Michelle Gilson

Phone: 262.623.4743 E-Mail:

February 5, 2013

Oncolytics Biotech, Inc.

**Disclosure: Michelle Gilson and family members currently hold shares of Oncolytics Biotech Inc.**

Product:Reolysin and 360 patents worldwide (including methods foroncolytic viral administration)

NASDAQ symbol: ONCY

Stock Price: $3.87

Net loss for 2012 expected to be $36 million

Oncolytics Biotech is a Development Stage Company that is in the process of developing Reolysin, a virus formulation that can be used in the treatment of cancer. It is undergoing 19 clinical trials, including a Phase III clinical trial. This is a high-risk stock, essentially worth nothing if the product does not achieve FDA approval. The company has 76.69 M shares; equity has been its main route of financing.

This stock is market-indifferent with a high risk, but a great reward potential. The potential for this stock could be upwards of $100/share. If it is approved for one strain of cancer, it will be prescribed off-label for other types of cancers as well. Although this market is competitive, Reolysin works in conjunction with a common therapy, chemotherapy. Oncolytics is currently undergoing a Phase II clinical trial with Pancreatic cancer and a Phase III clinical trial involving metastatic cancer. Since there are no effective treatments for either of these diseases, success in either of these trials could fast-track Reolysin for FDA approval, or approval in other countries (Europe is usually quicker to approve new products to market). Oncolytics would also have no competition in these markets, as there are no other effective treatments. If it is approved to go to market in the next year, Oncolytics has already partnered with Sigma-Aldrich Co. to manufacture the product and seems to be ready for commercialization.

In the following report I discuss the Stock Potential, The Product: Reolysin, The Key Clinical Trials, other viruses being developed and their impact on Oncolytics, Failed viruses, and a Conclusion including some key points about the company and why it is worth buying. My opinions are italicized.

Stock Potential

For Reolysin being approved for metastatic cancer alone, the potential is enormous.

The following assumptions have been made:

2.5 MM new metastatic disease patients diagnosed in the developed world each year

50% of those patients go on Reolysin= 1.25 MM patients

$18,000/year price for treatment

70% Gross Margin (this is relatively cheap to manufacture)

25% SG&A expense

100MM shares by the time the company reaches profitability

Based on these assumptions, pretax income would be over $10BN and Net Income over $6.5 BN.

With 100 MM shares, the EPS would be $65/share and assuming a 15 P/E multiple, discounted back 5 years required to build the business up after favorable Phase III results at a 25% higher risk equity return requirement, this could have the potential to be a $320+/share current value stock. However, I expect that upon favorable Phase III results, there will more likely be a $100-$200/share buyout by big Pharma.

The Product: Reolysin, a Reovirus

Baltimore Class III virus:

  • Double-Stranded (DS) RNA virus
  • No viral envelope
  • Not as specific
  • Not as penetrable

Found in Nature: Reolysin is a wild-type virus, a natural, unengineered strain

  • Most of human population has contracted and have built up an adapted immune response (antibodies) to quickly fight it off- as humans age more antibodies build up and humans become more resistant to the virus
  • Orphan virus: no known disease caused
  • Rotavirus class: causes diarrhea in infants, causing death in some infants in developing nations
  • Colorado Tick Fever: mild symptoms
  • Widespread prevalence in nature, but symptoms mild or nonexistent

The Mechanism

  • Has own enzymes and DS RNA in capsid
  • Binds to cell receptor protein-enters and is transported to lysosome (where it would theoretically be destroyed)
  • The lysosome dissolves the outer shell and frees the inner protein shell and its genetic materials into the cytoplasm
  • Outer shell being dissolved signals cell replication
  • Synthesize own mRNA (only from one of the strands) in cytoplasm from its own enzymes
  • When enough protein is made, the genetic material and protein is encapsulated and the cell undergoes lysis, being destroyed while also releasing the virus back into the body this is how it spreads throughout the body

The ras gene

  • Named from “rat sarcoma”
  • A controller gene that turns the ras pathways on or off
  • Ras pathways (multiple) signal the cell growth and division, it has a series of reactions, one which turns off the cell defense for reovirus, so the cell does not recognize it to be destroyed
  • In cancer, often the ras gene has a mutation and it creates uncontrolled cell division. The cells do not have enough time to copy all of the cell materials and this insufficient growth leads to abnormal cells (cancer cells), this is one of the most common causes of cancer

The reovirus and the ras pathways

  • The reovirus naturally is tumor selective
  • The immune response that would normally destroy the reovirus is deactivated when the ras pathway is activated
  • The reovirus replicates and destroys cancer cell, while in normal cells the body’s natural immune response kills the virus quickly leaving no effect on those cells

This virus is already existent in nature with mild symptoms (at most). Whether or not it is used to treat cancer, it will keep replicating and mutating. It will continue to infect people, as it has for centuries, and people will continue to build up antibodies against different strains. So its use as a cancer treatment does not expose it to any additional risk to the possibility of mutation than it has in nature. It cannot change the DNA of humans because it does not enter the nucleus or use human genetic material to replicate. It has also performed well in regards to safety in all clinical trials. There have been no adverse events during any of the trials.

