UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





———————


FORM 10-K


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þ
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended: December 31, 2009o
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from: _____________ to _____________




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




Ontario, Canada

0-31198

Not Applicable(State or Other Jurisdiction

(Commission

(I.R.S. Employerof Incorporation)

File Number)

Identification No.)




544 Egerton Street, London, Ontario, Canada, N5W 3Z8(Address of Principal Executive Office) (Zip Code)





(519) 434-1540(Registrant’s telephone number, including area code)


Securities registered pursuant to Section 12(b) of the Act:


Common Stock, no par value

NASDAQ Global Markets(Title of class)

(Name of exchange)





Securities registered pursuant to Section 12(g) of the Act: None


———————


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No þ 
 Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes o    No  þ 
 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 þ    No o 
 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this Form 10-K. o 
 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.




Large accelerated filero
Accelerated filero
Non-accelerated filero

(Do not check if a smallerreporting company)
Smaller reporting companyþ  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    Noþ 
 On December 31, 2009, 23,480,040 shares of the registrant's common stock were issued and outstanding.











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 1A 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 28, 2010, the exchange rate for Canadian dollars/United States dollars was $1.00 (Cdn.) = $0.9723 (U.S.).




Set forth below are the exchange rates based on the Bank of Canada noon rates for the Canadian dollar equivalent expressed in United States currency during 2009, 2008 and 2007.




Years ended December 31,2009


2008


2007At End of Year


0.9555



0.8166



1.0120Average


0.8760



0.9381



0.9304High


0.9484



1.0289



1.0905Low


0.7908



0.7711



0.8437





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. 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.













NOTICE TO READER
  Special Note Concerning 2008 Financial Statements
  The Company’s 2008 financial statements included in this annual report are unaudited.  Although the Company previously filed audited 2008 financial statements in its 2008 annual report on Form 10-K, the Company was unable to obtain the consent of the independent registered chartered accountants that prepared such financial statements by the filing deadline of this annual report.  The Company believes that its inability to obtain such consent is due to a billing dispute.  The unaudited 2008 financial statements contained in this annual report do not contain any adjustments, modifications or changes from the audited 2008 financial statements of the Company filed in its 2008 annual report on Form 10-K.




















PART I




ITEM 1.
DESCRIPTION OF BUSINESS




Overview




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.




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 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) NeoVisc® Single Dose and (iii) Uracyst®. NeoVisc, a three injection series, and NeoVisc Single Dose, a single injection of high molecular weight, sodium hyaluronate therapy, were developed to provide cost-effective alternative treatments to the over 3 million Canadians suffering from osteoarthritis. Uracyst, a chondroitin sulfate-based therapy, was developed to provide symptomatic relief to patients with glycosaminoglycan (GAG) deficient cystitis (defects in the urinary bladder lining) such as interstitial cystitis / painful bladder syndrome. Each of these products has received regulatory approval in Canada. Uracyst is patented in the United States and in Canada with international patents pending.




Stellar markets its products in Canada through its own sales force and currently has licensing agreements for the distribution of its products in over 58 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, conducts clinical trials where necessary, to obtain the required regulatory approvals for its products in international markets.




During the twelve month period ended December 31, 2009, the Company signed two new license agreements for Italy and South Korea, continuing to expand its penetration into global markets. As provided in these agreements, the Company received $273,580 in non-recurring, non-refundable license fees, which were recognized as income in 2009. In addition to upfront payments made to the Company upon signing, these agreement will provide Stellar with milestone payments and an ongoing royalty stream from future sales of Uracyst in these European markets.   The terms of these license agreements are as follows:




LiLicensee

Agreement Date

Territory

Agreement TermSigmar Italia S.p.a.

May 2009

Italy

5 years +Jeil Medix Pharmaceutical Co.

October 2009

Korea

5 years +





+ Extensions of 3 years apply to these contracts.






1





In October 2008, the Company entered into license and supply agreements with EIP Eczacibasi for marketing Uracyst in Turkey.  In December 2008, the Company entered into licensing and supply agreements with Galen, for marketing Uracyst in UK & Ireland, Vitaflo, for marketing Uracyst in Denmark, Finland, Iceland, Norway and Sweden, and EuroCept for marketing of Uracyst in Belgium, Luxembourg and Netherlands.
  In November 2007, the Company entered into license and supply agreements with Torrex Chiesi Pharma GmbH ("Torrex Chiesi") to grant the exclusive rights and license to use the methods and technical know-how for the purposes of developing, marketing and selling NeoVisc in Eastern Europe.  The territory covers a number of countries, including Austria, Czech Republic, Slovakia, Croatia, Serbia, Montenegro, Macedonia, Bosnia, Herzegovina, Poland, Hungary, Russia and the Commonwealth of Independent States ("CIS").    The term of this agreement will continue for a period of five years and will be renewable for an additional three years, unless earlier terminated by either party.




In December 2006, the Company entered into license and supply agreements with Watson Pharma, Inc. ("Watson"), whereby Watson was granted 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. 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.    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 July 2006, the Company entered into a licensing agreement with Bio-technic Romania SRL for NeoVisc in Romania.  Sales in this territory have showed solid growth since signing the agreement. The term of this agreement has been extended until June 2014.




In December 2005, the Company also entered into a license agreement with Megapharm Ltd for the sale of Uracyst in Israel. While Uracyst has received regulatory approval from the ministry of health; it still lacks approval on the reimbursement formulary. Further sales for Uracyst in this market are not expected until reimbursement status is received, which at the time of this report is uncertain.. The term of this agreement is for a period of five years.




In September 2005, the Company entered into a licensing agreement with Shanghai Ya Jun Medical for the sale of Uracyst in China.  All product specifications have been approved by the Chinese regulatory body ("SFDA") and the final document submission was delivered to the SFDA in June 2007.  Although the Company anticipated this registration would have occurred in 2007, to-date such approval has not been granted.  The Company is uncertain at this time, as to when final approval by SFDA will be received.




In August 2005, the Company entered into a distribution agreement with Technimed for the sale of NeoVisc in Lebanon.  Although, sales recorded for Technimed continue to be a small portion of the international revenues, year over year sales continue to increase. The term of this agreement has been extended until June 2010.




In June 2004, the Company signed a NeoVisc® license agreement with Triptibumis Sdn. Bhd. ("Triptibumis") for the sale of NeoVisc in Malaysia, Singapore and Brunei.  Triptibumis has obtained reasonable success in this small, competitive market. New areas of the territory however, have been slow in receiving regulatory approval.  Although it was expected that some of these territories would receive approval in the first half of 2008, to date no such approvals have occurred.  The Company is uncertain at this time as to when such regulatory approval will occur. The term of this agreement has been extended until June 2010.




In June 2003, Stellar entered into distribution agreements with BurnsAdler Pharmaceuticals to sell Stellar’s products in Latin America and the Caribbean. Sales have been ongoing in the Dominion Republic and Bahamas, two of the smaller territories included in the territory, but progress has been slow in the major Latin American markets due to competitive pricing issues. The term of this agreement is for a period of ten years.






2







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 that can result in increased frequency and urgency to void along with severe pelvic pain for many patients.




“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 GAG deficient cystitis such as IC and other non-common cystitis. The products are instilled by catheter directly into a patient’s bladder.




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;




3




(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) NeoVisc Single dose and (iii) Uracyst. Each of these products is presently approved for use in Canada and NeoVisc (3 dose only) and Uracyst have their CE Mark approval for the European Community. In the past Stellar has relied on Canadian revenues for its income. However, with Stellar entering into more out-licensing agreements it is expected that out-licensing revenues will dominate the Company’s sales.  In addition, Stellar has signed an in-license agreement for Canada to market BladderChek, sales of which commenced in October 2004.




NeoVisc and NeoVisc Single Dose




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 called an intra-articular injection.




NeoVisc Single Dose is a 6 mL pre-filled syringe of sterile 1.0% sodium hyaluronate solution delivered as a single intra-articular injection and is sold as a single dose therapy. Single dose therapy offers all the benefits of the NeoVisc 3 dose therapy but its duration of effect does not last as long as the 3 dose therapy.




This type of treatment, 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 since the mid 1980s in many European markets. Replacing or supplementing the joint fluid provides symptomatic relief from the pain of osteoarthritis for up to 6 to 12 months with the 3 dose products before a repeat set of injections is required. In late 2003 a single dose product was launched and by 2009 there were 4 single dose therapies available in the Canadian market. Single doses offer convenience of a single injection but the clinical effect lasts only 3 to 6 months.




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 3.3 million Canadians suffer from the “osteo” form of arthritis. Stellar estimates the number of OA sufferers in American to be 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)
SteroidalAnti-Inflammatory:
Corticosteroids are also used to treat the inflammation associated with the disease; and


(iii)
Joint Replacement:
Surgical replacement with artificial joints.


4





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.  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: There are a number of competitive viscosupplements to NeoVisc in Canada for both NeoVisc and NeoVisc Single Dose. The competitive landscape in the United States and other international markets is now very similar to the Canadian market. If approved for sale in the United States, NeoVisc would compete with Genzyme’s products Synvisc and Synvisc One, 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, Euflexxa marketed by Ferring Pharmaceuticals.  In Canada, NeoVisc also competes with these products plus Suplasyn, marketed by Alveda Pharma, Ostenil, marketed by Garvinci and single dose products, Durolane sold by Smith and Nephew and Monovisc by Rivex Pharma. 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 June 2004, Stellar entered into a distribution agreement with Triptibumus Sdn Bhd. for sale of NeoVisc in Malaysia, Singapore and Brunei;




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




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




(v)
in November of 2007, the Company signed a licensing agreement with Torrex Chiesi Pharma GmbH, based in Vienna, Austria for the distribution and sale of NeoVisc in Eastern Europe. The territory covers a number of countries, including Austria, Czech Republic, Slovakia, Croatia, Serbia, Montenegro, Macedonia, Bosnia, Herzegovina, Poland, Hungary, Russia and the Commonwealth of Independent States.




5





Uracyst




Stellar developed Uracyst, a sterile 2.0% sodium chondroitin sulfate solution available in a 20 mL vial. Uracyst is used in the treatment of certain forms of IC and non-common cystitis. This product is instilled by catheter directly into a patient’s bladder.




Uracyst provides symptomatic relief for patients suffering from GAG deficient cystitis such as 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 between urine and the bladder wall. It protects the bladder wall 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 bladder.




Uracyst is typically instilled weekly for six 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 Uracyst treatments and has international patents pending. Uracyst is classified in Canada by TPD as medical devices under the Medical Devices Regulations of the Food and Drugs Act (Canada).




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 a 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 was 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. In April 2007, the Company terminated its license agreement with Pohl-Boskamp. Pohl-Boskamp disputed the basis on which the Company terminated the agreement and the consequences that result from such termination. The parties attended mediation in September 2007 where they agreed to a settlement of this dispute. Under the terms of the settlement the parties agreed that the license agreement would remain in full force and effect until March 31, 2008.




In late 2008, the Company signed four new Uracyst licensing agreements for eleven European countries. In 2009, the company signed additional Uracyst licensing agreements for Italy adding to its European presence.  Stellar continues in discussions with other potential partners for the remaining European countries. Stellar expects to have most of these markets covered and selling Uracyst in 2010.




The Company has signed the following agreements for Uracyst:




(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 Megapharm 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.




6




(iv)
In late 2008, the Company signed four licensing agreements in Europe to improve penetration into this important market. EIP Eczacibasi Ilac Pazarlama signed an Uracyst licensing agreement in October 2008, for Turkey and the Turkish Republic of Northern Cyprus. In December 2008, the Company signed Uracyst license agreements with; Galen Limited, for the United Kingdom and the Republic of Ireland, with VitaFlo Scandinavia AB, for Denmark, Finland, Iceland, Norway, Sweden and with EuroCept B. V. for the Netherlands, Belgium and Luxembourg.




(v)
In May 2009, the Company signed a new Uracyst license agreement with Sigmar Italia S.p.a. for the Italian market and in October 2009 with Jeil Medix Pharmaceutical Co. for the Korean market, continuing to expand its penetration into global markets.




The Company used consultants to source licensees for European contracts entered into by Stellar in 2008 and 2009.   These agreements involved royalty payments to be issued to the consultants upon the signing of the license agreement.  The royalty payments being issued to consultants included 10% of the upfront fees received from the licensee and 10% to 50% of any future milestone payments received.  In addition, royalty payments were also based on 4 % of the total Uracyst sales at a declining rate of 1% per year over a four-year period, declining to a 1% rate effective in the final year.




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 six months of active treatment before patients start to show symptomatic improvement.




