**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSIONWashington, D.C. 20549**
  **FORM
        10-KSB**
  **ANNUAL
        REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**
 **SECURITIES
        EXCHANGE ACT OF 1934**
  For
        the
        fiscal year ended December 31, 2005
  Commission
        file number 0-31198
  Stellar
                  International Inc.(Name
                  of small business issuer in its charter)
  Ontario,
                  Canada
              Not
                  Applicable(Jurisdiction
                  of incorporation or organization)
              (I.R.S.
                  Employer Identification No.)
  544
                  Egerton Street, London, Ontario, Canada
              N5W
                  3Z8(Address
                  of principal executive offices)
              (Postal
                  Code)
  Issuer’s
        telephone number (519) 434-1540
  Securities
        registered under Section12(b) of the Exchange Act:
  Title
                  of each class
              Name
                  of each exchange on which registeredNot
                  Applicable
              Not
                  Applicable
  Securities
        registered under Section 12(g) of the Exchange Act:
  Common
                  SharesTitle
                  of Class)
  Check
        whether the issuer (1) filed all reports required to be filed by Section
        13 or
        15(d) of the Exchange Act during the past 12 months (or for such shorter
        period
        that the registrant was required to file such reports), and (2) has been
        subject
        to such filing requirements for the past 90 days. Yes X No ___.
  Check
        if
        there is no disclosure of delinquent filers in response to Item 405 of
        Regulation S-B contained in this form, and no disclosure will be contained,
        to
        the best of registrant’s knowledge, in definitive proxy or information
        statements incorporated by reference in Part III of this Form 10-KSB [ ]
  State
          issuer’s revenues “from all sources” for its most recent fiscal year $1,942,253
          (Cdn.).
  
  As
          of
          March 27, 2005, the aggregate market value of the voting and non-voting
          common
          equity held by non-affiliates computed by reference to the average bid
          and asked
          price of such common equity, as of such date,
 was
          $18,787,854(Cdn.)
 
 As
          of
          December 31, 2005, 23,470,190 Common Shares were outstanding.
 
 Transitional
          small business disclosure format (check one): Yes __  No X
  
 
 **General**
  In
          this
          annual report, “Stellar” and the “Company” refer to Stellar Pharmaceuticals Inc.
          (formerly Stellar International Inc.), an Ontario, Canada corporation.
          All
          dollar amounts in this annual report are stated in Canadian Dollars unless
          stated otherwise. Certain terms used in this annual report are defined
          below in
          the section entitled “Glossary.” The names of products referred to in this
          annual report are the trademarks or registered trademarks of their respective
          owners. All rights reserved.
  **Forward-Looking
          Statements**
  Readers
          are cautioned that actual results may differ materially from the results
          projected in any "forward-looking" statements included in this annual report,
          which involve a number of risks or uncertainties. Forward-looking statements
          are
          statements that are not historical facts, and include statements regarding
          the
          Company’s planned research and development programs, anticipated future losses,
          revenues and market shares, planned clinical trials, expected future
          expenditures, the Company’s intention to raise new financing, sufficiency of
          working capital for continued operations, and other statements regarding
          anticipated future events and the Company’s anticipated future performance.
          Forward-looking statements generally can be identified by the words "expected",
          "intends", "anticipates", "feels", "continues", "planned", "plans", "potential",
          "with a view to", and similar expressions or variations thereon, or that
          events
          or conditions "will", "may", "could" or "should" occur, or comparable
          terminology referring to future events or results.
 
