Oncolytics Message to Shareholders

Oncolytics Message to Shareholders

In an effort to maximize the future commercial potential of REOLYSIN , we continue to build upon and progress through our REOLYSIN research and development program. In the second quarter of 2011, we focused on the expansion of our Phase III clinical trial in head and neck cancer, broadened our clinical program through a new sponsored clinical trial in a new indication, and generated positive clinical trial results in two early studies. We also secured a leading manufacturer for the clinical and commercial supply of REOLYSIN, which is a significant step forward in our plans to expand our development program.

Positive Clinical Results in an Expanding Group of Indications

During the quarter we announced interim data from a U.K. translational clinical trial (REO 013a) investigating intravenous administration of REOLYSIN in patients with metastatic colorectal cancer prior to surgical resection of liver metastases. On initial histological analysis of the 10 treated patients to date, there was evidence of selective delivery of virus to tumour versus normal liver and viral replication in the majority (seven) of patients. In an additional two patients, only necrotic tumour was found; in one of these cases virus was detected in immune cells in the tumour. In six of 10 patients there was no evidence of virus in the normal liver surrounding the tumour, with virus found only rarely in liver cells in the other four patients. These data suggest reovirus can be intravenously administered as a monotherapy and successfully delivered specifically and selectively to colorectal liver metastases without affecting surrounding normal liver tissue. We expect to fully report the results of this study later in 2011.

Subsequent to quarter-end, we presented positive interim results for our Phase II non-small cell lung cancer clinical trial at the 14th World Conference on Lung Cancer. The trial investigated intravenous administration of REOLYSIN in combination with paclitaxel and carboplatin in patients with non-small cell lung cancer (NSCLC) with Kras or EGFR-activated tumours. The presentation, entitled "Phase II study of reovirus with paclitaxel (P) and carboplatin (C) in patients with metastatic non-small cell lung cancer (NSCLC) who have Kras or EGFR-activated tumors" indicated that 22 patients had received REOLYSIN in combination with carboplatin and paclitaxel To date the study has enrolled patients with Adenocarcinoma (15), Squamous Cell Carcinoma (three), Bronchioloalveolar Carcinoma (one), and not otherwise specified non-small cell lung cancer (three). Molecular tumor demographics included: nine Kras mutant, three EGFR mutant, 16 EGFR amplified. Response evaluation to date in 21 patients showed six partial responses (PR) (28.6%), 13 stable disease (SD) (61.9%), and two progressive disease (PD) (9.5%). This translates into a clinical benefit rate (complete response (CR)+PR+SD) of 90.5% and a response rate (CR+PR) of 28.6%. The investigators noted that the clinical benefit noted so far is encouraging and that a follow up randomized clinical trial appears warranted.

Broadening the Clinical Program

We continue to collaborate with a number of groups, specifically the U.S. National Cancer Institute (NCI), to cost effectively expand the scope of our clinical program. During the quarter we announced that the Cancer Therapy Evaluation Program, Division of Cancer Treatment and Diagnosis, NCI, which is part of the National Institutes of Health, has agreed to sponsor a Phase I study of REOLYSIN alone in patients with relapsed multiple myeloma. The NCI is sponsoring the trial under its Clinical Trials Agreement with Oncolytics, while Oncolytics will provide clinical supplies of REOLYSIN. The study will initially be a proof of concept, open-label Phase I study of REOLYSIN in patients with relapsed multiple myeloma. This is the sixth clinical trial using REOLYSIN to be sponsored by the NCI, but is the first trial testing REOLYSIN in the multiple myeloma indication.

Agreement for Commercial Supply of REOLYSIN

During the quarter, we announced that we entered into a commercial supply agreement with SAFC, a Division of Sigma-Aldrich Corporation, for the commercial manufacture of REOLYSIN. Under the terms of the agreement, SAFC will perform process validation of the product, will continue to supply clinical requirements and will supply commercial material upon approval of the product. This agreement represents a significant step forward towards the commercialization of REOLYSIN as we prepare to produce supplies for new and ongoing clinical trials and build inventory for potential commercial sales.