Key Clinical Trials

Oncolytics is currently undergoing 19 active clinical trials. The two key ones that I believe will mean the most are the Phase III Head and Neck/Metastatic Cancer trial and the Phase II Pancreatic Cancer trial. The Phase III trial is important because it is the last stage of FDA testing. However, the metastatic and Pancreatic cancer trials are important because there are currently no effective treatments for either of these cancers. If either of these passes their trials, Reolysin could be fast-tracked toward approval. Another fact to note is that on the rare occasion that these clinical trials yielded full recoveries, the patients who stopped taking Reolysin had their cancer come back. This is an important fact to note because it signifies that people who take this virus, would have to take it for their entire lives.

Head and Neck cancer type: Platinum-refractory recurrent and/or metastatic squamous cell cancers

Treatment: Paclitaxel (175 mg/m2) and Carboplatin (AUC 5) every three weeks in combination with the reovirus

Phase II results:

13 patients evaluable for response, four had PRs, for an objective response rate of 31%. Six patients had SD or better for 12 weeks or longer for a disease control rate (SD or better) of 46% compared to 3%-13% historical rates in chemotherapy alone.

Phase III trial:

The Phase III trial is randomizied, two-arm (meaning there is a test and a control group), double blind, multi-center (different places trained to administer virus and perform study), two stage adaptive trial. This trial was designed with an initial phase and an adaptive second phase. The initial stage had 80 patients enrolled and had a requirement to pass an independent safety evaluation after 6 weeks as well as an independent statistical analysis of the probability of success after 12 weeks. The second stage was designed to have a larger number of patients enrolled.

This first stage was analyzed while still blinded and unexpected results were discovered, however, so the second-stage did not continue as planned. A protocol amendment was submitted to the FDA to change the trial after it was noted (while the trial was still blinded) that the patients with metastatic disease had a statistically significant greater progression free survival rates than the patients with local regional head and neck cancers. This signified two separate test groups to be analyzed and the trial was redesigned.

The new study splits the patients into two categories: local recurrent disease and metastasis. Also it increases the number of enrolled patients to 160 in order to achieve statistical significance when separating the groups. While still blinded, these groups will be analyzed both together and separately to determine if further clinical trials will be necessary to determine effectiveness of Reolysin for either groups. This replaced the second stage of trials, though a further support trial may be required to strengthen statistical significance.

In December, an unblinding occurred pertaining only to the secondary endpoint of determining if Reolysin adds tumor-specific differential activity between metastatic and loco-regional cancers. The partialunblinding did not measure the primary endpoints of Progression-Free Survival (PFS) or Overall Survival (OS), all parties remain blinded to this data so as to not invalidate any of the results of these two primary goals when the study is complete. It measured pre-treatment and post-treatment percentage changes from the patients in the study (after 6 weeks of treatment). The data from the unblindingwas supportive of the decision to separate the groups in order to highlight the metastatic results. Of all the people in the metastatic test group (with reo), 86% experienced stabilization (no growth at all) or tumor shrinkage, while 71% of those in the loco regional testgroup experienced this result. The RECIST criteria for tumor stabilization remains blinded and will be measured at the end of the study for both of these groups; however theseinitial measurements demonstrate promise in the new study particularly with metastatic cancer, which will likely be the focus the company takes in its route to approval.

Also, this unblinding revealed positive results in the effectiveness of Reolysin as a cancer treatment relative to the control groups. It was observed in the test group that 86% of the 50 patients had exhibited tumor stabilization (0% growth) or shrinkage, while only 67% of the control group (chemo only) experienced it. At a p-value of .025, this is a statistically significant result. This shows promising evidence for the success of the Phase III trial that is currently in progress. However, the criteria for RECIST was not unblinded, so it can not be known if this data will translate to positive PFS and OS rates (primary study goals) for Reolysin at the end of the study.

Figure 1: Results of a 3rd party study on Reolysin on different strains of Head and Neck cancers in the lab. It was done on the cells in lab, it is not a clinical study.

This new Phase III trial looks promising for Oncolytics. Changing the trial was a good move for getting FDA approval due to the potential it has for metastatic cancer. More than 2.6 million people die of metastatic cancer every year, this is a large amount of people who would need this treatment. Because there is no cure for metastatic cancer, nor very effective treatment options, this would make Reolysin one of the only effective treatments for this type of cancer.

However promising the virus looks in the lab though, problems may arise in clinical trials with the actual effectiveness of the virus. Because our immune system’s response to this virus is already so strong, it is possible that the immune system will seek out and destroy this virus before it can infect the cancer cells. This problem, however, has been addressed by the use of chemotherapy as a way to suppress the body’s immune system, which had not been done in previous oncolytic virus trials done by other companies. Reolysin has also been effective in the earlier clinical trials, and the unblinding of the secondary goal data in the double-blinded Phase III trialis encouraging as well.

