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Optiscan Imaging (ASX: OIL) Initiation of Coverage – Tuesday 18 April 2017

Phoenix from the ashes

Optiscan Imaging has historically been an important player in the field of live micro-imaging, where powerful microscopes are used to image internal organs at the cellular level in real time for surgery and during diagnostic procedures such as endoscopy. In the 1990s the company introduced one of the first fibre optic confocal microscopy devices, while its Pentax ISC-1000, FDA approved in late 2004, was the world’s first flexible endomicroscope. The commercialisation of this landmark instrument stalled in 2007 and 2008 due to a combination of factors - Pentax was taken over by Hoya not long before the Global Financial Crisis, which led to cancellation of all Pentax-originated research and development, leading in turn to the discontinuation of the Pentax ISC-1000. Ten years later, we see the phoenix rising from the ashes. Last year a new leadership team took office at Optiscan, focused on gaining commercial outcomes from the historic A$100m that has been invested in the company since the 1990s. With the support of Carl Zeiss Meditec AG, the German manufacturer of optical systems, Optiscan is now nearing completion of its second-generation device specifically designed for neurosurgery, which has the potential to become a new gold standard for brain tumour surgery by making current practice obsolete. We expect this device will gain FDA approval later this year. We see the new product and the new Optiscan pipeline as helping to re-rate the stock. We value Optiscan at 11 cents per share base case and 25 cents per share optimistic case. Our 17-cent target price sits at around the midpoint of our valuation range.

Rating Risk Current price Target price

Buy Medium $0.095 $0.17

Stock details Daily Turnover: ~A14,000 Market Cap: A$35.7m Shares Issued: 376.1m 52-Week High: $0.11 52-Week Low: $0.027

Analyst: Stuart Roberts [email protected] +61 447 247 909

Please note: Please refer below for risks related to Optiscan Imaging as well our General Advice Warning, disclaimer and full disclosures. Also, please be aware that the investment opinion in this report is current as at the date of publication but that the circumstances of the company may change over time, which may in turn affect our investment opinion.

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Report on Optiscan Imaging (ASX: OIL) 18 April 2017


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Ferry at the end of a rainbow on Sydney Harbour, August 2014




In this report Financial summary..................................................................................................................................... 4

Ten reasons to consider Optiscan Imaging ............................................................................................... 6

The era of endomicroscopy is here ........................................................................................................... 7

Optiscan’s world-leading endomicroscope............................................................................................. 10

Why microendoscopy works in neurosurgery ......................................................................................... 12

Carl Zeiss Meditec is a great partner to have .......................................................................................... 14

Upside beyond the forthcoming Zeiss device ......................................................................................... 15

Better flexible endomicroscopes are coming ......................................................................................... 15

Potentially significant upside from ViewnVivo ....................................................................................... 16

Optiscan’s earnings profile and valuation ............................................................................................... 17

Building with Optiscan’s new leadership team ....................................................................................... 18

Appendix I – An Optiscan Glossary ......................................................................................................... 18

Appendix II – Optiscan’s IP position ........................................................................................................ 20

Appendix III - Major shareholders ........................................................................................................... 22

Appendix IV – Key relevant papers.......................................................................................................... 22

Appendix V – Background to Optiscan Imaging ..................................................................................... 23

Appendix VI – Optiscan’s capital structure ............................................................................................. 26

Risks related to Optiscan Imaging .......................................................................................................... 27

General Advice Warning, Disclaimer & Disclosures ................................................................................ 28




Financial summary

Code OIL Rating BUYAnalyst Stuart Roberts Price target $0.170Date Upside/downside 78.9%Share price $0.0950 Valuation $0.112 / $0.25Market capitalisation $36m Valuation method DCFYear end 30 June Risk Medium

PROFIT AND LOSS (A$m) EARNINGS (A$m)

Y/e June 30 (A$m) FY15A FY16A FY17E FY18E FY19E Y/e June 30 FY15A FY16A FY17E FY18E FY19E

Revenue 1.0 1.4 1.3 4.0 9.6 Net profit ($m) -1.4 -1.3 -3.1 0.2 2.8

EBITDA -1.4 -1.2 -3.1 0.3 4.0 EPS (c) -0.7 -0.6 -0.8 0.0 0.7

D&A 0.0 -0.1 0.0 0.0 0.0 EPS growth (%) N/A N/A N/A N/A 1489%EBIT -1.4 -1.3 -3.1 0.3 4.0 P/E ratio (x) -13.2 -15.7 -11.3 207.5 13.1Net interest 0.0 0.0 0.0 0.0 0.0 CFPS (c) -0.8 -0.2 -0.5 0.1 0.8Pre-tax profit -1.4 -1.3 -3.1 0.3 4.0 Price/CF (x) -12.6 -41.2 -20.2 87.2 12.5

Tax 0.0 0.0 0.0 -0.1 -1.2 DPS ( c ) 0.0 0.0 0.0 0.0 0.0

NPAT -1.4 -1.3 -3.1 0.2 2.8 Yield (%) 0.0% 0.0% 0.0% 0.0% 0.0%Minority interests 0.0 0.0 0.0 0.0 0.0 Franking (%) N/A N/A N/A N/A N/ANet profit after minorities -1.4 -1.3 -3.1 0.2 2.8 EV/EBITDA -26.0 -30.2 -10.8 98.3 7.6

EV/EBIT -25.8 -26.8 -10.7 111.5 7.7

BALANCE SHEET (A$m)

Y/e June 30 FY15A FY16A FY17E FY18E FY19E PROFITABILITY RATIOS

Cash 0.3 1.0 2.0 2.5 5.3 Y/e June 30 FY15A FY16A FY17E FY18E FY19E

Current receivables 0.7 0.8 0.5 0.6 0.8 EBITDA/revenue (%) N/A N/A N/A 8.5% 41.5%Inventories 0.0 0.0 0.0 0.1 0.4 EBIT/revenue (%) N/A N/A N/A 7.5% 41.1%Other current assets 0.0 0.0 0.1 0.1 0.1 Return on assets (%) -137.0% -73.4% -115.9% 5.0% 41.3%

Current assets 1.0 1.8 2.6 3.3 6.6 Return on equity (%) 797.1% 178.3% -178.1% 7.2% 50.0%Return on funds empl’d (%) -416.4% -357.5% -175.5% 7.1% 49.7%

PPE 0.0 0.0 0.1 0.1 0.1 Dividend cover (x) N/A N/A N/A 0% 0%Intangible assets 0.0 0.0 0.0 0.0 0.0 Effective tax rate (%) 0.0% 0.0% 0.0% 43.3% 30.0%Other non-current assets 0.0 0.0 0.0 0.0 0.0Non-current assets 0.0 0.0 0.1 0.1 0.1 LIQUIDITY AND LEVERAGE RATIOS

Y/e June 30 FY15A FY16A FY17E FY18E FY19E

Total assets 1.0 1.8 2.7 3.4 6.7 Net debt/(cash) ($m) 0 0 -2 -2 -5Net debt/equity (%) -137.7% -22.5% -111.0% -100.5% -95.4%

Payables 0.4 1.2 0.7 0.8 0.9 Net interest cover (x) N/A N/A N/A N/A N/A

Debt 0.5 1.1 0.0 0.0 0.0 Current ratio (x) 0.8 0.7 2.8 3.2 5.7

Other liabilities 0.3 0.2 0.2 0.2 0.2

Total liabilities 1.2 2.6 0.9 1.0 1.2 INTERIMS

Y/e June 30 ($m) 2H15A 1H16A 2H16A 1H17F 2H17F

Shareholders’ equity -0.2 -0.8 1.8 2.4 5.6 Revenue 0.7 0.6 0.8 0.7 0.5Minorities 0.0 0.0 0.0 0.0 0.0 EBITDA -0.5 -0.7 -0.4 -2.2 -1.0

Total shareholders funds -0.2 -0.8 1.8 2.4 5.6 D&A 0.0 0.0 -0.1 0.0 0.0

EBIT -0.5 -0.7 -0.6 -2.2 -1.0Total funds employed 1.0 1.8 2.7 3.4 6.7 Net interest 0.0 0.0 0.0 0.0 0.0

Pre-tax profit -0.5 -0.7 -0.6 -2.2 -1.0

W/A shares on issue 194 221 375 378 382 Tax 0.0 0.0 0.0 0.0 0.0NPAT -0.5 -0.7 -0.6 -2.2 -1.0

CASH FLOW (A$m) Minority interests 0.0 0.0 0.0 0.0 0.0

Y/e June 30 FY15A FY16A FY17E FY18E FY19E Net profit after minorities -0.5 -0.7 -0.6 -2.2 -1.0NPAT plus discontinued ops. -1.4 -1.3 -3.1 0.2 2.8Non-cash items 0.0 0.2 1.0 0.4 0.4 VALUATIONWorking capital -0.1 0.6 0.4 -0.2 -0.3Other operating cash flow 0.0 0.0 0.0 0.0 0.0

