UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-KSB



ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006Commission file number 0-31198



| |                                                | 
| | ---------------------------------------------- | 
| | Stellar Pharmaceuticals Inc.                   | 
| | (Name of small business issuer in its charter) | 





|                                                |  |                                     
|----------------------------------------------- |  | ------------------------------------
|Ontario, Canada                                 |  | Not Applicable                      
|(Jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)





|                                            |  |              
|------------------------------------------- |  | -------------
|544 Egerton Street, London, Ontario, Canada |  | N5W 3Z8      
|(Address of principal executive offices)    |  | (Postal Code)





|                          |               
|------------------------- | --------------
|Issuers telephone number | (519) 434-1540



Securities registered under Section 12(b) of the Exchange Act:



|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange on which registered
|Not applicable      |  | Not Applicable                           



Securities registered under Section 12(g) of the Exchange Act:



| |                  |  | 
| | ---------------- |  | 
| | Common Shares    | 
| | (Title of Class) | 



Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes [ X ]  No [   ].



Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB  [  ]



State issuers revenues from all sources for its most recent fiscal year $4,377,697 (Cdn.).



As of March 26, 2007, the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the average bid and asked price of such common equity, as of such date, was $12,673,144(Cdn.).



As of March 26, 2007, 23,819,040 Common Shares were outstanding.



Transitional small business disclosure format (check one):  Yes [   ] No [ X ]



---





General

In this annual report, Stellar and the Company refer to Stellar Pharmaceuticals Inc. an Ontario, Canada corporation.  All dollar amounts in this annual report are stated in Canadian Dollars unless stated otherwise.  Certain terms used in this annual report are defined below in the section entitled Glossary.  The names of products referred to in this annual report are the trademarks or registered trademarks of their respective owners.  All rights reserved.

Forward-Looking Statements

Readers are cautioned that actual results may differ materially from the results projected in any "forward-looking" statements included in this annual report, which involve a number of risks or uncertainties. Forward-looking statements are statements that are not historical facts, and include statements regarding the Companys planned research and development programs, anticipated future losses, revenues and market shares, planned clinical trials, expected future expenditures, the Companys intention to raise new financing, sufficiency of working capital for continued operations, and other statements regarding anticipated future events and the Companys anticipated future performance.  Forward-looking statements generally can be identified by the words "expected", "intends", "anticipates", "feels", "continues", "planned", "plans", "potential", "with a view to", and similar expressions or variations thereon, or that events or conditions "will", "may", "could" or "should" occur, or comparable terminology referring to future events or results.



The Companys actual results could differ materially from those anticipated in these forward-looking statements as a result of numerous factors, including those listed under "Risks and Uncertainties" in Item 6 of this annual report, any of which could cause actual results to vary materially from current results or the Company's anticipated future results.  The Company assumes no responsibility to update the information contained herein.

Exchange Rate for Canadian Dollar

The accounts for Stellar are maintained in Canadian dollars which is the Companys functional currency.  All dollar amounts contained herein are expressed in Canadian dollars, except as otherwise indicated.  As at March 26, 2007, the exchange rate for Canadian dollars/United States dollars was $1.00 (Cdn.) = $0.8601 (U.S.).



Set forth below are the exchange rates for the Canadian dollar equivalent expressed in United States currency during 2006, 2005 and 2004.



|               |                                              |        |        |      |  |     
|-------------- | -------------------------------------------- | ------ | ------ | ---- |  | ----
|               | Years ended December 31, 2006, 2005 and 2004
|               |                                              | 2006   |        | 2005 |  | 2004
|At End of Year | 0.8581                                       | 0.8585 | 0.8038
|Average        | 0.8816                                       | 0.8224 | 0.7689
|High           | 0.9013                                       | 0.8672 | 0.8493
|Low            | 0.8640                                       | 0.7853 | 0.7159



Enforceability of Certain United States Judgments



The Company is incorporated in the Province of Ontario, Canada and a substantial part of its assets are located outside of the United States.  All but one (1) of the Companys directors and officers are neither citizens nor residents of the United States, and all or a substantial part of the assets of such persons may be located outside the United States.  As a result, it may be difficult to affect service of process within the United States upon the Company and such persons or to realize against the Company or such persons within the United States upon judgments of courts of the United States predicated upon civil liabilities under the United States federal securities laws.  Fogler, Rubinoff LLP, Canadian counsel for the Company, has advised that there is doubt as to whether courts in the Province of Ontario would (i) enforce judgments of United States courts obtained in actions against the Company or such persons predicated upon the civil liability provisions of the United States federal securities laws or (ii) enforce, in original actions, liabilities against the Company or such persons predicated solely upon such statutory provisions.









---







PART I



Item 1.

Description of Business.

Overview



Stellar is a Canadian pharmaceutical company involved in the development and marketing of high quality, cost-effective, polysaccharide-based therapeutic products used in the treatment of osteoarthritis and certain types of cystitis.  Stellar also intends to develop additional healthcare products aimed at niche pharmaceutical markets.  Stellars product development strategy focuses on seeking novel applications in markets where its products demonstrate true cost effective therapeutic advantages. Stellar also intends to build revenues through out-licensing its products and in-licensing other products for Canada and international markets that are focused on similar niche markets.

Stellar has developed and currently markets the following three medical products:  (i) NeoVisc®, (ii) Uracyst® and (iii) the Uracyst® Test Kit.  NeoVisc, a 3 injection, high molecular weight, sodium hyaluronate therapy, was developed to provide a cost-effective alternative treatment to the over 3 million Canadians suffering from osteoarthritis.  Uracyst, a chondroitin sulfate-based therapy, and the Uracyst Test Kit were developed to identify defective bladder linings and provide symptomatic relief to the over 70,000 patients in Canada with interstitial cystitis.  Each of these products has received regulatory approval in Canada.  Uracyst and the Uracyst Test Kit are patented in the United States and in Canada with international patents pending.

Stellar markets its products in Canada through its own commissioned and salaried sales force and currently has licensing agreements for the distribution of its products in 30 countries.  The Companys focus on product development continues to be two fold utilizing in-licensing and out-licensing for immediate impact on its revenue stream.  These activities enable Stellar to fund its own in-house product development for future growth and stability. Stellar, through its out-licensing partners, intends to conduct clinical trials necessary to obtain the required regulatory approvals for its products in foreign markets.



Effective December 2001, Stellar entered into a strategic licensing agreement with G. Pohl-Boskamp GmbH & Co. ("Pohl-Boskamp") for the sale of Uracyst products in Europe. In December of 2003, Pohl-Boskamp received approval to begin selling Uracyst in Europe.



In September 2002, Stellar was granted the exclusive Canadian marketing and distribution rights to sell Skelite® by Millenium Biologix Inc.  Skelite is a bone void filler that is resorbed by the natural remodeling process and replaced with new bone during the healing period.  Stellar commenced sales of Skelite in Canada in January 2004.



In June 2003, Stellar entered into distribution agreements with BurnsAdler Pharmaceuticals to sell Stellars products in Latin America and the Caribbean.



In October 2003, the Company entered into an exclusive distribution agreement with Matritech, Inc., to sell NMP22®BladderChek® ("BladderChek") in the Canadian market. BladderChek is a unique point of care diagnostic, used in the diagnosis and monitoring of bladder cancer.  In October 2004, Stellar commenced selling BladderChek in Canada.

In March 2004, the Company entered into supply and license agreements with SJ Pharmaceuticals, Inc. (now Leitner Pharmaceuticals Inc.) ("Leitner"). Under these agreements, Leitner was granted an exclusive license to use certain of the Companys methods and technical know-how for the purposes of developing, marketing and selling NeoVisc and Uracyst products in the United States.  In addition to an upfront payment made to the Company upon signing, these agreements will provide Stellar with milestone payments and an ongoing royalty stream from future sales of these products in the United States.  Leitner will be responsible for conducting clinical trials and obtaining regulatory approvals for these products in the United States. These agreements were terminated in March of 2006 by mutual agreement.



In June 2004, Stellar entered into a NeoVisc licensing agreement with Triptibumis Sdn. Bhd. for Malaysia, Singapore and Brunei.  The first shipment to this market was initiated in October 2004.  Although this agreement covers a relatively small market, Stellar pursued this agreement to further its global expansion.









---







In July 2005, Stellar entered into a licensing agreement with Innogen Ilac for the sale of NeoVisc in Turkey.  In August 2005, the Company entered into a distribution agreement with Technimed for the sale of NeoVisc in Lebanon.



In September 2005, the company entered into a licensing agreement with Shanghai Ya Jun Medical for the sale of Uracyst in China.  Stellar also entered into licensing agreements with: Al-Mohab Co. for the sale of NeoVisc® in Kuwait in November 2005 and. Mega Pharm for the sale of Uracyst in Israel in December 2005.

In July 2006, a distribution agreement was signed with Bio-Technic Romania for NeoVisc® in Romania and subsequently, in August of 2006 the Company received its CE Mark for NeoVisc in Europe.



The Company signed a license and supply agreement with Watson Pharma, Inc ("Watson") in December 2006 for the distribution and sale of Uracyst in the United States market Under these agreements, Watson was granted an exclusive license to use certain of the Companys methods and technical know-how for the purposes of developing, marketing and selling Uracyst products in the United States.  In addition to an upfront payment made to the Company upon signing, these agreements will provide Stellar with milestone payments and an ongoing royalty stream from future sales of these products in the United States.  Watson will be responsible for conducting clinical trials and obtaining regulatory approvals for these products in the United States.



Stellar was incorporated under the Business Corporations Act (Ontario) on November 14, 1994.  The Companys registered office and executive offices are located at 544 Egerton Street, London, Ontario, Canada N5W 3Z8.  The Companys telephone number is (519) 434-1540, its facsimile number is (519) 434-4382 and its e-mail address is stellar@stellarpharma.com.

Glossary

hyaluronate or HA-  A naturally occurring polysaccharide, which by virtue of its viscosity and elasticity, acts as a lubricating and shock absorbing component in synovial fluids.   HA is the active ingredient in NeoVisc.

FDA- The Food and Drug Administration of the United States, which, among other functions, regulates medical devices and other therapeutic products used in the United States.

interstitial cystitis or IC-  A chronic inflammation of the bladder wall.

NeoVisc®- A 2 mL pre-filled syringe of sterile 1.0% sodium hyaluronate solution used for the temporary replacement of synovial fluid in osteoarthritic joints.  NeoVisc is the Companys proprietary product for the treatment for osteoarthritis.

osteoarthritis or OA-  A degenerative disease associated with long-term wear primarily on weight bearing joints.

polysaccharide - A carbohydrate containing a large number of saccharide (sugar) groups.  Starch is a common type of polysaccharide.

synovial fluid  -  A clear viscid fluid, the function of which is to lubricate the joint.

TPD- The Therapeutic Products Directorate of Health Canada, which, among other functions, regulates medical devices and other therapeutic products used in Canada.

Uracyst®- A sterile 2.0% sodium chondroitin sulfate solution. Uracyst products are the Companys proprietary  treatments  for certain forms of IC and non-common cystitis.  The products are instilled by catheter directly into a patients bladder.

Uracyst®Test Kit- The Companys proprietary test kit that confirms the existence of bladder lining defects in IC patients and identifies those patients who should respond positively to Uracyst.









---





Development Strategy

Stellar focuses its product development activity around naturally occurring, well-studied (human body) chemicals and seeks novel applications in markets where its products demonstrate cost-effective therapeutic advantages.  By using this development strategy, management of Stellar believes it can bring products with niche applications to unsatisfied, under-serviced markets with relatively low regulatory risk.  In addition, management of the Company believes that a focus on in-licensing additional products focused on these same niche pharmaceutical markets improves its ability to compete with larger companies and gain significant market share for its products and licensed-in products.  Stellar is also building revenues through out-licensing its current products to international markets.

Competition Generally

The pharmaceutical industry is highly competitive and is characterized by rapidly changing technology.  The Company competes with other companies to market its products aimed at treating similar conditions.  Many of these companies have substantially greater resources than the Company. There can be no assurance that the Company will continue to be able to compete with such companies or that developments by others will not render the Companys products or technologies non-competitive or obsolete.  In order to maintain and improve its position in the industry, the Company must continue to enhance its current products, develop or acquire new products and product extensions and implement a comprehensive international sales and distribution marketing strategy.  The Companys competition comes from a variety of sources, including companies, which target all, or a portion of the Companys current product offerings.  See  Products and Markets.  Also, many current and potential competitors of the Company may have greater name and brand recognition and more extensive customer bases that could be leveraged to gain market share to the Companys detriment.  In addition, competitors may be able to complete the regulatory approval process sooner than the Company, and therefore market their products earlier than the Company can market certain of its products.  If the Company is not able to compete effectively against current and future competitors, such failure may result in fewer customer orders, reduced gross margins and profitability and loss of market share, any of which would materially adversely affect the Company.

Competitive Advantages of Stellar

Management believes that Stellars main competitive advantages include:

(i)

the ability to conduct research and development and produce products in a cost-effective manner;

(ii)

a focus on the development of formulations and technologies targeted at smaller market niches that larger multi-national pharmaceutical companies have largely ignored because of size;

(iii)

the ability to offer cost-effective pricing while maintaining acceptable gross profit margins;

(iv)

the patents it holds for certain of its products; and

(v)

the ability to identify market needs and develop new niche products.

Products and Markets

Stellar has developed and currently markets the following three medical products: (i) NeoVisc, (ii) Uracyst and (iii) the Uracyst Test Kit.  Each of these products is presently approved for use in Canada and the Companys sales are primarily in Canada. In addition, Stellar has signed an agreement for the distribution of two other medical products, Skeliteand BladderChek.  Stellar commenced selling Skelite in January 2004 and BladderChek in October 2004.

NeoVisc



NeoVisc is a 2 mL pre-filled syringe of sterile 1.0% sodium hyaluronate solution used for the temporary replacement of synovial fluid in osteoarthritic joints.  NeoVisc is classified in Canada by the TPD as a medical device under the Medical Devices Regulations of the Food and Drugs Act (Canada).  NeoVisc is packaged, sold and marketed as a three injection therapy.  The product is administered weekly by injection directly into the affected joint.  This type of injection is referred to as an intra-articular injection.









---







This administration process, referred to as viscosupplementation, is a relatively new therapy for the treatment of osteoarthritis, having gained Canadian approval in 1992 and United States approval in 1997.  However, viscosupplementation has been used for many years in the veterinarian market.  Replacing or supplementing the joint fluid provides symptomatic relief from the pain of osteoarthritis for up to 6 to 8 months before a repeat set of injections is required.

Osteoarthritis and Treatment Options.  Osteoarthritis is a degenerative disease associated with long-term wear on weight bearing joints.  With no known cure, it is estimated that OA affects an estimated 33% of persons over 45 years of age, and approximately 85% over the age of 70.  The Canadian Arthritis Association estimates that 3 million Canadians suffer from the osteo form of arthritis.  Stellar estimates the number of American OA sufferers at over 30 million.  The aggregate number of patients with OA is expected to grow significantly as the average age of the population increases.

Current OA remedies focus on symptomatic relief and postponement of surgical intervention.  These remedies include:

|      |                              |  |                                                                                                                                                                       
|----- | ---------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(i)   | Drugs:                       |  | Pain killers such as aspirin, acetaminophen and other non-steroidal anti-inflammatory drugs (NSAID), such as naproxen and diclofenac, as well as new COX/2 Inhibitors;
|(ii)  | Steroidal Anti-Inflammatory: |  | Corticosteroids are also used to treat the inflammation associated with the disease; and                                                                              
|(iii) | Joint Replacement:           |  | Surgical replacement with artificial joints.                                                                                                                          



Products such as NeoVisc have added a fourth non-pharmacological option in obtaining symptomatic improvements by supplementing the synovial fluid in the affected joint.  NeoVisc can also be used in conjunction with drug treatments like NSAIDs, thereby reducing the overall cost of treatment, increasing clinical benefits and delaying or avoiding steroid use and joint replacement.

Role of Hyaluronate.  The active ingredient in NeoVisc is hyaluronate, also referred to as hyaluronic acid or HA.  HA is a naturally occurring polysaccharide found throughout the human body, which has been shown to play an important role in such biological processes as cell differentiation, tissue hydration and proteoglycans organization.  Injected HA also provides an anti-inflammatory and analgesic effect.  HA also plays a fundamental role in human joints, where by virtue of its viscosity, elasticity and other rheological properties, acts as a lubricating and shock absorbing component in joint fluids, and as an ocular lubricant.  HA products are currently being used in eye surgery, wound healing, intra-articular injections and as an adjunct to certain grafting procedures.

Marketing Strategy.  Purchase decisions in the prescription pharmaceutical market are influenced by the prescribing physician, pharmacist and end use patient/customer.  State and private health care plans and patient user groups may also play a role in product/therapy selection, especially where the cost of therapy is high.  In treating OA, it is typically the physician that decides which therapeutic option is best for the patient and which related products to use.

Stellars marketing and sales strategy focuses on those physicians currently prescribing HA viscosupplements.  Stellar has created a database focused on orthopaedic surgeons, rheumatologists, sports medicine specialists and select general practitioners in Canada.  Direct marketing to the physicians in this database has been, and will continue to be, effective in persuading treating physicians and specialists already using viscosupplementation to convert to NeoVisc or recommend it to their patients.  Management of the Company believes that NeoVisc is at least as effective as any other competitive product and is the lowest cost intra-articular therapy currently on the market.  Stellars strategy is to demonstrate that NeoVisc is the most cost-effective viscosupplement therapy available.

Competitive Analysis.  The major competitive product to NeoVisc in Canada and the United States is Synvisc®, which is manufactured and sold by Genzyme Corp.  Synvisc is a three injection dosage regime, which has been available in Canada since 1992 and in the United States since 1997.  Synvisc is the dominant product in the viscosupplementation market.  Management of Stellar estimates Synviscs market share at over 60% in the United States and 50% in Canada.









---







If approved for sale in the United States, NeoVisc would also compete with Fidia, SpAs product, marketed under the trade name Hyalgan® by Sanofi-Synthelabo Inc. and Seikagakus product Supartz® marketed by Smith and Nephew, Orthovisc®, manufactured by Anika Therapeutics, Inc. and marketed by Johnson & Johnson.  In Canada, NeoVisc also competes with Suplasyn®, manufactured by Bioniche Life Sciences Inc. With little to differentiate these HA products for use in the treatment of degenerative joint disease, management of the Company believes that Stellars lower patient cost and high quality will allow NeoVisc to effectively further penetrate the market and obtain a significant share in Canada and, if approved for sale, the United States.

As stated above, the Company has signed the following agreements for NeoVisc;



(i)

in June 2003, Stellar entered into a distribution agreement with BurnsAdler Pharmaceuticals (located in Charlotte, North Carolina), to distribute NeoVisc in Latin America and the Caribbean;



(ii)

in July 2005, Stellar entered into a licensing agreement with Innogen Ilac for the sale of NeoVisc in Turkey;



(iii)

in August 2005, the Company signed a distribution agreement with Technimed for the sale of NeoVisc in Lebanon;

(iv)

in November 2005, with Al-Mohab Co. (Al-Mohab) for the sale of NeoVisc® in Kuwait;

(v)

in July 2006, a distribution agreement was signed with Bio-Technic Romania SRL for NeoVisc® in Romania; and

Uracyst and the UracystTest Kit



Stellar developed Uracyst a sterile 2.0% sodium chondroitin sulfate solution available in a 20 mL vial and the Uracyst Test Kit, comprising Uracyst 2.0% and Solution K, a 3.0% potassium chloride solution.  Uracyst and the Uracyst Test Kit are used in the diagnosis and treatment of certain forms of IC and non-common cystitis.  The Uracyst Test Kit contains a 100 mL pouch of Solution K and a 20 mL vial of Uracyst.  These products are instilled by catheter directly into a patients bladder.

Uracyst provides symptomatic relief for patients suffering from IC and non-common cystitis (including radiation-induced cystitis and hemorrhagic cystitis) by supplementing and replenishing deficiencies in the glycosaminoglycan (GAG) lining of the bladder wall.  This GAG lining acts as a protective barrier against irritants and toxins (e.g., micro crystals, carcinogens and acid) in the urine and serves as an important defense mechanism against bacterial adherence.  Many researchers believe that a large number of IC patients (over 70%) have leaky or deficient GAG layers in their bladders.

When Solution K is instilled in an IC patients bladder with GAG deficiencies, the patient experiences pronounced IC like symptoms.  Instilling Uracyst into the bladder of those patients responding positively to the test neutralizes the irritations.  This test allows the clinician to determine which IC patient has a leaking GAG layer and therefore determine which IC patient will more likely respond positively to Uracyst to control IC symptoms.

Uracyst is typically instilled in patients weekly for 6 weeks, then once a month until symptoms resolve.  Because these types of cystitis are typically chronic diseases of no known cause, patients will usually require re-treatment after a variable period of time when symptoms recur.

The Company has been issued a patent in the United States and Canada for the use of the Uracyst Test Kit and Uracyst treatments and has international patents pending.  Uracyst and the Uracyst Test Kit are both classified in Canada by TPD as medical devices under the Medical Devices Regulations of the Food and Drugs Act (Canada).

