Annual Financial Report

PAION AG, Aachen

Annual Financial Report

for the Fiscal Year 2013

Group Management Report 3 Consolidated Financial Statements

Consolidated Balance Sheet 34

Consolidated Statement of Comprehensive Income 36

Consolidated Cash Flow Statement 37

Consolidated Statement of Changes in Equity 38 Notes 39

Responsibility Statement 60

Audit Opinion 61

PAION AG, Aachen

Consolidated Financial Statements

as of 31 December 2013 and

Group Management Report

for the Fiscal Year 2013

Fundamental information of PAION AG and the PAION Group

1. Business model of PAION AG and PAION Group

PAION AG is a holding company providing management and other services only to its subsidiaries. These services primarily focus on the development of the group strategy, administrative tasks, including accounting, legal, human resources, public relations, and controlling. In addition, PAION AG supports the financing of its subsidiaries' ongoing business activities, while the Group com-panies provide each other with development-related services. The activities of the PAION Group (hereinafter also referred to as PAION) are thus mainly determined by the development operations of PAION Deutschland GmbH and PAION UK Ltd, which are presented below.

PAION’s portfolio at year-end comprised four candidates in clinical development, specifi-cally the substances Remimazolam, Solulin and PN 13 in internal development and the substance GGF2, which is being developed by a cooperation partner. Furthermore, Remimazolam is being developed by cooperation partners for the markets in Japan, China, Russia/CIS and Turkey. Remi-mazolam is being developed by the subsidiary PAION UK Ltd, while Solulin and PN 13 are being developed by the subsidiary PAION Deutschland GmbH. GGF2 is an asset of PAION Holdings UK Ltd.

PAION has rights to further substances which are partly out-licensed and may lead to additional performance-related income and expenses. At present, the likelihood is still assessed to be low, since these substances are not a major part of PAION’s or its partners’ strategy.

Fiscal year 2013 was marked by the concentration of PAION on the further development of Remimazolam and the search for partners for this development candidate.

2. Internal management system of PAION AG and PAION Group

The financial management system of PAION and the PAION Group is based on monthly reports on a cost centre and cost unit basis that also show deviations from budget. Significant deviations are updated in the short- and long-term corporate planning. By simulating different scenarios, the planning tool used for this purpose enables the management to identify and assess opportunities and risks at an early stage and determine their influence on the future development of the group, particularly with regard to the key financial performance indicator "liquidity".

The development activity both clinically and in terms of production technology is cha-racterised by the involvement of external service providers. The management of the development activities is based on using detailed project plans that contain defined work packages associated with specified reporting and information obligations. The results are continuously processed in the internal project teams and reported to the Management Board.

The cooperation partners operate independently in their respective licence area. However, the cooperation agreements require the partners to provide each other with information. The cen-tral coordinating of the information flow is managed by PAION.

3. Research and Development

The business of PAION is driven mainly by the research and development activities which are described in detail in Section "Presentation of the course of business and the development activi-ties of PAION Deutschland GmbH and PAION UK Ltd" course of business.

Report on economic position

1. Macroeconomic and sector-specific environment

a. Macroeconomic development

The German economy once again proved to be largely stable in 2013 and was only slightly influ-enced by the ongoing recession in some European countries and the subdued global economic development. German gross domestic product increased in real terms in 2013 by approximately 0.4% after 0.7% in 2012. Strong domestic demand could only partly compensate for the weak European and global economic environment (source: Federal Statistical Office). After the mode-rate economic growth in 2013, the 2014 forecasts from individual economic institutes predict acceleration of the pace of expansion in Germany and an increase in gross domestic product by 1.7% compared to the previous year. It is assumed that the debt crisis does not return and that the currently very expansionary monetary policies of major central banks of the industrialised coun-tries will remain in place. Under these conditions, the German economy should be supported in 2014 by both the domestic economy and foreign trade (source: Hamburg Institute of International Economics).

Given the persistently difficult economic environment within the EU, the economic deve-lopment of important non-European countries is naturally significant for the export-oriented Ger-man economy. The U.S. economy grew by 1.8% in 2013. Economic development in China is wea-kening further; GDP growth in China was 7.7% in 2013 (source: Commerzbank). The uncertainty caused by the financial crisis and the EU-debt crisis has receded. For example, at many places the Economic Policy Uncertainty Index has returned to pre-crisis levels, but not yet for Europe as a whole. Especially in Europe, but also in some emerging markets there are still structural challenges to overcome. The necessary adjustment processes are putting a damper on economic development for the time being. Therefore, the global economy remains less dynamic than before the crisis. For the world's GDP, the IMF estimates growth of 3.6% for 2014 after an increase of 2.9% in the last year, with growth being driven mainly by the industrialised countries. The U.S. economy now appears to be on a stable growth trajectory. In contrast, the euro zone is only slowly leaving the recession behind. However, leading indicators such as the global purchasing manager index or the OECD composite leading indicator point to a continuation of current trends towards improvement for both the euro zone and the global economy (source: Federal Ministry of Economy and Energy).

The positive development of the stock markets seen in 2012 continued in 2013, with some indices reaching record highs in 2013. As in the previous year, the DAX outperformed the EURO STOXX 50. Overall, the DAX recorded growth of 26% and the EURO STOXX 50 increased by 18% in 2013. The Dow Jones index rose by 27% and the S & P 500 by 30% compared to the closing level of the previous year.

b. Development of the pharmaceutical and biotechnology industry

The consolidation pressure in the pharmaceutical and biotechnology industry continues unabated. This results particularly from the high risks and costs associated with pharmaceutical develop-ment, the expiry of patent protection on a number of products in recent and coming years (“patent cliff”) as well as the budget cuts in the healthcare sector by several industrial nations as a result of the high budget deficits. Especially the pressure on drug prices in the most important Euro-pean markets as well as in the U.S., e.g. the Drug Market Reform Act (AMNOG) in Germany, does have a negative impact on the development of new drugs or even makes it unprofitable in certain cases. The pharmaceutical and biotechnology industry in Europe is also stressed by compulsory rebates (Germany) and outstanding debts. Pharma companies address these strategic challenges for instance with business acquisitions, cooperation agreements, in-licensing and out-licensing, restructuring of companies and sharpening the focus of research and development activities. It is encouraging that patent expirations are gradually slowing down. The number of registrations of new drugs has declined in 2013 compared to 2012, but is still higher than in previous years (source: www.reuters.com).

The financing environment for biotechnology companies has further improved compared to previous years. This applies in particular for the U.S. The portion of financing through equity has increased significantly in 2013. In global terms, the portion of equity financing in relation to the total funding rose from 31.6% in 2012 to 42.6% in 2013. Overall, the equity financing through IPOs and capital increases amounted to USD 40.8 billion worldwide. This represents an increase of 39.2% compared to the previous year (source: Burrill & Company). This positive trend was also reflected in 2013 in the valuations of listed pharmaceutical and biotechnology companies. The NASDAQ Biotechnology Index gained 66% (previous year: 32%), the AMEX Biotechnology Index 51% (previous year: 42%) and the DAXsubsector Biotechnology index of the German Stock Exchange 38% (previous year: 37%) compared to the closing level of the prior year. In 2013, the acquisition and cooperation volume also increased significantly year on year. The global acqui-sitions in the life sciences sector in 2013 rose by 21% to a total transaction volume of USD 131.8 billion and the transaction value of cooperation agreements increased by 14% to USD 43.5 billion (source: Burrill & Company).

