Annual Report and Accounts 2014

30 July 2014

Vectura Group plc

Annual Report and Accounts 2014

In accordance with the Listing Rule 9.6.1, a copy of the following document has been submitted to the UK Listing Authority.

- A copy of the Company's Annual Report and Accounts for 2014.

This document has been submitted to the National Storage Mechanism and will shortly be available for inspection at www.morningstar.co.uk/uk/nsm.

The Annual Report and Accounts 2014 are available on the Company website at www.vectura.com.

In accordance with DTR 6.3.5, extracted below from the Annual Report and Accounts is a management report in full unedited text which contains the Statement of Directors' responsibilities and principal risk factors for the Company. References to page numbers and note in the exact refer to those in the Annual Report and Accounts 2014. A condensed set of financial statements were appended to Vectura Group's preliminary results announcement issued on 21 May 2014.

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Unedited extract from Annual Report and Accounts 2014

Statement of Directors' responsibilities

The Directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare such financial statements for each financial year. Under that law the Directors are required to prepare the group financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union and Article 4 of the IAS Regulation and have also chosen to prepare the parent company financial statements under IFRSs as adopted by the European Union. Under company law the Directors must not approve the accounts unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, International Accounting Standard 1 requires that Directors:

· properly select and apply accounting policies;

· present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information;

· provide additional disclosures when compliance with the specific requirements in IFRSs are insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity's financial position and financial performance; and

· make an assessment of the Company's ability to continue as a going concern.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

Directors' responsibility statement

We confirm that to the best of our knowledge:

· the financial statements, prepared in accordance with International Financial Reporting Standards as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole;

· the Strategic report includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties which they face; and,

· the Annual Report and financial statements, taken as whole, are fair, balanced and understandable and provide the information necessary for shareholders to assess the Company's performance, business model and strategy.

Risks and risk management

Our performance and prospects may be affected by a number of risks and uncertainties relating to our strategy, business model and operating environment. Our approach to risk management is to develop a risk management process that is aligned to our strategy, which will ensure that significant risks are identified, assessed and managed. Creating awareness of these risks throughout the organisation allows them to be limited, controlled and managed to ensure that business activities can be undertaken and opportunities can be maximised.

Objectives of the Vectura risk management process:

· to understand the business risks that Vectura faces in the execution of its strategy and the operation of its business model;

· to create and manage a register of these risks, documenting the decisions taken and judgements made;

· to ensure that the risk appetite of the Board is fully understood by those who are responsible for managing risk across the business;

· to ensure that mitigating actions and controls are aligned to the risk appetite of the Board;

· to ensure that risks are appropriately managed or mitigated and to ensure that where appropriate, risk is mitigated through insurance; and

· to control systematic risks within the organisation by maintaining and improving a system of internal controls to manage risks in decision making, legal contract management, quality and regulatory processes and the processing of financial transactions.

Identified risks

The principal risks specific to our business have been outlined below as well as an explanation of how we manage and mitigate them. Other risks are unknown or are deemed less material.

Some of these risk factors are specific to the Group and others are more generally applicable to the pharmaceutical industry or specific markets within which the Group operates. Our strategy is to become a speciality pharmaceutical company with a focus on airways-related diseases. In order to be successful, our business model involves the in-licensing of drug assets at various stages of their clinical development and developing those assets in an appropriate way and, partnering/co-developing or self-commercialising where appropriate.

The key risks highlighted below and on the following pages relate predominately to our stated strategy and current business model.

Strategic risks

Regulatory approvals

There can be no assurance that Vectura's, or a collaborator's, products will receive and maintain regulatory approvals. Even if Vectura's or a collaborator's products are approved, they may still face subsequent regulatory difficulties.

The international pharmaceutical industry is highly regulated by governmental authorities in the UK, the US and Europe and by regulatory agencies in other countries where the Group or a collaborator intends to test or market products they may develop. Regulatory authorities administer a wide range of laws and regulations governing the testing, approval, manufacturing, labelling and marketing of drugs and also review the quality, safety and effectiveness of pharmaceutical products. These regulatory requirements are a major factor in determining whether a substance can be developed into a marketable product and the amount of time and expense associated with such development.

As each regulatory authority may impose its own requirements, approval in one territory provides no guarantee that the product will receive subsequent regulatory approval in other territories. Even if regulatory approval to sell products is received, the FDA, the UK MHRA or comparable foreign regulatory agencies could require Vectura or a collaborator to conduct post-marketing trials or could prevent Vectura or a collaborator from using the labelling claims which Vectura or a collaborator would like to use to promote its products.

