##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from _________ to _________
 Commission file number: 000-15686
 NUCRYST Pharmaceuticals Corp.
  Alberta, Canada
    
    Not Applicable(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 50 Audubon Road, Suite BWakefield, Massachusetts
    
    01880(Address of principal executive offices)
    
    (Zip Code)
 (781) 224-1444
    o þ
  o þ
  þ o
 þ
  o o þ
  o þ
   Class
    
    Outstanding at March 15, 2006Common Shares
    
    18,199,444 shares




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##### 



TABLE OF CONTENTS
 Part IItem 1. BusinessItem 1A. Risk FactorsItem 1B. Unresolved Staff CommentsItem 2. PropertiesItem 3. Legal ProceedingsItem 4. Submission of Matters to a Vote of Security HoldersPart IIItem 5. Market for the Registrants Common Equity and Related Stockholder MattersItem 6. Selected Financial DataItem 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RisksItem 8. Financial Statements and Supplementary DataItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other MattersPart IIIItem 10. Directors and Executive Officers of the RegistrantItem 11. Executive CompensationItem 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder MattersItem 13. Certain Relationships and Related Party TransactionsItem 14. Principal Accounting Fees and ServicesPart IVItem 15. Exhibits, Financial Statements and SchedulesSignaturesIndex to Exhibits
  FORWARD-LOOKING STATEMENTS
   2




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
    
    the initiation, timing, progress and results of our preclinical and clinical trials, research and development programs;
    
    our reliance on our relationship with Smith & Nephew;
    
    our reliance on sales of Acticoat products with our SILCRYST coatings;
    
    the implementation of our business model, strategic plans for our business, product candidates and technology;
    
    our ability to maintain and establish corporate collaborations;
    
    the scope of protection we are able to establish and maintain for intellectual property
rights covering our product candidates and technology;
    
    our ability to operate our business without infringing the intellectual property rights of others;
    
    estimates of our expenses, future revenues, capital requirements and our needs for additional financing;
    
    the timing or likelihood of regulatory filings and approvals;
    
    our financial performance;
    
    competitive companies, technologies and our industry;
    
    changes in regulation or tax laws applicable to us;
    
    changes in accounting policies or practices;
    
    changes in general economic conditions;
    
    other risks and uncertainties that have not been identified at this time; and
    
    managements response to these factors.
   INDUSTRY AND MARKET DATA
  3




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PART I
 ITEM 1. BUSINESS
 Overview
 
       
  
  Our Nanocrystalline Technology
  4




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##### 



 
 a
   Market Overview
 Wound Care Market
  
  5




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##### 



   
    
 
 Pharmaceutical Market
  6




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##### 



Acticoat Products With Our SILCRYST Coatings
     
    Staphylococcus aureus   
  
 Acticoat  3/Acticoat  Burn Dressings
      
 Acticoat  7 Dressings
    
 7




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 
 Acticoat  Absorbent Dressings
    
 Acticoat  Moisture Control Dressings
      
 New Acticoat  Products
     
 Our Pharmaceutical Products
  Topical Cream with NPI 32101
     8




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##### 



Other Products with NPI 32101
 a
 Our Other Products
 SILCRYST  Coatings on Implants
    
 Our Clinical Development Program
    9




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10




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Smith & Nephew Agreements
       
 License and Development Agreement
     
     
     
   
   
 11




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  
  
 Supply Agreement
    
    
   
 12




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##### 



Manufacturing and Technology Escrow Agreement
   
 Security Trust Agreement and Trust Indenture
  
 Indemnities
  
 Marketing
       
 Manufacturing
  
  13




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##### 



Intellectual Property
        Competition
   
 
 14




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##### 



Third-Party Reimbursement and Pricing Controls
 
  
 Government Regulation
  United States
  Medical Device Regulation.
  
 15




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##### 



 
  New Drug Approval Process.
    Manufacturing cGMP Requirements.
  16




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##### 



European Union Regulation
 Marketing Authorizations for Drugs.
   European GMP.
 Medical Devices. 
  
 17




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##### 



Environmental and Occupational Safety and Health Regulations
   Employees
  ITEM 1A. RISK FACTORS
 If any of the following risks materialize, then our business, financial condition, results of
operations and future prospects would likely be materially and adversely affected.
 Risks Related to Our Business and Industry
 We have a history of net losses and negative cash flow from operations; this will likely continue
in the future and our cash may not be adequate to accomplish our objectives.
  We have in the past been wholly dependent upon Westaim for financial support, and Westaim does not
intend to provide us with financial support in the future.
  18




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We are dependent on our relationship with Smith & Nephew.
 
      
  Smith & Nephew is our only customer for all of our existing products.
       
  
 
 
 19




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
 We may be unable to sell our existing products to other parties, even if our agreements with Smith
& Nephew expire or terminate.
    
 
      
 We are required to manufacture Acticoat products according to Smith & Nephews
forecasts and, if we suffer a material difficulty supplying Acticoat products, Smith &
Nephew would have the right to manufacture or cause a third party to manufacture
Acticoat products using our technology and facilities.
    
    
 20




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    
     
 We rely on Smith & Nephew for regulatory filings for Acticoat  products and our results
would be adversely affected if they do not fully comply with regulatory requirements.
 
 Our agreements with Smith & Nephew may limit our ability to enter into agreements to transfer
certain of our assets.
 
 We have agreed to indemnify Smith & Nephew for claims under our agreements, which could result in
significant costs to us.
 
 21




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Our ability to develop and sell future products, particularly our dermatological, gastrointestinal
and future wound care products, is critical to our success, and if we fail to do so, our business
and financial condition will suffer.
 
  
    
    our ability to develop safe and effective products;
    
    our ability to obtain regulatory approval in the United States, the European Union and
other markets and the scope of such approval;
    
    our ability to add sufficient manufacturing capacity and capability at an acceptable cost
and in compliance with regulatory requirements;
    
    our ability to generate commercial sales of our products;
    
    acceptance of the product by the medical community and by patients and third-party payors;
    
    inherent development risks, such as the product proving to be unsafe or unreliable, or not having the anticipated effectiveness;
    
    preclusion or obsolescence resulting from third parties proprietary rights or superior or equivalent products;
    
    our ability to enter into favorable and effective marketing and distribution agreements, or
to be able to effectively market and distribute on our own;
    
    our ability to develop repeatable processes to manufacture new products in sufficient
quantities;
    
    our ability to raise on acceptable terms the substantial additional capital expected to be
necessary to successfully develop and commercialize such products; and
    
    general economic conditions.
  If product liability lawsuits are brought against us, they could result in costly litigation and
significant liabilities.
   22




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##### 



The market for advanced wound care and pharmaceutical products is intensely competitive and many of
our competitors have significantly more resources and experience than we do, which may limit our
commercial opportunities and revenues.
   
 
 
   23




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If we are unable to effectively manage our expected future growth, we may be unable to meet demand
for Acticoat products with our SILCRYST coatings and we may be unable to
develop or commercialize future products successfully.
   
 We depend on our executive officers and scientific and technical personnel, and if we are not able
to retain them or recruit additional qualified personnel, we may be unable to successfully develop
or commercialize future products.
    We currently purchase most of our raw materials from single suppliers. If we are unable to obtain
raw materials and other products from our suppliers that we depend on for our operations, our
ability to deliver our products to market may be impeded.
   
 24




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If we are not successful in establishing collaborations with prominent health care companies, we
may not be able to grow our business.
  If a natural or man-made disaster strikes one or more of our facilities, or facilities upon which
we depend, we may be unable to manufacture certain products for a substantial amount of time and
our revenue could decline.
  We have historically had internal controls and accounting processes in place and have modified
these controls and processes over time as the need has arisen. However, if our internal controls
and accounting processes are insufficient, we may not detect in a timely manner misstatements that
could occur in our financial statements in amounts that could be material.
   We may incur losses associated with currency fluctuations and may not be able to effectively hedge
our exposure.
  25




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Risks Related to Regulatory Matters
 Smith & Nephew may be unable to maintain existing regulatory approvals or obtain new regulatory
approvals for the Acticoat products that it currently sells, which would negatively
affect our results of operations. Our future products may not be approved by the regulatory
agencies, and any failure or delay associated with our product development and clinical trials or
the agencies approval would increase our product development costs and time to market.
  
  
    
    delays in obtaining regulatory approvals, including approvals by the competent
institutional review board, or IRB, or ethics committee, or EC, to commence or continue a
study;
    
    delays in identifying and reaching agreement on acceptable terms with prospective clinical trial sites;
    
    insufficient quantities of the study product;
    
    scheduling conflicts with participating clinicians and clinical institutions;
    
    slower than expected rates of patient recruitment and enrollment or the inability to reach full enrollment;
    
    improper enrollment practices resulting in protocol management problems and statistical analysis problems;
    
    inconclusive or negative interim results during clinical trials, including lack of effectiveness or unforeseen safety issues;
    
    death of, or serious adverse effects experienced by, one or more patients during a clinical
trial even if the reasons are not related to the study product candidate, including the
advanced stage of the patients disease or medical condition;
    
    uncertain dosing issues;
    
    inability to monitor patients adequately during and after treatment;
    
    inability or unwillingness of contract laboratories to follow good laboratory practices or
of our clinical investigators and us to follow good clinical practices;
    
    the occurrence of adverse events during the clinical trials;
 26




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##### 




    
    inability or unwillingness of clinical investigators to follow our clinical protocols or good clinical practices generally;
    
    inability or unwillingness of patients to follow our clinical protocols; and
    
    inability or unwillingness of other third parties to perform data collection and analysis in a timely or accurate manner.Delays or failures in obtaining regulatory approvals may:
    
    delay or prevent the commercialization of any product that we develop for new indications
or any product within an already approved indication for which the submission of additional
clinical trial data is required;
    
    in the case of delays, materially and adversely increase the cost of completing the
development of such product and obtaining regulatory approval to market it;
    
    diminish any competitive advantages; and
    
    adversely affect our ability to attract new collaborators.
 Completion of clinical trials does not guarantee successful commercialization of future products.
  
    
    clinical trials can have negative or inconclusive results;
    
    regulators may not agree with our results or our analysis of the safety or the efficacy of our products;
    
    there is a risk of failure in commercialization even after a product has been launched into
the market, for example due to unexpected side effects of the product which were not
discovered during clinical trials; and
    
    the market may fail to respond positively to a product for a variety of factors outside our
control, including but not limited to inadequate or unsuccessful marketing efforts by third
parties on which we depend but cannot control, competition from other products, cost,
reimbursement policies of third-party payors or the buying decisions of consumers for a
variety of unforeseen reasons.
 In the case of products that have already received regulatory approval or products for which we may
receive regulatory approval in the future, we, Smith & Nephew and any companies with which we may
collaborate in the future may still face development and regulatory difficulties that may delay or
impair future sales.
  
 27




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##### 



If government and third-party payors fail to provide coverage and adequate reimbursement rates for
Acticoat products or our future products, our revenues and potential for profitability
will be reduced.
   
