFRS 16 (at January 1, 2019) 536 (944) 2,942 ––––––––– 2,534 ––––––––– ––––––––– Certain lease agreements include an option which allows the Group to extend the lease. The Group is reasonably certain that it will invoke the extension option on the lease of medical equipment used in ongoing clinical trials, as the Group expects that the studies will extend beyond the initial lease term. Where the Group is reasonably certain that the lease will be extended, the cash flows are included in the calculation of the lease liability. The adoption of IFRS 16 (Leases) results in a decrease in other operating expenses in the consolidated statement of comprehensive loss where lease payments were previously recorded. IFRS 16 (Leases) results in an increase in depreciation and interest expense going forwards following the recognition of a right-of- use asset and lease liability. The weighted average incremental borrowing rate applied to lease liabilities recognized on transition was 15.0%. As at December 31, 2019, in relation to leases under IFRS 16 (Leases) the Group has recognized the following amounts in the consolidated statement of comprehensive loss: Depreciation Interest expense Foreign exchange gain Income from sub-leasing right-of-use assets 1,505 1,314 29 855 103 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS For the year ended December 31, 2019, within the consolidated statement of cash flows under IFRS 16 (Leases) the Group has opted to disclose both the cash paid for the interest portion and cash payments for the principal portion of the lease liability as part of ﬁnancing activities. The adoption of IFRS 16 (Leases) did not have an impact on net cash flows. The total cash outflow for leases amounted to £2.2 million during the year (2018: £0.3 million). e) Subsequent updates As at December 31, 2019, the lease term remaining on the medical equipment has been reassessed in line with the contractual agreement. The reassessment of lease term has been accounted for as a change in accounting estimate and the lease liability has been remeasured accordingly to reflect the change in estimated future lease payments. The carrying amount of the right-of-use asset has been adjusted for the remeasurement of the lease liability, both reduced by £0.3 million respectively. 4.2 Changes in accounting policies 2018 Effective January 1, 2018, the Group has adopted IFRS 9 (Financial Instruments) which introduces new requirements for: 1. 2. 3. 4. The classiﬁcation and measurement of ﬁnancial assets and ﬁnancial liabilities; Impairment for ﬁnancial assets; General hedge accounting; and New accounting for certain modiﬁcations and exchanges of ﬁnancial liabilities measured at amortized cost. The only impact on the Group is in relation to the non-substantial modiﬁcation of the convertible loan notes, as detailed below. The Group has applied IFRS 9 (Financial Instruments) in full without restating comparatives with an initial date of application of January 1, 2018. In relation to the non-substantial modiﬁcation of ﬁnancial liabilities, IFRS 9 (Financial Instruments) requires the recognition of a modiﬁcation gain or loss for exchanges or modiﬁcations of ﬁnancial liabilities that do not result in the of a ﬁnancial liability. As a result, under IFRS 9 (Financial Instruments) the carrying value of the convertible loan note as at the date of modiﬁcation was adjusted to recognize the modiﬁcation gain in retained earnings as of the date of initial application of January 1, 2018. At January 1, 2018 (as calculated under IAS 39) Amounts restated through retained earnings At January 1, 2018 (as calculated under IFRS 9) 1,977 (124) ––––––––– 1,853 ––––––––– ––––––––– The Group has considered the adoption of IFRS 9 on receivables and determined the expected credit loss to be immaterial, and therefore no adjustment has been made for this. 5. Acquisition of subsidiary On April 23, 2019, the Group obtained control of OncoMed, a Company based in the U.S., which was previously listed on the Nasdaq Global Market, by acquiring 100 per cent of its issued share capital. OncoMed is a clinical-stage biopharmaceutical company focused on discovering and developing novel therapeutics that address the fundamental biology driving cancer’s growth, resistance, recurrence and metastasis. OncoMed was acquired in order to broaden the Group's asset base, strengthen its cash position and obtain a US listing to diversify international shareholder base of the combined group. 104 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The ﬁnal acquisition accounting is set out below: Cash and short-term deposits Short-term investments Other receivables Prepayments Property, plant and equipment Right-of-use assets Identiﬁable intangible assets Other liabilities Lease liabilities Net identiﬁable assets Bargain purchase Total consideration Equity instruments (24.8 million ordinary shares) Contingent consideration arrangement Total consideration OncoMed 10,074 29,019 155 1,699 82 10,755 12,693 (9,215) (10,689) ––––––––– 44,573 ––––––––– (3,681) ––––––––– 40,892 ––––––––– 40,892 ––––––––– — ––––––––– 40,892 ––––––––– ––––––––– The Group acquired net cash of £10.1 million with the acquisition of OncoMed, being the value of the cash and short-term deposits on April 23, 2019. The fair value of the 24.8 million ordinary shares issued as the consideration paid for OncoMed was measured based on the Group’s quoted share price on April 23, 2019. As the Group acquired OncoMed for an amount less than the fair market value of the net assets acquired, a gain on bargain purchase of £3.7 million was realized. The was attributable to the following factors: • • Subject to working capital adjustments, the immediately pre-closing proportion of shares in the Company due to be issued to OncoMed’s shareholders was agreed in December 2018, based on the Group’s 90-day volume-weighted average share price ending on December 4, 2018. Following a movement downward in the Group’s quoted share price on the completion date in comparison with the reference share price, this reduced the overall fair value of the consideration paid. The impact in the reduction in the fair value of consideration paid was partly offset by; In the period from announcement of the deal and the date of acquisition (April 23, 2019), a period of approximately ﬁve months, OncoMed continued to generate losses, reflecting continue research and development activity, together with recurring expenditure on its overheads. This had the effect of reducing net assets acquired on the acquisition date compared with net assets at the time the acquisition was agreed. Additional cash consideration, accounted for as contingent consideration, becomes payable under a Contingent Value Rights Agreement (“CVR”) relating to OncoMed’s etigilimab (“TIGIT”) and navicixizumab (“Navi”) products. The contingent consideration would become payable upon the achievement of certain milestones in the future speciﬁc to TIGIT (“the TIGIT milestone”) and Navi (“the Navi milestone”). As at the date of acquisition the fair value of the contingent consideration was estimated to be close to £nil. In making that assessment, the following information and factors were considered: 1) 2) 3) 4) The uncertain outcomes of current clinical studies; The level of uncertainty regarding the availability of future funding partners; The level of uncertainty relating to the success of future development of such products; The dependency of the CVR milestones on the occurrence of events that are outside of the control of the Group; and 105 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 5) The likelihood of Celgene exercising the exclusive option granted by OncoMed to Celgene in relation to OncoMed’s TIGIT product, particularly given Bristol-Myers Squibb’s proposed acquisition of Celgene. In June 2019 it was announced that Celgene had decided, in light of strategic product portfolio considerations, not to exercise its option to license TIGIT. Accordingly, the TIGIT milestone can no longer be achieved. As at December 31, 2019, the Group estimates the fair value of the Navi milestone to be £0.4 million ($0.5 million) which is accounted for as a contingent consideration liability (see Note 25 and Note 30). The maximum undiscounted amount of the Navi milestone is subject to an aggregate cap of $80 million. The fair value of the ﬁnancial assets includes receivables from the landlord under OncoMed's ofﬁce lease arrangement in relation to tenant improvements with a fair value and a gross contractual value of £0.2 million. It is estimated at acquisition date that all contractual cash flows are collectable in full. Short-term investments acquired with OncoMed were treasury bills (recognized at fair value through other comprehensive income), in line with the Group’s accounting policy (see Note 25). Acquisition related costs (presented net against the gain on bargain purchase in the consolidated statement of comprehensive loss) amounted to £2.6 million (rounded). Transaction costs incremental and directly attributable to the issuance of new share capital associated with the acquisition of OncoMed amounted to £0.8 million, which is accounted for within equity. The net gain on bargain purchase in the consolidated statement of comprehensive loss is therefore £1.0 million (rounded). OncoMed contributed £nil revenue and £5.7 million to the Group’s loss for the period between the date of acquisition and the balance sheet date. If the acquisition of OncoMed had been completed on the ﬁrst day of the ﬁnancial year, group revenues for the period would have been £3.3 million and the Group’s loss would have been £42.9 million. This information is provided for illustrative purposes only and is not necessarily indicative of the results that the Group would have occurred had OncoMed been acquired at the beginning of the year, or indicative of future results of the Group. 6. Group information Information about subsidiaries The consolidated ﬁnancial statements of the Group include: % equity % equity interest interest December December 31, Country of 31, 2018 Name Principal activities incorporation 2019 Mereo BioPharma 1 Limited Pharmaceutical R&D U.K. 100 Mereo BioPharma 2 Limited Pharmaceutical R&D U.K. 100 Mereo BioPharma 3 Limited Pharmaceutical R&D U.K. 100 Mereo BioPharma 4 Limited Pharmaceutical R&D U.K. 100 Mereo BioPharma Ireland Limited Pharmaceutical R&D Ireland 100 OncoMed Pharmaceuticals, Inc. Pharmaceutical R&D U.S. 100 Navi Subsidiary, Inc. Pharmaceutical R&D U.S. 100 Mereo US Holdings Inc. Holding company U.S. 100 Mereo MergerCo One Inc. Holding company U.S. – Mereo BioPharma Group plc Employee Beneﬁt Trust Employee share scheme Jersey – 100 100 100 100 100 – – 100 100 – The registered ofﬁce of Mereo BioPharma 1 Limited, Mereo BioPharma 2 Limited, Mereo BioPharma 3 Limited and Mereo BioPharma 4 Limited is located at Fourth Floor, 1 Cavendish Place, London W1G 0QF. The registered ofﬁce of Mereo BioPharma Ireland Limited is 25/28 North Wall Quay, Dublin 1 D01H104, Ireland. Mereo US Holdings Inc. and Mereo MergerCo One Inc. were incorporated on December 3, 2018 for the sole purpose of effecting the business combination with OncoMed (see Note 5). Following the business combination with OncoMed, Mereo MergerCo One Inc. ceased to exist. The registered ofﬁce of Mereo US 106 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Holdings Inc. is 251 Little Falls Drive, City of Wilmington, County of New Castle, Delaware 19808, U.S. Mereo MergerCo One Inc. was a 100% owned subsidiary of Mereo US Holdings Inc. OncoMed became a wholly owned subsidiary of Mereo US Holdings Inc. on April 23, 2019 and is therefore an indirect, wholly owned subsidiary of Mereo BioPharma Group plc. The registered ofﬁce of OncoMed Pharmaceuticals, Inc. is 251 Little Falls Drive, City of Wilmington, Country of New Castle, Delaware 19808, U.S. Navi Subsidiary, Inc, incorporated on April 15, 2019, is a wholly owned subsidiary of OncoMed. Under IFRS, the Employee Beneﬁt Trust is treated as an extension of the Group and the Company as it is controlled and therefore consolidated. 7. Loss before taxation Loss before tax is stated after charging: Year ended December 31, Fees payable to the Company’s Auditor for the audit of Group accounts Fees payable to the Company’s Auditor for other services: Audit of subsidiary accounts Audit-related assurance services Accounting advisory services Legal and professional fees including patent costs Operating lease expense (IAS 17) Depreciation of right-of-use assets (IFRS 16) Depreciation (excluding right-of-use assets) 2018 323 30 171 10 936 293 – 40 2019 514 45 311 – 2,413 – 1,505 52 Following the adoption of IFRS 16 (Leases) on January 1, 2019, the Group has recognized £1.5 million of expense relating to depreciation of right-of-use assets and £1.3 million of interest expense relating to ﬁnance lease liabilities in the consolidated statement of comprehensive loss. No prior year comparative is disclosed, however under IAS 17 (Leases) the Group previously recognized £0.3 million relating to operating lease expense in the consolidated statement of comprehensive loss. 8. Employees The average monthly number of persons employed by the Group (including Directors) during the year was: Year ended December 31, By activity Administrative Research and development Total 2018 2019 24 12 ––––––––– 36 ––––––––– ––––––––– 28 18 ––––––––– 46 ––––––––– ––––––––– 107 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Total compensation costs for persons employed by the Group (including Directors) during the year was: Year ended December 31, Included in research and development expenses: Salaries Social security costs Pension contributions Share-based payment expenses Included in administrative expenses: Salaries Social security costs Pension contributions Share-based payment expenses Total employee beneﬁt expenses 2018 1,792 (30) 73 526 2019 2,824 110 62 152 2,903 (828) 99 1,663 ––––––––– 6,198 ––––––––– ––––––––– 3,384 (124) 114 1,485 ––––––––– 8,007 ––––––––– ––––––––– Total compensation costs for Directors during the year was: Year ended December 31, Salaries and fees Beneﬁts in kind Pension contributions Bonus Total 2018 2019 1,047 15 11 512 ––––––––– 1,585 ––––––––– ––––––––– 1,106 17 25 294 ––––––––– 1,442 ––––––––– ––––––––– During 2019, two Directors were members of a deﬁned contribution pension scheme (period ended December 31, 2018: two). Further details concerning the remuneration of Key Management Personnel can be found in Note 28. 9. Other income/expenses and adjustments 9.1 Finance income Year ended December 31, Bank interest earned Interest earned on short-term investments Gain on short-term investments Total ﬁnance income 2017 2018 2019 827 – – ––––––––– 827 ––––––––– ––––––––– 307 – – ––––––––– 307 ––––––––– ––––––––– 42 141 194 ––––––––– 377 ––––––––– ––––––––– 108 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 9.2 Finance charge Year ended December 31, Interest payable on convertible loan Interest on TAP funding Interest payable on bank loan Interest on lease liabilities Accreted interest on bank loan Transaction costs on bank loan Modiﬁcation (loss)/gain on bank loan Loss on short-term deposits Discounting of provision for deferred cash consideration Change in warrant fair value Total ﬁnance charge 2017 2018 2019 (103) – (327) – (67) (200) – (339) – (54) ––––––––– (1,090) ––––––––– ––––––––– (185) – (1,645) – (782) – (730)* (22) (443) 716 ––––––––– (3,091) ––––––––– ––––––––– (20) (10) (1,739) (1,314) (1,523) — 456 – (221) 875 ––––––––– (3,496) ––––––––– ––––––––– * We have reclassiﬁed the loan modiﬁcation loss occurring in 2018 resulting in the reduction of administrative expenses by £0.7 million, and the increase in ﬁnance charges of an equivalent amount. Please refer to Note 2 for further details. 