EXHIBIT 3

# March 2, 2006

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

The following information should be
read in conjunction with our 2005 audited financial statements and notes thereto, which
were prepared in accordance with Canadian generally accepted accounting principles
(GAAP).

# 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. Forward-looking statements, including our belief as to the
potential of REOLYSIN® as a cancer therapeutic and our expectations as to the success
of our research and development and manufacturing programs in 2006 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. 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.

# OVERVIEW

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.

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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 2005

We have been developing our product
REOLYSIN® as a possible cancer therapy since our inception in 1998. Our goal each year
is to advance REOLYSIN® through the various steps and stages of development required
for potential pharmaceutical products. In order to achieve this goal, we believe that we
have to 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

In the first part of 2005, we
reported that we received regulatory clearance to commence three additional clinical trial
studies. The first trial approved in 2005 was our first co-therapy study that is
investigating REOLYSIN® in combination with radiation therapy in the United Kingdom
(U.K.). Our second and third trials that received regulatory clearance were
two United States (U.S.) clinical trial studies. The first of these trials was
a Phase I/II recurrent malignant glioma clinical trial. The second was a Phase I systemic
delivery clinical trial.

During 2005, we commenced patient
enrollment in the U.K. combination radiation therapy and the U.S. systemic delivery
clinical trials while continuing to enroll patients in our ongoing U.K. systemic delivery
and Canadian glioma clinical trials. In the fourth quarter of 2005, we ended patient
treatment in the Canadian glioma study and exited 2005 with three actively enrolling
clinical trials.

In the fourth quarter of 2005, we
reported interim results from two of our clinical trials. The first report was in
conjunction with a poster presentation at the AACR-NCI-EORTC conference in Philadelphia by
our principal investigator for our Phase I systemic delivery clinical trial in the U.K.
Our principal investigator presented data on 22 patients and reported that REOLYSIN®
is well tolerated when administered intravenously with minimal toxicity observed and that
reovirus replication in tumours has been identified with evidence of tumor necrosis. The
principal investigator also reported that there have been encouraging hints of activity in
prostate and colorectal cancer. This trial continues to enroll and we expect that patient
enrollment will be completed in 2006. We also reported on the Canadian glioma clinical
trial. In this trial a total of 12 patients were enrolled. A maximum tolerated dose was
not reached and REOLYSIN® was well tolerated.

# Pre-Clinical Trial and
Collaborative Program

We perform pre-clinical studies and
engage in collaborations to help support our clinical trial programs and expand our
intellectual property base. In 2005, we investigated the interaction of the reovirus with
the immune system and the use of reovirus as a co-therapy with existing chemotherapies and
radiation. In the fourth quarter of 2005, we reported in conjunction with one of our
collaborators at the AACR-NCI-EORTC conference in Philadelphia, that reovirus enhances
radiation cytotoxicity in vitro and in vivo. The results of this collaboration were also
used to support our radiation co-therapy clinical trial application in the U.K.

# Manufacturing and
Process Development

During 2005, we contracted cGMP
(current good manufacturing practices) production runs that we believe produced
sufficient REOLYSIN® to supply our existing
clinical trials in the U.S. and the U.K. We also entered into process development
activities that examined ways to improve the process yields.

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# Intellectual Property

During 2005 four Canadian patents and
one European patent were issued. At the end of 2005, we exited with a total of thirteen
U.S., four Canadian and two European patents. We also have other patent applications filed
in the U.S., Europe and Canada and other jurisdictions.

# Financial Impact

We estimated at the beginning of 2005
that our cash usage would be approximately $12,000,000 for 2005. Our actual cash usage for
the year was $12,146,806 with $11,052,462 from operating activities and $1,094,344 from
the purchases of intellectual property and capital assets. Our net loss for the year was
$12,781,831.

# Cash Resources

We have used the equity markets to
acquire the cash resources required to fund our operations. In 2005, we received cash
proceeds in two types of financing transactions. The first was the exercise of existing warrants in the first quarter of
2005 and options for total cash proceeds of $3,384,787. The second occurred in the fourth
quarter of 2005 when we issued units comprised of one common share and one half of one
common share purchase warrant for net cash proceeds of $15,395,402. We exited 2005 with
cash resources totaling $40,406,167 (see Liquidity and Capital
Resources).

REOLYSIN® Development
For 2006

We believe that patient enrollment in
our two U.K. clinical trials and our U.S. systemic trial will conclude in 2006 and we
believe that we will be able to report additional patient data pertaining to these trials.
The timing of when and what we are able to report will be determined in conjunction with
the principal investigator and the clinical trial site.

We believe that the results from our
existing clinical trials will provide us with support to expand our clinical trial program
in 2006. We plan to expand our program to focus on specific cancer indications and drug
combinations and move into Phase II clinical trials.

We expect to produce REOLYSIN® in
2006 to supply our expanding clinical trial program. We also plan to continue process
yield improvement and scale up studies in 2006 in an effort to continue to improve our
manufacturing process.

We estimate, based on our expected
activity in 2006 that our monthly cash usage for the year will increase to $1,500,000 per
month (see Liquidity and Capital Resources).

Recent 2006 Progress

On January 18, 2006, the U.S. NCI
issued a solicitation for Letters of Intent with respect to the conduct of two human
clinical trials using REOLYSIN®. The first is a Phase II study administering
REOLYSIN® systemically in patients with melanoma. The dosage and dosing regimen to be
used in the study will be determined based on data derived from our ongoing U.K. and U.S.
Phase I systemic administration studies. The second solicitation is for proposals for a
Phase I/II study of REOLYSIN® co-administered both systemically and intraperitoneally
(IP) in patients with ovarian cancer. The purpose of the Phase I portion of
the trial is to determine the Maximum Tolerated Dose of REOLYSIN® given by IP
administration in combination with a constant systemic dose and dosing regimen.

On January 24, 2006, we announced
that an oral presentation of the preliminary results of our Phase I combination
REOLYSIN®/radiation clinical trial is scheduled to be made at the American Association
of Cancer Researchers annual meeting held April 1  5 in Washington D.C. by our
principal investigator Dr. Kevin Harrington.

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# ACCOUNTING POLICIES

# Critical Accounting
Policies and Estimates

In preparing our financial
statements, we are required to make certain estimates, judgments and assumptions that we
believe are reasonable based upon the information available. These estimates and
assumptions affect the reported amounts of assets at the date of the financial statements
and the reported amounts of expenses during the periods presented. Significant estimates
are used for, but not limited to, the treatment of our research and development
expenditures, the assessment of realizable value of long-lived assets, the amortization
period of intellectual property and the calculation of stock based compensation.