Looking to the Future

For the balance of the year one of our most important areas of focus remains completing enrollment in the first stage of our Phase 3 study in head and neck cancer and completing a number of our other studies. We want to thank all our stakeholders for their continued support in what promises to be an exciting time ahead.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

BASIS OF PRESENTATION AND TRANSITION TO IFRS

On January 1, 2011, we adopted International Financial Reporting Standards ("IFRS") for Canadian publicly accountable enterprises. Prior to the adoption of IFRS, we followed Canadian Generally Accepted Accounting Principles ("Canadian GAAP"). While IFRS has many similarities to Canadian GAAP, some of our accounting policies have changed as a result of our transition to IFRS. The most significant accounting policy changes that have had an impact on the results of our operations are discussed in more detail in the Accounting Changes section of this Management Discussion and Analysis of Financial Condition and Results of Operations ("MD&A").

This MD&A should be read in conjunction with our unaudited consolidated interim financial statements as at and for the period ending June 30, 2011 which have been prepared using IFRS and should also be read in conjunction with the audited consolidated financial statements, which were prepared using Canadian GAAP, and MD&A contained in our annual report for the year ended December 31, 2010.

FORWARD-LOOKING STATEMENTS

The following discussion contains forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended and under applicable Canadian provincial securities legislation. Forward-looking statements, including our belief as to the potential of REOLYSIN , a therapeutic reovirus, as a cancer therapeutic and our expectations as to the success of our research and development and manufacturing programs in 2011 and beyond, future financial position, business strategy and plans for future operations, and statements that are not historical facts, involve known and unknown risks and uncertainties, which could cause our actual results to differ materially from those in the forward-looking statements.

Such risks and uncertainties include, among others, the need for and availability of funds and resources to pursue research and development projects, the efficacy of REOLYSIN as a cancer treatment, the success and timely completion of clinical studies and trials, our ability to successfully commercialize REOLYSIN , uncertainties related to the research, development and manufacturing of pharmaceuticals, uncertainties related to competition, changes in technology, the regulatory process and general changes to the economic environment.

With respect to the forward-looking statements made within this MD&A, we have made numerous assumptions regarding among other things: our ability to obtain financing to fund our development program, our ability to receive regulatory approval to commence enrollment in our clinical trial program, the final results of our co-therapy clinical trials, our ability to maintain our supply of REOLYSIN and future expense levels being within our current expectations.

Investors should consult our quarterly and annual filings with the Canadian and U.S. securities commissions for additional information on risks and uncertainties relating to the forward-looking statements. Forward-looking statements are based on assumptions, projections, estimates and expectations of management at the time such forward-looking statements are made, and such assumptions, projections, estimates and/or expectations could change or prove to be incorrect or inaccurate. Investors are cautioned against placing undue reliance on forward-looking statements. We do not undertake to update these forward-looking statements except as required by applicable law.

Oncolytics Biotech Inc. is a Development Stage Company

Since our inception in April of 1998, Oncolytics Biotech Inc. has been a development stage company and we have focused our research and development efforts on the development of REOLYSIN , our potential cancer therapeutic. We have not been profitable since our inception and expect to continue to incur substantial losses as we continue research and development efforts. We do not expect to generate significant revenues until, if and when, our cancer product becomes commercially viable.

General Risk Factors

Prospects for biotechnology companies in the research and development stage should generally be regarded as speculative. It is not possible to predict, based upon studies in animals, or early studies in humans, whether a new therapeutic will ultimately prove to be safe and effective in humans, or whether necessary and sufficient data can be developed through the clinical trial process to support a successful product application and approval.

If a product is approved for sale, product manufacturing at a commercial scale and significant sales to end users at a commercially reasonable price may not be successful. There can be no assurance that we will generate adequate funds to continue development, or will ever achieve significant revenues or profitable operations. Many factors (e.g. competition, patent protection, appropriate regulatory approvals) can influence the revenue and product profitability potential.

In developing a pharmaceutical product, we rely upon our employees, contractors, consultants and collaborators and other third party relationships, including the ability to obtain appropriate product liability insurance. There can be no assurance that these reliances and relationships will continue as required.

In addition to developmental and operational considerations, market prices for securities of biotechnology companies generally are volatile, and may or may not move in a manner consistent with the progress being made by Oncolytics.

REOLYSIN Development Update for the Second Quarter of 2011

We continue to develop our lead product REOLYSIN as a potential cancer therapy. Our goal each year is to advance REOLYSIN through the various steps and stages of development required for pharmaceutical products. In order to achieve this goal, we actively manage the development of our clinical trial program, our pre-clinical and collaborative programs, our manufacturing process and supply, and our intellectual property.