10. Income tax Year ended December 31, U.K. corporation tax R&D credit Other tax income / (expense) Income tax credit 2017 2018 2019 8,152 – ––––––––– 8,152 ––––––––– ––––––––– 5,277 – ––––––––– 5,277 ––––––––– ––––––––– 5,149 1,125 ––––––––– 6,274 ––––––––– ––––––––– U.K. income tax The Group is entitled to claim tax credits in the U.K. under the U.K. R&D small or medium-sized enterprise (SME) scheme, which provides additional taxation relief for qualifying expenditure on R&D activities and includes an option to surrender a portion of tax losses arising from qualifying activities in return for a cash payment from HM Revenue & Customs (HMRC). The amount included in the ﬁnancial statements represents the credit for the year ended December 31, 2018 which was received in early 2020 together with the estimated recoverable credit for the year ended December 31, 2019. U.S. income tax On December 22, 2017, the Tax Cuts and Jobs Act were entered into law. Following the acquisition of OncoMed during the year, the Group has analyzed the effects of the tax reform for the ﬁnancial year ended December 31, 2019. The new tax law permanently repeals the corporate Alternative Minimum Tax (“AMT”) and provides a transition period where existing AMT credits are refundable. Other tax income of £1.1 million reflects amounts received or receivable by the Group as AMT credits. As at December 31, 2019, £1.0 million is receivable, recognized as other taxes recoverable within the consolidated balance sheet. At December 31, 2019, the Group had an Uncertain Tax Position of £2.5 million being held off the Balance Sheet, in respect of the R&D tax credits in the US. The Uncertain Tax Position is calculated based upon historic US R&D claims and equates to around 20% of the outstanding US R&D claims. 109 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Reconciliation of effective tax rate Year-ended December 31, Loss on ordinary activities before income tax Loss on ordinary activities before tax at the U.K.’s statutory income tax rate of 19% (2018: 19%) Expenses not deductible for income tax purposes (permanent differences) Temporary timing differences R&D relief uplift Losses (unrecognized) Deferred income from MBG loan guarantee costs Differences in overseas tax rates Gain on bargain purchase Other Tax credit for the year 2017 2018 2019 (46,951) (37,306) (41,118) 9,038 7,088 7,812 (13) (712) 3,447 (3,785) 177 – – – ––––––––– 8,152 ––––––––– ––––––––– (1,070) (277) 2,271 (2,804) 69 – – – ––––––––– 5,277 ––––––––– ––––––––– (317) (343) 2,540 (4,380) (54) 340 699 (23) ––––––––– 6,274 ––––––––– ––––––––– Deferred tax The analysis of unrecognized deferred tax is set out below: December 31, Losses US tax credits Accruals Fixed assets Other Temporary differences trading Net deferred tax asset (unrecognized) 2017 2018 2019 6,121 – – – – 2,267 ––––––––– 8,388 ––––––––– ––––––––– 8,604 – – – 6 495 ––––––––– 9,105 ––––––––– ––––––––– 19,443 10,032 947 400 202 4 ––––––––– 31,028 ––––––––– ––––––––– The analysis of recognized deferred tax is set out below: At January 1, 2019 Acquisition of subsidiary (Note 5) Recognized in income At December 31, 2019 Deferred tax liabilities Intangible asset Deferred tax asset Net operating losses – ––––––––– Net deferred tax asset / (liability) – ––––––––– ––––––––– – (2,686) – (2,686) – ––––––––– (2,686) ––––––––– ––––––––– 2,686 ––––––––– 2,686 ––––––––– ––––––––– 2,686 ––––––––– – ––––––––– ––––––––– The deferred tax liability has arisen from the recognition of separately identiﬁable intangible assets on the acquisition of OncoMed (see Note 5). A deferred tax asset on losses has been recognized up to the level of the deferred tax liability, resulting in a net deferred tax liability of £nil. The remaining deferred tax assets, as set out in the table above, have not been recognized as there is uncertainty regarding when suitable future proﬁts against which to offset the accumulated tax losses will arise. U.K. deferred tax A reduction in the rate of UK corporation tax to 19% from April 1, 2017 and to 17% from April 1, 2020 was substantively enacted at the Balance Sheet date. However subsequently, the UK Government announced that the UK corporation tax rate would remain at 19% and not reduce to 17% on 1 April 2020. This was 110 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS substantively enacted on 17 March 2020. The standard rate of UK corporation tax applied to reported loss is 19% (2018: 19%). Unrecognized UK deferred tax assets and liabilities are calculated at a rate of 17%, being the rate that was substantively enacted at the Balance Sheet date. There is no expiration date for accumulated tax losses in the U.K. entities. At December 31, 2019, the Group had U.K. tax losses to be carried forward of approximately £70.2 million (2018: £50.0 million). U.S. deferred tax In the U.S., the Tax Cuts and Jobs Act reduced the corporation tax rate to 21% from January 1, 2018. The effect of the new U.S. corporation tax rate has been considered in these ﬁnancial statements. U.S. deferred tax assets and liabilities are calculated at a blended rate of approximately 21%. For OncoMed, with respect to accumulated tax losses carried forward prior to the acquisition of the Company, there is a change of control restriction which will limit the amount available in any one year. At December 31, 2019, the Group had U.S. federal tax losses to be carried forward of approximately £47.5 million, of which £40.9 million can be carried forward indeﬁnitely and £6.6 million which will begin to expire in 2023. At December 31, 2019, the Group had U.S. state tax losses to be carried forward of approximately £3.2 million which begin to expire in 2028. 11. Loss per share Basic loss per share is calculated by dividing the loss attributable for the year to ordinary equity holders of the parent by the weighted average number of ordinary shares outstanding during the year. As the net amount attributable for the year to ordinary equity holders of the parent was a loss in the year (2018: loss), the dilutive potential shares are anti-dilutive for the earnings per share calculation. 2017 Weighted Loss shares £’000 number Loss per share £ December 31, 2018 Weighted shares number Loss £’000 Loss per share £ 2019 Weighted shares number Loss £’000 Loss per share £ Basic and diluted (38,799) 69,012,348 (0.56) (32,029) 71,144,786 (0.45) (34,844) 89,424,476 (0.39) The Company operates share option schemes (see Note 26) which could potentially dilute basic earnings per share in the future. In addition, there exist within equity nil (2018: 864,988) shares to be issued which also have the potential to dilute basic earnings per share in the future (see Note 18). As part of a license and option agreement with AstraZeneca (see Note 26) additional future payments of a maximum of 1,349,692 new ordinary shares would be payable on reaching certain clinical milestones. Warrants totaling 321,444 were issued in 2019 (2018: 41,286) that could potentially dilute basic earnings per share if converted. The equity-settled transactions were considered to be anti-dilutive as they would have decreased the loss per share and were therefore excluded from the calculation of diluted loss per share. For transactions involving ordinary shares or potential ordinary shares between the reporting date and the date of authorization of these ﬁnancial statements, see Note 30. 12. Property, plant and equipment The Group has decided to present right-of-use assets within property, plant and equipment. On initial application of IFRS 16 (Leases), the Group recognized a right-of-use asset of £2.6 million. Subsequently, following the acquisition of OncoMed, the Group recognized a right-of-use asset of £10.8 million relating to an acquired property lease. 111 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Further details on the initial application of IFRS 16 (Leases) are presented in Note 4. Right-of-use Right-of-use asset (equipment) asset (building) Leasehold improve- ments Ofﬁce equipment IT equipment – – – – 1,237 1,314 10,755 – – – – (290) 164 – – – – – 31 – – 58 (18) – 71 21 – 24 – – Total 266 21 2,551 10,837 (18) (290) (115) ––––––––– 11,877 ––––––––– ––––––––– – ––––––––– 1,024 ––––––––– ––––––––– – ––––––––– 164 ––––––––– ––––––––– – ––––––––– 71 ––––––––– ––––––––– – ––––––––– 116 ––––––––– ––––––––– (115) ––––––––– 13,252 ––––––––– ––––––––– Depreciation and impairment At January 1, 2019 Disposals Depreciation for the year – – – – (53) – (16) – (48) – (117) – (996) ––––––––– (996) ––––––––– ––––––––– (509) ––––––––– (509) ––––––––– ––––––––– (16) ––––––––– (69) ––––––––– ––––––––– (14) ––––––––– (30) ––––––––– ––––––––– (42) ––––––––– (90) ––––––––– ––––––––– (1,577) ––––––––– (1,694) ––––––––– ––––––––– – ––––––––– 10,881 ––––––––– ––––––––– – ––––––––– 515 ––––––––– ––––––––– 111 ––––––––– 95 ––––––––– ––––––––– 15 ––––––––– 41 ––––––––– ––––––––– 23 ––––––––– 26 ––––––––– ––––––––– 149 ––––––––– 11,558 ––––––––– ––––––––– Cost or valuation At January 1, 2019 Additions Transition to IFRS 16 (Leases) Acquisition of subsidiary (Note 5) Disposals Adjustment to carrying value Currency translation effects At December 31, 2019 At December 31, 2019 Net book value At January 1, 2019 At December 31, 2019 112 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Leasehold improvements Ofﬁce equipment IT equipment Cost or valuation 155 At January 1, 2018 9 Additions Disposals – ––––––––– At December 31, 2018 164 ––––––––– ––––––––– Depreciation and impairment (37) At January 1, 2018 – Disposals Depreciation for the year (16) ––––––––– At December 31, 2018 (53) ––––––––– ––––––––– 30 1 — ––––––––– 31 ––––––––– ––––––––– (10) — (6) ––––––––– (16) ––––––––– ––––––––– 48 25 (2) ––––––––– 71 ––––––––– ––––––––– (33) 2 (17) ––––––––– (48) ––––––––– ––––––––– Total 233 35 (2) ––––––––– 266 ––––––––– ––––––––– (80) 2 (39) ––––––––– (117) ––––––––– ––––––––– Net book value At January 1, 2018 118 ––––––––– At December 31, 2018 111 ––––––––– ––––––––– 20 ––––––––– 15 ––––––––– ––––––––– 15 ––––––––– 23 ––––––––– ––––––––– 153 ––––––––– 149 ––––––––– ––––––––– Leasehold improvements Ofﬁce equipment IT equipment Cost or valuation 155 At January 1, 2017 – Additions Disposals – ––––––––– 155 At December 31, 2017 ––––––––– ––––––––– Depreciation and impairment (21) At January 1, 2017 – Disposals Depreciation for the year (16) ––––––––– At December 31, 2017 (37) ––––––––– ––––––––– 20 10 – ––––––––– 30 ––––––––– ––––––––– (5) – (5) ––––––––– (10) ––––––––– ––––––––– 43 5 – ––––––––– 48 ––––––––– ––––––––– (18) – (15) ––––––––– (33) ––––––––– ––––––––– Total 218 15 – ––––––––– 233 ––––––––– ––––––––– (44) – (36) ––––––––– (80) ––––––––– ––––––––– Net book value At January 1, 2017 134 ––––––––– At December 31, 2017 118 ––––––––– ––––––––– 15 ––––––––– 20 ––––––––– ––––––––– 25 ––––––––– 15 ––––––––– ––––––––– 174 ––––––––– 153 ––––––––– ––––––––– 113 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 13. Intangible assets Cost at January 1, 2018 Cost at December 31, 2018 Acquisition of subsidiary (Note 5) Currency translation effects Cost at December 31, 2019 Revision to estimated value at January 1, 2018 Revisions to estimated value Revision to estimated value at December 31, 2018 Revision to estimated value Revision to estimated value at December 31, 2019 Net book value at January 1, 2018 Net book value at December 31, 2018 Net book value at December 31, 2019 Acquired development programs 33,005 33,005 ––––––––– 12,693 (171) ––––––––– 45,527 ––––––––– – (373) ––––––––– (373) ––––––––– (698) ––––––––– (1,071) ––––––––– 33,005 32,632 ––––––––– 44,456 ––––––––– The Group’s strategy is to acquire and develop clinical-stage development programs for the treatment of non-rare and rare diseases from large pharmaceutical companies. On April 23, 2019, the Group acquired an intangible asset of £12.7 million following the acquisition of OncoMed (Note 5). On October 28, 2017, the Group acquired the exclusive license for MPH-966 and included the option to acquire certain assets from AstraZeneca AB (“AstraZeneca”). On that date the fair value of MPH-966 was measured at £7.2 million which consisted of upfront cash and equity payments as well as deferred cash and equity consideration. The provision for deferred cash consideration, in line with the Group’s accounting policy, is re-measured to fair value at each balance sheet date and recognized in the intangible asset. During the year, the provision for deferred cash consideration has decreased by £0.7 million (2018: £0.4 million) due to changes in timelines and the probability of contractual milestones being achieved. Cost at January 1, 2017 Cost at December 31, 2017 Cost at December 31, 2018 Revision to estimated value at January 1, 2017 Revisions to estimated value Revision to estimated value at December 31, 2017 Revision to estimated value Revision to estimated value at December 31, 2018 Net book value at January 1, 2017 Net book value at December 31, 2017 Net book value at December 31, 2018 114 Acquired development programs 25,813 33,005 ––––––––– 33,005 ––––––––– – – ––––––––– – ––––––––– (373) ––––––––– (373) ––––––––– 25,813 33,005 ––––––––– 32,632 ––––––––– MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 14. Impairment testing of acquired development programs not yet available for use Acquired development programs not yet available for use are assessed annually for impairment. The carrying amount of acquired development programs is as follows: Navicixizumab BPS-804 (navi) (setrusumab) As at December 31, 2019 BGS-649 MPH-966 (alvelestat) BCT-197 (leflutrozole)(acumapimod) Total Acquired development programs Acquired development programs 12,522 ––––––––– 11,616 ––––––––– 6,121 ––––––––– 9,886 ––––––––– 4,311 ––––––––– 44,456 ––––––––– BPS-804 (setrusumab) As at December 31, 2018 BGS-649 MPH-966 (alvelestat) BCT-197 (leflutrozole)(acumapimod) Total 11,616 ––––––––– 6,819 ––––––––– 9,886 ––––––––– 4,311 ––––––––– 32,632 ––––––––– The Group considers the future development costs, the probability of successfully progressing each program to product approval and the likely commercial returns after product approval, among other factors, when reviewing for indicators of impairment. The results of this testing did not indicate any impairment of the acquired products’ rights in the year to December 31, 2019. Management believe that the likelihood of a materially different outcome using different assumptions is remote. The acquired development programs are assets which are not used in launched products. These assets have not yet begun to be amortized but have been tested for impairment by assessing their value in use. Value in use calculations for each program are utilized to calculate the recoverable amount. The calculations use pre-tax cash flow projections covering the period through product development to commercial sales up to the later of loss of patent protection or market exclusivity, which extend beyond ﬁve years from the balance sheet date. Approved products are assumed to be out-licensed such that the Group receives signature fees, milestone receipts and royalties on sales; therefore, the Group does not incur any costs of commercialization after out-licensing. Key assumptions for the value in use calculations are described as follows: • • • • • • • Development costs to obtain regulatory approval – costs are estimated net of any contributions expected from collaborative arrangements with future partners. Management have developed cost estimates based on their previous experience and in conjunction with the expertise of their clinical development partners; Launch dates of products – these reflect management’s expected date of launch for products based on the timeline of development programs required to obtain regulatory approval. The assumptions are based on management’s and clinical development partners’ prior experience; Probability of successful development – management estimates probabilities of success for each phase of development based on industry averages and knowledge of speciﬁc programs; Out-licensing signature fees, milestones and royalty rates on sales – management estimates these amounts based on prior experience and access to values from similar transactions in the industry, which are collated and accessible from specialist third-party sources; Sales projections – these are based on management’s internal projections using external market data and market research commissioned by the Company; Proﬁt margins and other operational expenses – these are based on the Company’s internal projections of current product manufacturing costings, with input from manufacturing partners where applicable, and estimates of operating costs based on management’s prior industry experience; Cash flow projections – for all assets, cash flows are assessed over an industry-standard asset life of 20 years; and 115 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS • Discount rates – the discount rate is estimated on a pre-tax basis reflecting the estimated cost of capital of the Group and is applied consistently across each of the operating segments. The cost of capital was calculated at 15.3% (2018: 15.3%). Where an out-licensing agreement has been reached with a third party, known and observable inputs replace management assumptions if available. At this stage of product development, the key sensitivity for all development programs is the probability of successful completion of clinical trials in order to obtain regulatory approval for sale. Therefore, full impairment of a development program is expected should such related trials be unsuccessful. 