The significant accounting policies
which we believe are the most critical to aid in fully understanding and evaluating our
reported financial results include the following:

Research and Development

Our research and development costs
are expensed as they are incurred. Under Canadian generally accepted accounting
principles, development costs should be capitalized if certain criteria are met. Companies
with products in clinical trials do not necessarily meet these criteria. Our development
costs do not meet the following two criteria: (i) the technical feasibility of the product
or process has been established; and (ii) the future market for the product or process is
clearly defined. With regard to (i), we have completed three Phase I clinical trials and
are presently enrolling in three additional Phase I clinical trial studies for
REOLYSIN®. We are also planning to add to our clinical trial program. Until the
appropriate clinical studies have been completed, the technical feasibility of this
product will not be known. With regard to (ii), the future market for the product will not
be clearly defined until the completion of the clinical studies. Clinical studies not only
determine the technical feasibility of the product, but also provide information regarding
the proper use of the product and, therefore, the future market. Once the feasibility is
determined a New Drug Application, or equivalent, is made to the appropriate regulatory
body. Regulatory approval is required before the product can be marketed. For these
reasons, our development costs are expensed and not capitalized.

Capitalization and
Amortization of Patent Costs

We treat third party costs incurred
(primarily legal and registration costs) in the development of our Patent portfolio as
limited-life intangible assets, and we amortize the costs related to these assets over the
lesser of 17 years or their estimated useful life. We also review the valuation of our
Patent costs for impairment when any events that might give rise to impairment are known
to us. If there is an indication of impairment, we would assess the fair value of our
Patents and would record a reduction if the fair value were less than the book value.

In capitalizing these costs, we are
recognizing the inherent future benefit of our Patents, not only in protection of our own
potential products, but also as a possible asset that could give rise to revenues in the
future through licensing agreements. While Patent life is different in different
jurisdictions it is normally considered to be 20 years from date of application. With an
assumption of an average of three years from initial Patent application to Patent
issuance, we have set a maximum of 17 years to amortize the costs from the date of
issuance. We have then assessed the nature of the market and the continuing efforts to
develop and market new and better products, as well as the incurrence of costs associated
with Patents that have been issued and, as a result, we have chosen to amortize the costs
on a straight-line basis over ten years.

As the product to which the Patents
relate is in the development stage, with commercial recognition and revenue potential
highly uncertain, should we experience a significant failure in our clinical trial program
or other areas of risk, then the value of the Patents could be in serious question, giving
rise to a possible write-down or write-off of the asset.

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In the event that we are successful
in our product development and sales, or other parties enter into licensing agreements
with us, then it is also possible that the Patents may have a life and value beyond the
ten years assumed for the amortization policy.

In any event, the revision to any of
these policies or estimates outlined above would impact losses but not impact cash flows.

# Changes in Accounting
Policy including Initial Adoption

GAAP Hierarchy and
General Standards of Financial Statement Presentation

In 2005, we adopted the new CICA
Handbook Sections 1100, Generally Accepted Accounting Principles, and 1400,
General Standards of Financial Statement Presentation. Section 1100 describes
what constitutes Canadian GAAP and its sources and provides guidance on sources to consult
when selecting accounting policies and determining appropriate disclosures when a matter
is not dealt with explicitly in the primary sources of generally accepted accounting
principles, thereby re-codifying the Canadian GAAP hierarchy. Section 1400 provides
general guidance on financial statement presentation and further clarifies what
constitutes fair presentation in accordance with GAAP. The application of this standard
had no impact on our financial position or results of operations.

Non-monetary Transactions

In 2006, we will prospectively adopt
the new Canadian standard, Non-monetary Transactions, which requires application of fair
value measurement to non-monetary transactions determined by a number of tests. The new
standard is consistent with recently amended US standards. We do not expect this standard
to have a significant impact on our financial statements upon adoption.

Financial Instruments

On January 1, 2007, we will
prospectively adopt the new Canadian accounting standards for financial instruments and
comprehensive income. These new accounting standards will impact our accounting policy for
investment securities. The new rules will require us to classify these securities as
held-to-maturity or available-for-sale. Available-for-sale securities will be measured at
fair value with gains and losses recorded in a new section of shareholders equity
called other comprehensive income. There will be no change in accounting for
held-to-maturity securities. We do not expect these standards to have a significant impact
on our financial statements upon adoption as our short-term investments will be classified
as held-to-maturity securities.

# Fair Presentation

We prepare our financial statements
in accordance with GAAP. As a result of complying with GAAP, we believe that the following
should be mentioned in an effort to understand and fairly present our financial
information:

Stock Based Compensation

As required by the fair value based
method for measuring stock based compensation, we use the Black Scholes Option Pricing
Model (Black Scholes or the Model) to calculate the fair value of
our options. Though there are other models available to calculate the option values (for
example, the binomial model), Black Scholes is currently widely used and accepted by other
publicly traded companies. Therefore, we have concluded that Black Scholes is the
appropriate option pricing model to use for our stock options at this time.

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Black Scholes uses inputs in its
calculation of fair value that requires us to make certain estimates and assumptions. For
2005, we used the following weighted average assumptions:

|                                          | 2005
|----------------------------------------- | ----
|                                         
|Risk-free interest rate                   |     
|Expected hold period to exercise          |     
|Volatility in the price of the our shares |     
|Dividend yield                            |     

A change in these estimates and
assumptions will impact the value calculated by the Model. For instance, the volatility in
the price of our shares is based on the quoted trading price. We assume that weekly
trading prices best reflects our trading price volatility. However, an entity can choose
between daily, weekly, monthly or quarterly trading prices in the volatility calculation.
For example, based upon periods chosen, if we were to use daily trading prices, volatility
would increase 34%, resulting in an option value increase of 27% from that calculated from
the stated volatility. If we were to use monthly trading prices over the same period,
volatility would increase 17%, resulting in an option value increase of 15%. Also,
volatility would change based on the period chosen and the frequency of price points
chosen.

The Model also uses an expected hold
period to exercise in its calculation of fair value. When we are estimating the expected
hold period to exercise we take into consideration past history, the current trading price
and volatility of our common shares and have concluded that 3.5 years is an appropriate
estimate. However, our options have a 10 year life and given the fluctuations in our stock
price the expected hold period could be different. If the hold period was to increase 1
year, there would have been a 13% increase in our stock based compensation expense.

Consequently, in complying with GAAP
and selecting what we believe are the most appropriate assumptions under the
circumstances, we have increased our reported non-cash employee stock based compensation
expense for the year by $64,104. However, given the above discussion this expense could be
increased between 13%  27% and still be in accordance with GAAP.

Warrant Values

In 2005, we continued to raise cash
through the issue of units and the exercise of warrants and options. Each issued unit
consisted of one common share and one half of one common share purchase warrant with each
whole warrant exercisable at a specified price for one additional common share for up to
36 months from the issue date. GAAP requires that when recording the issued units, a value
should be ascribed to each component of the units based on the components fair
value. The fair value of our common shares is established based on trading on stock
exchanges in Canada and the U.S. However, as the warrants do not trade on an exchange, the
Black Scholes Option Pricing Model was used to determine the fair value of the warrants.
In the event that the total calculated value of each individual component is greater than
the price paid for the unit the value of each component is reduced on a relative basis
until the total is equal to the units issue price.

For reasons discussed above under
Stock Based Compensation, the Model can produce a wide range of calculated
values for our warrants.

