AVECHO BIOTECHNOLOGY LIMITED — Management Reports 2013

Sep 9, 2013

PHOSPHAGENICS LIMITED news 09 CEO’s Message There is little doubt that we have an extremely valuable platform technology. While a platform 13

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There is little doubt that we have an extremely valuable platform technology. While a platform technology provides many commercial opportunities, it also creates challenges. It follows that the more versatile the technology, the greater its application and the more diverse will the decisions be to direct and execute development and commercialisation.

the low side to $1.4 billion, depending on the final characteristics of the product profile.

While we remain focussed on opioids, we are also developing other applications for the technology. We view our diversification into other areas as de-risking the Company by undertaking much easier, but valuable, revenue-generating projects that are tackling significant markets. It is no coincidence that we are developing lidocaine, diclofenac, retinoic acid and ketoconazole, products that have all previously been delivered topically. We just deliver them better.

From the inception of our project, management’s prime role has been to ensure that the technology is applied in a manner that provides maximum value to the Company. Once our opioid program succeeds, we will have achieved this. There are compelling reasons why oxycodone and oxymorphone have never been delivered through a patch. It is difficult but it is this difficulty that will provide the Company with a valuable commercial outcome.

While we accept that our share is our currency and a healthy share price leads to happy shareholders, we are firmly of the belief that building a profitable company with diverse revenue streams will ultimately lead to a sustainable share price that reflects the true success of our Company.

Until now we have not provided the financial market with any guidance on the potential market size of any of our products however, in the current circumstances, we think that it is important to give our shareholders a sense of the commercial potential of our opioid pipeline.

We are poised to commence five Phase 2 clinical studies over the next 12 months. We have commenced our retinoic acid (acne indication) Phase 2 study with a third of the patients having been recruited. Ketoconazole (dermatitis indication) will commence towards the middle

A qualitative and quantitative market survey commissioned by the Company recently suggests that if we achieve our Targeted Product Profile (“TPP”) for our transdermal product, the TPM/oxymorphone patch, it should achieve peak annual sales of between $700 million on

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commercial one. To that end, measures had been underway to drive this transition as we shift our focus to commercialising our assets. Over the past few years, we commenced recruiting commercial staff to augment the skill set of our distinguished scientific team. The recent events have provided the opportunity to continue this process as we seek to appoint an experienced pharmaceutical executive as CEO, and wellcredentialed Board members to lead the Company into its next phase of its development.

of next year. Both of these studies should be relatively simple and cost effective. They tackle substantial markets so that if superiority over market leading products is demonstrated as we expect, these projects will lead to attractive outlicensing deals for the Company.

Moving Forward

The events over the last few months have been personally disappointing but we are moving on. You will see significant changes in the coming months within the Company. We are determined and confident that our Company will succeed.

These events have thrown up unique challenges to our Company. We are acutely aware that the misappropriation by our former CEO of a substantial amount of the Company’s funds has greatly damaged our credibility and we are taking measures to restore our reputation by implementing changes in an orderly manner at all appropriate levels.

As we have reported to the market, we expect to recover a substantial amount of the stolen funds. We have secured assets and are negotiating the disposition of these assets. Some of the properties secured have been sold and others are in the process of being sold. We will update the market as we make progress recovering these funds.

We recognise that a research and development company requires a different skill set to a

In the circumstances confronting them, our employees have been incredible. Morale is excellent and once the situation had settled our staff simply focussed on their roles with no further distraction. Initial disbelief and disappointment has turned into diligence and determination to succeed.

Our external commercial partners have been informed of the misappropriation and from their perspective it has been business as usual.

In our half-year results we reported that we had discovered a further $500,000 in misappropriated funds. It should be emphasised that this does not impact on our current cash position. We believe that we have uncovered all the misappropriated funds that can reasonably be found and expect no further material variation.

In the accounts we made provisions for tax penalties. They were made in accordance with accounting standards but we do not believe that these penalties will be significant, if at all.

