Aurinia Pharmaceuticals Inc.

Interim Condensed Consolidated Financial Statements
(Unaudited)

(Expressed in thousands of United States (U.S.) dollars)

Third quarter ended September 30, 2016

(Expressed in thousands of U.S. dollars)

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

(Expressed in thousands of U.S. dollars, except per share data)

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

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(Expressed in thousands of U.S. dollars)

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

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(Expressed in thousands of U.S. dollars)

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

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Aurinia Pharmaceuticals Inc. or the “Company” is a clinical stage pharmaceutical company with its head office located at #1203-4464 Markham Street, Victoria, British Columbia V8Z 7X8 where clinical, regulatory and business development functions of the Company are conducted. The Company has its registered office located at #201, 17904-105 Avenue, Edmonton, Alberta T5S 2H5 where the finance function is performed.

Aurinia Pharmaceuticals Inc. is organized pursuant to the Business Corporations Act (Alberta). The Company’s Common Shares are currently listed and traded on the NASDAQ Global Market (NASDAQ) under the symbol AUPH and on the Toronto Stock Exchange under the symbol AUP. The Company’s primary business is the development of a therapeutic drug to treat autoimmune diseases, in particular lupus nephritis (“LN”).

These interim condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Aurinia Pharma Corp., Aurinia Pharmaceuticals, Inc. (Delaware incorporated) and Aurinia Pharma Limited (UK incorporated).

These interim condensed consolidated financial statements have been prepared using International Financial Reporting Standards (IFRS) applicable to a going concern, which assumes the Company will continue its operations for the foreseeable future and will be able to realize its assets and discharge its liabilities and commitments in the ordinary course of business. The Company has no source of operating cash flow and operations to date have been funded primarily from the issue of share capital.

As at September 30, 2016, the Company had net working capital, excluding the current portion of contingent consideration, of $14,273,000 compared to $12,917,000 as at December 31, 2015. For the three month period ended September 30, 2016, the Company reported a loss of $7,419,000 (September 30, 2015 – $5,210,000) and a cash outflow from operating activities of $4,188,000 (September 30, 2015 – $5,198,000). As at September 30, 2016, the Company had an accumulated deficit of $272,715,000 (December 31, 2015 – $257,753,000).

On July 22, 2016 the Company entered into a Controlled Equity Offering Sales Agreement with Cantor Fitzgerald & Co. pursuant to which the Company could from, time to time, sell common shares through at-the-market (“ATM”) offerings, with Cantor Fitzgerald acting as sales agent. The Company received net proceeds of $5,735,000 in the third quarter ended September 30, 2016.

The Company also received proceeds of $1,673,000 from the exercise of warrants in the third quarter of 2016.

Previously, on June 22, 2016 the Company had completed a private placement of 3 million units of the Company at $2.36 per unit for net proceeds of $6,640,000.

On October 16, 2015, the Company had filed a Short Form Base Shelf Prospectus (the Shelf Prospectus). The Shelf Prospectus and corresponding shelf registration statement allows the Company to offer up to $250,000,000 of common shares, warrants and subscription receipts or any combination thereof during the 25-month period that the Shelf Prospectus is effective. The Shelf Prospectus is intended to give the Company the capability to access new capital from time to time. The Base shelf prospectus was utilized for the ATM facility, and as result, the remaining amount currently available under the Base Shelf Prospectus is $242,000,000.

The proceeds received from the ATM, warrant exercises and private placement have provided the Company with liquidity in the short-term and sufficient funding to complete the Phase 2b LN trial and continue the Phase 3 LN planning process. However, the Company will need to undertake substantial additional equity offerings within the next 12 months in order to continue the development and commercialization of voclosporin for LN, including the funding of the active patient portion of the Phase 3 program.

The outcome of these offerings is dependent on a number of factors outside of the Company’s control. The nature of the biotechnology sector and current financial equity market conditions make the success of any future financing ventures uncertain. There is no assurance the ATM financing or any new financings will be successful. This uncertainty casts

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significant doubt upon the Company’s ability to continue as a going concern and, accordingly, the appropriateness of the use of accounting principles applicable to a going concern.

The success of the Company and recoverability of amounts expended on research and development to date, including capitalized intangible assets, are dependent on the ability of the Company to raise additional cash, then to complete development activities, receive regulatory approval and to be able to commercialize voclosporin in the key markets and indications, whereby the Company can achieve future profitable operations. Depending on the results of the research and development programs and availability of financial resources, the Company may accelerate, terminate, cut back on certain areas of research and development, commence new areas of research and development or curtail certain or all of the Company’s operations. There is no assurance these initiatives will be successful.