Initial Value of Our
Intellectual Property

In 1999, we were acquired by SYNSORB
Biotech Inc. (SYNSORB) through the purchase of all of our share capital for
$2,500,000. In connection with this acquisition, the basis of accounting for the assets
and liabilities was changed to reflect SYNSORBs cost of acquiring theses assets and
liabilities. This was achieved through the application of push down
accounting. At the time, our major asset was our intellectual property, therefore the
$2,500,000 was allocated to this asset with the corresponding credit to contributed
surplus. This accounting treatment, permitted under GAAP, increased the value of our
assets and shareholders equity. As of December 31, 2005, the net book value of our
original intellectual property

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was $833,333. Consequently, without
the application of push down accounting the value of our intellectual property and
shareholders equity would be $833,333 lower than presented in the 2005 audited
financial statements.

# SELECTED ANNUAL
INFORMATION

|                                             | 2005
$ | 2004
$     | 2003
$
|-------------------------------------------- | ------ | ---------- | ------
|                                            
|Revenues(1)                                  |        | 783,456    |       
|Net loss(2),(4)                              |        | 12,781,831 |       
|Basic and diluted loss per share (2),(4),(5) |        | 0.39       |       
|Total assets(3),(5)                          |        | 46,294,326 |       
|Total long term financial liabilities(6)     |        | 150,000    |       
|Cash dividends declared per share(7)         |        | Nil        |       
|                                            

Notes:

| | (1) |  | Revenue
is comprised of interest income and income from short term investments.
| | --- |  | -------------------------------------------------------------------------------

| | (2) |  | Included
in net loss and net loss per share for 2005 is a net gain (net loss) from sale of
investments of $765 (2004 -          $34,185; 2003 - ($1,892,232)).
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) |  | Subsequent
to the acquisition of Oncolytics Biotech Inc. by SYNSORB in April 1999, we applied push
down accounting. See note          2 to the audited financial statements for 2005.
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (4) |  | Included
in net loss and net loss per share is stock based compensation expense of $64,104 (2004 -
$2,668,570; 2003 -          $996,707)
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------

| | (5) |  | We
issued 4,321,252 common shares for cash proceeds of $18,780,189 in 2005 (2004 - 4,685,775
common shares for cash proceeds          of $23,495,961; 2003 - 5,062,978 common shares
for $16,004,981).  In addition, 21,459 common shares were issued in 2004 as
         partial consideration for the cancellation of a portion of our contingent
payments (see note 10 to the audited financial          statements for 2005
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (6) |  | The
long-term debt recorded in 2005, 2004 and 2003 represents repayable loans from the
Alberta Heritage Foundation.
| | --- |  | -------------------------------------------------------------------------------------------------------------------

| | (7) |  | We
have not declared or paid any dividends since incorporation.
| | --- |  | ---------------------------------------------------------------

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# RESULTS OF OPERATIONS

Net loss for the year ended December
31, 2005 was $12,781,831 compared to $12,956,119 and $8,544,031,for 2004 and 2003,
respectively.

Research and Development
Expenses (R&D)

|                                                               | 2005
$ | 2004
$    | 2003
$
|-------------------------------------------------------------- | ------ | --------- | ------
|                                                              
|Manufacturing and related process development expenses         |        | 4,714,320 |       
|Clinical trial expenses                                        |        | 1,871,942 |       
|Pre-clinical trial expenses and collaborations                 |        | 786,488   |       
|Cancellation of contingent payment obligation                  |        |          |       
|Quebec scientific research and experimental development refund |        |          |       
|Other R&D expenses                                             |        | 1,936,227 |       
|                                                              
|Research and development expenses                              |        | 9,308,977 |       
|                                                              

In 2005, R&D was $9,308,977
compared to $7,107,998 and $2,818,962 in 2004 and 2003, respectively.

# Manufacturing &
Related Process Development (M&P)

M&P expenses include product
manufacturing expenses and process development. Production manufacturing expenses include
third party direct manufacturing costs, quality control testing, and fill costs. Process
development expenses include costs associated with studies that examine components of our
manufacturing process looking for improvements and costs associated with the creation and
testing of our master and working viral and cell banks.

|                                                       | 2005
$ | 2004
$    | 2003
$
|------------------------------------------------------ | ------ | --------- | ------
|                                                      
|Product manufacturing expenses                         |        | 4,326,577 |       
|Technology transfer expenses                           |        |          |       
|Process development expenses                           |        | 387,743   |       
|                                                      
|Manufacturing and related process development expenses |        | 4,714,320 |       
|                                                      

Our M&P expenses in 2005
increased to $4,714,320 compared to $3,868,883 and $1,328,480 in 2004 and 2003,
respectively. In 2005, we continued tofocus on the production of REOLYSIN® in
order to supply our expanding clinical trial program along with other research activity.
In the first part of 2005, we entered into a multiple cGMP  production run supply contract with Cobra Biomanufacturing
Plc (Cobra). Later in 2005, we further expanded our cGMP production contracts
by adding additional manufacturing runs. As well, we contracted Cobra to supply non-cGMP
product to be used in non-human research and collaborative studies. As a result, we
believe that the REOLYSIN® produced in 2004 and 2005 should be sufficient to complete
our existing clinical trials.

In 2004, we entered into an agreement
to commence the manufacturing of REOLYSIN® and consequently incurred expenses
associated with the technology transfer of our manufacturing process. This transfer was
completed in 2004. In 2003, we were producing REOLYSIN® with our former manufacturer.

We expect that our product
manufacturing expenses in 2006 will remain consistent compared to 2005. We are expecting
to enter into additional production run contracts to ensure a supply of REOLYSIN® for
our existing and future clinical trial and collaborative programs and to supply the NCI
clinical studies. However, we may choose to increase our product manufacturing commitments
in 2006 if we believe we will need additional REOLYSIN® as our clinical trial program
progresses.

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Our process development expenses in
2005 were $387,743 compared to $999,951 and $404,024 in 2004 and 2003, respectively. We
believe that improvements can be made to increase productivity. In 2005, our process
development activities focused on improving process yields. In 2003 and 2004, our process
development activity mainly related to establishing our own master and working viral and
cell banks.

Our process development expenses in
2006 may increase compared to 2005. We will continue to work on improving process yields.
We are also expecting to incur additional process development expenses associated with the
scale up of our manufacturing process.

# Clinical Trial Program

Clinical trial expenses include those
costs associated with our clinical trial program in the U.S., UK and Canada as well as
those incurred in the preparation of commencing other clinical trials. Included in
clinical trial expenses are direct patient costs, contract research organization
(CRO) expenses, clinical trial site costs and other costs associated with our
clinical trial program.

|                               | 2005
$ | 2004
$    | 2003
$
|------------------------------ | ------ | --------- | ------
|                              
|Direct clinical trial expenses |        | 1,675,003 |       
|Other clinical trial expenses  |        | 196,939   |       
|                              
|Clinical trial expenses        |        | 1,871,942 |       
|                              

In 2005, we incurred costs directly
associated with ongoing clinical trials of $1,675,003 compared to $649,405 and $64,559 in
2004 and 2003, respectively. In 2005, our clinical trial program expanded to include our
two U.S. studies and an additional study in the U.K. Consequently, we actively enrolled in
four clinical trials in 2005 compared to only having two ongoing studies in 2004 and 2003.
Also, we concluded our enrollment in the Canadian glioma study and incurred site closure
expenses towards the end of 2005. In 2004, we provided a final update with respect to our
T2 prostate cancer study and incurred site closure costs.