After the last two years were marked by a very good financing environment for biotechno-logy companies and a significant increase in valuations of listed pharmaceutical and biotechnobiotechno-logy companies, 2014 is expected to see a phase of consolidation, in which the financing environment will nevertheless continue to be positive.

2. Presentation of the course of business and the development activities of PAION

Deutschland GmbH and PAION UK Ltd

At year end, PAION’s portfolio comprised four candidates in clinical development which are descri-bed below.

a. Remimazolam

Remimazolam is an innovative short-acting general anaesthetic/sedative that was initially deve-loped by PAION for use in minor medical interventions (procedural sedation), primarily targeting the U.S. market. Sedatives are used, for example, in endoscopic procedures such as colonoscopies. After intravenous administration to over 900 volunteers/patients in the course of clinical trials, Remimazolam has clearly shown a controllable sedative and anaesthetic effect with rapid onset and offset. This means that the patient can be selectively sedated for the duration of the interven-tion and rapidly regains full consciousness after the procedure. The rapid offset of the substance’s effect is due to its metabolism by tissue esterase enzymes that are widely distributed throughout the body.

Remimazolam is being developed by PAION’s partner Ono Pharmaceutical (hereafter: Ono) for the Japanese market in the indication of general anaesthesia. Furthermore, Remimazolam is also being developed by Ono as a sedative during sedation in an Intensive Care Unit (ICU).

In November 2013, PAION reported the headline data of ONO’s phase II/III trial. Remima-zolam met the primary endpoint and showed good safety data.

Based on the fact that general anaesthesia is the more attractive business case for the EU, PAION decided to develop Remimazolam for general anaesthesia as the lead indication for Europe. In February 2013, PAION held a formal scientific advice meeting with the German regulatory authority BfArM on the European clinical development programme for Remimazolam in the general anaesthesia indication. After approval by the BfArM, the European Phase II trial with Remimazo-lam in general anaesthesia in cardiovascular surgery was started in September 2013. A total of 90 patients were treated and on 11 February 2014 the completion of recruitment has been announced. Results of the study are expected to be available in the first half of 2014.

Pending the outcome of the planned and ongoing trials, PAION assumes that the Phase II and one Phase III trial in general anaesthesia in addition to the Japanese development programme will be sufficient for EU approval. In preparation for the European Phase III trial, further scientific advice meetings are planned with European regulatory authorities. To finance the future develop-ment programme PAION is working on additional licence agreedevelop-ments and is evaluating various funding options. The recently completed financing measure have increased PAION’s operational leeway. The proceeds from the transactions will be used mainly for the preparation of the Remima-zolam Phase III development programme.

In the U.S., procedural sedation remains the lead indication. Insurance companies in the U.S. pay billions for colonoscopies with Propofol and the necessary presence of anaesthesiologists.

Under sedation with Midazolam, however, an anaesthesiologist does not need to be present, as Midazolam is a very safe agent for providing induction of conscious sedation. However, it requires long and variable recovery times for the patient, resulting in reduced numbers of procedures that can be performed. Gastroenterologists therefore often use Propofol to almost double the number of patients that can be screened. The high number of procedures in a doctor’s surgery/clinic is not only necessary to manage the facility’s business but also to fulfil the social mission to screen as many patients as possible as colonoscopies are the only proven preventive method for the early detection of colon cancer. Remimazolam is expected to be as safe as Midazolam. This assumption is based on the fact that Remimazolam belongs to the class of benzodiazepines (such as Midazolam) and the previously generated data indicate a very good safety profile.

The development programme required until market approval (Phase III studies, associated development activities, production development) will be prepared based on a positive End-of-Phase II Meeting with the FDA held in October 2013. The objective is to show in the development programme that Remimazolam is as quick as Propofol with respect to its efficacy (high throughput by rapid onset and offset of sedation) and at the same time is as good as Midazolam in terms of its safety profile. If this can be shown, it is possible that the FDA will grant approval, which means that the presence of an anaesthetist in the implementation of procedural sedation will not be requi-red. The FDA will be able to make this decision as usual only after the complete data set is available (i.e. after Phase III). This development is positively supported by the presence of a reversal agent (Flumazenil is an antagonist for all benzodiazepines such as Midazolam and Remimazolam) which can quickly terminate the effect of the drug in the event of an overdose, for example. Propofol does not have such an antagonist, which, among other things, requires the presence of an anaesthetist.

Remimazolam could offer savings to the U.S. healthcare system of USD 1 billion per year for simple procedures such as colonoscopies. This is why PAION sees a very attractive business case for conscious sedation in the U.S. market.

Clinical Development Procedural sedation

The clinical studies performed with Remimazolam comprise two Phase I and two Phase II studies with single or multiple dosing without an intervention or during endoscopy of the upper gastroin-testinal tract or the colon.

The generated data indicate a good tolerability of Remimazolam. A rapid onset and offset of the sedative effect was observed during the procedures. It was also shown that it is possible to achieve the same (safety) or better (efficacy) results with single or multiple dosing of Remimazolam as compared to single or multiple dosing of the gold standard Midazolam. The effect of Remimazo-lam can be reversed by the benzodiazepine antagonist Flumazenil.

In November 2013 PAION announced a positive End-of-Phase II Meeting with the FDA for Remimazolam in procedural sedation. At that meeting, the FDA laid out its expectations for the

remaining development programme up to NDA filing and offered a dialogue to finalise the neces-sary study designs together with PAION. Plans are to start a pivotal Phase III programme evaluating the safety and efficacy of Remimazolam in the second half of 2014 depending on the successful completion of current funding and/or partnering discussions. The proceeds from the capital incre-ases at the end of 2013/beginning of 2014 will mainly be used for the preparation of the Remima-zolam Phase III development programme. Specifically, the funds are to be used to produce the trial medication and validate the production at market scale.

General anaesthesia

PAION’s partner Ono Pharmaceutical has completed the Phase III programme of Remimazolam in anaesthesia as the lead indication for the Japanese market.

As part of the Phase III programme, a Phase II/III study was conducted in Japan as a multi-centre randomised parallel-group study with Propofol as a control in surgery patients undergoing general anaesthesia in combination with analgesics. Remimazolam and Propofol were intrave-nously administered to 375 patients (2 Remimazolam groups with induction doses of 6 mg/kg/h or 12 mg/kg/h and a dose of 1 mg/kg/h for maintenance, 150 subjects per group) and 75 patients received a standard dose of Propofol, respectively, to compare the success rates of induction and maintenance of general anaesthesia and the safety profiles.

All 375 patients achieved loss of consciousness and underwent successful intubation. As expected the primary endpoint (efficacy) as a general anaesthetic was achieved by 100% of pati-ents in all groups.