Clinical Trial Program

We began the second quarter of 2011 with 12 clinical trials which includes three randomized studies (our randomized Phase III head and neck trial, our randomized Phase II ovarian cancer trial, and our randomized Phase II pancreatic cancer trial). Five of these 12 trials are funded by us and the remainder are sponsored by the U.S. National Cancer Institute ("NCI"), the Cancer Therapy & Research Center at The University of Texas Health Center in San Antonio ("CTRC"), and the University of Leeds ("Leeds").

During the second quarter of 2011, our clinical trial program expanded to include an additional NCI Phase I clinical study of REOLYSIN alone in patients with relapsed multiple myeloma. This is the sixth clinical trial sponsored by the NCI. We exited the second quarter of 2011 with 13 clinical trials which includes the three randomized studies. Five of the 13 trials are funded by us with the remainder sponsored by the NCI, CTRC, and Leeds. Our clinical trial program currently encompasses various cancer indications including head and neck, non-small cell lung, ovarian, pancreatic, colorectal, melanoma, and squamous cell carcinoma of the lung among others.

Clinical Trial - Randomized Phase III Head and Neck Pivotal Trial

Our randomized Phase III head and neck pivotal trial continues to enroll patients. During the second quarter of 2011, we continued to expand the number of jurisdictions and the number of sites within these jurisdictions. We have increased the jurisdictions to include the U.S., Canada, the U.K., Belgium, along with other European countries.

Clinical Trial - Program Expansion

NCI Sponsored Phase I Multiple Myeloma Clinical Trial

During the second quarter of 2011, our clinical program expanded to include a Phase I study of REOLYSIN alone in patients with relapsed multiple myeloma. This clinical trial is sponsored by the Cancer Therapy Evaluation Program, Division of Cancer Treatment and Diagnosis, U.S. National Cancer Institute, which is part of the National Institutes of Health. The Principal Investigator is Dr. Craig Hofmeister of The Ohio State University Comprehensive Cancer Center - Arthur G. James Cancer Hospital and Richard J. Solove Research Institute.

The study will initially be a proof of concept, open-label Phase I study of REOLYSIN in patients with relapsed multiple myeloma. Approximately 12 patients will receive REOLYSIN, in a dose escalation up to 3 x 1010 TCID50 per day administered intravenously on days one through five every 28 days.

The primary endpoint for the dose escalation portion of this study will be adverse events using CTCAE criteria. Correlative studies will focus on the efficiency with which reovirus replicates in patient myeloma cells. Investigators will use standard cohorts-of-three phase I dose escalation design with three to six patients being treated at each dose level. Secondary endpoints will include clinical benefit, duration of response, and time to progression.

Clinical Trial - Results

U.K. Translational Colorectal Cancer Clinical Trial

During the second quarter of 2011, we released interim data from our U.K. translational clinical trial investigating intravenous administration of REOLYSIN in patients with metastatic colorectal cancer prior to surgical resection of liver metastases. The principal investigator of the study was Professor Alan Melcher of Leeds Institute of Molecular Medicine, University of Leeds, UK.

The trial was an open-label, non-randomized, single centre study of REOLYSIN given intravenously to patients for five consecutive days in advance of their scheduled operations to remove colorectal cancer deposits metastatic to the liver. Patients were treated with intravenous REOLYSIN at 1x1010 TCID50, one to three weeks prior to the planned surgery. After surgery, the tumour and surrounding liver tissue were assessed for viral status and anti-tumour effects.

On initial histological analysis of the 10 treated patients to date, there was evidence of selective delivery of virus to tumour versus normal liver and viral replication in the majority (seven) of patients. In two patients, only necrotic tumour was found; in one of these cases virus was detected in immune cells in the tumour. In six of 10 patients there was no evidence of virus in the normal liver surrounding the tumour, with virus found only rarely in liver cells in the other four patients.

Manufacturing and Process Development

During the second quarter of 2011, we entered into a commercial supply agreement with SAFC, a Division of Sigma-Aldrich Corporation, for the commercial manufacture of REOLYSIN. Under the terms of the agreement, SAFC will perform process validation of the product, will continue to supply clinical requirements and will supply commercial material upon approval of the product. As well, we completed a 100 litre cGMP production run along with associated fill and packaging activities. Our process development activity for the second quarter of 2011 continued to focus on process validation and formulation studies.