We expect our clinical trial expenses
will continue to increase in 2006 compared to 2005. The increase in these expenses is
expected to arise from enrollment in our existing clinical trial program and expansion
into further clinical trials.

# Pre-Clinical Trial
Expenses and Research Collaborations

Pre-clinical trial expenses include
toxicology studies and are incurred by us in support of expanding our clinical trial
program into other indications, drug combinations and jurisdictions. Research
collaborations are intended to expand our intellectual property related to reovirus and
other viruses and identify potential licensing opportunities arising from our technology
base.

|                                                        | 2005
$ | 2004
$  | 2003
$
|------------------------------------------------------- | ------ | ------- | ------
|                                                       
|Research collaboration expenses                         |        | 652,393 |       
|Pre-clinical trial expenses                             |        | 134,095 |       
|                                                       
|Pre-clinical trial expenses and research collaborations |        | 786,488 |       
|                                                       

In 2005, our research collaboration
expenses were $652,393 compared to $262,910 and $120,026 in 2004 and 2003, respectively. In
2005, we expanded our collaborative activities to include studies investigating the
interaction of the reovirus with the immune system and the use of the reovirus as a
co-therapy with existing chemotherapies and radiation. In the fourth quarter of 2005, we
reported the results of our collaboration with The Institute of Cancer Research that
examined the combination of REOLYSIN® and radiation therapy which showed that the
combination of REOLYSIN® and radiation therapy results in enhanced cytotoxicity in a
range of tumour cell lines in vitro and in vivo.

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In 2004, our collaborative activities
included studies that used reovirus as a co-therapy in combination with existing
chemotherapies and radiation. Data from our collaboration examining the use of
REOLYSIN® with approved chemotherapeutics in animal models was presented in 2004. In
2003, we entered into a collaboration to develop modified adenoviruses that are selective
for Ras mediated cancers.

In 2005, we incurred pre-clinical
trial expenses of $134,095 compared to $561,979 and $202,034 in 2004 and 2003
respectively. The decrease in pre-clinical trial expenses in 2005 compared to 2004 related
to toxicology and equivalency studies that were performed in 2004 but not in 2005. As we
move through our clinical trial program the number of pre-clinical studies required will
change from year to year.

In 2006, we expect that pre-clinical
trial expenses and research collaborations will remain consistent compared to 2005 and
2004. We expect to continue expanding our collaborations in order to provide support for
our expanding clinical trial program. However, in our efforts to enter into additional
combination therapy clinical trials we may be required to perform additional pre-clinical
trial studies which could increase these costs compared to 2005 and 2004.

# Other Research and
Development Expenses

Other R&D expenses include
compensation expenses for employees (excluding stock based compensation), consultant fees,
travel and other miscellaneous R&D expenses.

|                                        | 2005
$ | 2004
$    | 2003
$
|--------------------------------------- | ------ | --------- | ------
|                                       
|R&D consulting fees                     |        | 675,530   |       
|R&D salaries and benefits               |        | 1,018,144 |       
|Other R&D expenses                      |        | 242,553   |       
|                                       
|Other research and development expenses |        | 1,936,227 |       
|                                       

In 2005, our R&D consulting fees
were $675,530 compared to $290,135 and $187,513 in 2004 and 2003, respectively. For the
past three years, we have mainly incurred consulting activity associated with our clinical
trial applications, assistance with our existing and future clinical trial program and our
scientific advisory board. In 2005, we also incurred consulting expenses for executive
search activities associated with the hiring of our Chief Medical Officer which was not
incurred in 2004 or 2003.

Our R&D salaries and benefits
were $1,018,144 in 2005 compared to $722,136 and $815,869 in 2004 and 2003, respectively.
In 2005, along with increases in salary levels, we hired our Chief Medical Officer in the
third quarter of 2005.

In 2006, we expect that our Other
R&D expenses will remain consistent with 2005. We expect that salaries and benefits
will increase as 2006 should include a complete year of salary and benefit costs for our
Chief Medical Officer. Our R&D consulting fees should decline as we do not expect to
incur executive search costs in 2006. However, we may choose to engage additional
consultants to assist us in the development of protocols and regulatory filings for our
additional combination therapy and phase II clinical trial studies possibly causing our
R&D consulting expenses to increase.

# Cancellation of
Contingent Payment Obligation

On September 23, 2004, we reached an
agreement that cancelled a portion of our future contingent obligation to one of our
non-management founding shareholders for consideration of $400,000. The consideration paid
included cash of $250,000 and non-cash consideration of 21,459 common shares valued at
$150,000 and was recorded as additional research and development expense. The value of the
common shares was based on the September 23, 2004 closing price of $6.99. As a result, our
future contingent payment obligations were reduced to 11.75% (formerly in 2003 
14.25% and 2002  20%) of payments received associated with a partnership or other
arrangement for development. Similarly, if we develop the reovirus treatment to the point
where it may be marketed at a commercial level, the payment referred to in

- 10 -

---

the foregoing sentence has been
amended to a royalty payment of 2.35% (formerly in 2003  2.85% and 2002  4%)
of Net Sales received by us for such products.

Operating Expenses

|                                | 2005
$ | 2004
$    | 2003
$
|------------------------------- | ------ | --------- | ------
|                               
|Public company related expenses |        | 2,156,614 |       
|Office expenses                 |        | 928,283   |       
|                               
|Operating expenses              |        | 3,084,897 |       
|                               

In 2005, we incurred operating
expenses of $3,084,897 compare to $2,803,669 and $2,449,478 in 2004 and 2003 respectively.
The reason for the change is as follows:

Public company related expenses
include costs associated with investor relations activities, legal and accounting fees,
corporate insurance, and transfer agent and other fees relating to our U.S. and Canadian
stock listings. We incurred public company related expenses of $2,156,614 in 2005 compared
to $1,910,611 and $1,633,849 in 2004 and 2003, respectively. In 2005, after receiving
approval to commence our two U.S. clinical trials we initiated an expanded public
relations and investor relations program in the U.S. The increase in 2004 related to the
rising cost of directors and officers liability insurance which increased due
to general market conditions for companies with a U.S. stock listing.

Office expenses include compensation
costs (excluding stock based compensation), office rent, and other office related costs.
In 2005, we incurred office expenses of $928,283 compared to $893,058 and $815,629 in 2004
and 2003, respectively. Our office expense activity has remained consistent over the last
three years with increases mainly due to increased compensation and staff levels.

Stock Based Compensation

|                         | 2005
$ | 2004
$ | 2003
$
|------------------------ | ------ | ------ | ------
|                        
|Stock based compensation |        | 64,104 |       
|                        

Non-cash stock based compensation
recorded for 2005 was $64,104 compared to $2,668,570 and $996,707 in 2004 and 2003,
respectively. This expense is associated with the granting of stock options to our
employees, directors, and certain consultants and in 2005 there was a reduction in the
number of stock options granted compared to 2004 and 2003.