15. Other receivables Rent deposit VAT recoverable Other receivables 16. Cash and short-term deposits Cash at banks and on hand Short-term deposits December 31, 2018 2019 293 316 – ––––––––– 609 ––––––––– ––––––––– 293 269 10 ––––––––– 572 ––––––––– ––––––––– December 31, 2018 2019 5,344 19,698 ––––––––– 25,042 ––––––––– ––––––––– 15,803 544 ––––––––– 16,347 ––––––––– ––––––––– Cash at banks earns interest at floating rates based on daily bank deposit rates, with maturity of three months or less. Short-term deposits are available immediately and earn ﬁxed interest at the respective short-term deposit rates and are held in a diversiﬁed portfolio of counterparties. 17. Short-term investments Short-term investments December 31, 2018 2019 2,500 ––––––––– ––––––––– – ––––––––– ––––––––– Short-term investments consist of cash deposits held with greater than three months term to maturity. None of these investments are held with terms greater than a year. 116 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 18. Issued capital and reserves Ordinary share capital Balance at beginning of year Issuances in the year Nominal share capital as at December 31 Ordinary shares issued and fully paid Issued on April 3, 2017 for private placement ﬁnancing round Issued on April 26, 2017 for conversion of loan note Issued on October 28, 2017 for acquisition of license At December 31, 2017 Nominal value at December 31, 2017 (£) Issued capital at December 31, 2017 (£) Ordinary share capital Balance at beginning of year Issuances in the year Nominal share capital as at December 31 Ordinary shares issued and fully paid At January 1, 2018 Issued on June 1, 2018 for public offering Issued on August 3, 2018 for exercise of share options Issued on October 22, 2018 for exercise of share options At December 31, 2018 Nominal value at December 31, 2018 (£) Issued capital at December 31, 2018 (£) Ordinary share capital Balance at beginning of year Issuances in the year Nominal share capital as at December 31 Ordinary shares issued and fully paid At January 1, 2019 Issued on April 23, 2019 for OncoMed acquisition Issued on June 21, 2019 for conversion of loan note At December 31, 2019 Nominal value at December 31, 2019 (£) Issued capital at December 31, 2019 (£) 2017 193 20 –––––––––– 213 –––––––––– –––––––––– 5,042,017 1,221,361 490,798 –––––––––– 71,094,974 –––––––––– 0.003 213,285 –––––––––– –––––––––– 2018 213 1 –––––––––– 214 –––––––––– –––––––––– 71,094,974 50,076 10,000 85,222 –––––––––– 71,240,272 –––––––––– 0.003 213,721 –––––––––– –––––––––– 2019 214 80 –––––––––– 294 –––––––––– –––––––––– 71,240,272 24,783,320 1,936,030 –––––––––– 97,959,622 –––––––––– 0.003 293,879 –––––––––– –––––––––– Since January 1, 2017, the following alterations to the Company’s share capital have been made: • Under the private placement dated April 3, 2017, the Company issued and allotted 5,042,017 ordinary shares of £0.003 in nominal value in the capital of the Company on April 3, 2017 at a price of £2.975 per share to institutional investors. Gross cash received was £15,000,000; 117 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS • • • • • • • On April 26, 2017 Novartis converted £1,398,552 of loan notes dated June 3, 2016 into 632,829 ordinary shares of £0.003 in nominal value in the capital of the Company at the ﬁxed conversion price of £2.21 per share. Under the terms of the notes, Novartis also received 588,532 bonus shares; On October 31, 2017, Mereo BioPharma Group plc issued 490,798 ordinary shares of £0.003 in nominal value in the capital of the Company to AstraZeneca AB as part payment for the acquisition by Mereo BioPharma 4 Limited of an exclusive license and option to acquire certain assets; Under the public offering dated June 1, 2018, the Company issued and allotted 50,076 ordinary shares of £0.003 in nominal value in the capital of the Company on June 1, 2018 at a price of £3.00 per share to investors. Gross cash received was £150,228; On August 3, 2018 the Company issued and allotted 10,000 ordinary shares of £0.003 in nominal value in the capital of the Company pursuant to an exercise of employee share options; On October 22, 2018 the Company issued and allotted 85,222 ordinary shares of £0.003 in nominal value in the capital of the Company pursuant to an exercise of employee share options; On April 23, 2019, the Company issued and allotted 24,783,320 ordinary shares of £0.003 in nominal value in the capital of the Company as consideration for the acquisition of OncoMed. The fair value of the ordinary shares, measured on the date of acquisition, was £1.65; and On June 21, 2019, Novartis converted £2.4 million of loan notes dated June 3, 2016 into 1,071,042 ordinary shares of £0.003 in nominal value in the capital of the Company at a ﬁxed conversion price of £2.21 per share. Under the terms of the notes, Novartis also received 864,988 bonus shares. Share premium At January 1, 2017 Issued on April 3, 2017 for private placement ﬁnancing round Issued on April 26, 2017 for conversion of loan note Issued on October 28, 2017 for acquisition of license Transaction costs for issued share capital At December 31, 2017 Share premium At January 1, 2018 Issued on June 1, 2018 for public offering Issued on August 3, 2018 for exercise of share options Issued on October 22, 2018 for exercise of share options Transaction costs for issued share capital At December 31, 2018 Share premium At January 1, 2019 Issued on June 21, 2019 for conversion of loan note Transaction costs for issued share capital At December 31, 2019 118 December 31, 2017 99,975 14,985 2,478 1,519 (730) ––––––––– 118,227 ––––––––– December 31, 2018 118,227 150 13 110 (8) ––––––––– 118,492 ––––––––– December 31, 2019 118,492 3,953 (761) ––––––––– 121,684 ––––––––– Total 12,666 4,983 (1,083) (207) ––––––––– 16,359 ––––––––– ––––––––– Total 16,359 2,302 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Other capital reserves Shares to be issued Share-based payments Equity component of convertible loan 2,673 At January 1, 2017 – Share-based payments expense during the year (1,083) Shares issued Equity component of convertible loan instrument — ––––––––– At December 31, 2017 1,590 ––––––––– ––––––––– 9,476 4,983 – — ––––––––– 14,459 ––––––––– ––––––––– 517 — – (207) ––––––––– 310 ––––––––– ––––––––– Shares to be issued Share-based payments Equity component of convertible loan Warrants issued for TAP funding 1,590 14,459 – 2,302 310 — – – At January 1, 2018 Share-based payments expense during the year Share-based payments release for exercise of options Warrants issued for TAP funding At December 31, 2018 – – ––––––––– 1,590 ––––––––– ––––––––– (112) – ––––––––– 16,649 ––––––––– ––––––––– – – ––––––––– 310 ––––––––– ––––––––– – 44 ––––––––– 44 ––––––––– ––––––––– (112) 44 ––––––––– 18,593 ––––––––– ––––––––– Shares to Share-based payments be issued Equity component of convertible Warrants issued for loan TAP funding 1,590 16,649 310 – (1,590) – – – — — 1,636 – – (310) — 44 – – – – Merger reserve Total – 18,593 40,818 40,818 – – – (1,590) (310) 1,636 – ––––––––– – ––––––––– ––––––––– – ––––––––– 18,285 ––––––––– ––––––––– – ––––––––– – ––––––––– ––––––––– – ––––––––– 44 ––––––––– ––––––––– – ––––––––– 40,818 ––––––––– ––––––––– – ––––––––– 59,147 ––––––––– ––––––––– At January 1, 2019 Acquisition of OncoMed (Note 5) Shares issued during the year Convertible loan conversion Share-based payments expense during the year Share-based payments release for exercise of options At December 31, 2019 Share-based payments The Group has various share option schemes under which options to subscribe for the Group’s shares have been granted to certain executives, NEDs and employees. The share-based payment reserve is used to recognize a) the value of equity settled share-based payments provided to employees, including key management personnel, as part of their remuneration and b) deferred equity consideration. Refer to Note 26 for further details. 119 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Shares issued or to be issued At January 1, 2019, a maximum of 864,988 shares were remaining to be issued to Novartis pro rata to their percentage shareholding as and when the Company issued further ordinary shares. The fair value of these shares was £1.84 per share. On June 21, 2019, the remaining 864,988 shares were issued to Novartis as fully paid up bonus shares for £nil consideration. Equity component of convertible loan instrument The convertible loan notes issued to Novartis were a compound instrument consisting of a liability and an equity component. On June 21, 2019, Novartis exercised the right to convert the instrument therefore the value of the equity component as at December 31, 2019 is £nil. Merger reserve The consideration paid to acquire OncoMed was 24,783,320 ordinary shares with an acquisition date fair value of £40.9 million, based on the Group’s quoted share price. The nominal value of the issued capital was £0.1 million with the excess, £40.8 million, classiﬁed within other capital reserves as a ‘Merger reserve’. Warrants issued for TAP funding The funding arrangements with The Alpha-1 Project are a compound instrument consisting of a liability and an equity component (see Note 21). The value of the equity component (consideration received for the warrants) as at December 31, 2019 is £44,156 (2018: £44,156). Accumulated loss Year ended December 31, Other reserves Accumulated losses Accumulated deﬁcit 2017 2018 2019 7,000 (79,316) ––––––––– (72,316) ––––––––– ––––––––– 7,000 (111,221) ––––––––– (104,221) ––––––––– ––––––––– 7,000 (146,065) ––––––––– (139,065) ––––––––– ––––––––– On March 21, 2016, the Directors of the Company signed a solvency statement with the agreement of all shareholders and undertook a capital reduction, reducing the share premium account by £7.0 million and crediting a new other reserve by the same amount. 19. Interest-bearing loans and borrowings Year ended December 31, Convertible loan notes (“Novartis Notes”) Bank loan At December 31 Current Non-current 2018 2019 2,039 19,446 ––––––––– 21,485 ––––––––– ––––––––– 6,838 14,647 ––––––––– ––––––––– – 20,512 ––––––––– 20,512 ––––––––– ––––––––– 15,139 5,373 ––––––––– ––––––––– 19.1 Convertible loan notes (“Novartis Notes”) On June 21, 2019, Novartis converted the remaining balance of principal and interest of £2.4 million of convertible loan notes into 1,071,042 ordinary shares at a ﬁxed conversion price of £2.21 per share. This has been recorded as a reduction in interest bearing loans and borrowings of £2.0 million and a reduction in other capital reserves of £0.3 million. Under the terms of the arrangement, Novartis also received 864,988 bonus shares (for £nil consideration). 120 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS There are no convertible loan notes outstanding as at December 31, 2019. As at December 31, 2018, the carrying value of the convertible loan notes was £2.0 million. The value of the debt component of the convertible loan notes on the date of issuance of the instrument was £2.9 million. Cash flows attached to the convertible loan note up to the date of maturity were calculated and discounted at an appropriate venture debt rate of 10%. The value of the equity component of the instrument as at December 31, 2018 was £0.3 million. 19.2 Bank loan The bank loan has a principal amount of £20.5 million and will mature on March 1, 2021, unless extended on reaching certain milestones. The terms of the bank loan required interest-only payments up until April 30, 2019, and thereafter payments of interest and principle in 23 equal monthly instalments through maturity. The bank loan bears interest at an annual ﬁxed rate of 8.5% and is secured by substantially all of the Group’s assets, including intellectual property rights owned or controlled by the Group. On April 23, 2019, the Group agreed an amendment to the terms of its bank loan with its lenders. The new terms extended the interest-only period through to December 31, 2019 followed by a 15-month capital and interest repayment period. The Group has undertaken an assessment believes that the change in terms should not be accounted for as a modiﬁcation, but instead as a change in expected cash flows. The cash flows under the bank loan were revised from May 1, 2019. Management estimated the revised carrying value of the loan on May 1, 2019 to be £19.9 million by discounting the revised cash flows at the original discount rate of 18%. The difference between the previous and revised carrying value of the loan on May 1, 2019 was £0.5 million. The gain as a result of the changes in estimated cash flows is recognized as a true-up in total ﬁnance cost (i.e. together with interest expense). Following the re-estimation, the ﬁnancial liability continues to be accounted for at amortized cost using the original effective interest rate. On May 3, 2019, under the terms of the loan agreement, the Company issued 321,444 additional warrants (Note 21) to its lenders giving them the right to subscribe for ordinary shares at an exercise price of £2.95. The fair value of the additional warrants on their grant date was £0.1 million. A total of £1.5 million (2018: £0.8 million) of non-cash interest has been charged to the consolidated statement of comprehensive loss in the year. The fair value of the bank loan is not materially different from the carrying amount, since the interest payable on the borrowings is reflective of market rates following the most recent amendment to the bank loan on May 1, 2019. In the prior year, the bank loan was modiﬁed and a modiﬁcation loss of £0.7 million was recognized on the consolidated statement of comprehensive loss on the date of modiﬁcation. This balance has been reclassiﬁed from administrative expenses to ﬁnance charges within the statement of comprehensive loss. 20. Provisions Year ended December 31, Social security contributions on share options Provision for deferred cash consideration At December 31 Current Non-current 2018 2019 842 2,131 ––––––––– 2,973 ––––––––– ––––––––– 332 2,641 ––––––––– ––––––––– 104 1,654 ––––––––– 1,758 ––––––––– ––––––––– 309 1,449 ––––––––– ––––––––– 121 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Year ended December 31, Social security contributions on share options 2018 2017 2019 At beginning of year Arising during the year Released At December 31 Current Non-current 1,172 1,116 – ––––––––– 2,288 ––––––––– ––––––––– – 2,288 ––––––––– ––––––––– 2,288 – (1,446) ––––––––– 842 ––––––––– ––––––––– – 842 ––––––––– ––––––––– 842 – (738) ––––––––– 104 ––––––––– ––––––––– – 104 ––––––––– ––––––––– The provision for social security contributions on share options is calculated based on the number of options outstanding at the reporting date that are expected to be exercised. The provision is based on the estimated taxable gain arising on exercise of the share options, using the best estimate of the market price at the balance sheet date. Management assume the options will be held for their full contractual life of ten years (see Note 26) therefore the provision has been classiﬁed as non-current. The provision has been discounted. The negative charge in 2019 is due to the fall in the Company’s share price between December 31, 2018 and December 31, 2019. Year ended December 31, Provisions for deferred cash consideration 2017 2018 2019 At beginning of year Arising during the year Increase in provision due to the unwinding of the time value of money Decrease in provision due to a change in estimates relating to timelines and probabilities of contractual milestones being achieved (see Note 12) At December 31 Current Non-current – 2,061 — 2,061 – 443 2,131 — 221 — ––––––––– 2,061 ––––––––– ––––––––– 274 1,787 ––––––––– ––––––––– (373) ––––––––– 2,131 ––––––––– ––––––––– 332 1,799 ––––––––– ––––––––– (698) ––––––––– 1,654 ––––––––– ––––––––– 309 1,345 ––––––––– ––––––––– The deferred cash consideration is the estimate of the quantiﬁable but not certain future cash payment obligations due to AstraZeneca for the acquisition of certain assets (see Note 13). This liability is calculated as the risk-adjusted net present value of future cash payments to be made by the Group. The payments are dependent on reaching certain milestones based on the commencement and outcome of clinical trials. The likelihood of achieving such milestones is reviewed at the balance sheet date and increased or decreased as appropriate. 