PYC THERAPEUTICS LIMITED — Management Reports 2012

Mar 4, 2012

HARNESSING NATURAL DIVERSITY FOR DRUG DISCOVERY

March 2012

To our shareholders

Our Executive Chairman Doug Wilson uses this informal update as a forum to put recent announcements in context for shareholders in a consolidated newsletter.

In this edition:

• • First multi-product partnership
• • Four Pharma deals in two years
• • Contracts in late-stage negotiation
• • Strategic discussions on a number of fronts
• • Optimising the Phylomer libraries
• • Exploiting Phenomica with Cambridge University
• • New highly experienced biotech Director

I want to comment firstly on the disappointing performance of Phylogica's share price. There was unprecedented trading activity in PYC over the Christmas holidays, which is usually a quiet period for equity markets. This activity was associated with the exit of a significant shareholder. While it is not for me to speculate on the reasons or timing of any individual shareholder's decision to buy or sell, it is worth mentioning that some of our other significant shareholders and also some of my fellow Directors took the opportunity of this price weakness to top up their positions in recent weeks. Our largest shareholder NAOS Asset Management added over 10 million shares to its holding, which increased NAOS's ownership to 11.5%.

Furthermore, we were encouraged that, despite difficult global market conditions, Phylogica was able to raise $2.1 million in working capital to strengthen its balance sheet in December 2011. This reflects the strong support that we have within the investment community.

MAJOR COLLABORATION WITH JANSSEN

First multi-product partnership

At the beginning of 2012, we were very pleased to announce our first multi-product agreement. The alliance with Janssen, which is the pharmaceutical division of Johnson & Johnson, is our broadest and potentially most valuable partnership to-date. Many of you have asked us to disclose more details about the deal, particularly the financial terms. As I am sure you all appreciate, the specific terms of the contract are confidential for commercial reasons. Furthermore, we are obliged to respect Janssen's desire not to reveal any financial aspects of the broader alliance at this stage until they are finalised.

The collaboration is focused on the discovery of novel Phylomer peptides that can pull therapeutic cargoes through cell membranes of specific tissue types. The vast majority of known therapeutic targets reside within cells, but have generally proved inaccessible to drugs, particularly large biological molecules. There is an enormous opportunity in pursuing these intracellular targets, which, if successfully 'drugged' could lead to new treatment approaches to some of the world's major unmet medical needs such as neurodegenerative disorders, cancer and auto-immune diseases. Our Phylomer platform has unique capabilities to identify tissue-specific cell-penetrating peptides that can carry biological cargoes into cells.

The reason that we are so excited by this deal is that it could lead to multiple Phylomer-based drug candidates being developed and commercialised. In the initial stage of the collaboration, Phylogica will identify cell-penetrating Phylomer peptides for delivery to one specific tissue type, but this could be expanded to others. Under the terms of the agreement, Janssen has the rights to use our cell-penetrating peptides to deliver several different therapeutic cargoes, potentially addressing some highly prevalent diseases with new treatment options.

Thus far, Janssen has paid US$1.2 million to Phylogica and is also committed to pay for an initial 18-month research period. Pending ongoing discussions regarding commercial terms, Phylogica could receive further research funding as the alliance is expanded, in addition to license fees, milestone payments and royalties on worldwide sales. While we are unable to disclose the details of our confidential financial negotiations with Janssen, we can reassure our shareholders that the proposed terms are commensurate with other multiproduct drug discovery deals of this size and scope.

DELIVERING ON OUR COMMERCIALISATION STRATEGY

Four Pharma deals in two years

We recognise the importance of keeping our shareholders updated on a regular basis and I am pleased to report that we are making excellent progress towards our goals on all fronts.

Several years ago, Phylogica embarked on a plan to become a specialist drug discovery company offering peptide discovery services to the pharmaceutical industry in exchange for upfront licence fees, milestone payments and a downstream share in revenue arising from any drugs we discover. The plan envisaged that as Phylogica's revenue grows from such discovery alliances, it will be able to advance its internal discovery programs further to achieve milestones which add additional value, which can be captured through outlicensing. The first part of this plan required that we validated our technology and refined the libraries and screening procedures to ensure that they were sufficiently robust and rigorous to be competitive at the international level. Having achieved this goal, we have focussed our attention on the commercialisation phase of the business.

To the great credit of our management team, in a two-year period, we have signed agreements with four of the top-ten global drug companies: Roche, MedImmune (AstraZeneca), Pfizer and Janssen (J&J). We are particularly proud of this achievement, as we are not aware of another Australian biotechnology company who has signed partnerships with major Pharma at this rate. These deals confirm that the Company's core capability has succeeded in one of the most competitive commercial worlds, proving Phylogica's skills and its commercial value to these critical clients.