Foreign Exchange Loss
(Gain)

|                             | 2005
$ | 2004
$  | 2003
$
|---------------------------- | ------ | ------- | ------
|                            
|Foreign exchange loss (gain) |        | 253,608 |       
|                            

We acquire investments in foreign
currency to pay for anticipated expenses that are to be incurred in the U.S. and the U.K.
As a result of continued strengthening in the Canadian dollar relative to the U.S. dollar
and British pound, we recorded a foreign exchange loss of $253,608 in 2005 compared to
$358,068 and $2,881 in 2004 and 2003, respectively.

- 11 -

---

Sale of Investments

|                                                            | 2005
$ | 2004
$ | 2003
$
|----------------------------------------------------------- | ------ | ------ | ------
|                                                           
|Gain on partial sale of investment in BCY LifeSciences Inc. |        | (765   | )     
|Loss on sale of investment in Transition Therapeutics Inc.  |        |       |       
|                                                           
|Net (gain) loss from sale of investments                    |        | (765   | )     
|                                                           

BCY LifeSciences Inc. (BCY)

In 2005, we sold 120,000 (2004 
697,945; 2003  1,496,500) common shares of BCY for net cash proceeds of $7,965 (2004
 $133,609; 2003  $450,151). This resulted in an accounting gain of $765 (2004
 $34,185; 2003  $264,453). Our total cash invested with respect to our BCY
investment was $127,123.

Transition Therapeutics
Inc. (TTH)

In 2003, we sold 6,890,000 common
shares of TTH for net cash proceeds of $2,552,695 which had been acquired through the
issuance of 1,913,889 of our common shares. As a result of the sale, an accounting loss of
$2,156,685 was recorded. Our cash expenses with respect to our investment in TTH were
limited to acquisition legal costs of $20,352.

# Commitments

As at December 31, 2005, we are
committed to payments totaling $1,138,000 during 2006 for activities related to clinical
trial activity and collaborations. All of these committed payments are considered to be
part of our normal course of business.

Subsequent to 2005, we entered into
research and development agreements and under these contracts we have committed to
payments totaling $1,451,000.

# SUMMARY OF QUARTERLY
RESULTS

The following unaudited quarterly
information is presented in thousands of dollars except for per share amounts:

|                           | 2005 | 2004     
|-------------------------- | ---- | ---------
|                          
|
|                          
|Revenue(1)                 |      | 160      
|                          
|Net loss(2),(5)            |      | 3,941    
|                          
|Basic and diluted loss per |     
|common share(2),(5)        |      | $    0.12
|                          
|Total assets(3),(6)        |      | 46,294   
|                          
|Total cash(4),(6)          |      | 40,406   
|                          
|Total long-term debt(7)    |      | 150      
|                          
|Cash dividends declared(8) |      | Nil      
|                          

| | (1) |  | Revenue
is comprised of interest income and income from short term investments.
| | --- |  | -------------------------------------------------------------------------------

| | (2) |  | Included
in net loss and net loss per share between December 2005 and January 2004 is a quarterly
gain (loss) on sale of          investment of $nil, $nil, $nil, $765, $nil, ($12,817),
($646), and $47,648 , respectively.
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) |  | Subsequent
to the acquisition of Oncolytics Biotech Inc. by SYNSORB in April 1999, we applied push
down accounting. See note          2 to the audited financial statements for 2005.
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 12 -

---

| | (4) |  | Included
in total cash are cash and cash equivalents plus short-term                investments.
| | --- |  | ------------------------------------------------------------------------------------------------

| | (5) |  | Included
in net loss and loss per common share between December 2005 and January
               2004 are quarterly stock based compensation expenses of $38,152, $4,173,
$8,404,                $13,375, $1,870,596, $48,878, $734,670, and $5,426, respectively.
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (6) |  | We
issued 4,321,252 common shares for cash proceeds of $18,789,596 during 2005
               (2004  4,685,775 common shares for $23,495,961). In addition, 21,459
               common shares were issued in September 2004 as partial consideration for
the                cancellation of a portion of our contingent payments (see note 10 to
the audited                financial statements for 2005).
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (7) |  | The
long-term debt recorded represents repayable loans from the Alberta Heritage
               Foundation.
| | --- |  | -----------------------------------------------------------------------------------------------------------

| | (8) |  | We
have not declared or paid any dividends since incorporation.
| | --- |  | ---------------------------------------------------------------

# FOURTH QUARTER

Statement of loss for the three month
period ended December 31, 2005 and 2004

|                                  | 2005
$(unaudited) | 2004
$(unaudited)
|--------------------------------- | ----------------- | -----------------
|                                 
|Interest income                   |                   | 159,841          
|                                 
|Research and development expenses |                   | 2,809,943        
|Operating expenses                |                   | 973,470          
|Stock based compensation          |                   | 38,152           
|Foreign exchange loss (gain)      |                   | 55,127           
|Amortization                      |                   | 223,708          
|                                 
|                                  |                   | 4,100,400        
|                                 
|Loss before the following:        |                   | 3,940,559        
|Gain on sale of investment in BCY |                   |                 
|                                 
|Loss before taxes                 |                   | 3,940,559        
|Capital tax                       |                   |                 
|                                 
|Net loss                          |                   | 3,940,559        
|                                 

# Review of Operations

For the three month period ended
December 31, 2005, our net loss was $3,940,559 compared to $3,991,953 for the three month
period ended December 31, 2004. The reasons for the increase are as follows:

Research and Development
Expenses (R&D)

|                                                               | 2005
$(unaudited) | 2004
$(unaudited)
|-------------------------------------------------------------- | ----------------- | -----------------
|                                                              
|Manufacturing and related process development expenses (M&P) |                   | 1,129,891        
|Clinical trial expenses                                        |                   | 717,265          
|Pre-clinical trial expenses and research collaborations        |                   | 262,015          
|Other R&D expenses                                             |                   | 700,772          
|                                                              
|Research and development expenses                              |                   | 2,809,943        
|                                                              

Our R&D expenses increased to
$2,809,943 in the fourth quarter of 2005 compared to $1,425,286 in the fourth quarter of
2004.

- 13 -

---

# Manufacturing &
Related Process Development (M&P)

|                                                       | 2005
$(unaudited) | 2004
$(unaudited)
|------------------------------------------------------ | ----------------- | -----------------
|                                                      
|Product manufacturing expenses                         |                   | 951,667          
|Technology transfer expenses                           |                   |                 
|Process development expenses                           |                   | 178,224          
|                                                      
|Manufacturing and related process development expenses |                   | 1,129,891        
|                                                      

Our M&P expenses increased to
$1,129,891 in the fourth quarter of 2005 compared to $507,869 in the fourth quarter of
2004. In the fourth quarter of 2005, we continued to focus on the production of
REOLYSIN® by commencing additional production runs with Cobra. In the fourth quarter
of 2004, we had finished the technology transfer to Cobra and had begun producing
REOLYSIN®.