Our opioid strategy continues to be our key focus. We will take this opportunity to better explain our strategy and underlying rationale.

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Opioid Strategy Explained

Background

Pain is an unpleasant feeling that is conveyed to the brain by sensory neurons. The discomfort signals actual or potential injury to the body. Pain arises from any number of situations. Injury is a major cause, but pain may also arise from an illness.

The USA pain market is large and diverse with a recent report (Institute of Medicine) suggesting that chronic pain affects around 100 million adults in the USA. The estimated economic loss resulting from pain in the USA in lost production and medical costs exceeds $635 billion annually.

Drugs applied to the skin must traverse the different skin layers, encountering several lipophilic and hydrophilic domains on the way to the dermis where absorption into the systemic circulation occurs. TPM[®] can transverse the structural layers of the skin relatively easily. TPM’s characteristics enable us to control the depth of delivery of drugs by changing the formulations.

While the pain market is crowded, there are still significant unmet therapeutic needs in the treatment of chronic pain. Many medications are suboptimal in reducing pain and have deleterious side effects. The lack of tolerable medication for a variety of pain conditions offers a great opportunity for growth by the introduction of new drugs or by the development of new applications for existing drugs. The latter is an integral part of the Company’s strategy.

Our current pain portfolio includes diclofenac, lidocaine, oxycodone and oxymorphone. The development of lidocaine and diclofenac is relatively easy. We are able to compare the delivery of our formulations with the leading marketed products in in vitro studies, thereby demonstrating the superiority of our TPM[®] formulations. It is for this reason that Novartis India (Novartis is the second largest pharmaceutical company in the world) sublicensed our technology for diclofenac, a market it dominates (largely under the Voltaren[®] and Voveran[®] brands).

Transdermal/Topical Drug Delivery

The skin is the largest organ in the body. It is designed to protect against the influx of toxins and the efflux of water. It is, therefore, largely impermeable to the penetration of foreign molecules. Human skin consists of three main layers: the epidermis, dermis and hypodermis. The epidermis, in particular the stratum corneum, is the major barrier to drug absorption. The stratum corneum contains only 20% water and is a highly lipophilic (oil soluble) membrane.

Until now no company has been able to deliver oxycodone or oxymorphone topically or transdermally. However, this high hurdle will ensure that the Company will be economically well rewarded when we succeed.

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Opioids

Opioids are among the world’s oldest known drugs; the therapeutic use of the opium poppy predates recorded history. The analgesic (painkiller) effects of opioids are due to decreased perception of pain, decreased reaction to pain as well as increased pain tolerance.

Opioids work by binding to opioid receptors which are found principally in the central and peripheral nervous systems as well as the gastrointestinal tract.

The transdermal delivery of opioids provides advantages over oral administration. It avoids the peaks and troughs of intermittent dosage regimens that can lead to side effects such as sedation, nausea, vomiting and respiratory depression. The reduced need for dosage administration (our patch is designed for 72 hours) also improves patient compliance. Topical delivery provides even greater advantages over oral delivery.

Opioids are the gold standard for pain management and account for about a third of the revenue generated from pain products.

The traditional view that opioid pain-relieving effects could only take place systemically within the central nervous system has been shown to be wrong. Recent studies have confirmed that opioid receptors are up-regulated in peripheral nerves in response to inflammation. This phenomenon had been speculated over 20 years ago with animal experiments showing the existence of peripheral opioid receptors that could be affected by topically applied opioids.

In an animal study previously conducted at the University of Queensland, Phosphagenics demonstrated that its TPM/oxycodone gel reduced peripheral pain when delivered topically without systemic exposure, that is, without delivery into the plasma.

Recent research conducted by other parties has shown that peripheral opioid receptors can modulate nerve impulses in a similar way to the action of opioid receptors in or near the spinal cord. Therefore, exogenous opioids, such as oxycodone, applied at pain sites should have effects akin to systemic opioids (administered orally or parentally) that affect the central nervous system.