Intellectual Property

At the end of the second quarter of 2011, we had been issued over 250 patents including 43 U.S. and 11 Canadian patents as well as issuances in other jurisdictions. We also have approximately 200 patent applications filed in the U.S., Canada and other jurisdictions. We have an extensive patent portfolio covering the oncolytic reovirus that we use in our clinical trial program including a composition of matter patent that expires in 2028. Our patent portfolio also includes methods for treating proliferative disorders using modified adenovirus, HSV, parapoxvirus and vaccinia virus.

We estimated at the beginning of 2011 that our cash requirements to fund our operations would be approximately $29,000,000. Our cash usage for the first half of 2011 was $8,767,423 from operating activities and $49,107 for the purchases of property and equipment. Our net loss for the six month period ending June 30, 2011 was $11,135,354.

We exited the second quarter of 2011 with cash and short-term investments totaling $48,569,537 (see "Liquidity and Capital Resources").

Expected REOLYSIN Development for the Remainder of 2011

Our planned development activity for REOLYSIN in 2011 is made up of clinical, manufacturing, intellectual property and collaboration programs. Our 2011 clinical program continues to include the anticipated completion of stage 1 (approximately 80 patients) of our Phase III head and neck clinical trial and commencement of stage 2. As well, we still expect to complete enrollment in our non-small cell lung cancer trial and support those clinical trials that are sponsored by CTRC, Leeds and the NCI.

Our 2011 manufacturing program still includes several 100-litre cGMP production runs along with the related fill, labeling, packaging and shipping of REOLYSIN to the various clinical sites. As well, we plan on performing smaller process development studies examining formulation, stability and additional scale up. Our intellectual property program includes filings for additional patents along with monitoring activities required to protect our patent portfolio. Finally, our 2011 collaboration program will finish the studies in place at the end of 2010 and contemplates the addition of future studies that may be required.

We still estimate that the cash requirements to fund our operations for 2011 will be approximately $29,000,000 (see "Liquidity and Capital Resources").

On January 1, 2011, we adopted IFRS for Canadian publicly accountable enterprises, as required by the Accounting Standards Board of Canada. Prior to the adoption of IFRS, we followed Canadian GAAP. The most significant change to our accounting policies relates to the treatment of our warrants with an exercise price denominated in U.S. dollars. The impact of this change has been fully disclosed in Note 3 of our unaudited interim consolidated financial statements. There was no change in how we account for our research and development or operating activities and there was no impact on our cash, cash equivalents or short-term investment balances.

Although we adopted IFRS on January 1, 2011, we were required to restate our comparative 2010 annual and interim financial positions and results of operations, effective from January, 1, 2010. The 2010 comparative amounts have not been audited by our external auditor. Note 4 of our unaudited interim consolidated financial statements as at and for the six months ended June 30, 2011 outlines our IFRS accounting policies and Note 3 provides a complete list of our IFRS 1 elections; detailed reconciliations between Canadian GAAP and IFRS of shareholders' equity as at January 1, June 30, and Dec. 31, 2010, respectively, and of net earnings and comprehensive income for the three and six month periods ending June 30, 2010 and the twelve months ending December 31, 2010; and information regarding the impacts of IFRS transition on our cash flows. A summary of the changes are outlined below in the following tables and respective notes:

Consolidated Statement of Cash Flows

In transitioning to IFRS, there was no impact on our net change in cash for the three and six month periods ending June 30, 2010 or for the year ending December 31, 2010.

IFRS Transitional Arrangements

When preparing our consolidated statement of financial position under IFRS at January 1, 2010, our date of transition, the following optional exemptions from full retrospective application of IFRS accounting policies have been adopted:

Cumulative translation differences - cumulative translation differences resulting from the translation of the financial statements of our U.S. subsidiary have been set to zero at January 1, 2010.

IFRS requires warrants with an exercise price denominated in a currency other than the entity's functional currency to be treated as a liability measured at fair value. Changes in fair value are to be recorded in the consolidated statement of loss and comprehensive loss.

Classification of expenses within the statement of loss and comprehensive loss

Under IFRS, we have chosen to present our expenses based on the function of each expense rather than the nature of each expense. As a result, stock based compensation, depreciation of capital assets, and foreign currency gains and losses are no longer separately presented on the statement of loss and comprehensive loss. There is no impact on our net loss or comprehensive loss as a result of these classifications.