Our process development costs were
$178,224 in the fourth quarter of 2005 compared to $62,652 in the fourth quarter of 2004.
In the fourth quarter of 2005, our process development activities related to the
improvement of process yields. In the fourth quarter of 2004, process development
activities related to the technology transfer to Cobra.

# Clinical Trial Program

|                               | 2005
$(unaudited) | 2004
$(unaudited)
|------------------------------ | ----------------- | -----------------
|                              
|Direct clinical trial expenses |                   | 657,405          
|Other clinical trial expenses  |                   | 59,860           
|                              
|Clinical trial expenses        |                   | 717,265          
|                              

Our clinical trial expenses for the
fourth quarter of 2005 were $717,265 compared to $366,852 for the fourth quarter of 2004.
In the fourth quarter of 2005, we were actively enrolling patients in three clinical
trials in the U.S. and the U.K. and incurred clinical trial site closure costs associated
with the Canadian malignant glioma trial. In the fourth quarter of 2004, we were actively
enrolling in the U.K. systemic and the Canadian malignant glioma clinical trials.

# Pre-Clinical Trial
Expenses and Research Collaborations

|                                                        | 2005
$(unaudited) | 2004
$(unaudited)
|------------------------------------------------------- | ----------------- | -----------------
|                                                       
|Research collaboration expenses                         |                   | 224,673          
|Pre-clinical trial expenses                             |                   | 37,342           
|                                                       
|Pre-clinical trial expenses and research collaborations |                   | 262,015          
|                                                       

Our pre-clinical trial expenses and
research collaborations were $262,015 in the fourth quarter of 2005 compared to $89,425 in
the fourth quarter of 2004. In the fourth quarter of 2005, our research collaborations
continued to expand to include the interaction of the immune system and reovirus and the
use of reovirus as a co-therapy with existing chemotherapies. In the fourth quarter of
2004, our research collaboration activity mainly related to the use of reovirus as a
co-therapy with existing chemotherapies and the development of modified adenoviruses that
are selective for Ras mediated cancers.

- 14 -

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# Other Research and
Development Expenses

|                                        | 2005
$(unaudited) | 2004
$(unaudited)
|--------------------------------------- | ----------------- | -----------------
|                                       
|R&D consulting fees                     |                   | 124,936          
|R&D salaries and benefits               |                   | 455,771          
|Other R&D expenses                      |                   | 120,065          
|                                       
|Other research and development expenses |                   | 700,772          
|                                       

Our other research and development
expenses were $700,772 for the fourth quarter of 2005 compared to $461,140 for the fourth
quarter of 2004. The increase mainly related to the hiring of our Chief Medical Officer at
the end of the third quarter of 2005.

Operating Expenses

|                                | 2005
$(unaudited) | 2004
$(unaudited)
|------------------------------- | ----------------- | -----------------
|                               
|Public company related expenses |                   | 672,010          
|Office expenses                 |                   | 301,460          
|                               
|Operating expenses              |                   | 973,470          
|                               

Our operating expenses for the fourth
quarter of 2005 were $973,470 compared to $690,628 for the fourth quarter of 2004. This
increase corresponds to an increase in investor relations activity in the fourth quarter
of 2005 compared to the fourth quarter of 2004.

Stock Based Compensation

|                         | 2005
$(unaudited) | 2004
$(unaudited)
|------------------------ | ----------------- | -----------------
|                        
|Stock based compensation |                   | 38,152           
|                        

Our non-cash stock based compensation
recorded for the fourth quarter of 2005 was $38,152 compared to $1,879,596 for the fourth
quarter of 2004. The stock based compensation expense in the fourth quarter of 2005
related to the vesting of previously granted options. In the fourth quarter of 2004, stock
based compensation expense related to the granting of options to officers, directors and
employees.

# Financing Activities

On December 29, 2005, we issued
3,200,000 units for gross cash proceeds of $16,480,000. Each unit consisted of one common
share and one half of one common share purchase warrant. Each whole common share purchase
warrant entitles the holder to acquire on common share in our capital upon payment of
$6.15 per share until December 29, 2008. In addition, we issued 320,000 common share
purchase warrants with an exercise price of $5.65 to the agent of this transaction. The
broker warrants expire on December 29, 2008.

- 15 -

---

# LIQUIDITY AND CAPITAL
RESOURCES

# Liquidity

As at December 31, 2005, we had cash
and cash equivalents (including short-term investments) and working capital positions of
$40,406,167 and $39,301,444, respectively, compared to $33,919,223 and $33,268,097,
respectively, for 2004. The increase in 2005 reflects the cash inflow of $18,780,189 from
one private placement and proceeds from the exercise of warrants and options. Cash usage
from operating activities and the purchase of intellectual property and capital assets in
2005 was $12,146,806 which was in line with our estimate of $12,000,000 for 2005.

We desire to maintain adequate cash
and short-term investment reserves to support our planned activities which include our
clinical trial program, product manufacturing, administrative costs, and our intellectual
property expansion and protection. In 2006, we are expecting to expand our clinical trial
program to include additional co-therapy clinical trials and Phase II clinical trials. We
are also expecting to continue with our collaborative studies pursuing support for our
future clinical trial program. Therefore, we will also need to ensure that we have enough
REOLYSIN® to supply our potentially expanding clinical trial and collaborative
programs. We presently estimate the cash usage for 2006 to increase to $1,500,000 per
month and we believe our existing capital resources are adequate to fund our current plans
for research and development activities into 2008. Factors that will affect our
anticipated monthly burn rate include, but are not limited to, the number of manufacturing
runs required to supply our clinical trial program and the cost of each run, the number of
clinical trials ultimately approved, the timing of patient enrollment in the approved
clinical trials, the actual costs incurred to support each clinical trial, the number of
treatments each patient will receive, the timing of the NCIs R&D activity, and
the level of pre-clinical activity undertaken.

In the event that we choose to seek
additional capital, we will look to fund additional capital requirements primarily through
the issue of additional equity. We recognize the challenges and uncertainty inherent in
the capital markets and the potential difficulties we might face in raising additional
capital. Market prices and market demand for securities in biotechnology companies are
volatile and there are no assurances that we will have the ability to raise funds when
required.

# Capital Expenditures

We spent $1,033,035 on intellectual
property in 2005 compared to $958,809 in 2004. The change in intellectual property
expenditures reflects the timing of filing costs associated with our expanded patent base.
As well, we have benefited from a stronger Canadian dollar as our patent costs are
typically incurred in U.S. currency. In 2005, four Canadian and one European patents were
issued bringing our total patents issued to thirteen in the U.S., four in Canada and two
in Europe.

# Contractual Obligations

We have the following contractual
obligations as at December 31, 2005:

|Contractual Obligations       | Payments Due by Period
|----------------------------- | ----------------------
|                             
|
|                             
|Long term debt(1)             |                       
|Capital lease obligations     |                       
|Operating leases(2)           |                       
|Purchase obligations          |                       
|Other long term obligations   |                       
|                             
|Total contractual obligations |                       
|                             

- 16 -

---

Note:

| | (1) |  | Our
long term debt is a $150,000 loan from the Alberta Heritage Foundation.  Repayments are
required upon the realization of        sales (see note 9 of the Company's audited 2005
financial statements).
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) |  | Our
operating leases are comprised of our office lease and exclude our portion of operating
costs.
| | --- |  | --------------------------------------------------------------------------------------------------

We will fund our capital expenditure
requirements and commitments with existing working capital.