No adverse events of concern were observed. The incidence rates of decrease in blood pressure were 35.3%, 34.7% and 60.0% in the 6 mg/kg/h and 12 mg/kg/h Remimazolam and Propofol groups, respectively. This suggests that Remimazolam has a smaller, clinically relevant cardio-depressive effect than Propofol. The incidence rate was significantly lower in each Remima-zolam group as compared to the Propofol group (p=0.0004 and p=0.0003 for the 6 and 12 mg/kg/h doses vs. Propofol).

The recruitment of the second study in the Phase III programme (American Society of Anesthesiologists classification III or higher) in more severely sick patients and the hepatic impairment study have also been completed recently. No unexpected adverse reactions have been reported. The clinical development programme for the indication of induction and maintenance of general anaesthesia has been completed. The pharmacokinetic and pharmacodynamic modelling is still ongoing to support filing for marketing approval, which is expected in 2014.

In Europe PAION has completed recruitment of a Phase II study, which was a randomised, Propofol and Sevoflurane (standard treatment) controlled Phase II study to evaluate the efficacy, safety and pharmacokinetics of Remimazolam during general anaesthesia in patients undergoing major cardiac surgery. After surgery, follow-up sedation in the recovery room or the intensive care unit (ICU) for up to 24 h took place. A total of 90 patients were treated. Results of the study are expected to be available in the first half of 2014.

The study was carried out at the Leipzig Heart Center, which follows the "fast track" approach in anaesthesia. The aim of the "fast track" approach is to prevent as many patients as possible from having to move to the ICU by achieving rapid weaning from mechanical ventilation (extubation) shortly after surgery, a goal that can be reached by the administration of short-acting and very safe substances. Clinical studies demonstrated that this concept delivers better treatment results and reduces the length of stay on the ICU and in the hospital. In addition to benefiting the patients, this leads to a substantial reduction in resource use. The aim is to establish Remimazolam as a key component in the “fast track” approach.

The study was designed to provide detailed information about the cardiovascular safety profile of Remimazolam. Furthermore it is expected to deliver clear insights on early and predicta-ble offset of its effect as well as easy titration of sedation in the postoperative phase.

Two doses of Remimazolam will be evaluated against each other and against Propofol during induction of general anaesthesia. In addition, Remimazolam will be tested during the main-tenance phase of anaesthesia against the combination of Propofol and Sevoflurane with respect to efficacy and safety. Data in the postoperative sedation phase in the recovery room or ICU will also be obtained for further exploration of the ICU sedation indication. The study was designed such that the data can be compared with the anaesthesia study conducted by Ono in Japan.

ICU sedation

In parallel to the initiation of the programme in anaesthesia, Ono initiated a Phase II study in the indication "Sedation in the ICU". Ono investigated the efficacy and safety of Remimazolam for sedation during mechanical ventilation in the intensive care unit in a multi-centre, randomised, parallel-group study in postoperative patients. The target sample size in this study was 90 patients.

Due to unclear pharmacokinetic data in long-term administration in this explorative study (in a few patients higher than expected Remimazolam plasma levels were observed), ONO decided to discontinue the study in August 2013. Overall all patients were sedated successfully and no significant adverse events were reported. The planned preclinical experiments and additional PK modelling based on the plasma samples is underway. The results will be the basis for a dose adjust-ment, if necessary, for new studies.

Cooperation Agreements

In 2007 Ono was granted the rights to develop and market Remimazolam for the Japanese mar-ket in return for undertaking to make development milestone payments and pay royalties. Ono is developing Remimazolam for interventions that require continuous infusion. In this co-operation, data and information are continually shared so that all parties, including the other Remimazolam partners, may benefit from each other’s development progress.

This substantial data package generated by Ono supports and accelerates the development of Remimazolam for the indications anaesthesia and ICU sedation in the PAION territories and reduces costs. In addition, the FDA considers the data to be an important part of the safety data on Remimazolam.

In July 2012, Yichang Humanwell (Yichang) received an exclusive licence for the develop-ment, manufacture and commercialisation in the territory of People’s Republic of China in return for undertaking to make development milestone payments and pay royalties. By entering into the licence agreement, PAION has received upfront payments totalling EUR 3 million. In addition, milestone payments and royalties of 10% have been agreed. The amount of future milestone pay-ments will depend on the eventual development strategy for Remimazolam selected by Yichang in China and has a volume of up to EUR 4 million. Yichang and PAION have completed the technology transfer in 2013 to enable Yichang to produce Remimazolam in the territory. The data generated in China are also available for PAION and its licence partners.

In October 2013, PAION signed an exclusive licence agreement with Hana Pharm for Remimazolam in South Korea against an upfront payment of EUR 1 million. In addition, potential milestone payments of up to EUR 2 million and 10% royalties on sales in the South Korean market have been agreed. Hana Pharm will manage and finance the development and marketing approval process in South Korea. The data generated in South Korea are also available for PAION and its licence partners.

Also in October 2013 an exclusive licence agreement with R-Pharm for Remimazolam in Russia and other CIS countries was signed. PAION has received an upfront payment in the amount of EUR 1 million and will receive potential milestone payments of up to EUR 3 million and low double digit royalties on net sales in the CIS. R-Pharm will manage the development and marketing approval process in the CIS. R-Pharm intends to market Remimazolam in all indications with the lead indication anaesthesia and plans to start a bridging study in anaesthesia as soon as possible. The data generated in the CIS are also available for PAION and its licence partners.

In November 2013, it was announced that PAION and R-Pharm have extended their licence agreement for Remimazolam to include Turkey. TR-Pharm, an affiliate of R-Pharm based in Istanbul, will manage the development and marketing approval process in Turkey. PAION has received an upfront payment in the amount of EUR 1.0 million and will receive potential regulatory and commercial milestone payments of up to EUR 3.0 million and low double digit royalties on net sales in the territory. TR-Pharm intends to market Remimazolam in all indications with the lead indication anaesthesia. The data generated in Turkey are also available for PAION and its licence partners.

The following table is a summary of the Licensing deals:

Total received Total outstanding Royalty rate

Ono, Japan (2007) USD 8 m not disclosed not disclosed

Yichang,China (2012) EUR 3 m Up to EUR 4 m 10%

Hana Pharm, S. Korea (2013) EUR 1 m EUR 2 m 10%

R-Pharm, CIS (2013) EUR 1 m EUR 3 m Low double digit (T)R-Pharm, Turkey (2013) EUR 1 m EUR 3 m Low double digit

Total ~EUR 11 m

b. Solulin

Solulin is an improved variant of the human protein thrombomodulin, an important natural regu-lator of the clotting system. One of the functions of thrombomodulin is to stabilise the initial fibrin clot to stop bleeding. Other than native thrombomodulin, which is anchored in the wall of blood vessels, Solulin can enter the blood stream to reach its potential site of action. In low concentra-tions, Solulin is able to stabilise blood clots and to support coagulation. Haemophilia patients could benefit from this property.