    Our business involves the use, handling, storage and disposal of hazardous materials and may
subject us to environmental liability, and any future environmental liability could seriously harm
our financial condition. We do not maintain insurance covering these risks.
   We perform and manage our clinical trials rather than relying on third-party clinical research
organizations, or CROs, and since we do not have extensive experience in this area, there may be
delays in completing, or a failure to complete, clinical trials that comply with regulatory
requirements.
  28




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##### 



Failure to comply with workplace safety legislation could seriously harm our financial condition.
  Risks Related to Intellectual Property
 The protection of our intellectual property rights is critical to our success and any failure on
our part to adequately protect those rights would materially adversely affect our business.
 Patents.
      29




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##### 



Trade Secrets and Proprietary Know-how.
 Trademarks.  
  The ability to market Acticoat  products and any other products we develop is subject to
the intellectual property rights of third parties.
 
  We may be subject to damages resulting from claims that we or our employees have wrongfully used or
disclosed alleged trade secrets of their former employers.
  30




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##### 



We may become involved in expensive intellectual property litigation or other proceedings related
to intellectual property rights.
     Risks Related to Our Common Shares
 There has been limited trading in our common shares and, as a result, our common share price may be
highly volatile.
   
    
    variations in our operating performance and the performance of our competitors;
    
    actual or anticipated fluctuations in our quarterly or annual operating results;
    
    results of pre-clinical and clinical trials by us and our competitors;
    
    matters relating to our agreements with Smith & Nephew, including fluctuations in sales of
Smith & Nephews Acticoat products;
 31




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##### 




    
    assertions that our intellectual property infringes on the intellectual property rights of
others or other matters calling into question our intellectual property;
    
    changes in estimates or recommendations by securities analysts;
    
    publication of research reports by securities analysts about us or our competitors or our industry;
    
    our failure or the failure of our competitors to meet analysts projections or guidance
that we or our competitors may give to the market;
    
    additions and departures of key personnel;
    
    strategic decisions by us or our competitors, such as acquisitions, divestitures,
spin-offs, joint ventures, strategic collaborations or investments or changes in business
strategy;
    
    the passage of legislation or other regulatory developments affecting us or our industry;
    
    speculation in the media or investment community;
    
    changes in accounting principles;
    
    terrorist acts, acts of war or periods of widespread civil unrest; and
    
    changes in general market and economic conditions.
  Future sales of currently restricted shares could cause the market price of our common shares to
decrease significantly, even if our business is doing well.
    32




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##### 



Westaim controls and will continue to control us and may have conflicts of interest with us or you
in the future.
   The amount of our net operating loss carryovers may be limited.
  If we are classified as a passive foreign investment company, it could have adverse tax
consequences to investors.
  We do not intend to pay dividends, which may adversely affect the market price of our common
shares.
  33




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##### 



As a foreign private issuer, we are subject to different U.S. securities laws and rules than a
domestic U.S. issuer, which may limit the information publicly available to our shareholders.
  You may be unable to enforce actions against us or certain of our directors and officers under U.S.
federal securities laws.
  We have outstanding options and share appreciation rights that have the potential to dilute
shareholder value and cause the price of our common shares to decline.
  Our articles and certain Canadian laws could delay or deter a change of control.
   34




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##### 



ITEM 1B. UNRESOLVED STAFF COMMENTS
  ITEM 2. PROPERTIES
  
 ITEM 3. LEGAL PROCEEDINGS
  ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  35




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##### 



PART II
 ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES
 Market Price
  High
    
    
    LowCalendar Quarter Ended:December 31, 2005
    
    $
    10.05
    
    
    $
    10.00
 Number of Shareholders
  Dividends
  Securities Authorized for Issuance Under Equity Compensation Plans
 Equity Compensation Plan Information as at December 31, 2005
 Number of securities to
    
    
    Weighted-average
    
    
    Number of securitiesbe issued upon exercise
    
    
    exercise price of
    
    
    remaining available forEquity compensation plans
    
    of outstanding
options,
    
    
    outstanding options,
    
    
    future issuance underapproved by securityholders
    
    warrants and rights
    
    
    warrants and rights
    
    
    equity compensation plans1998 Equity Incentive Plan
    
    
    
    
    
    
    
    
    
    
    1,416,907
    (3)a) Options
    
    
    713,770
    (1)
    
    CDN$3.47b) Stock Appreciation Rights
    
    
    9,323
    (2)
    
    CDN$3.08
 
 (1)
    
    This amount excludes 60,000 options to purchase our common shares at an exercise price of
$10.00 that have been allocated and approved for issuance to the non-employee directors but
for which award agreements have not yet been executed. For more information, see Directors
and Executive Officers of the RegistrantDirector Compensation.(2)
    
    The number of common shares issuable on exercise of these stock appreciation rights has been
determined based on the December 31, 2005 closing price of our common shares on the NASDAQ of
$10.05. The actual number of common shares issuable upon exercise of these stock appreciation
rights will vary depending on whether we elect to settle in cash or common shares and, if we
elect to settle in common shares, the value of the common shares at the time of exercise.(3)
    
    This amount assumes the issuance of the options to purchase the 60,000 common shares referred
to in note (1) above and the issuance of the 9,323 common shares referred to in note (2)
above. Unregistered Sales of Equity Securities
  36




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##### 



Use of Proceeds from Initial Public Offering
  Repurchases of Equity Securities
  37




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##### 



ITEM 6. SELECTED FINANCIAL DATA
   Year EndedDecember 31,2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005Results of Operations Data:Revenue:Wound care product revenue
    
    $
    5,350
    
    
    $
    5,312
    
    
    $
    8,404
    
    
    $
    14,682
    
    
    $
    18,636Milestone revenue(1)
    
    
    1,000
    
    
    
    
    
    
    
    3,000
    
    
    
    10,000
    
    
    
    5,000Total revenue
    
    
    6,350
    
    
    
    5,312
    
    
    
    11,404
    
    
    
    24,682
    
    
    
    23,636Costs:Manufacturing
    
    
    2,378
    
    
    
    3,206
    
    
    
    4,430
    
    
    
    7,141
    
    
    
    10,015Research and development
    
    
    2,137
    
    
    
    3,467
    
    
    
    5,704
    
    
    
    8,971
    
    
    
    8,520General and administrative(2)
    
    
    5,762
    
    
    
    2,985
    
    
    
    2,797
    
    
    
    3,901
    
    
    
    3,945Depreciation and amortization
    
    
    89
    
    
    
    139
    
    
    
    158
    
    
    
    221
    
    
    
    300(Loss) income from operations
    
    
    (4,016
    )
    
    
    (4,485
    )
    
    
    (1,685
    )
    
    
    4,448
    
    
    
    856Other income (expenses):Gain on sale of assets
    
    
    12,993
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign exchange (losses) gains
    
    
    (10
    )
    
    
    (6
    )
    
    
    (230
    )
    
    
    82
    
    
    
    193Interest income
    
    
    157
    
    
    
    41
    
    
    
    47
    
    
    
    66
    
    
    
    12Interest expense(3)
    
    
    (212
    )
    
    
    (14
    )
    
    
    (414
    )
    
    
    (3,229
    )
    
    
    (3,540
    )Income (loss) before income taxes
    
    
    8,912
    
    
    
    (4,464
    )
    
    
    (2,282
    )
    
    
    1,367
    
    
    
    (2,479
    )Current income tax expense(4)
    
    
    (10
    )
    
    
    (7
    )
    
    
    (19
    )
    
    
    (19
    )
    
    
    (162
    )Net income (loss)
    
    $
    8,902
    
    
    $
    (4,471
    )
    
    $
    (2,301
    )
    
    $
    1,348
    
    
    $
    (2,641
    )Net income (loss) per common share  basic
and diluted
    
    $
    0.92
    
    
    $
    (0.46
    )
    
    $
    (0.24
    )
    
    $
    0.14
    
    
    $
    (0.27
    )Weighted average number of common shares
outstanding basic
    
    
    9,727,500
    
    
    
    9,727,500
    
    
    
    9,727,500
    
    
    
    9,727,500
    
    
    
    9,764,486 diluted
    
    
    9,727,500
    
    
    
    9,727,500
    
    
    
    9,727,500
    
    
    
    9,905,464
    
    
    
    9,764,486
 
 (1)
    
    Certain milestone revenue may relate in part to sales activity in prior periods.(2)
    
    In 2001, before we entered into the Smith & Nephew agreements, we incurred selling expenses
that we did not incur in subsequent periods.(3)
    
    Historically, Westaim has provided all of the external funding necessary to operate our
business, and all of the indebtedness reflected on our consolidated balance sheets for periods
through December 31, 2005 reflects funding from Westaim. In 2001, 2002 and 2003, Westaim did
not charge interest on substantially all of our indebtedness to Westaim. Accordingly,
interest expense for the years ended December 31, 2001 to 2003 is substantially less than the
interest expense that would have been incurred had we been charged interest on all of our
indebtedness.(4)
    
    Although we are currently a majority owned subsidiary of Westaim, Canadian tax laws do not
allow for the filing of a consolidated income tax return with Westaim. Accordingly, we have
filed our own tax returns and the income tax expenses reflected in the above financial data
reflect our actual consolidated income tax expense for the applicable periods. 38




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##### 



As of December 31,2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005Consolidated Balance
Sheet Data:Cash and cash equivalents
    
    $
    5,293
    
    
    $
    345
    
    
    $
    201
    
    
    $
    948
    
    
    $
    35,901Current assets
    
    
    6,913
    
    
    
    2,927
    
    
    
    4,655
    
    
    
    8,002
    
    
    
    48,992Total assets
    
    
    9,176
    
    
    
    6,640
    
    
    
    10,042
    
    
    
    15,597
    
    
    
    59,460Current liabilities(1)
    
    
    19,980
    
    
    
    22,046
    
    
    
    31,273
    
    
    
    37,181
    
    
    
    45,691Working capital (deficiency)
    
    
    (13,067
    )
    
    
    (19,119
    )
    
    
    (26,618
    )
    
    
    (29,179
    )
    
    
    3,301Common shares
    
    
    3,534
    
    
    
    3,534
    
    
    
    3,534
    
    
    
    3,534
    
    
    
    42,629Accumulated other comprehensive
income (loss)
    
    
    1,136
    
    
    
    1,045
    
    
    
    (2,479
    )
    
    
    (4,180
    )
    
    
    (5,281
    )Accumulated deficit
    
    
    (15,474
    )
    
    
    (19,985
    )
    
    
    (22,286
    )
    
    
    (20,938
    )
    
    
    (23,579
    )Total shareholders (deficit)
equity
    
    
    (10,804
    )
    
    
    (15,406
    )
    
    
    (21,231
    )
    
    
    (21,584
    )
    
    
    13,769
 
 (1)
    
    Includes indebtedness to Westaim of $18,583, $20,913, $29,612, $33,482 and $39,642 as of
December 31, 2001, 2002, 2003, 2004 and 2005, respectively, which was converted into a term
loan effective August 31, 2005. Year EndedDecember 31,2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005Wound care product revenue
    