Operating cashflow -1.5 -0.5 -1.8 0.4 2.9

Base OptimisticCapex 0.0 0.0 -0.1 -0.1 0.0 Value of business 44.6 100.1Investments 0.0 0.0 0.0 0.0 0.0 Value of tax losses -0.5 -0.5Other investing cash flow 0.0 0.0 0.0 0.0 0.0 Corporate overhead -3.9 -3.9Investing cashflow 0.0 0.0 -0.1 -0.1 0.0 Cash now (A$m) 3.1 3.1

Cash to be raised (A$m) 0.0 0.0Change in borrowings 1.1 0.5 -0.5 0.0 0.0 Option exercises (A$m) 1.6 1.6Equity raised 0.6 0.7 3.4 0.1 0.0 Total value (A$m) 45.0 100.4Dividends paid 0.0 0.0 0.0 0.0 0.0 Total diluted shares (million) 401.6 401.6Other financing cash flow 0.0 0.0 0.0 0.0 0.0 Value per share $0.112 $0.250Financing cashflow 1.7 1.2 2.9 0.1 0.0 Valuation midpoint $0.181

Share price now (A$ per share) $0.095Net change in cash 0.2 0.7 1.0 0.5 2.9 Upside to midpoint 90.5%

Cash at end of period 0.3 1.0 2.0 2.5 5.3

18 April, 2017




Introducing Optiscan Imaging (ASX: OIL) Who is Optiscan Imaging? Optiscan Imaging has been a global pioneer in the field of live micro-imaging, where

powerful microscopes are used to image internal organs at the cellular level in real time for surgical and diagnostic

purposes. In the early 2000s, in conjunction with the Japanese camera company Pentax, Optiscan used its know-

how in confocal laser microscopy to develop the world’s first flexible endomicroscope for use in gastrointestinal

imaging. The company is now getting ready to launch a second-generation endomicroscope, this time with the

support of Carl Zeiss Meditec, the major German manufacturer of optical systems. We expect that the new device,

which is around 70% smaller than its predecessor, will gain its first regulatory approval in 2017. We see potential

for this product to enjoy rapid uptake, driven by neurosurgeon and patient demand.

What is confocal laser microscopy and why is it important in modern medicine? In confocal laser microscopy,

a laser light is focused onto a very small spot on a tissue sample that has been stained with a ‘contrast agent’ such

as fluorescein sodium and then scanned across the whole sample, building up a visual image in a similar fashion to

the way television images are created point by point. Confocal laser microscopy allows images of extraordinary

detail to be assembled at high levels of magnification, typically 1000-fold. This has obvious medical applications

where the ability to image at the cellular and subcellular mucosal layer can allow diseased tissue to be identified

and removed in real time, and where the next best imaging modality – MRI – is expensive. However, up until now,

this level of magnification has typically only been available to clinicians and scientists through biopsy specimens

examined in pathology laboratories. Optiscan hopes to change all that with a non-invasive ‘virtual biopsy’.

What is an endomicroscope? An endoscope is a is a long tube, either flexible or rigid, with a lens at one end and

a video camera at the other allowing internal body parts to be visually examined. An endomicroscope is simply an

endoscope in which a microscope is placed at the lens end of the device, allowing the tissue being visualised to be

magnified as well. Optiscan was one of the first companies in the world to develop an endomicroscope with the

Pentax ISC-1000, which gained FDA approval in late 2004 and was launched by Pentax in 2006. This product has

since been used in a variety of indications, particularly in the diagnosis and management of gastrointestinal

disorders.

What is Optiscan’s second-generation endomicroscope? The product which Optiscan is developing, in

conjunction with Carl Zeiss, is a rigid endomicroscope for use in neurological imaging applications. The new device

will be 70% smaller than the old Pentax system, taking advantage of developments over the last decade in high

definition imaging and image processing.

Who is Carl Zeiss Meditec? Carl Zeiss Meditec1 is a significant supplier of optics-based medical equipment, with

FY162 revenue of €1.09bn and EBIT of €154m. The company has two major franchises, in ophthalmology and in

microsurgery, with the latter business a leading supplier of surgical microscopes for use in a range of treatments.

Carl Zeiss estimate it has more than 50% of the global market for surgical microscopes3. We believe the decision

1 Jena, Germany, Xetra: AFX, www.zeiss.com/meditec-ag. 2 Year to September 30. 3 Source: Carl Zeiss Meditec, 2014/15 Annual Report, page 33.

OPTISCAN IS A WORLD LEADER IN SURGICAL IMAGING TECHNOLOGY




of this company to work with Optiscan bodes well for market acceptance of the upcoming second-generation

endomicroscope.

If Optiscan is so good, how come the company is only capitalised at A$36m? We believe the company’s

apparent failure to progress its second-generation rigid endomicroscope since 2007 has until recently seriously

depressed sentiment towards Optiscan stock. Also, the company has not actively communicated its story to

investors for several years now. However, we believe that with a new leadership team in place, and the new

endomicroscope now nearing commercialisation, sentiment has already begun to change for the better. The new

leadership have clearly reversed Optiscan’s fortune by reconnecting with its long term and new shareholders,

stabilising its finances and focusing on delivering commercial products.

Ten reasons to consider Optiscan Imaging 1. Optiscan has considerable know-how in the field of microscopic imaging technologies. This

company, founded in 1994, was a pioneer of fibre optic confocal microscopy in the 1990s and in 2006

helped launch the world’s first flexible endomicroscope. Roughly A$100m has been invested in Optiscan

over the last two decades. The know-how acquired with this funding, embodied in numerous long-dated

US patents covering Optiscan’s core intellectual property, has enabled the company to successfully

develop a second-generation product, despite the funding constraints that company has faced since

2008.

2. Optiscan currently has a second-generation endomicrosope in the works. This product is around 70%

smaller than the original device, but has considerably improved imaging power. The first prototypes

were handed over to Zeiss in May 2016.

3. Zeiss is a good partner to have. Carl Zeiss Meditec unit is a world leader producer of surgical

microscopes and ‘microsurgical visualisation’ solutions with a worldwide marketing, distribution and

support network. We believe that Zeiss has shown itself to be a strong partner for Optiscan, having

support the development of the second-generation endomicroscope since 2007. With Zeiss aggressively

expanding in this field, we believe they will be a strong marketing partner from later in 2017 when the

product is launched.

4. Optiscan’s device has the potential to be transformational. With live micro-imaging useful across a

range of surgical procedures from neuro to ENT (ear, nose and throat) to spinal, we expect Optiscan’s

device will attract a great deal of attention at its launch later this year. For the neurosurgeon treating

brain tumours, the device has the potential to be transformational. For the first time, he will be able to

see live tumour cells in theatre, in real time, with immediate feedback. This avoids the current surgical

practice of relying on time-consuming, expensive and potentially dangerous and unrepresentative

biopsies sent repeatedly to the histopathologist during prolonged operations. This has potentially very

favourable impacts on surgical operating times and patient outcomes.

5. Optiscan’s ViewnVivo product has good prospects in the research field. Benchtop researchers have

never had the kind of live micro-imaging power now coming available with the upcoming Zeiss device.

OPTISCAN IS PARTNERING WITH ZEISS ON ITS NEXT MAJOR PRODUCT




With Optiscan now making this available under the ViewnVivo brand, we expect a strong sales response

for the new research tools.

6. Optiscan has few competitors in the live imaging field. We argue that the only real competitor which

Optiscan faces is a French company called Mauna Kea Technologies. We see Optiscan’s technology as

representing a superior offering to that of Mauna Kea, who was a later arrival than Optiscan in the field.

7. The market for Optiscan’s products is growing rapidly. With a strong trend towards minimally invasive

surgery driving double-digit growth in the usage of the relevant tools, Optiscan is well-placed to grow its

live micro-imaging offering.

8. Optiscan has strong clinical relationships, with many top tier hospitals around the world having hosted

clinical studies of the company’s devices over the years. This provides considerable credibility for

Optiscan as it seeks the buy-in of Key Opinion Leaders for its current product suite.

9. Optiscan has a new, commercially-focused leadership team. Under a revamped board which was

installed in May 2016, and under new CEO Archie Fraser, who joined around that time, Optiscan is now

focused on realising shareholder value from its existing live micro-imaging projects as well as its

considerable technology base in the field.

10. Optiscan is undervalued on our numbers. We value Optiscan at 11 cents per share base case and 25

cents per share optimistic case. Our target price of 17 cents sits at the midpoint of these two numbers.

We see Optiscan re-rating on the back of a progress in the Zeiss collaboration as well as a good reception

for the company’s LIVE1 research system.