These interim condensed consolidated financial statements do not reflect the adjustments to the carrying values of assets and liabilities and the reported revenues and expenses and statement of financial position classifications that would be necessary if the Company were unable to realize its assets and settle its liabilities as a going concern in the normal course of operations. Such adjustments could be material.

These interim condensed consolidated financial statements of the Company have been prepared in accordance with International Financial Reporting Standards (“IFRS”), as applicable to interim financial reports including IAS 34, Interim Financial Reporting, and should be read in conjunction with the annual financial statements of the Company for the year ended December 31, 2015 which have been prepared in accordance with IFRS, as issued by the International Accounting Standards Board (“IASB”).

These interim condensed consolidated financial statements were authorized for issue by the audit committee of the Board of Directors on November 3, 2016.

The short-term investment, recorded initially at fair value and subsequently at amortized cost using the effective interest method, is a 61 day HSBC Bank US denominated discount note due November 8, 2016, with an amortized cost of $3,047,000 and an initial cost of $3,046,000. (December 31, 2015 - 6 month HSBC US denominated discount note due February 10, 2016 with an amortized cost of $9,997,000 and an initial cost of $9,984,000). The note has an effective interest rate of 0.428%. (December 31, 2015 - 0.311%).

The outstanding fair value of contingent consideration payable to ILJIN Life Science Co., Ltd. (“ILJIN”) resulting from the Arrangement Agreement completed on September 20, 2013 between the Company, Aurinia Pharma Corp. and ILJIN consists of potential payments of up to $10,000,000 to be paid in five equal tranches according to the achievement of pre-defined clinical and marketing milestones.

The fair value of this portion of contingent consideration at September 30, 2016 was estimated to be $5,082,000 (December 31, 2015 - $3,810,000) and was determined by applying the income approach. The fair value estimates at September 30, 2016 were based on a discount rate of 10% which has remained unchanged since December 31, 2015.

The Company achieved a positive 24 week primary endpoint result in the Phase 2b clinical LN trial in the third quarter of 2016. As such while no milestone was attached to this positive primary endpoint result, it was an event that triggered an adjustment of the probability of success of the milestones such that the probability of success factors were increased for certain of the milestones. As a result of this adjustment the probability factors, the probability adjusted payment ranges were increased to 35% to 90% as at September 30, 2016 from 35% to 70% as at June 30, 2016. The current portion of the contingent consideration liability of $1,716,000 represents the first milestone that is expected to be achieved within the year. The change in probability factors for the milestones resulted in revaluation of contingent consideration expense of $1,146,000 for the three months ended September 30, 2016 compared to $25,000 for the comparable period in 2015.

This is a level 3 recurring fair value measurement.

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If the probability for success were to increase by the factor of 10% for each milestone this would increase the obligation by approximately $775,000 at September 30, 2016. If the probability for success were to decrease by the factor of 10% for each milestone this would decrease the obligation by approximately $775,000.

The holders of the warrants issued pursuant to the February 14, 2014 private placement may elect, in lieu of exercising the warrants for cash, a cashless exercise option to receive common shares equal to the fair value of the warrants based on the number of warrants to be exercised multiplied by a five day weighted average market price less the exercise price with the difference divided by the weighted average market price. No warrants were exercised in the nine month period ended September 30, 2016. In the first quarter ended March 31, 2015, a holder of these warrants elected this option and the Company issued 66,000 common shares upon the cashless exercise of 182,000 warrants. These warrants had a fair value of $636,000 at the date of exercise, determined using the Black-Scholes warrant pricing model. This amount was transferred from derivative warrant liability to common shares.

At September 30, 2016 the Company estimated the fair value of the derivative warrant liability at $4,425,000 (December 31, 2015 - $5,499,000) which resulted in a loss on revaluation of derivative warrant liability for the three months ended September 30, 2016 of $951,000 (September 30, 2015 - gain on revaluation of derivative warrant liability of $1,163,000).

The Company considers the expected volatility of its common shares in estimating its future stock price volatility. The risk-free interest rate for the expected life of the warrants was based on the yield available on government benchmark bonds with an approximate equivalent remaining term at the time of the grant. The expected life is based upon the contractual term.

The Company uses the Black-Scholes option pricing model to estimate fair value. The following weighted average assumptions were used to estimate the fair value of the derivative warrant liability on September 30, 2016 and December 31, 2015:

This is a Level 3 recurring fair value measurement. The key level 3 inputs used by management to determine the fair value are the market price and the expected volatility. If the market price were to increase by a factor of 10% this would increase the obligation by approximately $913,000 at September 30, 2016. If the market price were to decrease by a factor of 10% this would decrease the obligation by approximately $856,000. If the volatility were to increase by 10%, this would increase the obligation by approximately $441,000. If the volatility were to decrease by 10%, this would decrease the obligation by approximately $449,000 at September 30, 2016.