Market For Uracyst: Data on the number of IC patients being treated and the method of treatment have not been 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 has made it difficult to define the size of the IC market. More recently epidemiology studies have been able to better define the size of the IC market.  Recent U.S. epidemiological data from the Interstitial Cystitis Association suggests a prevalence rate of between 3 & 8 million women who may have IC (3 – 6% of US women). The Rand Institute Study (AUA 2009) reported that the incidence & prevalence for women 18+ was between 2.7 & 6.5%. Statistics Canada reported 13,177,938 women over 18 in 2009 - extrapolating this information for Canada suggests a potential patient population of 395,338. It is believed that somewhere between 60% and 80% of IC patients are “GAG” deficient patients in the IC population.  Both of these estimates have been used to project the target market for Uracyst in Canada to be 276,700 patients.





7





Marketing Strategy: Stellar currently markets Uracyst 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 approximately 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 European licensees.




Uracyst has demonstrated a rapid onset of clinical response, compared to all other therapies. Combining this with lower cost is important, as most patients will be on and off GAG replacement therapy for an indeterminate amount of time. Management believes that the high efficacy results and low monthly therapy cost make Uracyst the most cost effective therapy available. Stellar expects to gain acceptance more readily from both physicians and patients as the most cost-effective therapy for treating GAG-deficient IC patients.




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 for competitive products, 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 per month as compared to $80 per month for DMSO and $75 per month for Uracyst.




BladderChek




Stellar has licensed BladderChek for the Canadian market from Inverness Medical Innovations North America, Inc. (successor to certain contracts of Matritech, Inc.). The initial term of this licence began on January 1, 2004 and ends on December 31, 2011. 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.




8





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’s 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 five 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 Uracyst and BladderChek sales. See “– Human Resources.” Marketing and sales efforts are coordinated from Stellar’s office located in London, Ontario. Stellar will continue to seek to build a strong 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, Western Europe, Eastern Europe, Romania, Russia, China, South Korea, Israel, 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 that any of its current customers intends to discontinue its relationship with the Company or to reduce purchases of the Company’s products.





Human Resources




The Company currently employs thirteen full-time employees and three part-time. Eight of these full-time and three part-time employees are located at the Company’s main office in London Ontario, Canada. The remaining five employees 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”. The 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 outsources the manufacturing of its products to special sterile facilities, operated by third party contractors. These facilities, which are in compliance with applicable Health Canada, TPD division medical device guidelines and current Good Manufacturing Practice ("cGMP") regulations, have sufficient excess capacity at present to meet the Company’s short and long term objectives. A significant interruption in the supply of any of the Company’s products could impair the successful marketing of such products.




9





The Company has established non-contractual supply arrangements for its raw materials with several sources. Stellar currently purchases the HA used in NeoVisc from Fidia Farmaceutici S.p.A. and the chondroitin sulfate used in the formulation of Uracyst from Bioiberica S.A., a Spanish supplier. In the event of an interruption in the supply of these raw materials from such suppliers, the Company has 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 files 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.





10





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 and Uracyst 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 re-certification on March 12, 2009.




Under the European authority, Stellar must gain approval for its products by complying with MDD regulations, which are similar to the Canadian system. Once approved in one of the member countries of the European Community (“EC”), Stellar can then apply for its CE mark. The CE mark amounts to an approval to sell in all of the 27 EC countries and allows for faster approvals in many other non-EC countries in Europe. Both NeoVisc and Uracyst are currently CE marked.




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. Through its out-licensing partnerships, the Company believes that its products can 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.




Although it cannot be certain, Stellar anticipates that the FDA approval required to market Uracyst in the United States will be obtained around the end of 2011. 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.




11





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 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 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. 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, 2009 and 2008, the Company expensed approximately $18,100 (2008 (unaudited) - $97,700) on in-house research and development activities. The expense in 2008 however, was offset by provincial government tax cash refunds of $34,900 for research and development activities performed in 2006, 2007 and 2008.  No tax cash refunds were recorded in 2009.




ITEM 1A.
RISKS AND UNCERTAINTIES




Investing in common shares in the capital of Stellar (the “Common Shares”) involves a degree of risk.  You should carefully consider the following factors and all other information contained in this report before purchasing Common Shares.  If any of the following risks occur, our business, financial condition and/or results of operations could be materially and adversely affected.  In that case, the trading price of the Common Share could decline, and you may lose some or all of your investment.




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.




12





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;




-
risks of expanding and funding manufacturing to ensure adequate product inventory as FDA and other approvals are obtained;




-
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.




Competitive Risks




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.




Manufacturing Risks




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.




13





International Contract & Currency Risks




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.




Additional Information




We make available free of charge through our website, www.stellarpharma.com, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as soon as reasonably practicable after those reports are filed with or furnished to the Securities and Exchange Commission (“SEC”).




The public may read any of the items we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding the Company and other issuers that file electronically with the SEC at http://www.sec.gov.




14




ITEM 2.
PROPERTIES




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 $258,300 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 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 the date of this report, which 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




No matters were submitted to a vote of shareholders in the quarter ended December 31, 2009.




15





PART II




ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED TO STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES




Market Information




Since December 2002, the Company’s 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


Low2009
First Quarter


0.35



0.21Second Quarter


0.65



0.28Third Quarter


0.70



0.51Fourth Quarter


0.98



0.582008
First Quarter


0.58



0.33Second Quarter


0.45



0.33Third Quarter


0.51



0.32Fourth Quarter


0.42



0.222007
First Quarter


0.92



0.65Second Quarter


0.87



0.60Third Quarter


0.72



0.47Fourth Quarter


0.66



0.37





On March 28, 2010, the last reported per share sale price for the Common Shares on the OTC Bulletin Board was $0.90 (USD).




Holders




As at January 1, 2010, there were 28 holders of record of the Common Shares. For greater certainty, the beneficial holders who hold their shares in an account with an investment dealer are represented by one nominee.  Therefore, although the number of registered shareholders is only 28 the number of beneficial shareholders is likely to be much larger.




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.




Purchases of Equity Securities (expressed in Canadian dollars)





Shares repurchased in 2009 were as follows:




16




Period

Total # of

Shares

Purchased


Average

Price Paid

per Share


Total # of

Shares

Purchased

as Part of

Publicly Announced

Plan


Maximum #

of Shares

that May Yet

Be Purchased

Under the

PlanJanuary 1 to 31


25,000


$
0.32



25,000



893,627March 1 to 31


35,000


$
0.37



35,000



858,627September 1 to 30


15,000


$
0.59



15,000



843,627Total


75,000


$
0.40



75,000



843,627




Shares repurchased in 2008 were as follows:




Period

Total # of

Shares

Purchased


Average

Price Paid

per Share


Total # of

Shares

Purchased

as Part of

Publicly Announced

Plan


Maximum #

of Shares

that May Yet

Be Purchased

Under the

PlanApril 1 to 30


55,000


$
0.38



55,000



1,136,127May 1 to 31


50,000


$
0.36



50,000



1,086,127June 1 to 30


12,500


$
0.32



12,500



1,073,627July 1 to 31


30,000


$
0.33



30,000



1,043,627September 1 to 30


25,000


$
0.42



25,000



1,018,627October 1 to 31


50,000


$
0.38



50,000



968,627November 1 to 30


25,000


$
0.38



25,000



943,627December 1 to 31


25,000


$
0.27



25,000



918,627Total


272,500


$
0.36



272,500



918,627





Equity Compensation Plan Information




The table set forth below provides information as of December 31, 2009 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


Weighted average

exercise price

of outstanding

options, warrants

and rights in

Canadian Dollars


Number of securities

remaining available

for future issuance

under equity

compensation plans

(excluding securities

reflected in column (a))(a)


(b)


(c)Equity compensation plans approved by security holders


460,000



0.84



1,519,452Equity compensation plans not approved by security holders


—



—



—Total


460,000



0.69



1,519,452




17





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”), 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) or establish a “new Canadian business” (as defined in the ICA) may be required to file either a notification or an application for review with a governmental agency known as “Industry Canada”. The ICA 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 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. The ICA 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 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.




18





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




Not applicable.




Issuer Purchases of Equity Securities.




During the fourth quarter of 2009, 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.
SELECTED FINANCIAL DATA




Not applicable.




ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS




NOTICE TO READER
  Special Note Concerning 2008 Financial Statements
  The Company’s 2008 financial statements included in this annual report are unaudited.  Although the Company previously filed audited 2008 financial statements in its 2008 annual report on Form 10-K, the Company was unable to obtain the consent of the independent registered chartered accountants that prepared such financial statements by the filing deadline of this annual report.  The Company believes that its inability to obtain such consent is due to a billing dispute.  The unaudited 2008 financial statements contained in this annual report do not contain any adjustments, modifications or changes from the audited 2008 financial statements of the Company filed in its 2008 annual report on Form 10-K.


Year Ended December 31, 2009 Compared to Year Ended December 31, 2008 (in Canadian Dollars)




MANAGEMENT'S DISCUSSION AND ANALYSIS




General




The following discussion and analysis was prepared on March 23, 2010 and 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”).




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.




19





CRITICAL ACCOUNTING POLICIES




The Securities and Exchange Commission ("SEC") defines critical accounting policies as those that are, in management’s view, important to the portrayal of the Company’s financial condition and results of operations and require management’s judgment.  The Company’s discussion and analysis of its financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").  The preparation of these statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses.  The Company bases its estimates on experience and on various assumptions that it believes are reasonable under the circumstances, the results of which form the basis for making judgments about its carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from those estimates.  The Company’s critical accounting policies include:




Revenue Recognition.




Revenue is recognized in accordance with Staff Accounting Bulletin No. 104, Topic 13 "Revenue Recognition Revised and Updated" ("SAB 104") and Accounting Standards Codification ("ASC") 605-25, "Revenue Arrangements with Multiple Deliverables." The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectibility is reasonably assured.  License fees which are comprised of initial fees and milestone payments are recognized upon achievement of the milestones and provided that collectibility is reasonably assured and other revenue recognition criteria are met.   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 collectibility 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 transfer of methods and technical know-how, not requiring the Company to perform additional research or development activities or other significant future performance obligations, are recognized upon delivery of the methods and technical know-how.




Milestone payments are recognized into income upon the achievement of the specified milestones when the Company has no further involvement or obligation to perform services, as 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.




Royalty revenue is recognized when the Company has fulfilled the terms in accordance with the contractual agreement and has no material future obligation, other than inconsequential and prefunctory support, as would be expected under such agreements and the amount of the royalty fee is determinable and collection is reasonably assured.




Share-Based Compensation




Share based compensation is estimated at the date of grant based on the fair value of the award and is recognized as an expense over the requisite service period of the award. Determining the appropriate fair value model and calculating the fair value of the stock based awards on the grant date requires considerable judgment, including estimating stock price volatility, expected option life and forfeiture rates. The Company developed estimates based on historical data.  If factors change and different assumptions are employed in future periods, the compensation expense that the Company record may differ significantly from what it has recorded in the current period. A small change in the estimates used may have a relatively large change in the estimated valuation. The Company uses the Black-Scholes pricing model to value stock option awards.




20





RESULTS FOR THE YEAR ENDED DECEMBER 31, 2009




Total revenue for the year ended December 31, 2009 increased by 39.9% to $3,581,300 compared to $2,559,400 in the same period during 2008 (unaudited).  In 2009, the Canadian market again showed positive growth. NeoVisc sales increased 17.2%, Uracyst sales increased 13.4% and BladderChek sales decreased 14.5%, with a total increase in Canadian product sales of 15.7%. Given the market conditions in 2008 (unaudited) and 2009, the Company is satisfied with these increases.




International revenues from all sources, including licensing fees for the 12 month period end December 31, 2009, were up 74.8% compared to the same period in 2008 (unaudited), impacted greatly by increased Uracyst revenues in Europe. NeoVisc sales for the twelve month period ended December 31, 2009, were also up by 25.7%, compared to the same period in 2008 (unaudited), due to strong growth from global licensees.




In the fourth quarter of 2009, total revenues for the quarter ended December 31, 2009, were up only 0.5% compared to the same period in 2008 (unaudited). The comparative revenues were impacted by milestone payments received from four new licensing agreements for Uracyst, in the fourth quarter of 2008, compared to one licensing agreement for the same period in 2009. International NeoVisc sales decreased 72.9% for the quarter compared to the same quarter in 2008 (unaudited), due to larger orders received by two licensees that were received in the fourth quarter in 2008, but occurred in the third quarter for 2009. Canadian Uracyst sales grew by 21.3% over the same quarter in 2008 (unaudited), while the Company recognized its first sale of Uracyst to international markets in the first quarter of 2009.




The Company’s net income for the fourth quarter of 2009 was $23,200 compared to a net income of $196,000 for the same period in 2008(unaudited). This differential is mainly attributed to $232,600 in licensing and milestone payments received and recognized as revenues in the fourth quarter of 2008 (unaudited) while only $155,500 was received and recognized as revenues for the same quarter in 2009.  In addition, the Company had non cash expenses of $55,400 in 2009, related to stock option compensation expense in 2009 compared to a credit of $3,100 during the same period of 2008 (unaudited). This is the fifth consecutive quarter that Stellar has shown profitability.