 The
          Company’s actual results could differ materially from those anticipated in these
          forward-looking statements as a result of numerous factors, including those
          listed under "Risks and Uncertainties" in Item 6 of this annual report,
          any of
          which could cause actual results to vary materially from current results
          or the
          Company's anticipated future results. The Company assumes no responsibility
          to
          update the information contained herein.
  **Exchange
          Rate for Canadian Dollar**
  The
          accounts for Stellar are maintained in Canadian dollars which is the Company’s
          functional currency. All dollar amounts contained herein are expressed
          in
          Canadian dollars, except as otherwise indicated. As at March 27, 2006,
          the
          exchange rate for Canadian dollars/United States dollars was $1.00 (Cdn.) =
          $0.8557 (U.S.).
  Set
          forth
          below are the exchange rates for the Canadian dollar equivalent expressed
          in
          United States currency during 2004, 2003 and 2002.
  **Years
                    ended December 31, 2005, 2004 and 2003****2005**
                **2004**
                **2003**At
                    End of Year
                0.8585
                0.8038
                0.7738Average
                0.8224
                0.7689
                0.7281High
                0.8672
                0.8493
                0.7726Low
                0.7853
                0.7159
                0.6381
  **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. The Company’s
          directors and officers are neither citizens nor residents of the United
          States,
          and all or a substantial part of the assets of such persons may be located
          outside the United States. As a result, it may be difficult to affect service
          of
          process within the United States upon the Company and such persons or to
          realize
          against the Company or such persons within the United States upon judgments
          of
          courts of the United States predicated upon civil liabilities under the
          United
          States federal securities laws. Fogler, Rubinoff LLP, Canadian counsel
          for the
          Company, has advised that there is doubt as to whether courts in the Province
          of
          Ontario would (i) enforce judgments of United States courts obtained in
          actions
          against the Company or such persons predicated upon the civil liability
          provisions of the United States federal securities laws or (ii) enforce,
          in
          original actions, liabilities against the Company or such persons predicated
          solely upon such statutory provisions.
 
 
  **PART
          I**
  
 **Item
                  1.**
                **Description
                    of Business.**
  **Overview**
  Stellar
          is a Canadian pharmaceutical company involved in the development and marketing
          of high quality, cost-effective, polysaccharide-based therapeutic products
          used
          in the treatment of osteoarthritis and certain types of cystitis. Stellar
          also
          intends to develop additional healthcare products aimed at niche pharmaceutical
          markets. Stellar’s product development strategy focuses on seeking novel
          applications in markets where its products demonstrate true cost effective
          therapeutic advantages. Stellar also intends to build revenues through
          in-licensing products for Canada and international markets that are focused
          on
          similar niche markets.
  Stellar
          has developed and currently markets the following three medical products:
          (i)
          NeoVisc®, (ii) Uracyst® and (iii) the Uracyst® Test Kit. NeoVisc, a 3 injection
          sodium hyaluronate therapy, was developed to provide a cost-effective
          alternative treatment to the over 3 million Canadians suffering from
          osteoarthritis. Uracyst, a chondroitin sulfate-based therapy, and the Uracyst
          Test Kit were developed to identify defective bladder linings and provide
          symptomatic relief to the over 40,000 patients in Canada diagnosed with
          interstitial cystitis. Each of these products has received regulatory approval
          in Canada. Uracyst and the Uracyst Test Kit are patented in the United
          States
          and in Canada with international patents pending.
  Stellar
          markets its products in Canada through its own commissioned and salaried
          sales
          force. The Company’s focus on product development continues to be two fold
          utilizing in-licensing and out-licensing for immediate impact on its revenue
          stream. These activities enable Stellar to fund its own in-house product
          development for future growth and stability. Stellar, through its out-licensing
          partners, intends to conduct clinical trials necessary to obtain the required
          regulatory approvals for its products in foreign markets.
 
 Effective
          December 2001, Stellar entered into a strategic licensing agreement with
          G.
          Pohl-Boskamp GmbH & Co. ("Pohl-Boskamp") for the sale of Uracyst products in
          Europe. In December of 2003, Pohl-Boskamp received approval to begin selling
          Uracyst in Europe.
 
 In
          September 2002, Stellar was granted the exclusive Canadian marketing and
          distribution rights to sell Skelite® by Millenium Biologix Inc. Skelite is a
          bone void filler that is resorbed by the natural remodeling process and
          replaced
          with new bone during the healing period. Stellar commenced sales of Skelite
          in
          Canada in January 2004.
 
 In
          June
          2003, Stellar entered into distribution agreements with CMI Canada Medical
          Inc.
          and BurnsAdler Pharmaceuticals to sell Stellar’s products in the Middle East,
          Latin America and the Caribbean. Subsequently the distribution agreement
          with
          CMI was terminated due to performance issues. This has allowed Stellar
          to move
          forward with other distribution agreements in Lebanon, Kuwait and Israel
          as
          discussed below.
 