Pain is a Pain

The Use of Opioids for Topical (Local) Pain Application

Topical application of drugs for peripheral pain has been used for a long time in a variety of dosage forms including creams, ointments and gels. Drugs used include various NSAIDs, capsaicin, local anesthetics (e.g. lidocaine) and rubefacients or counterirritants (e.g. menthol, camphor). Topical application of opioids has been largely overlooked.

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Pain is generally classified as acute or chronic. The generally accepted view is that acute pain refers to pain that dissipates within three months of onset while chronic pain is pain that extends beyond this period. The Company’s opioid strategy is primarily aimed at the chronic market as patches lend themselves perfectly to this market. Additionally, chronic pain exceeds 70% of the overall pain market.

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Opioids work by binding to opioid receptors which exist in the central and peripheral nervous systems. For pain that occurs beyond peripheral areas of the body, opioids need to be delivered to the Central Nervous System (CNS). This can only be achieved through systemic circulation and, therefore, requires transdermal delivery. On the other hand when peripheral opioid receptors are up-regulated in response to inflammation, topical delivery of opioids would have many advantages over oral and transdermal delivery.

Business Case

Overall the potential market for transdermal and topical opioids exceeds $10 billion per annum.

Pain is felt in the brain. Opioids, by binding to the peripheral opioid receptors, prevent the perception of pain. Preventing or greatly reducing the spillage of opioids into the systemic circulation eliminates most, if not all, of the deleterious side effects of opioids. This is key to the Company’s strategy. The use of a powerful painkiller without the onset of side effects is a compelling business and marketing model.

The extended release opioid market in the USA for the year ending February 2013 was about US$6 billion. Of the total market, sales of patches were about $1.4 billion (over 90% of sales was for fentanyl, the balance for buprenorphine); for oxycodone $2.9 billion and for oxymorphone around $0.6 billion. Of the total $6 billion extended release market, around $1.2 billion of oral opioids were used for peripheral neuropathic pain.

There exists a substantial unmet need to provide an opioid patch for opioid naïve patients, as fentanyl cannot be prescribed for this large patient population. Both oxycodone and oxymorphone are capable of meeting this unsatisfied need.

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Our qualitative and quantitative market survey show that either an oxycodone or oxymorphone patch would compete in the total extended release market of $6 billion and not with their equivalent oral product. If both patches were launched into the transdermal market, one would cannibalise the other. Indeed, the survey suggests that if we can achieve our Targeted Product Profile (“TPP”), the TPM/oxymorphone patch will achieve peak sales between $700 million on the low side and $1.4 billion on the high side. These exceed the current total oxymorphone market.

Peripheral neuropathy is a disorder that occurs in nerves outside the brain and spinal cord.

Regarding the topical oxycodone product, the US market size for the neuropathic pain is similar to the extended release market at around $6 billion per annum. Neuropathic back pain accounts for 45% of the market; diabetic neuropathy 14%, while post-surgical and trauma accounts for about 12%. Osteoarthritis causes peripheral pain and is primarily treated with oral pain killers. The global market for this indication exceeds $4.5 billion. As osteoarthritis occurs in joints, topical delivery is challenging. However, because of the potential market size and the successful use of topical NSAIDs for this indication, the Company views the risk/reward ratio as very attractive.

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Company Strategy and Implementation

Our commercial imperatives have changed over the past 12 months. Before the development of our oxymorphone patch the aim was to take oxycodone to completion of a Phase 3 clinical trial before licensing the product. With the development of two opioid products it is now our position that the commercial outcome for licensing two products for different indications during or after Phase 2 is commercially more attractive than licensing one at the completion of Phase 3. This pathway is substantially more cost effective and less risky. It will also occur in a shorter time frame.

The Company’s opioid products strategy should not be surprising. We will develop the TPM/ oxymorphone patch for the extended release market (delivery into the blood, transdermal) while we will develop the TPM/oxycodone patch for the peripheral pain market (delivery into the local site of pain, topical) which includes neuropathic pain.