Foreign currency translation

Under IFRS, we record the impact of fluctuations in foreign currency exchange rates relating to our net investment in our U.S. subsidiary and any foreign currency effects on the translation of our U.S. subsidiaries financial statements as a separate component of equity and other comprehensive income. Under CGAAP we treated our U.S. subsidiary as an integrated subsidiary with foreign currency translation differences recorded as part of our statement of loss. The result of the transition to IFRS is a reclassification of the related foreign currency gains and losses from net loss to other comprehensive income. There is no impact on our net comprehensive loss as a result of these re-classifications.

SECOND QUARTER RESULTS OF OPERATIONS

(for the three months ended June 30, 2011 and 2010)

Net loss for the three month period ending June 30, 2011 was $7,164,238 compared to $3,984,852 for the three month period ending June 30, 2010.

Research and Development Expenses ("R&D")

Clinical Trial Program

During the second quarter of 2011, our clinical trial expenses increased to $1,748,854 compared to $1,034,847 for the second quarter of 2010. In the second quarters of 2011 and 2010, we incurred direct patient expenses related to the clinical trials that we are currently sponsoring. We also continue to incur start up costs relating to our randomized Phase III head and neck cancer trial as we increase the number of jurisdictions and clinical sites initiated to enroll patients.

Manufacturing & Related Process Development ("M&P")

In the second quarter of 2011, our product manufacturing expenses were $1,879,306 compared to $1,425,477 for the second quarter of 2010. During the second quarter of 2011, our production activity included the commencement and completion of the bulk harvest of one 100-litre cGMP production run along with related fill, finish and packaging costs. During the second quarter of 2010, our production activity included the completion of a 100-litre cGMP production run that had been initiated in the first quarter of 2010.

Our process development expenses for the second quarter of 2011 were $133,840 compared to $350,385 for the second quarter of 2010. Our process development activity for the second quarter of 2011 focused on optimization and validation studies anticipated to be required in support of product registration.

Intellectual Property Expenses

Our intellectual property expenses for the second quarter of 2011 were $279,568 compared to $107,332 for the second quarter of 2010. The change in intellectual property expenditures reflects the timing of filing costs associated with our expanded patent base. At the end of the second quarter of 2011, we had been issued over 250 patents including 43 U.S. and 11 Canadian patents, as well as issuances in other jurisdictions. We also have over 200 patent applications filed in the U.S., Canada and other jurisdictions.

Research Collaborations

During the second quarter of 2011, our research collaboration expenses were $79,928 compared to $17,093. Our research collaboration activity continues to focus on the interaction of the immune system and the reovirus and the use of the reovirus as a co-therapy with existing chemotherapeutics and radiation.

Other Research and Development Expenses

During the second quarter of 2011, our Other Research and Development expenses were $1,266,373 compared to $626,034 for the second quarter of 2010. In the second quarter of 2011, our salaries and benefits costs increased compared to the second quarter of 2010 as we increased the number of employees and consultants in order to support our randomized Phase III head and neck clinical trial along with our other clinical trials. As well, in the second quarter of 2011, we incurred severance costs associated with the change in our Chief Medical Officer that did not occur in the second quarter of 2010.

Foreign Exchange (Gain) Loss

During the second quarter of 2011, our foreign exchange loss was $54,793 compared to a foreign exchange gain of $325,351 for the second quarter of 2010. The foreign exchange loss/(gain) is primarily a result of the fluctuations in the U.S. dollar exchange rate used on the translation of our U.S. currency that was received from our U.S. denominated financing in 2009 and the exercise of U.S. denominated warrants in 2011.

During the second quarter of 2011, our public company related expenses were $723,138 compared to $820,585 for the second quarter of 2010. In the second quarter of 2011 our public company related expenses declined compared to the second quarter of 2010 as we incurred professional fees associated with the renewal of our base shelf prospectus in 2010 that were not incurred in 2011.

Our office expense activity during the second quarter of 2011 remained consistent compared to the second quarter of 2010.

Write Down of Asset Available for Sale

During the second quarter of 2011, we continued the sales process relating to our investment in British Canadian Biosciences Corp. ("BCBC"). At the end of the second quarter, we were unable to complete a sale under current market conditions. As a result, we elected to write down our investment in BCBC to $nil recognizing a write down of $735,681. We continue to pursue potential future buyers.

YEAR TO DATE RESULTS OF OPERATIONS

(for the six months ended June 30, 2011 and 2010)