In order to obtain the necessary clinical work for the approval of Uracyst, Stellar entered into an agreement with Dr. Gary Steinhoff of Vancouver, British Columbia.  Under this agreement, Dr. Steinhoff agreed to perform such work, on behalf of Stellar, in consideration for a declining variable royalty payable until August 31, 2008. The royalty is based upon a percentage of Uracyst net sales.  The royalty percentage for the period which began on September 1, 2003 and ends on August 31, 2008 is 2 %.  Dr. Steinhoff is not otherwise affiliated with Stellar or any of its officers, directors or principal shareholders.









---





In December 2001, the Company entered into a license agreement (the European License) with Pohl-Boskamp of Hohenlockstedt, Germany. Under the European License, Pohl-Boskamp was granted the exclusive right to manufacture market and sell the Companys Uracyst product line in Europe.  In consideration for the grant of such exclusive right, Pohl-Boskamp made cash payment to Stellar upon execution of the European License and at the time of Pohl-Boskamps first sale of Uracyst products in Europe, which occurred in December of 2003.  Pohl-Boskamp is also obligated to pay the Company a royalty based on the quarterly net sales of Uracyst products by Pohl-Boskamp and its affiliates and sub-licensees.  Subject to extension in the case of patented improvements to the Uracyst product line, the term of the European License is scheduled to expire on December 21, 2008.

In addition, the Company signed the following agreements:

(i)

In September 2005, the company entered into a licensing agreement with Shanghai Ya Jun Medical for the sale of Uracyst in China.

(ii)

Stellar also entered into a licensing agreement in December 2005 with Mega Pharm for the sale of Uracyst in Israel.

(iii)

In December 2006, the Company signed a license and supply agreement with Watson who was granted an exclusive license to use certain of the Companys methods and technical know-how for the purposes of developing, marketing and selling Uracyst products in the United States.

Interstitial Cystitis and Treatment Options.  Interstitial cystitis is a chronic inflammation of the bladder wall.

Unlike common cystitis, IC is not caused by bacteria and does not respond to conventional antibiotic therapy. IC can affect people of any age, race or sex, but is more frequently diagnosed in women.

Interstitial cystitis causes some or all of the following symptoms:

Frequency:

Day and/or night frequency of urination (up to 60 times a day in severe cases).  In early or very mild cases, frequency is sometimes the only symptom.

Urgency:

Pain, pressure or spasms may also accompany the sensation of having to urinate immediately.

Pain:

Can be abdominal, urethral or vaginal.  Pain is also frequently associated with sexual intercourse.

Other:

Some patients also report experiencing symptoms such as muscle and joint pain, migraines, allergic reactions, colon and stomach problems, as well as the more common symptoms of IC described above.

At present, there is no cure for IC nor is there an effective treatment, which works for everyone.  The following treatments have been used to relieve the symptoms of IC in some people:  (i) diet, (ii) bladder distention, (iii) instilled dimethylsulfoxide (DMSO), heparin or HA, (iv) anti-inflammatory drugs, (v) antispasmodic drugs, (vi) antihistamines and (vii) muscle relaxants.

In severe cases, several types of surgery have been performed including bladder augmentation and urinary diversion. Products available for treating IC vary in their effectiveness.  Most work for short periods of time and, in general, are effective in about 30% to 40% of patients.  Some therapies can take up to 6 months of active treatment before patients start to show symptomatic improvement.

Market For Uracyst and the Uracyst Test Kit.  Data on the number of IC patients being treated and the method of treatment is not readily available in Canada or the United States.  Many products such as dimethylsulfoxide (DMSO) and heparin are not used exclusively to treat IC.  This lack of detailed end-use product and prescription data make it difficult to define the size of the IC market.  The number of people in Canada and the United States with IC is estimated by Stellar to be 150,000 and 1,500,000 respectively.









---







Marketing Strategy.  Stellar currently markets Uracyst and Uracyst Test Kits directly to physicians and pharmacies (although in many cases the patient is the ultimate purchaser) in Canada.  Stellar focuses its promotion to a core group of urologists currently treating interstitial cystitis, largely in major Canadian urban centers (i.e., all Provincial capitals and cities with medical teaching centers).  Management estimates that there are over 550 practicing urologists in Canada and 7,500 in the United States.  This well-defined target audience makes direct marketing an effective strategy for Stellar.  Pursuant to the European License, Stellar markets its Uracyst product line in Europe through the European Licensee.

Stellars sales efforts emphasize the patented Uracyst Test Kits ability to determine those IC patients who are GAG deficient, and then demonstrate the potential to treat these same patients with Uracyst.  This ability is important as GAG replenishment therapy can take up to 6 months before patients start to show substantial symptomatic improvement.  Sales efforts also promote the ongoing clinical work that Stellar has undertaken with Uracyst, which shows a response rate of over 60% and an excellent safety profile.

Management believes that the monthly maintenance therapy cost of Uracyst is less than that of all other active treatments.  Stellar expects to gain acceptance more readily from both physicians and patients as the most cost-effective therapy for treating GAG-deficient IC patients.  Cost is an important factor in selecting a treatment option, as most patients will be on and off GAG replacement therapy for an indeterminate amount of time.  In addition, Stellars unique test kit provides Stellar with a substantial competitive advantage over its competitors.

Competitive Analysis.  The treatment of IC is a relatively small niche market supplied by smaller pharmaceutical companies.  Because of low efficacy rates and relatively expensive treatment costs, management believes the treatment of IC remains an unsatisfied market with no dominant competitive product.  Ortho McNeil Pharmaceutical, Inc and Shire Pharmaceutical Corporation are the two major suppliers to the IC market.

Ortho McNeil Pharmaceutical, Inc (Alza Corporation) has marketed Elmiron® (pentosan polysulfate sodium) in Canada since 1993.  Elmiron is used as an oral GAG replenishment therapy.  Alza Corporation has been active in the market providing comprehensive materials and services to physicians and IC patients.  Side effects from the use of Elmiron are difficult to manage for some patients and can include hair loss, diarrhea and extreme to mild gastrointestinal discomfort.

Shire Pharmaceutical Corporations RIMSO 50Ò (also known as DMSO) was previously a market leader for urinary tract diseases, but has seen its market eroded by generic DMSO selling for a fraction of its price.  Since DMSO may be used in treatments for diseases or symptoms other than IC, it is difficult to find exact usage data for DMSO in the treatment of IC.  DMSO works to desensitize the bladder wall and has numerous negative side effects.  The principal side effects include discomfort and an emission of a strong, unpleasant odor (similar to garlic) for up to 48 hours after an instillation.  DMSO, although not favored by patients, remains a product of choice for many urologists.

Elmiron has a typical cost of about $150 month as compared to $80 month for DMSO and $65 month for Uracyst.

Skelite

Stellar has acquired the exclusive Canadian marketing and distribution rights to Skelitefrom Millenium Biologix Inc.  Skelite has been approved by both the FDA in the United States and TPD in Canada, as synthetic bone void filler. Stellars right to market and distribute Skelite expires on December 31, 2007, and may be renewed by Stellar for an additional three-year period.

Skelite is a novel, 100% synthetic, resorbable bone void filler consisting of 67% silicon stabilized tricalcium phosphate (TCP) + 33% hydroxyapatite.  Skelite contains a multi-directional, interconnected porosity similar in structure to human cancellous bone allowing for the integration of tissue and fluids.  This product provides a bone void filler that is resorbed by the natural remodeling process and replaced with new bone during the healing period.  Orthopedic surgeons use this product, with or without bone marrow, to pack into bony voids or gaps of the skeletal system (i.e., the extremities, spine and pelvis).  The defects may be surgically created osseous defects or osseous defects created from traumatic injury to the bone.









---







Bone Graft Treatment Options.  Bone grafting materials are primarily divided into three categories: autologous, allograft and synthetics.

For more than a century, bone fracture repair has been augmented with the use of autologous (taken from patients own body) cancellous bone grafting.  The advantages are that autologous grafts provide the three requisite properties: the scaffolds for osteoconduction, the growth factors for osteoinduction and the progenitor stem cells for osteogenesis.  The disadvantages are procurement (harvesting) site morbidity, longer operating times and limited availability.

Allograft (taken from other human donors) bone material is processed bone taken from cadavers.  Many countries have some form of bone donor programs whereby bone material is harvested upon death from patients who have given prior consent.  However, to combat the risks of disease transmission and histoincompatible response, this bone material is subject to harsh processing techniques that diminish the mechanical properties (osteoconduction) and the biological (osteoinductive) properties.  There are national bone banks and many hospitals have instituted their own bone bank.  The costs for allograft range from minimal to extensive and the supply of material is still limited.

Synthetic alternatives for bone graft procedures have been available since the 1990s.  These new materials, currently used in about 10% of the 2.2 million bone graft procedures worldwide, offer the advantages of unlimited availability and safety.  Newer materials offer the improved osteoconductive characteristics necessary for bone and tissue integration.

Marketing.  The rising cost of healthcare in hospitals has resulted in purchasers (i.e., materials management departments and state/provincial/private plans) reducing the number of products covered and restricting the entry of new products.  New products must offer real competitive benefits and cost advantages.  Skelite is expected to offer the high quality that is important to orthopedic surgeons and the cost attractiveness demanded by the purchaser.  While orthopaedic surgeons can use Skelitein many procedures, it is expected that Skelitewill be initially used in trauma and hip/knee revisions. Stellar has had limited success in the Canadian market with Skelite. Larger hospital formularies generally are slow to add new products and require more evidence-based clinical work for products such as Skelite.  Unfortunately, Millenium Biologix Inc has not performed large clinical trials and the smaller case studies performed by Stellar are not sufficient for this purpose.  Stellars focus on smaller hospitals has been more effective in generating interest with respect to Skelite.

Competitive Analysis.  Skelite competes directly with other synthetic bone graft products.  ProOsteonÒ (Interpore Cross), DynaGraftÒ (GenSci) and OsteosetÒ (Wright Medical Technology) are available in Canada.  Stellar management feels that the animal studies and more recent case studies for Skelite have not kept pace with the competitive clinical work. Skelites cost advantage has been the key factor in its acceptance to date.

BladderChek



Stellar has licensed BladderChek for the Canadian market from Matritech, USA.  The initial term of this licence began on January 1, 2004 and expires on December 31, 2008. Stellar may extend the term of the agreement for an additional one-year period.  The BladderChek test is a simple to use, point-of-care, in vitro diagnostic test for bladder cancer, and provides results (within 30 minutes) while the patient is in the physician's office.  By placing four drops of urine on the BladderChek test cassette, a physician is able to detect the presence of elevated NMP22.

The scientists that developed BladderChek, discovered that high levels of the nuclear matrix protein, NMP22, in urine frequently indicated the presence of cancer.  This protein is found in the nuclei of cells where they contribute to nuclear structure and regulate important cell functions. NMP22 is elevated in bladder cancer cells 20 to 80 fold and is released into the urine of bladder cancer patients.

Market Overview:In the United States, more than one million patients receive a diagnostic work up for bladder cancer each year.  Another 10 million are at risk for the disease.  According to data released by the American Cancer Society in 2001, 54,300 new cases of bladder cancer (2.5:1 men: women) are diagnosed each year.

If diagnosed in its early stages, the five-year bladder cancer survival rate exceeds 90 percent. However, 12,400 people in the United States died of bladder cancer in 2001.  Many died because the disease was not caught in its earliest stages









---





The estimate for Canada is 270,000 opportunities for use (diagnosis and monitoring) for BladderChek.

Market Growth:BladderChek, a third generation urine based biomarker, was able to correctly identify cancers not seen by cystoscopy and provides more accurate and clinically useful information than cytology.  Stellar commenced selling BladderChek in October 2004 directly to hospitals and urology clinics where the overall value of a point of care device has been well received.

BladderChek is being sold at a competitive price to cytology, which is an important selling feature, given that BladderChek is 3 to 5 times more effective than cytology.  The excellent clinical support combined with BladderChek ease of use and price point is one key to its early adoption in most centres.  Stellar is currently working on moving BladderChek through the complex institutional protocols of the large teaching hospitals.  Stellar expects to see a faster adoption as reimbursement issues are resolved in these larger hospitals.

Sales and Distribution

Stellar currently has six commissioned and salaried sales representatives, promoting its products in key Canadian centres.  These sales representatives primarily target medical physicians, pharmacies, hospitals and patient support groups.  Stellar is building a sales network across Canada to generate NeoVisc and Uracyst sales.  See  Human Resources.  Marketing and sales efforts are coordinated from Stellars London, Ontario main office.  One of Stellars immediate corporate goals is to establish a stronger network of representatives selling its products and in-licensed products in Canada.

As discussed above, Stellars product line has been out-licensed to companies in the United States, Europe, China, Middle East, Latin America, Caribbean, Malaysia, Singapore and Brunei.

Customers

The Company has historically derived the majority of its revenues from a small number of major customers, although the composition of this group of customers has changed from year to year.  In the event that one or more of these major customers significantly reduce or terminate their purchases of the Companys products, the Companys results of operations and financial condition could be materially affected.  The Company has not, however, received any indication from any of its current major customers that it intends to discontinue its relationship with the Company or to reduce its purchases of the Companys products.

Human Resources

Stellar currently employs fourteen full-time employees and eight of the Companys full-time employees are located at the Companys main office in London Ontario, Canada.  The other six full-time employees of the Company sell the Companys products in major urban areas throughout Canada.  The Company plans to add additional staff in the areas of sales, marketing, regulatory affairs and administration over the next 18 to 24 months.  Management of the Company believes that its relations with its employees are good.

The Company is substantially dependent on the services of its key senior management personnel.  The Company has entered into an employment agreement with Peter Riehl, the Chief Executive Officer.  See Item 10 - Executive Compensation of this annual report.  Loss of the services of Mr. Riehl, or any other key management employee, would have a material adverse effect on the Company.  The Company does not maintain key man life insurance on the life of Mr. Riehl.  In addition, the Companys future success will depend in part upon its continuing ability to hire, train, motivate and retain key senior management and skilled technical and marketing personnel.  The market for qualified personnel has historically been, and the Company expects that it will continue to be, intensely competitive.









---





Manufacturing

Stellar currently out sources the manufacturing of its products, other than Uracyst offered for sale in Europe, to a special sterile facility, operated by Dalton Pharmaceutical Services ("Dalton").  This facility, which is in compliance with applicable Health Canada, TPD division medical device guidelines and current Good Manufacturing Practice ("cGMP") regulations, has sufficient excess capacity at present to meet the Companys short and long term objectives.  The Companys products offered for sale in Europe are manufactured by Pohl-Boskamp and its sub-licensees.  See - Products and Markets.

Under this supply agreement (the "Supply Agreement") with Dalton, Stellar started to source product from Daltons facility during the second quarter of 2004.  The Supply Agreement provides for Dalton to supply all of the Companys clinical and commercial production requirements well into the future.  Dalton is a cGMP manufacturing facility that has the capability to meet domestic and international manufacturing regulations.  Stellar believes the Supply Agreement will cause its production costs to improve based on the economies of scale projected.  Dalton will be used as Stellars manufacturer for the United States market once in receipt of the necessary FDA approvals.  A significant interruption in the supply of any of the Companys products could impair the successful marketing of such products.

Dalton is a contract pharmaceutical manufacturer that supplies chemistry and analytical services to the biotechnology and pharmaceutical industries in the areas of medicinal chemistry, fine chemical manufacturer customer peptides and antisense oligo production.  Dalton has a site establishment license and provides cGMP manufacturing and sterile filling capabilities to its customers at any stage of the regulatory process (Phase I, II, III or commercial).

The Company has established non-contractual supply arrangements for its raw materials with several sources. Stellar currently purchases the HA used in NeoVisc from Lifecore Biomedical and the chondroitin sulfate used in the formulation of Uracyst from Bioiberica, a Spanish supplier.  In the event of an interruption in the supply of these raw materials from such suppliers, the Company has a sourced a secondary supplier for the HA raw material and believes it would be able to secure similar raw materials at competitive prices from other suppliers located worldwide.

The manufacture of the Companys products involves the handling and use of substances that are subject to various environmental laws and regulations that impose limitations on the discharge of pollutants into the soil, air and water, and establish standards for their storage and disposal.  The Company believes that the manufacturers of its products are in material compliance with such environmental laws and regulations.

The sale and use of the Companys products entails risk of product liability and the Company presently carries product liability insurance.  There can be no assurance that, despite testing by the Company, as well as testing in use by current and potential customers and regulatory agencies, defects will not be found in new products after commencement of commercial shipments.  The occurrence of such defects could result in the loss of, or delay in, market acceptance of the Companys products, which could have a material adverse effect on the Company.  Furthermore, litigation, regardless of its outcome, could result in substantial costs to the Company, divert managements attention and resources from the Companys operations and result in negative publicity that might impair the Companys on-going marketing efforts.

Patent and Proprietary Protection

Where deemed appropriate, Stellar may file patent applications for technologies, which it owns or in respect of which it has acquired a license and, if necessary, then further developed to make such technologies marketable.  Such applications may cover composition of matter, the production of active ingredients and their novel applications.

The Company retains independent patent counsel where appropriate.  Management of the Company believes that the use of outside patent specialists ensures prompt filing of patent applications, as well as the ability to access specialists in various areas of patents and patent law to ensure complete patent filing.









---





The patent position relating to medical devices and drug development is uncertain and involves many complex legal, scientific and factual questions.  While the Company intends to protect its valuable proprietary information and believes that certain of its information is novel and patentable, there can be no assurance that:  (i) any patent application owned by or licensed to the Company will issue to patent in all countries; (ii) proceedings will not be commenced seeking to challenge the Companys patent rights or that such challenges will not be successful; (iii) proceedings taken against a third party for infringement of patent rights will be successful; (iv) processes or products of the Company will not infringe upon the patents of third parties; or (v) the scope of patents issued to or licensed by the Company will successfully prevent third parties from developing similar and competitive products.  It is not possible to predict how any litigation may affect the Companys efforts to develop, manufacture or market products.  The cost of litigation to uphold the validity and prevent infringement of the patents owned by or licensed to the Company may be significant.

Issues may arise with respect to claims of others to rights in the patents or patent applications owned by or licensed to the Company.  As the industry expands, and more patents are issued, the risk increases that the Companys processes and products may give rise to claims that they infringe the patents of others.  Actions could be brought against the Company or its commercial partners claiming damages or an accounting of profits and seeking to enjoin them from clinically testing, manufacturing and marketing the affected product or process.  If any such action were successful, in addition to any potential liability for damages, the Company or its commercial partners could be required to obtain a license in order to continue to manufacture or market the affected product or use the affected process.  There can be no assurance that the Company or its commercial partners could prevail in any such action or that any license required under any such patent would be made available or, if available, would be available on acceptable terms.  If no license is available, the Companys ability to commercialize its products may be negatively affected.  There may be significant litigation in the industry regarding patents and other intellectual property rights and such litigation could consume substantial resources.  If required, the Company may seek to negotiate licenses under competitive or blocking patents, which it believes are required for it to commercialize its products.

Although the scope of patent protection ultimately afforded by the patents and patent applications owned by or licensed to the Company is difficult to quantify, management of the Company believes that such patents will afford adequate protection for it to ensure exclusivity in the conduct its business operations as described herein.  The Company also intends to rely upon trade secrets, confidential and unpatented proprietary know-how, and continuing technological innovation to develop and maintain its competitive position.  To protect these rights, the Company whenever possible requires all employees and consultants to enter into confidentiality agreements with the Company.  There can be no assurance, however, that these agreements will provide meaningful protection for the Companys trade secrets, know-how or other proprietary information in the event of any unauthorized use or disclosure.  Further, in the absence of patent protection, the Companys business may be adversely affected by competitors who independently develop substantially equivalent or superior technology.

Regulatory Considerations

Product Regulation

The Canadian health care industry is regulated by TPD.  This agency has a role similar to that of the FDA and has responsibility for regulating drugs for both human and animal use, cosmetics, radiation-emitting and other medical devices, and other products affecting human health.  A manufacturer is required to follow the cGMP regulations in the manufacture of such products.  Regulations imposed by federal, provincial, state and local authorities in Canada and the United States are a significant factor in the conduct of the development, manufacturing and eventual marketing activities for any proposed product.

Stellar has received a license to manufacture and sell NeoVisc, Uracyst and the Uracyst Test Kit in Canada from the TPD.  These products are regulated under the Medical Devices Regulations of the Food and Drugs Act (Canada) and the regulations promulgated thereunder by TPD to ensure the safety and efficacy of medical devices for the Canadian public.  The Company is in material compliance with all such regulations and was audited and approved ISO 13485:2003 certification on March 3, 2006.

Under the European License, Pohl-Boskamp is required to cause all Uracyst products offered for sale in Europe to be manufactured in accordance with all applicable laws including, without limitation, Council Directive 90/385/EEC of 20 June 1990 and Council Directive 93/42/EEC of 14 June 1993 concerning medical devices.  See -  Products and Markets.









---







Stellar intends to market its products through its license agreement in the United States and, as such, it is important that a quality assurance program be designed to also comply with the FDAs Medical Device cGMP regulations.  Thorough its out-licensing partnerships, the Company feels that its products canl be submitted for approval under the Pre-Market Approval (PMA) program of the FDA for marketing in the United States.  The FDA GMP regulations require significant documentation on all relevant procedures of the manufacturing and quality control of each product submitted for approval.