In addition, changes in applicable legislation or regulatory policies, or discovery of problems with the class of product, or its production process, site or manufacturer, may result in the imposition of restrictions on the product, its sale, manufacture or use, including withdrawal of the product from the market, or may otherwise have an adverse effect on Vectura's business.

Mitigating activities

The Group manages its regulatory risk by working closely with its expert regulatory advisors and, where appropriate, by seeking advice from regulatory authorities on the design of key development plans for its pre-clinical and clinical programmes.

The Group works closely with a number of blue-chip pharmaceutical partners such as Novartis, Sandoz, Baxter and GSK, who have significant regulatory expertise.

Unforeseen side effects

Unforeseen side effects may result from use of Vectura's or a collaborator's products or product candidates.

All drugs have a risk of adverse reactions and side effects. If any of Vectura's or its collaborators' products are found to cause adverse reactions and side effects other than those acceptable to regulators, Vectura or such collaborators may have to conduct additional clinical trials. This would cause delays and result in additional costs in the development of a product and in extreme circumstances a development programme may have to be terminated or suspended on the basis that participants are being exposed to unacceptable health risks.

Even after a pre-clinical or clinical trial is deemed successful or regulatory approval is received, a product may later be shown to be unsafe. In this circumstance, Vectura or its collaborator may be required to conduct additional trials or studies and regulatory approval may be suspended or withdrawn.

Mitigating activities

Vectura and its collaborators conduct extensive pre-clinical and clinical trials, designed to test for and identify any adverse side effects.

In addition, there is a significant amount of safety data available regarding existing marketing products to which our generic products relate.

However, clearly this is a risk inherent in the nature of Vectura's business and adverse side effects may be identified at any time, even after a product has been approved and sold commercially.

Competition

Vectura's business faces intense competition from a range of pharmaceutical and biotechnology companies. Technological changes could overtake the products being developed by Vectura or by its collaborators.

Vectura's competitors in the biotechnology and pharmaceutical industries may have superior research and development capabilities, products, manufacturing capability or sales and marketing expertise. Many of Vectura's competitors have significantly greater financial and human resources and may have more experience in research and development. As a result, Vectura's competitors may develop safer or more effective products, implement more effective sales and marketing programmes or be able to establish superior proprietary positions. In addition, Vectura anticipates that it will face increased competition in the future as new companies enter Vectura's markets and alternative products and technologies become available.

Mitigating activities

Vectura's current royalty generating products are expected to continue to provide royalties until patent expiry or until Vectura is no longer entitled to receive royalties in accordance with a license agreement.

For programmes managed in-house, Vectura has an established project management framework. The potential commercial opportunities for each project are assessed at the end of each stage of the project. Projects are assessed using widely accepted valuation metrics based upon discounted cash flows. These cash flows are discounted using a hurdle rate that is in line with industry standards and the expected return of each project is further risk adjusted by its phase of development. Vectura has experienced development and commercial teams who all contribute to this assessment. This in-house review is supplemented by well-regarded disease area reports and, where appropriate, bespoke market research.

Under this framework, research and development programmes will only be approved by the Board if it can be shown that the expected benefits outweigh the expected costs. All programmes are subject to a stage-gate approval process and in the event that it was no longer considered that the future revenues would be higher than the future costs, the Board would consider terminating or redefining the programme.

Vectura works closely with its advisors and obtains, where necessary, opinions on the intellectual property landscape relevant to the Group's product development programmes and manufacturing activities and processes. In addition, Vectura works with a number of key licensing partners who have significant expertise in the research, development and commercialisation of pharmaceuticals. These licensing partners have access to significant financial and human resources.

Partnerships

Vectura is dependent upon a number of key partners, the loss of any of which could have a material impact on the Group.

At present Vectura has several partnership and licensing agreements and may depend upon single or multiple key partners to assist in future commercialisation of its products. These partners may be unwilling or unable to meet Vectura's future needs. Vectura cannot guarantee that:

· existing collaborative arrangements or licence agreements or agreements with third-party contractors will be able to be maintained; or

· any collaborative arrangements or licence agreements or agreements with third-party contractors will prove successful.

Mitigating activities

All collaborations are performed under a suitable legal agreement which is assessed by Vectura and its external legal advisors.

Typically, for collaborations a Joint Steering Committee (JSC) will be established, which provides a mechanism by which Vectura can ensure that any joint project team activity is managed appropriately within standard project management processes.