The era of endomicroscopy is here The endomicroscopy field is getting ready to mainstream. Confocal laser endomicroscopy (CLE) has been

around for a while now. The Pentax ISC-1000 system that Optiscan developed, which was the world’s first flexible

CLE device, gained 510(k) approval from the FDA in October 2004 while its competitor, a system called Cellvizio,

from a French company called Mauna Kea Technologies4, gained its 510(k) in September 2005. However, we argue

that it is only now that CLE is mainstreaming as an imaging modality. For proof of this, consider the International

Society for Endomicroscopy, or ‘IS4E’ for short5, whose mission is to promote the use of real-time microscopic

imaging technologies in the diagnosis and treatment of disease. IS4E only started up in October 2016 and held its

first annual meeting in April 2017 in New York.

4 Paris, France, Euronext Paris: MKEA, www.maunakeatech.com. 5 www.is4e.org.

OPTISCAN HAS A NEW, COMMERCIAL LEADERSHIP TEAM




Figure 1: Publications on confocal laser endomicroscopy6

Why endomicroscopy has become an increasingly accepted imaging tool. If one were to describe the future of

surgery in one sentence, it would this this: less invasive, more roboticised and better imaged7. Consequently,

Optiscan’s products are arguably on the right side of history. We see seven main reasons why CLE is becoming

increasingly commonplace in hospitals and in research labs around the world:

- The commercial success of the CLE pioneer Mauna Kea, which has consistently grown its user base in

recent years and in calendar 2016 enjoyed €8.8m in revenue;

- The increasing number of publications on CLE, with seven or eight papers added to the knowledge base

each month (see Figure 1), helping to increase interest in the technology by surgeons;

- The proven ability of CLE to diagnose premalignant and malignant lesions in the gastrointestinal tract,

reducing the need for potentially dangerous and expensive traditional tissue biopsy8;

- Endorsement by professional associations, such as in 2015 when the American Gastroenterological

Association deemed CLE an appropriate alternative to random biopsies in the management of Barrett's

Esophagus9;

- Increasing use of CLE tools by brain surgeons, who now have a tool that can visualize the cells of a brain

tumour as they are operating on the brain10;

- Use of CLE in imaging other tumours, as diverse as squamous cell carcinoma11, bladder cancer12, lung

cancer13 and upper urinary tract carcinoma14;

6 Source: PubMed. 7 See The Future of Surgery: Less Cutting, More Robots by Sarah Laskow, The Atlantic, 2 October 2014. 8 PLoS One. 2016 May 4;11(5):e0154863. eCollection 2016. 9 Clin Gastroenterol Hepatol. 2015 Dec;13(13):2209-18. Epub 2015 Oct 14. 10 See Neurosurg Focus. 2016 Mar;40(3):E11 and Neurosurgery. 2015 Aug;62 Suppl 1:171-6. 11 Br J Dermatol. 2007 Jan;156(1):81-4. 12 Int J Oncol. 2003 Mar;22(3):523-8. 13 Rom J Morphol Embryol. 2016;57(4):1221-1227. 14 Curr Opin Urol. 2017 Mar;27(2):170-175.

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OPTISCAN’S TECHNOLOGY IS GOING MAINSTREAM




- Increasing research use of CLE by groups where the future therapeutic benefit can be significant.

Consider, for example, the landmark 2010 work by scientists at Mainz University in Germany which

showed that intramucosal bacteria in inflammatory bowel disease could be imaged using CLE15, or some

work from 2014 at the University of Munich showing that CLE could potentially improve testicular sperm

extraction procedures used for treating infertility16.

Mauna Kea has pioneered CLE, making it acceptable to researchers and surgeons alike. Mauna Kea17 may have

come in behind Optiscan in terms of having a CLE system on the market, but, unlike Optiscan, it has stayed in the

business in the years since 2005 in terms of consistently growing the installed base of Cellvizio. Thus, there are

now over 500 Cellvizio systems in operation around the world, with the number currently increasing at >10% p.a.

We see Mauna Kea as having greatly raised the credibility of CLE over the last ten years:

- The company was instrumental in securing category 1 CPT codes to allow CLE to be reimbursed in the

US18. It has also obtained endorsements and recommendations from key US medical professional

bodies;

- The company released a second-generation system called Cellvizio 100 in 201119, greatly increasing the

usability, and therefore the physician appeal, or CLE20;

- The company has conducted multiple studies to demonstrate the utility of CLE, and helped to move use

of its system beyond gastrointestinal applications21;

- The company is now pioneering the use of CLE with robotic surgery solutions.

Mauna Kea is vulnerable to competition. Mauna Kea may have effectively pioneered the CLE market, but it is

still a small company, with a market capitalisation of only US$56m22, in part because it has yet to turn a profit and

also because its growth was stalled by a tough sales climate in 2015. It is therefore vulnerable to established

medical device companies which choose to enter this market with superior products backed by larger marketing

budgets. Carl Zeiss Meditec believes that it has the right product in Optiscan’s forthcoming second-generation

device, and the German company’s size - FY1623 revenue of €1.09bn and EBIT of €154m – suggests it has the

requisite firepower to get established. The market has been betting against Mauna Kea’s prospects in this market

since April 2014 (see Figure 2).

Once endomicroscopy has mainstreamed, the opportunity is significant. Optiscan estimated in 2007 that the

flexible endomicroscope market opportunity was US$1.2bn while the rigid endoscope opportunity was another

US$1bn24. The flexible segment at that time primarily represented the gastrointestinal opportunity where only a

flexible endoscope can properly access the target tissue. For most other applications, the rigid versus flexible

15 Gut. 2011 Jan;60(1):26-33. Epub 2010 Oct 27. 16 J Biophotonics. 2015 May;8(5):415-21. Epub 2014 Jul 3. 17 Named after the dormant volcano on Hawaii’s ‘Big Island’. 18 Category I is the most common and widely used set of codes within CPT, describing most of the procedures performed by healthcare providers in inpatient and outpatient offices and hospitals. 19 See the Mauna Kea press release dated 29 August 2011 and headlined ‘Mauna Kea Technologies receives FDA clearance for next-generation Cellvizio system’. 20 Cellvizio 100 had much better image quality and a ‘Cine Review’ feature allowing focus on a single frame of clinical evidence for as long as necessary. There was also improved user interface, faster start up and shut down times, and the ability to easily export images to the patient's Electronic Health Record. 21 See, for example, NCT03013894 at clinicaltrials.gov, which is evaluating the use of CLE in the lower urinary tract. 22 13 April 2017 close on Euronext. 23 Year to September 30. 24 See the company’s 10 July 2007 presentation to the Australian Bio-Investment Forum, slide 4.

OPTISCAN IS GOING AFTER BILLION DOLLAR MARKETS




distinction is probably less important in 2017 given endoscope probes are set to decline in size, making the whole

device smaller. US$2.2bn is a lot bigger than the mere €8.8m Mauna Kea enjoyed in 2016, but reflects the potential

once endomicroscopy is being marketed by companies of Zeiss’s scale, and the efficiency benefits of surgery using

endomicroscopy become apparent.

Figure 2: The market has been betting against Mauna Kea for three years now

Optiscan’s world-leading endomicroscope There are two basic kinds of Confocal Laser Endomicroscope –Optiscan’s and Mauna Kea’s. We noted above

that Optiscan and Mauna Kea both developed CLE systems at around the same time. The two systems reflect

different technology paradigms:

- Mauna Kea’s approach of ‘Proximal Scanning’. In this approach, there’s a bundle of up to 30,000 optical

fibres in the probe, and a scanner to gather the light from each fibre at the proximal end of the probe,

that is, the point closest to the human viewer. This approach allows for probe-based CLE, where the

imaging probe is small enough, thanks to the miniscule size of fibre, to be insertable into the working

channels of standard endoscopes.

- Optiscan’s approach of ‘Distal Scanning’. In this approach, there’s a single optical fibre probe, and a

MEMS-based scanner at the ‘distal’ end of the probe, that is, the point farthest away from the human

viewer. The image is built up by the scanner moving back and forth and up and down through the sample

and sending the light back up the optical fibre. The probes that can be developed through this approach,

because they have historically been too big to fit into the channels of a standard endoscope, had to be

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THE MARKET HAS BEEN BETTER AGAINST MAUNA KEA FOR THREE YEARS NOW




custom-built into the endoscope itself. The big advantage of this endoscope-based CLE is that the image

quality is such higher25.

Which is better – Optiscan’s or Mauna Kea’s? As you’d expect, there are advantages and disadvantages with

each approach:

- Optiscan is better for image resolution. For the Pentax ISC-1000 the axial resolution - the ability to

properly distinguish a structure in terms of its depth – was 4.5 m, while the lateral resolution – the ability

to distinguish in two dimensions – was 0.5 m. The field of view, which is what the user could see across

his whole screen, was 500 m. For Mauna Kea’s Cellvizio the comparable figures are 20 m, 2.5 m and 450

m respectively, if you are using a large field-of view probe. The reason why Optiscan users can see better

is that there are no gaps in the image, whereas with Mauna Kea the spaces between each optical fibre

represent gaps that don’t get properly imaged, and therefore have to be interpolated with software.