21. Warrant liability Year ended December 31, At beginning of year Issued during the year Movement during the year At December 31 122 2017 2018 2019 – 1,292 54 ––––––––– 1,346 ––––––––– ––––––––– 1,346 376 (716) ––––––––– 1,006 ––––––––– ––––––––– 1,006 131 (1,006) ––––––––– 131 ––––––––– ––––––––– MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2018, as part of the bank loan facility, the Company had issued 922,464 warrants (Note 19) to its lenders giving them the right to subscribe for ordinary shares at a range of exercise price between £2.31 and £3.30. On May 3, 2019, the Company issued a further 321,444 warrants to its lenders giving them the right to subscribe for ordinary shares at an exercise price of £2.95. The fair value of the additional warrants on their grant date was £0.1 million. At December 31, 2019, a total of 1,243,908 warrants are outstanding which are held by lenders of the bank loan facility. The warrants outstanding are equivalent to 1.27% of the ordinary share capital of the Company. The movement during the year ended December 31, 2019 of £1.0 million was mostly due to the decrease in the market price of ordinary shares (refer to table below). The warrant instrument is classiﬁed as a ﬁnancial liability as the terms of the instrument allow for a cashless exercise. At each balance sheet date, the fair value of the warrants will be assessed using the Black Scholes model considering appropriate amendments to inputs in respect of volatility and remaining expected life of the warrants. The following table lists the weighted average inputs to the models used for the fair value of warrants granted during the year ended December 31: Year ended December 31, Expected volatility (%) Risk-free interest rate (%) Expected life of share options (years) Market price of ordinary shares (£) Model used 2018 2019 67 1.26 10.0 0.83 Black Scholes Black Scholes 65 1.56 10 2.31 Since there is no historical data in relation to the expected life of the warrants, the contractual life of the options was used in calculating the expense for the year. Volatility was estimated by reference to the share price volatility of a group of comparable companies over a retrospective year equal to the expected life of the warrants. 22. Other liability Year ended December 31, At beginning of year Interest accretion Arising during the year At December 31 2018 2019 – – 34 ––––––––– 34 ––––––––– ––––––––– 34 10 – ––––––––– 44 ––––––––– ––––––––– On October 8, 2018, the Group entered into a funding agreement with The Alpha-1 Project (“TAP”), which provides for total potential payments to Mereo of $400,000 as contributions towards the development of MPH-966 upon completion of certain milestones by the Group. In exchange, on receipt of such funding, the Group will issue warrants allowing TAP to subscribe for shares in the company (see Note 18). Under the agreement, TAP is potentially entitled to receive a payment equivalent to amounts received by Mereo (up to a maximum of $400,000) conditional on and within thirty days of the ﬁrst regulatory approval received by the Group for MPH-966. The ﬁrst payment (“Payment 1”) of $100,000 (£78,445) was made to Mereo on November 16, 2018. The fair value of the liability of Payment 1 on November 16, 2018 was £34,289. Application of the effective interest method is required to accrete the initial liability value up to the face value of the liability over a period of ﬁve 123 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS years, being the estimate of the earliest date that the liability could be repaid and assuming that the agreement is not terminated earlier. This non-cash interest charge will be made in each statutory reporting period. The annual value of this interest charge is 25.8%. The fair value of warrants issued as part of Payment 1 on November 16, 2018 was £44,156. 23. Trade and other payables Year ended December 31, Trade payables Social security and other taxes Other payables At December 31 2018 2019 4,393 161 16 ––––––––– 4,570 ––––––––– ––––––––– 6,148 183 21 ––––––––– 6,352 ––––––––– ––––––––– Terms and conditions of the above ﬁnancial liabilities: • • Trade payables are non-interest bearing and are normally settled on 30-day terms; and Other payables are non-interest bearing and have an average term of one month. 24. Changes in liabilities arising from ﬁnancing activities Contingent consideration Lease liability Bank loan Novartis Warrant Notes Deferred cash liability consideration TAP agreement Total – 2,038 19,446 – – – – – – 1,977 – – 185 – (124) 18,775 (2,111) (375) 2,427 730 – Carrying value 1,346 at January 1, 2018 – – Financing cash flows – (716) Changes in fair values – – Interest expense – – Loss on modiﬁcation – Other – 375 –––––––– –––––––– –––––––– –––––––– –––––– Carrying value December 31, 2018 – 1,005 –––––––– –––––––– –––––––– –––––––– –––––– Adoption of IFRS 16 (Leases) – Financing cash flows – Changes in foreign exchange – Changes in fair values 354 Interest expense – Gain on modiﬁcation — Issuance of equity – Acquisition of subsidiary (Note 5) – Lease term reassessment – – –––––––– –––––––– –––––––– –––––––– –––––– Carrying value at December 31, 2019 354 131 –––––––– –––––––– –––––––– –––––––– –––––– – – 20 – (2,058) (131) – 1,314 – – – — 3,262 (457) – – (874) – – – – (1,739) 2,534 (2,212) 20,512 11,904 10,689 (290) – – – – – – – – – – 2,061 – 70 – – – 24,159 (2,077) (1,021) 2,612 730 251 –––––––– –––––––– –––––––– – 34 – – – – 2,131 24,654 –––––––– –––––––– –––––––– 34 – – – (477) – – – – – – 10 – – – 2,534 (3,951) (131) (987) 4,596 (457) (2,058) – – 10,689 (290) –––––––– –––––––– –––––––– – – 1,654 34,599 –––––––– –––––––– –––––––– 44 25. Financial and capital risk management and fair value measurement 25.1 Capital risk management For the purpose of the Group’s capital management, capital includes issued capital, share premium, the equity component of a convertible loan note and all other equity reserves attributable to the equity holders of the parent. 124 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The Group’s objectives when managing capital are to safeguard the ability to continue as a going concern and ensure that sufﬁcient capital is in place to fund the Group’s R&D activities. The Group’s principal method of adjusting the capital available is through issuing new shares or arranging suitable debt ﬁnancing, including any related warrants. The Group’s share capital and share premium are disclosed in Note 18. The Group’s loans are disclosed in Note 19. The Group monitors the availability of capital with regard to its committed and planned forecast future expenditure on an ongoing basis. The Group has set up an Employee Beneﬁt Trust which makes market purchases of the Company’s shares to provide some cover against future exercise of options under the Company’s share option schemes (see Note 28). 25.2 Financial risk management objectives and policies Monitoring of ﬁnancial risk is part of the Board’s ongoing risk management, the effectiveness of which is reviewed annually. Our agreed policies are implemented by the Chief Financial Ofﬁcer, who submits periodic reports to the Board. The Group seeks to maintain a balance between equity capital and convertible and secured debt to provide sufﬁcient cash resources to execute the business plan. In addition, the Group maintains a balance between cash held on deposit and short-term investments in Sterling and other currencies to reduce its exposure to foreign exchange fluctuations in respect of its planned expenditure. Except for the bank loan, the Group’s principal ﬁnancial instruments comprise trade payables which arise directly from its operations and are not designed as a means of raising ﬁnance for the Group’s operations. The Group has various ﬁnancial assets, such as receivables and cash and short-term deposits. The Group does not consider that its ﬁnancial instruments gave rise to any material ﬁnancial risks during the year to December 31, 2019. Interest rate risk The Group’s policy in relation to interest rate risk is to monitor short and medium-term interest rates and to place cash on deposit for periods that optimize the amount of interest earned while maintaining access to sufﬁcient funds to meet day-to-day cash requirements. The interest payable on the bank loan is ﬁxed. Consequently, there is no material exposure to interest rate risk in respect of interest payable. Foreign currency risk The Group currently has no revenue. The majority of operating costs are denominated in pound sterling, Euros and U.S. Dollars. Funding to date has been secured in a mixture of pound sterling and U.S. Dollars and therefore a level of natural hedging exists in respect of operating costs. Foreign exchange risk arises from commercial transactions and recognized assets and liabilities in foreign currencies. Credit risks The Group’s policy is to place funds with ﬁnancial institutions which have a minimum long-term credit rating with Standard & Poor’s of A. The Group also allocates a quota to individual institutions in respect of cash deposits and also seeks to diversify its investments where this is consistent with achieving competitive rates of return. It is the Group’s policy to place not more than £10 million with any one investment counterparty and no more than £5 million with any one cash deposit counterparty. Cash flow and liquidity risk Credit risk from balances with banks and ﬁnancial institutions is managed by the Group’s ﬁnance department in accordance with the Group’s policy. Investments of surplus funds are made only with approved counterparties and within credit limits assigned to each counterparty. Counterparty credit limits are reviewed by the Group’s Board of Directors on an annual basis and may be updated throughout the year subject to approval of the Group’s Audit and Risk Committee. The limits are set to minimize the concentration of risks and therefore mitigate ﬁnancial loss through a counterparty’s potential failure to make payments. The Group’s maximum exposure to credit risk for the components of the balance sheet at December 31, 2019 is the carrying amounts. The Group does not face a signiﬁcant liquidity risk with regards to its lease liabilities. 125 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The Group monitors its funding requirements through preparation of short-term, mid-term and long-term forecasts. All short-term deposits are immediately convertible to liquid funds without penalty and are recorded in the balance sheet at their open market value. Please refer to Note 2 “Going concern” regarding the Directors’ assessment of liquidity for further information. 25.3 Fair value hierarchy Fair value measurement using Date of valuation Total Quoted prices in active markets (Level 1) Signiﬁcant Signiﬁcant observable unobservable inputs (Level 3) inputs (Level 2) Liabilities measured at fair value Provision for deferred cash consideration (Note 20) Provision for contingent consideration (Note 5) Warrant liability (Note 21) December 31, 2019 December 31, 2019 December 31, 2019 1,654 354 131 Liabilities for which fair values are disclosed Bank loan (Note 19) December 31, 2019 20,512 There were no transfers between Level 1 and Level 2 during 2019. – – – – – – 131 20,512 1,654 354 – – Fair value measurement hierarchy for liabilities as at December 31, 2018: Fair value measurement using Date of valuation Total Quoted prices in active markets (Level 1) Signiﬁcant Signiﬁcant observable unobservable inputs (Level 3) inputs (Level 2) Liabilities measured at fair value Provision for deferred cash consideration (Note 20) Warrant liability (Note 21) December 31, 2018 December 31, 2018 Liabilities for which fair values are disclosed Convertible loan (Note 19) Bank loan (Note 19) December 31, 2018 December 31, 2018 2,061 1,346 1,977 18,775 – – – – – 2,061 1,346 1,977 18,775 – – – There were no transfers between Level 1 and Level 2 during 2018. The management of the Group assessed that the fair values of cash and short-term deposits, other receivables, trade payables, and other current liabilities approximate their carrying amounts largely due to the short-term maturities of these instruments. The following table presents the changes in level 3 items for the periods ended December 31, 2019 and December 31, 2018: 126 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS January 1, 2018 Unwinding of the time value of money recognised as a ﬁnance charge Change in estimate relating to probabilities (revision to intangible asset, see Note 13) December 31, 2018 January 1, 2019 Unwinding of the time value of money (recognized as a ﬁnance charge) Change in estimate relating to probabilities (revision to intangible asset, see Note 13) Change in estimate relating to probabilities (recognized as an administrative expense) December 31, 2019 Provision for Provision for deferred cash contingent consideration consideration 2,061 443 (373) ––––––––– 2,131 ––––––––– 2,131 221 – – – ––––––––– – ––––––––– – – (698) – – ––––––––– 1,654 ––––––––– 354 ––––––––– 354 ––––––––– The following methods and assumptions were used to estimate the fair values: • • • The warrant liability is estimated using a Black Scholes model, taking into account appropriate amendments to inputs in respect of volatility, remaining expected life of the warrants, cost of capital, probability of success and rates of interest at each reporting date. The fair value of the provision for deferred cash consideration is estimated by discounting future cash flows using rates currently available for debt on similar terms and credit risk. In addition to being sensitive to a reasonably possible change in the forecast cash flows or the discount rate, the fair value of the deferred cash consideration is also sensitive to a reasonably possible change in the probability of reaching certain milestones. The valuation requires management to use unobservable inputs in the model, of which the signiﬁcant unobservable inputs are disclosed in the tables below. Management regularly assesses a range of reasonably possible alternatives for those signiﬁcant unobservable inputs and determines their impact on the total fair value. At December 31, 2019, the Group estimates the fair value of the contingent consideration liability to be £0.4 million, which is an increase from £nil on the date of acquisition. Total potential payments under the CVR arrangement on a gross, undiscounted basis are approximately $80.0 million (see Note 13). The increase in the fair value of the contingent consideration liability reflects the terms subsequently agreed with Oncologie, Inc. (“Oncologie) with respect to the global licensing agreement of navicixizumab (“Navi”) (see Note 30). The estimated contingent consideration payable is based on a risk-adjusted, probability-based scenario. Under this approach the likelihood of future payments being made to the former shareholder of OncoMed under the CVR arrangement is considered. The estimate could materially change over time as the development plan and subsequent commercialization of the Navi product progresses. 