According to the WHO, about 400,000 people worldwide are currently affected by the hereditary disease haemophilia, including 10,000 in Germany. Therefore, the definition of an “orphan disease” is fulfilled. Solulin has the potential to significantly improve the existing treat-ment options for the patients.

Solulin could possibly represent an improved therapeutic approach in the treatment of haemophilia and various acute diseases associated with hyperfibrinolysis (excessive dissolution of blood clots).

Hyperfibrinolysis is a coagulation deficit that leads to unstable clots and their premature dissolution. In patients with haemophilia this is the cause of recurrent or - after initial coagulation - delayed bleedings (as the major complication). In the absence of haemophilia, the same disorder can result in blood losses and a need for blood transfusions, i.e. when patients are treated in the ICU after surgery or severe trauma. Solulin and its mutants correct hyperfibrinolysis via the so-called "Thrombin Activatable Fibrinolysis Inhibitor" (TAFI) pathway. The novelty of the approach lies in the anticipated specific TAFI activation to mitigate or prevent coagulation failure.

Due to the focus of the available resources on anaesthesia and due to the restructuring in 2011, the Phase Ib study had to be completed in October 2012 as the enrolment lagged far behind the study objectives. Nevertheless, the available data showed that Solulin has the expected effect in haemophilia patients. PAION considers the potential for Solulin and PN 13 in the indications mentioned to be very attractive. As PAION focuses all resources on Remimazolam, the project can only be continued with third party funding.

c. PN 13

In July 2012, PAION announced that the Federal Ministry for Education and Research (BMBF) will be subsidising the production and preclinical development of novel PAION thrombomodulin – mutants (PN 13) with a maximum of EUR 0.7 million until end of 2014 under the funding initiative “KMU-INNOVATIV: Biotechnologie – BioChance“. The lead candidate could possibly represent an improved therapeutic approach in the treatment of haemophilia and various acute diseases associ-ated with hyperfibrinolysis (excessive dissolution of blood clots).

The project is in a very early stage of development. The funding was used to produce several Solulin mutants as a first step. The resulting Solulin mutants could not be tested using the standard methods. Therefore, further research will require a higher financial expenditure than expected, which is not covered by the current funding. As PAION focuses all resources on Remi-mazolam, PAION has asked for a discontinuation of the grant from BMBF. The project can only be continued with third party funding.

d. Glial Growth Factor (GGF2)

GGF2 (Glial Growth Factor 2) is known to stimulate the growth and differentiation of a variety of cells including glial cells, the support cells of the nervous system. These glial cells form the myelin sheath that insulates nerve cells and is essential for their survival and proper functioning. In demy-elinating diseases such as multiple sclerosis, the myelin sheath is damaged, leading to the degene-ration of nerve cells.

In preclinical studies PAION’s licence partner Acorda Therapeutics, Inc. (Acorda) demons-trated that GGF2 can stimulate the cell growth necessary to protect and regenerate a damaged myelin sheath. GGF2 is the lead neuregulin in Acorda’s portfolio. Neuregulins have also shown the ability to restore cardiac function in preclinical models of heart failure caused by myocardial infarc-tion, heart rhythm disorders and myocardial dysfunctions.

At the beginning of March 2013, Acorda announced positive results of the Phase I trial with GGF2. The study identified a maximum tolerated dose of GGF2 and the preliminary efficacy measures showed that GGF2 improves heart function. Acorda has discussed the findings from the study with the FDA and has reached agreement on the next clinical study of GGF2 in heart failure. This Phase Ib study will primarily involve the continued investigation of the safety profile but also the efficacy of GGF2 across a range of doses; the start of the study was announced by Acorda on 8

October 2013. In December 2013, the enrolment was paused pending the review of additional pre-clinical data in coordination with the FDA. The FDA has granted Fast Track designation for GGF2 for the treatment of heart failure.

Cooperation Agreements

The rights relating to the recombinant GGF2, rh GGF2, were licensed to Acorda in 2002 by PAION UK. In total, further milestone payments of USD 2.5 million prior to market approval and an additi-onal milestone payment of USD 5 million are due upon market authorisation; after that PAION will receive royalties depending on net sales.

3. Net assets, financial position and results of operations

a. Results of operations

Research and development -4,584 -3,251 -1,333

General administrative and selling -3,314 -4,709 1,395

Other income (expenses) 860 16 844

Operating expenses -7,038 -7,944 906

Operating result -2,810 18,867 -21,677

Financial result -170 -592 422

Income taxes 768 -2,266 3,034

Net result -2,212 16,009 -18,221

The revenues of the fiscal year relate in the amount of KEUR 4,200 to payments in connection with the licence agreements of Remimazolam for the countries China, South Korea, Russia/CIS and

Turkey signed in 2012 and 2013. The revenues of the prior year mainly related to the sale of Des-moteplase to Lundbeck (KEUR 22,591), a milestone payment from Ono for the start of the Phase III study with Remimazolam in Japan (KEUR 2,356) and the out-licensing of Remimazolam for China (KEUR 1,800).

Research and development expenses amounted to KEUR 4,584 and increased by KEUR

1,333 compared to the previous year. The research and development activities in 2013 focused on the clinical development and the production development of Remimazolam.

General administrative and selling expenses amounted to KEUR 3,314 and decreased

by KEUR 1,395 compared to the previous year. This reduction mainly relates to the selling expenses which compared to previous year decreased by KEUR 1,233 to KEUR 899. Selling expenses include internal and external expenses in connection with out-licensing. The administrative expenses amounted to KEUR 2,416 in fiscal year 2013 and decreased by KEUR 162 compared to the prior year.

Other income (expenses) in the fiscal year mainly comprises income from the reversal

of a provision (KEUR 533), which had been setup for rented but unused premises. In fiscal year 2013, a termination agreement was signed with the landlord and therefore the provision could be reversed. Furthermore, the figure contains a payment in the amount of KEUR 354 received from Cambridge Cognition, a spin-off from Cenes (now PAION UK), which was conducted in 2002. The total value of the agreement is GBP 1,000,000, of which GBP 700,000 were already paid in 2002, and another GBP 300,000 became due in May 2013 after the listing of Cambridge Cognition.

The financial result amounted to KEUR -170, an improvement of KEUR 422 compared to the previous year. The reason for this is mainly the repayment of the subordinated loan of KEUR 7,000 in April 2013 and consequently a lower interest burden in the fiscal year.

The income taxes of the fiscal year relate mainly to tax credits received from the British tax authorities in connection with portions of the research and development costs. The income tax expenses in the previous year resulted from the taxation of the net income of 2012, which was influenced by the sale of Desmoteplase rights to Lundbeck.

PAION closed fiscal year 2013 with a net loss of KEUR -2,212 after a net income of KEUR 16,009 in the previous year. In particular due to the successful out-licensing of Remimazolam for several regions, which was not foreseeable in the previous year, the net loss of the year is below the range expected in the previous year.

b. Net Assets

Equity and liabilities 18,016 28,336 -10,320

The non-current assets mainly comprise the development project Remimazolam (KEUR 3,466). The decrease compared to the previous year by KEUR 384 results mainly from amortisation.