Open label trials of Uracyst have been completed and published in The Canadian Journal of Urology.  The Company is currently working with an American clinic in establishing an animal model to further demonstrate the role of Uracyst in the treatment of cystitis.  In connection with the FDA approval process, Stellar anticipates that it will utilize such American clinics to perform additional services.

Stellar anticipates that the FDA approval required to market Uracyst in the United States will be obtained around the end of 2010.  There can be no assurance, however, that such FDA approvals will be obtained or that Stellar or its United States licensee will be able to successfully market its products in the United States.  The costs associated with obtaining such FDA approval for Uracyst is the responsibility of Watson.

Pricing and Reimbursement

As pressures for cost containment increase, particularly in Canada and the United States, there can be no assurance that the prices the Company can charge for its products will be as favorable as historical pharmaceutical product prices.  Reimbursement by government and managed care organizations, and other healthcare payers, has become increasingly important, as has the listing of new products on large formularies, such as those of pharmaceutical benefit providers and group buying organizations.  The failure of one or more products to be included on formulary lists, or to be reimbursed by government or managed care organizations, could have a negative impact on the Companys results of operation and financial condition.

Other Laws and Regulations



Stellars operations are or may be subject to various federal, provincial, state and local laws, regulations and recommendations relating to the marketing of products and relationships with treating physicians, data protection, safe working conditions, laboratory and manufacturing practices, the export of products to certain countries and the purchase, storage, movement, use and disposal of hazardous or potentially hazardous substances.  Although the Company believes its safety procedures comply with the standards prescribed by federal, provincial, state and local regulations, the risk of contamination, injury or other accidental harm cannot be eliminated completely.  In the event of an accident, the Company could be held liable for any damages that result.  The amount of such damages could have a materially adverse effect on the Companys results of operations, financial condition or liquidity.

Future Product Development



Stellar believes that a well-targeted research and development program constitutes an essential part of its activities.  Stellar is currently developing a number of new product line extensions, with the intention of expanding the indications for its current products, NeoVisc and Uracyst, and, ultimately, expanding into other product areas.  However, Stellars efforts will be focused initially on developing strategic partners to assist Stellar in gaining regulatory approval in the United States and other international markets for its NeoVisc and Uracyst related products.  These submissions will be a priority for the Company, as management believes that these markets offer significant opportunities for the sale of the Companys products.  The registration for all current products will likely require completion of clinical trials.  Clinical work, done in Canada and the United States, can then be used for submissions for entry into other countries.  As previously stated Stellar has signed an agreement for Uracyst in the United States with Watson.  Watson is responsible to fund the FDA approval process for Uracyst.  Stellar continues to search for suitable partners for NeoVisc in the United States.

For the years ended December 31, 2006 and 2005, the Company expensed approximately $217,607 and $608,957, respectively on in-house research and development activities.









---







Item 2.

Description of Property.



In 2004 the Company moved its main office to 544 Egerton Street in London, Ontario, Canada by purchasing the property and building located at such address for $450,000.  In connection therewith, the Company has incurred costs to-date of $193,433 for renovations to the office, packaging and warehouse space of approximately 10,600 square feet in the aggregate contained in the building.  Stellar believes that its existing property is in good condition and suitable for the conducting of its business.

Item 3.

Legal Proceedings.



Stellar may periodically become subject to legal proceedings and claims arising in connection in business.  The Company does not believe that there were any claims outstanding against it as of March 30, 2006 that will have a material adverse effect on the Companys results of operations, financial condition and liquidity.

Item 4.

Submission of Matters to a Vote of Security Holders.



Not applicable.









---







PART II

Item 5.

Market for Common Equity and Related Stockholder Matters.



Market Information

Since December 2002, the Companys common shares (Common Shares) have traded on the OTC Bulletin Board service of the National Association of Securities Dealers, Inc. (the OTC Bulletin Board).  The Common Shares currently trade thereon under the symbol SLXCF.  The following table sets forth the high and low per share sale price expressed in United States Dollars for the Common Shares as reported by the OTC Bulletin Board.



|     |                |           |     
|---- | -------------- | --------- | ----
|     |                | ($) (USD)
|     |                | High      | Low 
|2006 |                |           |     
|     | First Quarter  | 1.38      | 0.86
|     | Second Quarter | 1.12      | 0.77
|     | Third Quarter  | 1.01      | 0.80
|     | Fourth Quarter | 1.22      | 0.70
|2005 |                |           |     
|     | First Quarter  | 2.10      | 1.50
|     | Second Quarter | 1.80      | 1.10
|     | Third Quarter  | 1.40      | 1.01
|     | Fourth Quarter | 1.07      | 0.76
|2004 |                |           |     
|     | First Quarter  | 1.78      | 0.64
|     | Second Quarter | 2.27      | 1.35
|     | Third Quarter  | 2.19      | 0.86
|     | Fourth Quarter | 2.02      | 1.19







On March 26, 2007, the last reported per share sale price for the Common Shares on the OTC Bulletin Board was $0.83 (USD).



Since December 2000, the Common Shares have been listed and traded on the TSX Venture Exchange.  The Common Shares are currently listed and trade on Tier 2 of the TSX Venture Exchange under the symbol SLX.  The following table sets forth the high and low per share sale price expressed in Canadian Dollars for the Common Shares as reported by the TSX Venture Exchange.











---







|     |                |            |     
|---- | -------------- | ---------- | ----
|     |                | ($) (Cdn.)
|     |                | High       | Low 
|2006 |                |            |     
|     | First Quarter  | 1.60       | 1.00
|     | Second Quarter | 1.20       | 0.86
|     | Third Quarter  | 1.00       | 0.86
|     | Fourth Quarter | 1.38       | 0.75
|2005 |                |            |     
|     | First Quarter  | 2.45       | 1.80
|     | Second Quarter | 2.00       | 1.35
|     | Third Quarter  | 1.50       | 1.20
|     | Fourth Quarter | 1.20       | 0.85
|2004 |                |            |     
|     | First Quarter  | 2.28       | 0.85
|     | Second Quarter | 3.00       | 1.90
|     | Third Quarter  | 2.80       | 1.95
|     | Fourth Quarter | 2.44       | 1.75





Holders

As at January 1, 2007, there were 31 holders of record of the Common Shares.

Dividends

The Company currently intends to retain future earnings, if any, for use in its business.  The Company does not anticipate paying dividends on the Common Shares in the foreseeable future.  Any determination to pay any future dividends will remain at the discretion of the board of directors of the Company (the Board of Directors) and will be made taking into account Stellars financial condition and other factors deemed relevant by the Board of Directors.

Equity Compensation Plan Information

The table set forth below provides information as of December 31, 2006 with respect to Common Shares that may be issued under the Companys existing equity plans.  For additional information, see Item 10  Executive Compensation.

|                                                           |                                                                                                  |                                                                                                     |                                                                                                                                               
|---------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------
|Plan category                                              | Number of  securities to be issued upon exercise of outstanding options, warrants and rights
(a) | Weighted-average exercise price of outstanding options, warrants and rights
in Canadian Dollars
(b) | Number of securites remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
(c)
|Equity compensation plans approved by security holders     | 1,010,000                                                                                        | 1.84                                                                                                | 901,635                                                                                                                                       
|Equity compensation plans not approved by
security holders |                                                                                                  |                                                                                                     |                                                                                                                                               
|Total                                                      | 1,010,000                                                                                        | 1.84                                                                                                | 901,635                                                                                                                                       











---







Exchange Controls and Other Limitations Affecting Security Holders.

Canada has no system of exchange controls.  There are no exchange restrictions on borrowing from citizens or residents of foreign countries nor on the remittance of dividends, interest, royalties or similar payments, management fees, loan repayments, settlement of trade debts or the repatriation of capital.

Under the Investment Canada Act (the ICA Act), a Canadian federal statute, certain non-Canadian individuals, governments, corporations or other entities who wish to acquire a Canadian business (as defined in the ICA Act) or establish a new Canadian business (as defined in the ICA Act) may be required to file either a notification or an application for review with a governmental agency known as Industry Canada.  The ICA Act further requires that certain acquisitions of control of a Canadian business by a non-Canadian must be reviewed and approved by the Minister responsible for the ICA Act on the basis that he is satisfied that the acquisition is likely to be of net benefit to Canada.  Only acquisitions of control are reviewable under the ICA Act; however, the ICA Act provides detailed rules for the determination of whether control has been acquired and, pursuant to those rules, the acquisition of one-third or more of the voting shares of the Company may, in some circumstances, be considered to constitute an acquisition of control.  Failure to comply with the review provisions of the ICA Act could result in, among other things, an injunction or a court order directing disposition of assets or shares.

There are no limitations on the rights of non-Canadian residents or non-Canadian shareholders to hold or vote the Common Shares contained in the Companys Articles of Incorporation, as amended, or By-Laws, as amended.

Taxation

Dividends



In general, dividends paid by a corporation resident in Canada to non-residents of Canada are subject to Canadian withholding tax.  The rate of withholding tax under the Income Tax Act (Canada) (the Tax Act) on dividends is twenty-five percent (25%).  Such rate may be reduced under the provisions of a relevant international tax treaty to which Canada is a party.  The Canada-United States Income Tax Convention (1980) (the U.S. Treaty) provides for a general reduction in the rate of Canadian withholding tax to fifteen percent (15%) on dividends paid on shares of a corporation resident in Canada to residents of the United States, and also provides that where the beneficial owner of the dividends is a corporation resident in the United States.  Notwithstanding the foregoing, a reduced rate of (i) ten percent (10%) applies to dividends from a non-resident owned investment corporation if the recipient is a corporation that is the beneficial owner of at least ten percent (10%) of the voting shares of the corporation paying the dividends and (ii) five percent (5%) applies if the recipient is a corporation resident in the United States that is the beneficial owner of at least ten percent (10%) of the voting shares of the corporation paying the dividends.

Capital Gains



A non-resident of Canada is not subject to tax under the Tax Act in respect of a capital gain realized upon the disposition of a share of a public corporation for purposes of the Tax Act unless the share represents taxable Canadian property to the holder thereof.  A share of a public corporation will be taxable Canadian property to the holder thereof if, at any time during the period of sixty (60) months immediately preceding a disposition, the non-resident, persons with whom the non-resident did not deal at arms length, or the non-resident together with persons with whom he did not deal at arms length, owned (or had an option in respect of or had an interest in) twenty-five percent (25%) or more of the issued shares of any class or series of the corporation or if, upon ceasing to be a resident of Canada, the holder elected that the share be taxable Canadian property.  The Company is a public corporation for purposes of the Tax Act.

The U.S. Treaty provides that, in general, a resident of the United States will not be subject to tax on any capital gains realized by him on the disposition of shares that are taxable Canadian property unless (i) such resident has or had (within the twelve-month period preceding the disposition) a permanent establishment in Canada and such shares formed part of the business property of that permanent establishment, (ii) such shares formed part of the personal property pertaining to a fixed base which is or was available (within a twelve-month period preceding the disposition)  to such resident for the purpose of performing independent personal services, (iii) the value of the shares is derived principally from real property situated in Canada or (iv) the shareholder is an individual who was resident in Canada for 120 months in any twenty-year period preceding the disposition and at any time during the ten-year period immediately preceding the disposition and who owned the shares of the corporation at the time he or she ceased to be a resident of Canada.









---







Estate and Gift Tax



At present, Canada does not impose any estate or gift tax.

Recent Sales of Unregistered Securities

In February 2004, Stellar issued 4,088,794 Common Shares to SJ Strategic Investments LLC, a Tennessee limited liability company ("SJ"), for aggregate gross proceeds of approximately $4 million.  At such time, this issuance represented approximately 19.9% of the issued and outstanding Common Shares, on a non-diluted basis.



In connection with the aforesaid issuance, SJ also obtained the right to subscribe for additional Common Shares in the future from time to time in order to maintain its percentage equity ownership interest in Stellar, subject to adjustment in certain circumstances and regulatory approval.  SJ was further granted the right to participate as a selling shareholder in future offerings of Common Shares.  In addition, Peter Riehl, Stellars President and Chief Executive Officer and his spouse, entered into an agreement with SJ pursuant to which they have granted rights of first refusal to SJ in respect of the sale of securities in Stellar owned by them.



The Common Shares were acquired by SJ for investment purposes only, and not with the purpose of influencing control or direction over Stellar.  SJ has advised Stellar that it may acquire further Common Shares or dispose of its holdings of Common Shares as investment conditions warrant.



Exemption from the registration provisions of the United States Securities Act of 1993, as amended (the Securities Act), for the issuance described above was claimed under Section 4(2) of the Securities Act and the rules and regulations promulgated thereunder on the basis that such issuance did not involve any public offering, the purchaser was sophisticated with access to the kind of information registration would provide and that such purchaser acquired such securities without a view towards distribution thereof.



In January 2006, Stellar entered into a financial advisory and consulting agreement with LMT Financial Inc., a company beneficially owned by a director and his spouse.  Mr. Tenney currently serves as Chairman of the Board of Stellar.  In consideration for services provided under this agreement, LMT Financial Inc. earned a fee of $72,000 (Cdn.) in 2006.  This fee was satisfied in full through 12 monthly payments of $6,000 during 2006.



Issuer Purchases of Equity Securities.

During the fourth quarter of 2006, neither Stellar nor any affiliated purchaser (as defined in Rule 10b-18 promulgated under the United States Securities Exchange Act of 1934, as amended) (the Exchange Act) purchased any Common Shares.

Item 6.

Managements Discussion and Analysis or Plan of Operation

General

The following discussion and analysis should be read in conjunction with the Companys financial statements and notes thereto appearing elsewhere in this annual report.  Such discussion and analysis contains forward-looking statements.  The Companys actual results may differ significantly from those projected in the forward-looking statements.  The Companys consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (GAAP).  All dollar amounts are expressed in Canadian dollars.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with United States GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial reporting period.  Actual results could differ from those estimates.  These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the period in which they become known.









---







Recent Accounting Pronouncements



Recent accounting pronouncements followed by the Company under United States. GAAP are summarized below.



Recent accounting pronouncements followed by the Company under U.S. GAAP are summarized below.



(i)

SFAS No. 151.  SFAS No. 151, Inventory Costs, an amendment to Accounting Research Bulletin No. 43, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material.  This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of so normal.  Additionally, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.  The provisions of SFAS No. 151 have been adopted by the Company in 2006 with no material impact to the financial statements.



(ii)

SFAS No. 153.  SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment to Accounting Principles Board Opinion No. 29. Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged.  The guidance in that Opinion, however, included certain exceptions to that principle.  This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges in which the future cash flows of the entity are not expected to change significantly as a result of the exchange.  The provisions of SFAS No. 153 have been adopted by the Company in 2006 with no material impact to the financial statements.



(iii)

SFAS No. 48.  SFAS No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. which is a change in accounting for income taxes. This Statement specifies how tax benefits for uncertain tax positions are to be recognized, measured, and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions. SFAS 48 is effective for fiscal years beginning after December 15, 2006 and as a result is effective for the Company in the first quarter of fiscal 2008.  The Company is currently evaluating the impact of SFAS 48 on its financial statements.

(iv)

SFAS No. 157.   In September 2006, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 157," Fair Value Measures."  SFAS No. 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  The Company is currently evaluating the impact that the adoption of SFAS No. 157 will have on our future financial statements.

(v)

SFAS No. 108.   In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" ("SAB 108"), which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 is effective for fiscal years ending after November 15, 2006, allowing a one-time transitional cumulative effect adjustment to beginning retained earnings as of January 2006 for errors that were not previously deemed material, but are material under the guidance in SAB 108.  The Company adopted SAB 108 in the fourth quarter of 2006 with no material impact to the financial statements.











---





Year Ended December 31, 2006 Compared to Year Ended December 31, 2005 (in Canadian Dollars)

Revenues

For the year ended December 31, 2006, total revenues from all sources increased 125.4% to $ 4,377,697 compared to $1,942,251 in the same period during 2005.  When revenue for 2006 is adjusted for licensing fees of $2,548,352, the revenues for 2006 would show a decrease of 5.7%. This growth was negatively impacted by the NeoVisc (decline of 21.5%) as discussed above, in the review of the fourth quarter highlights. In 2006, Uracyst revenue grew by 33.8% over 2005 due mainly to growth in the Canadian market.

BladderChek sales grew by 95.4% in 2006 due to strong clinical support out of the United States and growing physician support in Canada.

Gross profit for 2006 was up 194.4% to $3,921,549 compared to $1,332,270 in 2005. The Companys net income increased to $1,255,225 in 2006 compared to a loss of $1,740,498 for 2005. Although profitability was driven by licensing revenues the company received in the year, profitability from operations experienced in both October and November 2006 will be the objective the company will strive for in 2007.

During 2006, the Company incurred non-cash expenses totaling $271,354. The Company recorded an expense of $112,237 which was related to options which vested in the year, of which $77,703 was for options issued to employees and directors as compensation expenses. The balance of $34,534 was related to share options granted to consultants and has been expensed under professional fees as a consulting expense. Stellar also incurred non-recurring costs of $363,984, which includes $321,846 for professional fees related to the completion of the Watson agreement and $42,139 for obsolete materials intended for use in the NeoVisc clinical trials.



Cost of Sales

Cost of goods sold for the twelve month period ended December 31, 2006, was $419,652 (without the effect of the $36,496 for other product costs and write-downs) or 29.4% of product sales compared to $450,591 or 27.7% of product sales in 2005. The costs associated with NeoVisc had a negative impact on the cost of goods for 2006. However, improvements in the manufacturing process will improve the cost of goods going forward.

Research and Development

Stellar continues to invest in research, which is essential to advancing the use of its products in Canada and in international markets. In the twelve month period ended December 31, 2006, the Company incurred $217,607, in research costs compared to $608,957 in 2005.

During 2006, the Company continued development of manufacturing processes to improve yields from both Uracyst and NeoVisc production. This work is expected to improve Stellars competitiveness in the global market.

In 2006 the Stellar continue to work with Dr. Robert Hurst from the University of Oklahoma on Uracyst and its treatment of GAG deficient cystitis. Dr Hurst work will further enhance Uracyst treatment of this bladder defect.

Business Development

Progress continues to be made as Stellar focuses on a number of business development activities associated with out-licensing Stellars current products in other international markets, in-licensing products for the Canadian market and developing additional products.  As previously referenced in the overview, Stellar entered into two new out-licensing distribution agreements in 2006. Stellar also received its CE mark in August of 2006 for NeoVisc. These events will continue to enhance Stellars objectives in growing a global presence for its products.









---





Selling, general and administrative expenses

Selling, general and administrative expenses for the year ended December 31, 2006 were $2,332,452, compared to $2,418,918 for the same period in 2005. This decrease includes the cost of $112,237 related to non-cash expenses for options to acquire common shares ("Common Shares") in the capital of the Company issued to consultants and the directors of the Company. During this period, the Company incurred fee expenses to members of the board of directors, which totaled $42,000.

Interest income and expense

Interest and other income for the year ended December 31, 2006 was $42,852 as compared to $99,689 during the same period in 2005. This amount includes the investment of dividends; interest received on a short-term loan and the gain on a sale of short term investments. Cash will be maintained in liquid investments.





Year Ended December 31, 2005 Compared to Year Ended December 31, 2004 (in Canadian Dollars)

Revenues

For the year ended December 31, 2005, total revenues from all sources increased 6.0% to $1,942,251 compared to $1,832,325 in the same period during 2004.  When revenue for 2004 is adjusted for a onetime licensing fee of $267,220 the revenue growth for 2005 is 24.1%.

This growth was negatively impacted by a NeoVisc batch recall in the fourth quarter. In November of 2005, the company experienced higher than anticipated reports of side effects with a NeoVisc batch. Since the NeoVisc process is relatively new, the Company chose to react on the side of caution and withdrew this batch from sale. This was a costly step in the short term but Stellar believed the right step to maintain Stellars excellent track record and reputation in the market. This batch was thoroughly reviewed by Stellars quality management team and was found to be within specifications for all control factors. A new batch of NeoVisc was released for sale in mid December has not experienced any abnormal responses. The marketing strategies implemented earlier this year are now having a positive impact on sales and we expect this to continue into 2006.

BladderChek sales remain flat as we continue to work on in market reimbursement issues. Strong clinical support out of the United States and growing physician support in Canada is expected to help turn this around in 2006.

During 2005, the Companys operating loss was $1,840,187 as compared to $1,441,226 in 2004.



Cost of Sales

For the  year ended December 31, 2005, cost of sales were $450,591 (without the effect of the $159,390 for other product costs and the write-down) compared to $340,123 for the same period in 2004 or 27.7% of product sales,  compared to 23.9% in 2004.  The Company incurred costs of $159,390 associated with a product recall and obsolete inventory. During the last quarter of 2005, the cost of sales was negatively affected by the NeoVisc recall.  Continued improvements in the manufacturing process have caused a marginal increase in the cost of goods sold, going forward the Company expects to see benefits from these processes, with these benefits showing in 2006.

Research and Development

Stellar continues to invest in research necessary to advancing its products into international markets.  In 2005, the Company incurred $608,957 in research costs compared to $659,759 in 2004. These costs are amortized in Stellars Canadian statement as deferred manufacturing development costs, but under United States GAAP they cannot be amortized.