Net income for the twelve month period ended December 31, 2009 was $238,900 compared to loss of ($31,100) for the same period in 2008




Gross Profit and Cost of Products Sold




Gross profit for the year ended December 31, 2009, was $2,579,400, up 28.8%, compared to $2,003,000 recorded for the same period in 2008 (unaudited). This improvement in gross profits was driven by the positive sales growth in domestic and international markets. Stellar’s cost of goods sold for the year ended December 31, 2009 increased to 33.4% of sales compared to 26.3% of sales for the same period in 2008 (unaudited). The increase cost of goods is due to the 2009 growth in product sales through Stellar’s international partners (up 105.9% over 2008 (unaudited)) which generate lower margins.




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. For the year ended December 31, 2009, the Company recorded $18,100 (2008 (unaudited) - $98,100) in research and development expenses before reductions of tax credits. Government tax credits are recorded as a reduction of the expense when reasonable assurance exists that the Company has complied with the terms and conditions for the approval of the credit.  In prior years, the Company determined the collection of the tax credit was less than likely. No tax credits were recorded in 2009, while expenses recorded in 2008 (unaudited) were less provincial government tax credits of $34,900 from prior years, which the government assessed and approved.




During 2009, the Company continued its development of manufacturing processes to improve yields from both Uracyst and NeoVisc production. This work is an ongoing task allowing Stellar to improve its manufacturing processes and remain competitive in the global market.




In 2009, the Company continued to work with Dr. Robert Hurst from the University of Oklahoma on Uracyst and its treatment of GAG deficient cystitis. Although there can be no assurances, Dr. Hurst’s work is intended to further enhance Uracyst treatment of this bladder defect.




21





Selling, General and Administrative Expenses




Selling, general and administrative expenses for the year ended December 31, 2009 was $2,278,500 compared to $2,010,400, for the same period in 2008 (unaudited). The total increase of $268,100 or 13.3%, includes; an increase of $41,700 in costs related to non-cash expenses for stock options issued to directors, officers and employees of the Company; an increase of $30,800 in royalty license fee payouts (2009 - $60,400 and 2008 (unaudited) - $29,600); an increase of  $27,200 in business development expenses related to increased licensing negotiations (2009 – 50,300 and 2008 (unaudited) - $24,600); an increase of  sales and marketing expenses of $51,900 related to the NeoVisc Single Dose launch (2009 – $353,100 and 2008 (unaudited) - $301,200); an increase of $19,000 for consulting and other fees related to investor relations (2009 - $113,300 and 2008 (unaudited) - $94,300); and an increase of $91,000 related to effects of foreign currency (a foreign exchange loss of $50,600 in 2009 compared to a foreign exchange gain of $40,400 recognized in 2008 (unaudited)) recorded as selling, general and administrative expenses.




Stellar is pursuing a number of business development activities associated with out-licensing Stellar’s current products in other international markets, in-licensing products for Stellar’s markets and developing additional products.




Interest and Other Income




Interest and other income during the twelve month period ended December 31, 2009 was $12,000 (2008 (unaudited) - $93,400). These amounts include interest received on short-term investments for both 2009 and 2008. In 2009, interest earned on its short-term investments was an average of 0.64% compared to an average of 3.2% in 2008 (unaudited),  resulting in a significant decrease in interest income in 2009.






SUMMARY OF QUARTERLY RESULTS





Quarter Ended

Revenues


Net Income

(loss)


Earnings

(loss) per shareDecember 31, 2009

$
907,600


$
23,200


$
0.00September 30, 2009


826,900



25,900



0.00June 30, 2009


1,074,300



164,700



0.01March 31, 2009


772,500



25,200



0.00December 31, 2008


903,000



196,000



0.00September 30, 2008


481,100



(60,300
)


0.00June 30, 2008


647,900



(68,000
)


0.00March 31, 2008


527,400



(98,800
)


0.00




SELECTED FINANCIAL RESULTS AND HIGHLIGHTS




A discussion of the reasons behind the variations in the following amounts can be found under the heading “Results of Operations for the Year Ended December 31, 2009”.




Income Statement for the year ended

Dec 31, 2009


Dec 31, 2008

(Unaudited)


Dec 31, 2007Total revenue

$
3,581,300


$
2,559,400


$
2,247,300Cost of goods sold


1,001,900



556,400



519,300Expenses


2,352,500



2,127,500



2,088,500Net income (loss)


238,900



(31,100
)


(147,400
)- basic


0.01



(0.00
)


(0.01
)- diluted


0.01



n/a
(1)


n/a
(1)


Notes:


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






22






Balance Sheet as at

Dec 31, 2009


Dec 31, 2008
(Unaudited)


Dec 31, 2007Cash and cash equivalents

$
2,325,200


$
2,106,000


$
3,211,100Total assets


5,025,700



4,716,700



4,890,200Total liabilities


406,900



361,800



417,400Cash dividend declared per share


—



—



—Shareholders’ equity- Common shares


8,183,600



8,261,400



8,303,100- treasury shares


—



(51,600
)


—- paid-in capital for cancelled Common shares


—



2,300



—- paid-in capital options


724,100



758,300



746,400- deficit


(4,618,800
)


(4,615,600
)


(4,576,600
)Total liabilities and shareholders equity


5,025,700



4,716,700



4,890,200





LIQUIDITY AND CAPITAL RESOURCES




Cash and cash equivalents totaled $2,325,200 at December 31, 2009 as compared with $2,106,000 at December 31, 2008 (unaudited).




At December 31, 2009, the Company did not have any outstanding indebtedness.




Although there can be no assurance, the Company expects to remain in a profitable status in 2010, 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.




Cash utilization during 2010 included (but was not limited to):




·
Capital expenditures paid for in the amount of $155,630 related to property, plant and equipment;




·
Capital expenditures of $26,200 related to patent filings; and




·
Purchase for cancellation of capital stock in the amount of $30,400 pursuant to the Company’s normal course issuer bid;




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 to the Company.


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 February 2008 with LMT Financial Inc. ("LMT") (a company beneficially owned by a director and his spouse) for, among other things, services to be provided for a one year period.  Compensation under the agreement has been recorded at $6,000 per month or $72,000 for the year ended December 31, 2009 (2008 (unaudited) - $72,000).  Pursuant to this agreement, LMT assists and will continue to assist 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.





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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, 2009, no Common Shares (2008 (unaudited) – 5,000) were issued by the Company.  As of the date of this report, the Company has 23,480,040 Common Shares issued and outstanding.




As of the date of this report, the Company had 460,000 Common Share options outstanding with an average exercise price of $0.88 per option.




PURCHASES OF EQUITY SECURITIES


On April 1, 2008, the Company commenced a normal course issuer bid (the "NCIB") for its Common Shares. Pursuant to the terms of the NCIB, the Company may during the 12 month period commencing April 1, 2008 and ending March 31, 2009, purchase up to 1,191,127 Common Shares provided that the aggregate value of Common Shares so purchased, does not exceed $1,000,000.  Purchases of Common Shares will be made in open market transactions, at market prices prevailing at the time of acquisition.  Pursuant to the terms of the NCIB, during year ended December 31, 2009, the Company purchased 75,000 (2008 (unaudited) – 272,500) of its Common Shares at an average purchase price of $0.40 (2008 (unaudited) - $0.36).  All Common Shares purchased in 2009 have been cancelled (2008 (unaudited) – 125,000 were cancelled as at December 31, 2008 and 147,500 were shown as treasury shares, to be cancelled).




The total repurchase cost for these Common Shares for the year ended December 31, 2009 was $30,400 (2008 (unaudited) - $100,500). For the year ended December 31, 2009, $77,800 has been allocated to capital stock  (2008 - $43,400 and $51,600 was allocated to treasury shares), for the weighted average stated value of the shares in capital stock, $1,900 (2008 (unaudited) -$7,900) has been recorded to deficit for the amount in excess of the weighted average stated value and the remaining ($2,300) has been recorded to paid-in capital for cancelled Common Shares for the amount below the weighted average stated value (2008 (unaudited) - $2,300).




SIGNIFICANT CUSTOMERS




During the year ended December 31, 2009, the Company had two significant customers that represented 35% (one major wholesaler – 23%; and one international customer - 12%) of product sales (2008 (unaudited) – 40% (one major wholesaler – 28%; and one international customer - 12%).  The Company believes that its relationship with these customers is satisfactory.




OUTLOOK




As at March 28, 2010, the Company is debt free and had working capital of $2,654,100. 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.




24





RECENT ACCOUNTING PRONOUNCEMENTS




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




In April 2009, the FASB issued ASC 820-10-65-4 (formerly referred to as FSP SFAS 157-4), "Determining Whether a Market Is Not Active and a Transaction Is Not Distressed." ASC 820-10-65-4 provides guidelines for making fair value measurements more consistent with the principles presented in ASC 820-10-65-1. ASC 820-10-65-4 provides additional authoritative guidance in determining whether a market is active or inactive, and whether a transaction is distressed, is applicable to all assets and liabilities (i.e. financial and non-financial) and will require enhanced disclosures. This standard is effective for periods ending after June 15, 2009. The Company has evaluated this standard and determined that it does not have an impact on its financial position and results of operations.




In April 2009, the FASB issued ASC 825-10-65-1 (formerly referred to as FSP SFAS 107-1 and APB 28-1), "Interim Disclosures about Fair Value of Financial Instruments," and "Disclosures about Fair Value of Financial Instruments, (formerly referred to as FSP SFAS 107)" to require disclosures about fair value of financial instruments in interim as well as in annual financial statements. ASC 825-10-65-1 also includes an amendment to "Interim Financial Reporting (formerly referred to as APB 28-1)," to require those disclosures in all interim financial statements. This standard is effective for periods ending after June 15, 2009. The Company has adopted this standard and determined that it does not have an impact on its financial position and results of operations.





In May 2009, the FASB issued ASC 855-10 (formerly referred to as SFAS No. 165), Subsequent Events. ASC 855-10 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. ASC 855-10 is effective for interim or annual financial periods ending after June 15, 2009. As of this date, the Company has adopted ASC 855-10. In an evaluation of subsequent events through the date of this filing, the Company does not believe there are any material subsequent events which would require further disclosure.


In June 2009, the FASB issued ASC 105-10 (formerly referred to as SFAS No. 168), The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. On the effective date of this Statement, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification will become non-authoritative. ASC 105-10 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company has adopted this standard and determined that it does not have a material impact on its financial condition, results of operations, or cash flows.





In September 2009, the FASB Emerging Issues Task Force, or EITF, reached a consensus on ASC Update 2009-13 (Topic 605), Multiple-Deliverable Revenue Arrangements, or ASC Update 2009-13. ASC Update 2009-13 applies to multiple-deliverable revenue arrangements that are currently within the scope of ASC 605-25. ASC Update 2009-13 provides principles and application guidance on whether multiple deliverables exist and how the arrangement should be separated and the consideration allocated. ASC Update 2009-13 requires an entity to allocate revenue in an arrangement using estimated selling prices of deliverables, if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price. The update eliminates the use of the residual method and requires an entity to allocate revenue using the relative selling price method and also significantly expands the disclosure requirements for multiple-deliverable revenue arrangements. ASC Update 2009-13 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. As a result, ASC Update 2009-13 will be effective for the Company no later than the first quarter of fiscal 2011. The adoption of ASC Update 2009-13 may have a material impact on the Company’s financial position or results of operations for future collaborations arrangements.





25





ITEM 8.
FINANCIAL STATEMENTS




The financial statements of the Company for 2009 including the notes thereto, together with the report thereon of McGovern, Hurley, Cunningham LLP Chartered Accountants, attached to the end of this annual report and are hereby incorporated herein by reference.




ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE




Not applicable.




ITEM 9A.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES




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 2009, management of the Company, with the participation of the Chief Executive Officer and the Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as required by United States and Canadian securities laws.  Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.




Internal Control Over Financial Reporting




The Chief Executive Officer and the Chief Financial Officer of the Company are responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.




Management conducted an evaluation of the effectiveness of its controls over financial reporting on a risk based approach using the elements of the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Based on our assessment and those criteria, our management concluded that our internal control over financial reporting was effective as of December 31, 2009.




This Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Our management’s report was not subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this Report.




26




ITEM 9B.
OTHER INFORMATION




Not applicable.




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.




27




PART III




ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE




Directors and Executive Officers




The following table sets forth certain information with respect to the directors and executive officers of Stellar as of the date of this report.




Name

Age

PositionsPeter Riehl

64

Director, President and Chief Executive OfficerArnold Tenney

67

Chairman of the Board and Financial AdvisorJohn J. Kime

67

DirectorRobert H. Kayser

67

DirectorJohn M. Gregory

57

DirectorF. Martin Thrasher

58

DirectorJanice M. Clarke

49

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. Mr. 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. 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, Mr. 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. Mr. 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.