Compared with 31 December 2012, current assets decreased by KEUR 9,936 to KEUR 14,433. This decrease is substantially due to the decrease in cash and cash equivalents by KEUR 9,043 to KEUR 13,292. In the previous year, current assets further included trade receivables from Lundbeck in the amount of KEUR 1,500, which were received in the fiscal year 2013.

Equity decreased by KEUR 2,243 compared to 31 December 2012 and amounted to KEUR

13,329, mainly as a result of the net loss for the year. Because of the significant reduction in liabili-ties, the equity ratio improved from 55.0% in the previous year to 74.0% as of 31 December 2013.

The decrease in non-current liabilities by KEUR 988 to KEUR 28 relates primarily to the reversal of the provision for rented but unused premises. In fiscal year 2013, a termination agree-ment was signed with the landlord and a final payagree-ment amounting to KEUR 490 was made.

The reduction in current liabilities by KEUR 7,089 to KEUR 4,659 is mainly due to the repayment of the subordinated loan in the amount of KEUR 7,000 in April 2013.

c. Financial Position

Cash and cash equivalents decreased by KEUR 9,043 compared to 31 December 2012 and

amounted to KEUR 13,292. The change in cash and cash equivalents stems from the following:

2013 KEUR 2012 KEUR Change KEUR

Cash flow from operating activities -1,746 15,475 -17,221

Cash flow from investing activities -5 -33 28

Cash flow from financing activities -7,163 -590 -6,573

Effect of exchange rate changes -129 -32 -97

Change in Cash and cash equivalents -9,043 14,820 -23,863

The cash flow from operating activities of the fiscal year and of the previous year is mainly based on the net result for the respective year and is only to a small extent influenced by changes in the working capital.

In the fiscal year, the cash flow from financing activities results completely from the repayment of the subordinated loan and the interest payments on the subordinated loan accrued until maturity.

d. Overall appraisal

PAION was able to continue the successful out-licensing of Remimazolam in fiscal year 2013. PAION generated revenues of EUR 4.2 million from licence agreements. Based on this and on the capital increases carried out at the end of 2013/beginning of 2014, the financial position has improved significantly and will allow increased investments in the development of Remimazolam. Since Remimazolam is not yet marketed and therefore no sustainable revenue is generated, PAION continues to incur losses.

Headcount

As of 31 December 2013, the total headcount of the PAION Group amounted to 13 employees. By comparison, the headcount as of 31 December 2012 amounted to 14 employees.

Remuneration report

1. Management Board

The remuneration paid to Management Board members comprises fixed annual remuneration, a variable bonus, a long-term performance-based remuneration component in the form of stock options and stock appreciation rights as well as other remuneration in terms of company car remu-neration, insurance premiums and pension contributions. All stock options and stock appreciation rights granted to Management Board members so far have a ten-year term. The variable bonus depends on the achievement of long-term and sustainable financial and strategic corporate targets and personal goals which are defined by the Supervisory Board in conjunction with the Manage-ment Board at the beginning of each fiscal year. The level of target achieveManage-ment and the related amount of the variable remuneration is assessed and determined by the Supervisory Board at the end of each year. Bonuses are limited to a maximum amount and are paid depending on personal goal achievement. Furthermore, negative developments do have an effect on the amount of the variable bonus by applying a malus.

The compensation as Management Board member covers also the managing director func-tion at the subsidiaries.

The members of the Management Board received stock options from the Stock Option Plan 2005 approved by the Annual General Meeting on 30 December 2004. The number of shares to be allocated to the Management Board was determined by the Supervisory Board immediately after the IPO. The two- to four-year waiting period before stock options can be exercised acts as a long-term incentive to increase the company's value. The exercise price of the stock options is EUR 8.00, equivalent to the issue price of the shares at the IPO. As of 31 December 2013, the exercise hurdle was EUR 12.65.

Under the Employee Participation Plan 2006, a total of 50,000 stock appreciation rights are granted to current Management Board members. The stock appreciation rights have a two-year waiting period after which time the holder is entitled to receive a sum of money based on the PAION AG share price. In addition to an annual minimum appreciation, the Employee Participation Plan 2006 also limits the value of the amount payable. The maximum payable amount is 100% of the exercise price, which is EUR 7.89 for the stock appreciation rights granted in fiscal year 2006. As of 31 December 2013, the exercise hurdle was EUR 10.68.

From the Stock Option Plan 2008 approved by the Annual General Meeting on 5 May 2008, a total of 326,892 stock options were granted to current and former Management Board members. The Supervisory Board determined the number of stock options to be allocated to the Management Board. The two- to four-year waiting period before stock options can be exercised acts as a long-term incentive to increase the company's value. The exercise price is between EUR 1.11 and EUR 1.84 per stock option and is based on the average price of the shares in a certain time period before the allocation. As of 31 December 2013, the exercise hurdle for those options that have vested was EUR 1.59.

From the Stock Option Plan 2010 approved by the Annual General Meeting on 19 May 2010, a total of 324,000 stock options were granted to the Management Board members with effect from 18 January 2014. The Supervisory Board determined the number of stock options to be allocated to the Management Board. The four-year waiting period before stock options can be exercised acts as a long-term incentive to increase the company's value. The exercise price is EUR 2.01 per stock option and is based on the average price of the shares in a certain time period before the allocation.

The stock option agreements with the individual members of the Management Board limit the numbers of stock options which can be granted. With the exception of minimum increases in value, no restrictions have been imposed in respect of the performance of the stock options, which is directly linked to PAION’s share price performance. Regarding the performance of the stock appreciation rights granted to the Management Board members, which is directly linked to the performance of the PAION share price, a cap has been agreed.

In fiscal year 2013, no stock options or stock appreciation rights were exercised by the Management Board.

Based on the agreements with the members of the Management Board, the remuneration structure for fiscal year 2013 is as follows:

Dr Wolfgang Söhngen

Dr Mariola Söhngen

Total remuneration 2013:

Fixed salary EUR 250,000 230,000

Variable remuneration EUR 133,200 122,100

Other remuneration EUR 29,736 21,391

Status of non-exercised stock options and stock appreciation rights as of 31 December 2013:

Stock options 2005 No. 138,964 109,186

Stock options 2005 – fair value1 _{EUR 494,017 388,156}

Stock options 2008 No. 113,940 75,960

Stock options 2008 – fair value1 _{EUR 172,956 115,304}

Stock Appreciation Rights (SAR) No. 25,000 25,000

SAR – fair value2 _{EUR 5,250 5,250}

The "other remuneration" item contains company car remuneration, insurance premiums and pension contributions paid by PAION.

Management Board remuneration in fiscal year 2013 amounted to KEUR 786 (previous year: KEUR 927).

In the event of a change of control and the termination of employment within a certain period after the change of control, the Management Board members are each entitled to contrac-tual termination benefits, which correspond to 100% of their annual fixed basic remuneration and the annual bonus. However, claims to termination benefits in connection with a change of control can only be exerted if the change of control also entails a significant change in business strategy, a significant change in responsibilities or a relocation of the place of work by at least 300 kilometres.