127 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The signiﬁcant unobservable inputs used in the fair value measurements categorized within Level 3 of the fair value hierarchy, together with a quantitative sensitivity analysis as at December 31, 2019 and 2018 are as shown below: Signiﬁcant Input range Valuation unobservable (weighted technique inputs average) Sensitivity of the input to fair value Provision for DCF deferred cash consideration Contingent DCF consideration liability WACC 2019: 15.3% 1% increase would result in a decrease in fair value by £38,000. WACC 2018: 15.3% 1% decrease would result in an increase in fair value by £18,000. Probability of 2019: 15.8–95% 10% increase would result in an increase success in fair value by £0.4 million. Probability of 2018: 28%–95% 10% decrease would result in a decrease success fair value by £0.9 million. Ongoing Not applicable Total potential payments future payments uncertainty relating to the contingent consideration in the clinical liability on a gross, undiscounted basis are development approximately $80.0 million (see Note 30). of the Navi Product. Sensitivity of the input to fair value is primarily driven by uncertainty in the Regulatory clinical development of the Navi product. approval and As at December 31, 2019, we are commercialisation completing a Phase 1b clinical trial. risks. Future potential payments under the CVR arrangement are contingent on i) future development milestones and ii) future sales of the Navi product, following commercialisation. regulatory approval and 25.4 Financial assets at fair value through other comprehensive income During the year, the Group acquired £29.0 million of short-term debt investments following the acquisition of OncoMed (Note 5). The short-term debt investments acquired were in U.S. Treasury Bills (“T-Bill”) securities. All the short-term debt investments have reached maturity and been sold during the year, therefore the carrying value as at December 31, 2019 is £nil. On maturity, the related balance held within other comprehensive income has been reclassiﬁed to ﬁnance income within the consolidated statement of comprehensive loss. 128 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 25.5 Liquidity risk The table below summarizes the maturity proﬁle of the Group’s ﬁnancial liabilities based on contractual undiscounted payments at December 31, 2019: Payments due by period Up to 1 year 1–3 years 3–5 years Over 5 years Bank loan (Note 19) Leases (Note 4) Trade and other payables (Note 23) Contingent consideration liability (Note 5) 17,185 2,634 6,352 5,484 4,643 – – 4,913 – Total 22,669 20,295 – 8,105 – 6,352 354 ––––––––– 26,525 ––––––––– ––––––––– – ––––––––– 10,127 ––––––––– ––––––––– – ––––––––– 4,913 ––––––––– ––––––––– – ––––––––– 8,105 ––––––––– ––––––––– 354 ––––––––– 49,670 ––––––––– ––––––––– Further details regarding the contingent consideration liability following the acquisition of OncoMed are provided in Note 5. The table below summarizes the maturity proﬁle of the Group’s ﬁnancial liabilities based on contractual undiscounted payments at December 31, 2018: Payments due by period Up to 1 year 1–3 years 3–5 years Over 5 years Convertible loan (Note 19) Bank loan (Note 19) Leases (Note 27) Trade and other payables (Note 23) 83 8,260 332 2,162 15,589 204 – – – – – – 4,570 ––––––––– 13,245 ––––––––– ––––––––– – ––––––––– 17,955 ––––––––– ––––––––– – ––––––––– – ––––––––– ––––––––– – ––––––––– – ––––––––– ––––––––– 4,570 ––––––––– 31,200 ––––––––– ––––––––– Total 2,245 23,849 536 The Group may incur potential payments upon achievement of clinical, regulatory and commercial milestones, as applicable, or royalty payments that may be required to be made under license agreements the Group entered into with various entities pursuant to which the Group has in-licensed certain intellectual property, including license agreements with Novartis and AstraZeneca. Due to the uncertainty of the achievement and timing of the events requiring payment under these agreements, the amounts to be paid are not ﬁxed or determinable at this time. 25.6 Market risk The functional currency of the Company and all subsidiaries is pound sterling except for OncoMed whose functional currency is US dollars. The Group incurs expenditures in foreign currencies and is exposed to the risks of foreign exchange rate movements, with the impact recognized in the consolidated statement of comprehensive loss. The Group seeks to minimize this exposure by passively maintain foreign currency cash balances at levels appropriate to meet foreseeable foreign currency expenditures. 129 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The table below shows analysis of the pound sterling equivalent of period-end cash and cash equivalent balances by currency: Year ended December 31, Cash at bank and in hand: Pound sterling US dollars Swiss francs Euro 2019 2018 2,525 13,807 11 4 ––––––––– 16,347 ––––––––– ––––––––– 23,189 1,809 – 44 ––––––––– 25,042 ––––––––– ––––––––– The table below shows those transactional exposures that give rise to net currency gains and losses recognized in the consolidated income statement. Such exposures comprise the net monetary assets and monetary liabilities of the Group that are not denominated in the functional currency of the relevant Group entity. As at year end, these exposures were as follows: Year ended December 31, Net foreign currency assets/(liabilities): US dollars Swiss francs Euro 2019 2018 (219) (6) (812) ––––––––– (1,037) ––––––––– ––––––––– (542) – (1,430) ––––––––– (1,972) ––––––––– ––––––––– The most signiﬁcant currencies in which the Group transacts, other than pound sterling, are the US dollar and the Euro. The Group also trades in other currencies in small amounts as necessary. The following table details the Group’s sensitivity to a 10% change in the period-end rate, which the Group feels is the maximum likely change in rate based upon recent currency movements, in the US dollar and the Euro against pound sterling: Year ended December 31, 2019 Net foreign currency assets/(liabilities): Loss before tax Equity Year ended December 31, 2018 Net foreign currency assets/(liabilities): Loss before tax Equity US dollar Euro 20 20 ––––––––– 74 74 ––––––––– US dollar Euro 49 49 ––––––––– 130 130 ––––––––– In management’s opinion, the sensitivity analysis is unrepresentative of the inherent foreign exchange risk as the period end exposure does not reflect the exposure during the period. 130 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 26. Share-based payments The charge for share-based payments under IFRS 2 arises across the following schemes: Year ended December 31, 2019 Equity Incentive Plan 2019 NED Equity Incentive Plan 2015 Plan Mereo BioPharma Group plc Share Option Plan Long Term Incentive Plan Deferred Bonus Share Plan 2017 2018 2019 – – 2,442 586 299 325 ––––––––– 3,652 ––––––––– ––––––––– – – 806 1,064 320 – ––––––––– 2,190 ––––––––– ––––––––– 635 160 63 685 93 – ––––––––– 1,636 ––––––––– ––––––––– 26.1 2019 Equity Incentive Plan (“EIP”) Our Board adopted the 2019 EIP on April 4, 2019. The 2019 EIP provides for the grant of market value options over ADR’s (each ADR represented by 5 ordinary shares) to executive directors and employees. During the year, market value options were granted to executive directors and employees. Subject to the executive director or employees continued employment, one fourth of each such market value option grant shall vest on the ﬁrst anniversary of the grant date and the remainder shall vest in equal monthly instalments over the three-year period following the ﬁrst anniversary. No performance conditions apply to such market value options. The fair value of share options granted was estimated at the date of grant using a Black Scholes pricing model, taking into account the terms and conditions upon which the share options were granted. The fair value calculation does not include any allowance for dividends as the Company has no available proﬁts for distribution. The exercise price of the share options will be equal to the market price of the underlying shares on the date of grant. The contractual term of the share options is 10 years. Movements during the year The following table illustrates the number and weighted average exercise prices (WAEP) of, and movements in, options for the 2019 EIP during the year: Outstanding at beginning of the year Granted during the year Cancelled during the year Forfeited during the year Exercised during the year Outstanding at December 31 Exercisable at December 31 2019 Options over ADR Number WAEP $ – 801,200 3,150 – – ––––––––– 798,050 ––––––––– ––––––––– – ––––––––– ––––––––– – 4.29 5.40 – – ––––––––– 4.29 ––––––––– ––––––––– – ––––––––– ––––––––– The weighted average remaining contractual life for the share options outstanding as at December 31, 2019 was 9.5 years. The weighted average fair value of options granted during the year was £0.49 (2018: £nil). Options outstanding at the end of the year had an exercise price of between $2.60 and $5.40. 131 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 26.2 2019 Non-Executive Director Equity Incentive Plan (“NED EIP”) Our Board adopted the 2019 NED EIP on April 4, 2019. The 2019 NED EIP provides for the grant of market value options over ADR’s to non-executive directors. Subject to the participant holding the participant’s current ofﬁce (or being otherwise employed) through each applicable vesting date, such awards shall vest in equal monthly instalments over a one-year period following the grant date. No performance conditions apply to such market value options. The fair value of share options granted was estimated at the date of grant using a Black Scholes pricing model, taking into account the terms and conditions upon which the share options were granted. The fair value calculation does not include any allowance for dividends as the Company has no available proﬁts for distribution. The exercise price of the share options will be equal to the market price of the underlying shares on the date of grant. The contractual term of the share options is 10 years. Movements during the year The following table illustrates the number and weighted average exercise prices (WAEP) of, and movements in, options for the 2019 NED EIP during the year: Outstanding at beginning of the year Granted during the year Cancelled during the year Forfeited during the year Exercised during the year Outstanding at December 31 Exercisable at December 31 2019 Options over ADR’s Number WAEP $ – 77,000 – – – ––––––––– 77,000 ––––––––– ––––––––– 38,472 ––––––––– ––––––––– – 4.20 – – – ––––––––– 4.20 ––––––––– ––––––––– 4.40 ––––––––– ––––––––– The weighted average remaining contractual life for the share options outstanding as at December 31, 2019 was 9.5 years. The weighted average fair value of options granted during the year was £0.49 (2018: £nil). Options outstanding at the end of the year had an exercise price of between $3.00 and $5.40. 26.3 The 2015 Plan Under the Mereo BioPharma Group Limited Share Option Plan (the “2015 Plan”), the Group, at its discretion, granted share options to employees, including executive management and NEDs. Share options vest over four years for executive management and employees and over three years for NEDs. No further share option grants are envisaged under the 2015 Plan. 132 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Movements during the year The following table illustrates the number and weighted average exercise prices (WAEP) of, and movements in, options for the 2015 Plan during the year: 2017 2018 2019 WAEP £ Number WAEP £ Number WAEP £ Number Outstanding at beginning of the year Granted during the year Cancelled during the year Forfeited during the year Exercised during the year Outstanding at December 31 Exercisable at December 31 9,198,655 1.32 9,124,610 1.32 8,983,133 1.32 – – – – – – – – – – – – (74,045) 1.29 (46,255) 1.29 (59,533) 1.29 – ––––––––– – ––––––––– (95,222) ––––––––– 1.29 ––––––––– – ––––––––– – ––––––––– 9,124,610 ––––––––– ––––––––– 1.32 ––––––––– ––––––––– 8,983,133 ––––––––– ––––––––– 1.32 ––––––––– ––––––––– 8,923,600 ––––––––– ––––––––– 1.32 ––––––––– ––––––––– 5,655,676 ––––––––– ––––––––– 1.31 ––––––––– ––––––––– 8,007,029 ––––––––– ––––––––– 1.31 ––––––––– ––––––––– 8,901,478 ––––––––– ––––––––– 1.32 ––––––––– ––––––––– The weighted average remaining contractual life for the share options outstanding as at December 31, 2019 was 5.6 years (2018: 6.6 years). Options outstanding at the end of the year had an exercise price of between £1.29 and £2.21. 26.4 The Mereo BioPharma Group plc Share Option Plan The Mereo BioPharma Group plc Share Option Plan (“Share Option Plan”) provides for the grant of options to acquire our ordinary shares to employees, executive directors and executive ofﬁcers. Options may be granted to all eligible employees on commencement of employment and may be granted on a periodic basis after that. Under the Share Option Plan, our Board of Directors may determine if the vesting of an option will be subject to the satisfaction of a performance condition. Following the introduction of the EIP and NED EIP, no further share option grants under the Share Option Plan are envisaged. 133 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Movements during the year The following table illustrates the number and weighted average exercise prices (WAEP) of, and movements in, options for the Option Plan during the year: 2017 2018 2019 WAEP £ Number WAEP £ Number WAEP £ Number Outstanding at beginning of the year Granted during the year Cancelled during the year Forfeited during the year Outstanding at December 31 Exercisable at December 31 – – 1,578,188 3.05 1,881,555 3.10 1,593,188 3.05 388,000 – – – 3.14 – – – – – (15,000) 3.03 (84,633) 3.03 (357,490) 3.21 1,578,188 ––––––––– 3.05 ––––––––– 1,881,555 ––––––––– 3.10 ––––––––– 1,524,065 ––––––––– 3.07 ––––––––– – ––––––––– ––––––––– – ––––––––– ––––––––– – ––––––––– ––––––––– – ––––––––– ––––––––– 40,141 ––––––––– ––––––––– 3.03 ––––––––– ––––––––– The weighted average remaining contractual life for the share options outstanding as at December 31, 2019 was 7.6 years (2018: 8.6 years). The weighted average fair value of options granted during the year was £nil (2018: £2.29). Options outstanding at the end of the year had an exercise price of between £2.76 and £3.25. 26.5 Long Term Incentive Plan Under the Company’s Long Term Incentive Plan (LTIP), initiated in 2016, the Group, at its discretion, may grant nil-cost options to acquire shares to employees. Under the LTIP rules, vesting of 75% of the options issued to employees is subject to a share price performance condition (the “Share Price Element”) and vesting of 25% of the options is subject to achievement of strategic operational targets (the “Strategic Element”). Share options vest over a maximum of ﬁve years, dependent upon achievement of these targets. The fair value of the LTIP Share Price Element is estimated at the date of grant using a Monte Carlo pricing model, taking into account the terms and conditions upon which the share options were granted. The fair value of the LTIP Strategic Element is estimated at the date of grant using a Black Scholes pricing model, taking into account the terms and conditions upon which the share options were granted, and the expense recorded is based upon the expected level of achievement of non-marked based performance measures (strategic targets). With respect to the LTIP Strategic Element, during the year the non-market based performance measures were reassessed. Based on that reassessment, an adjustment with respect to the cumulative compensation expense recognized in equity has been recorded which resulted in a credit of £0.1 million recorded in the consolidated statement of comprehensive loss. The fair value calculations do not include any allowance for dividends as the Company has no available proﬁts for distribution. The contractual term of the LTIP options is ﬁve years. The expense recognized for employee services received during the year to December 31, 2019 was £0.1 million (2018: £0.3 million). 134 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Granted during the year Cancelled during the year Lapsed during the year Outstanding at December 31 Exercisable at December 31 2017 Number 2018 Number 2019 Number 185,950 – – 1,151,446 ––––––––– ––––––––– – ––––––––– ––––––––– — – – 1,151,446 ––––––––– ––––––––– – ––––––––– ––––––––– – – (241,374) 910,072 ––––––––– ––––––––– – ––––––––– ––––––––– During the year 241,373 options under the LTIP Share Price Element lapsed as the performance conditions for a tranche were not met. The weighted average remaining contractual life for the LTIP options outstanding as at December 31, 2019 was 0.9 years (2018: 1.8 years). The weighted average fair value of LTIP options granted during the year to December 31, 2019 was £nil (2018: £nil). The following tables list the weighted average inputs to the models used for the fair value of LTIP options granted during the years ended December 31, 2017, 2018 and 2019. LTIP Share Price Element Year ended December 31, Expected volatility (%) Risk-free interest rate (%) Expected life of share options (years) Market price of ordinary shares (£) Model used 2017 2018 2019 51.7 0.17-0.39 3-5 3.03 Monte Carlo – – – – – – – — – – LTIP Strategic Element Year ended December 31, Expected volatility (%) Risk-free interest rate (%) Expected life of share options (years) Market price of ordinary shares (£) Model used 2017 2018 2019 51.7 0.39 5 3.03 Black Scholes – – – – – – – – – – Since there is no historical data in relation to the expected life of the LTIP options, the contractual life of the options has been used in calculating the expense for the year. Volatility is estimated by reference to the share price volatility of a group of comparable companies over a retrospective period equal to the expected life of the LTIP options. 26.6 Deferred Bonus Share Plan Under the previous terms of the Company’s Deferred Bonus Share Plan (DBSP), 30% of the annual bonus for 2017 for the senior management team was payable in deferred shares, which are governed by the DBSP plan rules. At the date of grant of the awards, the monetary bonus amount will be divided by the closing share price to give the number of shares issued to the employee under the DBSP. The number of shares is ﬁxed and not subject to adjustment between the issue date and vesting date. Under the DBSP, awards vest after three years from the date of the award. There are no further performance conditions attached to the award, nor any service conditions (including no requirement for continued employment once the awards have been made). 