Investing Activities

Under our Investment Policy, we are
permitted to invest in short-term instruments with a rating no less than R-1 (DBRS) with
terms less than two years. We have $36,894,810 invested under this policy and we are
currently earning interest at an effective rate of 2.9%.

OFF-BALANCE SHEET
ARRANGEMENTS

As at December 31, 2005, we have not
entered into any off-balance sheet arrangements.

TRANSACTIONS WITH RELATED
PARTIES

In 2005 and 2004, we did not enter
into any related party transactions.

FINANCIAL INSTRUMENTS AND
OTHER INSTRUMENTS

We do not use financial derivatives
or other financial instruments.

RISK FACTORS AFFECTING
FUTURE PERFORMANCE

All of our potential products,
including REOLYSIN(R), are in the research and development stage and will require further
development and testing before they can be marketed commercially.

Prospects for companies in the
biotechnology industry generally may be regarded as uncertain given the nature of the
industry and, accordingly, investments in biotechnology companies should be regarded as
speculative. We are currently in the research and development stage on one product,
REOLYSIN(R), for human application, the riskiest stage for a company in the biotechnology
industry. It is not possible to predict, based upon studies in animals, or early studies
in humans, whether REOLYSIN(R)will prove to be safe and effective in humans.
REOLYSIN(R)will require additional research and development, including extensive clinical
testing, before we will be able to obtain the approval of the United States Food and Drug
Administration (the FDA) or from similar regulatory authorities in other
countries to market REOLYSIN(R)commercially. There can be no assurance that the research
and development programs conducted by us will result in REOLYSIN(R)or any other products
becoming commercially viable products, and in the event that any product or products
result from the research and development program, it is unlikely they will be commercially
available for a number of years.

To achieve profitable operations
Oncolytics Biotech Inc., alone or with others, must successfully develop, introduce and
market our products. To obtain regulatory approvals for products being developed for human
use, and to achieve commercial success, human clinical trials must demonstrate that the
product is safe for human use and that the product shows efficacy. Unsatisfactory results
obtained from a particular study relating to a program may cause us to abandon our
commitment to that program or the product being tested. No assurances can be provided that
any current or future animal or human test, if undertaken, will yield favorable results.
If we are unable to establish that REOLYSIN(R)is a safe, effective treatment for cancer,
we may be required to abandon further development of the product and develop a new
business strategy.

- 17 -

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There are inherent risks in
pharmaceutical research and development.

Pharmaceutical research and development
is highly speculative and involves a high and significant degree of risk. The
marketability of any product developed by us will be affected by numerous factors beyond
our control, including:

| |  |  | the
discovery of unexpected toxicities or lack of sufficient efficacy of products which make
them unattractive or unsuitable for human use;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | preliminary
 results as seen in animal and/or limited human testing may not be  substantiated  in
larger  controlled  clinical          trials;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | manufacturing
costs or other factors may make manufacturing of products impractical and non-competitive;
| | - |  | --------------------------------------------------------------------------------------------------------

| |  |  | proprietary
rights of third parties or competing products or technologies may preclude
commercialization;
| | - |  | ---------------------------------------------------------------------------------------------------------

| |  |  | requisite
regulatory approvals for the commercial distribution of products may not be obtained; and
| | - |  | ---------------------------------------------------------------------------------------------------

| |  |  | other
factors may become apparent during the course of research, up-scaling or manufacturing
which may result in the discontinuation of research and other critical projects.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our product under development has
never been manufactured on a commercial scale, and there can be no assurance that such
products can be manufactured at a cost or in a quantity to render such products
commercially viable. Production and utilization of our products may require the
development of new manufacturing technologies and expertise. The impact on our business in
the event that new manufacturing technologies and expertise are required to be developed
is uncertain. There can be no assurance that we will successfully meet any of these
technological challenges, or others that may arise in the course of development.

Pharmaceutical products are subject
to intense regulatory approval processes.

The regulatory process for
pharmaceuticals, which includes preclinical studies and clinical trials of each compound
to establish its safety and efficacy, takes many years and requires the expenditure of
substantial resources. Moreover, if regulatory approval of a drug is granted, such
approval may entail limitations on the indicated uses for which it may be marketed.
Failure to comply with applicable regulatory requirements can, among other things, result
in suspension of regulatory approvals, product recalls, seizure of products, operating
restrictions and criminal prosecution. Further, government policy may change, and
additional government regulations may be established that could prevent or delay
regulatory approvals for our products. In addition, a marketed drug and its manufacturer
are subject to continual review. Later discovery of previously unknown problems with the
product or manufacturer may result in restrictions on such product or manufacturer,
including withdrawal of the product from the market.

The FDA in the United States and
other relevant regulatory authorities may deny approval of a new drug application
(NDA) or its equivalent in the relevant jurisdiction if required regulatory
criteria are not satisfied, or may require additional testing. Product approvals may be
withdrawn if compliance with regulatory standards is not maintained or if problems occur
after the product reaches the market. The FDA may require further testing and surveillance
programs to monitor the pharmaceutical product that has been commercialized.
Non-compliance with applicable requirements can result in fines and other judicially
imposed sanctions, including product withdrawals, product seizures, injunction actions and
criminal prosecutions.

In addition to our own
pharmaceuticals, we may supply active pharmaceutical ingredients and advanced
pharmaceutical intermediates for use in our customers drug products. The final drug
products in which the pharmaceutical ingredients and advanced pharmaceutical intermediates
are used, however, are subject to regulation for safety and efficacy by the FDA and other
jurisdictions, as the case may be. Such products must be approved by such agencies before
they can be commercially marketed. The process of obtaining regulatory clearance for
marketing is uncertain, costly and time consuming. We cannot predict how long

- 18 -

---

the necessary regulatory approvals
will take or whether our customers will ever obtain such approval for their products. To
the extent that our customers do not obtain the necessary regulatory approvals for
marketing new products, our product sales could be adversely affected.

The FDA and other governmental
regulators have increased requirements for drug purity and have increased environmental
burdens upon the pharmaceutical industry. Because pharmaceutical drug manufacturing is a
highly regulated industry, requiring significant documentation and validation of
manufacturing processes and quality control assurance prior to approval of the facility to
manufacture a specific drug, there can be considerable transition time between the
initiation of a contract to manufacture a product and the actual initiation of manufacture
of that product. Any lag time in the initiation of a contract to manufacture product and
the actual initiation of manufacture could cause us to lose profits or incur liabilities.

The pharmaceutical regulatory regime
in Europe and other countries is, by and large, generally similar to that of Canada and
the United States. We could face similar risks in these other jurisdictions, as the risks
described above.

Our
operations and products may be subject to other government manufacturing and testing
regulations.

Securing regulatory approval for the
marketing of therapeutics by the FDA in the United States and similar regulatory agencies
in other countries is a long and expensive process, which can delay or prevent product
development and marketing. Approval to market products may be for limited applications or
may not be received at all.