With the exception of changes of control as described above, the employment contracts entered into with Management Board members do not contain any specific termination benefit pro-visions in the event of early termination of employment relationships. The employment contracts of Management Board members do not provide for transitional benefits upon expiry.

Pursuant to the terms of the Stock Option Plans 2008 and 2010 in the event of a change of control, the waiting period for all stock options issued to Management Board members ends two years (Stock Option Plan 2008) and four years (Stock Option Plan 2010) after the day of issue in the case of those stock options whose two- or four-year waiting period has expired or, in case a longer waiting period has been defined, on the day the controlling acquisition comes into effect. In the case of issued stock options for which the two- or four-year waiting period has not yet expired, the entitlement to subscribe to shares on the basis of issued stock options is converted into an entitlement to a corresponding cash settlement based on the share price on the day the controlling acquisition comes into effect. The corresponding stock options lapse. The company may choose to grant listed shares in the acquiring company instead of the cash settlement.

2. Supervisory Board

Supervisory Board remuneration comprises basic remuneration and per-meeting fees. The mem-bers of the Supervisory Board do not currently receive performance-based remuneration. The Chairman of the Supervisory Board receives twice the basic remuneration and per-meeting fee, his deputy receives one-and-a-half times these amounts. Members of the Supervisory Board who are resident in a country outside Europe receive double the regular per-meeting fee for each Super-visory Board meeting they physically attend. The per-meeting fee is paid for a maximum of six meetings per year. The members of the Supervisory Board received the following remuneration for their activities in fiscal year 2013:

Basic remuneration EUR Per-meeting fees EUR Total EUR Dr Jörg Spiekerkötter 40,000 18,000 58,000 Dr. Karin Dorrepaal 30,000 13,500 43,500 Alan Goodman 20,000 9,000 29,000

Supervisory Board remuneration in fiscal year 2013 amounted to KEUR 131. In the previous year the remuneration amounted to KEUR 87, because the Supervisory Board members waived 50% of their fixed remuneration for 2012 in the context of the restructuring of the PAION group at the end of 2011.

Disclosures pursuant to section 315 (4) HGB and explanatory report

Composition of subscribed capital

As of 31 December 2013, PAION AG had a subscribed capital of EUR 25,379,906.00, divided into 25,379,906 no-par value shares, each representing a notional share in the share capital of EUR 1.00. The shares are issued to the bearer and are fully paid in. Shareholders are not entitled to demand share certificates for their shares under Art. 6 (2) of the Articles of Incorporation. All sha-res carry the same rights and duties. Each share carries the right to one vote at the Annual General Meeting and also forms the basis of the holder's share in profit. More information on the individual rights and duties of shareholders can be found in the German Stock Corporation Act (Aktiengesetz, AktG), in particular Sections 12, 53a et seqq., 118 et seqq. and 186.

Restrictions relating to voting rights or the transfer of shares

Pursuant to German legislation and the Articles of Incorporation of PAION AG, no restrictions are imposed on the voting rights or transferability of the shares. The Management Board of PAION AG is also not aware of any voting rights or share transfer restrictions at shareholder level.

Equity interests exceeding 10% of voting rights

The German Securities Trading Act (Wertpapierhandelsgesetz, WpHG) stipulates that any share-holder who achieves, exceeds or falls short of specific shares in the voting rights in the company through the purchase or sale of shares or by other means, must notify the company and the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) accordingly. The lowest threshold for this reporting obligation is 3%. Direct or indirect shares in the

company's capital that equal or exceeded as of 31 December 2013 10% of the voting rights were not reported to the company.

Shares with special rights conferring powers of control

The bearers of PAION AG shares have not been granted any special rights by the company, in parti-cular with regard to powers of control.

Type of control of voting rights when employees are shareholders and do not directly exer-cise their control rights

The share options issued to employees and members of the Management Board can be exercised once the defined waiting period has expired and the other conditions have been met by the benefi-ciaries. Shares acquired in this way give the beneficiaries the same rights as other shareholders and are not subject to any voting rights control.

Legal provisions and provisions of the Articles of Incorporation on the appointment and removal of members of the Management Board and amendments to the Articles of Incorporation

Members of the Management Board are appointed and removed in accordance with Sections 84 and 85 AktG and the supplementary provisions of the Supervisory Board's rules of procedure, which stipulate an age limit of 65 years for Management Board members. Pursuant to Section 84 AktG, members of the Management Board can be elected for a maximum of five years by the Supervisory Board. Re-appointments or extensions of the term of office for up to a maximum of five years at a time are permissible. Pursuant to Art. 8 (1) of the Articles of Incorporation, the Management Board must comprise at least one member. The Supervisory Board determines the number of members on the Management Board. Furthermore, pursuant to Section 84 (2) AktG and Art. 8 (2) of the Articles of Incorporation, the Supervisory Board may appoint a member of the Management Board as CEO.

Amendments to the Articles of Incorporation are effected in accordance with Sections 179 and 133 AktG in conjunction with Art. 27 of PAION AG's Articles of Incorporation. The shareholder resolution required for any amendment to the Articles of Incorporation can, under PAION AG's Articles of Incorporation, be adopted by a simple majority of the share capital represented at the adoption of the resolution, provided this is permitted by law.

Authority of the Management Board to issue or buy back shares

The Management Board is authorised to increase the share capital on or prior to 23 May 2016, with the consent of the Supervisory Board, on one or more occasions, by up to EUR 12,680,388.00 in total by issuing up to 12,680,388 new no-par value bearer shares in return for cash contribu-tions or contribucontribu-tions in kind (Authorised Capital 2011). In the case of capital increases against contributions in kind, the Management Board may also exclude pre-emptive rights, subject to the Supervisory Board's consent. Shareholders must be granted pre-emptive rights if the capital is to be increased against payments in cash. The new shares may also be taken by one or more financial

institutions on condition that they offer them to shareholders. The Management Board may, subject to the Supervisory Board's consent, exclude fractional shares from shareholders' pre-emptive rights. The Management Board is also authorised to exclude shareholders' pre-emptive rights, sub-ject to the consent of the Supervisory Board, if the issue price of the new shares is not significantly less than the market price and the shares issued in return for cash contributions with pre-emptive rights excluded pursuant to Section 186 (3) Sentence 4 AktG do not exceed 10% of the share capital as of 24 May 2011. The Management Board is moreover authorised to exclude shareholders' pre-emptive rights, subject to the consent of the Supervisory Board, to the extent necessary to grant pre-emptive rights to holders of convertible bonds, participation rights or options as defined in Section 221 AktG. The Authorised Capital 2011 was used for the first time in early 2014. For more information on the measures carried out, please see the explanations in the section “Report on post-balance sheet date events” in this management report.