---





During 2005, the Company incurred costs of $550,471 for the continued development of manufacturing processes focused on the production of the high molecular weight NeoVisc.  These expenditures incurred over the last two years on process development, will improve Stellars competitiveness in the global viscosupplement market. In the first quarter of 2005, Stellar began the process of implementing an open-label, community-based, clinical trial for Uracyst, which will assist the Company in demonstrating the effectiveness of Uracyst to physicians in the treatment of GAG deficient cystitis, such as IC. In 2005, the Company has incurred cost of $51,235 in developing this trial as well as $7,251 was issued to a consultant for services provided for a Uracyst study being conducted.

Business Development

Progress continues to be made as Stellar focuses on a number of business development activities associated with out-licensing Stellars current products in other international markets, in-licensing products for the Canadian market and developing additional products.  As previously referenced to in the overview, Stellar entered into five new out-licensing distribution agreements for its products in 2005; these include the distribution of NeoVisc in Turkey, Lebanon, and Kuwait and Uracyst agreements for distribution in China and Israel.  The Company anticipates revenue from these agreements to commence during 2006.

In 2005, $20,000 was incurred in business and development to conduct a pharmico-economic review of BladderChek, for use in assisting the Company in attaining reimbursement programs for the product.  These costs are included in selling, general and administrative expenses.

Selling, general and administrative expenses

Selling, general and administrative expenses for the year ended December 31, 2005 were $2,418,918, compared to $2,185,329 for the same period in 2004.  This increase includes the cost of $257,279 related to non-cash expenses for options issued to acquire common shares ("Common Shares") in the capital of the Company to consultants and the directors of the Company.  In addition, the Company had costs of $212,098 related to consulting agreements, as well as legal costs associated to the Companys name change.  During this period, the Company incurred fee expenses to members of the board of directors, which totaled $42,666.

The Companys ongoing commitment to increase sales and marketing activity in order to improve in-market sales has resulted in direct selling costs and marketing cost to increase by $36,922 over the same period in 2004.  In addition, there have also been increased costs associated with business development and investor relations activities with $496,438 being expensed in 2005, in comparison to $287,553 in 2004, for a total increase of $163,485.  These expenditures were in furtherance of the Companys growth and are expected to aid Stellar considerably in attaining its long-term goals.

Change in the Companys name, which became effective in January 2005 added non re-occurring legal costs of $7,795 to the selling, general and administrative expenses.

Interest income and expense

Interest revenue was $99,689 for the year ended December 31, 2005 as compared to $96,117 for 2004.  These amounts include: the investment of dividends, interest received on a short-term loan and the gain on a sale of short term investments.  Cash will be maintained in liquid investments.



Liquidity and Capital Resources



Cash, cash equivalents and short-term investments totaled $3,515,193 at December 31, 2006 as compared with $2,108,755 at December 31, 2005.  During the year ended December 31, 2006, the Company received aggregate proceeds of $156,163 in respect of 346,350 Common Shares issued upon the exercise of previously granted options.



At March 26, 2007, the Company did not have any outstanding indebtedness for borrowed money.









---







While the Company has generated royalty revenue and revenue from the distribution of pharmaceutical products in Canada, such revenue has not been sufficient to fund the Companys research, development and marketing activities. Accordingly, the Company continued to incur losses in 2006 and drew from its holdings of cash, cash equivalents and short-term investments. Although there can be no assurance, the Company does expects to move towards a profitable status in 2007, thereby funding its future growth from the sale of its products, milestone payments and royalty income resulting from out-licensing agreements for at least the next 12 months.

The Company may seek additional funding, primarily by way of one or more equity offerings, to carry out its business plan and to minimize risks to its operations.  The market for equity financings for companies such as Stellar is challenging, and there can be no assurance that additional funding by way of equity financing will be available.  Any additional equity financing may result in significant dilution to the existing shareholders at the time of such financing.  The Company may also seek additional funding from other sources, including technology licensing, co-development collaborations, and other strategic alliances, which, if obtained, may reduce the Companys interest in its projects or products.  There can be no assurance, however, that any alternative sources of funding will be available.

Risks and Uncertainties



Stellar is subject to risks, events and uncertainties, or "risk factors", associated with being both a publicly-traded company operating in the biopharmaceutical industry, and as an enterprise with several projects in the research and development stage. Such risk factors could cause reported financial information to not necessarily indicate future operating results or future financial position. The Company cannot predict all of the risk factors nor can it assess the impact, if any, of such risk factors on its business, or the extent to which any factor, or combination of factors, may cause future results or financial position to differ materially from those reported or those projected in any forward-looking statements. Accordingly, reported financial information and forward-looking statements should not be relied upon as a prediction of actual future results.



Some of the risks and uncertainties affecting the Company, its business, operations and results include, but are not limited to: the Companys dependence on a few customers and a few suppliers, the loss of any of which would negatively impact the Companys operations; the need to develop and commercialize new products which will require further time-consuming and costly research and development, the success of which cannot be assured; the Companys dependency on third parties for manufacturing, materials and for research, development and commercialization assistance and support; the Companys dependency on assurances from third parties regarding licensing of proprietary technology owned by others; government regulation and the need for regulatory approvals for both the development and commercialization of products, which are not assured; uncertainty that the Companys products will be accepted in the marketplace; rapid technological change and competition from pharmaceutical companies, biotechnology companies and universities, which may make the Companys technology or products obsolete or uncompetitive; the need to attract and retain skilled employees; risks associated with claims of infringement of intellectual property and of proprietary rights; risks inherent in manufacturing (including up-scaling) and marketing; product liability and insurance risks; risks associated with clinical trials, including the possibility that trials may be terminated early, delayed or unsuccessful; exchange rate fluctuations; political, economic and environmental risks; the need for performance by buyers and suppliers of products; the Companys dependency on performance by its licensees regarding the sale of our licensed-out products, NeoVisc and Uracyst; and the risk of unanticipated expenses or unanticipated reductions in revenue, or both, any of which could cause the Company to reduce, delay or divest one or more of its research, development or marketing programs.



In addition to the foregoing, the industry in which the Company operates is very competitive. Many of our competitors and potential competitors have substantially greater product development capabilities, experience conducting clinical trials and financial, scientific, manufacturing, sales and marketing resources and experience than the Company.  The pharmaceutical industry is an industry of innovation and change, which can change the competitive landscape rapidly.  This could result in a material adverse affect on the financial condition of the Company.



The Company currently outsources the manufacturing of its products to a third party contract manufacturer, located in Toronto, Ontario. Although the Company has taken several measures to control the quality and on-time delivery of its products by this manufacturer, Stellar is unable to control all aspects of its third party manufacturer's operations.  If a supplier of a product or component discontinued or restricted such supply, the Companys business may be harmed by the resulting delays.  This could result in a material adverse affect on the financial condition of the Company.











---





While management has some experience conducting business activities with international accounts, the Company is subject to a number of risks associated with international accounts that may increase the Company's costs, lengthen sales cycles, and require significant management attention.  International accounts carry certain risks associated with foreign currency fluctuations; exchange controls; uncertainties of laws and enforcement relating to the protection of intellectual property; and other factors, depending on the country involved.  There can be no assurance that the Company will not experience these factors in the future, or that they will not have a material adverse affect on the Company's business, results of operations or financial condition.



Off-Balance Sheet Arrangements



The Company, as part of its ongoing business, does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often  referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of March 26, 2007, the Company was not involved in any material unconsolidated SPE transactions.

Item 7.

Financial Statements.



The financial statements of the Company for 2006 and 2005, including the notes thereto, together with the report thereon of Mintz & Partners, LLP Chartered Accountants are attached to the end of this annual report and are hereby incorporated herein by reference.

Item 8.

Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.



Not applicable.

Item 8A.

Controls and Procedures.



Within the 90-day period prior to the Companys filing of this annual report, an evaluation was carried out under the supervision and with the participation of the Companys management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures (as defined in Rule 13a-15 and 15d-15 under the Exchange Act.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that those disclosure controls and procedures were adequate to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and regulations promulgated there under.  There have been no significant changes in the Companys internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Item 8B.

Other Information.



Not applicable.









---







PART III

Item 9.

Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act.





Directors and Executive Officers



The following table sets forth certain information with respect to the directors and executive officers of Stellar as of March 26, 2007.

|                     |  |     |  |                                                
|-------------------- |  | --- |  | -----------------------------------------------
|Name                 |  | Age |  | Positions                                      
|                     |  |     |  |                                                
|Peter Riehl          |  | 61  |  | Director, President and Chief Executive Officer
|Arnold Tenney        |  | 64  |  | Chairman of the Board and Financial Advisor    
|John J. Kime         |  | 64  |  | Director                                       
|David A. Rosenkrantz |  | 49  |  | Director                                       
|Robert H. Kayser     |  | 64  |  | Director                                       
|John M. Gregory      |  | 54  |  | Director                                       
|Janice M. Clarke     |  | 46  |  | Chief Financial Officer                        



Set forth below are brief biographies of the Companys directors and officers.  All of the directors and executive officers of the Company have held their principal occupations indicated below for the past five years unless otherwise noted.

Peter Riehl, President, Chief Executive Officer and Director.  Peter Riehl joined the Company in 1996.  Mr. Riehl has over 30 years experience in the Canadian and international pharmaceutical markets.  He was a former director of sales and marketing for Fisons Corp. Ltd. in Canada responsible for the commercial side of their pharmaceutical business in Canada.  His experience covers sales, marketing, business development and logistics in the pharmaceutical industry.  In 1993, Mr. Riehl was Chairman of the prescription drug sector of the Canadian Wholesale Drug Association.  He is also a former director of sales and marketing for Bioniche Life Sciences Inc.  Mr. Riehl has been involved in numerous professional and industry related training programs and has a Diploma in Business Administration from Conestoga College, Kitchener and studied marketing at York University, Toronto.

Arnold Tenney, Chairman of the Board and Financial Advisor.Since 2002, Arnold S.. Tenney has been a financial consultant at Devine Entertainment Corporation ("Devine"), a children and family film production and development company.  Prior to his position at Devine Mr. Tenney was Chief Executive Officer of ARC International Corporation from 1978 to 2000.  ARC International Corporation was a developer of indoor ice arenas and tennis clubs, as well as an investment company involved in entertainment and cable television whose shares were traded on the American Stock Exchange until its liquidation in 2000.  Mr. Tenney was a director and Chairman of the Board of Cabletel Communications from 1985 to 2000, which is a leading supplier of broadband equipment to the cable television industry whose shares currently trade on both the Toronto and American Stock Exchanges.  Mr. Tenney was a director of Ballantyne of Omaha, Inc. from 1988 to 2000 and served as Chairman of the Board from 1992 to 2000.  Ballantyne of Omaha, Inc. is a leading manufacturer of commercial motion picture projection equipment whose shares trade on the American Stock Exchange.  Mr. Tenney served as a director for Phillip Services Inc., a Canadian metal recycling company, from 1998 to 2000.  He served in the capacity as a representative of Mr. Carl Icahn.

Robert H. Kayser, Director.Robert H. Kayser spent 29 years in positions of increasing responsibility with Medtronic, Inc., the world's leading medical technology company providing lifelong solutions for people with chronic disease.  He retired in 2001 as Director of Global Marketing, Cardiac Surgery Products, in Grand Rapids, MI.  During his four-year tenure in this position, Mr. Kayser introduced more than 20 new products, and increased product revenue and market share.  Prior to this, he served as Vice President, Pacing and Customer Education in Lausanne, Switzerland, where he implemented









---





brand strategies and European customer education activities that resulted in higher market share for Medtronics cardiac pacing and electrophysiology product lines.  From 1993-1996, he was General Manager, Medtronic UK, where he was responsible for all businesses and functions.

John J. Kime, Director.  John J. Kime has been a director of the Company since December 2000.  Mr. Kime has been the President and Chief Executive Officer of the London Economic Development Corporation since 1998.  The London Economic Development Corporation is a public/private partnership with primary responsibility for economic development activities in London, Ontario, Canada.  From 1991 to 1998, Mr. Kime served as Director of International Development for Big O Incorporated, a company primarily engaged in the design and manufacture of control and containment systems for water, chemicals and other substances.  Mr. Kime has a B.A. from the University of Western Ontario and is a chartered accountant.  Mr. Kime is also a director of Cancer Care Ontario, Canada.

David A. Rosenkrantz, Director.  Mr. Rosenkrantz is Chairman of Patica Corporation, a small-cap merchant bank based in Toronto, which focuses on junior growth companies and President of Patica Securities Ltd.  He has over fifteen years experience in investment and merchant banking.  Mr. Rosenkrantz has been involved in private and public financing and merger and acquisition transactions involving health care, real estate, oil and gas, and high technology companies.  Mr. Rosenkrantz is a graduate of Carleton University and obtained his MBA from York University.

John M. Gregory, Director.  Mr. Gregory is managing partner of SJ Strategic Investments, LLC.  a private, family-owned investment vehicle with a diverse portfolio of public and private investments. Mr. Gregorys leadership as chairman and CEO of King Pharmaceuticals helped the company grow from a 90-employee family business to an S&P 500 Index company on the New York Stock Exchange with revenues exceeding $1 billion. Mr. Gregory is a graduate from the University of Maryland with a degree in pharmacy.



Janice M. Clarke, Chief Financial Officer. Ms. Clarke has over twenty years of office administration and financial management experience with proven abilities to implement and manage various financial systems and office procedures.  Ms. Clarke joined Stellar Pharmaceuticals Inc. in August 2000 and currently manages its administrative and financial processes.

Board of Directors

The Board of Directors consists of six members.  Directors serve for terms of one year or until their successors are duly elected or appointed.

Committees of the Board of Directors

The Company has established an Audit Committee and a Compensation Committee of the Board of Directors.

Audit Committee

The Audit Committee consists of Messrs. Rosenkrantz, Kayser and Kime, and is responsible for recommending the firm to be appointed as auditors to audit financial statements and to perform services related to the audit; reviewing the scope and results of the audit with the auditors, reviewing with management and the auditors the Companys annual operating results; and considering the adequacy of the internal accounting procedures and the effect of such procedures on the auditors independence.  Mr. Kime who chairs this committee is a chartered accountant and provides financial expertise to the Audit Committee.  Each Audit Committee member is an independent director of the Company.

Compensation Committee

The Compensation Committee consists of Messrs. Rosenkrantz and Kime, and is responsible for evaluating, reviewing and supervising the procedures of the Company with regard to human resources; assessing the performance of the officers of the Company; reviewing annually the remuneration of the officers; and recommending to the Board of Directors general remuneration policies regarding salaries, bonuses and other forms of remuneration for the directors and executive officers of the Company.









---







Audit Committee Financial Expert

The Board of Directors has determined that Mr. Kime is an audit committee financial expert as defined by Item 401(h) of Regulation S-K of the Exchange and is independent within the meaning of Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act.

Compliance with Section 16(a) of the Exchange Act

Section 16(a) of the Exchange Act, requires Stellars executive officers, directors and persons who beneficially own more than 10% of the Common Shares ("reporting persons") to file initial reports of ownership and reports of changes of ownership with the United States Securities and Exchange Commission.  Executive officers, directors and greater than 10% beneficial owners are required to furnish Stellar with copies of all Section 16(a) forms they file.

The Company believes that all of its officers and directors have filed reports required by Section 16 (a) of the Exchange Act during 2006.

Code of Ethics

The Company has not adopted a code of ethics in light of its limited number of executive officers.



Item 10.

Executive Compensation.



Summary Compensation Table

The Company does not have a long-term incentive plan or pension plan and has never granted stock appreciation rights to any of its directors, officers or employees.

The following table sets forth all compensation earned during each of the three years included in the period ended December 31, 2006 by the Chief Executive Officer of Stellar, such individual being the only executive officer of Stellar whose total annual salary, bonus and other annual compensation exceeded $100,000 (USD).



|                               |      |                     |                        |                           |                                  
|------------------------------ | ---- | ------------------- | ---------------------- | ------------------------- | ---------------------------------
|                               |      | Annual Compensation | Long Term Compensation
|Name of Principal
and Position | Year | Salary              | Bonus                  | Other Annual Compensation | Securities Underlying Options (#)
|                               |      | ($)(Cdn.)           |                       
|Peter Riehl                    | 2006 | 175,000             | -                      | -                         | -                                
|President & Chief              | 2005 | 175,000             | -                      | -                         | 70,000                           
|Executive Officer              | 2004 | 140,000             | -                      | -                         | 35,000                           
|                               | 2003 | 100,000             | -                      | -                         | 25,000                           

Employment Agreements and Termination of Employment

Effective as of September 1, 2000, Stellar entered into an employment agreement with Peter Riehl.  Under Mr. Riehls employment agreement, Mr. Riehl agreed to serve as a director of Stellar and is employed as the President and Chief Executive Officer of Stellar.

Effective January 1, 2007, Mr. Riehls employment agreement provides for a gross annual remuneration of $175,000, plus standard dental and life insurance benefits.  Mr. Riehl is also entitled to be reimbursed for all Company-related travel and other out-of-pocket expenses.  Pursuant to his employment agreement, Mr. Riehl is further entitled to receive an annual bonus, at the discretion of the Board of Directors, in the form of cash and/or stock options, based upon the achievement of certain









---





performance goals to be established by the Compensation Committee of the Board of Directors.

The employment agreement is automatically renewable for successive one year terms unless and until notice of intent to terminate is given by either Mr. Riehl or Stellar at least three months prior to the expiration of the term.  Notwithstanding the foregoing, in the event that Mr. Riehls employment is terminated, other than for cause, by the Company, Mr. Riehl is entitled to a lump sum payment equal to 200% of his then current base salary.  In the event of any such termination, any unvested stock options held by the Mr. Riehl will immediately vest.   Mr. Riehl has agreed to not compete with the Company for a period of two years from the date of the termination of his employment, irrespective of the cause of such termination.

Stock Option Plan

The Company has established a stock option plan for the directors, executive officers, employees and consultants of the Company and any subsidiaries of the Company that may be formed (the Plan) in order to attract and retain competent persons motivated to work toward ensuring the Companys success and to encourage such persons to acquire Common Shares.  Individuals who are eligible to be selected to receive options under the Plan are directors, executive officers, employees and consultants of the Company and subsidiaries of the Company.  The Board of Directors administers the Plan and has the power to amend, modify, suspend or terminate the Plan, subject to any necessary regulatory approvals.

All of the options granted under the Plan may be exercised within a maximum period of three and one-half years following the date of grant thereof.  Subject to the Plan, the Board of Directors designates the recipients of options and determines the number of Common Shares covered by each option, the date of vesting of each option, the exercise price of each option, the expiry date and any other terms relating thereto, in each case, in accordance with applicable legislation and the rules and policies of the applicable securities regulatory authorities.  The price at which the Common Shares may be purchased pursuant to the Plan may not be lower than the closing price of the Common Shares on the principal stock exchange where the Common Shares are listed on the date of grant.  On June 29, 2005, the Company increased the number of options in the plan to 4,629,452 from 4,157,841; the maximum number of Common Shares that were issuable under the Plan may not exceed 4,629,452.  The maximum number of Common Shares that may be granted to any person may not exceed 5% of the outstanding Common Shares.

As at March 26, 2007 the number of Common Shares which remain available for issuance under the Plan is 1,911,635 of which 901,635 Common Shares remain available for option grants.

The Plan has been approved by the Companys shareholders.

Option Grants in Last Fiscal Year

There were no options to purchase Common Shares granted to Mr. Riehl during the fiscal year ended December 31, 2006 (2005  70,000).

Compensation of Directors

In 2006, the directors of the Company were entitled to receive cash compensation for serving in such capacity.  The director acting as Chairman of the Board receives $10,000 annually.  All other directors receive $6,000 annually.  In addition, members of the Audit Committee receive $4,000 annually and members of the Compensation Committee receive $1,000 annually. Board members are eligible to participate in the Plan.

No options to purchase Common Shares were granted to the directors and officers under the Option Plan in 2006.

Aggregated Option Exercises and Fiscal Year-End Option Value Table

The following table sets forth information concerning each exercise of options by Mr. Riehl during the year ended December 31, 2006.









---







|            |                                     |                           |                                                                         |                                                                                                     
|----------- | ----------------------------------- | ------------------------- | ----------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------
|Name        | Securities Acquired on Exercise (#) | Value Realized ($) (Cdn.) | Unexercised Options at December 31, 2006 (#) Exercisable/ Unexercisable | Value of Unexercised
In-the-Money Options at December 31, 2006 ($) (Cdn.) Exercisable/ Unexercisable
|            |                                     |                           |                                                                         |                                                                                                     
|Peter Riehl | 25,000                              | $         5,750           | 93,333/11,667                                                           | $41,599 / - $0 -                                                                                    

Indemnification of Directors

The Company has agreed to indemnify each of its directors to the fullest extent permitted by Ontario, Canada corporate law for all costs, liabilities and expenses incurred by each director, including legal fees, in respect of claims to which a director is made a party by reason of being or having been a director of the Company or any subsidiary thereof, provided such director acted honestly and in good faith with a view to the best interests of the Company and, in the case of a criminal or administrative proceeding enforced by monetary penalty, such director had reasonable grounds for believing that his conduct was lawful.