An alliance manager is identified for all licensing partnerships or contract research organisation engagements.

Vectura has an established Business Development team which is responsible for negotiating terms with key partners. There is an agreed process for managing the process of entering agreements and this includes appropriate oversight and approval at Board level.

Commercial success

The products that Vectura and its collaborators bring to market may not be commercially successful.

Vectura may not be able to sell its products profitably if reimbursement from third-party payors, including government and private health insurers, is unavailable or limited.

A significant portion of Vectura's future revenue is likely to depend on payments by third-party payors, including government health administration authorities and private health insurers. As such, Vectura may be adversely affected by third-party reimbursement and healthcare cost containment initiatives.

Vectura may not be able to sell its products profitably if reimbursement from these sources is unavailable or limited. Third-party payors are increasingly attempting to contain healthcare costs through measures that are likely to impact the products Vectura is developing, including:

· challenging the prices charged for healthcare products, limiting both coverage and the amount of reimbursement for new therapeutic products, and denying or limiting coverage for products that are approved by the regulatory agencies but are considered experimental by third-party payors; and

· refusing to provide coverage when an approved drug is used in a way that has not received regulatory marketing approval.

In addition, in many European countries, there has been an increasing trend towards reference pricing, where the amount of reimbursement is determined in light of reimbursement levels for comparable drugs in other European countries, which is likely to severely restrict the potential per unit price for many new drugs unless such drugs can be significantly differentiated from existing products. If products developed by Vectura or its partners are not covered by government or other third-party reimbursement schemes, are reimbursed at prices lower than those expected by Vectura, or become subject to legislation controlling treatments or pricing, Vectura and/or its partners may not be able to generate significant revenue or attain profitability for any product candidates which are approved for marketing.

Mitigating activities

Products may be out licensed to partners who have the expertise to commercialise products and negotiate pricing structures with third-party payors, especially in disease indications that require large sales forces. Should Vectura self-commercialise, this would be targeted commercialisation for niche products with significant unmet need, which require a small sales force to target specialist physicians.

Vectura's business model includes bringing highly innovative products to address unmet needs and the Company is also involved in a number of generics programmes which support government initiatives to reduce costs. This adds balance to our business model in an era of increasing cost containment.

Future acquisitions

Should the Group make further acquisitions, there is a risk that it will fail to identify appropriate investment opportunities or perform sound due diligence.

There is also a risk that any acquired business will not be successfully integrated into the Group.

Mitigating activities

The Board will continue to review all investment opportunities and oversee a rigorous due diligence process. Plans are in place to ensure structured post-acquisition integration is executed successfully.

Operational risks

Commercialisation

The successful development and commercialisation of medicines carries a high level of risk and the returns may be insufficient to cover the costs incurred.

Vectura's competitors in the biotechnology and pharmaceutical industries may have superior research and development capabilities, products, manufacturing capability or sales and marketing expertise. Many of Vectura's competitors have significantly greater financial and human resources and may have more experience in research and development. As a result, Vectura's competitors may develop safer or more effective products, implement more effective sales and marketing programmes or be able to establish superior proprietary positions. In addition, Vectura anticipates that it will face increased competition in the future as new companies enter Vectura's markets and alternative products and technologies become available.

Mitigating activities

The Group performs detailed reviews of the development process and progress of projects through trials.

Where appropriate, the Group looks to mitigate the development and commercial risk of its product pipeline by partnering drug candidates at an appropriate stage. The partnering event crystallises part of the programme's value, with the goal of retaining an attractive proportion of the commercial upside through future milestones and an ongoing royalty interest from commercial sales.

As explained above, programmes which are managed in-house are assessed using widely accepted valuation metrics based upon discounted cash flows. These cash flows are discounted using a hurdle rate that is in line with industry standards and the expected return of each project is further risk adjusted by its phase of development. Vectura has experienced development and commercial teams who all contribute to this assessment. This in-house review is supplemented by well-regarded disease area reports and, where appropriate, bespoke market research.

Product liability

In carrying out its activities Vectura will potentially face contractual and statutory claims, or other types of claim from customers, suppliers and/or investors.

Vectura is exposed to potential product liability risks that are inherent in the research, the pre-clinical and clinical evaluation, pre-clinical study, clinical trials, manufacturing, marketing and use of pharmaceutical products. Consumers, healthcare producers or persons selling products based on Vectura's and its collaborators' technology may be able to bring claims against Vectura based on the use of such products in clinical trials and the sale of products based on Vectura's technology.