135 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Since the awards are issued at nil cost, they will be satisﬁed by the issue of shares from the Employee Beneﬁt Trust. The following table illustrates the number of, and movements in, DBSP options during the year: Outstanding at January 1 Awarded during the year Granted during the year Outstanding at December 31 Exercisable at December 31 2017 Number 2018 Number 2019 Number 62,180 100,820 – 163,000 ––––––––– ––––––––– – ––––––––– ––––––––– 163,000 — – 163,000 ––––––––– ––––––––– – ––––––––– ––––––––– 163,000 – – 163,000 ––––––––– ––––––––– – ––––––––– ––––––––– The weighted average remaining contractual life for the DBSP options outstanding as at December 31, 2019 was 1.6 years (2018: 2.6 years). The weighted average fair value of DBSP options granted during the year was £nil (2018: £nil). From January 1, 2018, under the new Deferred Bonus Plan (“2019 DBP”), 100% of the annual bonus is paid in cash, of which 30% of amounts granted to Executive Directors (after deduction of income tax and the relevant employee’s national insurance contributions) is required to be utilized to acquire shares in the Company in the open market within 12 months of the grant of the award. No further grants under the DBSP are envisaged. 26.7 Deferred equity consideration In October 2017, our wholly owned subsidiary Mereo BioPharma 4 Limited entered into an exclusive license and option agreement (the “License Agreement”), to obtain from AstraZeneca an exclusive worldwide, sub- licensable license under AstraZeneca’s intellectual property rights relating to MPH-966, with an option to acquire such intellectual property rights following commencement of a pivotal trial and payment of related milestone payments (the “Option”), together with the acquisition of certain related assets. Under the agreement with AstraZeneca, the Company may issue up to 1,349,693 ordinary shares which are dependent on achieving certain milestones. In respect of milestones that are probable, the Group has accounted for, but not yet issued, 429,448 ordinary shares which have been measured at fair value on grant date, being £3.10, giving a total of £1.3 million. 26.8 Weighted average inputs The following tables list the weighted average inputs to the models used for the fair value of share options granted during the year ended December 31, 2019: Expected volatility (%) Risk-free interest rate (%) Expected life of share options (years) Market price of ordinary shares (£) Model used EIP 2019 NED EIP 2019 grants grants 66 0.97 10 0.63 Black Scholes Black Scholes 66 0.95 10 0.66 During the year ended December 31, 2019, grants were issued under the EIP 2019 and NED EIP 2019 plans. 136 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The following tables list the weighted average inputs to the models used for the fair value of share options granted during the year ended December 31, 2018: Expected volatility (%) Risk-free interest rate (%) Expected life of share options (years) Market price of ordinary shares (£) Model used Share option plan grants 65-67 1.39-1.53 10 2.76-3.25 Black Scholes During the year ended December 31, 2018, grants were issued under the share option plan. Grants issued in previous years under the LTIP Strategic element are subject to fair value movements at each reporting date. 27. Commitments and contingencies 27.1 Group as a lessee Following the adoption of IFRS 16 (Leases), information relating to the Group as a lessee can be found in Note 4 (Changes in accounting policies), Note 12 (Property, Plant and Equipment) and Note 25 (Financial and capital risk management). 27.2 Operating lease arrangements Operating leases, in which the Group is the sublessor, relate to a portion of an ofﬁce leased by the Group, with lease terms of between one to two years. One of the subleases has an automatic extension on a month- to-month basis following the initial lease term, with rental increasing at a set percentage on each annual anniversary of the agreement. The lessee does not have an option to purchase the property at the expiry of the lease period. The unguaranteed residual values do not represent a signiﬁcant risk for the Group, as the lease terms are for a remaining period of 12 months or less, and the Group expects to be able to enter into new leases at market value at the end of the sublease term. The maturity analysis of payments receivable by the Group in its capacity as sublessor is disclosed below: December 31, Within one year After one year but not more than ﬁve years More than ﬁve years 2019 2018 552 – – ––––––––– 552 ––––––––– – – – ––––––––– – ––––––––– The Group does not have any leasing arrangements classiﬁed as ﬁnance leases at December 31, 2019 (2018: £nil). 27.3 Financial commitments Each of Mereo BioPharma 1 Limited, Mereo BioPharma 2 Limited and Mereo BioPharma 3 Limited issued to Novartis loan notes (the “Novartis Notes”) (which were assigned by Novartis to the Company in exchange for ordinary shares pursuant to the Subscription Agreement) and each of Mereo BioPharma 1 Limited, Mereo BioPharma 2 Limited and Mereo BioPharma 3 Limited agreed to make future payments to Novartis comprising amounts equal to ascending speciﬁed percentages of tiered annual worldwide net sales (beginning at high single digits and reaching into double digits at higher sales) by such subsidiary of products that include the assets acquired. The levels of ascending percentages of tiered annual worldwide net sales are the same for each of Mereo BioPharma 1 Limited, Mereo BioPharma 2 Limited and Mereo BioPharma 3 Limited under the respective Purchase Agreements. Each of Mereo BioPharma 1 Limited, Mereo BioPharma 2 Limited and Mereo BioPharma 3 Limited further agreed that in the event it transfers, licenses, assigns or leases all or substantially all of its assets, it will pay 137 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Novartis a percentage of the proceeds of such transaction. The Company will retain the majority of the proceeds from such a transaction. Such percentage is the same for each of Mereo BioPharma 1 Limited, Mereo BioPharma 2 Limited and Mereo BioPharma 3 Limited under the respective Purchase Agreements. The payment of a percentage of proceeds is not payable with respect to any transaction involving equity interests of Mereo BioPharma Group plc, a merger or consolidation of Mereo BioPharma Group plc, or a sale of any assets of Mereo BioPharma Group plc. In October 2017, the Group’s wholly owned subsidiary Mereo BioPharma 4 Limited entered into an exclusive license and option agreement (“the License Agreement”), to obtain from AstraZeneca an exclusive worldwide, sub-licensable license under AstraZeneca’s intellectual property rights relating to MPH-966, with an option to acquire such intellectual property rights following commencement of a pivotal trial and payment of related milestone payments (“the Option”), together with the acquisition of certain related assets. Upon entering into the License Agreement, the Group made a payment of $3.0 million and issued 490,798 ordinary shares to AstraZeneca, for an aggregate upfront payment equal to $5.0 million. In connection with certain development and regulatory milestones, the Group has agreed to make payments of up to $115.5 million in the aggregate and issue additional ordinary shares to AstraZeneca for licensed products containing MPH- 966. In addition, the Group has agreed to make payments to AstraZeneca based on speciﬁed commercial milestones of the product. The Group has also agreed to pay a speciﬁed percentage of sub-licensing revenue to AstraZeneca and to make royalty payments to AstraZeneca equal to ascending speciﬁed percentages of tiered annual worldwide net sales by the Group of licensed products (subject to certain reductions), ranging from the high single digits to low double digits. Royalties will be payable on a licensed-product-by-licensed- product and country-by-country basis until the later of ten years after the ﬁrst commercial sale of such licensed product in such country and expiration of the last patent covering such licensed product in such country that would be sufﬁcient to prevent generic entry. Under the License Agreement, the Group may freely grant sub-licenses to afﬁliates upon notice to AstraZeneca and must obtain AstraZeneca’s consent, which is not be unreasonably withheld, to grant sub-licenses to a third party. The Group has agreed to use commercially reasonable efforts to develop and commercialize at least one licensed product. The License Agreement will expire on the expiry of the last-to-expire royalty term with respect to all licensed products. Upon the expiration of the royalty term for a licensed product in a particular country, the licenses to the Group for such product in such country will become fully paid and irrevocable. Prior to exercise of the Option, if at all, the Group may terminate the License Agreement upon prior written notice. Either party may terminate the agreement upon prior written notice for the other party’s material breach that remains uncured for a speciﬁed period of time or insolvency. AstraZeneca has agreed to a three-year non competition restriction in relation to the direct or indirect commercialization or development of NE inhibitors for the treatment of AATD. In addition, AstraZeneca agreed not to assert any AstraZeneca intellectual property rights that were included in the scope of the License Agreement against the Group. 28. Related party disclosures 28.1 Compensation of key management personnel of the Group The remuneration of key management personnel of the Group is set out below in aggregate: Year ended December 31, Short-term beneﬁts Post-employment beneﬁts IFRS 2 share-based payment charge Total compensation paid to key management personnel 2017 2018 2019 2,757 87 2,726 ––––––––– 5,570 ––––––––– ––––––––– 3,176 60 1,470 ––––––––– 4,706 ––––––––– ––––––––– 3,488 64 1,152 ––––––––– 4,704 ––––––––– ––––––––– The amounts disclosed in the table above are the amounts recognized as an expense during the reporting period related to key management personnel. Key management personnel of the Group consist of executive directors (the Chief Executive Ofﬁcer and Chief Financial Ofﬁcer), non-executive directors and other members of management (the General Counsel, the Chief Medical Ofﬁcer, the Head of Corporate Development, the Head of Patient Access and Commercial Planning and the US Site Head (SVP Regulatory Affairs)). 138 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 28.2 Employee Beneﬁt Trust In 2016 the Company set up an Employee Beneﬁt Trust (“EBT”) for the purposes of buying and selling shares on the employees’ behalf. A total of £1.0 million of funding was paid into the EBT by the Company during the year ended December 31, 2019 (2018: £0.3 million). A total of 1,074,274 shares were purchased by the EBT during the year ended December 31, 2019 (2018: 163,000). As at December 31, 2019 a cash balance of £21,762 (2018: £21,762) was held by the EBT. 28.3 Novartis Notes On June 6, 2019, Novartis delivered to the Company a notice of conversion with respect to the aggregate principal amount and interest of the Novartis Notes. Pursuant to such notice, on June 21, 2019, £2.4 million aggregate principal amount of Novartis Notes was converted into 1,071,042 fully paid ordinary shares at a ﬁxed conversion price of £2.21 per ordinary share (see Note 18). Additionally, in connection with such conversion, the Company issued 864,966 bonus shares to Novartis. On February 10, 2020, the Company entered into a £3.8 million convertible equity ﬁnancing with Novartis Pharma (AG) (“Novartis”). Under the terms of the convertible equity ﬁnancing, Novartis will purchase $5 million in a convertible loan note (see Note 30). 29. Standards issued but not yet effective Certain new accounting standards and interpretations have been published that are not mandatory for December 31, 2019 reporting periods and have not been early adopted by the Group. These standards are not expected to have a material impact on the entity in the current or future reporting periods and on foreseeable future transactions. 30. Events after the reporting period 30.1 Global licensing agreement On January 13, 2020, the Company and Oncologie, Inc. (“Oncologie”) announced a global licensing agreement for the development and commercialization of navicixizumab (“Navi”). Under the terms of the global licensing agreement, Oncologie will receive an exclusive worldwide license to develop and commercialize Navi. The Company received an upfront payment of $4 million on January 17, 2020. The Company is also eligible for an additional payment of $2 million conditional on a Chemistry, Manufacturing and Controls (“CMC”) milestone. Oncologie will be responsible for all future research, development and commercialization of Navi. Additionally, the Company will be eligible to receive up to $300 million in future clinical, regulatory and commercial milestones, tiered royalties ranging from the mid-single digit to sub-teen percentages on global annual net sales of Navi, as well as a negotiated percentage of sublicensing revenues from certain sublicenses. As a consequence of the global licensing agreement with Oncologie, and in accordance with the terms and conditions of the Contingent Value Rights Agreement for former stockholders of OncoMed, dated April 23, 2019, by and among the Company and Computershare Inc., as rights agent, (the “Mereo CVR Agreement”), holders of contingent value rights (“CVRs”) pursuant to the Mereo CVR Agreement will be entitled to receive certain eligible cash milestone payments made to the Company under the global licensing agreement relating to Navi. Those eligible cash milestone payments are equal to 70% of the aggregate principal amount received by the Company after deduction of costs, charged and expenditures within a period of ﬁve years following completion of the OncoMed acquisition on April 23, 2019. Such eligible milestone payments are subject to a cash consideration cap of approximately $79.7 million. As at December 31, 2019, the Company was reasonably certain payment of approximately $0.5 million (£0.4 million) would be made under the Mereo CVR Agreement. The full amount is recorded as a contingent consideration payable on the consolidated balance sheet as at December 31, 2019 and was subsequently paid out in the Q1 2020. 139 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 30.2 Novartis convertible equity ﬁnancing On February 10, 2020, the Company entered into a £3.8 million convertible equity ﬁnancing with Novartis Pharma (AG) (“Novartis”). Under the terms of the convertible equity ﬁnancing, Novartis will purchase £3.8 million in a convertible loan note (“Loan Note”). The Loan Note is convertible at any time at the option of the holder, at a ﬁxed price of £0.265 per ordinary share. The maturity of the Loan Note is three years from issuance, and it bears an interest rate of 6% per annum. In connection with the Loan Note issuance, the Company also issued a warrant instrument to Novartis to purchase up to 1,449,614 of the Company’s ordinary shares, which are exercisable at an exercise price of £0.265 per ordinary share at any time before the close of business on February 10, 2025. 30.3 Aspire Capital Securities Purchase Agreement On February 10, 2020, the Company entered into a Securities Purchase Agreement (the “Agreement”) to issue up to $28 million of the Company’s ordinary shares exchangeable for American Depositary Shares (“ADSs”), including a $3 million initial purchase, with Aspire Capital Fund, LLC (“Aspire Capital”), a Chicago-based institutional investor. Under the terms of the Agreement, Aspire Capital has made an initial investment of $3 million to purchase 11,423,925 of the Company’s ordinary shares (equivalent to 2,286,585 ADSs) at a price equivalent to $1.31 per ADS, which represents a 16% discount over Mereo’s ADS closing stock price of $1.56 on February 8, 2020. Under the terms of the Agreement, Aspire Capital has also committed to subscribe at Mereo’s request from time to time during a 30-month period for up to an additional $25 million of Mereo’s ordinary shares exchangeable for ADSs at prices based on the ADS market price at the time of each sale. In consideration for Aspire Capital’s initial investment and its commitment to purchase up to an additional $25 million ADSs, Mereo has agreed to pay Aspire Capital a commission to be satisﬁed wholly by the issue to Aspire Capital of a further 2,862,595 of the Company’s ordinary shares (equivalent to 572,519 ADSs). 