28





John J. Kime, Director. Mr. Kime has been a Director of the company since December 2000. Mr. Kime is the President and CEO of iBD Advisors Inc., a privately owned Canadian company providing guidance to Canadian and international companies on site location needs and business considerations connected with their plans to locate and expand in North America. Prior to assuming his responsibilities at iBD Advisors, Mr. Kime was the President and CEO of the London Economic Development Corporation a public/private partnership with responsibility for providing economic development services to the city of London, Ontario, Canada. From 1991 to 1998, Mr. Kime served as Director of International Development for Big ‘O’ Inc., a company engaged in the development of manufacturing technologies used in the control and containment of water, chemicals and other substances. Mr. Kime has a BA from The University of Western Ontario, and is a Chartered Accountant.




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.




F. Martin Thrasher, Director. Mr. Thrasher is a seasoned international executive. After graduating from the Richard Ivey School of Business, Mr. Thrasher spent over 30 years working around the globe for such blue chip companies as General Foods, McCormick & Co, Campbell Soup Co and ConAgra Foods Inc. Mr. Thrasher lived and worked in Canada, Australia, Belgium and the USA. His responsibilities with Campbell included positions as President, International Grocery and President, North America Grocery. At ConAgra, he was President of the Retail Products Co, a $9 billion business with over 30,000 employees. Currently, Mr. Thrasher is President of FMT Consulting, a boutique advisory and consulting firm.




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. Kayser, Thrasher 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. Kime and Tenney, 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.




29





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 2009.




Code of Ethics




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




ITEM 11.
EXECUTIVE COMPENSATION




Compensation Discussion and Analysis





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.




Compensation Philosophy and Objectives





The compensation philosophy of the Company is to provide market competitive pay to employees and reward them for their contribution to the operating and financial performance of the Company and the success in implementing the Company’s short-term and long-term strategies.





The objectives of the compensation program are: (i) to attract and retain individuals critical to the success of the Corporation; (ii) to reward performance of individuals by recognizing their contribution to the Company; (iii) to align the interests of Peter Riehl and Janice Clarke ("the Named Executive Officers") and the broader management group, with shareholders' interest and the execution of the Company’s strategic plan; and (iv) to compensate individuals based on their performance and, to the extent applicable, on similar compensation for companies at a comparable stage of development.





Compensation Committee





The Company has established a Compensation Committee which is composed of two directors, Arnold Tenney and John Kime, one of whom is independent of management. The Compensation Committee meets no less than once each year and is responsible for making recommendations to the Board regarding:





·
reviewing and approving the compensation and other terms of employment of our Chief Executive Officer;


·
reviewing and approving corporate performance goals and objectives of our executive officers and other senior management; and


·
administration of our stock option plan and other benefit plans and programs.




30





The Compensation Committee makes recommendations to the Board regarding various other matters, and the Board then determines whether to adopt such recommendations as submitted or otherwise.





The Compensation Committee provides guidance with respect to and the purpose and principles behind the Company’s compensation decisions and overall compensation philosophy and objectives, oversee the Company’s compensation policies, plans and programs, and reviews and determines executive officer compensation.  The Compensation Committee annually evaluates the performance and determines the compensation of the Chief Executive Officer of the Company based upon a mix of factors including the achievement of corporate goals, achievement of individual goals, overall individual performance, and comparisons with other companies selected based on size and similar business.





Total Compensation





Total compensation for Named Executive Officers is based on the following components: (i) fixed compensation, which includes base salary and benefits; (ii) performance based compensation, which includes annual and long-term incentives; and (iii) other compensation.





Fixed Compensation





Fixed Compensation includes:





1.           Base Salary




Base salary is determined through formal job evaluation, salary survey data and market comparators. Salary ranges are reviewed annually. Base salaries for all employees are typically increased at contract renewal based on a cost of living factor, such factor being sourced from publicly available salary survey data.





2.           Benefits




Each of the Named Executive Officers and other senior management are enrolled in a benefits plan offering medical, dental, life and long-term disability benefits.





Performance Based Compensation





Performance based compensation includes annual and long-term incentives.





1.           Annual Incentives




The Chief Executive Officer's annual incentive is approved by the Compensation Committee and is dependent upon corporate and individual performance, measured against the strategic plan approved by the Board.  The annual incentive pay for Ms. Clarke and other senior management is recommended to the Compensation Committee by the Chief Executive Officer based on corporate, divisional and individual performance measured against the strategic plan.





2.           Long-Term Incentives – Stock Option Plan




The Company’s stock option plan (the "Stock Option Plan") was adopted to provide the Company with a share ownership incentive program to attract, retain and motivate qualified directors, officers, full-time employees and consultants of the Company (collectively, "Service Providers"), to reward those Service Providers for their contributions toward the long term goals of the Company and enable and encourage such Service Providers to acquire Common Shares as long term investments.








31





The Stock Option Plan is administered by the Board, and at its option, the Compensation Committee of the Board.  Subject to the provisions of the Stock Option Plan, the Board is authorized in its sole discretion to make decisions regarding the administration of the Stock Option Plan.  Recommendations for stock options are prepared by management and presented to the Board for approval. The Board reviews the proposal, the individual or individuals involved and the terms and conditions proposed before approving the recommendations.





Summary Compensation Table





Name and principal position
Year
Salary
Option-based awards(1)
Non-equity incentive plan compensation
Pension value
All other compensation
Total compensation($)
(S)
Annual incentive plans
Long-term incentive plans
($)
($)
($)Peter Riehl

President and Chief Executive Officer
2009
191,800
9,269
Nil
Nil
Nil
Nil
201,0692008
185,000
Nil
Nil
Nil
Nil
Nil
185,0002007
175,000
Nil
Nil
Nil
Nil
Nil
175,000Janice M. Clarke

Chief Financial Officer and

VP of Administration
2009
114,800
3,972
Nil
Nil
Nil
Nil
118,7722008
108,700
3,455
Nil
Nil
Nil
Nil
112,1552007
99,700
10,535
Nil
Nil
Nil
Nil
110,235




Notes:




(1)
Calculated based on the Black-Scholes valuation model at the date of grant. The computation of expected volatility is based on the Company’s market close price over the period equal to the expected life of the options. The computation of expected life is calculated using the simplified method. The dividend yield is 0.0%, since there is no history of paying dividends and there are no plans to pay dividends. The risk-free interest rate is the Canadian Treasury Bond rate for the period equal to the expected term.




Incentive Plan Awards




Outstanding Option-Based Awards Outstanding at the end of the Most Recently Completed Financial Year




The below table sets forth information regarding the options held by the Named Executive Officers as at December 31, 2009.





Option-based AwardsName
Number of securities underlying unexercised options (#)
Option exercise price

(Cdn$)
Option expiration date
Value of unexercised in-the-money options (Cdn$)Peter Riehl

President and Chief Executive Officer
35,000
1.00
December 9, 2014
18,537Janice M. Clarke

Chief Financial Officer and

VP of Administration
15,000

30,000

30,000
1.00

0.84

0.69
December 9, 2014

December 9, 2014

June 30, 2010
7,945

16,557

10,535





32




Incentive Plan Awards – Value Vested or Earned during the Most Recently Completed Financial Year




The incentive plan awards for each of the Named Executive Officers during 2009 is shown in the table below and is comprised of vested stock options vested.





Name
Option-based awards – Value vested during 2009

(Cdn$) (1)
Non-equity incentive plan compensation – Value earned during 2009

(Cdn$)Peter Riehl

President and Chief Executive Officer
9,269
NilJanice M. Clarke(2)

Chief Financial Officer and

VP of Administration
3,972
Nil





Notes:




(1)
Calculated as the aggregate dollar value of options vested during the year that would have been realized if the options under the option-based award had been exercised on the vesting date. All options which vested in the year were out-of-money at the time the options vested.




(2)
In 2009, the Company issued 30,000 options to its Chief Financial Officer at an exercise price of US$0.84. However, these options were performance based options with 10,000 of these options subject to profitability being achieved in 2009 (vesting 25% at the end of each calendar quarter in 2010), while the remaining 20,000 are subject to  profitability in 2010, (vesting 25% at the end of each calendar quarter in 2011).




Termination and Change of Control Benefits




Peter Riehl, the Company’s President and Chief Executive Officer is the only officer who currently has an employment agreement with the Company. The agreement provides that in the event that Mr. Riehl’s employment is terminated, by the Company other than for cause, by Mr. Riehl for good reason or by Mr. Riehl within six months of a change of control of the Company, Mr. Riehl is entitled to (i) a lump sum payment equal to 200% of his then current base salary, (ii) all outstanding and accrued regular and vacation pay and expenses and (iii) the immediate vesting of his options which shall continue to be available for exercise for a period of 30 days following the date of termination.





For the purposes of the agreement "good reason" includes the following:(a) a change (other than those that are clearly consistent with a promotion) in the executive's position or duties, responsibilities (including to whom the executive reports and who reports to the executive), title or office, which includes any removal of the executive from or any failure to re-elect or re-appoint the executive to any such positions or offices; (b) a reduction by the Company of the executive's salary, benefits or any other form of remuneration or change in the basis upon which the executive's salary, benefits or any other form of remuneration payable by the Company is determined or any failure by the Company to increase the executive's salary, benefits or other forms of remuneration payable by the Company in a manner consistent (both as to frequency and percentage increase) with practices in effect at the time in question with respect to the senior executives of the Company; (c) any failure by the Company to continue in effect any benefit, bonus, incentive, remuneration or compensation plan, stock option plan, pension plan or retirement plan in which the executive is participating or entitled to participate, or the Company taking any action or failing to take any action that would adversely effect the executive's participation in or reduce his rights or benefits under or pursuant to any such plan, where the Company failing to increase or improve such rights or benefits on a basis consistent with practices in effect at the time in question with respect to the senior executives of the Company; (d) any failure by the Company to provide the executive with the number of paid vacation days to which he was entitled at the time in question or the Company failing to increase such paid vacation on a basis consistent with practices in effect at the time in question with respect to the senior executives of the Company; (e) the Company taking any action to deprive the executive of any material fringe benefit not hereinbefore mentioned and enjoyed by him immediately prior to the time in question, or the Company failing to increase or improve such material fringe benefits on a basis consistent with practices in effect at the time in question with respect to the senior executives of the Company; (f) any breach by the Company of any material provision of the agreement; (g) the good faith determination by the executive that constructive dismissal of the executive has occurred; or (h) the failure by the Company to obtain, in a form satisfactory to the executive, an effective assumption of its obligations hereunder by any successors to the Company, including a successor to a material portion of its business.





33





For the purposes of the employment agreement a "change of control" means (a) the acquisition or continued ownership of shares of the Company and/or securities ("Convertible Securities") convertible into, exchangeable for or representing the right to acquire shares of the Company as a result of which a person, group of persons or persons acting jointly or in concert or persons associated or affiliated (within the meanings of the Business Corporations Act (Ontario)) with any such person, group of persons or any of such persons acting jointly or in concert (collectively, the "Acquirors") beneficially own shares of the Company and/or Convertible Securities such that, assuming only the conversion, exchange or exercise of Convertible Securities beneficially owned by the Acquirors, the Acquirors would beneficially own shares of the Company that would entitle the holders thereof to cast more than 50% of the votes cast attaching to all shares of the Company that may be cast to elect members of the Board; and (b) exercise of voting power over all or any such shares of the Company so as to cause or result in the election of such number of directors of the Company as would constitute a majority of the Board and who were not incumbent directors.





Director Compensation




The following table sets out the total compensation earned by each non-executive director who served in that capacity for any part of the most recently completed financial year:





Name
Fees earned

($)
Option-based awards

($)
All other compensation

($)
Total

($)John Kime(1)(2)(4)
14,000
7,553
Nil
21,553Robert Kayser(1)
10,000
7,553
Nil
17,553John Gregory
6,000
7,553
Nil
13,553Arnold Tenney(2)
11,000
8,811
72,000(3)
91,311F. Martin Thrasher(1)
7,500
7,553
Nil
15,053





Notes:




(1)
Member of the Audit Committee
 (2)
Member of the Compensation Committee


(3)
The Company entered into a financial advisory and consulting agreement with LMT, a company beneficially owned by Mr.    Tenney (a director of the Company) and his spouse.  In consideration for services provided under this agreement, LMT earned a fee of $72,000 (Cdn.) in 2009.


(4)
Audit Committee Chairman
  34





Option-based awards




The following table sets out details, as at December 31, 2009, details of options held by each non-executive director who served in that capacity for any part of the most recently completed financial year:







Name
Number of Securities Underlying Unexercised Options

(#)
Option Exercise Price

(Cdn$)
Option Expiration Date
Value of Unexercised In-the-Money Options

(Cdn$)John Gregory
30,000
1.00
December 9, 2014
15,890Robert Kayser
30,000
1.00
December 9, 2014
15,890John Kime
30,000
1.00
December 9, 2014
15,890Arnold Tenney
35,000
1.00
December 9, 2014
18,538F. Martin Thrasher
30,000
1.00
December 9, 2014
15,890







Name
Option-based awards – Value vested during 2009

(Cdn$) (2)
Non-equity incentive plan compensation – Value earned during 2009

(Cdn$) (3)John Gregory
7,945
NilRobert Kayser
7,945
NilJohn Kime
7,945
NilArnold Tenney
9,269
NilF. Martin Thrasher
7,945
Nil





Equity Compensation Plan Information





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

(b)
Number of securities

remaining available for

future issuance under equity

compensation plans

(excluding securities reflected

in column (a))

(c)Equity compensation plans approved by security holders
460,000
$0.88
1,519,452Equity compensation plans not approved by security holders
Nil
Nil
NilTotal
460,000
$0.88
1,519,452





35





INDEBTEDNESS OF DIRECTORS AND SENIOR OFFICERS





Since the beginning of the last completed financial year and up to March 29, 2010, no director, executive officer or employee or former executive officer, director or employee of the Company or any of its subsidiaries was indebted to the Company.