Directors and Officers Liability Insurance

The Company maintains insurance for the benefit of its directors and officers against liability in their respective capacities as directors and officers.  The annual premium payable by the Company in respect of such insurance is $26,460 for 2006 compared to $30,780 in 2005. The total amount of insurance purchased for the directors and officers as a group in 2006 and 2005 is $2,000,000.  The directors and officers are not required to pay any premium in respect of the insurance.  The insurance policy does not contain deductibility provisions.

Item 11.

Security Ownership of Certain Beneficial Owners and Management.

The following table sets forth, as at March 26, 2007, certain information as to (i) each person, who to the knowledge of the Company, is the beneficial owner of more than five percent (5%) of any class of the Companys voting securities and (ii) each class of equity securities of the Company or any of its subsidiaries (other than directors qualifying shares) beneficially owned by (A) each director of the Company and the Chief Executive Officer and (B) all directors and executive officers of the Company as a group.

|               |                                                                    |                                           |                 
|-------------- | ------------------------------------------------------------------ | ----------------------------------------- | ----------------
|Title of Class | Name and Address of Beneficial Owner                               | Amount and
Nature of Beneficial Ownership | Percent of Class
|Common Shares  | Peter Riehl
14 Exmoor Pl.
London, Ontario
Canada N5X 3W2           | 3,569,741(1)                              | 15.1%           
|               |                                                                    |                                           |                 
|Common Shares  | Arnold Tenney
31 Maple Avenue
Toronto, Ontario
Canada M4W 2T8      | 989,200(2)                                | 4.2%            
|               |                                                                    |                                           |                 
|Common Shares  | Robert H. Kayser
156 McGarrel Drive
London, Ontario
Canada N6G 5E7 | 41,667(3)                                 | 0.2%            
|               |                                                                    |                                           |                 









---







|              |                                                                                         |              |      
|------------- | --------------------------------------------------------------------------------------- | ------------ | -----
|Common Shares | John J. Kime
138 Hunt Club Dr.
London, Ontario
Canada N6H 3Y7                           | 191,667(4)   | 0.8% 
|              |                                                                                         |              |      
|Common Shares | David A. Rosenkrantz
105 Adelaide Street West
Toronto, Ontario
Canada M5H 1P9           | 625,5000(5)  | 2.7% 
|              |                                                                                         |              |      
|Common Shares | Janice Clarke
8664 Parkhouse Drive
Mt. Brydges, Ontario
Canada N0L 1W0                  | 82,222(7)    | 0.5% 
|              |                                                                                         |              |      
|Common Shares | SJ Strategic Investments LLC
340 Edgemont Ave
Suite 500
Bristol, Tennessee
U.S.A  37620 | 5,188,794(6) | 22.1%
|              |                                                                                         |              |      
|Common Shares | All directors and executive officers
(7 individuals)                                    | 5,576,996(8) | 23.1%



(1)

Includes (i) 1,690,714 Common Shares owned by Mr. Riehls wife and (ii) currently exercisable options on 93,333 Common Shares granted under the Plan - See Item 10.  Executive Compensation.  Stock Option Plan.

(2)

Includes (i) 672,700 Common Shares owned by LMT Financial Inc, a company beneficially owned by Mr. Tenney and his spouse ; (ii) 126,500 Common Shares  owned by Arnmart Investments Limited, a company in which Mr. Tenney holds and equity interest; (iii) 85,000 Common Shares owned by Mr. Tenneys spouse; (iv) currently exercisable options on 105,000 Common Shares granted under the Plan.  See Item 10.  Executive Compensation.  Stock Option Plan,

(3)

Includes (i) currently exercisable options on 41,667 Common Shares granted under the Plan.  See Item 10.  Executive Compensation.  Stock Option Plan,

(4)

Includes currently exercisable options on 66,667 Common Shares granted under the Plan.  See Item 10.  Executive Compensation.  Stock Option Plan.

(5)

Includes (i) 441,333 Common Shares owned by Mr. Rosenkrantzs wife and (ii) currently exercisable options on 66,667 Common Shares granted under the Plan.  See Item 10.  Executive Compensation.  Stock Option Plan

(6)

Shares are directly owned by SJ, with John M. Gregory as the managing member deemed to have sole voting and dispositive power over the shares. Joan P. Gregory, Susan Gregory and James M. Gregory are deemed to be indirect beneficial owners of shares due to their financial interest in SJ.

(7)

Includes (i) currently exercisable options on 10,000 Common Shares granted under the Plan.  See Item 10.  Executive Compensation.  Stock Option Plan,

(8)

Includes currently exercisable options on 371,667 Common Shares granted under the Plan.  See Item 10. Executive Compensation.  Stock Option Plan.









---







Item 12.

Certain Relationships and Related Transactions.



As discussed in Item 5 of this annual report, the Company entered a fiscal advisory and consulting agreement on January 1, 2006, with LMT Financial Inc. (a company beneficially owned by a director and his spouse) for services provided in 2006.  Under the terms of this agreement the Company has extended LMTs consulting services for one additional one year period.  Mr. Tenney currently serves as Chairman of the Board of Stellar.



Item 13.

Exhibits and Reports on Form 8-K.

(a)

Exhibits

|            |                                                                                                                   |                       
|----------- | ----------------------------------------------------------------------------------------------------------------- | ----------------------
|Exhibit No. | Description of Exhibit                                                                                            | Sequential Page
Number
|2.1         | Articles of Incorporation of the Company                                                                          | *                     
|2.2         | First Articles of Amendment                                                                                       | *                     
|2.3         | Second Articles of Amendment                                                                                      | *                     
|2.4         | By-Laws of the Company                                                                                            | *                     
|3.1         | Specimen Form of Common Share Certificate                                                                         | **                    
|10.1        | United States Patent No. 6,083,933                                                                                | *                     
|10.2        | Canadian Patent No. 2,269,260                                                                                     | *                     
|10.3        | License Agreement dated December 21, 2001 between the Company and G. Pohl-Boskamp GmbH & Co.                      | *                     
|10.4        | Consulting agreement dated February 21, 2001 between the Company and LMT Financial Inc.                           | *                     
|10.5        | Contract Services Agreement Inc. dated October 10, 2003 between the Company and Dalton Chemical Laboratories Inc. | **                    
|10.6        | Amended Agreement dated January 1, 2004 between the Company and LMT Financial Inc.                                | ***                   
|10.7        | NeoVisc Licence and Supply Agreements dated March 24, 2004 between the Company and SJ Pharmaceuticals Inc.        | ***                   
|10.8        | Uracyst Licence and Supply Agreements dated March 24, 2004 the Company and SJ Pharmaceuticals Inc                 | ***                   
|10.9        | Amending Consulting Agreement dated December 10, 2004 between the Company & LMT Financial Inc.                    | ***                   
|10.10       | Option Plan                                                                                                       | ***                   
|10.11       | Amendment to Option Plan  2001                                                                                   | ***                   
|10.12       | Amendment to Option Plan  2004                                                                                   | ***                   
|10.13       | Amendment to Option Plan  2005                                                                                   | ***                   
|10.14       | Uracyst Licence and Supply Agreements dated December 13, 2006 the Company and Watson Pharma, Inc                  | ****                  
|99.1        | Certification of Chief Executive Officer                                                                          | ****                  
|99.2        | Certification of Chief Financial Officer                                                                          | ****                  



*

Filed as an exhibit to Amendment No. 1 to the Companys Registration Statement on Form 10-SB dated February 4, 2002.

**

Filed as an exhibit to Amendment No. 2 to the Companys Registration Statement on Form 10-SB dated April 26, 2003.

***

Filed as an exhibit to Amendment No. 2 to the Companys Registration Statement on Form 10-SB dated January 13, 2006

****

Filed as an exhibit Companys 2006 Annual Report Form 10-KSB dated March 30, 2007.

*****

Filed on December 28, 2006 on Form 8-K









---





(b)

Reports on Form 8-K

Filed May 9, 2006  1st Qtr 2006 Financial Results

Filed August 10, 2006  2nd Qtr 2006 Financial Results

Filed November 8, 2006  3rd Qtr 2006 Financial Results





Item 14.

Principal Accountant Fees and Services.



Fees for Services Provided by Independent Auditors

Fees for all services provided by Mintz & Partners, LLP the Companys independent auditors, for 2006 and 2005 were as follows:

Audit Fees.

Fees for services for fiscal years 2006 related to the annual financial statement audits and reviews of quarterly financial statements filed in the reports on Form 10-Q and statutory audits were approximately $93,550, compared to $76,500 in 2005.

Audit-Related Fees.

In addition to the Audit Fees, the company paid Kraft, Berger, Grill, Swartz & Cohen LLP approximately $2,910 in 2006 for tax advice services and review issues with regards to employee benefit issues and research & development credits.

Tax Fees.

Collins Barrows (a company affiliated with Mintz & Partners, LLP) will be filing the Companys taxes for 2006, it is estimated that fees related to the 2006 and 2005 tax filings will be $2,500 for each year filed.

All Other Fees.

The Company generally does not engage Mintz & Partners, LLP for "other" services.

Pre-Approval Policy for Services of Independent Auditors

As part of its duties, the Audit Committee is required to pre-approve audit and non-audit services preformed by the independent auditors in order to assure that the provision of such services does not impair the auditors independence.  On an annual basis, the Audit Committee will review and provide pre-approval for certain types of services that may be provide by the independent auditors without obtaining specific approval from the Audit Committee. If a type of service to be provided by the independent auditors has not received pre-approval during this annual process, it will require specific pre-approval form the Audit Committee. The Audit Committee does not delegate to management its responsibilities to pre-approve services performed by the independent auditors.



The Audit Committee of the board has recommended that Mintz & Partners, LLP be appointed as the companys independent auditors for the fiscal year ending December 31, 2007.











---







SIGNATURES



In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

|              |     |                             
|------------- | --- | ----------------------------
|April 2, 2007 |     | Stellar Pharmaceuticals Inc.
|              |     |                             
|              | By: | /s/Arnold Tenney            
|              |     | Arnold Tenney               
|              |     | Chairman of the Board       



In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

|               |  |     |                        
|-------------- |  | --- | -----------------------
|               |  |     |                        
|April 2, 2007  |  | By: | /s/Arnold Tenney       
|               |  |     | Arnold Tenney          
|               |  |     | Chairman of the Board  
|               |  |     |                        
|April 2, 2007  |  | By: | /s/Peter Riehl         
|               |  |     | Peter Riehl            
|               |  |     | Chief Executive Officer
|               |  |     |                        
|April 2, 2007  |  | By: | /s/David A. Rosenkrantz
|               |  |     | David A. Rosenkrantz   
|               |  |     | Director               
|               |  |     |                        
|April 2, 2007  |  | By: | /s/Robert H. Kayser    
|               |  |     | Robert H. Kayser       
|               |  |     | Secretary and Director 
|               |  |     |                        
|April 2, 2007  |  | By: | /s/John J. Kime        
|               |  |     | John J. Kime           
|               |  |     | Director               
|               |  |     |                        
|March 30, 2007 |  | By: | /s/John M. Gregory     
|               |  |     | John M. Gregory        
|               |  |     | Director               
|               |  |     |                        
|April 2, 2007  |  | By: | /s/Janice M. Clarke    
|               |  |     | Janice M. Clarke       
|               |  |     | Chief Financial Officer











---







STELLAR PHARMACEUTICALS INC.

FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006













---







STELLAR PHARMACEUTICALS INC.

DECEMBER 31, 2006

CONTENTS

|                                              |     
|--------------------------------------------- | ----
|                                              | PAGE
|FINANCIAL STATEMENTS                          |     
|AUDITORS REPORT                              | 1   
|BALANCE SHEETS                                | 2   
|STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY | 3   
|STATEMENTS OF OPERATIONS                      | 4   
|STATEMENTS OF CASH FLOWS                      | 5   
|NOTES TO FINANCIAL STATEMENTS                 | 6-23
|                                              |     















---





[stellar10ksbfiling2006ver001.jpg]









REPORT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS





To the Stockholders of 
Stellar Pharmaceuticals Inc.



We have audited the accompanying balance sheets of Stellar Pharmaceuticals Inc. as of December 31, 2006 and December 31, 2005, and the related statements of operations, shareholders equity, and cash flows for each of the years ended December 31, 2006 and December 31, 2005. These financial statements are the responsibility of the companys management. Our responsibility is to express an opinion on these financial statements based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Stellar Pharmaceuticals Inc. as of December 31, 2006 and December 31, 2005, and the results of its operations and its cash flows for each of the years ended December 31, 2006 and December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.







Toronto, Ontario

/S/ MINTZ & PARTNERS LLP 
March 26, 2007

CHARTERED ACCOUNTANTS





















[stellar10ksbfiling2006ver002.jpg]

















---







STELLAR PHARMACEUTICALS INC.

BALANCE SHEETS

(Canadian Funds)

December 31



|                                                |                                                          |                                                               |                          |             |                     |             |                   
|----------------------------------------------- | -------------------------------------------------------- | ------------------------------------------------------------- | ------------------------ | ----------- | ------------------- | ----------- | ------------------
|ASSETS                                         
|                                                |                                                          |                                                               |                          |             | 2006                |             | 2005              
|CURRENT                                         |                                                          |                                                               |                          |             |                     |            
|                                                | Cash and cash equivalents (Note 3)                       |                                                               | $        3,515,193       |             | $        2,108,755 
|                                                | Accounts receivable, net of allowance $nil (2005 - $nil) |                                                               | 199,704                  |             | 157,749            
|                                                | Inventories (Note 4)                                     |                                                               | 274,597                  |             | 288,337            
|                                                | Prepaid, deposits and sundry receivables (Note 5)        |                                                               | 55,407                   |             | 152,514            
|                                                |                                                          |                                                               |                          |             | 4,044,901           |             | 2,707,355         
|PROPERTY, PLANT AND EQUIPMENT(Note 6)           |                                                          | 853,818                                                       |                          | 959,999    
|                                                |                                                          |                                                               |                          |             |                     |             |                   
|OTHER ASSETS(Note 7)                            |                                                          | 49,691                                                        |                          | 46,187     
|                                                |                                                          |                                                               |                          |             | $        4,948,410  |             | $        3,713,541
|LIABILITIES                                    
|                                                |                                                          |                                                               |                          |             |                     |             |                   
|CURRENT                                         |                                                          |                                                               |                          |             |                     |            
|                                                | Accounts payable                                         |                                                               | $           226,026      |             | $           487,359
|                                                | Accrued liabilities                                      |                                                               | 135,198                  |             | 122,999            
|                                                | Deferred revenues                                        |                                                               | 1,500                    |             | 43,397             
|                                                |                                                          |                                                               |                          |             | 362,724             |             | 653,755           
|CONTINGENCIES AND COMMITMENTS(Note 13)          |                                                          |                                                               |                          |            
|SHAREHOLDERS' EQUITY                           
|CAPITAL STOCK                                   |                                                          |                                                               |                          |            
|                                                | AUTHORIZED                                               |                                                               |                          |             |                     |            
|                                                | Unlimited                                                | Non-voting, convertible, redeemable and retractable preferred |                          |            
|                                                |                                                          |                                                               | shares with no par value |             |                     |             |                   
|                                                | Unlimited                                                | Common shares with no par value                               |                          |             |                     |            
|                                                | ISSUED (Note 8)                                          |                                                               |                          |             |                    
|                                                | 23,819,040                                               | Common shares (2005 - 23,470,190)                             |                          | 8,299,554   |                     | 8,100,253  
|                                                |                                                          | Paid-in capital options - outstanding                         |                          | 513,990     |                     | 545,025    
|                                                |                                                          |                                                               | - expired                |             | 201,322             |             | 98,913            
|                                                |                                                          |                                                               |                          |             | 9,014,866           |             | 8,744,191         
|DEFICIT                                         |                                                          |                                                               |                          | (4,429,180) |                     | (5,684,405)
|                                                |                                                          |                                                               |                          |             | 4,585,686           |             | 3,059,786         
|                                                |                                                          |                                                               |                          |             | $        4,948,410  |             | $        3,713,541
|See accompanying notes to financial statements. |                                                          |                                                               |                          |            

Approved on behalf of the Board:



/s/Peter Riehl

/s/Arnold Tenney_

Director

Director









---







STELLAR PHARMACEUTICALS INC.

STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

(Canadian Funds)

FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005

|                              |            |           |             |         |            
|----------------------------- | ---------- | --------- | ----------- | ------- | -----------
|                              |            |           |             |        
|                              |            |           |             |         |            
|                              |            |           |             |         |            
|                              | Number of  |           |             |        
|                              | Common     | Common    | Options     | Options |            
|                              | Shares     | Shares    | Outstanding | Expired | Deficit    
|                              | #          | $         | $           | $       | $          
|BALANCE,                      |            |           |             |         |            
|January 1, 2005               | 22,802,373 | 7,720,873 | 374,712     | 67,263  | (3,943,911)
|Shares issued for cash        | 667,817    | 324,064   | -           | -       | -          
|Options issued to consultants | -          | -         | 204,303     | -       | -          
|Options exercised             | -          | 55,316    | (55,316)    | -       | -          
|Options issued to employees   | -          | -         | 52,976      | -       | -          
|Employees options forfeited   | -          | -         | (26,650)    | 26,650  | -          
|Consultants options expired   | -          | -         | (5,000)     | 5,000   | -          
|Net loss for the year         | -          | -         | -           | -       | (1,740,494)
|                              |            |           |             |         |            
|BALANCE,                      |            |           |             |         |            
|December 31, 2005             | 23,470,190 | 8,100,253 | 545,025     | 98,913  | (5,684,405)
|Shares issued for services    | 2,500      | 2,275     | -           | -       | -          
|Options issued to consultants | -          | -         | 34,534      | -       | -          
|Options exercised             | 346,350    | 197,026   | (40,863)    | -       | -          
|Options issued to employees   | -          | -         | 77,703      | -       | -          
|Employees options forfeited   | -          | -         | (6,561)     | 6,561   | -          
|Consultants options expired   | -          | -         | (95,848)    | 95,848  | -          
|Net income for the year       | -          | -         | -           | -       | 1,255,225  
|BALANCE,                      |            |           |             |         |            
|December 31, 2006             | 23,819,040 | 8,299,554 | 513,990     | 201,322 | (4,429,180)





See accompanying notes to financial statements.











---







STELLAR PHARMACEUTICALS INC.

STATEMENTS OF OPERATIONS

(Canadian Funds)

FOR THE YEARS ENDED DECEMBER 31

|                                             |                                     |                        |                        |                         |                           | 
|-------------------------------------------- | ----------------------------------- | ---------------------- | ---------------------- | ----------------------- | ------------------------- | 
|                                             |                                     |                        | 2006                   |                         | 2005                     
|PRODUCT SALES(Note 9)                        |                                     | $        1,427,264     |                        | $        1,627,670     
|COST OF GOODS SOLD                           |                                     | 419,652                |                        | 450,591                
|MARGIN ON PRODUCT SOLD                       |                                     | 1,007,612              |                        | 1,177,079              
|                                             |                                     |                        |                        |                        
|                                             |                                     |                        |                        |                        
|ROYALTIES & LICENSING REVENUE(Note 9)        |                                     | 2,950,433              |                        | 314,581                
|WRITE-DOWN OF OBSOLETE INVENTORY             |                                     | (7,291)                |                        | (36,238)               
|OTHER PRODUCT COST(Note 10)                  |                                     | (29,205)               |                        | (123,152)              
|GROSS PROFIT                                 |                                     | 3,921,549              |                        | 1,332,270              
|                                             |                                     |                        |                        |                        
|                                             |                                     |                        |                        |                        
|EXPENSES                                     |                                     |                        |                        |                        
|                                             | Selling, general and administrative |                        | 2,332,452              |                         | 2,418,918                
|                                             | Research and development            |                        | 217,607                |                         | 608,957                  
|                                             | Amortization                        |                        | 159,117                |                         | 144,582                  
|                                             |                                     |                        | 2,709,176              |                         | 3,172,457                
|INCOME (LOSS) FROM OPERATIONS                |                                     | 1,212,373              |                        | (1,840,187)            
|INTEREST AND OTHER INCOME                    |                                     | 42,852                 |                        | 99,689                 
|NET INCOME (LOSS) FOR THE YEAR BEFORE TAXES  |                                     | $        1,255,225     |                        | $       (1,740,498)    
|INCOME TAXES(Note 11)                        |                                     | -                      |                        | -                      
|NET INCOME (LOSS)                            |                                     | $        1,255,225     |                        | $       (1,740,498)    
|EARNINGS (LOSS) PER SHARE(Note 12)   - Basic |                                     | $                 0.05 |                        | $                (0.08)
|                                             | - Fully diluted                     |                        | $                 0.05 |                         | $                       -
|WEIGHTED AVERAGE NUMBER OF COMMON SHARES     |                                     |                        |                        |                        
|                                             | OUTSTANDING- Basic                  |                        | 23,575,479             |                         | 23,182,107               
|                                             | - Fully diluted                     |                        | 23,634,070             |                         | -                        

See accompanying notes to financial statements.









---







STELLAR PHARMACEUTICALS INC.