30.4 Equity investment from Boxer Capital, LLC On February 19, 2020, the Company entered into a Securities Purchase Agreement with Boxer Capital, LLC to make an investment of $3 million to purchase 12,252,715 of the Company’s ordinary shares (equivalent to 2,450,543 ADSs) at a price equivalent to 18.8 pence per share, which represents a 20% discount over the Company’s closing share price of 23.5 pence on AIM on February 18, 2020. 30.5 Share-based payments On February 20, 2020, the Company granted 962,836 market value options over ADSs under the Mereo 2019 EIP (Note 26.1) to certain Executive Directors and other employees at an exercise price of $1.84 per ADS. On the same date, the Company granted 77,000 market value options over ADSs under the Mereo 2019 NED EIP (Note 26.2) to certain Non-Executive Directors at an exercise price of $1.84 per ADS. 30.6 Issuance of additional warrants to lenders Following the transactions noted above, it is anticipated that a further 362,534 additional warrants will be issued to the lenders of the bank loan facility giving them the right to subscribe for ordinary shares at an exercise price of £2.95 (see Note 21). 30.7 Resignation of Chief Financial Ofﬁcer (“CFO”) On March 27, 2020, we announced the resignation of Richard Jones. Michael Wyzga, a Non-Executive Director, will assume the role of Interim Chief Financial Ofﬁcer following the departure of Richard Jones. Richard Jones will remain in his position as CFO for a transitionary period of up to ﬁve months. For further details, refer to the Directors’ Remuneration Report within this report. 140 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 30.8 Coronavirus (“COVID-19”) The outbreak of COVID-19 has developed into a global pandemic, spreading to most regions of the world including the United States and the United Kingdom and to locations where we have facilities or ongoing clinical trials. The pandemic has resulted in impacts both direct and indirect to businesses including disruptions to resources, inability of workers to carry out their jobs effectively, disruptions to supply chains, inability to travel and increased pressure on health systems required to treat COVID-19. As a result of government and local regulation we have been required to introduce a work from home policy for the large majority of our work force and our facilities remain open only for business critical activities. The requirement by governments to stay at home or to “social distance” limits normal communications and may also increase cyber security risk or create data accessibility concerns. It also signiﬁcantly curtails the numbers of individuals who can work in our ofﬁces. COVID-19 has created an unprecedented burden on health systems in impacted countries around the world. As a result, clinical centers have diverted resources away from the performance of clinical trials and because of that and the vulnerability of patients in the Company’s setrusumab clinical development program for osteogenesis imperfecta (OI) and its Phase 2 alvelestat program for patients with alpha-1 antitrypsin deﬁciency (AATD), the Company’s clinical activities will face some delays. AATD patients, in particular, are at greater risk from COVID-19 given that the condition is a respiratory and lung condition, for this reason, our Phase 2 alvelestat trial will be delayed with topline data now expected in 2021. We are also currently planning to initiate a Phase 3 study in children with OI in late 2020, however, the initiation of the study may also be delayed. 30.9 Equity fund raise On June 4, 2020, Mereo BioPharma Group plc announced completion of a private placement offering (the "Fundraising") of $70 million (£56 million) before commission and expenses with a number of new and existing principally U.S based institutional and accredited investors (the "Purchasers"). The net proceeds from the Fundraising will be used primarily to fund clinical development activities of the Company’s lead product candidates and for general corporate purposes. The Company will utilize $13 million (£10.4 million) to reduce current indebtedness (including interest) of $17.6 million (£14.1 million). In the absence of the receipt of any other income, the Board expects that the resulting net proceeds of the Fundraising will fund the Company into early 2022. The Fundraising comprised proceeds of a total of $19.4 million (£15.5 million) through the issue of 89.1 million new Ordinary Shares of £0.003 each in the Company at a price of 17.4 pence per share and proceeds of a total of $50.6 million (£40.5 million) through the issue by the Company of convertible notes (the "Tranche 1 Notes"). The Purchasers also received conditional warrants to subscribe for further Ordinary Shares (the "Warrants"). The ability for the Tranche 1 Notes to be converted into Ordinary Shares and for the Warrants to be exercised is conditional on the passing of certain resolutions (the "Resolutions") at a general meeting of shareholders scheduled for June 30, 2020 (the "General Meeting"). If the Resolutions are passed, the Tranche 1 Notes will automatically convert into Ordinary Shares at 17.4p, subject to limitations that apply to the percentage of voting shares that may be held by Purchasers. Any Tranche 1 Notes not so converted will remain outstanding. The Tranche 1 Notes will not be separately admitted to trading on AIM, but the Ordinary Shares which will arise following any valid conversion of the Tranche 1 Notes will be admitted to trading as part of the Company’s single class of shares admitted to trading on AIM or the relevant exchange on which the Company’s shares are traded at the time the Tranche 1 Notes are converted. The Board estimates that 21,674,143 Tranche 1 Notes will convert automatically if the Resolutions are passed on June 30, 2020, resulting in 124,564,033 Ordinary Shares (excluding Ordinary Shares resulting in respect of interest on the converted Tranche 1 Notes) being issued, leaving 18,859,528 Tranche 1 Notes in issue. The Tranche 1 Notes are constituted by the Note Instrument, details of which are set out below. The Warrants are constituted by the Warrant Instrument, details of which are also set out below. If the Resolutions are not passed on or before August 7, 2020 the convertible notes will not convert into ordinary shares, the warrants will not become capable of exercise and the holders of the convertible notes 141 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS and warrants will become entitled to certain amounts (up to £137 million) that will represent material liabilities for the Company. The Purchasers, representing in aggregate approximately 40 per cent. of the Company’s total number of shares and votes have undertaken to vote in favour of the Resolutions relating to the warrants and the convertible notes. Note Instrument The Note Instrument constitutes three potential tranches of Loan Note: • an initial tranche of 40,533,671 Tranche 1 Notes representing $50.6 million (£40.5 million) issued to all Purchasers; • • a second tranche of up to £40.0 million Tranche 2 Notes representing approximately 115,034,554 ordinary shares which may be issued following the third anniversary of the date on which the Resolutions are passed to certain holders of Tranche 1 Notes in lieu of the holder exercising its subscription rights under the Warrants and in return for payment by that holder of the aggregate exercise price of the relevant Warrants; and a third tranche of up to £56.0 million Tranche 3 Notes, which may be issued, if the Resolutions are not passed at the General Meeting (or at any subsequent general meeting) held on or before August 7, 2020. The Tranche 1 Notes have a maturity date of June 2023 unless otherwise extended, converted or accelerated. The Tranche 2 Notes have a maturity date of three years from their date of issue (i.e. such that they would be anticipated as becoming due in 2026) unless otherwise extended, converted or accelerated. The Tranche 3 Notes have a maturity date of August 2025 unless otherwise extended, converted or accelerated. The Tranche 1 Notes and Tranche 2 Notes may be extended by certain holders beyond the initial maturity date to have a longstop maturity date of 10 years from the date of the Note Instrument. Tranche 3 Notes may also be extended by certain holders beyond the initial maturity date up to the same longstop maturity date of 10 years from the date of the Loan Note Instrument, however, such extension is subject to the consent of the Company. Tranche 1 Notes will initially bear interest at a ﬁxed rate of 10 per cent. per annum, which will be retroactively reduced to a rate of 6 per cent. per annum to the date of issue if the Resolutions are passed on or before August 7, 2020. If the Tranche 1 Notes are extended, they cease to bear interest from that extension. Tranche 2 Notes and Tranche 3 Notes do not accrue interest (unless default interest applies). Following an event of default by the Company, default interest will accrue on all Loan Notes at 2 per cent. above the applicable interest rate in force at that time for the relevant Loan Notes. All the Loan Notes are unsecured and have been contractually subordinated to the Company’s existing senior debt facility with Silicon Valley Bank and Kreos Capital pursuant to the terms of a Subordination Agreement to which all Purchasers have acceded as part of the Fundraising. If the Resolutions are not passed on or before August 7, 2020, the holders of Tranche 1 Notes are entitled to an additional fee (the “Uplift Payment”). The Uplift Payment is designed to compensate the Tranche 1 Noteholders for being unable to participate in the equity of the Company through the conversion of the Tranche 1 Notes and the exercise of Warrants. The value of the Uplift Payment for each Purchaser shall be equal to the aggregate principal amount of the Loan Notes held by such Purchaser on August 7, 2020. Any Purchaser who fails to attend the General Meeting (in person or by proxy) and vote in favour of the Resolutions relating to the Warrants and the Tranche 1 Notes shall not be entitled to the Uplift Payment. Any Uplift Payment if due, is payable on the redemption date of the relevant Loan Notes. If the Resolutions are not passed on or before August 7, 2020, an original holder of the Warrants may elect without payment to convert its Warrants into fully paid Tranche 3 Notes with a principal amount equal to the aggregate exercise price (being 34.8 pence per Warrant Share) of those Warrants, in compensation for the right to exercise those Warrants not having arisen. If the Resolutions have not been passed at a time when the Company undergoes a change of control, each Noteholder on the date of such change of control, shall (to the exclusion of the Uplift Payment) be entitled to a payment equal to the amount of consideration they would have received on such change of control had 142 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS the Resolutions been passed and they had received their full entitlement of Ordinary Shares and all Warrants they held had become exercisable, less the aggregate principal and interest outstanding on the Tranche 1 Notes and certain residual interests in the Warrants (if any) they held on the date of the change of control (the “Change of Control Payment”). Until the Resolutions have been passed, no Tranche 1 Notes are capable of conversion. If the Resolutions are passed on or before August 7, 2020, the Tranche 1 Notes will automatically convert into Ordinary Shares, except that no new Ordinary Shares will be issued which would result in any person holding in excess of 9.99 per cent. of the aggregate voting rights in the Company as a result of the relevant conversion. Any Tranche 1 Notes not converted will remain outstanding. After the Resolutions have been passed, those Tranche 1 Notes not automatically converted and any Tranche 2 Notes that may be issued, will be convertible into Ordinary Shares at the election of the Noteholders at any time prior to their maturity date, and subject to the 9.99 per cent. beneﬁcial ownership limit. The Tranche 3 Notes are not capable of conversion. The Loan Notes are required to be repaid on the earlier of (i) the applicable maturity date; and (ii) a change of control taking place in respect of the Company, and are otherwise not able to be prepaid other than with the consent of a noteholder majority, or if accelerated following an event of default. The Loan Notes are subject to customary events of default (for example, insolvency events in respect of the Company and default under the Company’s material contracts, amongst others) and any principal amount and interest outstanding is capable of being accelerated following the occurrence of such an event of default and the expiry of any cure periods applicable thereto. Warrants All the participants in the Fundraising have received conditional warrants to subscribe for further Ordinary Shares in an aggregate number equal to 50 per cent. of both the Ordinary Shares purchased in the Fundraising and the Ordinary Shares initially issuable upon conversion of the Tranche 1 Notes. A total of 161,048,366 Warrants have been issued. The Warrants have an exercise price of 34.8 pence per Ordinary Share, which is equal to 200 per cent. of the Fundraising issue price, and will be capable of being exercised at any time from and after the date the Resolutions are passed at the General Meeting (or at any subsequent general meeting) until the third anniversary of the date the Resolutions are passed. The Warrants can be exercised for cash or on a cashless basis. If the Resolutions are not passed at the General Meeting (or at any subsequent general meeting), the Warrants remain non-exercisable but will, until August 8, 2025, continue to beneﬁt from rights to participate in certain transactions. These include if the Company is acquired, following which the Company is required to use its best efforts to ensure that Warrant holders receive alternate warrants in the acquirer. In certain circumstances, Warrant holders may require the Company (or the acquirer) pay them (to the extent lawful) the value of the Warrants, determined in accordance with a BlackScholes valuation provision. The Warrant exercise price and the number of shares issuable upon exercise of the Warrants will be adjusted in certain circumstances, including if the Company effects a subdivision or consolidation of its Ordinary Shares, declares a dividend or distribution, or there is a reorganisation of its Ordinary Shares. Arrangements with OrbiMed In recognition of OrbiMed’s participation in, and assistance with, the Fundraising, the Company has agreed to grant OrbiMed certain rights. OrbiMed will have the right to nominate two persons to be appointed to the Board of Directors (out of a maximum number of 9 directors), within a period of 180 days of the Fundraising subject to the appropriateness of the nominees. OrbiMed has also been granted the right to participate in future ﬁnancings of the Company, subject, amongst other things, to the existing pre-emption rights of the Shareholders under the Companies Act 2006 and certain existing agreements to which the Company is a party. OrbiMed has been paid a subscription fee of $325,000 by the Company by way of a commission in consideration of its participation in the Fundraising. 