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The following table presents the changes in the derivative warrant liability categorized as Level 3:

 

 

Authorized

The Company is authorized to issue an unlimited number of common shares without par value.

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At-the-Market Facility

On July 22, 2016 the Company entered into a Controlled Equity Offering Sales Agreement with Cantor Fitzgerald & Co. (“Cantor Fitzgerald”) pursuant to which the Company may from time to time sell common shares, through at-the-market (“ATM”) offerings with Cantor Fitzgerald acting as sales agent, such common shares as would have an aggregate offer price of up to US$10,000,000. The Company intends to use the net proceeds from the ATM to continue development of its lead drug candidate, voclosporin, as a therapy for LN, and for general corporate purposes.

Pursuant to this agreement the Company issued 2,618,000 common shares, receiving proceeds of $5,735,000, net of share issue costs of $407,000 for the three months ended September 30, 2016. Share issue costs of $407,000 included a 3% commission of $184,000 paid to the agent and professional fees and filing fees of $223,000 directly related to the ATM. See also note 13-subsequent events.

Private placement

On June 22, 2016, the Company completed a private placement for net proceeds of $6,640,000. The Company intends to use the net proceeds from the private placement to continue development of its lead drug candidate, voclosporin, as a therapy for LN, and for general corporate purposes.

Under the terms of the private placement, the Company issued 3,000,000 units (the “Units”) at a price of $2.36 per Unit. Each Unit consisted of one common share and 0.35 of a common share purchase warrant (a “Warrant”), exercisable for a period of two years from the date of issuance at an exercise price of $2.77.

Share issue costs of $440,000 included a cash commission of $250,000 paid to the agent and legal and filing fees of $190,000 directly related to the private placement.

 

On June 22, 2016, pursuant to the private placement noted above, the Company issued 1,050,000 warrants to purchase common shares at a price of $2.77 per common share. The warrants have a term of two years from the date of issuance. The fair value attributed to the warrants using the Black-Scholes option pricing model was $769,000, net of share issue costs of $51,000.

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The following assumptions were used to estimate the fair value of the warrants issued during the three and nine month period ended September 30, 2016:

 

 

A summary of the outstanding stock options as of September 30, 2016 and 2015 and changes during the nine month periods ended on those dates is presented below:

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On June 8, 2016 the Shareholders of the Company approved the amendment to the Stock Option Plans to increase the maximum number of Common Shares reserved for issuance under the Stock Option Plan from 10% to 12.5% of the outstanding Common Shares of the Company at the time of granting.

Therefore, the maximum number of Common Shares issuable under the Stock Option Plan is equal to 12.5% of the issued and outstanding Common Shares at the time the Common Shares are reserved for issuance. As at September 30, 2016 there were 38,794,000 Common Shares of the Company issued and outstanding, resulting in a maximum of 4,849,250 options available for issuance under the Stock Option Plan. An aggregate total of 3,898,000 options are presently outstanding in the Stock Option Plan, representing 10.0% of the issued and outstanding Common Shares of the Company.

The Stock Option Plan requires the exercise price of each option to be determined by the Board of Directors and not to be less than the closing market price of the Company’s stock on the day immediately prior to the date of grant. Any options which expire may be re-granted. The Board approves the vesting criteria and periods at its discretion. The options issued under the plan are accounted for as equity-settled share-based payments.

The Company granted 60,000 stock options to directors of the Company on March 23, 2016 at a price of $3.00 (CDN$3.96) per common share. On March 30, 2016 the Company granted 220,000 stock options to officers and employees of the Company at a price of $3.02 (CDN$3.91) per common share. On March 31, 2016 the Company granted 40,000 stock options to the Chief Executive Officer, at the time, of the Company at a price $2.90 (CDN$3.76) per common share. On January 6, 2015, the Company granted 960,000 stock options to directors, officers and employees of the Company at a price of $3.59 (CDN$4.25) per common share. The options granted in 2015 and 2016, mentioned above, all vest in equal amounts over 12 months and are exercisable for a term of five years.

On June 17, 2016 the Company granted 1,000,000 stock options to the Chief Executive Officer of the Company at a price of $2.48 (CDN$3.20) per common share. These options vest in equal amounts over 36 months and are exercisable for a term of five years.