STATEMENTS OF CASH FLOWS

(Canadian Funds)

FOR THE YEARS ENDED DECEMBER 31



|                                             |                                                      |                                                      |                     |                    |                     |            
|-------------------------------------------- | ---------------------------------------------------- | ---------------------------------------------------- | ------------------- | ------------------ | ------------------- | -----------
|                                             |                                                      |                                                      |                     |                   
|                                             |                                                      |                                                      |                     |                   
|                                             |                                                      |                                                      |                     | 2006               |                     | 2005       
|CASH FLOWS PROVIDED BY (USED IN)             |                                                      |                                                      |                     |                   
|OPERATING ACTIVITIES                         |                                                      |                                                      |                     |                   
|                                             | Net income (loss) for the year                       |                                                      | $         1,255,225 |                    | $       (1,740,498)
|                                             | Amortization                                         |                                                      | 159,117             |                    | 144,582            
|                                             | Issuance of equity instruments for services rendered |                                                      | 114,512             |                    | 257,279            
|                                             |                                                      |                                                      |                     | 1,528,854          |                     | (1,338,637)
|                                             | Change in non-cash operating assets and liabilities  |                                                      |                     |                    |                    
|                                             |                                                      | (Increase) decrease in accounts receivable           |                     | (41,955)           |                     | 24,011     
|                                             |                                                      | Decrease in inventories                              |                     | 13,740             |                     | 48,154     
|                                             |                                                      | Decrease in prepaid, deposits and sundry receivables |                     | 97,107             |                     | 3,458      
|                                             |                                                      | Increase (decrease) in accounts payable and          |                     |                    |                     |            
|                                             |                                                      | accrued liabilities                                  |                     | (249,134)          |                     | 235,231    
|                                             |                                                      | Decrease in deferred revenues                        |                     | (41,897)           |                     | (177,923)  
|                                             |                                                      |                                                      |                     | 1,306,715          |                     | (1,205,707)
|INVESTING ACTIVITIES                         |                                                      |                                                      |                     |                   
|                                             | Additions to property, plant and                     |                                                      |                     |                    |                    
|                                             |                                                      | equipment                                            |                     | (51,581)           |                     | (151,558)  
|                                             | Increase in other assets                             |                                                      | (4,859)             |                    | (30,915)           
|                                             |                                                      |                                                      |                     | (56,440)           |                     | (182,473)  
|FINANCING ACTIVITIES                         |                                                      |                                                      |                     |                   
|                                             | Issuance of common stock                             |                                                      | 156,163             |                    | 324,064            
|                                             |                                                      |                                                      |                     | 156,163            |                     | 324,064    
|CHANGE IN CASH AND CASH EQUIVALENTS          |                                                      | 1,406,438                                            |                     | (1,064,115)       
|                                             |                                                      |                                                      |                     |                    |                     |            
|CASH AND CASH EQUIVALENTS, beginning of year |                                                      | 2,108,755                                            |                     | 3,172,870         
|                                             |                                                      |                                                      |                     |                    |                     |            
|CASH AND CASH EQUIVALENTS, end of year       |                                                      | $         3,515,193                                  |                     | $        2,108,755
|                                             |                                                      |                                                      |                     |                    |                     |            



See accompanying notes to financial statements.













---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

1.

DESCRIPTION OF BUSINESS

Stellar Pharmaceuticals Inc. ("Stellar" or "Company") is a Canadian pharmaceutical company involved in the development and marketing of high quality, cost-effective, polysaccharide-based therapeutic products used in a treatment of osteoarthritis and certain types of cystitis.  Stellar also intends to develop additional healthcare products aimed at niche pharmaceutical markets.

The Company markets its products in Canada and currently has agreements in place for distribution of its products in various countries including the United States of America.

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

(a)

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash and all highly liquid investments purchased with an original or remaining maturity of three months or less at the date of purchase or are otherwise highly liquid.  Cash and cash equivalents are under the custodianship of two major financial institutions located in Canada and one financial institution located in Dublin, Ireland.

(b)

ACCOUNTS RECEIVABLES

The Company routinely assesses the recoverability of all material trade and other receivables to determine their collectibility by considering factors such as historical experience, credit quality, the age of the accounts receivable balances, and current economic conditions that may affect a customer's ability to pay.

(c)

REVENUE RECOGNITION



Revenue from the sale of products, net of trade discounts and allowances, is recognized when legal title to the goods has been passed to the customer and collection is reasonably assured.  The Company has a "No Return" policy on the sale of its goods.



Revenues associated with multiple-element arrangements are attributed to the various elements, if certain criteria are met including whether the delivered element has stand alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered elements. Non-refundable up-front fees for the licensing of technology and products under agreements which do not require the Company to perform research or development activities or other significant future performance obligations is recognized at the time the agreement is executed.  Milestone payments are recognized into income upon the achievement of the specified milestones when the Company has no further involvement or obligation to perform related to that specific element of the arrangement. Up-front fees and other amounts received in excess of revenue recognized are recorded as deferred income.











---







STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006



2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  (continued)

Royaltyrevenue is recognized when the Company has fulfilled the terms in accordance with the contractual agreement and has no future obligation, the amount of the royalty fee is determinable and collection is reasonably assured.

(d)

INVENTORIES



Inventories are valued at the lower of cost and net realizable value with cost being determined on a first-in, first-out basis.

(e)

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated at cost.  Amortization is being provided for on a

straight-line basis over the estimated useful lives of the assets.  The Company periodically compares the carrying values of property, plant and equipment to their net realizable values and charges income with any impairment to net assets.  The estimated useful lives of the assets are as follows:



Asset Classification

Useful Life



Building

20 years

Computer and office equipment

5 years

Manufacturing equipment

5 years



(f)

OTHER ASSETS

Amortization of other assets is being provided for on a straight-line basis as noted below:



Asset Classification

Useful Life

Patents

17 years



Patents represent capitalized legal costs incurred in connection with applications for patents.  For patents and applications that are abandoned, the company charges the remaining net book value to expenses.

(g)

USE OF ESTIMATES

The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the











---







STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the period in which they become known.

(h)

DEFERRED INCOME TAXES



The Company accounts for income taxes using the asset and liability method.  Deferred tax assets and liabilities are recognized based on the difference between the accounting values of assets and liabilities and their related tax bases using future income tax rates when these differences are expected to reverse.  Valuation allowance is recorded to reduce deferred tax assets when it is more likely than not that the benefit will not be realized.

(i)

STOCK-BASED COMPENSATION



The Company uses fair value based method of accounting for all its stock-based compensation in accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 123(R).  SFAS 123(R) requires companies to estimate the fair value of share based payment awards on the date of grant using an option pricing model.  The value of awards that are ultimately expected to vest is recognized as expense near the requisite service periods in the Companys statements of operations.

(j)

FOREIGN CURRENCY TRANSACTIONS



Foreign currency transactions are recorded at the exchange rate in effect on the date of the transaction.

(k)

FOREIGN CURRENCY TRANSLATION



Monetary assets and liabilities are translated into Canadian dollars which is the functional currency of the company at the year-end exchange rate, while foreign currency revenues and expenses are translated at the exchange rate in effect on the date of the transaction.  The resultant gains or losses are included in income.  Non-monetary items are translated at historical rates.

(l)

RESEARCH AND DEVELOPMENT



Research and development costs are expensed as incurred.  Approved investment tax credits are netted against the related expenses.



(m)

COMPREHENSIVE INCOME



Statement of Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income", establishes standards for the reporting and display of comprehensive income and its components and requires restatement of all previously reported information for comparative purposes.  For the year ended December 31, 2006 and 2005, comprehensive income was the same as net earnings.









---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)



(n)

EARNINGS (LOSS) PER SHARE



Basic earnings (loss) per share is computed by dividing the net earnings (loss) by the weighted average number of common shares outstanding during the year, adjusted for any subdivision or consolidation.



Fully diluted earnings per share are computed using the weighted average number of common and dilutive common equivalent shares outstanding during the year.  Dilutive common equivalent shares consist of shares issuable upon exercise of stock options and warrants and conversion of preferred stock.  Diluted loss per share is not calculated when the effect is antidilutive.



(o)

NON-MONETARY TRANSACTIONS



Shares issued for commercial transactions are valued based on the value of services provided.

3.

CASH AND CASH EQUIVALENTS

| |                        |              |             
| | ---------------------- | ------------ | ------------
| | Consists of -          | December 31,
| |                        | 2006         | 2005        
| | Cash                   | $    659,880 | $    169,974
| | Short-term investments | 2,855,313    | 1,938,781   
| |                        | $ 3,515,193  | $ 2,108,755 

4.

INVENTORIES

| |                     |              |           
| | ------------------- | ------------ | ----------
| | Consists of -       | December 31,
| |                     | 2006         | 2005      
| | Raw material        | $    85,262  | $   71,131
| | Finished goods      | 64,088       | 44,331    
| | Packaging materials | 46,386       | 27,457    
| | Work in process     | 78,861       | 145,418   
| |                     | $ 274,597    | $ 288,337 

5.

PREPAID, DEPOSITS AND SUNDRY RECEIVABLES

| |                                      |              |            
| | ------------------------------------ | ------------ | -----------
| | Consists of -                        | December 31,
| |                                      | 2006         | 2005       
| | Prepaid operating expenses           | $    31,686  | $    81,761
| | Deposit on manufactured goods        | 17,000       | -          
| | Materials for use in clinical trials | -            | 47,138     
| | Interest receivable on investments   | 6,721        | 23,615     
| |                                      | $ 55,407     | $ 152,514  









---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

6.

PROPERTY, PLANT AND EQUIPMENT

| |                         |                   |  |                    |  |               
| | ----------------------- | ----------------- |  | ------------------ |  | --------------
| |                         | December 31, 2006
| |                         |                   |  | Accumulated        |  | Net Carrying  
| |                         | Cost              |  | Amortization       |  | Amount        
| | Land                    | $       90,000    |  | $                - |  | $       90,000
| | Building                | 560,927           |  | 58,285             |  | 502,642       
| | Office equipment        | 39,394            |  | 29,485             |  | 9,909         
| | Manufacturing equipment | 569,474           |  | 375,426            |  | 194,048       
| | Computer equipment      | 108,454           |  | 51,235             |  | 57,219        
| |                         | $   1,368,249     |  | $      514,431     |  | $      853,818
| |                         |                   |  |                    |  |               
| |                         | December 31, 2005
| |                         |                   |  | Accumulated        |  | Net Carrying  
| |                         | Cost              |  | Amortization       |  | Amount        
| | Land                    | $       90,000    |  | $                - |  | $       90,000
| | Building                | 536,759           |  | 30,663             |  | 506,096       
| | Office equipment        | 39,394            |  | 26,019             |  | 13,375        
| | Manufacturing equipment | 542,061           |  | 267,889            |  | 274,172       
| | Computer equipment      | 108,454           |  | 32,098             |  | 76,356        
| |                         | $   1,316,668     |  | $      356,669     |  | $      959,999

7.

OTHER ASSETS

| |          |                   |  |                 |  |               
| | -------- | ----------------- |  | --------------- |  | --------------
| |          | December 31, 2006
| |          |                   |  | Accumulated     |  | Net Carrying  
| |          | Cost              |  | Amortization    |  | Amount        
| | Patents  | $       53,865    |  | 4,175           |  | $       49,690
| | Goodwill | 1                 |  | -               |  | 1             
| |          | $       53,866    |  | $         4,175 |  | $       49,691
| |          |                  
| |          | December 31, 2005
| |          |                   |  | Accumulated     |  | Net Carrying  
| |          | Cost              |  | Amortization    |  | Amount        
| | Patents  | $       49,006    |  | 2,820           |  | $       46,186
| | Goodwill | 1                 |  | -               |  | 1             
| |          | $       49,007    |  | $         2,820 |  | $       46,187









---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

8.

CAPITAL STOCK

(a)

Common Shares

During 2006, the Company issued 348,850 (2005  667,817) Common Shares, of these 346,350 were issued to consultants, employees and directors, who exercised stock options, with a weighted average price per share of $0.45 for cash.  The remaining Common Shares were issued to a consultant for services rendered with an average price of $0.91.

| |                                                 |               |            
| | ----------------------------------------------- | ------------- | -----------
| |                                                 | #  of  Shares | $ Amount   
| |                                                 |               |            
| | Balance, January 1, 2005                        | 22,802,373    | $ 7,720,873
| | Issued for cash consideration                   | 667,817       | 379,380    
| | Balance, December 31, 2005                      | 23,470,190    | 8,100,253  
| | Issued for consulting services rendered in 2005 | 2,500         | 2,275      
| | Issued for cash consideration                   | 346,350       | 197,026    
| | Balance, December 31, 2006                      | 23,819,040    | $ 8,299,554



(b)

Shares to be Issued

Subsequent to the year ended 2006 there were 3,500 Common Shares issued for consulting services rendered during 2006, with a value $3,500.  During 2006, 2,500 Common Shares were issued for consulting services rendered in 2005 with a value of $2,275.

(c)

Paid-in Capital Options - Outstanding

| | 
| | 

The activities in the paid-in capital options and warrants are as follows:



| |                                                        |  |           
| | ------------------------------------------------------ |  | ----------
| |                                                        |  | $ Amount  
| |                                                        |  |           
| | Balance, January 1, 2005                               |  | $  374,712
| | Options issued to consultants                          |  | 204,303   
| | Options issued to employees                            |  | 52,976    
| | Options exercised                                      |  | (55,316)  
| | Options of consultants expired                         |  | (5,000)   
| | Options forfeited by employees                         |  | (26,650)  
| |                                                        |  |           
| | Balance, December 31, 2005                             |  | 545,025   
| | Expense recognized for options to consultants          |  | 34,534    
| | Options exercised                                      |  | (40,863)  
| | Expense recognized for options to employees/ directors |  | 77,703    
| | Options forfeited by employees                         |  | (6,561)   
| | Options of consultants expired                         |  | (95,848)  
| |                                                        |  |           
| | Balance, December 31, 2006                             |  | $  513,990











---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

8.

CAPITAL STOCK (continued)

(d)

Paid in Capital Options  Expired

| |                                       |  |           
| | ------------------------------------- |  | ----------
| |                                       |  | $ Amount  
| | Balance, January 1, 2005              |  | $   67,263
| | Options issued to consultants expired |  | 26,650    
| | Options issued to employees forfeited |  | 5,000     
| | Balance, December 31,  2005           |  | 98,913    
| | Options issued to consultants expired |  | 95,848    
| | Options issued to employees forfeited |  | 6,561     
| | Balance, December 31, 2006            |  | $  201,322



(e)

Stock Options

Under the terms of the Company's stock option plan ("Plan"), the Company is authorized to grant directors, officers, employees and others options to purchase Common Shares at prices based on the market price of shares as determined on the date of grant.  On December 31, 2006, the maximum number of Common Shares that may be issued under the Plan was 4,629,452 (2005 - 4,629,452).  Stock options become exercisable at dates determined by the Board or the Compensation Committee of the Board, with the term of an option not to exceed five years from the date of the grant of the option.



During the year ended December 31, 2006, no options (2005  775,000) were issued by the Company. The Company recorded $112,237 (2005 - $257,279) as an expense related to options issued to directors, officers, employees and consultants, for services rendered in 2006. $77,703 (2005 - $52,976) of the total expense has been recognized for options to the Companys directors, officers and employees as selling, general, and administrative expense. There were 110,000 options granted to employees in 2005 with a vesting period of 18 months with one-half of the options vesting equally at the end of each of the six fiscal quarters in 2006 and 2007. The second half of these options was contingent on the Company reaching the profit objective for fiscal 2006. The remaining $34,534 (2005 - $204,303) of the total expense has been recognized for services provided by consultants in 2006 as selling, general, and administrative expense based on the fair value of the options. The total number of options outstanding as at December 31, 2006 was 1,010,000 (2005  1,540,000).

The fair value of options granted in 2005 was estimated as $0.57 at the date of grant using the Black-Scholes option-pricing model with the following assumptions:









---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

8.

CAPITAL STOCK (continued)

| |                         |  |              
| | ----------------------- |  | -------------
| | Risk-free interest rate |  | 2.93% - 3.47%
| | Expected life           |  | 3 years      
| | Expected volatility     |  | 54% - 58.9%  
| | Dividend yield          |  | 0%           

On June 29, 2005, pursuant to resolutions by the Board of Directors and shareholders, the Company increased the number of options in the plan to 4,629,452 from 4,157,841.



The following table presents information relating to stock options outstanding and exercisable at December 31, 2006.



| |                         |                    |                                            |                                 |                                         |                                
| | ----------------------- | ------------------ | ------------------------------------------ | ------------------------------- | --------------------------------------- | -------------------------------
| | Range of
Exercise Price | Number Outstanding | Weighted Average RemainingContractual Life | Weighted Average Exercise Price | Number Exercisable at December 31, 2006 | Weighted Average
Exercise
Price
| | $0.91 to $1.99          | 395,000            | 1.5 years                                  | $ 1.19                          | 342,500                                 | $ 1.23                         
| | $2.00 to $2.05          | 245,000            | .24 years                                  | 2.02                            | 245,000                                 | 2.02                           
| | $2.08 to $3.52          | 370,000            | .28 years                                  | 2.41                            | 370,000                                 | 2.29                           
| |                         | 1,010,000          | .75 years                                  | $ 1.84                          | 957,500                                 | $ 1.89                         



The following table presents information relating to stock options outstanding and exercisable at December 31, 2005.

| |                         |                    |                                            |                                 |                                         |                                 | 
| | ----------------------- | ------------------ | ------------------------------------------ | ------------------------------- | --------------------------------------- | ------------------------------- | 
| | Range of
Exercise Price | Number
Outstanding | Weighted Average RemainingContractual Life | Weighted Average Exercise Price | Number Exercisable at December 31, 2005 | Weighted
Average
Exercise
Price
| | $0.33 to $0.79          | 375,000            | .56 years                                  | $ 0.47                          | 375,000                                 | $ 0.47                         
| | $0.80 to $1.99          | 400,000            | 2.5 years                                  | 1.18                            | 48,334                                  | 1.66                           
| | $2.00 to $3.54          | 765,000            | 1.13 years                                 | 2.29                            | 765,000                                 | 2.29                           
| |                         | 1,540,000          | 1.35 years                                 | $ 1.56                          | 1,188,334                               | $ 0.85                         











---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

8.

CAPITAL STOCK (continued)

The activities in options outstanding are as noted below:

| |                            |           |          |                                 | 
| | -------------------------- | --------- | -------- | ------------------------------- | 
| |                            |           | Options  | Weighted
Average
Exercise
Price
| | Balance, January 1, 2005   | 1,590,000 | $   0.98
| | Granted                    | 775,000   | 1.18    
| | Exercised                  | (667,817) | 0.49    
| | Forfeited                  | (157,183) | 1.33    
| | Balance, December 31, 2005 | 1,540,000 | 1.56    
| | Cancelled                  | (5,000)   | -       
| | Exercised                  | (346,350) | 0.45    
| | Forfeited                  | (178,650) | 2.14    
| | Balance, December 31, 2006 | 1,010,000 | $  1.84 



When employees or non-employees exercise their stock options, the capital stock is credited by the sum of the consideration paid together with the related portion previously credited to additional paid-in capital when compensation costs were charged against income.

The weighted average fair value of options granted during the year ended December 31, 2005 was estimated to be $0.52.  There were no options granted during the year ended December 31, 2006.

9.

REVENUES

Revenue for the year includes products sold in Canada and, international sales of products and raw materials sold at cost to our European licensee.  Revenue earned is as follows:

| |                                       |              |                | 
| | ------------------------------------- | ------------ | -------------- | 
| |                                       | December 31,
| |                                       | 2006         | 2005          
| | Products Sales                        |              |               
| | Domestic sales                        | $ 1,314,641  | $ 1,528,352   
| | International sales                   | 106,343      | 86,346        
| | Other revenue                         | 6,280        | 12,972        
| | Total Product Sales                   | $ 1,427,264  | $ 1,627,670   
| |                                       |              |               
| | Royalties and licensing revenue       | 2006         | 2005          
| | Licensing fees                        | $ 2,548,352  | $        2,923
| | Royalty payments                      | 402,081      | 311,658       
| | Total royalties and licensing revenue | $ 2,950,433  | $    314,581  











---







STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

9.

REVENUE (continued)

The Company currently sells its own products and is in-licensingother products in Canada.  In addition, revenues include products which the Company out-licenses in Europe, the Caribbean, Lebanon, Malaysia, Kuwait, Romania the United Arab Emirates and Turkey.  The continuing operations reflected in the statements of operations include Stellars activity in these markets.

10.

OTHER PRODUCT COST

In November of 2005, the Company experienced higher than anticipated reports of side effects with one of its products, NeoVisc and withdrew this batch from sale.  Subsequent to a second batch of the product released in early 2006, the Company decided to stop the sale of product from this batch  The Company has recorded $29,205 as other product cost in 2006 (2005 - $123,152).

11.