    $
    5,350
    
    
    $
    5,312
    
    
    $
    8,404
    
    
    $
    14,682
    
    
    $
    18,636Milestone revenue(1)
    
    
    1,000
    
    
    
    
    
    
    
    3,000
    
    
    
    10,000
    
    
    
    5,000Total revenue
    
    $
    6,350
    
    
    $
    5,312
    
    
    $
    11,404
    
    
    $
    24,682
    
    
    $
    23,636Manufacturing costs
    
    $
    2,378
    
    
    $
    3,206
    
    
    $
    4,430
    
    
    $
    7,141
    
    
    $
    10,015Gross margin excluding
milestone
revenue(2)
    
    $
    2,972
    
    
    $
    2,106
    
    
    $
    3,974
    
    
    $
    7,541
    
    
    $
    8,621Gross margin percent excluding
milestone revenue(2)
    
    
    55.6
    %
    
    
    39.6
    %
    
    
    47.3
    %
    
    
    51.4
    %
    
    
    46.3
    %
 
 (1)
    
    Certain milestone revenue may relate in part to sales activity in prior periods.(2)
    
    Gross margin excluding milestone revenue is equal to wound care product revenue minus
manufacturing costs. Gross margin percent excluding milestone revenue is equal to gross
margin excluding milestone revenue divided by wound care product revenue. ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Overview
  
 39




---



##### 



     
       
        
 40




---



##### 



  
      
 
    41




---



##### 




  Results of Operations
 Year EndedDecember 31,2003
    
    
    2004
    
    
    2005Wound care product revenue
    
    $
    8,404
    
    
    $
    14,682
    
    
    $
    18,636Milestone revenue(1)
    
    
    3,000
    
    
    
    10,000
    
    
    
    5,000Total revenue
    
    $
    11,404
    
    
    $
    24,682
    
    
    $
    23,636Manufacturing costs
    
    $
    4,430
    
    
    $
    7,141
    
    
    $
    10,015Gross margin excluding milestone revenue(2)
    
    $
    3,974
    
    
    $
    7,541
    
    
    $
    8,621Gross margin percent excluding milestone revenue(2)
    
    
    47.3
    %
    
    
    51.4
    %
    
    
    46.3
    %
 
 (1)
    
    Certain milestone revenue may relate in part to sales activity in prior periods.(2)
    
    Gross margin excluding milestone revenue is equal to wound care product revenue minus
manufacturing costs. Gross margin percent excluding milestone revenue is equal to gross
margin excluding milestone revenue divided by wound care product revenue. Year Ended December 31, 2005 and December 31, 2004
 Revenue.  
 Manufacturing Costs  
 Gross Margin. 
 Research and Development Costs.
 General and Administrative Costs
 Interest Expense.
 Income Taxes
 42




---



##### 



Year Ended December 31, 2004 and December 31, 2003
 Revenue.  
 Manufacturing Costs.  
 Gross Margin 
 Research and Development Costs
 General and Administrative Costs. 
 43




---



##### 



Interest Expense.
 Liquidity and Capital Resources
         44




---



##### 



Contractual Commitments and Obligations at December 31, 2005
  Cash Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    
    More than1 year
    
    
    1-3 years
    
    
    3-5 years
    
    

5 years
    
    

Total(in millions)Consolidated Obligations and
Commitments
as of December 31, 2005:Due to Westaim (1)Term loan
    
    $
    39.6
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    39.6Facilities operating leases:Westaim
    
    
    0.5
    
    
    
    1.0
    
    
    
    0.9
    
    
    
    2.0
    
    
    
    4.4Third Parties
    
    
    0.5
    
    
    
    0.9
    
    
    
    0.1
    
    
    
    
    
    
    
    1.5Purchase Obligations:Capital
    
    
    1.2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.2Operations
    
    
    3.8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.8Total obligations and commitments
    
    $
    45.6
    
    
    $
    1.9
    
    
    $
    1.0
    
    
    $
    2.0
    
    
    $
    50.5
 
 (1)
    
    The term loan had a five-year maturity and bore interest at 10% per annum. On
January 27, 2006, the term loan was
converted to 3.96 million common shares at $10.00 per share. Related Party Transactions
  45




---



##### 



Off-Balance Sheet Commitments as of December 31, 2005
    Critical Accounting Policies and Significant Judgments and Estimates
  Revenue Recognition
  46




---



##### 



Research and Development Costs
  Income Taxes
  Intangible Assets
  Translation of Foreign Currencies
   47




---



##### 



Year Ended December 31,
    
    Period End Rate
    
    Period Average Rate
    
    High Rate
    
    Low Rate2003
    
    
    1.2923
    
    
    
    1.4008
    
    
    
    1.5750
    
    
    
    1.29232004
    
    
    1.2034
    
    
    
    1.3017
    
    
    
    1.3970
    
    
    
    1.17752005
    
    
    1.1656
    
    
    
    1.2115
    
    
    
    1.2703
    
    
    
    1.1507Monthly 2005January
    
    
    1.2396
    
    
    
    1.2248
    
    
    
    1.2422
    
    
    
    1.1982February
    
    
    1.2295
    
    
    
    1.2401
    
    
    
    1.2562
    
    
    
    1.2294March
    
    
    1.2094
    
    
    
    1.2160
    
    
    
    1.2463
    
    
    
    1.2017April
    
    
    1.2568
    
    
    
    1.2359
    
    
    
    1.2568
    
    
    
    1.2146May
    
    
    1.2512
    
    
    
    1.2555
    
    
    
    1.2703
    
    
    
    1.2373June
    
    
    1.2256
    
    
    
    1.2402
    
    
    
    1.2578
    
    
    
    1.2256July
    
    
    1.2257
    
    
    
    1.2229
    
    
    
    1.2437
    
    
    
    1.2048August
    
    
    1.1893
    
    
    
    1.2043
    
    
    
    1.2185
    
    
    
    1.1888September
    
    
    1.1607
    
    
    
    1.1777
    
    
    
    1.1880
    
    
    
    1.1607October
    
    
    1.1796
    
    
    
    1.1774
    
    
    
    1.1887
    
    
    
    1.1657November
    
    
    1.1670
    
    
    
    1.1815
    
    
    
    1.1960
    
    
    
    1.1656December
    
    
    1.1656
    
    
    
    1.1615
    
    
    
    1.1736
    
    
    
    1.1507
 Stock Based Compensation
    Recently Adopted and Pending Accounting Pronouncements
 FSP No. 46(R)-5
  FIN 47
  SFAS 123(R)
  48




---



##### 



SFAS 151
  SFAS 153
  SFAS 154
  EITF 031
  EITF 0313
  49




---



##### 



EITF 0413
  FASB Exposure Draft Fair Value Measurements
  FASB Exposure Draft Business Combinations
  FASB Exposure Draft Accounting for Uncertain Tax Positions
   ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
  50




---



##### 



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 Report of Independent Registered Chartered Accountants
 .
          51




---



##### 



Comments
by Independent Registered Chartered Accountants for U.S. Readers on
Canada 
United States of America Reporting Differences
 
     52




---



##### 



NUCRYST Pharmaceuticals Corp.
 December 31
    
    
    December 31(thousands of U.S. dollars, except share data)
    
    2005
    
    
    2004ASSETSCurrentCash and cash equivalents
    
    $
    35,901
    
    
    $
    948Accounts receivable  net (note 3)
    
    
    6,401
    
    
    
    4,187Inventories (note 4)
    
    
    6,569
    
    
    
    2,727Other
    
    
    121
    
    
    
    14048,992
    
    
    
    8,002Restricted cash (note 2g)
    
    
    130
    
    
    
    128Capital assets  net (note 5)
    
    
    9,464
    
    
    
    6,561Intangible assets  net (note 6)
    
    
    874
    
    
    
    906$
    59,460
    
    
    $
    15,597LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)CurrentAccounts payable and accrued liabilities (note 7)
    
    $
    4,991
    
    
    $
    3,699Accounts payable and accrued liabilities to related party (note 11)
    
    
    1,058
    
    
    
    Indebtedness to related party (note 8)
    
    
    39,642
    
    
    
    33,48245,691
    
    
    
    37,181Guarantees (note 12)Commitments (note 13)Shareholders equity (deficit)Common shares no par value, unlimited shares authorized:issued and outstanding - 14,227,500 and 9,727,500 shares at
December 31, 2005 and 2004, respectively (note 9)
    
    $
    42,629
    
    
    $
    3,534Accumulated other comprehensive loss
    
    
    (5,281
    )
    
    
    (4,180
    )Accumulated deficit
    
    
    (23,579
    )
    
    
    (20,938
    )Total shareholders equity (deficit)
    
    
    13,769
    
    
    
    (21,584
    )$
    59,460
    
    
    $
    15,597
  53




---



##### 



NUCRYST Pharmaceuticals Corp.
 Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31
    
    
    December 31
    
    
    December 31(thousands of U.S. dollars except share and per share data)
    
    2005
    
    
    2004
    
    
    2003RevenueWound care product revenue
    
    $
    18,636
    
    
    $
    14,682
    
    
    $
    8,404Milestone revenue
    
    
    5,000
    
    
    
    10,000
    
    
    
    3,00023,636
    
    
    
    24,682
    
    
    
    11,404CostsManufacturing (note 5)
    
    
    10,015
    
    
    
    7,141
    
    
    
    4,430Research and development (note 5)
    
    
    8,520
    
    
    
    8,971
    
    
    
    5,704General and administrative
    
    
    3,945
    
    
    
    3,901
    
    
    
    2,797Depreciation and amortization (note 5)
    
    
    300
    
    
    
    221
    
    
    
    158Income (loss) from operations
    
    
    856
    
    
    
    4,448
    
    
    
    (1,685
    )Foreign exchange gains (losses)
    
    
    193
    
    
    
    82
    
    
    
    (230
    )Interest income
    
    
    12
    
    
    
    66
    
    
    
    47Interest expense (note 8)
    
    
    (3,540
    )
    
    
    (3,229
    )
    
    
    (414
    )(Loss) income before income taxes
    
    
    (2,479
    )
    
    
    1,367
    
    
    
    (2,282
    )Current income tax expense (note 10)
    
    
    (162
    )
    
    
    (19
    )
    
    
    (19
    )Net (loss) income
    
    $
    (2,641
    )
    
    $
    1,348
    
    
    $
    (2,301
    )(Loss) income per common share (note 16)Net (loss) income  basic and diluted
    
    $
    (0.27
    )
    
    $
    0.14
    
    
    $
    (0.24
    )Weighted average number of common shares outstanding: basic
    
    
    9,764,486
    
    
    
    9,727,500
    
    
    
    9,727,500 diluted
    
    
    9,764,486
    
    
    
    9,905,464
    
    
    
    9,727,500
  54




---



##### 



NUCRYST Pharmaceuticals Corp.
 Year Ended
    
    
    Year Ended
    
    
    Year EndedDecember 31
    
    
    December 31
    
    
    December 31(thousands of U.S. dollars)
    
