Annual Report and Accounts

15 June 2015

Vectura Group plc

Annual Report and Accounts 2015

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

- Annual Report and Accounts 2015.

The 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 2015 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 2015. A condensed set of financial statements were appended to Vectura Group's preliminary results announcement issues on 20 May 2015.

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Enquiries

About Vectura

Vectura is a product development company that focuses on the development of pharmaceutical therapies for the treatment of airways-related diseases (airways diseases). This growing market includes asthma and chronic obstructive pulmonary disease (COPD) and is estimated to be worth $44 billion worldwide.

Vectura now has eight products marketed by partners with growing global royalty streams and a portfolio of drugs in clinical development, a number of which have been licensed to major pharmaceutical companies. Vectura currently has disclosed development collaborations and licence agreements with several global pharmaceutical and biotechnology companies, including Novartis, Sandoz, Baxter, GlaxoSmithKline, UCB, Ablynx, Grifols, Janssen Biotech and Tianjin KingYork Group Company.

Vectura develops products for airways diseases and owns formulation and inhalation technologies that are available to other pharmaceutical companies on an out-licensing basis where this complements Vectura's business strategy.

For further information, please visit Vectura's website at www.vectura.com.

Unedited extract from Annual Report and Accounts 2015

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, IAS 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 UK 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 IFRSs 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 ability to meet our goals and objectives 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 and implement a risk management process which will ensure that significant risks are identified, assessed, managed and reported to relevant stakeholders in a concise and timely manner to inform and support decision making.

Objectives of the Vectura risk management process:

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

• to ensure that the risk appetite of the Board is embedded throughout the organisation and fully understood by those who are responsible for managing risk and making key decisions across the business;

• to assess the potential impact of identified risks and to create and maintain a register of these risks, documenting the decisions taken and the judgements made;

• to ensure that appropriate mitigating actions and controls are in place for all identified risks and that the residual risk is aligned to the risk appetite of the Board;

• 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; and

• to ensure that identified risks are reported to relevant stakeholders in a timely manner to facilitate effective decision making.

Our principal risks and uncertainties

The principal risks specific to our business have been outlined below together with an explanation of how we manage and mitigate them. Some of these risks are specific to the Group and others are more generally applicable to the pharmaceutical industry or specific markets within which Vectura operates.

Risks specific to the Group:

Strategic risks

1. Implementation of strategy

In order to become a specialty pharmaceutical company, Vectura needs to transition to a hybrid business model focused on driving R&D to its earliest inflection point for value realisation whilst actively evaluating the landscape for attractive M&A opportunities.

Delivering this strategy requires significant decisions to be made, including decisions on M&A activity, investment capex and balance of product development versus partnerships.

Failure to make these strategic decisions in a timely manner may mean that strategic or commercial opportunities are missed or are not maximised. Perceived exposure to this risk may increase as a result of recent changes within the management team.

Mitigating activities

Vectura's strategy has been endorsed by the Board and communicated to shareholders through the Annual Report, corporate website and through management presentations at investor conferences.

2. Identification and execution of merger and acquisition activity and integration of acquired businesses and assets

Vectura is at a pivotal point in its maturity and strategic direction, and in order to deliver our Board-approved strategy of becoming a specialty pharmaceutical company we must undertake further M&A activity. Realising anticipated benefits from such acquisitions depends upon how well we identify M&A targets, how well we conduct due diligence and how well we integrate acquired businesses and assets into our business operations.

A shortage of skills, experience and transactional capability in certain aspects of M&A due diligence and post-acquisition integration could result in the sub-optimal management of acquisitions, eroding enterprise value and delaying our transition to a specialty pharmaceutical company.

Mitigating activities

We have established processes in place to manage acquisitions and the associated due diligence prior to acquisition. Our internal due diligence teams are supported by external subject matter experts to ensure that the wider due diligence team has the appropriate breadth and depth of knowledge and experience.

Structured post-acquisition integration plans are established to ensure that integration is executed successfully.

3. Recruitment and retention of key employees

Vectura operates in a specialised industry and in order to deliver against our strategic objectives we require highly skilled and experienced employees. Challenges in attracting, retaining and motivating such employees may impact our ability to maintain performance levels and to deliver against our strategic growth objectives.

Mitigating activities

A comprehensive review of total remuneration packages is underway to ensure that our pay and benefits are market competitive.

Vectura is positive about developing all employees for current and future roles and our career development and talent management programmes remain a key area of focus for our management team. We continue to invest in ongoing training and development.

Succession plans for key roles are being developed to ensure that a talent pool is identified, developed and ready for succession.

Operational risks

4. Operational disruption

A significant and prolonged disruption to a research and development or manufacturing operation upon which Vectura relies could result in a substantial loss of royalty revenues, other liabilities or a significant delay to a development programme.