- Optiscan is better for capturing depth. Without changing the probe, the Pentax ISC-1000 could image

all the way down to 250 m. By contrast, with the Mauna Kea system you can only image at a single fixed

depth, due to the fact that the scanner is blocked from the tissue by the bundle of fibres. Consequently,

If you want to image at a different depth you have to change the probe, and there are probes for 0 m, 30

m, 50 m and 80m.

- Optiscan is better for workflow. When you have an endoscope that does CLE, like the Pentax ISC-1000,

you can image tissue at the same time as you physically biopsy that tissue. With probe-based CLE like

Mauna Kea’s you must remove the probe from the endomiscroscope before you can biopsy. With the

next-generation Optiscan device the imaging power becomes so good a physical biopsy becomes

unnecessary.

- Mauna Kea has been better for size. The big advantage for Cellvizio was you can have a smaller probe

when it is just optical fibre at the distal end. A probe can go as low as 0.3 mm in diameter, meaning that

it can get into tighter spaces such as pancreatic and biliary canals, or lung bronchioles. The downside is,

of course, that one has a smaller field of view with a probe that small, but it suggests strong competitive

advantage against the Pentax ISC-1000, whose scanhead diameter was fixed at 5 mm. With Cellvizio you

could scan organs such as the urinary tract. With Optiscan’s technology it wasn’t believed that you could.

- Mauna Kea has been better for frame speed. The Pentax ISC-1000 has an image refreshment frequency

of around 1 to 6 images per second. Cellvizio could do 12 frames per seconds26. Optiscan has traditionally

argued that the difference isn’t meaningful, but it did provide a marketing advantage to Mauna Kea.

If Optiscan’s original endomicroscope product was so good, how come it was a market failure? The problem

for Optiscan with the Pentax ISC-1000 was that, while its microscope could be built directly into an endoscope, it

didn’t have the capability to develop such an endomicroscope on its own, and had to partner instead. It chose to

go with Pentax, which had only around ~15-20% of the global endoscope market27. Consequently, when Pentax’s

businesses were rationalised after the Global Financial Crisis by Hoya, Optiscan was effectively left high and dry.

25 J Dig Dis. 2015 May;16(5):279-85. 26 Although it can go all the way up to 200 frames per second – see The FASEB Journal, April 2016, vol. 30 no. 1 Supplement 959.8 27 See the company’s 10 July 2007 presentation to the Australian Bio-Investment Forum, slide 13.

OPTISCAN’S TECHNOLOGY ALLOWS BETTER IMAGE RESOLUTION




By contrast, since Mauna Kea’s probe could plug in to any endoscope, so it could be used right across the market

without extra investment in new equipment. This proved to be the commercially correct development approach

at that time.

Optiscan believes that with this year’s new product, it can leapfrog the competition. The last decade has seen

rapid improvements in imaging technology right across the industrial, consumer and medical spectrum. These

developments, particularly those involving optical MEMS, have allowed Optiscan’s engineers to miniaturise the

components within its prototype second-generation CLE devices as well as improve their imaging power.

Optiscan has been working for ten years now on developing a next-generation CLE device. These efforts have

evolved since 2010 into a rigid CLE device that can be used in neurosurgical applications and is expected to be

launched by Optiscan’s commercial partner, Zeiss, in the second half of calendar 2017. We describe the history of

this product in Appendix V of this note. Optiscan has suggested that this forthcoming product will be 70% smaller

than the Pentax ISC-1000 and have 30 times the imaging capability of current Cellvizio. This breakthrough will be

driven by better imaging depth, a larger field of view and a faster ‘near video’ frame rate. Importantly, the structure

will be small enough and flexible enough along its length and breadth to fit into standard endoscope working

channels.

Why microendoscopy works in neurosurgery Better magnification means better surgical resection of brain tumours. The ability to directly see, in real time,

tumour cells will be transformative to brain tumour neurosurgery. The better the magnification, the easier it is for

the surgeons to cut out diseased tissue when using fluorescence-guided surgery. In the cases of brain tumours, an

increasing amount of evidence suggests that the more extensive the surgical resection, the longer the life

expectancy28, in part because patients need at least 4-5 weeks of recovery after their surgery before starting

radiotherapy, so the less cancer there is after surgery, the more effective the radiotherapy. The trouble with brain

tumour surgery historically has been twofold:

- The difficulty of ex vivo histologic validation to determine if the resected tissue harbours tumours on the

margins, since that would involve taking healthy tissue that could disrupt brain function.

- The difficulty of seeing diffuse or microscopic tumours.

While existing imaging modalities have gone some way towards solving these problems29 Optiscan’s new product

is expected to take the solution to a whole new level.

Early evidence that Optiscan’s CLE approach will work in brain tumour diagnosis and resection. When Zeiss

started working with Optiscan to adapt Optiscan’s CLE technology to a rigid endoscope for neurological

applications, it studied the Australian company’s FIVE1 system, ordinarily used in preclinical imaging. Several

28 See, for example, Curr Neurol Neurosci Rep. 2015;15(2):517 and Neurosurgery. 2008 Apr;62(4):753-64; discussion 264-6. 29 Photodiagnosis Photodyn Ther. 2008 Dec;5(4):260-3. Epub 2009 Feb 7.

OPTISCAN GETS BACK IN THE LEAD FROM THIS YEAR




neurosurgeons practising at the Barrow Neurological Institute in Phoenix, Az.30 that had relationships with Zeiss,

including Dr Nader Sanai, worked with this device and came away with favourable results31:

- Neurosurgery, June 201132. In 33 patients imaged with sodium fluoroscein, intraoperative CLE was found

by the Barrow group to be reliable in helping identify tumour cells and the tumour-brain interface.

- Journal of Neurosurgery, July 201133: At the Barrow, surgeons had historically found, when seeking to

surgically resect gliomas34, that only the glioblastoma subset of glioma would fluoresce when the

contrast agent was 5-aminolevulinic acid. When they used Optiscan’s device in low-grade glioma

patients, they could identify tumour fluorescence at the cellular level, and thereby find the brain/tumour

interface35.

- Journal of Neurosurgery, January 201236. In 28 lesions, the Barrow group found that intraoperative CLE

could diagnose a brain tumour in 26 of them – almost as well as the traditional frozen-section analysis by

a histopathologist.

- Neurosurgery, February 201437. Here the Barrow group demonstrates, in animal models of glioma, that

Optiscan’s CLE approach could distinguish normal brain from brain tumour using a variety of contrast

media38. A concurrently published paper showed that Optiscan’s CLE device could detect glioma cells

using fluorescently labelled tumour-specific antibodies39.

Evidence that the new CLE device can work. In May 2016, the Barrow researchers showed that the new device

could diagnose brain tumours as effectively as histopathology in only around 15 minutes per patient, and with

specificities and sensitivities north of 90%40.

Optiscan’s device is finishing Phase III. The Barrow researchers are principal investigators in a 192-patient

randomised, placebo-controlled Phase III study initiated in late 2010 called BALANCE (Barrow 5-ALA

Intraoperative Confocal)41 in which the approach used by Sanai et. al. above is used in both low and high grade

glioma. The primary endpoint in this study is the volume of residual disease, that is, the size of the tumour after

surgery. This study is only single blind (ie at the patient’s end). We understand data from BALANCE will be

available in mid-2017 ahead of a filing for 510(k) approval of the Zeiss/Optiscan device.

Post-approval, Zeiss and Optiscan will need to show a survival advantage. While the BALANCE study is

intended in the first instance to show that the CLE device improves tumour resection, its clinical utility will

ultimately depend on patient survival. As an aggressive cancer, survival rates for brain cancers tend to be low, at

around 35% on average42, and the evidence suggests that Overall Survival for glioma patients in the US is around

30 An institute associated with St. Joseph's Hospital and Medical Center, which is No. 16 on the US News Best Hospitals rankings for Neurology & Neurosurgery – see health.usnews.com/best-hospitals. 31 For some early pre-clinical work see Neurosurgery. 2010 Feb;66(2):410-7; discussion 417-8 and J Neurosurg. 2011 Dec;115(6):1131-8. Epub 2011 Sep 16. 32 Neurosurgery. 2011 Jun;68(2 Suppl Operative):282-90; discussion 290. 33 J Neurosurg. 2011 Oct;115(4):740-8. Epub 2011 Jul 15. 34 This is the brain tumour that killed America’s Senator Ted Kennedy (1932-2009). 35 The reason why the identification of low-grade glioma is significant is that cancer cells with a higher level of metabolic activity are more likely to fluoresce using traditional contrast media. 36 J Neurosurg. 2012 Apr;116(4):854-60. Epub 2012 Jan 27. 37 See Mooney et. al. for a review of CLE in neurology (Neurosurg Focus. 2014 Feb;36(2):E9) that accompanied the other two papers published in February 2014. 38 Neurosurg Focus. 2014 Feb;36(2):E16. 39 Neurosurg Focus. 2014 Feb;36(2):E12. A similar finding was reported in Surg Neurol Int. 2016 Dec 12;7(Suppl 40):S995-S1003. eCollection 2016 40 Neurosurg Focus. 2016 Mar;40(3):E11. 41 See NCT01502280 at www.clinicaltrials.gov. 42 Source: America Cancer Society, Cancer Facts and Figures 2017.