    2005
    
    
    2004
    
    
    2003Operating activitiesNet (loss) income
    
    $
    (2,641
    )
    
    $
    1,348
    
    
    $
    (2,301
    )Items not affecting cashDepreciation and amortization
    
    
    1,282
    
    
    
    875
    
    
    
    639Dividends on preferred shares (note 8b)
    
    
    
    
    
    
    389
    
    
    
    414Accounts receivable
    
    
    (2,000
    )
    
    
    (1,254
    )
    
    
    (812
    )Inventories
    
    
    (3,612
    )
    
    
    (850
    )
    
    
    (345
    )Other
    
    
    22
    
    
    
    (15
    )
    
    
    (39
    )Accounts payable and accrued liabilities
    
    
    1,191
    
    
    
    1,150
    
    
    
    216Accounts payable and accrued liabilities to related party (note 11)
    
    
    1,058
    
    
    
    
    
    
    
    Accrued interest on indebtedness to related party (note 8)
    
    
    2,589
    
    
    
    3,122
    
    
    
    Cash (used in) provided from operating activities
    
    
    (2,111
    )
    
    
    4,765
    
    
    
    (2,228
    )Investing activitiesRestricted cash
    
    
    (2
    )
    
    
    (2
    )
    
    
    (9
    )Capital expenditures
    
    
    (3,784
    )
    
    
    (1,817
    )
    
    
    (1,265
    )Intangible assets
    
    
    (127
    )
    
    
    (115
    )
    
    
    (134
    )Cash used in investing activities
    
    
    (3,913
    )
    
    
    (1,934
    )
    
    
    (1,408
    )Financing activitiesIssuance of common shares, net of share issuance costs (note 9)
    
    
    39,095
    
    
    
    
    
    
    
    Net advances from (repayments to) related party (note 8)
    
    
    1,662
    
    
    
    (1,949
    )
    
    
    3,329Cash provided from (used in) financing activities
    
    
    40,757
    
    
    
    (1,949
    )
    
    
    3,329Effect of exchange rate changes on cash and cash equivalents
    
    
    220
    
    
    
    (135
    )
    
    
    163Net increase (decrease) in cash and cash equivalents
    
    
    34,953
    
    
    
    747
    
    
    
    (144
    )Cash and cash equivalents at beginning of year
    
    
    948
    
    
    
    201
    
    
    
    345Cash and cash equivalents at end of year
    
    $
    35,901
    
    
    $
    948
    
    
    $
    201Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    1,699
    
    
    $
    
    
    
    $
    Cash paid for income taxes
    
    $
    121
    
    
    $
    19
    
    
    $
    19
  55




---



##### 



NUCRYST Pharmaceuticals Corp.
 AccumulatedOther
    
    
    
    
    
    
    TotalCommon Shares
    
    
    
    
    
    
    Comprehensive
    
    
    Accumulated
    
    
    Comprehensive(thousands of U.S. dollars, except share data)
    
    Number
    
    
    Stated Amount
    
    
    Income (Loss)
    
    
    Deficit
    
    
    LossDecember 31, 2002
    
    
    9,727,500
    
    
    $
    3,534
    
    
    $
    1,045
    
    
    $
    (19,985
    )Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    (3,524
    )
    
    
    
    
    
    $
    (3,524
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,301
    )
    
    
    (2,301
    )December 31, 2003
    
    
    9,727,500
    
    
    
    3,534
    
    
    
    (2,479
    )
    
    
    (22,286
    )
    
    
    (5,825
    )Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    (1,701
    )
    
    
    
    
    
    
    (1,701
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,348
    
    
    
    1,348December 31, 2004
    
    
    9,727,500
    
    
    
    3,534
    
    
    
    (4,180
    )
    
    
    (20,938
    )
    
    
    (353
    )Issuance of common shares
    
    
    4,500,000
    
    
    
    39,095
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    (1,101
    )
    
    
    
    
    
    
    (1,101
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,641
    )
    
    
    (2,641
    )December 31, 2005
    
    
    14,227,500
    
    
    $
    42,629
    
    
    $
    (5,281
    )
    
    $
    (23,579
    )
    
    $
    (3,742
    )
  56




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 1 DESCRIPTION OF BUSINESS
  
        
   2 SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
 a)
    
    Basis of presentationThe Corporations consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America (GAAP).The financial statements of entities which are controlled by the Corporation through
voting equity interests, referred to as subsidiaries, are consolidated. Entities which
are jointly controlled, referred to as joint ventures, and entities which are not
controlled but over which the Corporation has the ability to exercise significant
influence, referred to as associated companies, are accounted for using the equity
method. Investments in other entities are accounted for using the cost method. Variable
interest entities (VIEs) (which include, but are not limited to, special purpose
entities, trusts, partnerships, certain joint ventures and other legal structures), as
defined by the Financial Accounting Standards Board (FASB) in FASB Interpretation No.
(FIN) 46 (Revised 2003), Consolidation of Variable Interest Entities  an
Interpretation of Accounting Research Bulletin No. 51 (FIN 46R), are entities in which
equity investors do not have the characteristics of a controlling financial interest or
there is not sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support. VIEs are consolidated by the Corporation when
it is determined that it will, as the primary beneficiary, absorb the majority of the
VIEs expected losses and/or expected residual returns. The Corporation currently does
not have any VIEs. Intercompany accounts and transactions are eliminated upon
consolidation and unrealized intercompany gains and losses are eliminated when accounting
under the equity method.
 57




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 2 SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (continued)
  b)
    
    Use of estimatesThe preparation of the consolidated financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and the reported amounts of revenue and expenses during the year. Actual
results could differ from those estimates. Significant estimates include the useful
lives of capital assets and intangible assets, inventory valuation, valuation allowance
against deferred tax assets and the fair value of stock-based compensation.c)
    
    Translation of foreign currenciesThe Corporations functional currency is the Canadian dollar. The functional currency of
the Corporations wholly owned subsidiary, NUCRYST Pharmaceuticals Inc., is the United
States dollar (U.S. dollar). The balance sheet accounts of the subsidiary are
translated into Canadian dollars at the period end exchange rate, while income, expense
and cash flows are translated at the average exchange rate for the period. Translation
gains or losses related to net assets of such operations are shown as a component of
accumulated other comprehensive loss in shareholders equity. Gains and losses resulting
from foreign currency transactions, which are transactions denominated in a currency
other than the entitys functional currency, are included in the consolidated statement
of operations.The Corporation uses the U.S. dollar as its reporting currency to be consistent with
other companies in its industry peer group. The Canadian functional currency
consolidated financial statements are translated to the U.S. dollar reporting currency
using the current rate method of translation.d)
    
    Accumulated other comprehensive lossComprehensive loss is comprised of net loss and other comprehensive loss.Other comprehensive loss consists of foreign currency translation adjustments for the
year, which arise from the conversion of the Canadian dollar functional currency
consolidated financial statements to the U.S. dollar reporting currency consolidated
financial statements. Accumulated other comprehensive loss of $5,281 (2004  $4,180)
consists of foreign currency translation adjustments.e)
    
    Revenue recognitionRevenue from direct sales to third parties is recognized when persuasive evidence of an
arrangement exists, delivery has occurred, the price to the buyer is fixed or
determinable, and collection is reasonably assured. The Corporations revenues under its
agreements with Smith & Nephew consist primarily of manufacturing cost reimbursements,
royalties and payments upon the achievement of specific milestones. Manufacturing cost
reimbursements and royalties are reported as wound care product revenue in the
consolidated statement of operations as they relate directly to the sale of the
Corporations products to Smith & Nephew. For products manufactured under agreements
with Smith & Nephew, revenue is recorded by the Corporation at the date of shipment.
Royalty revenue is earned based on a percentage of Smith & Nephews sales to third
parties. Revenue relating to the achievement of milestones under agreements with Smith &
Nephew is recognized when the milestone event has occurred and is recorded separately as
milestone revenue. The Corporation also derives fees from research activities under
agreements with Smith & Nephew and this revenue is recognized as services are performed.f)
    
    Product warrantyWound care products currently sold by the Corporation carry a limited short term product
warranty. No provision for product warranty claims was required for the years ended
December 31, 2005 and 2004 as the Corporations claims experience has been negligible.
 58




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 2 SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (continued)
 g)
    
    Cash and cash equivalentsCash and cash equivalents consist of cash on deposit and highly liquid short-term
investments with original maturities at the date of acquisition of 90 days or less and
are recorded at cost.At December 31, 2005 the Corporation had $130 (2004  $128) on deposit as collateral for
the lease of its Wakefield, Massachusetts facility.h)
    
    Allowance for doubtful accountsThe Corporation evaluates the collectibility of accounts receivable and records an
allowance for doubtful accounts, which reduces the accounts receivable to the amount
management reasonably believes will be collected. A specific allowance is recorded
against customer receivables that are considered to be impaired based on the
Corporations knowledge of the financial condition of its customers. In determining the
amount of the allowance, the Corporation considers factors, including the length of time
the receivables have been outstanding, customer and industry concentrations, the current
business environment and historical experience.i)
    
    InventoriesFinished products, raw materials and materials in process are valued at the lower of
average cost and market. Inventories include direct labor and an application of relevant
overhead.The Corporation manufactures products based on specific orders for Smith & Nephew under a
long-term manufacturing agreement. The carrying value of inventories is recoverable
through future sales as product costs are fully recoverable under the terms of this
agreement, and therefore no provision for inventory valuation is required.j)
    
    Capital assetsCapital assets are stated at cost. Internal labor costs directly relating to capital
projects are included in the cost of the specific capital assets. Depreciation is
calculated using a straight-line method based on estimated useful lives of the particular
assets as follows:
 Machinery and equipment
    
    
    5 to 10 yearsComputer hardware and software
    
    
    2 to 5 yearsLeasehold improvements
    
    Over term of lease
  k)
    
    Intangible assetsThe Corporations definite life intangible assets consist of the prosecution and
application costs of patents and trademarks and are amortized on a straight-line basis
over their estimated useful lives to a maximum of 10 years. The cost of maintaining
patents and trademarks are expensed as incurred. The Corporation evaluates the carrying
value of definite life intangible assets whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Any impairment in the carrying
value is charged to expense in the period that impairment has been determined.Indefinite life intangible assets are recorded at fair value. On a regular basis,
the Corporation reviews the carrying value of these assets for impairment. As at
December 31, 2005 and 2004, the Corporation had no indefinite life intangible assets.
 59




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 2 SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (continued)
 l)
    
    Research and development costsThe costs of materials, equipment, or facilities that are acquired or constructed for a
particular research and development project and that have no alternative future uses (in
other research and development projects or otherwise) are expensed as research and
development costs at the time the costs are incurred. Research and development
expenditures, which include the cost of materials consumed in research and development
activities, salaries, wages and other costs of personnel engaged in research and
development, costs of services performed by others for research and development on behalf
of the Corporation, depreciation on equipment used for research and development and
indirect costs are expensed as research and development costs when incurred.m)
    