Mitigating activities

Vectura maintains an appropriate level of product liability insurance and operates quality systems relating to the manufacture of products. Vectura has a pharmacovigilance system to monitor safety events arising with respects to products sold.

Vectura's insurance portfolio also includes other third-party liability insurances which would provide cover in the event of certain other contractual or statutory claims.

Intellectual property

The Group and its collaborators may be unable to successfully establish and protect intellectual property which is significant to the Group's competitive position.

Certain companies are developing medicines that may restrict the potential commercial success of Vectura's products or render them obsolete. Third-party companies may have intellectual property that restricts Vectura's or Vectura's partners' freedom to operate. Obtaining licences to intellectual property may not be possible or may be costly and may reduce net royalty income to Vectura. Vectura's intellectual property may become invalid or expire before its products are successfully commercialised.

Vectura's success depends in part on its ability to obtain and maintain protection for its inventions and proprietary information, so that it can prevent others from making, using or selling its inventions or proprietary rights.

There is a significant delay between the time of filing of a patent application and the time its contents are made public, and competitors may have filed patent applications for subject matter covered by the Group's pending patent applications without the Group being aware of those applications.

To develop and maintain its competitive position, the Group also relies upon unpatented trade secrets and improvements, unpatented know-how and continuing technological innovation.

Generic drug manufacturers, particularly in the US, may seek marketing approval for pharmaceutical products currently under patent protection by attacking the validity or enforceability of a patent. The more successful the product is commercially, the more likely the patent covering the product will be challenged by generic manufacturers. If such a challenge is successful the product could be exposed to generic competition before the expected expiration date of the patent. This could have a material effect on Vectura's revenues and results.

Mitigating activities

Vectura owns a portfolio of patents and patent applications and is the authorised licensee of other patents.

The Group works closely with its legal advisors and obtains, where necessary, opinions on the intellectual property landscape relevant to the Group's product development programmes and manufacturing activities and processes.

The Group ensures that patent applications are filed in a timely manner and are monitored closely to ensure that the result of any application is acted upon as soon as possible.

Reasonable security measures are adopted to protect this unpatented property, including confidentiality agreements with collaborators, consultants and employees.

Financial risks

Financial operations

Foreign exchange rate fluctuations may adversely affect Vectura's results of operations and financial condition.

Vectura records its transactions and prepares its financial statements in pounds sterling, but a substantial proportion of Vectura's income from collaborative agreements is received in euros and US dollars. Furthermore, Vectura incurs a proportion of its expenditure in euros, US dollars and other currencies.

Vectura's cash balances are predominantly held in pounds sterling. To the extent that Vectura's foreign currency assets and liabilities are not matched, fluctuations in exchange rates between pounds sterling, the US dollar and the euro may result in realised or unrealised exchange gains and losses on translation of the underlying currency into pounds sterling that may increase or decrease Vectura's results from operations and may adversely affect Vectura's financial condition, each as stated in pounds sterling. In addition, if the currencies in which the Group earns its revenues and/or holds its cash balances weaken against the currencies in which it incurs its expenses, this could adversely affect Vectura's profitability and liquidity.

Mitigating activities

Where known liabilities arise in these currencies the revenues are retained on deposit in the appropriate currency in order to offset the exchange risk on these liabilities. As at 31 March 2014, the Group had sufficient euro and US dollar reserves to cover its immediate and short-term liabilities in respect of these currencies.

Where a substantial net foreign currency liability exists, Vectura will consider hedging against it to minimise foreign currency expense. However, such hedging is based on estimates of liabilities and future revenues and will not fully eliminate future foreign currency exchange fluctuations.

Liquidity

The Group may be exposed to credit or liquidity risk.

The Group's credit and liquidity risk is primarily attributed to its cash and cash equivalents. With the current economic uncertainty, failure of an institution which the Group uses to hold cash deposits would have a material impact on the Group's ability to continue as a going concern.

Mitigating activities

This risk is limited because the counterparties are banks with high credit ratings assigned by international credit-rating agencies. Deposits are made in accordance with the Group's Treasury Policy approved by the Board, which contains strict criteria on minimum credit ratings and maximum deposit size. However, the recent global credit problems could result in the failure of even high credit-rated banks where funds are deposited.

In order to maintain liquidity to ensure that sufficient funds are available for ongoing operations and future developments, the Group closely monitors the cash available to the Group, which is invested in a mixture of current and short-term deposit accounts.

A list of current Directors of Vectura Group plc is maintained on the Vectura Group plc website, www.vectura.com.