OPTISCAN IS CURRENTLY A PHASE III COMPANY




12-14 months. BALANCE will also track six-month Progression-Free Survival and Overall Survival. We believe that

if these numbers are favourable compared to the existing standard of care, the result could be heavy interest from

clinicians in the Zeiss/Optiscan offering.

The incidence of brain cancer is rising. In the US, there will be an estimated 24,000 new cases of brain cancer in

2017, and around 17,000 deaths. Brain cancer incidence in America has been rising at 2.2% p.a. since 2000 (see

Figure 3), faster than the 1.9% rate for cancers as a whole43, in part because of better detection of brain cancer44.

Blue sky for the Zeiss device – use in other neurological disorders. Worldwide, approximately 12% of deaths are

caused, directly or indirectly, by neurological disorders such as Alzheimer’s Disease, brain injuries, epilepsy,

Parkinson’s Disease, strokes, peripheral neuropathy, paralysis and brain aneurysmss. We see the ageing

populations of many Western world countries as helping drive uptake of live micro-imaging applications in the

neurological field. We expect that the ability to image brain tissue in real time can be useful for developing surgical

therapies for many neurological conditions.

Figure 3: There will be around 24,000 new cases of brain cancer in the US this year

-

Carl Zeiss Meditec is a great partner to have Zeiss is a well-heeled company. The first thing to note about Zeiss is that it has the scale to help establish live

micro-imaging in brain surgery as well as more broadly in general surgery and in diagnostics. As we noted above,

the company enjoyed FY16 revenue of €1.09bn and EBIT of €154m. Its current market capitalisation on Xetra is

about €3.77bn45.

43 Source: America Cancer Society, Cancer Facts and Figures 2017. 44 J Neurooncol. 2011 Sep;104(2):589-94. Epub 2011 Feb 17. 45 13 April 2017 close.

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AMERICA SEES 24,000 NEW CASES OF BRAIN CANCER EVERY YEAR




Zeiss has expertise in surgical microscopes, particularly those used in neurosurgery. Zeiss has a long history of

marketing visualisation solutions for neurosurgeons46. A good example is the Zeiss Pentero series of microscopes,

widely regarded as one of the best for wide-field fluorescence image-guided surgery47. These devices are able to

sell at a premium price48, although they have nowhere near the imaging power of the Optiscan-developed rigid

endomicroscope. Wide-field fluorescence imaging devices have a spatial resolution of tens to hundreds of microns

and typically magnify 10-fold. As we’ve previously seen, Optiscan can do 1,000-fold magnification with resolution

under a single micron.

Zeiss needs new growth for its microsurgery business. In the year to September 2016 Zeiss only grew its

microsurgery business by 1.3% at the revenue line. Adjusted for currency effects, the business declined during the

year by 0.9%. There was year-on-year growth in the December 2016 quarter, but only 0.2% in constant currency

terms. The Pentero product line, now about 12 years old, may be well regarded in the marketplace but it is always

in danger of losing ground to competitors with lower-priced products such as Leica. We believe that Zeiss is

interested in the neurosurgery CLE product from Optiscan as a way of maintaining its lead in the surgical

microscopes segment.

The path forward for Optiscan with the Zeiss relationship. We expect that Zeiss will launch in neurosurgery, but

ultimately look to branch out to other markets where rigid endomicroscope solutions are appropriate, such as in

ENT, spinal and breast cancer.

Upside beyond the forthcoming Zeiss device We see four medium term upside elements for Optiscan beyond the next Zeiss product

1) Growth in the Zeiss relationship. We see potential for a co-promote deal regarding the new device where

Zeiss markets it in certain regions and verticals while Optiscan takes the rights to other regions and

verticals. There is also the potential for Zeiss to leave the non-neuro indications of the new device,

beyond the licensed applications in spinal, ENT, and breast cancer, with Optiscan.

2) Introduction of Optiscan’s next-generation flexible endomicroscope probes in other surgical and

diagnostic applications such as gastrointestinal and women’s health;

3) Continued growth in the company’s ViewnVivo research product, which was relaunched in 2016.

4) Development of next-generation, AI-based systems with better ability to analyse images and assist

clinicians and surgeons in diagnosis and treatment.

Better flexible endomicroscopes are coming Optiscan has next-generation flexible endomicroscope probes ready to go. While Optiscan’s primary focus at

present is the Zeiss rigid endomicroscope product, the company has also developed probes that would now fit

46 See zeiss.com/meditec/int/products/neurosurgery.html. 47 Neurosurgery. 2014 Jul;75(1):61-71. 48 A typical sticker is US$500,000 in the US – see Unique microscope aids hospital’s neurosurgeons by Chistina Cox, The Signal, 8 February 2017.

ZEISS IS A WORLD LEADER IN SURGICAL MICROSCOPES




comfortably inside flexible endoscopes. We describe the history of these new probes in Appendix V of this note.

The upside from here, should these new probes go into clinical development, are significant:

- A new flexible endomicroscope would allow Optiscan to re-engage potential partners in the

gastrointestinal imaging space, with a next-generation product allowing diagnosis and characterisation

of conditions such as Barrett’s Esophagus and colorectal cancer.

- A whole range of other surgeries can be enhanced with flexible endomicroscopes, including surgeries to

remove endometrial tumours as well as tumours in the prostate, liver and pancreas.

- The probes are potentially so small that it is technically feasible to develop, with the help of partners,

integrated CLE systems in a similar fashion to the way in which the Pentax ISC-1000 was developed, but

with much less bulk and a much lower development cost.

We envisage Optiscan conducting further development of flexible endomicroscope probes once the Zeiss rigid

endomicroscope is performing commercially.

Potentially significant upside from ViewnVivo Optiscan sells live micro-imaging solutions in the research market. While its core focus over the years has been

the development of endomicroscopes for clinical use, Optiscan has also gone after benchtop researchers with a

strong need for live micro-imaging solutions. The company released its research system called FIVE1, in 2007, and,

as we noted above, that system proved a useful entrée into the clinical market for neurosurgery via the Zeiss

relationship. A second-generation system called CellLIVE was developed in 2014 and formally launched in

September 2015. This device had a probe diameter of only 4 mm. In November 2016 CellLIVE was rebranded

ViewnVivo49. The utility of ViewnVivo is strong because there is now the potential to look at tissue inside an animal

model, in real time and at the cellular level, with smaller and less expensive hardware than the traditional bench-

mounted microscope.

The research market is significant. Optiscan has suggested that the market for preclinical imaging solutions,

either radiologically-based (eg MRI) or optical as in Optiscan’s systems, could be a US$1.5bn market today50,

growing at a double-digit rate. While publicly-funded medical research has been declining in many parts of the

world over the last two decades51, we believe that the pharma industry is stepping up its commitment to preclinical

work, as evidenced by Boehringer Ingelheim’s recent public commitment to preclinical R&D52.

Optiscan is now looking for new ViewnVivo distributors. Optiscan traditionally addressed this market through

direct sales, where the margins were higher than would be the case for a partnered product. However, from 2014

the company has distributed via MR Solutions, a UK-based developer of benchtop MRI products. Optiscan has

49 See www.viewnvivo.com. 50 See the company’s 30 November 2015 Annual General Meeting presentation, slide 17. 51 For example, from 2003 to 2015, America’s NIH lost 22% of its capacity to fund research due to budget cuts, sequestration, and inflationary losses - source: FASEB. 52 See the Boehringer Ingelheim press release dated 11 November 2015 and headlined 'Boehringer Ingelheim will invest 11 billion euros in Research and Development in the next five years to accelerate the discovery of next generation medical breakthroughs'. Boehringer will spend 5 billion of that 11 billion on pre-clinical.

PRE-CLINICAL IMAGING SOLUTIONS IS A US$1.5BN MARKET




indicated that it is looking for new ViewnVivo distributors in addition to MR Solutions, which continues to market

Optiscan’s system as CellLIVE53.