    Income taxesThe Corporation uses the asset and liability method of accounting for income taxes.
Deferred income taxes are recognized for the tax consequences in future years of
differences between the tax bases of assets and liabilities and their financial reporting
amounts at each year end, based on enacted tax laws and statutory tax rates applicable to
the years in which the differences are expected to reverse. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount that, in the
opinion of management, is more likely than not to be realized. The effect of changes in
tax rates is recognized in the year in which the rate change occurs. Research and
development investment tax credits are accounted for as a reduction of income taxes in
accordance with Accounting Principle Board Opinion No. 4, Accounting for the Investment
Credit.n)
    
    Stock-based compensation plansThe Corporation has stock-based compensation plans, which are described in Note 9.
Compensation expense for awards that call for settlement in cash or other assets is
measured on an ongoing basis as the amount by which the market value exceeds the exercise
price at each measurement date. Any obligations related to increases in Stock
Appreciation Rights (SARs) are accrued when the change in value occurs, with an offset
to the consolidated statement of operations. Any consideration paid by option holders
for the purchase of shares is credited to common shares.SFAS 123 Accounting for Stock-Based Compensation (SFAS 123) encourages that
stock-based compensation be accounted for based on a fair value methodology. As
permitted by the Statement, the Corporation has elected to continue measuring
compensation costs as the excess, if any, of the market value of the shares at the date
of the grant over the exercise price. As the exercise price of options granted by the
Corporation is not less than the market value of the shares at the date of grant, no
compensation expense is recognized.If compensation costs for the Corporations stock option plans had been determined based
on the fair value methodology over the vesting period consistent with SFAS 123, the
Corporations net (loss) income and (loss) income per share would have been (increased)
reduced to the pro-forma amounts indicated below:
 Year Ended December 312005
    
    
    2004
    
    
    2003Net (loss) income applicable to common shareholders
    
    $
    (2,641
    )
    
    $
    1,348
    
    
    $
    (2,301
    )Total stock-based employee compensation expense
determined under fair-value based method for
awards net of tax effects
    
    
    (96
    )
    
    
    (55
    )
    
    
    (48
    )Pro forma net (loss) income applicable to common
shareholders
    
    $
    (2,737
    )
    
    $
    1,293
    
    
    $
    (2,349
    )Net (loss) income per common share
    
    $
    (0.27
    )
    
    $
    0.14
    
    
    $
    (0.24
    )Pro forma net (loss) income per common share
    
    $
    (0.28
    )
    
    $
    0.13
    
    
    $
    (0.24
    )
 60




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 2 SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (continued)
  o)
    
    Earnings per shareBasic earnings per common share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated on the
basis of the average number of shares outstanding during the period plus the additional
common shares that would have been outstanding if potentially dilutive common shares had
been issued using the treasury stock method.p)
    
    Financial instrumentsThe Corporation presents financial instruments which are, in substance, contractual
arrangements, including the Corporations redeemable and retractable (at the option of
the Parent) preferred shares, as financial liabilities in the consolidated balance sheet
(Note 8b). Payments of dividends on the preferred shares are reported in the
consolidated statement of operations as interest expense.q)
    
    Employee future benefitsThe Corporation maintains a defined contribution pension plan (Note 15). All employee
future benefits are accounted for on an accrual basis.r)
    
    Recently adopted and pending accounting pronouncementsFSP No. 46(R)-5In March 2005, the FASB issued FASB Staff Position (FSP) No. 46(R)-5, Implicit
Variable Interests under FASB Interpretation No. (FIN) 46 (revised December 2003),
Consolidation of Variable Interest Entities (FSP FIN 46R-5). FSP FIN 46R-5 provides
guidance for a reporting enterprise on whether it holds an implicit variable interest in
Variable Interest Entities (VIEs) or potential VIEs when specific conditions exist.
This FSP is effective in the first period beginning after March 3, 2005 in accordance
with the transition provisions of FIN 46 (Revised 2003), Consolidation of Variable
Interest Entities  an Interpretation of Accounting Research Bulletin No. 51 (FIN
46R). The adoption of FSP FIN 46R-5 had no impact on the Corporations results of
operations or financial position.FIN 47In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional
Asset Retirement Obligations (FIN 47), which clarifies that the term conditional
asset retirement obligation as used in FASB statement No. 143, Accounting for Asset
Retirement Obligations, refers to a legal obligation to perform an asset retirement
activity in which the timing and/or method of settlement are conditional on a future
event that may or may not be within the control of the entity. An entity is required to
recognize a liability for the fair value of a conditional asset retirement obligation if
the fair value of the liability can be reasonably estimated. FIN 47 is effective for
fiscal years ending after December 15, 2005. The adoption of FIN 47 did not have a
material impact on the Corporations financial position or results of operations.
 61




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 2 SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (continued)
 SFAS 123(R)
  SFAS 151
  SFAS 153
  SFAS 154
  62




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 2 SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (continued)
 EITF 031
  EITF 0313
  EITF 0413
  FASB Exposure Draft Fair Value Measurements
  FASB Exposure Draft Business Combinations
  63




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 2 SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (continued)
 FASB Exposure Draft Accounting for Uncertain Tax Positions
   3 ACCOUNTS RECEIVABLE
  4 INVENTORIES
 December 31, 2005
    
    
    December 31, 2004Raw materials
    
    $
    3,921
    
    
    $
    1,928Materials in process
    
    
    2,121
    
    
    
    767Finished product
    
    
    527
    
    
    
    32$
    6,569
    
    
    $
    2,727
 5 CAPITAL ASSETS
 Accumulated
    
    
    NetDecember 31, 2005
    
    Cost
    
    
    Depreciation
    
    
    Book ValueMachinery and equipment
    
    $
    9,387
    
    
    $
    2,620
    
    
    $
    6,767Leasehold improvements
    
    
    1,888
    
    
    
    825
    
    
    
    1,063Computer hardware and software
    
    
    393
    
    
    
    185
    
    
    
    208Construction in progress
    
    
    1,426
    
    
    
    
    
    
    
    1,426$
    13,094
    
    
    $
    3,630
    
    
    $
    9,464
 Accumulated
    
    
    NetDecember 31, 2004
    
    Cost
    
    
    Depreciation
    
    
    Book ValueMachinery and equipment
    
    $
    5,161
    
    
    $
    1,775
    
    
    $
    3,386Leasehold improvements
    
    
    1,392
    
    
    
    562
    
    
    
    830Computer hardware and software
    
    
    80
    
    
    
    79
    
    
    
    1Construction in progress
    
    
    2,344
    
    
    
    
    
    
    
    2,344$
    8,977
    
    
    $
    2,416
    
    
    $
    6,561
  64




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 6 INTANGIBLE ASSETS
 December 31, 2005
    
    December 31, 2004Patents and trademarks
    
    $
    2,028
    
    
    $
    1,837Less accumulated amortization
    
    
    (1,154
    )
    
    
    (931
    )$
    874
    
    
    $
    906
   2006
    
    $
    1942007
    
    
    1722008
    
    
    1432009
    
    
    1192010
    
    
    99Total
    
    $
    727
 7 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
 December 31, 2005
    
    December 31, 2004Accrued compensation liabilities
    
    $
    1,030
    
    
    $
    817Trade payables related to capital projects
    
    
    590
    
    
    
    674Other trade payables and accrued liabilities
    
    
    3,371
    
    
    
    2,208$
    4,991
    
    
    $
    3,699
 8 INDEBTEDNESS TO RELATED PARTY
  December 31, 2005
    
    December 31, 2004Shareholder advances (a)
    
    $
    
    
    
    $
    23,689Cumulative preferred shares (b)
    
    
    
    
    
    
    Promissory note (c)
    
    
    
    
    
    
    9,793Term loan (d)
    
    
    39,642
    
    
    
    $
    39,642
    
    
    $
    33,482
 a) Shareholder advances
 December 31, 2005
    
    December 31, 2004
    
    December 31, 2003Balance at beginning of year
    
    $
    23,689
    
    
    $
    23,600
    
    
    $
    20,339Net advances from (repayment to) Parent
    
    
    7,120
    
    
    
    (1,949
    )
    
    
    3,329Accrued interest on indebtedness to Parent
    
    
    2,589
    
    
    
    3,122
    
    
    
    Dividends on preferred shares
    
    
    
    
    
    
    389
    
    
    
    414Conversion of advances to
Class F preferred shares
    
    
    
    
    
    
    (3,113
    )
    
    
    (4,899
    )Foreign currency adjustment
    
    
    588
    
    
    
    1,640
    
    
    
    4,417Conversion to term loan
    
    
    (33,986
    )
    
    
    
    
    
    
    Balance at end of year
    
    $
    
    
    
    $
    23,689
    
    
    $
    23,600
 65




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 8 INDEBTEDNESS TO RELATED PARTY (continued)
   b) Cumulative redeemable preferred shares
   Number
    
    Stated CapitalDecember 31
    
    December 312005
    
    2004
    
    2003
    
    2005
    
    2004
    
    2003Balance at beginning of year
    
    
    
    
    
    
    7,770
    
    
    
    907
    
    
    $
    
    
    
    $
    6,012
    
    
    $
    574Shares issued
    
    
    
    
    
    
    3,503
    
    
    
    6,291
    
    
    
    
    
    
    
    2,724
    
    
    
    4,485Stock dividend
    
    
    
    
    
    
    514
    
    
    
    572
    
    
    
    
    
    
    
    389
    
    
    
    414Foreign currency adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    539Conversion to
promissory note
    
    
    
    
    
    
    (11,787
    )
    
    
    
    
    
    
    
    
    
    
    (9,134
    )
    
    
    Balance at end of year
    
    
    
    
    
    
    
    
    
    
    7,770
    
    
    $
    
    
    
    $
    
    
    
    $
    6,012
  c) Promissory note
 December 31, 2005
    
    December 31, 2004
    
    December 31, 2003Balance at beginning of year
    
    $
    9,793
    
    
    $
    
    
    
    $
    Conversion from Class F preferred shares
    
    
    
    
    
    
    9,134
    
    
    
    Foreign currency adjustment
    
    
    121
    
    
    
    659
    
    
    
    Conversion to term loan
    
    
    (9,914
    )
    
    
    
    
    
    
    Balance at end of year
    
    $
    
    
    
    $
    9,793
    
    
    $
    
  66




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 8 INDEBTEDNESS TO RELATED PARTY (continued)
 d) Term loan
 December 31, 2005
    
    December 31, 2004
    
    December 31, 2003Balance at beginning of year
    
    $
    
    
    
    $
    
    
    
    $
    Conversion from shareholder advances
    
    
    33,986
    
    
    
    
    
    
    
    Conversion from promissory note
    
    
    9,914
    
    
    
    
    
    
    
    Net repayment during the year
    
    
    (5,458
    )
    
    
    
    
    
    
    Foreign currency adjustment
    
    
    1,200
    
    
    
    
    
    
    