INCOME TAXES

Rate reconciliation

A reconciliation of income tax expense (benefit) computed at the statutory income tax rate included in the statements of operations follows:

| |                                                           |  |                    |                  
| | --------------------------------------------------------- |  | ------------------ | -----------------
| | Income tax expense (benefit) is comprised of:             |  | 2006               | 2005             
| |                                                           |  |                    |                  
| | Income tax expense (recovery) at statutory rate at 36.12% |  | $   355,940        | $  (628,668)     
| | Adjusted for:                                             |  |                    |                  
| | Benefits realized from loss carried forward               |  | (404,269)          | -                
| | Tax deferral from timing differences on expenses          |  | 3,496              | 128,150          
| | Non-deductible expenses                                   |  | 44,833             | 96,751           
| | Non-recognition of tax benefit from net losses            |  | -                  | 403,767          
| |                                                           |  | $                - | $               -



Deferred tax assets and liabilities reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their corresponding tax basis. A significant component of net deferred tax assets is as listed below:

Components of deferred income tax assets and liabilities:

| |                                                                                    |  |                   |                  
| | ---------------------------------------------------------------------------------- |  | ----------------- | -----------------
| |                                                                                    |  | 2006              | 2005             
| |                                                                                    |  |                   |                  
| | Benefit of net operating loss carry-forward                                        |  | $   835,900       | $ 1,217,000      
| | Book values of property and equipment and intangible assets in excess of tax bases |  | (23,000)          | -                
| | Valuation allowance                                                                |  | (812,900)         | (1,217,000)      
| |                                                                                    |  | $               - | $               -











---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

11.

INCOME TAXES (continued)



The valuation allowance was provided against the net deferred tax assets at December 31, 2006 and 2005, because the Company has determined that it is more likely than not, that benefit for the assets will not be realized.





The Company has non-capital losses carry-forward for income tax purposes in the amount of $2,313,822 which may be applied against future years taxable income. The losses expire as follows:



| |      |              
| | ---- | -------------
| | 2009 | $      62,874
| | 2010 | 542,224      
| | 2014 | 706,270      
| | 2015 | 1,002,454    
| |      | $ 2,313,822  

12.

EARNINGS (LOSS) PER SHARE



The treasury stock method assumes that proceeds received upon the exercise of all warrants and options outstanding in the year are used to repurchase the Company's shares at the average share price during the period.

The following table sets forth the computation of earnings (loss) per share:

| |                                                              |                    |                    
| | ------------------------------------------------------------ | ------------------ | -------------------
| |                                                              | 2006               | 2005               
| | Net income (loss) per share available to common shareholders | $     1,255,225    | $ (1,740,498)      
| | Weighted average Common Shares outstanding                   | 23,575,479         | 23,182,107         
| | Diluted weighted average number of Common Shares outstanding | 23,634,070         | -                  
| | Basic earnings (loss) per share                              | $             0.05 | $         (0.08)   
| | Diluted earnings per share                                   | $             0.05 | $                 -

13.

CONTINGENCIES AND COMMITMENTS

(a)

Royalty Agreements

In September 2000, the Company entered into a royalty agreement for sales of Uracyst® product.   The agreement involves royalty payments, which initially were based on 5% of the total sales of Uracyst at a declining rate of 1% per year over a three-year period, declining to 2% rate effective October 1, 2003 and this royalty will remain at 2% until the end of the agreement on September 30, 2008. The total royalty payments for the year ended December 31, 2006 were $4,549 (2005 - $3,414). These amounts have been recorded as royalty expense in selling, general and administrative.

In February 2002, the Company entered into a royalty agreement for products which were introduced to the Company by a consultant.  The agreement involves royalty payments, which will be paid based on gross dollar sales.   The schedule for royalty payments is presently calculated on Skelite® sales as:









---







STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

13.

CONTINGENCIES AND COMMITMENTS (continued)

First $1,000,000 in sales  3%

Second $1,000,000 in sales  2%

All sales over $2,000,000  1% out to the 5th year.

(b)   License Agreements

The Company has the following license agreements in place:



In December 2006, the Company entered into license and supply agreements with Watson Pharma, Inc. to grant the exclusive rights and license to use the methods and technical know-how for the purposes of developing, marketing and selling Uracyst products in the United States.  As provided in the agreements, the Company received non-recurring, non-refundable license fees which were recognized as income in 2006.  The term of this agreement will continue for a period of fifteen years and will be renewable for an additional two years, unless earlier terminated by either party in accordance with the agreement.



In July 2006, the Company entered into a licensing agreement with Bio-technic Romanaia SRL for NeoVisc in Romania.  This agreement is for a period of three years.



In July 2005, the Company entered into a license agreement with Innogen Ilac for the sale of NeoVisc in Turkey.  In August 2005, the Company entered into a distribution agreement with TECHNIMED for the sale of NeoVisc in Lebanon. In September 2005, the Company entered into a license agreement with Shanghai Ya Jun Medical for the sale of Uracyst in China.  Each of these agreements is for a period of 3 years.



In November 2005, the Company entered into a license agreement with Al-Mohab Trading & Contracting for the sale of NeoVisc in Kuwait.  This agreement is for a period of three years.



The Company also entered into a license agreement with Mega Pharm for the sale of Uracyst in Israel in December 2005.  This agreement is for a period of five years.



On June 30, 2004, the Company signed a NeoVisc® license agreement with Triptibumis Sdn. Bhd. ("Triptibumis") for Malaysia, Singapore and Brunei.  The Company will supply Triptibumis with NeoVisc in Canadian packaging at a set price for this market.  The term of this agreement will continue for a period of three years and will be renewable for an additional three years, unless earlier terminated by either party in accordance with the agreement.



On August 17, 2004, the Company entered into a license agreement with Pharmore GmbH ("Pharmore") to sell NeoVisc in the German market.  The Company will supply NeoVisc in a German package format at a set price.  This agreement will require Pharmore to pay a 5% royalty on their net sales (gross sales less allowances and returns) in the German market. Pharmore will be responsible for all costs incurred in obtaining both German regulatory approval and registering the









---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

13.

CONTINGENCIES AND COMMITMENTS (continued)



CE mark for NeoVisc, plus all sales, marketing and distribution costs.  The term of this agreement is for a period of three years and will be renewable for an additional three years, unless earlier terminated by either party in accordance with the agreement.



On December 28, 2001, the Company entered into a license agreement with G. Pohl-Boskamp GmbH & Co. ("Pohl-Boskamp"), to grant the exclusive rights and license to use the methods and technical know-how for the purposes of manufacturing, marketing and selling Uracyst-S products in specified territories in Europe.  In consideration, the Company is to receive a combination of non-recurring, non-refundable license fees and royalty payments.  The license fees are due upon achievement of specified milestones.



One of the license fees was due upon signing of the agreement and was recognized as income during the fiscal year 2001, and the remaining license fees are recognized in income upon meeting revenue recognition criteria.



The royalties, which equal 17.5% of net sales of each quarter, are to be paid in arrears on or before the 45th day of each quarter with respect to net sales in the preceding quarter.  Until such time as there are net sales aggregating three million dollars, only 7.5% of the 17.5% royalty will be paid to the Company with the balance of 10% of the royalty being credited against the license fee.  The agreement will expire seven years after December 21, 2001 or unless earlier terminated by the parties in accordance with the agreement.



(c)

Distribution Agreement

In October 2003, the Company entered into an exclusive agreement with a company in the United States, to manufacture and distribute bladder cancer test kit products within the field and territory as defined in the agreement, for a five year period commencing January 1, 2004, in consideration for a technology access fee of US$10,000 and an initial order.  Either party may terminate the agreement 30 days after delivery of written notice for failure to correct a material default under the agreement.  The Company may terminate the agreement immediately, in the event that any conditions specified in the agreement are not satisfied.

(d)

Manufacturing Agreement

On April 20, 2004, the Company signed a manufacturing agreement with Dalton Chemical Laboratories, Inc. in Toronto, Ontario, Canada, to manufacture Stellars NeoVisc® product.  The agreement is for five years and may be renewed only by a written agreement between the parties.  This agreement, along with the agreement to manufacture Uracyst® previously made with Dalton, will allow the Company to expand the sale of its products in international markets.









---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

13.

CONTINGENCIES AND COMMITMENTS (continued)

(e)

Leases

The Company presently leases office equipment under operating leases.  At December 31, 2006, the remaining future minimum lease payments under operating leases are $2,383 (2005 - $4,429).

(f)

Consulting Agreements

In December 2004, the Company entered into two consulting agreements with investor relations firms, which included services, which would be rendered in 2005 and 2006.  Under the terms of the agreements options of 250,000 were issued to the Equity Group and are exercisable at $2.07 per share with such options vesting quarterly in equal portions.  Of these options 125,000 were for services provided in 2005 and the remaining 125,000 were granted for services to be provided in 2006.  These options have a term expiring on June 1, 2007.  In addition, 120,000 options were issued to FF Investors LLC.  Of these 120,000 options, 40,000 are exercisable at $2.69 per share, 40,000 are exercisable at $3.11 per share and the final 40,000 options are exercisable at $3.52 per share.  All of these 120,000 options vest quarterly in equal portions over the two years following the day of grant and have a term expiring on April 4, 2007.

In June 2005, the Company entered into an agreement with Basic Investors to provide management and financial consulting services to the Company.  The term of this agreement is for a period of six months, which will continue until February 2006.  This agreement was satisfied in full by the issuance of monthly payments of $4,000US in cash, in arrears. The Company has recorded $9,197 (2005 - $14,051) as selling, general and administrative costs.

In May 2005, the Company entered into a research agreement with a major United States University.  This program is on Bladder Urothelial research in interstitial cystitis and will cost the Company US$194,350 for the period May 2005 to May 2007, to be paid over the term of the agreement. The Company has recorded $126,216 (2005 - $54,442) as selling, general and administrative costs.

14.

SIGNIFICANT CUSTOMERS

During the year, the Company had one customer that represented 36.0% of sales (2005  34.4%).

15.

RELATED PARTY TRANSACTIONS

The Company entered a fiscal advisory and consulting agreement with LMT Financial Inc. (a company beneficially owned by a director and his spouse) for services to be provided. Compensation under the agreement is $6,000 per month.  The Company has recorded $72,000 (2005 - $72,000) as selling, general and administrative costs.









---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

16.

FINANCIAL RISKS

(a)

Credit Risk



The Company is engaged in the sale of pharmaceutical products, typically to a small number of major customers, although the composition of this group of customers has changed from year to year.  The Company performs ongoing credit evaluation of its customers' financial condition and, generally, requires no collateral.



(b)

Concentration Risk



The Company's cash and cash equivalents are maintained with two Canadian banking institutions and one institution in Ireland.  Deposits held with these banks may exceed the amount of insurance provided on such deposits ($60,000 per bank). Generally, these deposits may be redeemed upon demand and, therefore, bear minimum risk.



As at December 31, 2006 the Company had two customers which made up 78.0% of the outstanding accounts receivable, in comparison to two customers which made up 63.8% at December 31, 2005.  The largest portion of the outstanding accounts receivable is in regards to royalty revenue owed at the end of the year, which is 64.1% (2005  23.3%) of this value.  This payment is due on or before February 15, 2007.

(c)

Currency Risk



The Company is subject to currency risk through its revenues earned and expenses incurred in US dollars and Euros.



Unfavorable changes in the exchange rate may affect the operating results of the Company.



The Company does not actively use derivative instruments to reduce its exposure to foreign currency risk.  However, dependant on the nature, amount and timing of foreign currency receipts and payments, the Company may enter into forward exchange contracts to mitigate the associated risks.  There were no forward exchange contracts outstanding at December 31, 2006 and 2005.



(d)

Fair Value of Financial Assets and Liabilities



The carrying amounts of the Companys financial assets and liabilities including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value due to short-term maturity of these items.





17.

RECONCILATION OF CANADIAN AND UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("US GAAP")



These financial statements were prepared in accordance with GAAP in the United States.  The Company has included the significant differences which would result if the Canadian GAAP were applied in the preparation of the Statement of Operations, the Balance Sheet and the Statement of Cash Flows. These statements are as follows:









---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2006

17.

RECONCILATION OF CANADIAN AND UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("US GAAP") continued

Statement of Operations



|                                                       |                                             |                   |           |                   |          
|------------------------------------------------------ | ------------------------------------------- | ----------------- | --------- | ----------------- | ---------
|For the Year Ended December 31                         |                                             | 2006              |           | 2005             
|                                                       |                                             |                   |           |                   |          
|Net income (loss), as reported under US GAAP           |                                             | $       1,255,225 |           | $      1,740,498)
|                                                       | Adjustments to arrive at Canadian GAAP      |                   |           |                   |          
|                                                       | Research and development expense            |                   | -         |                   | 490,694  
|                                                       | Amortization expense                        |                   | (269,787) |                   | (135,901)
|Net Income (loss) based on Canadian GAAP               |                                             | $         985,438 |           | $      1,385,705)
|                                                       |                                             |                   |           |                   |          
|Earnings per share (Basic) - US GAAP net income (loss) |                                             | $0.05             |           | ($0.08)          
|                                                       | - Canadian GAAP net income (loss)           |                   | $0.04     |                   | ($0.07)  
|                                                       | (Fully diluted) - US GAAP net income (loss) |                   | $0.05     |                   | -        
|                                                       | - Canadian GAAP net income (loss)           |                   | $0.04     |                   | -        





Balance Sheet



|                             |         |               |               |                    |                |               |               |               |               |                    |               |               |              
|---------------------------- | ------- | ------------- | ------------- | ------------------ | -------------- | ------------- | ------------- | ------------- | ------------- | ------------------ | ------------- | ------------- | -------------
|As at December 31            |         | 2006          |               | 2005              
|                             |         |               |               |                    |                |               |               |               |               |                    |               |               |              
|                             |         |               | United States |                    | Increase       |               | Canadian      |               | United States |                    | Increase      |               | Canadian     
|                             |         |               | GAAP          |                    | (Decrease)     |               | GAAP          |               | GAAP          |                    | (Decrease)    |               | GAAP         
|                             |         |               |               |                    |                |               |               |               |               |                    |               |               |              
|Current assets               |         | $   4,044,901 |               | $                - |                | $   4,044,901 |               | $   2,707,355 |               | $                - |               | $   2,707,355
|Property plant and equipment | 853,818 |               | -             |                    | 853,818        |               | 959,999       |               | -             |                    | 959,999      
|Other assets                 |         | 49,691        |               | 910,735            |                | 960,426       |               | 46,187        |               | 1,180,521          |               | 1,226,708    
|                             |         |               | $   4,948,410 |                    | $      910,735 |               | $   5,859,145 |               | $   3,713,541 |                    | $   1,180,521 |               | $   4,894,062
|                             |         |               |               |                    |                |               |               |               |               |                    |               |               |              
|Current liabilities          |         | 362,724       |               | -                  |                | 362,724       |               | 653,755       |               | -                  |               | 653,755      
|Shareholders' equity         |         | 4,585,686     |               | 910,735            |                | 5,496,421     |               | 3,059,786     |               | 1,180,521          |               | 4,240,307    
|                             |         |               | $   4,948,410 |                    | $      910,735 |               | $   5,859,145 |               | $   3,713,541 |                    | $   1,180,521 |               | $   4,894,062











---





Statements of Cash Flows

|                                                               |  |                      |  |                     | 
|-------------------------------------------------------------- |  | -------------------- |  | ------------------- | 
|For the Year Ended December 31                                 |  | 2006                 |  | 2005               
|                                                               |  |                      |  |                     | 
|Cash flows for operating activities, as reported under US GAAP |  | $        1,310,215   |  | $      (1,205,707) 
|Development costs deferred for Canadian GAAP purposes          |  | -                    |  | 490,694            
|Cash flows for operating activities, Canadian GAAP             |  | $        1,310,215   |  | $         (715,013)
|                                                               |  |                      |  |                     | 
|Cash flows for investing activities, as reported under US GAAP |  | $           (56,440) |  | $         (182,473)
|Development costs deferred for Canadian GAAP purposes          |  | -                    |  | (490,694)          
|Cash flows for investing activities, Canadian GAAP             |  | $           (56,440) |  | $         (673,167)
|                                                               |  |                      |  |                     | 
|For the Year Ended December 31                                 |  | 2006                 |  | 2005               
|                                                               |  |                      |  |                     | 
|Cash flows for financing activities, as reported under US GAAP |  | $           156,162  |  | $           324,064
|Change in cash and cash equivalents                            |  | 1,406,438            |  | (1,064,115)        
|Cash and cash equivalents, opening                             |  | 2,108,755            |  | 3,172,870          
|Cash and cash equivalents, closing                             |  | $        3,515,193   |  | $        2,108,755 





17.

RECONCILATION OF CANADIAN AND UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (continued)

Amortization of certain other assets is being provided for on the straight-line basis as noted below:



Asset Classification

Useful Life

Deferred development costs  products available for sale

5 years

Incorporation expenses

10 years

Deferred development costs relate to the development of the products, all of which were available for sale by the end of 2006.  The Company continues to invest in research necessary to expand its products revenues.  In 2005, the Company incurred manufacturing development costs associated with the development of its NeoVisc high molecular weight product.  These costs are amortized as deferred manufacturing development costs for Canadian GAAP purposes but under United States GAAP they cannot be capitalized.  Amortization in regards to these development costs starts once the product is ready for sale in the market.

18.

RECENT ACCOUNTING PRONOUNCEMENTS



Recent accounting pronouncements followed by the Company under U.S. GAAP are summarized below.



(a)

SFAS No. 151.  SFAS No. 151, Inventory Costs, an amendment to Accounting Research Bulletin No. 43, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material.  This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of so normal.  Additionally, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.  The provisions of SFAS No. 151 have been adopted by the Company in 2006 with no material impact to the financial statements.











---





STELLAR PHARMACEUTICALS INC.

NOTES TO FINANCIAL STATEMENTS

(Canadian Funds)

DECEMBER 31, 2005

18.

RECENT ACCOUNTING PRONOUNCEMENTS (continued)

(b)

SFAS No. 153.  SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment to Accounting Principles Board Opinion No. 29. Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged.  The guidance in that Opinion, however, included certain exceptions to that principle.  This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges in which the future cash flows of the entity are not expected to change significantly as a result of the exchange.  The provisions of SFAS No. 153 have been adopted by the Company in 2006 with no material impact to the financial statements.



(c)

SFAS No. 48.  SFAS No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. which is a change in accounting for income taxes. This Statement specifies how tax benefits for uncertain tax positions are to be recognized, measured, and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions. SFAS 48 is effective for fiscal years beginning after December 15, 2006 and as a result is effective for the Company in the first quarter of fiscal 2007.  The Company is currently evaluating the impact of SFAS 48 on its financial statements.



(d)

SFAS No. 157.  In September 2006, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 157," Fair Value Measures."  SFAS No. 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  The Company is currently evaluating the impact that the adoption of SFAS No. 157 will have on our future financial statements.



(e)

SFAS No. 108. In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" ("SAB 108"), which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 is effective for fiscal years ending after November 15, 2006, allowing a one-time transitional cumulative effect adjustment to beginning retained earnings as of January 2006 for errors that were not previously deemed material, but are material under the guidance in SAB 108.  The Company adopted SAB 108 in the fourth quarter of 2006 with no material impact to our financial statements.

19.

SEGMENTED INFORMATION

The Company is engaged in one line of business which is in the development and marketing of polysaccharide-based therapeutic products used in a treatment of osteoarthritis and certain types of cystitis.  Currently, all direct sales take place in Canada.  Licensing arrangements have been obtained to distribute and sell the Companys products in various countries including the United States of America.









---







20.

COMPARATIVE FIGURES

Certain comparative figures have been reclassified to conform to the current year's presentation.









---





MANAGEMENT'S DISCUSSION AND ANALYSIS

This document was prepared on March 26, 2007 and should be read in conjunction with the December 31, 2006 financial statements of Stellar Pharmaceuticals Inc. ("Company").

FORWARD-LOOKING STATEMENTS

Readers are cautioned that actual results may differ materially from the results projected in any "forward-looking" statements included in this report, which involve a number of risks or uncertainties. Forward-looking statements are statements that are not historical facts, and include statements regarding the Companys planned research and development programs, anticipated future losses, revenues and market shares, planned clinical trials, expected future expenditures, the Companys intention to raise new financing, sufficiency of working capital for continued operations, and other statements regarding anticipated future events and the Companys anticipated future performance. Forward-looking statements generally can be identified by the words "expected", "intends", "anticipates", "feels", "continues", "planned", "plans", "potential", "with a view to", and similar expressions or variations thereon, or that events or conditions "will", "may", "could" or "should" occur, or comparable terminology referring to future events or results.

The Companys actual results could differ materially from those anticipated in these forward-looking statements as a result of numerous factors, including those listed under "Risks and Uncertainties", any of which could cause actual results to vary materially from current results or the Company's anticipated future results. The Company assumes no responsibility to update the information contained herein.

OVERVIEW

Stellar founded in 1994, is a Canadian pharmaceutical company involved in the development and commercialization of high quality, polysaccharide-based therapeutic products used in the treatment of osteoarthritis and certain types of cystitis.  Stellar also markets a test kit that confirms the existence of bladder lining defects in interstitial cystitis ("IC") (an inflammatory disease of the urinary bladder wall) patients and helps identify those patients who should respond positively to the Companys proprietary therapeutic product. Stellars product development strategy focuses on seeking novel applications for its product technologies in markets where its products demonstrate true cost effective therapeutic advantages. Stellar is also building revenues through in-licensing products for Canada that are focused on similar niche markets and out-licensing to international markets.

Stellar has developed and is marketing three products in Canada based on its core polysaccharide technology:

(i)

NeoVisc®, for the treatment of osteoarthritis;

(ii)

Uracyst®; for the treatment of IC, and;

(iii)

Uracyst® Test Kit, Stellars patented technology for the diagnosis of IC.