Publications that feature Optiscan’s products can help to fuel new demand. We list in Appendix IV a range of

notable papers that have been published over the years showing the utility of Optiscan’s products. We see

publications from scientists using ViewnVivo as helping to fuel demand for the product by showing the robustness

of Optiscan’s technology.

Optiscan’s earnings profile and valuation We used three basic assumptions for the potential payoff from the Zeiss device in FY18 and FY19:

- Approval. We assume FDA approval of the new second-generation rigid endoscope in the second half of

2017 with sales in the first half of calendar 2018;

- Revenue. We assumed average revenue per system to Optiscan of US$64,000 in FY18, rising 2% pa

thereafter. The details of the Zeiss commercial relationship with Optiscan are highly confidential so no

estimates are available from Optiscan. However, we estimate that in the last year of commercial success

for the Pentax ISC-1000 device, Optiscan’s average revenue per device was US$49,000. Increasing this

number at the level of US healthcare inflation since 2006/0754 yields a US$64,000 number.

- Unit shipments. We assumed shipments in FY17 of 40 units in FY18, and 100 units in FY19, roughly

consistent with Optiscan’s last experience with a commercial product.

- Gross margins. We assumed initial gross margins of 65% on the device.

Base case 11 cents / Optimistic case 25 cents. We value Optiscan using a DCF approach at 11 cents per share base

case and 25 cents per share optimistic case. Our 17 cent target price sits at around the midpoint of our valuation

range. Our DCF of Optiscan was built on the following core assumptions:

Our WACC was ~11%, appropriate in our view for a ‘Medium’ risk rating55;

We used a measurement horizon beyond FY19 out to FY26;

We continued growth in revenue from the endoscope products to between US$27m p.a. (base case) and

US$41m (optimistic case);

We assume the AUD/USD exchange converges on 0.7 over a three-year period from now;

We assumed gross margins for Optiscan of around 65% at present, but will expand to between 70% (base

case) and 80% (optimistic case) by FY26;

53 www.mrsolutions.com/products/imaging-systems/confocal-microscopy. 54 Source: US Bureau of Labor Statistics. 55 For a relevant discount rate, we use WACCs of between 10.8% and 15.2% depending on the risk for Life Science companies. This is derived from a RFR of 2.5%; a MRP of 7.5%-11.5% (7.5% for ‘medium risk’ companies, 9.5% for ‘high risk’ companies and 11.5% for ‘speculative’ companies; and an ungeared beta of 1.1. We regard Life Science companies with existing businesses, or who have enough capital to reach the market with their products, as ‘Medium’ risk. Companies that have small revenue streams from marketed products but that are still potentially in need of capital are ‘High’ risk. Everything else is ‘Speculative’.

OPTISCAN’S TECHNOLOGY REGULARLY SHOWS UP IN PEER-REVIEWED PAPERS




We assumed that cost growth converged on revenue growth by FY26;

We assumed capex/R&D to run at 2-4% of revenue;

We assumed a terminal growth rate in each case of 4.5% and terminal EBITDA margins of 40%.

We assume no further capital needs to be raised, with Optiscan having funded itself last year in a recapitalisation

which raised $4m at an average 3.3 cents.

Re-rating Optiscan. We see the following factors playing a part in re-rating Optiscan over the next 12-18 months:

- Completion of development of the rigid endomicroscope that has been partnered to Zeiss;

- First regulatory approval for the new rigid endomicroscope;

- The publication of various papers related to Optiscan’s new system;

- Unveiling of new follow-on products by Optiscan.

Building with Optiscan’s new leadership team We believe that Optiscan’s new leadership team, which was installed in 2016, has the commercial smarts to

capitalise on the $100m which has been invested in the company to date:

Archie Fraser (CEO), who joined Optiscan in May 2016, brings valuable leadership skills to Optiscan, honed

through CEO roles in a range of industries and organisations as varied as Adecco, Inchcape, Cendant and the St

Kilda Football Club.

Peter Delaney (Chief Technology Officer), who has been working on optical fibre confocal microscopy since the

1990s and who helped develop the original technology suite that became Optiscan, brings invaluable corporate

memory to Optiscan as well as strong relations within Zeiss and Optiscan’s other technology partners.

The Optiscan board has, in our view, the commercial and technology smarts to create value from the existing

asset base of Optiscan. Chairman Alan Hoffman brings commercial acumen from his years at Shell, Wesfarmers

and Coventry Group. Dr Ian Griffiths, currently CEO of the Wound Management Innovation CRC, has a strong

knowledge of the biotech and medical device industry. Peter Francis of FAL Lawyers contributes legal and

regulatory expertise. And Ian Mann, an Optiscan substantial shareholder, brings business development expertise

gained from multiple private companies.

Appendix I – An Optiscan Glossary Axial resolution – The ability of an imaging system to properly distinguish a structure in terms of its depth.

Barrett's Esophagus – A condition in which irritation in the lining of the esophagus, caused by chronic reflux of

the contents from the stomach and small intestine into the esophagus, results in the lining of the esophagus

becoming similar to the lining of the intestine and stomach.

OPTISCAN GOT A NEW LEADERSHIP TEAM LAST YEAR




Biopsy – Removal of a sample of tissue from the body for diagnostic purposes.

CellLIVE – See ViewvVivo.

Confocal laser microscope – A microscope in which laser light is focused into a very small spot and this is scanned

across the sample and an image is built up. Confocal microscopy allows images of extraordinary detail to be built

up at high levels of magnification.

Contrast agent – A chemical that helps highlight specific tissue in an imaging system.

CPT – Short for Current Procedural Terminology, a code set developed by the American Medical Association used

to bill outpatient and office procedures in the US healthcare system.

Endomicroscope – An endoscope with the magnification power of a microscope. Optiscan has historically been a

global leader in the field of endomicroscopes.

Endoscope – A tube with a light and camera at the end used to image internal body structures. Rigid endoscopes

are often used when dealing with soft tissue, internal medicine and orthopaedic cases. Flexible endoscopes are

often used to inspect the inside of the digestive tract.

F900e – Optiscan’s original, desktop-based rigid confocal laser endomicroscope.

FIVE1 – Optiscan’s handheld fluorescence endomicroscope, designed for research imaging applications.

Flexible endoscope – See endoscope.

Fluorescence endomicroscope – An endomicroscope that works by imaging fluorescence given off by cellular

structures tagged with fluorophores, that is, ‘glow-in-the-dark’ molecules.

Glioma – A cancer of the glial cells that surround and support neurons. Glioblastoma is a subset of glioma.

Histopathology – The examination of sampled whole tissues under the microscope in order to return a diagnosis.

ISO13485 – The international standard for the design and manufacture of medical devices.

Lateral resolution – The ability of an imaging system to properly distinguish a structure in two dimensions.

MEMS – Short for microelectromechanical systems, mechanical devices manufactured on a silicon chip.

Micron (m) – One millionth of a metre.

Objective lens – The lens at the front of a microscope which provides its magnification capability.

Pentax ISC-1000 – Optiscan’s first flexible confocal laser endomicroscope, developed with Pentax, FDA approved

in October 2004 and launched by Pentax in March 2006.

Resect – To cut a tumour out of the body.

Resolution – In microscopy, the shortest distance between two separate points in a microscope's field of view that

can still be distinguished as distinct entities.

Rigid endoscope – See endoscope.




Stratum – A hand-held confocal microscope for dermatology developed by Optiscan.

ViewvVivo – Optiscan’s second-generation research imaging system, formerly called CellLIVE.

Z-axis – The vertical dimension in a three-dimensional co-ordinate system.

Appendix II – Optiscan’s IP position Optiscan’s intellectual property position centres around 15 granted and yet-to-expire US patents, some of them

resulting from PCT patent applications.

US Patent 6,567,585, Z sharpening for fibre confocal microscopes, granted May 200356

- This patent covers the use of Optiscan’s confocal microscopy technology to reduce the Z resolutions of

an image, by comparing ‘true’ confocal return light to ‘near’ confocal return light in the Z-axis.

US Patent 6,967,772, Scanning microscope with miniature head, granted November 200557

- This patent covers Optiscan’s method to move the fibre from the microscope across the focal spot,

namely, the use of a ‘tuning fork’ with one tine of the fork, the one containing the fibre, being made to

oscillate by electromagnetic means, and the other tine projecting a counterbalancing electromagnetic

force, thereby preventing natural transverse forces from detrimentally affecting image acquisition.

US Patent 7,010,978, Electrically operated tuning fork, granted March 200658

- This patent covers the tuning fork referred to in US Patent 6,967,772.

US Patent 7,123,790, Scanning method and apparatus, granted October 200659

- This patent covers an optimised tuning fork in which the eccentricity of the elliptical pattern formed by

the fibre tip is varied, producing more of a ‘raster pattern’60.

US Patent 7,248,390, Light scanning device, granted July 200761

- This patent covers the use of pivotably-mounted mirrors for receiving light to be transmitted back to the

microscope lens.