Oxymorphone is three and half times more powerful than oxycodone and, therefore, compared with oxycodone, less is needed in plasma for it to be effective. On the other hand, as a CNS effect is undesirable for a topically delivered opioid, the weaker oxycodone is perfectly suited for this application.

Oxymorphone will re-enter the clinic for a multiple dose Phase 1 study before the end of September. If appropriate plasma levels are obtained, planning for a Phase 2 trial will commence immediately. Results of the multidose study are expected towards the end of the year.

The clinical strategy for the TPM/oxycodone program has almost been finalised and is based on our physician surveys conducted with key

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opinion leaders. It is likely that we will conduct two Phase 2 studies for topical oxycodone in two different indications. The first is likely to be for postherpetic neuralgia. We would expect to commence this study towards the end of the first quarter 2014. The second Phase 2 is likely to be for osteoarthritis and we are aiming for a mid-year start. We will keep shareholders informed on timing and indications as we reach a final decision for our topical TPM/oxycodone application.

As we aggressively strive towards commercialising our platform technology our Chief Scientific Officer, Dr Paul Gavin, has been given the task of promoting our TPM[®] drug delivery technology externally and to recommence our publishing efforts that had been allowed to lapse in recent years. This is an important component of commercialisation of our technology.

To ensure we stay on the front foot in the medical arena, Phospagenics also recently received approval to present two posters on TPM[®] at the PAINWeek 2013 conference in the USA. PAINWeek is the largest pain conference in the USA with a principal focus on frontline practitioners in pain management. PAINWeek is attended by over 1,800 pain specialists.

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Harry Rosen Chief Executive Officer

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BioElixia[®] /Personal Care

Our BioElixia[®] team has recently launched four new products extending our very successful BodyShaper[®] Range. As can be seen from the photographs of the Myer displays in Melbourne, BioElixia[®] has been able to access very prime Myer retail space in its city store.

In a 10-subject study conducted in the USA using our new Stretch Mark Cream, subjects showed a reduction in the appearance of stretch marks by an average of 87% at 56 days of application. Forward orders for our new hero product have been very good and represent the most successful product launch since the original BodyShaper[®] product. With this launch occurring in the second half of the year, sales for the BioElixia[®] division will show an improvement for the second half of 2013.

GNC’s launch of their “toning cream” in the USA has gone well, with a second order being received from them shortly after the first. We are working closely with GNC to increase the exposure of the product in their stores throughout the USA.

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In South Korea we expect that our partners will shortly receive approval to register the anti-cellulite product. As part of the registration process they were required to conduct a 30-subject study to demonstrate that the product could reduce the appearance of cellulite. The results of the study showed a statistical significant reduction in the appearance of cellulite.

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L I V E W E L L .

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Mastitis

In the last quarter we announced details of a collaboration agreement with the Agricultural Research Service (ARS), the research arm of the USDA (US Department of Agriculture).

Under the agreement Phosphagenics will formulate and the ARS will evaluate products that contain different active ingredients combined with our TPM[®] technology.

The first part of the trials began late in June. Successful trials will lead to the establishment of a registered product to treat Mastitis in cows. The trials will continue throughout 2013 and 2014, with results expected to be announced in the first half of 2015 as a joint release by the USDA, ARS and Phosphagenics.

Diclofenac

Mastitis is a serious problem for dairy farmers with the estimate of losses in the USA alone of around $2 billion. The current treatment using antibiotics is of concern due to the growth in antibiotic resistant bacteria. Partnering these trials with the USDA will assist the Company in attracting interest from major animal health companies. The prospect of significant volumes of TPM[®] required would provide a significant boost to our TPM[®] manufacturing.

Phosphagenics recently shipped TPM[®] to Themis Medicare for the production of the Novartis’s and its own TPM/diclofenac commercial products. The upcoming launch of these products by Novartis and Themis in India in early Q1 2014 will signify the first Phosphagenic pharmaceutical product in the market. The developments for other markets continues.