Furthermore, subject to the consent of the Supervisory Board, the Management Board is authorised to issue on or before 18 May 2015, on one or more occasions, bearer and/or registered convertible and/or warrant bonds of up to an aggregate of EUR 98,000,000.00 with a maximum term of 20 years and to grant the holders or beneficiaries of the bonds conversion rights or options to new shares in PAION AG with a share in share capital of up EUR 9,800,000.00 in total (Conditio-nal Capital 2010 II). Conditio(Conditio-nal Capital 2010 II has not yet been used. Furthermore the company is authorised to issue 858,121 shares (Conditional Capital 2004 II), 741,105 shares (Conditional Capital 2008 I) and 720,000 shares (Conditional Capital 2010 I) in connection with the Stock Option Plans 2005, 2008 and 2010.

Material arrangements of the company dependent on a change in control in the event of a takeover bid

The company has not concluded material arrangements which are dependent on a change in control in the event of a takeover bid. In the past, the licence agreement with Lundbeck and the agreement with H.E.A.T. Mezzanine S.A., Luxembourg regarding the subordinated loan contained specific regulations in case of a change of control. Due to the sale of Desmoteplase to Lundbeck in 2012 and the repayment of the loan to H.E.A.T. Mezzanine S.A. in April 2013 such regulations no longer exist.

Compensation agreements entered into by the company with members of the Management Board and employees in the event of a takeover bid

The terms of the Stock Option Plan 2008 and 2010 stipulate both for members of the Management Board and for employees that in case of a change of control the waiting period for all options whose two-year (Stock Option Plan 2008) or four-years (Stock Option Plans 2010) waiting period has expired ends at the date of the change of control. For all options, whose two- or four-year waiting period has not expired at the date of the change of control, the entitlement to subscribe to shares is

converted into an entitlement to a cash settlement based on the share price on the day the change of control comes into effect; the corresponding stock options lapse. The company may choose to grant listed shares in the acquiring company instead of the cash settlement.

For information on further existing compensation agreements with Management Board members, please refer to our comments in the section "Remuneration Report".

Statement on Corporate Governance pursuant to Section 289a HGB

The Statement on Corporate Governance pursuant to Section 289a HGB has been published on PAION AG's website (www.paion.com/corporategovernance).

Report on risks and opportunities

1. Risk management

As a biopharmaceutical company, PAION is exposed to the segment and market risks that are typi-cally associated with the development of pharmaceutical products. In accordance with the German Law on Control and Transparency in Business (Gesetz zur Kontrolle und Transparenz im Unter-nehmensbereich, KonTraG), PAION has implemented a Group-wide comprehensive and effective risk management system which is integrated into the operating processes and flexibly adaptable to the changing environment. The task of the risk management system is to promote the conscious and responsible handling of risks, and to enable the early identification, monitoring, analysis, evaluation and management of future developments with inherent risks and future opportunities. Involving all management levels and project management in the process of strategic and business development creates a shared awareness of the critical success factors and related risks.

PAION's risk management system comprises an internal control system, an early warning system for the detection of risks and a controlling system. These three sub-systems interact directly with each other and also take on tasks from each of the other sub-systems.

The financial accounting and cost accounting software „Microsoft Dynamics NAV“ (for-merly Navision) and an enterprise planning tool customised for PAION form the basis for control-ling. Monthly internal reporting is performed on a cost centre and cost unit basis, allowing devi-ations from the budget to be identified at an early stage. Short and long-term corporate planning (cost centre planning, cost unit and project planning, budget income statement, budget balance sheet and budget cash flow statement) is conducted using an Excel-based planning tool. Using this planning tool, management and the controlling department are in a position to simulate various scenarios to identify, assess and determine the impact of opportunities and risks on the future development of the company, particularly with regard to the key financial performance indicator “liquidity”.

The implemented internal control system includes rules for the management of business activities as well as arrangements for monitoring compliance with these rules. The primary tasks

of the internal control system include application of the dual control principle, determining which types of business transactions require approval, limiting the issuance of signing and banking authority, standardising workflows using procedural instructions, monitoring compliance with process steps by using checklists and establishing measures for the protection of data and IT sys-tems. Furthermore PAION commissioned an auditing firm with carrying out the tasks of an internal audit department. Internal Audit works on the basis of a multi-year audit plan, which was develo-ped by Internal Audit in collaboration with the Management Board based on a risk-oriented audit approach and materiality aspects. The internal auditors report promptly on the audit procedures carried out and any findings therefrom. In addition, PAION has commissioned an external auditor to assume the function of Compliance Officer. The Compliance Officer monitors the compliance of the group-wide compliance policies and reports once a year on his activities and any findings ther-from. Both the audit plan and the reports of Internal Audit as well as the report of the Compliance Officer are forwarded to the Supervisory Board for information and discussion.

PAION has implemented a matrix organisation which combines both project organisa-tion and department organisaorganisa-tion. Detailed reporting and informaorganisa-tion structures have been set up within these organisational structures to ensure the early identification and communication of risks. The individual projects are managed and monitored by project teams. The project teams regu-larly provide the individual department heads and management with reports – also in writing – on the current progress of projects and potential risks.

2. Risk management and internal control system relevant for the financial reporting

process

The risk management system and the internal control system also involve the financial reporting processes and aim to ensure compliance and reliability of the consolidated financial statements, the group management report and the released interim financial statements.

The risk management and internal control system relevant for the financial reporting process address the risk of significant misstatements in the annual and interim financial state-ments. Essential measures and controls in financial reporting are the clear assignment of respon-sibilities, the dual control principle, the segregation of duties, the use of an appropriate financial accounting system with a corresponding authorisation concept as well as the use of checklists and work instructions. Furthermore separate and consolidated financial statements are prepared every month for internal purposes. The monthly, interim and annual financial statements are analysed by means of the Group-wide controlling with regard to plan/actual variances and implausibilities and inconsistencies in the accounting. The monthly financial statements are forwarded to the Supervi-sory Board. The interim and annual financial statements are published and are discussed with the Supervisory Board prior to publication.

The risk management system is reviewed once per year and discussed with the Supervisory Board. The risk analysis is updated during the year and presented to the Supervisory Board; special risks are communicated ad-hoc. The internal control system is reviewed continuously with regard

to the effectiveness of the controls and is adjusted if required. The risk management system and the internal control system are audited by Internal Audit in line with a multi-year audit plan.

Significant issues in connection with the preparation of financial statements are discussed promptly with the audit committee. Furthermore, the audit committee determines additional audit topics and key audit procedures for the auditor.

In addition, the auditor is obligated to report to the Supervisory Board on risks and control deficiencies relevant for the financial reporting process as well as other deficiencies of the risk management system and the internal control system that he becomes aware of in the course of his audit.

3. Significant risks to future development

a. Drug development risks

All of PAION's substances are currently still in different stages of development. Before they can be approved and marketed, their safety and efficacy must be proven in appropriate and carefully monitored clinical studies. The results of preclinical and clinical studies are not predictable. There is always the danger that promising results achieved in prior studies may not be achieved in subse-quent studies. If this turns out to be the case, further development can be delayed considerably or development of a specific drug candidate may be discontinued altogether.