DIRECTORS’ AND OFFICERS’ LIABILITY INSURANCE


The Company provides insurance for the benefit of the directors and officers of the Company against liability incurred by them in these capacities.  The current annual policy limit is $2,000,000.  Protection is provided to directors and officers for certain wrongful acts or omissions done or committed during the course of their duties as such.  Under the policy, the Company is reimbursed for payments which it is required or permitted to make to its directors and officers to indemnify them.  The current annual premium is $19,440.  No claims have been made under the policy.


ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS




The following table sets forth, as at March 28, 2010, 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.




Name, Municipality of Residence and Position and/or Office with the Company
Principal Occupation
Period Served as a Director
Common Shares Beneficially Owned, Directly or Indirectly, or Over Which Control or Direction is Exercised*Peter Riehl

London, Ontario

President, Chief Executive Officer and Director
President and Chief Executive Officer of the Company
Since December 19, 1996
3,474,741(3)John Kime(1)(2)

London, Ontario

Director
President, iBD Advisors Inc.
Since November 28, 2000
125,000Robert Kayser (2)

London, Ontario

Director
President, RHK Consulting
Since June 29, 2005
NilArnold Tenney(1)

Toronto, Ontario

Chairman
Financial Consultant at Divine Entertainment Corporation, a children's family film production and development company
Since April 29, 2004
884,200(4)Janice Clarke

Mt Brydges, Ontario

Chief Financial Officer
Chief Financial Officer
Since March 5, 2004
82,222(6)John Gregory

Tennessee, U.S.A.

Director
Managing partner of SJ Strategic Investments LLC
Since February 26, 2007
5,188,794(5)Francis Martin Thrasher(2)

London Ontario

Director
President of FMT Consulting
Since April 22, 2009
Nil




36





Notes:





*
Does not include options or other convertible securities.





(1)
Member of the Compensation Committee
 (2)
Member of the Audit Committee
 (3)
Includes 1,690,714 Common Shares owned by Mr. Riehl's spouse.
 (4)
Includes (i) 672,700 Common Shares owned by LMT Financial Inc. ("LMT"), 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 an equity interest; and (iii) 85,000 common shares owned by Mr. Tenney’s spouse.


(5)
The 5,188,794 Common Shares are owned by Strategic Investments LLC, a company beneficially owned by Mr. Gregory.





(6)
Includes 10,000 Common Shares owned by Ms. Clarke’s spouse.




ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE




In February 2008, Stellar entered into a consulting agreement with LMT Financial Inc., a company beneficially owned by, Mr. Tenney, a director, and his spouse. This consulting agreement has been extended for an additional one year. 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 2009 (2008 - $72,000). This fee was satisfied in full through 12 monthly payments of $6,000 during 2009 (2008 - $6,000).




ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES




The shareholders have appointed McGovern, Hurley, Cunningham LLP as the Company’s independent auditors for the fiscal year ended December 31, 2009.  McGovern, Hurley, Cunningham LLP replaced Deloitte & Touche LLP who were the Company’s independent auditors for the fiscal year ended December 31, 2008.




The following table shows the fees recorded by the Company for the audit and other services provided by McGovern, Hurley, Cunningham LLP for 2009 and Deloitte & Touche LLP for 2008:




2009


2008Audit Fees

$
60,000


$
87,400Audit-Related Fees


-



7,200Quarterly Reviews & Other Fees


31,500



46,000Total

$
91,500


$
142,600





As defined by the Commission, (i) “audit fees” are fees for professional services rendered by our principal accountant for the audit of our annual financial statements and review of financial statements included in our Form 10-Q, or for services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years; (ii) “audit-related fees” are fees for assurance and related services by our principal accountant that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “audit fees”; (iii) “tax fees” are fees for professional services rendered by our principal accountant for tax compliance, tax advice, and tax planning; and (iv) “all other fees” are fees for products and services provided by our principal accountant, other than the services reported under audit fees,” “audit-related fees,” and “tax fees.”




37





Audit Fees.




Audit fees consist of fees recorded for professional services rendered for the audit of the Company’s financial statements and services that are normally provided in connection with statutory and regulatory filings. The aggregate fees recorded by the Company for the 2009 and 2008 audit were approximately $60,000 and $87,400, respectively.




Audit-Related Fees.




Audit related fees are fees billed for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s consolidated financial statements and are not under “Audit Fees.” Deloitte & Touche LLP billed $7,200 for the year ended December 31, 2008 primarily in connection with review of the Company's responses to comment letters from the SEC.




All Other Fees.




Fees related to the review of the interim financial statements included in quarterly reports and services that are normally provided in connection with statutory and regulatory filings.




Tax Fees.




We do not engage our principal accountant to assist with the preparation or review of our annual tax filings. We do, however, engage an outside tax consultant to provide this service. The company recorded expense of $5,933 in 2009 in regards to the 2007 and 2008 tax years (2008 - $2,135).




Engagement of the Independent Auditor.




The Audit Committee is responsible for approving every engagement of McGoven, Hurley, Cunningham LLP to perform audit or non-audit services for the Company before McGoven, Hurley, Cunningham LLP is engaged to provide those services. Under applicable laws, the Audit Committee is required to pre-approve the audit and non-audit services performed by the independent auditors in order to ensure that they do not impair the auditors’ independence. Applicable laws  specify the types of non-audit services that an independent auditor may not provide to its audit client and establish the Audit Committee’s responsibility for administration of the engagement of the independent auditors.




Consistent with the applicable laws, the Audit Committee Charter requires that the Audit Committee review and pre-approve all audit services and permitted non-audit services provided by the independent auditors to us or any of our subsidiaries. The Audit Committee may delegate pre-approval authority to a member of the Audit Committee and if it does, the decisions of that member must be presented to the full Audit Committee at its next scheduled meeting.




The Audit Committee’s pre-approval policy provides as follows:




●
First, once a year when the base audit engagement is reviewed and approved, management will identify all other services (including fee ranges) for which management knows it will engage McGovern, Hurley, Cunningham LLP for the next 12 months. Those services typically include quarterly reviews, specified tax matters, certifications to the lenders as required by financing documents, consultation on new accounting and disclosure standards and, in future years, reporting on management’s internal controls assessment.




●
Second, if any new “unlisted” proposed engagement arises during the year, the engagement will require approval of the Audit Committee.




38




ITEM 15.
EXHIBITS




Exhibit

No.

Description of Exhibit

Sequential

Page

Number2.1

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.

*****31.1

Certification of Chief Executive Officer

****31.2

Certification of Chief Financial Officer

****32.1

Certification of Chief Executive Officer

****32.2

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 June 4, 2009 – 1st Qtr 2009 Financial Results


Filed August 5, 2009 – 2nd Qtr 2009 Financial Results


Filed November 12, 2009 – 3rd Qtr 2009 Financial Results




39





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.




Date: March 29, 2010
STELLAR PHARMACEUTICALS INC.By:
/s/ Arnold TenneyName: Arnold TenneyTitle:  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.




Date: March 29, 2010
By:
/s/  Arnold TenneyName: Arnold TenneyTitle:  Chairman of the Board





Date: March 29, 2010
By:
/s/ Peter RiehlName: Peter RiehlTitle:  Chief Executive Officer





Date: March 29, 2010
By:
/s/  Robert KayserName: Robert H. KayserTitle:  Director





Date: March 29, 2010
By:
/s/  John KimeName: John J. KimeTitle:  Director





Date: March 29, 2010
By:
/s/  John GregoryName: John M. GregoryTitle:  Director




Date: March 29, 2010
By:
/s/Martin ThrasherName: F. Martin ThrasherTitle:  Director
 Date: March 29, 2010
By:
/s/Janice ClarkeName: Janice ClarkeTitle: Chief Financial Officer
  40
       STELLAR PHARMACEUTICALS INC.
    FINANCIAL STATEMENTS
 
 (Expressed in Canadian dollars)
 
 
 DECEMBER 31, 2009 AND 2008
             41
  
 
 NOTICE TO READER
 
 Special Note Concerning 2008 Financial Statements
 
 The Company’s 2008 financial statements included in this annual report are unaudited.  Although the Company previously filed audited 2008 financial statements in its 2008 annual report on Form 10-K, the Company was unable to obtain the consent of the independent registered chartered accountants that prepared such financial statements by the filing deadline of this annual report.  The Company believes that its inability to obtain such consent is due to a billing dispute.  The unaudited 2008 financial statements contained in this annual report do not contain any adjustments, modifications or changes from the audited 2008 financial statements of the Company filed in its 2008 annual report on Form 10-K.
 
 
 
 
 
 
 
 STELLAR PHARMACEUTICALS INC.
 
 DECEMBER 31, 2009
 
 (Expressed in Canadian dollars)
 
 
 CONTENTS
  PAGEFINANCIAL STATEMENTSREPORT BY INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS
F-1REPORT BY INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS
F-2BALANCE SHEETS
F-3STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
F-4STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
F-5STATEMENTS OF CASH FLOWS
F-6NOTES TO FINANCIAL STATEMENTS
F-7-24
   
 43
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 To the Board of Directors and Shareholders of
 Stellar Pharmaceuticals Inc.
 
 
 We have audited the accompanying balance sheet of Stellar Pharmaceuticals Inc. (the “Company”) as at December 31, 2009 and the statements of operations and comprehensive income, changes in shareholders’ equity and cash flows for the year then ended. 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 audit.
 
 We conducted our audit 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.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  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 audit provides 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 at December 31, 2009 and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles in the United States of America.
 
 
 McGOVERN, HURLEY, CUNNINGHAM, LLP
 
 Chartered Accountants
 Licensed Public Accountants
 TORONTO, Canada
 March 22, 2010
  F-1
 
 Deloitte & Touche LLP

1 Concorde Gate

Suite 200

Toronto ON  M3C 4G4

CanadaTel: 416-601-6150

Fax: 416-601-6151

www.deloitte.ca
 
 Report of Independent Registered Chartered Accountants
 
 To the Board of Directors and Shareholders of
 Stellar Pharmaceuticals Inc.
 
 We have audited the accompanying balance sheets of Stellar Pharmaceuticals Inc. (the "Company") as of December 31, 2008 and 2007, and the related statements of operations and comprehensive loss, changes in shareholders' equity, and cash flows for each of the two years in the period ended December 31, 2008.  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.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.
 
 Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, such financial statements present fairly, in all material respects, the financial position of Stellar Pharmaceuticals Inc. at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.
 
 
 
 Independent Registered Chartered Accountants
 Licensed Public Accountants
 April 6, 2009
 F-2
 
 STELLAR PHARMACEUTICALS INC.
  BALANCE SHEETS
  (Expressed in Canadian dollars)
  December 31
  ASSETS

2009


2008

(Unaudited)CURRENTCash and cash equivalents (Note 3)

$
2,325,212


$
2,105,966Accounts receivable, net of allowance of $nil (2008 - $nil)


293,565



549,055Inventories (Note 4)


721,061



364,551Taxes recoverable


1,501



212,445Loan receivable (Note 8)


15,818



18,369Prepaids, deposits and sundry receivables (Note 5)


163,698



130,515Total current assets


3,520,855



3,380,901PROPERTY, PLANT AND EQUIPMENT, net (Note 6)


1,390,296



1,270,257OTHER ASSETS(Note 7)


114,553



65,495Total assets

$
5,025,704


$
4,716,653LIABILITIESCURRENTAccounts payable

$
228,367


$
173,812Accrued liabilities


175,637



186,201Deferred revenues


2,890



1,749Total current liabilities


406,894



361,762CONTINGENCIES AND COMMITMENTS (Note 13)SHAREHOLDERS’ EQUITYCAPITAL STOCKAUTHORIZEDUnlimited
Non-voting, convertible redeemable and retractable preferred shares with no par valueUnlimited
Common shares with no par valueISSUED (Note 9)23,480,040
Common shares (2008 – 23,702,540)


8,183,638



8,261,403Nil
Treasury shares (2008 – 147,500)


—



(51,625
)Additional Paid-in capital for cancelled Common shares


—



2,329Additional Paid-in capital options - outstanding


89,562



35,965Additional Paid-in capital options -  expired


724,127



722,3728,997,327



8,970,444DEFICIT




(4,378,517
)


(4,615,553
)Total shareholders’ equity


4,618,810



4,354,891Total liabilities and shareholders’ equity

$
5,025,704


$
4,716,653
  See accompanying notes to financial statements.
  