In local news, our partner, Mastitis Management Australia, has sold its first order of feed products to a northern Victorian dairy farm with approximately 750 cows. The formulations contain select anti-oxidants with our TPM[®] designed to help boost cow immune systems.

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Dermatological Program

Lidocaine

In late 2008 Phosphagenics announced results from a Phase 1 clinical trial that demonstrated that the TPM/lidocaine formulation delivered a statistically significant greater amount of lidocaine into the the skin compared to a leading commercial gel product, Xylocaine[®] .

As part of its pain portfolio, Phosphagenics will aim to commercialise its gel product in much the same way as it did with diclofenac by partnering it with interested parties. Since its Phase 1 study, the Company has developed a lidocaine patch which would be a very good adjunct to its oxycodone patch for topical delivery. Currently a lidocaine patch is approved for postherpetic neuralgia in the USA market. Endo Pharmaceutical markets a patch in the USA with sales of the product being approximately US$1.3 billion. With Endo’s patent about to expire, it opens up interesting opportunities for our Company. The lidocaine patch would be a very good addition to our pain franchise but, unless partnered in the near term, will need to wait until we have progressed our other pain product developments.

In July this year we announced our return to the clinic with a Phase 2 TPM/tretinoin trial. Tretinoin is used for the treatment of acne. Our Phase 1 trial conducted in 2009 showed that Phosphagenics’ formulation delivered more active, as well as delivering it deeper into the skin, compared to the market leader, Retin A.

The current Phase 2 trial of 45 patients has commenced with third of the subjects recruited so far. It expected to be concluded and deliver results in Q1 2014.

The retinoids market in the USA exceeds US$300 million per annum, with irritation and redness being the most common side effects. We expect that the TPM/tretinoin formulation will reduce these side effects.

In mid 2014 Phosphagenics will continue its dermatology initiative by commencing a Phase 2 trial for a ketoconazole product. Ketoconazole is indicated for the treatment of seborrheic dermatitis, an inflammatory skin disorder affecting the scalp face and torso.

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Product Development Update

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Product Target application R&D Pre-clinical Phase 1 Phase 2 Phase 3
Drug Delivery - Pharmaceutical
Topical Oxycodone Pain
Oxycodone Pain
Oxymorphone Pain
Lidocaine Pain
Injectable antibiotic with TPM [®] Antibiotic
(Agila, Strides Arcolab)
Diclofenac Pain
Drug Delivery - Dermatology
Retinoic acid Acne
Ketoconazole Seborrheic Dermatitis
Product Commercial
Product Target Application Development Market Development Production Launch
Cosmetic
BioELIXIA [® ] - Stretch Mark Crème Body Sculpting
BioELIXIA [®] - High Performance Range Anti-ageing
BioELIXIA [®] - BodyShaper [®] Body Sculpting
Le Métier - Peau Vierge Anti-ageing
GNC (General Nutrition Company) Body Sculpting
Animal Health - Products
Nutritional Supplements - Animal Feed
Using TPM [®]
(ENA - Thoroughbreds)
Nutritional Supplement - Animal Feed Minerals
(POH/ENA - EEA)
Nutritional Supplements - Dairy Cattle (MMA) Mastitis
Dairy Cattle Agreement (USDA/ARS) Mastitis
OTC Pharmaceuticals
Themis Medicare Ltd (Indian Market Exclusive) Topical Diclofenac
Novartis (India) sub-license Topical Diclofenac
Other Licensing Agreements - Personal Care
Ashland (Formerly ISP) TPM [®] Supply
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Phosphagenics Project

Collaborative Project for commercial partner

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Phosphagenics Limited 11 Duerdin Street, Clayton VIC 3168 PO Box 1415, Clayton South MDC VIC 3169 Australia Ph: +61 3 9565 1119 Fax: +61 3 9565 1151 Security Codes: ASX(POH); OTCQX(PPGNY) www.phosphagenics.com email: info@phosphagenics.com www.elixia.com.au

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