While this virus seems to be on track to getting FDA approval, it must perform in this phase III trial. However, there could be problems arising with Reolysin’s effectiveness on head and neck cancer, due to the variability of these particular types of cancers. Figure 1 above is the results of a study done testing the effectiveness of Reolysin on different types of head and neck cancers in lab (not on humans). As the graph shows, different types of head and neck cancers respond differently to the virus. This could be an issue with the performance during the clinical trial on head and neck cancer. Depending on the composition of the cancers in the test & control groups, Reolysin may perform more poorly than it has in other trials.

There could also be problems arising with the metastatic cancer test group in this trial. Metastatic cancer is also extremely variable. The mechanisms and properties of metastatic cancer cells are generally the same as the cancer cells from the place in which it originates. For example, if cancer in the lungs spreads to the pancreas, the cancer cells in the pancreaswould have characteristics of lung cancer, even though it is in the pancreas. The problem with a trial that is formetastatic cancer is that it is a combination of different kinds of cancers. These different types may have different compositions of the types of cancer cells. Because this virus works through mutated ras pathways, it would depend on the compositions of cells with this mutation in the metastatic cancer. So the results could be much better than expected in this trial if most of the cancers being tested are caused by mutated ras pathways, or they could be much worse due to the composition of the test group having cancer with a low percentage of ras mutations.

There have also been issues in clinical trials with the control group performing better than expected. This can be an issue when the drugs (virus in this case) need to have a better response in the test group than the control group. I do not view this as a problem, however, because I believe that the test group will perform at a much higher rate than the control group. In late-stage cancer, the placebo effect should not be as effective due to the disease’s advanced & widespread progression.In addition, the chemo in the control groups should be fairly predictable given a deep pool of data (they have been in use long enough to be in generic forms).

If this Phase III trial is unsuccessful, the company would need to undergo another. The expenses relating to continuing these trials for another 9 months would be: Clinical trial expenses + manufacturing and related process development expenses + other R+D expenses + Operating expenses= $27,379,185 for 9 months in 201. The available cash was $27,976,546 at September 30, 2012, which indicates that additional financing would be necessary if this phase III trial was to fail. If it were to succeed, Oncolytics Biotech, Inc. would have the ability to access funds needed to takereolysin to market. I still suspect that they will have another public offering to raise suchfunds.

Some other cancer-selective viruses in process

OncoVex

Modified Herpes (cold sore) virus

  • Manipulated virus to lower side effects
  • Combined with granulocyte and macrophage colony stimulating factor (gm-csf), which can be isolated and encourages the immune system response to attack cancer cells

In Phase III trial

  • ½ with gm-csf and ½ with OncoVexgm-csf
  • Expected to be first FDA approved oncolytic virus

Amgen

  • Acquired GenVex, company starting OncoVex
  • Shut down a Phase III safety trial, although another improved one has been started and is ongoing

JX-594

Vaccinia Virus

  • Modified smallpox vaccine
  • Considered safe because genetic material for mutation is removed

Mechanism

  • Attack cells with modified ras and EGFR pathways (common causes of cancer
  • Relies on pathway to replicate, which is what kills the cell- only can replicate if pathways are activated
  • Intravenous injection- stable in blood
  • Does not need chemotherapy
  • Flu-like symptoms

Phase II trials

  • Phase I saw 6/8 of high dose patients have stabilization or shrinkage of tumors
  • Primary liver cancer
  • One Phase II trial completed-10 patients only, saw positive results

The large amount of oncolytic viruses being developed shows that the researchers in this field are still hopeful that the FDA will start accepting viral therapy as a valid and safe way to battle cancer. The FDA has also been working with Oncolytics Biotech, Inc., to design the trials. In combination with the recent legislature that has been passed, I believe the FDA will be receptive to approving this form of treatment as long as the safety ratings stay high. The involvement of big pharmaceutical companies, like Amgen, show that there will be a lot of money put into getting at least one of them approved. Once one is approved it will open up many doors since there will be a precedent. I believe that OncoVex will be the first virus to pass Phase III testing, which would help Oncolytics Biotech, Inc., in two ways: It will set a precedent for oncolytic viruses, which I believe Reolysin will exceed, and bringing this virus to market will be using many of Oncolytics’ patented methods, this will bring in royalties to the company. Despite OncoVex being the first virus to pass Phase III trials, it could still have additional requirements to fulfill before being brought to market, due to the FDA being uneasy about manipulated viruses, since they are a new technology. This would not be a bad thing because it would leave the market for this type of treatment open. However, the metastatic cancer trials give Reolysin a monopoly in that area since OncoVex cannot spread through the blood.