US Patent 7,294,102, Method and apparatus for providing depth control or z-actuation, granted November 200762

- This patent covers a method of positioning Optiscan’s microscope in the Z-axis, involving an extensible

member that is made of a shape-memory alloy and is electrically controlled.

56 Invented by Martin Harris, Priority date 3 May 2000. 57 Invented by Martin Harris, Priority date 16 July 1997. 58 Invented by Martin Harris, Gavan Rosman, and James Rudge, Priority date 8 June 1999. 59 Invented by Gavan Rosman, Christopher Byrne, Bradley Jones, Priority date 30 October 2002. 60 That is, the rectangular pattern of image capture routinely used in television images. 61 Invented by Martin Harris, Priority date 26 March 2002. 62 Invented by Bradley Jones, Christopher Byrne, Johan Lemmens and Libin Ni, Priority date 14 April 2003.




US Patent 7,330,305, Laser scanning confocal microscope with fibre bundle return, granted February 200863

- This patent covers the use of optical fibre bundles in an Optiscan confocal microscope.

US Patent 7,338,439, Condensing optical system, confocal optical system, and scanning confocal endoscope,

granted March 200864

- This patent covers the kind of lens that properly condenses the light source in an Optiscan confocal

microscope.

US Patent 7,401,984, Optical connector, granted July 200865

- This patent covers the use of two optical fibre cables rather than one in order to provide Optiscan’s

confocal microscope with some redundancy.

US Patent 7,532,375, Tuning-fork-type scanning apparatus with a counterweight, granted May 200966

- This patent covers a miniaturised version of the tuning fork scanning approach.

US Patent 7,695,431, Objective lens unit for endoscope, granted April 201067

- This patent covers an objective lens barrel designed to be easier to manufacture.

US Patent 7,920,312, Optical fiber scanning apparatus, granted April 201168

- This patent covers a method of vibrating the fibre tip of Optiscan’s confocal microscope that does away

with the tuning fork but instead controls it remotely with magnets.

US Patent 8,047,985, Compact confocal endoscope and endomicroscope method and apparatus, granted

November 201169

- This patent covers the completed Optiscan confocal microscope.

US Patent 8,057,083, Fibre bundle confocal endomicroscope, granted April 201170

- This patent covers a fibre bundle version of Optiscan’s confocal microscope.

US Patent 9,456,734, A scanner for an endoscope, granted October 201671

- This patent covers Optiscan’s flexible endomicroscope.

63 Invented by Martin Harris, Priority date 26 April 2002. 64 Invented by Moriyasu Kanai, Priority date 5 September 2003. 65 Invented by Robert Pattie, Priority date 15 May 2003. 66 Invented by Christopher Byrne, Gavan Rosman and Robert Pattie, Priority date 29 September 2004. 67 Invented by Shinsuke Okada, Priority date 10 February 2003. 68 Invented by Gavan Rosman, Bradley Jones, Robert Pattie, Alan Robert and Christopher Byrne, Priority date 14 September 2006. 69 Invented by Martin Harris, Priority date 27 August 1998. 70 Invented by Martin Harris, Priority date 21 January 2005. 71 Invented by Christopher Byrne and Robert Pattie, Priority date 12 October 2010.




WO/2014/201501, Optical scanner and scanned lens optical probe72

- This patent application covers a lens group designed to allow high values for both field of view and

numerical aperture through wavefront aberration correction.

Appendix III - Major shareholders Optiscan currently has two substantial shareholders:

- the Melbourne businessman Ian Mann, an Optiscan director (11.1%);

- the Perth car retailer Bob Peters (6.9%).

Appendix IV – Key relevant papers Here are eight peer-reviewed papers that are relevant to Optiscan’s technology:

McLaren et al., 2001. In vivo detection of experimental ulcerative colitis in rats using fiberoptic confocal imaging

(FOCI). Dig Dis Sci. 2001 Oct;46(10):2263-76.

- This paper shows that the Optiscan F900e system being used to for the in vivo imaging of early colitis in

a rat model.

Kakeji et. al., 2006. Development and assessment of morphologic criteria for diagnosing gastric cancer using

confocal endomicroscopy: an ex vivo and in vivo study. Endoscopy. 2006 Sep;38(9):886-90.

- This paper shows that the Optiscan/Pentax flexible endomicroscope could distinguish between normal

tissue and cancerous tissue, dispensing with the need for biopsy.

Astner et. al., 2008. Clinical applicability of in vivo fluorescence confocal microscopy for noninvasive diagnosis and

therapeutic monitoring of nonmelanoma skin cancer. J Biomed Opt. 2008 Jan-Feb;13(1):014003.

- This paper shows that Optiscan’s first generation confocal microscope could be used in the management

of skin conditions such as actinic keratosis and basal cell carcinoma.

Hurlstone et. al., 2008. In vivo confocal laser scanning chromo-endomicroscopy of colorectal neoplasia: changing

the technological paradigm. Histopathology. 2008 Mar;52(4):417-26. Epub 2007 Sep 28.

- This paper reviews the Optiscan/Pentax flexible endomicroscope in the diagnosis of colonic

intraepithelial neoplasia and carcinoma.

72 Invented by Roderick Vance, Priority date 16 June 2013.




Nguyen et. al., 2009. Real time intraoperative confocal laser microscopy-guided surgery. Ann Surg. 2009

May;249(5):735-7.

- This paper shows that Optiscan’s confocal microscope can visualise the cellular and architectural

morphology of intra-abdominal organs as well as a light microscope, allowing diseased tissue to be

identified.

Musani et. al., 2010. A pilot study of the feasibility of confocal endomicroscopy for examination of the human airway.

J Bronchology Interv Pulmonol. 2010 Apr;17(2):126-30.

- This paper shows the Optiscan/Pentax flexible endomicroscope being used to look at the human airway

in histologic detail in vivo.

Goetz et. al., 2011. In vivo real-time imaging of the liver with confocal endomicroscopy permits visualization of the

temporospatial patterns of hepatocyte apoptosis. Am J Physiol Gastrointest Liver Physiol. 2011 Nov;301(5):G764-

72. Epub 2011 Jul 21.

- This paper demonstrates the use of Optiscan’s FIVE1 probe in monitoring the apoptosis of liver cells in

vivo and at high resolution.

Suihko and Serup, 2012. Fluorescent fibre-optic confocal imaging of lesional and non-lesional psoriatic skin

compared with normal skin in vivo. Skin Res Technol. 2012 Nov;18(4):397-404. Epub 2011 Nov 24.

- This paper shows that Optiscan’s first generation confocal microscope could be used to visualise the

epidermal structures of plaque psoriasis in vivo.

Appendix V – Background to Optiscan Imaging Optiscan Imaging originated from work in the 1980s on confocal laser microscopes. Microscopes for medical

imaging have been around since the Dutchman Anton van Leeuwenhoek (1632-1723) invented the first one in the

late 17th Century. The trouble with traditional optical microscopy was that it could magnify tissue using the optical

properties of lenses, but it couldn’t necessarily allow different kinds of cellular structures in tissue to be visualised.

Fluorescence microscopy, first developed in the 1970s, was a step forward in this regard because it allowed cellular

structures tagged with fluorescent molecules to be distinguished from the surrounding structures due to the

different light wavelength emitted by the tags when they were excited by a laser73. There was a problem, however.

With the first generation of fluorescence microscopes, the signal produced was from the full thickness of the

specimen, which meant that most of it was out-of-focus to the observer. This problem was solved with the

development in the 1980s of workable ‘confocal’ microscopes74, in which a screen with a pinhole was placed in

front of the focal plane of the device. The effect of this screen was to filter out light from above and below the

73 Because the fluorescent tag, called a fluorophore, would absorb a certain wavelength from the excitation laser and emit another wavelength. 74 The idea originated in 1957 with Marvin Minsky (1927-2016), an American cognitive scientist later known as a pioneer of artificial intelligence. It was perfected in the UK by Brad Amos et. al. at the MRC Laboratory of Molecular Biology in Cambridge in the 1980s (see Appl Opt. 1987 Aug 15;26(16):3239-43) and commercialised by the laboratory equipment supplier Bio-Rad.




focal plane. As the pinhole was scanned across as well as up and down the sample, an image of extraordinary detail

could be built up, in a manner not dissimilar to the way in which television images are built up one pixel at a time,

but in three dimensions rather than two.

Harris and Delaney developed one of the first optical fibre confocal microscopes. The first confocal laser

microscopes used mirrors to guide light into the tissue being imaged and collect the light coming back from the

issue. Around 1988 Professor Martin Harris in Melbourne developed a confocal microscope whose source and

detector pinhole was optical fibre75. Over the late 1980s and early 1990s Harris worked with Peter Delaney as well

as collaborators at the CSIRO to gradually reduce the size of the original device. The result was the HBH Desktop

Confocal Microscope, later called ‘Stratum’, a handheld device intended for melanoma detection and cosmetics

research, among other potential applications.