  F-3
  STELLAR PHARMACEUTICALS INC.
  STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
  (Expressed in Canadian dollars)
  FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008
  Number ofCommonShares#











AdditionalPaid inCapital

forCancelled Shares$


Additional Paid in

Capital OptionsTreasury

Shares

#


Common Shares

$


Treasury

Shares

$




Options

Outstanding

$


Options

Expired

$


Deficit

$BALANCE,December 31, 2007


23,822,540



—



8,303,054



—



—



123,002



623,417



(4,576,621
)Shares issued for services


5,000



—



1,700



—



—



—



—



—Stock-based compensation


—



—



—



—



—



11,918



—



—Employees options expired


—



—



—



—



—



(98,955
)


98,955



—Purchase and cancellation of Shares under normal course issuer bid

(Note 9(c))


(125,000
)


—



(43,351
)


—



2,329



—



—



(7,866
)Treasury Shares

(Note 9(c))


—



(147,500
)


—



(51,625
)


—



—



—



—Net loss for the year


—



—



—



—



—



—



—



(31,066
)BALANCE,December 31, 2008 (Unaudited)


23,702,540



(147,500
)


8,261,403



(51,625
)


2,329



35,965



722,372



(4,615,553
)Options issued to employees


—



—



—



—



—



55,352



—



—Stock-based compensation


—



—



—



—



—



(1,755
)


1,755



—Purchase and cancellation of Shares under normal course issuer bid

(Note 9(c))


(75,000
)


—



(26,140
)


—



(2,329
)


—



—



(1,888
)Treasury Shares cancelled


(147,500
)


147,500



(51,625
)


51,625



—



—



—



—Net income for the year


—



—



—



—



—



—



—



238,924BALANCE,December 31, 2009


23,480,040



—



8,183,638



—



—



89,562



724,127



(4,378,517
)
  See accompanying notes to financial statements.
 
 F-4
 
 STELLAR PHARMACEUTICALS INC.
  STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
  (Expressed in Canadian dollars)
  FOR THE YEARS ENDED DECEMBER 31
  2009


2008

(Unaudited)PRODUCT SALES

$
3,000,062


$
2,118,282ROYALTIES & LICENSING REVENUE


581,230



441,130TOTAL REVENUE FROM ALL SOURCES


3,581,292



2,559,412COST OF PRODUCTS SOLD


1,001,871



556,401GROSS PROFIT


2,579,421



2,003,011EXPENSESSelling, general and administrative *


2,278,530



2,010,383Research and development (Notes 2(k) and 13(f))


18,107



62,727Amortization of assets (non-manufacturing property, plant and equipment)


55,822



54,3842,352,459



2,127,494INCOME (LOSS) FROM OPERATIONS


226,962



(124,483
)INTEREST AND OTHER INCOME


11,962



83,741GAIN ON DISPOSAL OF EQUIPMENT


—



9,676NET INCOME (LOSS) AND COMPREHENSIIVE

INCOME (LOSS) FOR THE YEAR (before tax)


238,924



(31,066
)INCOME TAXES(Note 10)


—



—NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)

$
238,924


$
(31,066
)EARNINGS (LOSS) PER SHARE(Note 11)
- Basic

$
0.01


$
(0.00
)- Diluted

$
0.01


$
(0.00
)WEIGHTED AVERAGE NUMBER OF COMMONSHARES  OUTSTANDING
- Basic


23,498,889



23,801,450- Diluted


23,498,889



23,801,450
  See accompanying notes to financial statements.
  
   F-5
 STELLAR PHARMACEUTICALS INC.
 STATEMENTS OF CASH FLOWS
  (Expressed in Canadian dollars)
  FOR THE YEARS ENDED DECEMBER 31
  2009


2008
(Unaudited)CASH FLOWS USED IN OPERATING ACTIVITIESNet income (loss)

$
238,924


$
(31,066
)Items not affecting cashAmortization


108,492



126,556Gain on disposal of equipment


––



(9,676
)Write-down of property, plant & equipment


––



2,656Unrealized foreign exchange (gain) loss


24,203



(17,945
)Issuance of equity instruments for services rendered (Notes 9(d) & 9(e))


55,352



13,618Change in non-cash operating assets and liabilities (Note 12)


26,143



(562,256
)CASH FLOWS USED IN OPERATING ACTIVITIES


453,114



(478,113
)CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIESAdditions to property, plant and equipment


(155,630
)


(539,511
)Increase in other assets


(26,230
)


(11,420
)Proceeds from sale of equipment


––



10,000CASH FLOWS USED IN INVESTING ACTIVITIES


(181,860
)


(540,931
)CASH FLOWS USED IN FINANCING ACTIVITIESRepurchase of common shares for cash (Note 9(c))


(30,357
)


(100,514
)CASH FLOWS USED IN FINANCING ACTIVITIES


(30,357
)


(100,514
)EFFECT OF EXCHANGE RATES ON CASH HELD IN

FOREIGN CURRENCY


(21,650
)


14,398CHANGE IN CASH AND CASH EQUIVALENTS


219,246



(1,105,160
)CASH AND CASH EQUIVALENTS, beginning of year


2,105,966



3,211,126CASH AND CASH EQUIVALENTS, end of year

$
2,325,212


$
2,105,966
 
 See accompanying notes to financial statements.
  F-6
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  (Expressed in Canadian dollars)
  DECEMBER 31, 2009 AND 2008
  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. 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 maturity of three months or less at the date of purchase.  Cash and cash equivalents are held with two major financial institutions in Canada and one financial institution located in Dublin, Ireland.
  (b)           ACCOUNTS RECEIVABLE
  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
  The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectibility is reasonably assured.  License fees which are comprised of initial fees and milestone payments are recognized upon achievement of the milestones and provided that collectibility is reasonably assured and other revenue recognition criteria are met.   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 collectibility 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 transfer of methods and technical know-how, not requiring the Company to perform additional research or development activities or other significant future performance obligations, are recognized upon delivery of the methods and technical know-how.
  F-7
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  2.             SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Milestone payments are recognized into income upon the achievement of the specified milestones when the Company has no further involvement or obligation to perform services, as related to that specific element of the arrangement. Up-front fees and other amounts received in excess of revenue recognized are recorded as deferred revenues.
  Royalty revenue is recognized when the Company has fulfilled the terms in accordance with the contractual agreement and has no material future obligation, other than inconsequential and prefunctory support, as would be expected under such agreements and the amount of the royalty fee is determinable and collection is reasonably assured.
  A customer is obligated to pay for products sold to it within a specified number of days from the date that title to the products is transferred to the customer.  The Company’s standard terms are typically net 15 days from the transfer of title to the products to the customer.  The Company typically collects payment from a customer within 15 to 30 days from the transfer of title to the products to a customer.  Transfer of title occurs and risk of ownership passes to a customer at the time of shipment or delivery, depending on the terms of the agreement with a particular customer.  The sale price of the Company’s products is substantially fixed or determinable at the date of sale based on purchase orders generated by a customer and accepted by the Company.  A customer’s obligation to pay the Company for products sold to it is not contingent upon the resale of those products.  The Company recognizes revenues for the sale of products from the date the title to the products is transferred to the customer.
  (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.   Cost is determined to be purchased cost for raw materials and the production cost (materials, labor and indirect manufacturing cost) for work-in-process and finished goods. Throughout the manufacturing process, the related production costs are recorded within inventory.
  (e)           PROPERTY, PLANT AND EQUIPMENT
  Property, plant and equipment are stated at cost.  The Company periodically evaluates whether current facts or circumstances indicate that the carrying value of such assets to be held and used may not be recoverable. The Company reviews its long-lived assets, such as fixed assets to be held and used or disposed of, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected undiscounted cash flows undiscounted and without interest is less than the carrying amount of the asset, an impairment loss is recognized in the amount by which the carrying amount of the asset exceeds its fair value.  The basis and estimated useful lives of these assets are provided for as follows:
  Asset Classification

Amortization Method

Useful LifeBuilding

Straight-line

20 yearsComputer and office equipment

Straight-line

5 yearsManufacturing equipment

Straight-line & Activity based

5 to 10 yearsWarehouse equipment

Straight-line

5 to 10 yearsPackaging equipment

Activity based

5 to 10 years
  Activity based amortization is based on the number of uses for each asset in that category.
  F-8
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  2.             SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  (f)           OTHER ASSETS
  Amortization of other assets is being provided for on a straight-line basis as noted below:
  Asset Classification

Amortization Method

Useful LifePatents

Straight-line

17 years
 
 Patents represent capitalized legal costs incurred in connection with applications for patents.  For patents and applications that are abandoned or impaired, the Company charges the remaining net book value to expenses.
  (g)           USE OF ESTIMATES
  The preparation of these financial statements has required management to make estimates and assumptions that affect the amounts of assets and liabilities and disclosure of contingent liabilities as at December 31, 2009 and 2008, and the revenue and expenses recorded for the years then ended.   On an ongoing basis, the Company evaluates its estimates, including those related to provision for doubtful accounts, accrued liabilities, income taxes, stock based compensation, revenue recognition and intangible assets.  The Company bases its estimates on historical experiences and on various other assumptions believed to be reasonable under the circumstances.
  Actual results could differ from those estimates.  As adjustments become necessary, they are recorded 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, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements.  Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax results on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.  The Company records net deferred tax assets to the extent, management believes these assets will more likely than not be realized.  In making such determination, all available positive and negative evidence is utilzed, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations.  In the event a determination was made that the Company would be able to realize deferred income tax assets in the future in excess of the net recorded amount, an adjustment to the valuation allowance would be made, which would reduce the provision for income taxes.
  Tax benefits from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits.  Income tax positions must meet a more-likely-than-not recognition threshold to be recognized.  This interpretation also provides guidance on measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  It is the Company’s policy to recognize interest and penalties related to income tax matters in income tax expense.
  F-9
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  2.            SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  (i)
STOCK-BASED COMPENSATION
  The Company uses fair value based method of accounting for all its stock-based compensation in accordance with ASC 718 “Compensation – Stock Compensation”.  The estimated fair value of the options that are ultimately expected to vest based on performance related conditions, as well as the options that are expected to vest based on future service, is recorded over the option’s requisite service period and charged to stock-based compensation.  In determining the amount of options that are expected to vest, the Company takes into account, voluntary termination behaviour as well as trends of actual option forfeitures.  Total compensation cost for the stock option plans for the years ended December 31, 2009 and 2008 (unaudited) was $55,352 and $11,918, respectively (Note 9(d)).
  (j)           FOREIGN CURRENCY TRANSACTIONS AND 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.
  (k)           RESEARCH AND DEVELOPMENT
  Research and development costs are expensed as incurred.  The approved refundable portion of the tax credits are netted against the related expenses.  Non refundable investment tax credits are recorded in the period when reasonable assurance exists that the Company has complied with the terms and conditions required for approval of the tax credit and it is more likely than not that the Company will realize the benefits of these tax credits against the deferred taxes.  Refundable investment tax credits are recorded in the period when reasonable assurance exists that the Company has complied with the terms and conditions required for approval of the tax credit and it is more likely than not that the Company will collect it. At December 31, 2009, the Company had no outstanding tax credits (2008 (unaudited) - $34,926). Tax credits received in 2008 were recorded as an offset to research and development for prior year’s tax credits which were assessed and approved.
  (l)           COMPREHENSIVE INCOME
  Comprehensive income is defined as the change in equity during a period related to transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
  (m)           EARNINGS (LOSS) PER SHARE
  FASB ASC Section 260, “Earnings Per Share”, requires presentation of both basic and diluted earnings per share (EPS) with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution; diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue shares were exercised or converted into shares that would then share in the earnings.
  Basic earnings (loss) per share are computed based on the weighted average number of member shares outstanding each year.  The diluted earnings factor for stock options at December 31, 2009 is for 202,500 potential common shares (2008 (unaudited) – nil as its affect would be anti-dilutive). The diluted loss per share is not presented when the effect is anti-dilutive.
  F-10
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  2.             SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  (n)
RECENT ACCOUNTING PRONOUNCEMENTS
  Recent accounting pronouncements followed by the Company under U.S. GAAP are summarized below.
  In April 2009, the FASB issued ASC 820-10-65-4 (formerly referred to as FSP SFAS 157-4), "Determining Whether a Market Is Not Active and a Transaction Is Not Distressed." ASC 820-10-65-4 provides guidelines for making fair value measurements more consistent with the principles presented in ASC 820-10-65-1. ASC 820-10-65-4 provides additional authoritative guidance in determining whether a market is active or inactive, and whether a transaction is distressed, is applicable to all assets and liabilities (i.e. financial and non-financial) and will require enhanced disclosures. This standard is effective for periods ending after June 15, 2009. The Company has evaluated this standard and determined that it does not have an impact on its financial position and results of operations.
  In April 2009, the FASB issued ASC 825-10-65-1 (formerly referred to as FSP SFAS 107-1 and APB 28-1), "Interim Disclosures about Fair Value of Financial Instruments," and "Disclosures about Fair Value of Financial Instruments, (formerly referred to as FSP SFAS 107)" to require disclosures about fair value of financial instruments in interim as well as in annual financial statements. ASC 825-10-65-1 also includes an amendment to "Interim Financial Reporting (formerly referred to as APB 28-1)," to require those disclosures in all interim financial statements. This standard is effective for periods ending after June 15, 2009. The Company has adopted this standard and determined that it does not have an impact on its financial position and results of operations.
  In June 2009, the FASB issued ASC 105-10 (formerly referred to as SFAS No. 168), The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. On the effective date of this Statement, the Codification superseded all then-existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification will become non-authoritative. ASC 105-10 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company has adopted this standard and determined that it does not have a material impact on its financial condition, results of operations, or cash flows.
  In September 2009, the FASB Emerging Issues Task Force, or EITF, reached a consensus on ASC Update 2009-13 (Topic 605), Multiple-Deliverable Revenue Arrangements, or ASC Update 2009-13. ASC Update 2009-13 applies to multiple-deliverable revenue arrangements that are currently within the scope of ASC 605-25. ASC Update 2009-13 provides principles and application guidance on whether multiple deliverables exist and how the arrangement should be separated and the consideration allocated. ASC Update 2009-13 requires an entity to allocate revenue in an arrangement using estimated selling prices of deliverables, if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price. The update eliminates the use of the residual method and requires an entity to allocate revenue using the relative selling price method and also significantly expands the disclosure requirements for multiple-deliverable revenue arrangements. ASC Update 2009-13 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. As a result, ASC Update 2009-13 will be effective for the Company no later than the first quarter of fiscal 2011. The adoption of ASC Update 2009-13 may have a material impact on the Company’s financial position or results of operations for future collaborations arrangements.
  F-11
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  3.             CASH AND CASH EQUIVALENTS
  Consists of -
December 31,2009