None of our collaborative projects have been easy. Such is the nature of the drug discovery world we operate in, that we are typically presented with challenges, which even the largest Pharma companies continue to struggle with. Nevertheless, Phylogica is now building a track record of meeting these challenges and announcing the successful completion of its discovery programs. Moreover, each deal carries substantial down-stream revenue opportunities through preclinical and clinical milestone payments and royalties on sales.

There have been substantial advancements with each of our partnerships and I want to reassure our shareholders that all of our current relationships – Roche, MedImmune, Pfizer and Janssen – are progressing. With some of these companies, we are also discussing second deals that could be substantially larger than the first projects. Again, in the confidential world of drug development, we are not at liberty to disclose any details of these negotiations until they are finalised. However, we can confidently advise our shareholders that the results of the completed research projects are being evaluated by our respective partners. Once we have reached milestones here, we will certainly update the market, particularly to the extent that financial payments are triggered.

WELL POSITIONED TO SIGN NEW DEALS IN 2012

Contracts in late-stage negotiation

A number of new partnerships are in negotiation with major Pharma and also with large biotechnology companies. We expect to close our next deal in the near future, which will keep us on track to meet our revenue objectives for the current financial year.

While the time it takes for these contracts to be finalised may seem prolonged to outside observers, they have to be seen against the backdrop of major restructuring and strategic shifts in the Pharma industry, affecting most of our clients. These changes, while unsettling for the drug companies themselves as a number retrench, have had two impacts for Phylogica. Firstly, the time to settle a contract has often extended as new staff often take over responsibility for work that has been well advanced. In fact, the average time to negotiate a Pharma/ Biotech deal is 9-12 months, which matches Phylogica's own experience. Secondly, on a more positive note, the major drug companies are now outsourcing more and more R&D work and that has added to the opportunities for Phylogica.

Strategic discussions on a number of fronts

The Phylogica executives have been travelling extensively over the last few months. They have attended major international meetings, such as the JP Morgan Healthcare conference in San Francisco in January, and have recently returned from another partnering and investor road show in Europe and the USA at which they had dozens of meetings. More and more international drug companies are seeking meetings with Phylogica. This has driven the team to a number of indepth meetings with senior R&D groups at many different companies to explore concrete opportunities for discovery alliances.

For the first time there have been requests for Phylogica to meet with the investment arms of major drug companies. Most big Pharma have set up independent corporate investment teams. These are intended to run independently of their licensing and business development groups, but it seems probable that any approach is driven in part by the Pharma's strategic interest. In these meetings, Phylogica is being considered as an investment opportunity either as part of a drug discovery collaboration or in its own right, independently of whether there is an imminent deal with the parent pharmaceutical company.

ADDING VALUE TO THE CORE ASSET

Optimising the Phylomer libraries

Phylogica is in the enviable position of controlling access to an entire class of peptide drugs. While Phylogica's accumulating revenue streams remain important as a route to becoming cash flow sustainable, the main value of the Company is its core asset: the Phylomer libraries. It may be helpful to consider an analogy from the oil industry, in which Phylogica can be compared to the discoverer and owner of vast oil fields, who can control access to these fields, licensing rights to large oil companies (analogous to large pharmaceutical companies).

Generally, both oil fields and drug libraries are ultimately acquired for their impact on the future revenues of the acquirer. This is why the exit value of drug library companies and oil exploration companies does not typically correlate with their contractual revenues or stage of development. For example in the last few years, several library companies with lower revenues than Phylogica have been acquired for hundreds of millions of dollars (eg. Domantis: purchased by GlaxoSmithKline for US$454 million in 2007 despite negligible revenue and no clinical candidates).

Always mindful of the likelihood of an eventual trade sale exit around exclusive access to the Phylomer libraries, Phylogica continues to improve and validate its Phylomer library asset. In the last year, Phylogica made eight new Phylomer libraries and is currently constructing additional libraries as part of the Janssen collaboration. Moreover, the success of the Roche, MedImmune and Pfizer collaborations has demonstrated the versatility of the Phylomer libraries to allow the discovery of unique cell penetrating peptides, anti-infectives and vaccine candidates, respectively.

PHENOMICA: CREATING NEW MARKET OPPORTUNITIES

Exploiting Phenomica with Cambridge University

Most drugs are still discovered directly through the biological effects that they exert (ie: their 'Phenotype')1 . In fact, such a 'phenotypic screening' approach has lead to the discovery of many of the most important drugs, including Aspirin, Taxol and Penicillin. This approach has been made more efficient through the development of new 'proteomics' technology in recent years for the identification of the targets of such biologically active drugs.

Over a three-year collaboration with Cambridge University in

the UK, Phylomer libraries have been shown to be an ideal tool for the discovery and validation of new drug targets because of their vast structural diversity, resulting in a high quality and quantity of Phylomer hits against diverse targets. Because newly discovered targets might eventually be hit with a variety of different classes of drug, including antibodies, peptides and conventional 'small molecule' drugs, the market for Phylogica's services has been significantly expanded by this new application of the libraries.