143 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: COMPANY BALANCE SHEET as at December 31, 2018 and 2019 Year Ended December 31, 2019 Notes 2018 Assets (in £’000) Non-current assets Property, plant and equipment Investments 6 4 149 123,374 –––––––––– 123,523 –––––––––– 1,696 156,280 –––––––––– 157,976 –––––––––– Current assets Prepayments Other receivables Short-term investments Cash and short-term deposits Current liabilities Trade and other payables Accruals Interest-bearing loans and borrowings Lease liability Net current assets/(liabilities) Total assets less current liabilities Non-current liabilities Provisions Interest-bearing loans and borrowings Warrant liability Other liabilities Lease liability Net assets Equity shareholders’ funds Share capital Share premium Other capital reserves Other reserves Employee Beneﬁt Trust shares Losses brought forward Loss for the year Total equity shareholders’ funds 1,067 631 2,500 25,020 –––––––––– 29,218 –––––––––– 4,570 4,437 6,838 – –––––––––– 15,845 –––––––––– 13,373 –––––––––– 136,896 –––––––––– 842 14,647 1,006 34 – –––––––––– 16,529 –––––––––– 120,367 –––––––––– 214 118,492 18,593 7,000 (307) (13,650) (9,975) –––––––––– (23,625) –––––––––– 120,367 –––––––––– –––––––––– 1,557 565 – 4,307 –––––––––– 6,429 –––––––––– 5,254 3,414 15,139 697 –––––––––– 24,504 –––––––––– (18,075) –––––––––– 139,901 –––––––––– 104 5,373 131 44 911 –––––––––– 6,563 –––––––––– 133,338 –––––––––– 294 121,684 59,147 7,000 (1,305) (23,625) (29,857) –––––––––– (53,482) –––––––––– 133,338 –––––––––– –––––––––– 7 8 7 9 10 10 10 10 12 The accompanying notes form an integral part of these consolidated ﬁnancial statements. The Company has taken advantage of the exemption permitted by Section 408 of the Companies Act 2006 not to present an income statement for the year. Approved by the Board on June 14, 2020 and signed on its behalf by: Dr. Denise Scots-Knight Richard Jones Director Director Company number: 09481161 (England and Wales) 144 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: COMPANY STATEMENT OF CHANGES IN EQUITY for the years ended December 31, 2018 and 2019 Other Employee Accum- Issued Share capital Beneﬁt Other ulated Total capital premium reserves Trust reserves losses equity (in £’000) At December 31, 2017 213 118,227 16,359 — 7,000 (13,774) 128,025 ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– Loss for the year to December 31, 2018 — — — — — (9,975) (9,975) Adoption of IFRS 9 — — — — — 124 124 Share-based payments – share options — — 1,871 — — — 1,871 Share-based payments – LTIPs — — 319 — — — 319 Issue of share capital on June 1, 2018 — 150 — — — — 150 Issue of share capital on August 3, 2018 on exercise of options — 13 — — — — 13 Issue of share capital on October 22, 2018 on exercise of options 1 110 — — — — 111 Issue of warrants for TAP agreement — — 44 — — — 44 Transaction costs on issuance of share capital — (8) — — — — (8) Purchase of treasury shares — — — (307) — — (307) ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– At December 31, 2018 214 118,492 18,593 (307) 7,000 (23,625) 120,367 ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– Loss for the year to December 31, 2019 — — — — — (29,857) (29,857) Share-based payments – share options — — 1,543 — — — 1,543 Share-based payments – LTIPs — — 93 — — — 93 Issue of share capital on April 23, 2019 74 — 40,818 — — — 40,892 Transaction costs related to issuance of share capital on April 23, 2019 — (761) — — — — (761) Issue of share capital on conversion of loan note 3 2,366 — — — — 2,369 Issue of share capital on Novartis bonus shares 3 1,587 (1,590) — — — — Equity element of convertible loan note — — (310) — — — (310) Purchase of treasury shares — — — (998) — — (998) ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– At December 31, 2019 294 121,684 59,147 (1,305) 7,000 (53,482) 133,338 ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– ––––––– 145 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE COMPANY FINANCIAL STATEMENTS 1. Signiﬁcant accounting policies 1.1 Basis of preparation These ﬁnancial statements were prepared in accordance with Financial Reporting Standard 101 Reduced Disclosure Framework (FRS 101). In preparing these ﬁnancial statements, the Company applies the recognition, measurement and disclosure requirements of International Financial Reporting Standards as adopted by the EU (Adopted IFRSs) but makes amendments where necessary in order to comply with the Companies Act 2006 and has set out below where advantages for the FRS 101 disclosure exemptions has been taken. Under Section 408(4) of the Companies Act 2006, the Company is exempt from the requirement to present its own proﬁt and loss account. In these ﬁnancial statements, the Company has applied the exemptions available under FRS 101 in respect of the following disclosures: • • • • • • Presentation of a cash flow statement and related notes; Comparative period reconciliations for share capital, tangible ﬁxed assets and intangible assets; Transactions with wholly owned subsidiaries; The effects of new but not yet effective IFRSs; The compensation of key management personnel; and Required disclosures relating to capital management. As the consolidated ﬁnancial statements of Mereo BioPharma Group plc include the equivalent disclosures, the Company has also taken the exemptions under FRS 101 available in respect of the following disclosures: • • • • IFRS 2 (Share-Based Payments) in respect of Group-settled share-based payments; Certain disclosures required by IAS 36 (Impairment of Assets); Certain disclosures required by IFRS 13 (Fair Value Measurement); Certain disclosures required by IFRS 7 (Financial Instruments Disclosures). The Company proposes to continue to adopt the reduced disclosure framework of FRS 101 in its next ﬁnancial statements. The ﬁnancial information is presented in pound sterling and all amounts disclosed in the ﬁnancial statements and notes have been rounded off to the nearest thousand currency units, unless otherwise stated. 1.2 Changes of accounting policies The accounting policies for the Company that relate to the adoption of IFRS 16 (Leases) can be found in Note 4 of the consolidated ﬁnancial statements. The adoption of IFRS 16 (Leases) had a material impact on the Company. 1.3 Summary of signiﬁcant accounting policies The Company’s accounting policies are consistent with those described in the consolidated accounts of Mereo BioPharma Group plc, within Note 2 of the consolidated ﬁnancial statements. Below are accounting policies which are speciﬁc to the Company. a) Intercompany guarantee The Company accounts for ﬁnancial guarantees in accordance with IFRS 9 (Financial Instruments). Financial guarantees given by subsidiaries to the Company are initially measured at fair value. The total cost of such guarantees is charged to the proﬁt and loss account at the time the guarantee is given. 146 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE COMPANY FINANCIAL STATEMENTS b) Investment in subsidiaries Investments in subsidiary undertakings are stated at cost less amounts written off. Amounts capitalized as investments in subsidiary undertaking are reviewed for impairment at each period end in accordance with IAS 36 (Impairment of Assets). 2. Signiﬁcant accounting judgments, estimates and assumptions The preparation of the Company accounts requires the management of the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Company bases its estimates and judgments on historical experience and on various other assumptions that it considers to be reasonable. Actual results may differ from these estimates under different assumptions or conditions. Share-based compensation Incentives in the form of shares are provided to employees under a share option plan, long-term incentive plan and deferred bonus share plan. The fair value of the employee services received in exchange for the grant of the options is recognized as an expense. The selection of different assumptions could affect the results of the Company. Impairment of investments in subsidiaries An assessment was made in respect of indicators of impairment in the carrying value of the Group’s investment in subsidiaries as at December 31, 2019. If such an indication exists, the recoverable amount of the asset, being the higher of the asset’s fair value less costs to sell and value in use, is compared to the asset’s carrying value. Any excess of the asset’s carrying value over its recoverable amount is expensed to the income statement. The assessment of intangible assets involves a number of signiﬁcant judgments regarding the likelihood of successful product approval, the costs of reaching approval, the estimated useful life of intangible assets following commercialization and the subsequent commercial proﬁtability of the product once approved. 3. Loss for the year The Company has taken advantage of the exemption permitted by Section 408 of the Companies Act 2006 not to present an income statement for the year. The Company’s loss for the year was £29.9 million (2018: £10.0 million), which has been included in the Company’s proﬁt and loss account. The Auditor’s remuneration for audit and other services is disclosed in Note 7 of the consolidated ﬁnancial statements. The average number of employees employed by the Company (including Directors) in the year was 37 (2018: 36). 147 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE COMPANY FINANCIAL STATEMENTS 4. Company information 4.1 Investments in subsidiaries Cost At January 1, 2018 Additions in the year At December 31, 2018 Additions in the year Share-based payments to Group employees Acquisition of OncoMed on April 23, 2019 At December 31, 2019 Provision for impairment Charge during the year At December 31, 2019 Net book value At December 31, 2019 At December 31, 2018 97,105 26,269 ––––––––– 123,374 10,820 440 40,892 ––––––––– 175,526 ––––––––– ––––––––– 19,246 ––––––––– 19,246 ––––––––– ––––––––– 156,280 ––––––––– 123,374 ––––––––– On April 23, 2019, the Company issued 24.8 million ordinary shares to acquire OncoMed. The fair value of the 24.8 million ordinary shares issued as the consideration paid for OncoMed was measured based on the Group’s quoted share price on April 23, 2019 and is recorded as an investment in subsidiary within the Company’s ﬁnancial statements. The fair value is deemed to be £40.9 million. The Company grants rights to its own equity instruments to Group employees who are not employees of the Company. For these grants, the Company recognizes in equity the equity-settled share-based payment with a corresponding increase in the investment in the subsidiary in the separate ﬁnancial statements. The total amount of impairment loss recorded during the year ended December 31, 2019 was £19.2 million. The impairment loss was due to the recoverable value of an investment in a subsidiary falling below the carrying amount (held at cost, in accordance with the Company’s accounting policies). The recoverable value of the investment was measured based on either the value in use or the realizable value and the discount rate used in the calculation of value in use was 15.3%. Any change in assumptions could result in further impairment loss in the future. 148 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE COMPANY FINANCIAL STATEMENTS 4.2 Information about subsidiaries The following were subsidiary undertakings at the end of the year and have been included in the consolidated ﬁnancial statements of the Group: % equity interest Country of December 31, December 31, 2018 % equity interest 2019 incorporation Name Mereo BioPharma 1 Limited Mereo BioPharma 2 Limited Mereo BioPharma 3 Limited Mereo BioPharma 4 Limited Mereo BioPharma Ireland Limited OncoMed Pharmaceuticals, Inc. Navi Subsidiary, Inc. Mereo US Holdings Inc. Mereo MergerCo One Inc. Mereo BioPharma Group plc Employee Beneﬁt Trust Principal activities Pharmaceutical R&D Pharmaceutical R&D Pharmaceutical R&D Pharmaceutical R&D Pharmaceutical R&D Pharmaceutical R&D Pharmaceutical R&D Holding company Holding company U.K. U.K. U.K. U.K. Ireland U.S. U.S. U.S. U.S. Employee share scheme Jersey 100 100 100 100 100 100* 100* 100 – – 100 100 100 100 100 – – 100 100 – * denotes a subsidiary which is indirectly held by the Company The registered ofﬁce of Mereo BioPharma 1 Limited, Mereo BioPharma 2 Limited, Mereo BioPharma 3 Limited and Mereo BioPharma 4 Limited is located at Fourth Floor, 1 Cavendish Place, London W1G 0QF. The registered ofﬁce of Mereo BioPharma Ireland Limited is 25/28 North Wall Quay, Dublin 1 D01H104, Ireland. Mereo US Holdings Inc. and Mereo MergerCo One Inc. were incorporated on December 3, 2018 for the sole purpose of effecting the business combination with OncoMed (see Note 5 of the consolidated ﬁnancial statements). Following the business combination with OncoMed, Mereo MergerCo One Inc. ceased to exist. The registered ofﬁce of Mereo US Holdings Inc. is 251 Little Falls Drive, City of Wilmington, County of New Castle, Delaware 19808, U.S. Mereo MergerCo One Inc. was a 100% owned subsidiary of Mereo US Holdings Inc. OncoMed became a wholly owned subsidiary of Mereo US Holdings Inc. on April 23, 2019 and is therefore an indirect, wholly owned subsidiary of Mereo BioPharma Group plc. The registered ofﬁce of OncoMed Pharmaceuticals, Inc. is 251 Little Falls Drive, City of Wilmington, Country of New Castle, Delaware 19808, U.S. Navi Subsidiary, Inc, incorporated on April 15, 2019, is a wholly owned subsidiary of OncoMed. A capital contribution of £11.3 million (2018: £26.3 million) by Mereo BioPharma Group plc to its subsidiaries was recorded in the year to December 31, 2019. £0.4 million (2018: £0.7 million) has been recorded for the granting of employees’ share options for services rendered by the employees to the subsidiaries. £10.8 million (2018: £25.6 million) has been recorded for the conversion of intercompany balances at original cost. As at December 31, 2019, a total capital contribution of £4.0 million (2018: £3.6 million) by Mereo BioPharma Group plc to its subsidiaries has been recorded for the granting of employees’ share options for services rendered by the employees to the subsidiaries. As at December 31, 2019, a total capital contribution of £131.3 million (2018: £119.8 million) by Mereo BioPharma Group plc to its subsidiaries has been recorded for the conversion of intercompany balances at original cost. 5. Amounts owed by Group undertakings On January 1, 2018 Mereo BioPharma Group plc resolved to capitalize the intercompany loans and all outstanding intercompany receivables at that date. As at December 31, 2019, amounts owed by Group undertakings is nil (2018: £nil). 149 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE COMPANY FINANCIAL STATEMENTS 6. Property, plant and equipment Further details on the initial application of IFRS 16 (Leases) are presented in Note 4 (Adoption of new and revised standards) of the consolidated ﬁnancial statements. The Company has decided to present right-of- use assets within property, plant and equipment. On initial application of IFRS 16 (Leases), the Company recognized a right-of-use asset of £2.5 million relating to a building (£1.2 million) and scanning equipment (£1.3 million). During the year, the lease term on the scanning equipment was re-assessed. As at December 31, 2019, the net book value of right-of-use assets is £1.5 million (of which £1.0 million relates to a building and £0.5 million relates to scanning equipment). 7. Interest-bearing loans and borrowings The Group’s interest-bearing loans and borrowings all reside in the Company. Details on the interest-bearing loans and borrowings of the Company are provided in Note 19 of the consolidated ﬁnancial statements. 8. Provisions Social security contributions on share options At beginning of year Arising during the year Released At December 31 Current Non-current Year ended December 31, 2018 2019 2,288 – (1,446) ––––––––– 842 ––––––––– – 842 ––––––––– 842 – (738) ––––––––– 104 ––––––––– – 104 ––––––––– The provision for social security contributions on share options is calculated based on the number of options outstanding at the reporting date that are expected to be exercised. The provision is based on the estimated gain arising on exercise of the share options, using the best estimate of the market price at the balance sheet date. Since the Directors assume the options will be held for their full contractual life of ten years (see Note 26 of the consolidated ﬁnancial statements) the liability has been classiﬁed as non current. The provision has been discounted 9. Warrant liability The Group’s warrant liability resides in the Company. Details on the warrant liability of the Company are provided in Note 21 of the consolidated ﬁnancial statements. 10. Share capital, share premium and other reserves The Group’s share capital all resides in the Company. Details on the share capital of the Company are provided in Note 18 of the consolidated ﬁnancial statements. 150 MEREO BIOPHARMA GROUP PLC FINANCIAL STATEMENTS: NOTES TO THE COMPANY FINANCIAL STATEMENTS 11. Share-based payments The charge for share-based payments under IFRS 2 arises across the following schemes: 2015 Plan Mereo BioPharma Group plc Share Option Plan Long Term Incentive Plan 2019 Equity Incentive Plan 2019 NED Equity Incentive Plan Year ended December 31, 2018 2019 718 499 285 – – ––––––––– 1,502 ––––––––– 85 518 87 347 160 ––––––––– 1,197 ––––––––– Details on the share-based payments of the Company, including deferred equity consideration, are provided in Note 26 of the consolidated ﬁnancial statements. 12. Related party disclosures Details on related parties are provided in Note 28 of the consolidated ﬁnancial statements. 151

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