Stellar also has acquired the exclusive Canadian marketing and distribution rights for:

(i)

Millenium Biologix Inc.’s SkeliteTM, a proprietary synthetic bone grafting product; and

(ii)

Matritech’s, NMP22® BladderChek®, a proteomics-based diagnostic test for the diagnosis and monitoring of bladder cancer.

Stellar began selling Skelite to the Canadian market in February 2004 and NMP22 BladderChek in Canada, in October 2004. NMP22 BladderChek has had a small impact on 2006 sales but is expected to play a larger part in the sales mix going forward.



Effective December 2001, Stellar entered into a strategic licensing agreement with G. Pohl-Boskamp GmbH & Co. ("Pohl-Boskamp") for the sale of Uracyst products in Europe. In December of 2003, Pohl-Boskamp received approval to begin selling Uracyst in Europe.



In September 2002, Stellar was granted the exclusive Canadian marketing and distribution rights to sell Skelite® by Millenium Biologix Inc.  Skelite is a bone void filler that is resorbed by the natural remodeling process and replaced with new bone during the healing period.  Stellar commenced sales of Skelite in Canada in January 2004.



In June 2003, Stellar entered into distribution agreements with BurnsAdler Pharmaceuticals to sell Stellars products in Latin America and the Caribbean.









---







In October 2003, the Company entered into an exclusive distribution agreement with Matritech, Inc., to sell NMP22®BladderChek® ("BladderChek") in the Canadian market. BladderChek is a unique point of care diagnostic, used in the diagnosis and monitoring of bladder cancer.  In October 2004, Stellar commenced selling BladderChek in Canada.

In March 2004, the Company entered into supply and license agreements with SJ Pharmaceuticals, Inc. (now Leitner Pharmaceuticals Inc.) ("Leitner") of Bristol, Tennessee. Under these agreements, Leitner was granted an exclusive license to use certain methods and technical know-how of the Company for the purposes of developing, marketing and selling NeoVisc and Uracyst products in the United States.  In addition to an upfront payment made to the Company upon signing, these agreements were to provide Stellar with milestone payments and an ongoing royalty stream from future sales of these products in the United States.  Leitner was to be responsible for conducting clinical trials and obtaining regulatory approvals for these products in the United States. These agreements were terminated in March of 2006 under amicable circumstances.

In June 2004, Stellar entered into a NeoVisc licensing agreement with Triptibumis Sdn. Bhd. for Malaysia, Singapore and Brunei.  The first shipment to this market was initiated in October 2004.  Although this agreement covers a relatively small market, Stellar pursued this agreement to further its global expansion.

In July 2005, Stellar entered into a licensing agreement with Innogen Ilac for the sale of NeoVisc in Turkey.  In August 2005, the Company entered into a distribution agreement with Technimed for the sale of NeoVisc in Lebanon.



In September 2005, the Company entered into a licensing agreement with Shanghai Ya Jun Medical for the sale of Uracyst in China.  Stellar also entered into licensing agreements with Al-Mohab Co. for the sale of NeoVisc® in Kuwait in November 2005 and with Mega Pharm for the sale of Uracyst in Israel in December 2005.

In July 2006, a licensing agreement was signed with Bio-Technic Romania Srl for NeoVisc® in Romania and subsequently, in August of 2006 the Company received its CE Mark for NeoVisc in Europe.



The Company signed a licensing and supply agreement with Watson Pharma, Inc. ("Watson") in December 2006 for Uracyst in the United States market. Under this agreement, Watson was granted an exclusive license to develop, market and sell Uracyst in the United States.  In addition to an upfront payment made to the Company upon signing, this agreement will provide Stellar with milestone payments and an ongoing royalty stream from future sales of Uracyst in the United States.  Watson will be responsible for conducting clinical trials and obtaining regulatory approvals for Uracyst in the United States

Stellar markets its products in Canada through its own direct sales force of commissioned and salaried sales people. The Companys focus on product development continues to be both in-licensing and out-licensing for immediate impact on the revenue stream allowing Stellar to fund its own in-house product development for future growth and stability.

FOURTH QUARTER 2006 HIGHLIGHTS

In both October and November 2006, the Company was profitable from operations achieving a goal set for 2006. The payment received for signing the Watson license agreement made the Company profitable for the year.

Revenues for the three-month period ended December 31, 2006, from all sources increased 485.6% to $3,061,630 compared to $522,823 in the same period during 2005. This growth was mainly due to the initial payment received from the signing of the Watson license agreement, completed in December of 2006. Without this licensing revenue, income for the quarter in 2006 was $521,730 compared to $522,823 for the same period in 2005. Revenue for 2006 was impacted by a decline of $32,360 in international sales, which were attributed to one customer.  An order has been received from this customer with revenues for this sale to be recognized in the second quarter of 2007.

Although domestic NeoVisc sales for the quarter were down 8.8% compared to the same period in 2005, this product continues to regain market share from the problems experienced in the fourth quarter of 2005 and first quarter of 2006.  In November of 2005, the Company experienced higher than normal reports of side effects from a NeoVisc batch. Since the process being used was relatively new, the Company chose to react on the side of caution and withdrew this batch from sale. This batch was thoroughly reviewed by the Companys quality management team and was found to be within specifications for all control factors. The Company did extensive research in an attempt to find the causative factor. This research pointed to a process change by a raw material supplier, which when corrected, eliminated the increased trend of side effects with NeoVisc. The result of this incident dramatically depressed NeoVisc sales in the fourth quarter of 2005, showing a decrease in sales in the Canadian market of 9.1% which carried over to the first half of 2006.









---





This trend was compounded by the opportunity it presented to two new competitive products in the Canadian market. NeoVisc has regained market share in the last quarter of 2006 as the Company placed a focus on a campaign to recapture market share.  Although there can be no assurance,  the Company is confident that this trend will continue in 2007.



Uracyst sales grew by 23.1% for the quarter as the Canadian marketing focus on Uracyst continues to show good results. GAG deficient cystitis has few successful therapies and Uracyst is establishing its dominance as a treatment of choice for this disorder.



In-licensed revenue from NMP22 BladderChek also grew by 353.9% for the quarter, as this point-of-care diagnostic and monitoring device for bladder cancer continues to gain acceptance by Canadian urologists.



During this quarter, business development activities were focused on completing the Uracyst licensing agreement with Watson for the United States market.  The signing of this agreement will help to further the accelerated growth of Uracyst on a global basis.  Increased one time professional fees of $252,596, were incurred in connection with this agreement, which the Company has recorded as selling, general and administrative expenses.

RESULTS OF OPERATIONS FOR THE TWELVE MONTH PERIOD ENDED DECEMBER 31, 2006

For the year ended December 31, 2006, total operating revenues from all sources increased 125.4% to $4,377,697 compared to $1,942,251 in the same period during 2005.  When revenue for 2006 is adjusted for licensing fees of $2,548,352, the revenues for 2006 would show a decrease of 5.7%. This growth was negatively impacted by the NeoVisc decline of 21.5% as discussed above in the review of the fourth quarter highlights. In 2006, Uracyst revenue grew by 33.8% over 2005 due mainly to growth in the Canadian market.

BladderChek sales grew by 95.4% in 2006 due to strong clinical support in the United States and growing physician support in Canada.

Gross profit for 2006 was up 194.4% to $3,921,549 compared to $1,332,270 in 2005. The Companys net income increased to $1,255,225 in 2006 compared to a loss of $1,740,498 for 2005. Although profitability was driven by licensing revenue, profitability from operations experienced in both October and November 2006 will be an objective for the Company in 2007.

During 2006, the Company incurred non-cash expenses totaling $271,354. The Company recorded an expense of $112,237 which was related to options granted in 2005 that vested in 2006, of which $77,703 was for options issued to employees and directors as compensation expenses. The balance of $34,534 was related to share options granted to consultants and has been expensed under professional fees as a consulting expense. Stellar also incurred non-recurring costs of $363,984, which includes $321,846 for professional fees related to the completion of the Watson license agreement and $42,139 for obsolete materials intended for use in the NeoVisc clinical trials.

Cost of Sales

Cost of goods sold for the twelve-month period ended December 31, 2006, was $419,652 (without the effect of the $36,496 for other product costs and write-downs) or 29.4% of product sales compared to $450,591 or 27.7% of product sales in 2005. The costs associated with NeoVisc had a negative impact on the cost of goods for 2006 with fluctuation in production yields associated with the manufacturing process. However, proposed improvements in the manufacturing process in 2007 are expected to improve the cost of goods going forward.

Other Product Costs

In November of 2005, the Company experienced higher than anticipated reports of side effects with one of its products, NeoVisc and withdrew this batch from sale.  Subsequent to a second batch of the product released in early 2006, although not showing the same degree of side effects, which carried the same component which was determined by the Company to have caused these side effects, the Company decided to stop the sale of product from this batch and a write-off was recorded.  The Company has recorded $29,205 as other product cost in 2006 (2005 - $123,152). The Company has reviewed the returns in regards to this withdrawal and feels no further liability exist.









---





Research and Development

Stellar continues to invest in research, which is essential to advancing the use of its products in Canada and in international markets. In the twelve month period ended December 31, 2006, the Company incurred $217,607, in research costs compared to $608,957 in 2005.

In 2006, the Company continued developing its manufacturing processes to improve yields from both Uracyst and NeoVisc production. This work is expected to help improve the cost of these products and therefore Stellars competitiveness in the global market.

In 2006, the Stellar continue to work with Dr. Robert Hurst from the University of Oklahoma on Uracyst and its treatment of GAG deficient cystitis. Dr. Hursts work is expected to further enhance Uracyst treatment of this bladder defect.

Business Development

Progress continues to be made as Stellar focuses on a number of business development activities associated with out-licensing Stellars current products in other international markets, in-licensing products for the Canadian market and developing additional products.  As previously referenced in the overview, Stellar entered into two new out-licensing distribution agreements in 2006. Stellar also received its CE mark in August of 2006 for NeoVisc. These events are in furtherance of Stellars objective to create a global presence for its products.



Selling, General and Administrative Expenses

Selling, general and administrative expenses for the year ended December 31, 2006 were $2,332,452, compared to $2,418,918 for the same period in 2005. This decrease includes the cost of $112,237 (2005 - $257,279) related to non-cash expenses for stock options issued to consultants and the directors of the Company. During this period, the Company incurred fee expenses to members of the board of directors, which totaled $42,000 (2005 - $42,666).

Interest and Other Income

Interest and other income for the year ended December 31, 2006 was $42,852 as compared to $99,689 during the same period in 2005. This amount includes the investment of dividends; interest received on a short-term loan and the gain on a sale of short term investments. Cash will be maintained in liquid investments.

SUMMARY OF QUARTERLY RESULTS



|                                                         |             |             |                   |                   |  |                          
|-------------------------------------------------------- | ----------- | ----------- | ----------------- | ----------------- |  | -------------------------
|Quarter Ended                                            |             | Revenues    |                   | Net income (loss) |  | Earnings (loss) per share
|December 31, 2006*                                       | $ 3,061,630 | $ 2,120,263 | $            0.09
|September 30, 2006                                       | 429,868     | (278,771)   | (0.01)           
|June 30, 2006                                            | 440,281     | (232,327)   | (0.01)           
|March 31, 2006                                           | 445,917     | (354,044)   | (0.02)           
|December 31, 2005                                        | 522,823     | (485,366)   | (0.02)           
|September 30, 2005                                       | 497,789     | (453,165)   | (0.02)           
|June 30, 2005                                            | 496,341     | (347,312)   | (0.02)           
|March 31, 2005                                           | 425,298     | (454,655)   | (0.02)           
|* Includes one-time license fee income of US$2.2 million |            











---





SELECTED FINANCIAL RESULTS AND HIGHLIGHTS

A discussion of the reasons behind the variations in the following numbers can be found under the heading Results of Operations for the Twelve Month Period Ended December 31, 2006.

|                                                                     |             |               |              
|-------------------------------------------------------------------- | ----------- | ------------- | -------------
|Income Statement for the year ended                                  | 2006        | 2005          | 2004         
|Total revenue                                                        | $ 4,377,697 | $   1,942,251 | $   1,832,325
|Cost of goods sold                                                   | 419,652     | 450,591       | 340,123      
|Other product costs / write-down                                     | 36,496      | 159,390       | -            
|Expenses                                                             | 2,709,176   | 3,172,457     | 2,933,428    
|Income (loss) before interest, amortization
and other income/expense | 1,371,490   | (1,695,605)   | (1,352,886)  
|Net income (loss)                                                    | 1,255,225   | (1,740,498)   | (1,345,109)  
|- basic                                                              | 0.05        | (0.08)        | (0.06)       
|- fully diluted                                                      | 0.05        | n/a(1)        | n/a(1)       

Notes:

(1) The fully diluted loss per share has not been computed, as the effect would be anti-dilutive.



|                                          |               |               |               
|----------------------------------------- | ------------- | ------------- | --------------
|Balance Sheet as at                       | Dec. 31, 2006 | Dec. 31, 2005 | Dec. 31, 2004 
|Cash and cash equivalents                 | $  3,515,193  | $   2,108,755 | $    3,172,870
|Total assets                              | 4,948,410     | 3,713,541     | 4,815,384     
|Total liabilities                         | 362,724       | 653,755       | 596,447       
|Cash dividend declared per share          | -             | -             | -             
|Shareholders equity                      |               |               |               
|- options                                 | 715,312       | 643,938       | 441,975       
|- capital stock                           | 8,299,554     | 8,100,253     | 7,720,873     
|- deficit                                 | (4,429,180)   | (5,684,405)   | (3,943,911)   
|Total liabilities and shareholders equity | $   4,948,410 | $   3,713,541 | $   4,815,384 

LIQUIDITY AND CAPITAL RESOURCES

Cash, cash equivalents and short-term investments totaled $3,515,193 at December 31, 2006 as compared with $2,108,755 at December 31, 2005. During the year ended December 31, 2006, the Company received aggregate proceeds of $156,163 in respect of 346,350 Common Shares issued upon the exercise of previously granted stock options.

At December 31, 2006, the Company did not have any outstanding indebtedness.

While the Company has generated royalty revenue and revenue from the distribution of pharmaceutical products in Canada, this revenue has been insufficient to fund the Companys research, development and marketing activities. Without the inclusion of the licensing fee received from Watson, the Company continued to incur losses in 2006 and drew from its holdings of cash, cash equivalents and short-term investments. Although there can be no assurance, the Company expects to move towards a profitable status in 2007, thereby funding its future growth from the sale of its products, from milestone payments and from the royalty income resulting from out-licensing agreements for at least the next 12 months.

The Company may seek additional funding, primarily by way of one or more equity offerings, to carry out its business plan and to minimize risks to its operations. The market for equity financing for companies such as Stellar is challenging and there can be no assurance that additional funding will become available by way of equity financing. Any additional equity financing may result in significant dilution to the existing shareholders at the time of such financing. The Company may also seek additional funding from other sources, including technology licensing, co-development collaborations, and other strategic alliances. Such funding, if obtained, may reduce the Companys interest in its projects or products. Regardless, there can be no assurance that any alternative sources of funding will be available.









---





OFF-BALANCE SHEET ARRANGEMENTS



The Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

RELATED PARTY TRANSACTIONS

The Company entered a fiscal advisory and consulting agreement in December 2005 with LMT Financial Inc. ("LMT") (a company beneficially owned by a director and his spouse) for services to be provided in 2006. Compensation under the agreement is $6,000 per month or $72,000 for fiscal 2006.  Pursuant to this agreement LMT, assisted the Company in assessing available methods of financing the operations of the Company and the impact on the market for Common Shares in the United States created by developments in Stellars business.

CAPITAL STOCK

The Company has authorized an unlimited number of Common Shares, without par value. There are no other classes of shares issued. During the year ended December 31, 2006, the Company issued for cash 346,350 Common Shares to employees, directors, and consultants, who exercised stock options, with an approximate average price per share of $0.45. As of the date of this report, the Company had 23,819,040 Common Shares outstanding.

As of the date of this report, the Company had 1,010,000 Common Share options outstanding at various exercise prices and expiry dates.

SIGNIFICANT CUSTOMERS

During 2006, the Company had one significant customer, a national wholesaler, which represented 36.0% of sales, in comparison to 34.4% in the same period for 2005.

OUTLOOK

As at March 26, 2007, the Company is debt free and had working capital of $3,417,346. Management remains confident that it can continue to fund its ongoing operations from several sources, including the sale of its products, milestone payments and royalty income resulting from out-licensing agreements for at least the next 12 months.

As discussed above under the heading "Liquidity and Capital Resources," the Company may seek additional funding, primarily by way of one or more equity offerings, to carry out its business plan and to minimize risks to its operations. The market for equity financings for companies such as Stellar is challenging, and there can be no assurance that additional funding by way of equity financing will be available. The failure of the Company to obtain additional funding on a timely basis may result in the Company reducing or delaying one or more of its planned research, development and marketing programs and reducing related personnel, any of which could impair the current and future value of the business.  Any additional equity financing, if secured, may result in significant dilution to the existing shareholders at the time of such financing. The Company may also seek additional funding from other sources, including technology licensing, co-development collaborations, and other strategic alliances, which, if obtained, may reduce the Companys interest in its projects or products. There can be no assurance, however, that any alternative sources of funding will be available.

RISKS AND UNCERTAINTIES

Stellar is subject to risks, events and uncertainties, or "risk factors", associated with being both a publicly-traded company operating in the biopharmaceutical industry, and as an enterprise with several projects in the research and development stage. Such risk factors could cause reported financial information to not necessarily indicate future operating results or future financial position. The Company cannot predict all of the risk factors nor can it assess the impact, if any, of such risk factors on its business, or the extent to which any factor, or combination of factors, may cause future results or financial position to differ materially from those reported or those projected in any forward-looking statements. Accordingly, reported financial information and forward-looking statements should not be relied upon as a prediction of actual future results.









---







Some of the risks and uncertainties affecting the Company, its business, operations and results include, but are not limited to: the Companys dependence on a few customers and a few suppliers, the loss of any of which would negatively impact the Companys operations; the need to develop and commercialize new products which will require further time-consuming and costly research and development, the success of which cannot be assured; the Companys dependency on third parties for manufacturing, materials and for research, development and commercialization assistance and support; the Companys dependency on assurances from third parties regarding licensing of proprietary technology owned by others; government regulation and the need for regulatory approvals for both the development and commercialization of products, which are not assured; uncertainty that the Companys products will be accepted in the marketplace; rapid technological change and competition from pharmaceutical companies, biotechnology companies and universities, which may make the Companys technology or products obsolete or uncompetitive; the need to attract and retain skilled employees; risks associated with claims of infringement of intellectual property and of proprietary rights; risks inherent in manufacturing (including up-scaling) and marketing; product liability and insurance risks; risks associated with clinical trials, including the possibility that trials may be terminated early, delayed or unsuccessful; exchange rate fluctuations; political, economic and environmental risks; the need for performance by buyers and suppliers of products; the Companys dependency on performance by its licensees regarding the sale of our licensed-out products, NeoVisc and Uracyst; and the risk of unanticipated expenses or unanticipated reductions in revenue, or both, any of which could cause the Company to reduce, delay or divest one or more of its research, development or marketing programs.



In addition to the foregoing, the industry in which the Company operates is very competitive. Many of our competitors and potential competitors have substantially greater product development capabilities, experience conducting clinical trials and financial, scientific, manufacturing, sales and marketing resources and experience than the Company.  The pharmaceutical industry is an industry of innovation and change, which can change the competitive landscape rapidly.  This could result in a material adverse affect on the financial condition of the Company.



The Company currently outsources the manufacturing of its products to a third party contract manufacturer, located in Toronto, Ontario. Although the Company has taken several measures to control the quality and on-time delivery of its products by this manufacturer, Stellar is unable to control all aspects of its third party manufacturer's operations.  If a supplier of a product or component discontinued or restricted such supply, the Companys business may be harmed by the resulting delays.  This could result in a material adverse affect on the financial condition of the Company.



While management has some experience conducting business activities with international accounts, the Company is subject to a number of risks associated with international accounts that may increase the Company's costs, lengthen sales cycles, and require significant management attention.  International accounts carry certain risks associated with foreign currency fluctuations; exchange controls; uncertainties of laws and enforcement relating to the protection of intellectual property; and other factors, depending on the country involved.  There can be no assurance that the Company will not experience these factors in the future, or that they will not have a material adverse affect on the Company's business, results of operations or financial condition.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Disclosure controls and procedures are designed to provide reasonable assurance that all relevant information is gathered and reported to senior management, including the Companys Chief Executive Officer and Chief Financial Officer, on a timely basis so that appropriate decisions can be made regarding public disclosure.

As at the end of 2006, management of the Company, with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the Companys disclosure controls and procedures as required by United States and Canadian securities laws.  Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that  as of the end 2006, the disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the Companys annual filings and interim filings and other reports filed or submitted under the United States and Canadian securities laws is recorded, processed, summarized and reported within the time periods specified by those laws and that material information is accumulated and communicated to management of the Company, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.









---





ADDITIONAL INFORMATION

Additional information relating to the Company is available on SEC at www.sec.gov, SEDAR at www.sedar.com or visit Stellars website at www.stellarpharma.com.