Mitigating activities

Vectura identifies key suppliers in relation to its business and, where possible, alternative sources of supply are sought, although this is not always economically feasible.

Where appropriate, Vectura holds duplicates for business-critical equipment. We have established good working relationships with the manufacturers of business-critical equipment and we monitor our supplier relationships to ensure effective and responsive service levels.

Contingency is built into product development plans, and Group-wide business continuity plans have been established. Our operational team is currently reviewing our business continuity procedures and intends to undertake crisis simulations to test the robustness of our arrangements.

Vectura has insurance, subject to certain exclusions and deductibles, against the usual insurable perils, such as property damage and other business interrupting events.

Financial risks

5. Foreign exchange risk

A substantial proportion of the Group's income from collaborative agreements is received in US dollars and euros and expenditure is predominantly incurred 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 our presentational and functional currency of pounds sterling. Such gains or losses may increase or decrease Vectura's operating result 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 profitability and liquidity.

Mitigating activities

Where known foreign currency liabilities arise, foreign currency revenue receipts are retained on deposit in the appropriate currency in order to offset the exchange risk on these liabilities. As at 31 March 2015, 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.

Broader risks specific to the pharmaceutical industry

6. Regulatory approvals

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 Vectura or a collaborator intends to test or market products they may develop. 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. There can be no assurance that Vectura's, or a collaborator's, products will receive and maintain regulatory approvals. Even if products are approved, they may still face subsequent regulatory difficulties. Such difficulties may result in financial loss and reputational damage.

Mitigating activities

We work closely with expert regulatory advisors and, when appropriate, seek advice from regulatory authorities on the design of key development plans for pre-clinical and clinical programmes.

In respect of our collaborations and partnerships, we work with a number of blue-chip pharmaceutical partners such as Novartis, Sandoz, Baxter and GSK, who have significant regulatory expertise.

7. Unforeseen side effects

All drugs have a risk of adverse reactions and side effects and therefore unforeseen side effects may result from the use of Vectura's, or a collaborator's, products or product candidates. This is an inherent risk which may be identified at any time, even after a product has been approved and sold commercially. Discovery of unforeseen side effects, other than those acceptable to the regulators, may result in a substantial loss of royalty revenues, other liabilities, a significant delay to a development programme or withdrawal or suspension of regulatory approval.

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 marketed products to which our generic products relate.

8. Partnerships

Vectura currently has a number of strategically important partnerships, collaborations and licensing arrangements for development, manufacture and commercialisation of certain of its pipeline assets. Loss of any one of our strategically important partnerships, collaborations or licensing arrangements could have a material impact on Vectura's future prospects. Vectura is also reliant on suppliers for the development and manufacture of certain devices. Any poor performance of the third parties could delay or prevent devices from being successfully developed and delivered to plan. This could result in key development milestones being missed or associated payments being delayed and could also affect partners' confidence in Vectura's ability to deliver.

Mitigating activities

Vectura has an agreed process for managing entering agreements and this includes appropriate oversight and approval at Board level. 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 our standard project management processes.

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

9. Pricing and reimbursement

Vectura or our collaborators 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 new products that are approved by the regulatory agencies; 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. This 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

Where appropriate, 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 requires a small sales force to target specialist physicians.

Our business model includes bringing highly innovative products to address unmet needs and we are 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.

10. Competition

Our 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.

Our competitors in the biotechnology and pharmaceutical industries may have superior research and development capabilities, products, manufacturing capability or sales and marketing expertise. Many of our competitors have significantly greater financial and human resources and may have more experience in research, development and commercialisation. As a result, our 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, we anticipate that we will face increased competition in the future as new companies enter Vectura's markets and alternative products and technologies become available.

Mitigating activities

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

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 future revenues would be higher than future costs, the Board would consider terminating or redefining the programme.

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. 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 licence agreement.

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.

11. 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.

12. Intellectual property

Vectura's success depends in part on its ability to obtain and maintain protection for its inventions and proprietary information, so that Vectura or our partners can exclude others from making, using or selling its patented products. A failure to establish, maintain or enforce intellectual property which is significant to Vectura's competitive position may have a material impact on our future prospects.

Mitigating activities

Vectura owns a portfolio of patents and patent applications and is the authorised licensee of other patents. Processes are in place to ensure that patent applications are filed in a timely manner and that applications are prosecuted to grant and defended as appropriate.

Vectura has a dedicated IP team, who work closely with legal advisors and obtains, where necessary, freedom to operate and patentability opinions on the intellectual property landscape relevant to our product development programmes, manufacturing activities and processes.

Reasonable security measures are adopted to protect other intellectual property, including appropriate confidentiality provisions and agreements with collaborators, consultants and employees.

All our licensing and collaboration agreements contain provisions that underpin the strength and value of our patent estate and all staff are trained to help Vectura maximise patent value and identify opportunities for new patent protection.

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