The products anticipated to be
manufactured by us will have to comply with the FDAs current Good Manufacturing
Practices (cGMP) and other FDA and local government guidelines and
regulations, including other international regulatory requirements and guidelines.
Additionally, certain of our customers may require the manufacturing facilities contracted
by us to adhere to additional manufacturing standards, even if not required by the FDA.
Compliance with cGMP regulations requires manufacturers to expend time, money and effort
in production, and to maintain precise records and quality control to ensure that the
product meets applicable specifications and other requirements. The FDA and other
regulatory bodies periodically inspect drug-manufacturing facilities to ensure compliance
with applicable cGMP requirements. If the manufacturing facilities contracted by us fail
to comply with the cGMP requirements, the facilities may become subject to possible FDA or
other regulatory action and manufacturing at the facility could consequently be suspended.
We may not be able to contract suitable alternative or back-up manufacturing facilities on
terms acceptable to us or at all.

The FDA or other regulatory agencies
may also require the submission of any lot of a particular product for inspection. If the
lot product fails to meet the FDA requirements, then the FDA could take any of the
following actions: (i) restrict the release of the product; (ii) suspend manufacturing of
the specific lot of the product; (iii) order a recall of the lot of the product; or (iv)
order a seizure of the lot of the product.

We are subject to regulation by
governments in many jurisdictions and, if we do not comply with healthcare, drug,
manufacturing and environmental regulations, among others, our existing and future
operations may be curtailed, and we could be subject to liability.

In addition to the regulatory
approval process, we may be subject to regulations under local, provincial, state, federal
and foreign law, including requirements regarding occupational health, safety, laboratory
practices, environmental protection and hazardous substance control, and may be subject to
other present and future local, provincial, state, federal and foreign regulations.

Our
products may fail or cause harm, subjecting us to product liability claims, which are
uninsured.

The sale and use of our products
entail risk of product liability. We currently do not have any product liability
insurance. There can be no assurance that we will be able to obtain appropriate levels of
product

- 19 -

---

liability insurance prior to any sale
of our pharmaceutical products. An inability to obtain insurance on economically feasible
terms or to otherwise protect against potential product liability claims could inhibit or
prevent the commercialization of products developed by us. The obligation to pay any
product liability claim or a recall of a product could have a material adverse effect on
our business, financial condition and future prospects.

Our technologies may become obsolete.

The pharmaceutical industry is
characterized by rapidly changing markets, technology, emerging industry standards and
frequent introduction of new products. The introduction of new products embodying new
technologies, including new manufacturing processes, and the emergence of new industry
standards may render our products obsolete, less competitive or less marketable. The
process of developing our products is extremely complex and requires significant
continuing development efforts and third party commitments. Our failure to develop new
technologies and products and the obsolescence of existing technologies could adversely
affect our business.

We may be unable to anticipate
changes in our potential customer requirements that could make our existing technology
obsolete. Our success will depend, in part, on our ability to continue to enhance our
existing technologies, develop new technology that addresses the increasing sophistication
and varied needs of the market, and respond to technological advances and emerging
industry standards and practices on a timely and cost-effective basis. The development of
our proprietary technology entails significant technical and business risks. We may not be
successful in using our new technologies or exploiting the respective niche markets
effectively or adapting our businesses to evolving customer or medical requirements or
preferences or emerging industry standards.

We have no operating revenues and a
history of losses.

To date, we have not generated
sufficient revenues to offset our research and development costs and accordingly have not
generated positive cash flow or made an operating profit. As of December 31, 2005, we had
an accumulated deficit of $50.7 million and we incurred net losses of $12.8 million, $13.0
million, and $8.5 million for the years ended December 31, 2005, 2004, and 2003,
respectively. We anticipate that we will continue to incur significant losses during 2006
and in the foreseeable future. We will not reach profitability until after successful and
profitable commercialization of one or more of our products. Even if one or more of our
products are profitably commercialized, the initial losses incurred by us may never be
recovered.

We may need additional financing in
the future to fund the research and development of our products and to meet our ongoing
capital requirements.

As of December 31, 2005, we had cash
and cash equivalents (including short-term investments) of $40.4 million and working
capital of approximately $39.3 million. We anticipate that we may need additional
financing in the future to fund research and development and to meet our ongoing capital
requirements. The amount of future capital requirements will depend on many factors,
including continued scientific progress in our drug discovery and development programs,
progress in our pre-clinical and clinical evaluation of drug candidates, time and expense
associated with filing, prosecuting and enforcing our patent claims and costs associated
with obtaining regulatory approvals. In order to meet such capital requirements, we will
consider contract fees, collaborative research and development arrangements, and
additional public or private financings (including the incurrence of debt and the issuance
of additional equity securities) to fund all or a part of particular programs as well as
potential partnering or licensing opportunities. There can be no assurance that additional
funding will be available or, if available, that it will be available on acceptable terms.
If adequate funds are not available on terms favorable to us, we may have to reduce
substantially or eliminate expenditures for research and development, testing, production
and marketing of our proposed product, or obtain funds through arrangements with corporate
partners that require us to relinquish rights to certain of our technologies or product.
There can be no assurance that we will be able to raise additional capital if our current
capital resources are exhausted.

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The cost of director and officer
liability insurance may continue to increase substantially or may not be available to us
and may affect our ability to retain quality directors and officers.

We carry liability insurance on
behalf of our directors and officers. Given a number of large director and officer
liability insurance claims in the U.S. equity markets, director and officer liability
insurance is becoming increasingly more expensive with increased restrictions.
Consequently, there is no assurance that we will continue to be offered this insurance or
be able to obtain adequate coverage. The inability to acquire the appropriate insurance
coverage may limit our ability to attract and maintain directors and officers as required
to conduct our business.

We incur some of our expenses in
foreign currencies and therefore are exposed to foreign currency exchange rate
fluctuations.

We incur some of our manufacturing,
clinical, collaborative and consulting expenses in foreign currencies, primarily the U.S.
dollar and the Great British pound (GBP). Over the past year the Canadian
dollar has appreciated relative to the U.S. dollar and the GBP thereby decreasing the
Canadian dollar equivalent. However, if this trend reverses, our Canadian dollar
equivalent costs will increase.

Also, as we expand to other foreign
jurisdictions there may be an increase in our foreign exchange exposure.

We earn interest income on our excess
cash reserves and are exposed to changes in interest rates.

We invest our excess cash reserves in investment
vehicles that provide a rate of return with little risk to principle. As interest rates
change the amount of interest income we earn will be directly impacted.

OTHER MD&A
REQUIREMENTS

We have 36,236,748 common shares
outstanding at March 2, 2006. If all of our warrants and options were exercised we would
have 42,656,098 common shares outstanding.

Our 2005 Annual Information Form is
available on www.sedar.com.

Disclosure Controls and Procedures

As of the year ending December 31,
2005, we carried out an evaluation, under the supervision of our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures.  Based upon that evaluation, our Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and procedures are effective as of
the end of the period covered by the annual filings based on this evaluation.

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