2008
(Unaudited)Cash

$
824,558


$
1,205,094Short-term investments


1,500,654



900,872$
2,325,212


$
2,105,966
 
 The Company recorded $21,650 as an effect of exchange rates on cash held in foreign currency at December 31, 2009.
  4.             INVENTORIES
  Consists of -

December 31,2009


2008
(Unaudited)Raw material

$
182,123


$
135,315Finished goods


113,531



38,842Packaging materials


67,571



53,811Work in process


357,836



136,583$
721,061


$
364,551
  5.             PREPAIDS, DEPOSITS AND SUNDRY RECEIVABLES
  Consists of -

December 31,2009


2008
(Unaudited)Prepaid operating expenses

$
161,140


$
37,312Deposit on manufactured goods*


––



91,120Interest receivable on investments


2,558



2,083$
163,698


$
130,515
 
 *

Deposit on manufactured goods relates to a deposit required upon the issuance of the order for a stability studies related to manufacturing processes.
  6.
PROPERTY, PLANT AND EQUIPMENT
  Consists of -

December 31, 2009Cost


Accumulated

Amortization


Net Carrying

AmountLand

$
90,000


$
—


$
90,000Building


618,254



146,236



472,018Office equipment


43,302



40,338



2,964Manufacturing equipment


1,219,490



522,959



696,531Warehouse equipment


17,085



6,745



10,340Packaging equipment


110,120



10,724



99,396Computer equipment


125,116



106,069



19,047$
2,223,367


$
833,071


$
1,390,296
  F-12
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  6.
PROPERTY, PLANT AND EQUIPMENT (continued)
  Consists of -

December 31, 2008
(Unaudited)Cost


Accumulated

Amortization


Net Carrying

AmountLand

$
90,000


$
—


$
90,000Building


586,954



116,105



470,849Office equipment


40,495



36,801



3,694Manufacturing equipment


1,099,790



475,453



624,337Warehouse equipment


13,750



3,675



10,075Packaging equipment


48,467



5,840



42,627Computer equipment


116,735



88,060



28,675$
1,996,191


$
725,934


$
1,270,257
  During fiscal 2008, the Company performed an analysis of its property, plant and equipment and based on this analysis determined that $30,308 of its manufacturing equipment was no longer useable. The Company removed $30,308 in assets from manufacturing equipment and recorded a reduction to accumulated amortization of $27,652 and $2,656 to operations as a part of selling, general and administrative expenses.
  7.             OTHER ASSETS
 
 Consists of -

December 31, 2009Cost


Accumulated

Amortization


Net Carrying

AmountPatents

$
122,793


$
8,240


$
114,553
  Over the next four years the Company will record amortization expense of $1,355 for each of those years.  The Company currently has patents of $100,207 which are not being amortized as these patents are currently pending.
  Consists of -

December 31, 2008
(Unaudited)Cost


Accumulated

Amortization


Net Carrying

AmountPatents

$
72,380


$
6,885


$
65,495
  Estimated future amortization expense at December 31, 2009 is as follows:
  Amount2010

$
2,4442011


2,4442012


2,4442013


2,4442014


2,444Thereafter


53,275$
65,495
 
 F-13
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  8.             LOAN RECEIVABLE
  During the year ended December 31, 2007, the Company received a subordinated convertible promissory note and a common share purchase warrant to purchase 15,000 shares from an unrelated corporation, in the amount of US$15,000 (Cdn$15,818) (2008 (unaudited) – Cdn$18,369).  The note was extended for two additional one year periods, but will fully mature no later than April 23, 2011 and bears interest at a rate per annum of 6%.  The warrant entitles the Company to acquire 15,000 common shares of the unrelated corporation anytime on or before July 15, 2016 at $0.001 per common share.  During 2007, the Company converted its warrants to common shares for US$15 the common share price was US$0.001 at the time of exercise.  The Company used the fair value basis to calculate the value of the asset and allocated the entire US$15,000 to the promissory note.  The change in the value recorded was the result of the fluctuation in the value of the Canadian dollar relative to the US dollar.
  9.             CAPITAL STOCK
  (a)
Common Shares
  Authorized: An unlimited number of Common Shares, with no par value.
  # of Shares


AmountBalance, January 1, 2009


23,702,540


$
8,261,403Shares purchased in buyback (cancelled)


(75,000
)


(26,140
)Treasury shares (cancelled)


(147,500
)


(51,625
)Balance, December 31, 2009


23,480,040


$
8,183,638
 
 Treasury Shares
 
 # of Shares


AmountBalance, January 1, 2009


(147,500
)

$
(51,625
)Treasury shares


147,500



51,625Balance, December 31, 2009


—


$
—
  (b)           Shares to be Issued
  During 2009, no Common Shares (2008 (unaudited) – 5,000) were issued. Shares issued in 2008 were issued to satisfy in full, a debt for consulting services which were rendered and expensed in 2008 with a value of $1,700.
  (c)           Purchases of Equity Securities
  On April 1, 2008, the Company commenced a normal course issuer bid (the "NCIB") for its Common Shares. Pursuant to the terms of the NCIB, the Company may during the 12 month period commencing April 1, 2008 and ending March 31, 2009, purchase up to 1,191,127 Common Shares provided that the aggregate value of Common Shares so purchased, does not exceed $1,000,000.  The Company commenced a second NCIB on June 17, 2009 and ending on June 16, 2010. Purchases of Common Shares will be made in open market transactions, at market prices prevailing at the time of acquisition.  For the year ended December 31, 2009, 75,000 Common Shares purchased under the NCIB had been cancelled (2008 (unaudited) – 125,000 and 147,500 were recorded as Treasury Shares to be cancelled).
  F-14
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  9.             CAPITAL STOCK (continued)
  Pursuant to the terms of the NCIB, during the year ended December 31, 2009, the Company purchased 75,000 (2008 (unaudited) - 272,500), of its Common Shares at an average purchase price of $0.40 (2008 (unaudited) -$0.36).  The total repurchase cost for these Common Shares for the year ended December 31, 2009 was $30,357 (2008 (unaudited) - $100,513). For the year ended December 31, 2009, $77,765 for Common Shares repurchased (includes $51,625 for Treasury Shares paid for but not cancelled in 2008), has been allocated to Capital Stock  (2008 (unaudited) - $43,351), $1,888 has been recorded to deficit for the amount in excess of the weighted average stated value (2008 (unaudited) - $7,866) and the remaining $2,329 has been recorded to paid-in capital for cancelled Common Shares for the amount below the weighted average stated value (2008 (unaudited) – ($2,329)).
  (d)           Additional Paid-in Capital Options
  Additional Paid-in Capital Options – Outstanding
  The activities in the additional paid-in capital options are as follows:
  AmountBalance, January 1, 2009

$
35,965Expense recognized for options issued to employees/ directors


55,352Options issued to employees/directors expired


(1,755
)Balance, December 31, 2009

$
89,562
  Paid in Capital Options – Expired
  AmountBalance, January 1, 2009

$
722,372Options issued to employees expired


1,755Balance, December 31, 2009

$
724,127
  (e)Stock Options
  The Company’s stock based compensation program includes stock options in which some options vest based on continuous service while others vest based on performance conditions, such as profitability and sales goals.  For those equity awards that vest based on continuous service, compensation expense is recorded over the service period from the date of grant.  For performance-based awards, compensation expense is recorded over the remaining service period when management determines that achievement is probable.
  During the year ended December 31, 2009, there were 379,000 options granted (2008 (unaudited) – 115,000). Of the options 205,000 were granted to directors/officers of the Company at a premium price of $1.00 (US$0.95).  These options vest as to 50% on December 31, 2009 and 25% on each of March 31 and June 30, 2010.  The remaining 174,000 options were granted to employees at $0.84 (US$0.80) and vest (59,000 at 25% per quarter in 2010 and 115,000 at 25% per quarter in 2011) upon achieving certain financial objectives.  As at December 31, 2009, the performance criteria associated with 19,000 (2008 (unaudited) – 115,000) of these options were not met for the specified period and, therefore, the related performance based awards will not vest and have been cancelled.
  F-15
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  9.             CAPITAL STOCK (continued)
  Since share based compensation is recognized only for those awards that are ultimately expected to vest, the Company has applied an estimated forfeiture rate (based on historical experience and projected employee turnover) to unvested awards for the purpose of calculating compensation expense.  For the year ended December 31, 2009, the Company recorded $55,352 (2008 (unaudited) – $11,918) as compensation expense for options issued to directors, officers and employees based on continuous service.  This was recorded as selling, general and administrative expense.  The total number of options outstanding as at December 31, 2009 was 460,000 (2008 (unaudited) – 105,000).
  The weighted average grant date fair value of options was $0.88 and $0.21 for options granted during the years ended December 31, 2009 and 2008 (unaudited), respectively.
  The Company uses the Black-Scholes option-pricing model to estimate the grant date fair value of grants of stock options with the following weighted average assumptions:
 
 2009


2008
(Unaudited)Risk-free interest rate


2.42%



4.66%Expected life

5 years


3 yearsExpected volatility


88.6%



89.9%Dividend yield


0%



0%
  The Company’s computation of expected volatility for the year ended December 31, 2009 and 2008 is based on the Company’s market close price over the period equal to the expected life of the options. The Company’s computation of expected life is calculated using the simplified method. The Company’s dividend yield is 0.0%, since there is no history of paying dividends and there are no plans to pay dividends. The Company’s risk-free interest rate is the Canadian Treasury Bond rate for the period equal to the expected term.
  On June 29, 2005, pursuant to resolutions by the Board of Directors and shareholders, the Company increased the number of options issuable under the plan to 4,629,452 from 4,157,841.  The total number of options available for granting under the plan at December 31, 2009 was 1,519,452 (2008 (unaudited) – 1,874,452).
  The activities in options outstanding are as noted below:
  Options


Weighted

Average

Exercise PriceBalance, January 1, 2008


355,000


$
1.09Granted


115,000



0.50Cancelled


(115,000
)


0.50Forfeited


(250,000
)


1.26Balance, January 1, 2009


105,000


$
0.69Granted


379,000



0.88Cancelled


(5,000
)


0.69Forfeited


(19,000
)


0.80Balance, December 31, 2009


460,000


$
0.84
  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 stock-based compensation costs were recorded.
  F-16
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  9.             CAPITAL STOCK (continued)
  As at December 31, 2009, the Company had 202,500 vested options.  As at December 31, 2009, the number of unvested options expected to vest (including the impact of expected forfeitures) had been estimated at 138,670, with a weighted average contractual life of 4.9 years and exercise price of $0.88.  In April 2008, the Company had granted 115,000 options to its employees, which were cancelled due to certain financial objectives not being met by the end of the year.  As at December 31, 2009, compensation costs of $55,352 had been recognized and expensed in the year for options which vested during the period (2008 (unaudited) - $11,918).
  As at December 31, 2009, the aggregate intrinsic value of outstanding options was $66,462 and the aggregate intrinsic value of exercisable options was $35,948 based on the Company’s closing Common Share price of $1.03.
  The Company recognizes compensation expense for the fair values of stock options using the graded vesting method over the requisite service period for the entire award.
  The following table presents information relating to stock options outstanding and exercisable at December 31, 2009.
  Options Outstanding