There is a risk that the conduct of studies is approved with a delay or is denied. Upon occurrence of this risk, the further development can be delayed considerably or development of a specific drug candidate may be discontinued altogether.

The completion of clinical studies depends, among other things, on the ability to enrol a sufficient number of patients to participate in them. Difficulties in enrolling patients, additional requirements for the conduct of studies or more expensive study monitoring and more expensive analyses may increase costs and negatively affect the timing of these clinical studies.

There is also the risk that the data provided by the individual clinical studies are deemed to be insufficient by the regulatory authorities for commencement of the next development phase or as a basis for an application for approval and, as such, additional data may have to be generated or further studies conducted. The assessments of the regulatory authorities in different countries may also vary. A data package which is deemed sufficient in one country may be considered insufficient by a regulatory authority in another country. In addition, it is possible that the regulatory autho-rities demand additional studies, which would entail additional costs for the company and would significantly delay its receipt of regulatory approval.

Once a certain level of development has been reached, PAION aims to minimise these risks by seeking development cooperation agreements with established pharmaceutical and biotechno-logy companies, which then bear some or all of the respective financing risk. Furthermore, PAION also cooperates closely with the regulatory authorities to ensure that all requirements are met, and utilises the knowledge of external experts in this regard.

There is also a risk that PAION does not receive the required insurance coverage for potential damages from the conduct of clinical studies. This can result in a delay or termination of studies.

b. Risks in relation to the manufacture of pharmaceutical substances

PAION currently does not own or operate any production facilities. Accordingly, it relies on third parties for the supply of its pharmaceutical substances and the manufacture of clinical and commercial quantities of them. PAION might not be in a position to maintain or renew existing or required agreements with third parties at acceptable terms or at all.

PAION's substances are produced in production processes which are highly complex and require extensive validation. In the past, the substances have been produced in sufficient quantities for clinical development, but it is not entirely certain that the larger batches needed for commercial purposes can be produced. Problems with the production of substances could lead to higher costs, delays or even the discontinuation of the clinical development or market potential not being fully exploited.

c. Risks in relation to the marketing of drugs

In the foreseeable future, PAION expects to remain dependent on cooperation agreements with experienced partners to complete the development of its current and future drug candidates and to market them successfully. Drug prices are increasingly subject to governmental regulation. There is a risk that through governmental price regulation the development of certain drugs may become unprofitable. This could make it difficult or impossible for PAION to close cooperation agreements or to secure alternative financing for drug development. Should PAION fail to enter into cooperation agreements at favourable terms, fail to enter into cooperation agreements at all or fail to maintain existing cooperation agreements, the development and marketing of its existing and future drug candidates may be delayed or fail completely, which may increase development and marketing expenses and limit its financing ability.

d. Risks in relation to patents and other intellectual property

PAION's business operations are largely dependent on its ability to secure extensive patent protection and other intellectual property protection for the individual substances and to defend these against third parties without violating their rights. There can be no assurance that current or future patent applications will be granted or that any patents issued or licensed to PAION will be valid and sufficiently extensive to provide PAION with adequate legal protection or any commercial advantage.

e. Competitive risks

PAION's business environment is characterised by strong competition, intensive research activities and rapid technical change. PAION's success is highly dependent on its ability to develop existing and new drug candidates cost-effectively and to market them successfully. In doing so, it faces and will continue to face stiff competition from a variety of competitors, ranging from small biotech companies to large international pharmaceutical groups.

f. Risks in relation to additional financing requirements

PAION believes that the currently available cash and cash equivalents, the future payments expec-ted from the existing cooperation agreements and possible future cooperation agreements as well as the cash inflows from the capital increases in early 2014 will be sufficient to cover its short- and mid-term financing needs. However, PAION may need additional funding within this timeframe in order to keep the time to market approval for Remimazolam as short as possible and thus maximise shareholder value. Funding requirements may also arise due to delays or cost increases in develop-ment and the related delays in milestone paydevelop-ments from cooperation partners. Milestone paydevelop-ments could even be cancelled altogether if agreed targets are not met.

PAION's future ability to secure additional funding will depend on the success of its development activities, the situation on the capital markets and other factors. If PAION is unable to raise financing at favourable terms or unable to raise financing at all, it could be forced to reduce its operating expenses by delaying, reducing or discontinuing the development of one or more of its drug candidates.

g. Risks in relation to personnel

PAION's management and its scientific and technical staff in key positions are crucial to the company's success. Many of these members of staff have substantial experience with the company and would be difficult to replace. In addition, competition for qualified personnel is intense in PAION's industry and PAION might be unable to attract and retain highly qualified employees. This risk exists especially with regard to the company’s strategic realignment towards being a specialist player in the area of anaesthesia.

h. Currency risks

Some of PAION's contracts are based on foreign currencies, in particular on the U.S. dollar and the pound sterling. PAION does maintain a small reserve of foreign currency funds consisting of amounts in U.S. dollars and pound sterling. Currency risks also arise from translating the UK subsidiaries’ separate financial statements from pound sterling into euros because the pound is the

functional currency of the UK subsidiaries. Further currency risks for the UK subsidiaries arise from the euro-denominated loans granted by PAION AG.

Currency risks are systematically recorded and monitored. With the consent of the Super-visory Board of PAION AG, the Management Board has drawn up clear rules governing the hedging instruments that may be used to limit currency risks. Hedging contracts are transacted under cer-tain circumstances for foreign currency items, for which the amounts and due dates of cash flows are relatively certain.

i. Risk of availability of tax losses carried forward

PAION AG and its subsidiaries have considerable tax losses carried forward available. PAION assu-mes that based on the current German and British tax legislation, these losses can be carried for-ward indefinitely and offset against future earnings according to the relevant tax regulations (e.g. minimum taxation). If the usage of tax losses is partly or completely disallowed, for example due to changes in legislation, changes in capitalisation or ownership structure as well as other events, income tax payments would become due on the expected earnings if one or more compounds are developed successfully. These tax payments would correspondingly reduce liquidity.

j. Risk of insolvency

There is a risk that one or several subsidiaries could go into insolvency. The occurrence of this risk would lead to substantial impairment losses on the equity investments in subsidiaries and the loans to subsidiaries. This would accordingly reduce the equity of PAION. Furthermore, if expected payments from subsidiaries, e.g. loan repayments, are not made, this could lead to the insolvency of PAION.

4. Market opportunities

PAION AG and its subsidiaries are biopharmaceutical companies focusing so far on the clinical development of drug candidates for diseases or interventions for which there is a substantial unmet medical need.

Remimazolam is in Phase III development in anaesthesia and in Phase II development in ICU sedation in Japan and ready for Phase III in procedural sedation in the U.S. and Europe. PAION is pressing ahead with the Remimazolam partnering discussions but also with its own development in procedural sedation and anaesthesia.

The anaesthesia market is largely underserved and is a growing market because of an aging population with an increasing number and complexity of surgical interventions. Most big pharma companies have withdrawn from actively promoting their product range in this therapeu-tic field, and there have altogether been next to no product innovations during the past 20 years. In addition, despite being generally accepted, the existing compounds all have safety and other