On July 12, 2016, the Company granted 100,000 options to the newly hired employee at a price of $3.05 (CDN $4.00) per common share. On July 21, 2016 the Company granted 40,000 options to an employee at a price $3.03 (CDN $3.95) per common share. Both of these option grants vest in equal amounts over 36 months and are exercisable for a term of five years.

In addition, on May 2, 2016 the Company granted 200,000 inducement stock options to a new employee pursuant to Section 613 (g) of the TSX Company Manual at a price of $2.92 (CDN $3.66). These options vest in equal amounts over 36 months and are exercisable for a term of five years. These options are recorded outside of the Company’s stock option plan.

The Company recognized stock-based compensation expense of $548,000 and $1,027,000 for the three and nine month periods ended September 30, 2016 respectively (2015 – $679,000 and $2,736,000) with corresponding credits to contributed surplus. For the three and nine months ended September 30, 2016, stock compensation expense has been allocated to research and development expense in the amount of $79,000 and $288,000 respectively (2015 – $140,000 and $773,000) and corporate administration expense in the amount of $469,000 and $739,000 respectively (2015 – $539,000 and $1,963,000).

The Company used the Black-Scholes option pricing model to estimate the fair value of the options granted to employees, officers and directors.

The following weighted average assumptions were used to estimate the fair value of the options granted during the nine month periods ended September 30, 2016 and 2015:

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The Company considers historical volatility of its common shares in estimating its future stock price volatility. The risk-free interest rate for the expected life of the options was based on the yield available on government benchmark bonds with an approximate equivalent remaining term at the time of the grant. The expected life is based upon the contractual term, taking into account expected employee exercise and expected post-vesting employment termination behaviour.

Determining the fair value of stock options on grant date, requires judgment related to the choice of a pricing model, the estimation of stock price volatility and the expected term of the underlying instruments. Any changes in the estimates or inputs utilized to determine fair value could result in a significant impact on the Company’s reported operating results, liabilities or other components of shareholders’ equity. The key assumption used by management is the stock price volatility. If the market price or volatility factors were to increase or decrease by a change of 10% there would be no significant impact.

 

 

Basic and diluted net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. In determining diluted net loss per common share, the weighted average number of common shares outstanding is adjusted for stock options and warrants eligible for exercise where the average market price of common shares for the three and six months ended September 30, 2016 exceeds the exercise price. Common shares that could potentially dilute basic net loss per common share in the future that could be issued from the exercise of outstanding stock options and warrants were not included in the computation of the diluted loss per common share for the three and nine months ended September 30, 2016 and September 30, 2015 because to do so would be anti-dilutive.

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The numerator and denominator used in the calculation of historical basic and diluted net loss amounts per common share are as follows:

The outstanding number and type of securities that would potentially dilute basic loss per common share in the future and which were not included in the computation of diluted loss per share, because to do so would have reduced the loss per common share (anti-dilutive) for the years presented, are as follows:

 

The Company’s operations comprise a single reporting segment engaged in the research, development and commercialization of therapeutic drugs. As the operations comprise a single reporting segment, amounts disclosed in the financial statements represent those of the single reporting unit. In addition, all of the Company’s long-lived assets are located in Canada.

The following geographic area data reflects revenue based on customer location.

Geographic information

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Net change in other operating assets and liabilities:

 

The Company is exposed to financial risk related to the fluctuation of foreign currency exchange rates. Foreign currency risk is the risk that variations in exchange rates between the United States dollar, which is the Company’s functional currency, and foreign currencies, primarily with the Canadian dollar, will affect the Company’s operating and financial results.

The following table presents the Company’s exposure to the CDN dollar:

Based on the Company’s foreign currency exposures noted above, varying the foreign exchange rates to reflect a ten percent strengthening of the U.S. dollar would have decreased the net loss by $14,000 assuming that all other variables remained constant. An assumed 10 percent weakening of the U.S. dollar would have had an equal but opposite effect to the amounts shown above, on the basis that all other variables remain constant.

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Subsequent to the quarter end, a non-affiliated third party holder of February 14, 2014 warrants exercised the cashless exercise option and received 224,000 common shares of the Company upon the exercise of 619,000 warrants.

Subsequent to the end of the third quarter, the Company issued 688,000 common shares, receiving net proceeds of $1,803,000 from the ATM facility.

Sales pursuant to this ATM were concluded subsequent to the end of the third quarter and in total the Company received gross proceeds in the aggregate of $8,000,000, which was the maximum allowable pursuant to the limit imposed under the rules of the Toronto Stock Exchange. See note 7(a) for further discussion of the ATM.

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