Options ExercisableRange of

Exercise Price


Number

of Shares


Weighted
Average
Remaining
Contractual

Life (Years)


Weighted
Average
Exercise
Price


Number

of Shares


Weighted
Average

Exercise

Price$
0.60 to $0.69


100,000



0.5


$
0.69



100,000


$
0.69$
0.80 to $0.89


155,000



4.9



0.84



-



-$
0.90 to $1.00


205,000



4.9



1.00



102,500



1.00460,000



4.0


$
0.88



202,500


$
0.92
  The following table presents information relating to stock options outstanding and exercisable at December 31, 2008 (unaudited).
  Options Outstanding

Options ExercisableRange of

Exercise Price

Number

of Shares

Weighted

Average 
Remaining
Contractual

Life (Years)


Weighted

Average

Exercise Price

Number

of Shares


Weighted
Average

Exercise

Price$0.69

105,000

1.5

$
0.69

105,000

$
0.69
  10.           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:
  F-17
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  10.           INCOME TAXES (continued)
  Income tax expense (benefit) is comprised of:

2009


2008
(Unaudited)Income tax expense (benefit) at statutory rate

at 33.0% (2008 - 33.5%)

$
78,800


$
(10,400
)Adjusted for:Impact on legislated changes in rates of reversal

on current year loss


(200
)


1,300Valuation allowance


19,100



(2,100
)Non-deductible expenses


20,700



6,000Deferred tax liability for non-deductible tax credits


—



3,300Other


(118,400
)


1,900$
—


$
—
  Deferred tax assets and liabilities reflect losses carry-forward, the cumulative carry-forward pool of scientific research and experimental development ("SR&ED") expenditures and the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their corresponding tax basis. Significant components of net deferred tax assets are listed below:
  Components of deferred income tax assets and liabilities:
  2009


2008
(Unaudited)Benefit of net operating losses carry-forward

$
802,700


$
627,700Book values of property and equipment an intangible assets in

excess of tax bases


(133,300
)


(16,200
)Benefit of SR&ED expenditures


545,100



545,100Deferred tax liability for non-refundable tax credits


(97,200
)


(97,200
)Valuation allowance


(1,117,300
)


(1,059,400
)$
—


$
—
  The valuation allowance was provided against the net deferred tax assets at December 31, 2009 and 2008, because the realization of the asset remains not determinable.  The valuation allowance increased $57,900 in 2009 an $27,340 in 2008 (unaudited).
  The Company has non-capital losses carry-forward for income tax purposes in the amount of $2,432,200 which may be applied against future years’ taxable income. The losses expire as follows:
  2010

$
457,0002014


644,6002015


1,013,3002027


231,9002028


85,400$
2,432,200
  Tax years 2003 through 2009 remain open to examination by the taxing jurisdictions to which we are subject.  The Company has not been notified by any taxing jurisdictions of any proposed or planned examination.
  F-18
 
 STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  10.           INCOME TAXES (continued)
  The non-refundable portion of the SR&ED tax credits as at December 31, 2009 was $335,000 (2008 (unaudited) - $335,000).  The tax credits have a full valuation allowance on them as they do not meet the more likely than not test.  The non-refundable tax credit details are as follows:
  2004

$
144,7002005


127,5002006


45,2002007


6,5002008


11,100$
335,000
 
 The cumulative carry-forward pool of SR&ED expenditures applicable to future years, with no expiry date, is $1,880,800 (2008 (unaudited) - $1,880,800).
  The Ontario Harmonization Credit available to the Company over the next five years is $68,100.  The Company has taken a full valuation allowance against these credits as they do not meet the more likely than not test.
  11.           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 diluted loss per share has not been calculated for 2008 as the Company was in a loss position and their inclusion would be anti-dilutive.
  The following table sets forth the computation of earnings (loss) per share:
  For the years ended December 31

2009


2008
(Unaudited)Numerator:Net income (loss) per share available to common shareholders

$
238,924


$
(31,066
)Denominator:Weighted average Common Shares outstanding


23,498,889



23,801,450Effect of dilutive Common Shares


—



—Diluted weighted average Common Shares outstanding


23,498,889



23,801,450Earnings (loss) per share:Basic earnings (loss) per share

$
0.01


$
(0.00
)Diluted earnings (loss) per share

$
0.01


$
(0.00
)
 
 For the year ended December 31, 2008 (unaudited), options to purchase 105,000 of Common Shares, at an average price of $0.69 were excluded from the calculation of diluted earnings per share because their effects were antidilutive.
  F-19
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  12.            STATEMENTS OF CASH FLOWS
  Changes in non-cash balances related to operations are as follows:
  For the years ended December 31

2009


2008
(Unaudited)Accounts receivable

$
255,490


$
(276,714
)Inventories


(356,510
)


(59,509
)Prepaids, deposits and sundry receivables


(33,183
)


(86,449
)Taxes recoverable


210,944



(47,731
)Accounts payable and accrued liabilities *


(51,739
)


(83,029
)Deferred revenues


1,141



(8,824
)$
26,143


$
(562,256
)
 
 
 * Included in accounts payable at the year ended December 31, 2009, is an amount related to patents of $24,183 (2008 (unaudited) - $36,236).
  During the year ended December 31, 2009, there were no interest or taxes paid (2008 (unaudited) – nil).
  13.
CONTINGENCIES AND COMMITMENTS
  (a)           Royalty Agreements
  In September 2000, the Company entered into a royalty agreement for sales of Uracyst®.   The agreement involved 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 a 2% rate effective October 1, 2003 until the end of the agreement on September 30, 2008, at which time this agreement ended. The total royalty payments for the year ended December 31, 2008 (unaudited) was $4,348. This amount was recorded as royalty expense in selling, general and administrative.
  Royalty agreements were activated in November and December 2008 upon the signing of each of the European license agreements for sales of Uracyst® in the defined territories.   These agreements involved royalty payments to be issued to the consultants who assisted in acquiring the licensee who signed the license agreements with the Company.  The royalty payments being issued to consultants include 10% of the upfront fees received from the licensee and 10% to 50% of any future milestone payments received.  In addition, royalty payments are also based on 4 to 5% of the total sales of Uracyst at a declining rate of 1% per year over a three to five year period, declining to a 1% rate effective in the final year. The expenses recorded in regards to royalty fees for the year ended December 31, 2009 were $60,410 (2008 (unaudited) - $29,605). These amounts have been recorded as royalty expense in selling, general and administrative.
  (b)
License Agreements
  In 2009, the Company signed two license agreements for Italy and South Korea territories. As provided in these agreements, the Company received $273,580 in non-recurring, non-refundable license fees and milestone payments, which were recognized as income in 2009.
  (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 a specified 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.  This agreement was renewed in December 2008, for an additional three years, until December 2011.
  F-20
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  13.
CONTINGENCIES AND COMMITMENTS (continued)
  (d)           Manufacturing Agreement
  The Company’s products during 2009 were being manufactured at Hyaluron Contract Manufacturers in Burlington, Massachusetts, United States, for the manufacture of Stellar’s NeoVisc® and at Draxis Pharma, Inc. in Kirkland, Quebec, Canada, for the manufacture of its Uracyst®.  In November 2009, the Company terminated its agreement with Hyaluron Contract Manufacturers and entered into a new agreement with Therapure Biopharma Inc. in Mississauga, Ontario, Canada for the manufacture of its NeoVisc®.
  (e)           Leases
  The Company presently leases office and warehouse equipment under operating leases.  For the year ended December 31, 2009 the total expense related to leases was $5,096 (2008 (unaudited) - $5,096).  At December 31, 2009, the remaining future minimum lease payments under operating leases are $9,629.
  The Company is obligated to make the following operating lease payments as of December 31, 2009:
  Total


2010


2011


2012Operating lease obligations

$
9,629


$
4,446


$
3,057


$
2,126
  (f)           Consulting Agreements
  In May 2005, the Company entered into a research and development agreement with a major United States University.  This agreement was extended throughout 2008 for an additional three months and a subsequent four months, until January 2009, for additional research to be preformed.  The program is on Bladder Urothelial research in interstitial cystitis and cost the Company US$265,300 for the period May 2005 to January 2009. During the year ended December 31, 2009, the Company has recorded $3,536 (2008 (unaudited) - $34,846) as research and development costs.
  (g)           Executive Termination Agreement
  The Company’s President and Chief Executive Officer is the only officer who currently has an employment agreement with the Company. The agreement provides that in the event that the employment is terminated, by the Company other than for cause, for good reason or within six months of a change of control of the Company, there is an entitled to (i) a lump sum payment equal to $383,600 (based on current base salary), (ii) all outstanding and accrued regular and vacation pay and expenses and (iii) the immediate vesting of his options which shall continue to be available for exercise for a period of 30 days following the date of termination.
  14.
RELATED PARTY TRANSACTIONS
  The Company entered into 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 in the normal course of business. Compensation under the agreement is $6,000 per month.  During the year ended December 31, 2009, the Company has recorded and paid $72,000 (2008 (unaudited) - $72,000) as selling, general and administrative expense.
  F-21
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  15.
SIGNIFICANT CUSTOMERS
  During the year ended December 31, 2009, the Company had two significant customers that represented 35% (one major wholesaler – 23%; and one international customer - 12%) of product sales (2008 (unaudited) – 40% (one major wholesaler – 28%; and one international customer - 12%).
  16.
FINANCIAL RISKS
  (a)
Credit Risk
 The Companyis 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. Generally, these deposits may be redeemed upon demand and, therefore, bear minimum risk.
  As at December 31, 2009, the Company had three customers which made up 63.1% of the outstanding accounts receivable, in comparison to five customers which made up 90.8% at December 31, 2008 (unaudited).  Of these outstanding accounts receivables $109,013 or 38.8% was related to product sales to two international customers and $68,215 or 24.3% was related to a large wholesale account (2008 (unaudited) -57.5% were related to two customers: the first in regards to clinical products manufactured for Watson Pharma, Inc. (a company licensed for distribution of Uracyst in the United States market) at the end of the year, which was $159,015 or 31.9% and the second, $127,529 or 25.6% was related to licensing fees).  Substantially all of these amounts outstanding were received as of the date of this report.
  (c)
Currency Risk
 The Company is subject to currency risk through its revenues earned and expenses incurred in United States 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, depending 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, 2009 and 2008.  As at December 31, 2009, the Company held foreign cash balances in the following currencies:
  2009


2008
(Unaudited)Foreign $


Cdn $


Foreign $


Cdn $US dollars

$
203,528


$
213,012


$
1,789


$
2,191EURO dollars

$
36,844


$
55,266


$
47,400


$
80,798
  (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.
  F-22
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  17.           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 of the Company’s manufacturing assets are located in Canada (2008 (unaudited) – net book value of assets in the United States was $124,282).  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.
  The Company is engaged in the sale of three lines of product:
  2009


2008
(Unaudited)NeoVisc


59.9
%


69.8
%Uracyst


22.9
%


11.3
%BladderChek


0.8
%


1.3
%Royalty and Licensing Revenues


16.2
%


17.2
%Other


0.2
%


0.4
%
  Revenue for the years ended December 31, 2009 and 2008 includes products sold in Canada and international sales of products.  Revenue earned is as follows:
  December 31,Products Sales

2009


2008
(Unaudited)Canadian market sales

$
1,740,205


$
1,504,452International sales


1,255,520



609,634Other revenue


4,337



4,196Total Product Sales

$
3,000,062


$
2,118,282
  December 31,Royalties and Licensing Revenue


2009



2008
(Unaudited)Licensing fees

$
532,194


$
232,600Royalties


49,036



208,530Total Royalties and Licensing Revenue

$
581,230


$
441,130
  The Company currently sells its own products and is in-licensing other products in Canada.  In addition, revenues include products which the Company out-licenses in Europe, the Caribbean, Italy, 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.
  18.
FOREIGN CURRENCY GAIN (LOSS)
  The Company enters into foreign currency transactions in the normal course of business.  During the year ended December 31, 2009, the Company recorded foreign currency (loss) of ($50,617) (2008 (unaudited) – gain of $40,374).  These amounts have been included in selling, general and administrative expenses.
  F-23
  STELLAR PHARMACEUTICALS INC.
 NOTES TO FINANCIAL STATEMENTS
  19.
SUBSQUENT EVENTS
  The Company has been informed by the Chinese Patent Office that a patent has been allowed for one of its products, Uracyst®. The patent covers pharmaceutical compositions that comprise the greater and superior dosage sizes of chondroitin sulfate, and the use of those compositions for the treatment of IC/PBS.  Upon Stellar completing the final formalities, including the payment of applicable fees, the Company expects this patent to issue.  Once issued, the patent will expire on February 18, 2024.
  F-24