    Balance at end of year
    
    $
    39,642
    
    
    $
    
    
    
    $
    
  9 SHARE CAPITAL
   a) Common shares issued and outstanding
  Number
    
    Stated Capital2005
    
    2004
    
    2005
    
    2004Balance at beginning of year
    
    
    9,727,500
    
    
    
    9,727,500
    
    
    $
    3,534
    
    
    $
    3,534Issued upon share offering
    
    
    4,500,000
    
    
    
    
    
    
    
    39,095
    
    
    
    Balance at end of year
    
    
    14,227,500
    
    
    
    9,727,500
    
    
    $
    42,629
    
    
    $
    3,534
    67




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 9 SHARE CAPITAL (continued)
 b) Stock-based compensation plans
   Weighted Average Exercise PriceNumber of Options
    
    (CDN$)December 31
    
    
    
    
    
    December 312005
    
    2004
    
    2003
    
    2005
    
    2004
    
    2003Balance at beginning of year
    
    
    625,057
    
    
    
    486,440
    
    
    
    444,903
    
    
    $
    3.32
    
    
    $
    3.39
    
    
    $
    3.47Granted
    
    
    92,571
    
    
    
    165,205
    
    
    
    80,900
    
    
    
    4.50
    
    
    
    3.08
    
    
    
    3.08Cancelled
    
    
    (3,858
    )
    
    
    (26,588
    )
    
    
    (39,363
    )
    
    
    3.51
    
    
    
    3.08
    
    
    
    3.76Balance at end of year
    
    
    713,770
    
    
    
    625,057
    
    
    
    486,440
    
    
    $
    3.47
    
    
    $
    3.32
    
    
    $
    3.39
   Weighted-Number
    
    Average
    
    Weighted-
    
    Number
    
    Weighted-Outstanding at
    
    Remaining
    
    Average Exercise
    
    Exercisable at
    
    Average ExerciseRange of Exercise
    
    December 31,
    
    Contractual
    
    Price
    
    December 31,
    
    PricePrice (CDN$)
    
    2005
    
    Life (Years)
    
    (CDN$)
    
    2005
    
    (CDN$)$3.08 to $4.16
    
    
    662,605
    
    
    
    6.29
    
    
    $
    3.34
    
    
    
    493,563
    
    
    $
    3.36$4.17 to $6.32
    
    
    51,165
    
    
    
    9.20
    
    
    $
    5.15
    
    
    
    4,799
    
    
    $
    5.34$3.08 to $6.32
    
    
    713,770
    
    
    
    6.50
    
    
    $
    3.47
    
    
    
    498,362
    
    
    $
    3.38
   68




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 10 INCOME TAXES
  Year Ended December 312005
    
    2004
    
    2003(Loss) income before income taxes
    
    $
    (2,479
    )
    
    $
    1,367
    
    
    $
    (2,282
    )Statutory income tax rate
    
    
    33.62
    %
    
    
    33.87
    %
    
    
    36.74
    %Expected income tax (recovery) expense
    
    
    (833
    )
    
    
    463
    
    
    
    (838
    )Utilization of prior period losses
    
    
    
    
    
    
    (595
    )
    
    
    Losses and temporary differences
 valuation allowance
    
    
    937
    
    
    
    
    
    
    
    686Non-deductible expenses
    
    
    
    
    
    
    132
    
    
    
    152Large corporations tax
    
    
    58
    
    
    
    19
    
    
    
    19Income tax expense
    
    $
    162
    
    
    $
    19
    
    
    $
    19
   December 31, 2005
    
    December 31, 2004Deferred income tax assets:Tax benefit of loss carry-forwards and tax credits
    
    $
    13,178
    
    
    $
    11,767Less valuation allowance
    
    
    (12,638
    )
    
    
    (11,293
    )540
    
    
    
    474Deferred income tax liabilities:Capital, intangible and other assets
    
    
    (540
    )
    
    
    (474
    )Deferred income tax assets, net
    
    $
    
    
    
    $
    
    69




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 11 RELATED PARTY TRANSACTIONS
  Year Ended December 312005
    
    2004
    
    2003Building rent, including operating costs
    
    $
    1,399
    
    
    $
    793
    
    
    $
    907Services:Information technology
    
    
    58
    
    
    
    277
    
    
    
    186Treasury and accounting
    
    
    
    
    
    
    14
    
    
    
    60Legal
    
    
    204
    
    
    
    203
    
    
    
    110Insurance
    
    
    289
    
    
    
    255
    
    
    
    182Other
    
    
    154
    
    
    
    108
    
    
    
    143$
    2,104
    
    
    $
    1,650
    
    
    $
    1,588
   12 GUARANTEES
   13 COMMITMENTS
  2006
    
    2007
    
    2008
    
    2009
    
    2010$950
    
    $937
    
    $929
    
    $630
    
    $464
 14 FINANCIAL INSTRUMENTS
  70




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 14 FINANCIAL INSTRUMENTS (continued)
 Fair value of financial instruments
   Foreign currency risk
  Concentration of credit risk
  15 EMPLOYEE BENEFIT PLAN
   16 (LOSS) EARNINGS PER SHARE
  Year Ended December 312005
    
    2004
    
    2003Weighted average number of common shares
outstanding  basic
    
    
    9,764,486
    
    
    
    9,727,500
    
    
    
    9,727,500Effect of dilutive securities
Options
    
    
    
    
    
    
    172,052
    
    
    
    SARS
    
    
    
    
    
    
    5,912
    
    
    
    Weighted average number of common shares
outstanding  diluted
    
    
    9,764,486
    
    
    
    9,905,464
    
    
    
    9,727,500
  71




---



##### 



NUCRYST Pharmaceuticals Corp.
Notes to Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003  All amounts are expressed in thousands of U.S. dollars, except share and per share data
 16 (LOSS) EARNINGS PER SHARE (continued)
    17 SEGMENTED INFORMATION
  a) Assets by geographic segment
 December 31, 2005
    
    December 31, 2004Canada
    
    $
    56,005
    
    
    $
    11,837United States
    
    
    3,455
    
    
    
    3,760$
    59,460
    
    
    $
    15,597
 b) Capital assets and intangible assets by geographic segment
 December 31, 2005
    
    December 31, 2004Canada
    
    $
    8,874
    
    
    $
    6,558United States
    
    
    1,464
    
    
    
    909$
    10,338
    
    
    $
    7,467
  72




---



##### 



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
  ITEM 9A. CONTROLS AND PROCEDURES
 Evaluation of disclosure controls and procedures .
   Changes in internal control over financial reporting period
  ITEM 9B. OTHER MATTERS
  73




---



##### 



PART III
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 www.sedar.com www.edgar-online.com
  Name
    
    Age
    
    PositionScott H. Gillis
    
    
    53
    
    
    President, Chief Executive Officer and a DirectorPaul J. Schechter, M.D., Ph.D
    
    
    66
    
    
    Vice President, Drug Development & Regulatory
Affairs and Chief Medical OfficerEliot M. Lurier
    
    
    47
    
    
    Vice President, Finance and AdministrationDavid C. McDowell
    
    
    50
    
    
    Vice President, Manufacturing OperationsBarry M. Heck(1)(2)
    
    
    44
    
    
    Chairman of the BoardNeil Carragher(1)(3)
    
    
    67
    
    
    DirectorRoger G.H. Downer, Ph.D(2)(3)
    
    
    63
    
    
    DirectorRichard W. Zahn(1)(2)(3)
    
    
    54
    
    
    Director
 
 (1)
    
    Member of our audit committee.(2)
    
    Member of our human resources and compensation committee.(3)
    
    Member of our corporate governance and nominating committee. Scott H. Gillis
 Paul J. Schechter, M.D., Ph.D.
 Eliot M. Lurier
 David C. McDowell
 Barry M. Heck
 74




---



##### 



Neil Carragher
 Roger G.H. Downer, Ph.D
 Richard W. Zahn
   Composition of our Board of Directors
 Business Corporations Act
 Committees of the Board of Directors
  Audit Committee
   
    
    evaluating the performance, and assessing the qualifications, of our independent auditors and
recommending to our board of directors the appointment of, and compensation for, our
independent auditors for the purpose of preparing or issuing an auditors
 75




---



##### 



report or performing other audit, review or attest services;
    
    subject to the appointment of our independent auditors by our shareholders, determining and
approving the engagement of, and compensation to be paid to, our independent auditors;
    
    determining and approving the engagement, prior to the commencement of such engagement, of,
and compensation for, our independent auditors to perform any proposed permissible non-audit
services;
    
    reviewing our financial statements and managements discussion and analysis of financial
condition and results of operations and recommending to our board of directors whether or not
such financial statements and managements discussion and analysis of financial condition and
results of operations should be approved by our board of directors;
    
    conferring with our independent auditors and with our management regarding the scope,
adequacy and effectiveness of internal financial reporting controls in effect;
    
    establishing procedures for the receipt, retention and treatment of complaints received by us
regarding accounting, internal accounting controls or auditing matters and the confidential
and anonymous submission by our employees of concerns regarding questionable accounting or
auditing matters;
    
    reviewing and discussing with our management and independent auditors, as appropriate, our
guidelines and policies with respect to risk assessment and risk management, including our
major financial risk exposures and investment and hedging policies and the steps taken by our
management to monitor and control these exposures; and
    
    reviewing our compliance with environmental, health and safety and other laws and regulations
that may have an impact on our financial results.
 Human Resources and Compensation Committee
   
    
    reviewing and making recommendations to our board of directors with respect to our chief
executive officer and other executive officers in relation to their:
 
    
    annual base salary;
    
    annual incentive bonus, including the specific goals and amount;
    
    equity compensation;
    
    employment agreements, severance arrangements and change in control agreements/provisions; and
    
    other benefits, compensations, compensation policies or arrangements;
 
    
    reviewing and making recommendations to our board of directors regarding general compensation
goals and guidelines for employees and the criteria by which bonuses to employees are
determined;
    
    overseeing management succession planning;
    
    preparing any report on compensation to be included in our periodic filings or proxy statement; and
 76




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##### 




    
    acting as administrator of our amended equity incentive plan and determining its use, from
time to time, as a form of incentive compensation for those entitled to receive grants of
stock options and other benefits under that plan.
 Corporate Governance and Nominating Committee
   
    
    reviewing board structure, composition and practices, and making recommendations on these
matters to our board of directors;
    
    reviewing, soliciting and making recommendations to our board of directors and shareholders
with respect to candidates for election to the board;
    
    reviewing the compensation payable to board and committee members and providing
recommendations to our board of directors in regard thereto; and
    
    developing and reviewing a set of corporate governance principles for our company.
 Director Compensation
  
    
    each non-employee director will receive $2,500 for each board meeting attended in person
($1,000 for meetings attended by video or telephone conference);
    
    each non-employee director will, upon their election to our board, receive, under our amended
equity incentive plan, an initial stock option grant to purchase 20,000 of our common shares,
as well as an annual stock option grant to purchase 10,000 common shares. Messrs. Carragher,
Downer and Zahn will receive their initial grant of options to purchase 20,000 common shares
each, at an exercise price of $10.00 per common share. These stock options will vest in equal
annual amounts on the first three anniversaries of the date of grant;
    
    the chairman of our audit committee will receive $2,500 for each committee meeting attended
in person ($1,500 for meetings attended by video or telephone conference) and each other
member of such committee will receive $1,000 per committee meeting attended in person ($750
for meetings attended by video or telephone conference); and
    
    the chairmen of our human resources and compensation committee and corporate governance and
nominating committee will receive $1,500 per committee meeting attended in person ($1,000 for
meetings attended by video or telephone conference) and each other member of such committees
will receive $750 per committee meeting attended in person ($500 for meetings attended by
video or telephone conference).
   77




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##### 



Compensation Committee Interlocks and Insider Participation
  Scientific Advisory Board
  
    
    our research and development programs;
    
    the design and implementation of our clinical trials;
    
    market opportunities from a clinical perspective;
    
    new technologies relevant to our research and development; and
    
    scientific and technical issues relevant to our business.
  Name
    
    
    
    Professional AffiliationAllen J. Bard, Ph.D.
    