Optiscan Imaging pioneers confocal laser endomicroscopy, 1994-2008. Harris and Delaney formed Optiscan

Imaging in 1994 to go after the next big thing in live micro-imaging, which was an adaptation of the optical fibre

confocal microscope into flexible endoscopes that could be used to probe internal organs in the body. Optiscan

went public in 1997 to further this concept. Its foundation Stratum device gained FDA approval in May 2001, the

same year that the company completed development of a prototype of the world’s first confocal laser

endomicroscopy system for human use. This proved to be the peak for investor sentiment towards Optiscan, with

the stock’s all-time high being March 2000 (see Figure 4)76. The CLE prototype was licensed to the Japanese

company Pentax in a US$20m upfront agreement in February 2002. Pentax, famed for its cameras and medical

imaging products, was at the time one of the world's largest optical companies. The Pentax/Optiscan

collaboration saw the Pentax ISC-1000 device FDA approved in October 2004 and launched globally by Pentax as

a gastrointestinal imaging device in March 2006. In 2007 Optiscan introduced FIVE1, a CLE system for pre-clinical

use77. The Pentax ISC-1000 had remarkable imaging power, with 1,000-fold magnification ability and

demonstrated resolution at just 1 micron. The product, however, was not a commercial success. In August 2007

Pentax, having just been acquired by Hoya, a Japanese medical devices and IT company78, advised Optiscan that

they had too much inventory of the ISC-1000 control boxes79. The product was not able to come back from this

slow start. Hoya stopped active marketing of the Pentax ISC-1000 around 2010.

Optiscan starts work on second-generation CLE systems, 2008-2010. Optiscan had started work on a second-

generation flexible CLE system to be partnered with Hoya in 2008. However, in March 2009 the company

announced that the Hoya collaboration had been terminated. Optiscan had an initial prototype of the second-

generation flexible device ready for trialling by September 2009. Meantime the company had been collaborating

since mid-2007 with Carl Zeiss on a rigid CLE system80, and by 2009 Zeiss was specifically focused on the neurology

applications of Optiscan’s CLE technology. By December 2010 this interest of Zeiss’s had transitioned into an

75 See Scanning confocal microscope, WO/1990000754, propriety date 13 July 1988. 76 At $2.83 per share adjusted. 77 See Optiscan’s market release dated 28 March 2007 and headlined ‘Optiscan FIVE1 progress confirms second commercialisation’. 78 This merger was announced in December 2006 and completed in early August 2007. 79 See the Optiscan market release dated 2 August 2007 and headlined ‘Pentax advise soft sales in first half of financial year’. 2006/07 had seen around 88 system sales netting A$5m for Optiscan. 80 This collaboration was unveiled in July 2007.

OPTISCAN HAS WORKED WITH ZEISS FOR AROUND TEN YEARS NOW




Optiscan/Zeiss collaboration aimed at developing a second-generation rigid CLE system specifically for the

neurosurgical market.

Progressing the second-generation CLE systems, 2010-2016. Optiscan’s development pathway since 2010 has

had two parallel paths – development of a rigid CLE system for Zeiss in neurology, and development of new

generation flexible CLE systems for gastrointestinal and other indications.

- Zeiss rigid CLE system. By June 2012 Optiscan was selling pre-production prototypes of the rigid system

to Zeiss, with those systems having been manufactured at Optiscan’s ISO13485-accedited facility in

Melbourne81. A published description of the product at the time suggested that it had a lateral resolution

close to 0.7 µm and could image as deep as 250 µm82. One difficult technical problem for Optiscan to

solve was the sheath for the device to keep it sterile, but by August 2014 development and testing of this

component had been successfully completed83. In September 2015, with Optiscan in some funding

difficulties, Zeiss agreed to a package which made the financial burden of development of the rigid CLE

system less burdensome by >A$2m84.

- New generation flexible CLE systems: By late 2011 Optiscan had developed prototypes of new

integrated CLE systems as well as prototypes of probes that could plug into third-party endoscopes85.

By late 2013 the best of these probes had a diameter of only 3.5 mm (as against the 5 mm86 for the Pentax

ISC-1000) and a length of less than 20 mm (versus 43 mm), allowing a volume reduction of >80%87. When

the company was raising money in July 2016 it indicated that it wished to devote part of the proceeds to

go after a 2.4 mm probe that would have a rigid length of only 16 mm and have only 7% of the size of the

Pentax ISC-100088.

New management take control of Optiscan, mid-2016. In May 2016, the new Optiscan board brought in Archie

Fraser as CEO. Around the time of this leadership change Optiscan managed to deliver prototypes to Zeiss for the

new CLE system. After $4m was raised to recapitalise the company Optiscan stock recommenced trading in

August 2016, ending a six-month suspension. Under the new team the focus of Optiscan has been to complete

development of the Zeiss product and re-launch the pre-clinical research product, after which the company will

focus on new opportunities with flexible CLE systems. Optiscan made further deliveries of ‘Production Equivalent

Systems’ to Zeiss in December 2016 and February 2017. The company believes that Zeiss will be able to gain

regulatory approval and launch its product before the end of 2017.

81 ISO 13485 is the standard for Quality Management Systems for medical devices. Optiscan has had this certification since 2004. 82 See a PLoS pape from a well-regarded group at Mainz University -PLoS One. 2012;7(7):e41760. Epub 2012 Jul 24. 83 Zeiss paid a €180,000 milestone in November 2014 as a result of this achievement. 84 See the company’s market release dated 25 September 2015 and headlined ‘Optiscan extends and enhances its collaboration with Carl Zeiss Meditec’. 85 See Optiscan’s 21 November 2011 Annual General Meeting presentation. 86 Ann Biomed Eng. 2012 Feb;40(2):378-97. Epub 2011 Oct 13. 87 See Optiscan’s 19 November 2013 Annual General Meeting presentation, slide 13. In March 2014 Optiscan announced that it had deployed one its second-generation probes inside an Olympus endoscope at St Vincent’s Hospital in Sydney. This was a research project designed to study the permeability of the gut lining as it is altered by inflammatory events. 88 See the company’s 22 July 2016 prospectus for its 2 for 9 rights issue, page 8.

OPTISCAN’S LATEST PRODUCTS ARE MUCH SMALLER THAN A DECADE AGO




Appendix VI – Optiscan’s capital structure

% of fully diluted

Note

Ordinary shares, ASX Code OIL (million) 376.1 93.7%

Unlisted options (million) 25.5 6.3% Average exercise price 6.2 cents, average expiry date 30-Jun-2019

Milestone shares 0.0

Fully diluted shares 401.6

Current market cap: A$35.7 million (US$27.1 million)

Current share price $0.095

Trading range (since 22 August 2016) $0.027 - $0.11

Average turnover per day (last three months) 0.4 million




Figure 4: Optiscan stock has been base-building since around October 2008

Risks related to Optiscan Imaging Risks specific to Optiscan Imaging. We see four major risks for Optiscan Imaging as a company and as a listed

stock:

- Clinical risk. There is the risk that the BALANCE Phase III study may fail to hit its primary endpoints.

- Regulatory risk. There is the risk that Optiscan and Zeiss may take longer to gain regulatory approval

for the forthcoming rigid endomicroscope product than the time we have postulated in this note.

- Commercial risk. There is the risk that the Zeiss product may not prove as popular with the target

customer base as we have indicated in this note. ViewnVivo may similarly fail to get much traction with

potential laboratory customers.

- Development risk. There is the risk that Optiscan may not find development and commercialisation

pathways for its next-generation rigid and flexible endomicroscope products.

Risks related to pre-revenue Life Science companies in general.

- The stocks of biotechnology and medical device companies without revenue streams from product sales

or ongoing service revenue should always be regarded as speculative in character.

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Stratum gains FDA approval -May 2001

Partnering deal with Pentax -February 2002

Pentax ISC 1000 FDa approval -October 2004

Stratum gains FDA approval -May 2001

Partnering deal with Pentax -February 2002

Pentax ISC 1000 FDA approval -October 2004

Pentax ISC 1000 sales slow -August 2007 Agreement with

Zeiss to pursue neurologyproduct -December 2010

New leadership team and company recapitalised -August 2016




- Since most biotechnology and medical device companies listed on the Australian Securities Exchange fit

this description, the term 'speculative’ can reasonably be applied to the entire sector.

- The fact that the intellectual property base of most biotechnology and medical device lies in science not

generally regarded as accessible to the layman adds further to the riskiness with which the sector ought

to be regarded.

Caveat emptor. Investors are advised to be cognisant of the abovementioned specific and general risks before

buying any the stock of any biotechnology and medical device stock mentioned on this report, including Optiscan

Imaging.

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