Several pharmaceutical companies who have seen the results of our work with Cambridge University have expressed interest in accessing our target discovery and validation services, which are increasingly in demand as the 'low-hanging fruit' of conventional target space becomes increasingly scarce. This presents an opportunity for Phylogica to expand its customer base, to include those Pharma companies that are focused on small molecule rather than peptide drug discovery. To exploit this opportunity, Phylogica has been working with Cambridge University to assemble a set of tools under the 'Phenomica' brand to allow screening for new targets on an industrial scale.

A patent was filed earlier this month to cover this new method for target identification which also facilitates identification of the sites within each target that when hit with a drug, result in the desired therapeutically relevant effect (ie: Phenotype). Another technology has been developed which will, for the first time, allow the rapid screening of up to ten million Phylomers at a time in less than one week, to discover new targets at a fraction of the cost of conventional approaches.

Phylogica expects to sign its first Pharma deal around access to Phenomica's phenotypic screening platform later this year.

STRENGTHENING THE BOARD OF DIRECTORS

Appointment of highly experienced biotech Director

We were delighted to announce last week the appointment of Mr Jeremy Curnock Cook as a Non-Executive Director.

Mr Curnock Cook is an experienced entrepreneur, fund manager, executive and non-executive director in the life science sector. He is currently Executive Chairman of International Bioscience Managers Limited and was the former head of the life science private equity team at Rothschild Asset Management, based in the UK, and an active investor in the Australian life science sector.

Over his 40-year career, Mr Curnock Cook has specialised in creating value in emerging biotech enterprises, through active participation with management. He has served on over

40 Boards in various roles, including Chairman, of private and public companies listed on NASDAQ, LSE, TSX and ASX. As Phylogica seeks to build on the success of its discovery alliance activities as a core revenue and value driver, we believe Mr Curnock Cook's experience will be invaluable to the Board.

I spoke with Mr Curnock Cook about his reasons for joining the Board, his thoughts on the technology and his perception of Phylogica's next steps.

Chairman: "Jeremy, welcome to the Board. What attracted you to join Phylogica?"

Mr Curnock Cook: "I was particularly attracted to the opportunity to develop Phylogica's strategy, because it is not often that one has the opportunity to help grow a company, which controls global access to a new source of proprietary therapeutics. This is an important period of transition for the Company since it is only two years into the commercialisation phase and as it continues to validate its technology, both scientifically and through accumulating Pharma alliances. I believe that if Phylogica continues on its current trajectory, the Company will prove an attractive acquisition target for the pharmaceutical industry."

Chairman: "What are your thoughts on the competitiveness of the Phylomer platform?"

Mr Curnock Cook: "The structural diversity of the Phylomer libraries makes them an ideal source of novel peptides, whether for specific binding to therapeutic targets; for penetration of specific cell types; or for identifying and validating novel therapeutic targets. The data are impressive compared to anything that I have seen in the industry, particularly against difficult-to-drug targets. In my view, Phylogica has created a highly valuable platform for drug discovery that is uniquely positioned in the pharmaceutical market."

Chairman: "What do you perceive as the next stage of growth for Phylogica?"

Mr Curnock Cook: "The management team has achieved a lot over the past two years. To have signed four deals with such high quality names in the pharmaceutical industry is clear validation of the technology. In terms of the next stage of growth, I expect that the discovery alliance activities will accelerate as a result of the Company's success to date with the existing partnered projects. Also, my understanding is that the size and scope of the deals in negotiation could be significantly larger than previous deals. In addition, as Phylogica establishes itself in the growing market of target identification and validation, I expect this will become an important source of new revenue, also providing new opportunities for the Company to expand its patent estate."

SUMMARY

Phylogica has a rich pipeline of new deal opportunities ahead of it. These include: more multi-product collaborations potentially with equity investments from our Pharma partners; new revenue streams from the Phenomica collaboration with Cambridge University on target discovery and validation; and deals with other biotech companies with synergistic capabilities to Phylogica. This myriad of discussions serves to emphasise that Phylogica is now a firmly recognised entity in the international world of drug discovery, and is being engaged for its unique skills and achievements.

From all the above, accepting the limitations imposed by confidentiality obligations, you might understand the frustration of the Directors at the lack of recognition in the share price of Phylogica's growing stature in the global drug discovery field. The market for peptide drugs has accelerated greatly in recent years, particularly over the past 18 months. This is an attractive market environment for Phylogica. We believe that these positive factors will work in concert to support our value recognition so that the share price more accurately reflects our true worth.

I remain excited to be part of this great Company on the road to building a truly world-leading biotech company in the field of peptide drug discovery. Our progress on this journey is evident from our growing list of Pharma partners and our increasing international recognition and reputation within the industry.

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PHYLOGICA (ASX: PYC) Contact Nick Woolf, CFO and VP Corporate Development Email nwoolf@phylogica.com Telephone +61 (0) 417 986 005 Address PO Box 8207 Subiaco East, Western Australia 6008

www.phylogica.com