    
    
    Hackerman-Welch Regents Chair in Chemistry Department of Chemistryand Biochemistry, The University of Texas at Austin
    
    Member, National Academy of Sciences
    
    Formerly Editor-in-Chief, Journal of the American Chemical Society
    
    Formerly President, International Union of Pure and Applied ChemistryRobert H. Demling, M.D.
    
    
    
    Professor of Surgery, Harvard Medical School, Boston
    
    Director, Intensive Care Unit, Brigham and Womens Hospital, Boston
    
    Director, Burn Center, Brigham and Womens Hospital, Boston
    
    Surgeon, Brigham and Womens Hospital, Boston
    
    Formerly President, American Burn AssociationByron D. McLees, M.D., Ph.D.
    
    
    
    Formerly Chief Medical Officer, ClinTrials Research, Inc.
    
    Formerly President, MPI Development
    
    Formerly Vice President Worldwide Clinical Development and MedicalAffairs, Procter and Gamble Pharmaceuticals
    
    Formerly Chief Medical Officer, The Upjohn Company
 78




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##### 



Name
    
    
    
    Professional Affiliation
    
    Formerly Professor of Medicine and Director of Pulmonary/CriticalCare Medicine, Bowman Gray School of MedicinePaul M. Newberne, D.V.M., Ph.D.
    
    
    
    Professor of Pathology Emeritus, Boston University School ofMedicine
    
    Professor of Nutritional Pathology Emeritus, MassachusettsInstitute of Technology
    
    Formerly President, American College of Veterinary Pathologists
    
    Formerly Scientific Advisory Board, FDA Center for ToxicologicalResearch (NCTR)
    
    Formerly Chairman, FDA Expert Panel, Evaluation of Flavor, Extractand Food Additive for Generally Regarded as Safe statusRobert S. Stern, M.D.
    
    
    
    Professor of Dermatology, Harvard Medical School
    
    Chairman, Department of Dermatology, Beth Israel Deaconess MedicalCenter, Boston
    
    Formerly Chairman, Dermatologic Drugs Advisory Committee, U.S. Foodand Drug Administration
    
    Formerly Co-editor, Archives of DermatologyMichael Weintraub, M.D.
    
    
    
    Weintraub Pharmaceutical Consulting
    
    Formerly Head, Clinical Pharmacology, University of RochesterMedical School, New York
    
    Formerly Director, Office of Drug Evaluation 5 (OTC Drugs,Dermatologic/Dental Drugs, Analgesics, Anti-inflammatory andOphthalmologic Drugs), U.S. Food and Drug Administration
    
    Editor Emeritus, Current Therapeutics Research
  79




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##### 



ITEM 11. EXECUTIVE COMPENSATION
  Summary Compensation Table
 Long-TermCompensationAwardsNumber ofSharesAnnual Compensation
    
    
    
    
    
    UnderlyingOther Annual
    
    All Other
    
    OptionsName and Principal Position
    
    Year
    
    Salary
    
    Bonus
    
    Compensation
    
    Compensation
    
    GrantedScott H. Gillis
    
    
    2005
    
    
    $
    249,375
    
    
    $
    98,004
    
    
    $
    20,000
    (1)
    
    $
    6,850
    
    
    
    President and Chief
    
    
    2004
    
    
    $
    245,000
    
    
    $
    105,774
    
    
    $
    20,000
    (1)
    
    
    
    
    
    
    Executive Officer
    
    
    2003
    
    
    $
    243,333
    
    
    $
    107,553
    
    
    $
    20,000
    (1)
    
    
    
    
    
    
    25,940Paul J. Schechter, M.D., Ph.D
    
    
    2005
    
    
    $
    231,122
    
    
    $
    93,373
    
    
    
    
    
    
    $
    9,060
    
    
    
    Vice President, Drug
    
    
    2004
    
    
    $
    222,232
    
    
    $
    82,772
    
    
    
    
    
    
    $
    6,667
    
    
    
    16,213Development & Regulatory
    
    
    2003
    
    
    $
    213,938
    
    
    $
    96,272
    
    
    
    
    
    
    $
    1,298
    
    
    
    12,970Affairs and Chief Medical OfficerEliot M. Lurier, CPA
    
    
    2005
    
    
    $
    105,297
    
    
    $
    41,277
    
    
    
    
    
    
    
    
    
    
    
    19,455Vice President, Finance & AdministrationDavid C. McDowell
    
    
    2005
    
    
    $
    74,967
    (2)
    
    $
    28,509
    (2)
    
    
    
    
    
    $
    1,979
    (2)
    
    
    38,910Vice President, Manufacturing OperationsDomenic J. Vatalero(3)
    
    
    2005
    
    
    $
    177,662
    
    
    $
    117,187
    
    
    
    
    
    
    
    6,300
    
    
    
    Former Vice President, Marketing
    
    
    2004
    
    
    $
    212,034
    
    
    $
    89,951
    
    
    
    
    
    
    
    6,361
    
    
    
    16,213and Operations
    
    

    2003
    
    
    $
    201,713
    
    
    $
    87,543
    
    
    
    
    
    
    
    419
    
    
    
    19,455
 
 (1)
    
    Mr. Gillis received cash allowances in lieu of perquisites in the amount of $20,000 in each
of 2003, 2004, and 2005.(2)
    
    Mr. McDowells compensation is denominated in Canadian dollars and has been translated into
U.S. dollars for purposes of this table at an average exchange rate of U.S.$1.00 = C$1.1873.(3)
    
    Mr. Vatalero transitioned from his position as Vice President, Marketing and Operations to a
part time non-executive position, effective July 4, 2005. Option Grants in 2005
  Individual Grants

    
    Potential RealizablePercent of
    
    
    
    
    
    
    
    
    
    Value at AssumedNumber of
    
    Total
    
    
    
    
    
    
    
    
    
    Annual Rates ofSecurities
    
    Options
    
    
    
    
    
    
    
    
    
    Share PriceUnderlying
    
    Granted to
    
    Exercise
    
    
    
    
    
    Appreciation forOptions
    
    Employees
    
    Price Per
    
    
    
    
    
    Option Term(1)Name
    
    Granted
    
    in 2005
    
    Share(1)
    
    Expiration Date
    
    5%
    
    10%(in thousands)Scott H. Gillis
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Paul J. Schechter, M.D., Ph.D
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Eliot M. Lurier
    
    
    19,455
    
    
    
    21.8
    %
    
    $
    3.57
    
    
    April 2015
    
    $
    222
    
    
    $
    358David C. McDowell
    
    
    38,910
    
    
    
    43.6
    %
    
    $
    4.37
    
    
    July 2015
    
    $
    419
    
    
    $
    685Domenic J. Vatalero
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 
 (1)
    
    Potential realizable value is the hypothetical gain that could be achieved if options were
exercised at the end of their terms. This determination assumes options are exercised at the
end of their terms, based on assumed annually compounded rates of share appreciation of 5% and
10% and based on the market price per common share at December 31, 2005, net of the exercise
price but before taxes associated with exercise. These assumed rates of appreciation comply
with the rules of the SEC and do not represent our estimate or projection of future common
share prices. Actual gains, if any, on option exercises will depend on the future market price
of our common shares. Exercise prices are denominated in Canadian dollars and have been
translated into U.S. dollars for purposes of this table at the noon buying rate reported by
the Federal Reserve Bank of New York on December 31, 2005 of U.S.$1.00 = C$1.1656. 80




---



##### 



December 31, 2005 Option Values
  Number of Securities
    
    Value of UnexercisedUnderlying Unexercised
    
    In-the-Money Options atOptions at December 31, 2005
    
    December 31, 2005(1)Name
    
    Exercisable
    
    Unexercisable
    
    Exercisable
    
    Unexercisable(in millions)Scott H. Gillis
    
    
    263,724
    
    
    
    8,646
    
    
    $
    1.8
    
    
    $
    0.1Paul J. Schechter, M.D., Ph.D
    
    
    52,960
    
    
    
    15,133
    
    
    $
    0.4
    
    
    $
    0.1Eliot M. Lurier
    
    
    
    
    
    
    19,455
    
    
    
    
    
    
    $
    0.1David McDowell
    
    
    
    
    
    
    38,910
    
    
    
    
    
    
    $
    0.2Domenic J. Vatalero
    
    
    50,799
    
    
    
    17,294
    
    
    $
    0.4
    
    
    $
    0.1
 
 (1)
    
    Exercise prices are denominated in Canadian dollars and have been translated into U.S.
dollars for purposes of this table at the noon buying rate as reported by the Federal Reserve
Bank of New York on December 31, 2005 of U.S.$1.00 = C$1.1656. Equity Incentive Plan
  Eligible Participants.
 Options.
 Share Appreciation Rights.
 
    
    Tandem Rights.A tandem right is a SAR granted in connection with an option that is
subject to the same terms and conditions applicable to the particular option grant to which it
pertains with the following exceptions: the tandem right shall require the holder to elect
between the exercise of the underlying option to purchase common shares and the surrender, in
whole or in part, of such option in exchange for a payment of cash or, if provided in the
award agreement, at our option in common shares, in an amount equal to the excess of (A) the
fair market price of the number of common shares covered by that portion of the surrendered
option in which the optionholder is vested over (B) the aggregate exercise price payable for
such vested shares. For the purposes of tandem rights, fair market price shall be equal to the
closing price immediately preceding the date of the option surrender.
    
    Concurrent Rights.A concurrent right is a SAR granted in connection with an option that
applies to all or a portion of common shares subject to the underlying option and which is
subject to the same terms and conditions applicable to the particular option grant to which it
pertains with the following exceptions: a concurrent right shall be exercised automatically at
the same time the underlying option is exercised with respect to the common shares to which
the concurrent right pertains and, on exercise, entitles the holder to receive a payment of
cash or, if provided in the award agreement, at our option in common shares, in an amount
 81




---



##### 



equal to the excess of (A) the aggregate fair market price of the common shares purchased under
the underlying option over (B) the aggregate exercise price paid for such shares. For the
purposes of concurrent rights, fair market price shall be equal to the closing price immediately
preceding the date of the exercise of the concurrent right.
 
    
    Independent Rights.An independent right means a SAR granted independently of any option
but that is subject to the same terms and conditions applicable to an option with the
following exceptions: an independent right shall be denominated in share equivalents. Upon
exercise, independent rights will be payable in cash or, if provided in the award agreement,
at our option in common shares, in an amount equal to the excess of (A) the aggregate fair
market price of a number of common shares equal to the number of share equivalents in which
the holder is vested under such independent right, and with respect to which the holder is
exercising the independent right on such date, over (B) the aggregate exercise price for the
independent right exercised. For the purposes of independent rights, fair market price shall
be equal to the closing price immediately preceding the date of exercise of the independent
right.
 Restricted Shares.
 Other Stock-Based Awards.
 Incentive Awards.
 Shares Reserved; Plan Limits.
 Adjustment.
 Other Terms.
   Amendments.
 82




---



##### 



Transferability.
   Employment Agreements
 Scott H. Gillis
  Paul J. Schechter, M.D., Ph.D.
  Eliot M. Lurier
  David C. McDowell
  83




---



##### 



Domenic J. Vatalero
  Limitation of Liability and Indemnification of Directors and Officers
 Under the ABCA, we may indemnify an individual who:
    
    is or was our director or officer; or
    
    is or was a director or officer of another corporation, of which we are or were a shareholder or creditor, at our request;
  However, indemnification is prohibited under ABCA if:
    
    such eligible party did not act honestly and in good faith with a view to our best
interests (or the best interests of the other entity, as the case may be); and
    
    in the case of a criminal or administrative proceeding that is enforced by monetary
penalty, such eligible party did not have reasonable grounds for believing that such
persons conduct was lawful.
     84




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##### 



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.
  
    
    each person known by us to be the beneficial owner of more than 5% of our common shares;
 
    
    our named executive officers;
 
    
    our directors; and
 
    
    our directors and executive officers as a group.
    Percentage ofNumber of Shares
    
    SharesNumber of
    
    Percentage of
    
    Beneficially Owned
    
    Beneficially OwnedShares Beneficially
    
    Shares Beneficially
    
    After Debt
    
    After DebtName and Address of Beneficial Owner
    
    Owned
    
    Owned
    
    Conversion(1)
    
    Conversion(1)The Westaim Corporation
10102114 Street
Fort Saskatchewan, Alberta
T8L 3W4
    
    
    9,727,500
    
    
    
    68.4
    %
    
    
    13,691,700
    
    
    
    75.3
    %Scott H. Gillis2
    
    
    272,370
    
    
    
    1.9
    %
    
    
    272,370
    
    
    
    1.5
    %Paul J. Schechter, M.D., PhD(2)
    
    
    52,960
    
    
    
    *
    
    
    
    52,590
    
    
    
    *Eliot M. Lurier
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    David C. McDowell
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Domenic J. Vatalero(2)
    
    
    50,800
    
    
    
    *
    
    
    
    50,800
    
    
    
    *Barry M. Heck
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Neil Carragher
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Roger G.H. Downer, Ph.D.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Richard W. Zahn
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    All directors and executive officers as a
group (9 persons)(2)
    
    
    376,130
    
    
    
    2.6
    %
    
    
    376,130
    
    
    
    2.0
    %
 
 *
    
    Less than one percent.(1)
    
    On January 27, 2006, the outstanding debt owed to Westaim of $39.6 million was converted to
3.96 million common shares at $10.00 per share.(2)
    
    Includes the options to purchase common shares exercisable within 60 days of December 31,
2005 as follows: 272,370 shares for Mr. Gillis; 52,960 shares for Dr. Schechter; and 50,800
for Domenic J. Vatalero.  ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
  Employment Agreements
  85




---



##### 



Director and Officer Indemnification
  Relationship with Westaim
  Westaim
 .
 Services Agreement
  Debt Agreement
  Master Separation Agreement
  86




---



##### 



Registration Rights Agreement
  Westaim Directors and Officers
  ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
  2004
    
    
    2005(in millions)Audit Fees
    
    $
    
    
    
    $
    0.4Audit-Related
Fees
    
    
    
    
    
    
    Tax Fees
    
    
    
    
    
    
    All Other Fees
    
    
    
    
    
    
    
 Audit-Related Fees
  Tax Fees
  All Other Fees
    87




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##### 



PART IV
 ITEM 15. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES
 1. Consolidated Financial Statements
 The following documents are filed as part of this Annual Report on Form 10-K:
 Report of Deloitte & Touche LLP, Independent Registered Chartered Accountants
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Cash Flows Statements
Consolidated Statements of Shareholders Equity (Deficit)
Notes to Consolidated Financial Statements
 2. Financial Statement Schedules
  3. Exhibits
 Exhibit No.
    
    Description
    
    Incorporated by reference herein2.1
    
    Asset Purchase Agreement, dated May 8, 2001, between
the Registrant and Smith & Nephew, Inc.
    
    Amendment No. 3 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)3.1
    
    Articles of the Registrant
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)3.2
    
    Articles of Amendment
    
    R Amendment No. 2 to
Registration Statement on Form
F-1, as amended (File No.
333-130073)3.3
    
    By-laws of the Registrant
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)4.1
    
    Specimen certificate evidencing common shares
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.1
    
    Form of Master Separation Agreement between the
Registrant and The Westaim Corporation (Westaim)
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.2
    
    Form of Services Agreement between the Registrant
and Westaim
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.3
    
    Form of Registration Rights Agreement between the
Registrant and Westaim
    
    Amendment No. 3 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.4
    
    Amended and Restated Loan Agreement, dated August
31, 2005, between the Registrant and Westaim
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.5
    
    Amended and Restated General Security Agreement,
dated as of August 31, 2005, between the Registrant
and Westaim
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.6
    
    Amended and Restated License and Development
Agreement, dated as of February 20, 2002, among the
Registrant, NUCRYST Pharmaceuticals Inc., Smith &
Nephew, Inc. and T.J. Smith & Nephew Limited
    
    Amendment No. 3 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.7
    
    Letter Agreement, dated March 14, 2002, among the
Registrant, NUCRYST Pharmaceuticals Inc., Smith &
Nephew, Inc. and T.J. Smith & Nephew Limited
    
    Amendment No. 3 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.8
    
    Amending Agreement, dated November 3, 2003, among
the Registrant, NUCRYST Pharmaceuticals Inc., Smith
& Nephew, Inc. and T.J. Smith & Nephew Limited
    
    Amendment No. 3 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)
 88




---



##### 



Exhibit No.
    
    Description
    
    Incorporated by reference herein10.9
    
    Supply Agreement, dated May 8, 2001, among the
Registrant, Smith & Nephew, Inc. and T.J. Smith &
Nephew Limited
    
    Amendment No. 3 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.10
    
    Manufacturing Technology Escrow Agreement, dated May
8, 2001, among the Registrant, Smith & Nephew, Inc.,
T.J. Smith & Nephew Limited and Montreal Trust
Company of Canada, as escrow agent
    
    Amendment No. 1 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.11
    
    Security Trust Agreement, dated as of May 8, 2001,
between the Registrant and Montreal Trust Company of
Canada, as trustee
    
    Amendment No. 1 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.12
    
    Trust Indenture, dated May 8, 2001, among the
Registrant, NUCRYST Pharmaceuticals Inc. and
Montreal Trust Company of Canada, as trustee
    
    Amendment No. 3 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.13
    
    Subordination and Non-Disturbance Agreement, dated
as of May 8, 2001, among the Registrant, NUCRYST
Pharmaceuticals Inc., Smith & Nephew, Inc., T.J.
Smith & Nephew Limited and Montreal Trust Company of
Canada
    
    Amendment No. 1 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.14
    
    Memorandum of Lease Agreement, dated as of July 1,
2005, between the Registrant and The Westaim
Corporation
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.15
    
    Commercial Lease, dated as of September 1, 2001,
between NUCRYST Pharmaceuticals Inc. and Cummings
Properties, LLC
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.16*
    
    1998 Equity Incentive Plan
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.17*
    
    Forms of Stock Option Agreements under the 1998
Equity Incentive Plan
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.18*
    
    Form of Amended and Restated 1998 Equity Incentive
Plan
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.19*
    
    Form of Stock Option Agreement under the Amended and
Restated 1998 Equity Incentive Plan
    
    Amendment No. 3 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.20*
    
    Employment Agreement, dated December 6, 1999,
between NUCRYST Pharmaceuticals Inc. and Scott H.
Gillis
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.21*
    
    Stock Option Agreement, dated December 6, 1999,
among the Registrant, Westaim and Scott H. Gillis
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.22*
    
    Letter Agreement, dated March 16, 2005, between the
Registrant and Eliot M. Lurier
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.23*
    
    Letter Agreement, dated June 15, 2005, between the
Registrant and David C. McDowell
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.24*
    
    Letter Agreement, dated March 14, 2002, between the
Registrant and Paul J. Schechter, M.D., Ph.D.
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.25*
    
    Summary of Non-Employee Director Compensation
    
    Amendment No. 3 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.26
    
    Form of Indemnification Agreement
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)10.27*
    
    Change of Control Agreement, dated December 6, 1999,
between NUCRYST Pharmaceuticals Inc. and Scott H.
Gillis
    
    Amendment No. 2 to Registration
Statement on Form F-1, as
amended (File No. 333-130073)21.1
    
    Subsidiaries of the Registrant
    
    Registration Statement on Form
F-1, as amended (File No.
333-130073)23.1
    
    Consent of Deloitte & Touche
LLP (filed herewith)24.1
    
    Power of Attorney (included on signature page hereto)31.1
    
    Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (filed herewith)
 89




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##### 



Exhibit No.
    
    Description
    
    Incorporated by reference herein31.2
    
    Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (filed herewith)32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (filed herewith)32.2
    
    Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (filed herewith)
 
 
    
    Confidential treatment has been granted for portions of this exhibit.*
    
    Indicates management compensatory plan, contract or arrangement. SIGNATURES
  NUCRYST PHARMACEUTICALS CORP.By:
    
    /s/ Scott H. GillisScott H. GillisPresident and Chief Executive Officer
 POWER OF ATTORNEY
  Name
    
    Title/s/ Scott H. Gillis
    
    President and Chief Executive OfficerScott H. Gillis
    
    (Principal Executive Officer)/s/
Eliot M. Lurier
    
    Vice President  Finance and AdministrationEliot M. Lurier
    
    (Principal Financial and Accounting Officer)/s/
Barry M. Heck
    
    DirectorBarry M. Heck/s/
Neil Carragher
    
    DirectorNeil Carragher/s/
Roger G.H. Downer
    
    DirectorRoger G.H. Downer/s/
Richard Zahn
    
    DirectorRichard Zahn
 90