 
  In
          October 2003, the Company entered into an exclusive distribution agreement
          with
          Matritech, Inc., to sell NMP22®BladderChek® ("BladderChek") in the Canadian
          market. BladderChek is a unique point of care diagnostic, used in the diagnosis
          and monitoring of bladder cancer. In October 2004, Stellar commenced selling
          BladderChek in Canada.
  In
          March
          2004, the Company entered into supply and license agreements with SJ
          Pharmaceuticals, Inc. (now Leitner Pharmaceuticals Inc.) ("Leitner") of
          Bristol,
          Tennessee. Under these agreements, Leitner was granted an exclusive license
          to
          use certain of the Company’s methods and technical know-how for the purposes of
          developing, marketing and selling NeoVisc and Uracyst products in the United
          States. In addition to an upfront payment made to the Company upon signing,
          these agreements will provide Stellar with milestone payments and an ongoing
          royalty stream from future sales of these products in the United States.
          Leitner
          will be responsible for conducting clinical trials and obtaining regulatory
          approvals for these products in the United States.
  In
          June
          2004, Stellar entered into a NeoVisc licensing agreement with Triptibumis
          Sdn.
          Bhd. for Malaysia, Singapore and Brunei. The first shipment to this market
          was
          initiated in October 2004. Although this agreement covers a relatively
          small
          market, Stellar pursued this agreement to further its global
          expansion.
 
 In
          August
          2004, the Company entered into a licensing agreement with Pharmore GmbH
          for the
          sale of NeoVisc in the German market. This agreement was expected to provide
          Stellar with access to the large European viscosupplement market. Subsequently,
          in July of 2005, Pharmore
          asked to be released from this licensing agreement due to a significant
          change
          in their business environment. Pharmore agreed to pay a proportion of the
          costs
          to continue the NeoVisc registration process in Germany. The Company expects
          to
          have a German registration and a CE mark by mid-2006. The CE mark will
          allow
          NeoVisc to quickly enter other European markets.
 
 In
          July
          2005, Stellar entered into a licensing agreement with Innogen Ilac for
          the sale
          of NeoVisc in Turkey. In August 2005, the Company entered into a distribution
          agreement with TECHNIMED for the sale of NeoVisc in Lebanon.
 
 In
          September 2005, the company entered into a licensing agreement with Shanghai
          Ya
          Jun Medical for the sale of Uracyst in China. Stellar also entered into
          a
          licensing agreement with Mega Pharm for the sale of Uracyst in Israel in
          December 2005.
 In
          November 2005, the Company signed a distribution agreement with Al-Mohab
          Co.
          (“Al-Mohab”) for the sale of NeoVisc® in Kuwait.
 
 Stellar
          was incorporated under the Business Corporations Act (Ontario) on November
          14,
          1994. The Company’s registered office and executive offices are located at 544
          Egerton Street, London, Ontario, Canada N5W 3Z8. The Company’s telephone number
          is (519) 434-1540, its facsimile number is (519) 434-4382 and its e-mail
          address
          is stellar@stellarpharma.com .
   **Glossary**
  **“hyaluronate”
          or “HA”** -
          A
          naturally occurring polysaccharide, which by virtue of its viscosity and
          elasticity, acts as a lubricating and shock absorbing component in synovial
          fluids. HA is the active ingredient in NeoVisc.
  
 
 
 **“FDA”** -
          The
          Food and Drug Administration of the United States, which, among other functions,
          regulates medical devices and other therapeutic products used in the United
          States.
  **“interstitial
          cystitis” or “IC”** -
          A
          chronic inflammation of the bladder wall.
  **“NeoVisc** **®** **”** -
          A 2 mL
          pre-filled syringe of sterile 1.0% sodium hyaluronate solution used for
          the
          temporary replacement of synovial fluid in osteoarthritic joints. NeoVisc
          is the
          Company’s proprietary product for the treatment for osteoarthritis.
  **“osteoarthritis”
          or “OA”** -
          A
          degenerative disease associated with long-term wear primarily on weight
          bearing
          joints.
  **“polysaccharide”** - A
          carbohydrate containing a large number of saccharide (sugar) groups. Starch
          is a
          common type of polysaccharide.
  **“synovial
          fluid”** - A
          clear viscid fluid, the function of which is to lubricate the
          joint.
  **“TPD”** -
          The
          Therapeutic Products Directorate of Health Canada, which, among other functions,
          regulates medical devices and other therapeutic products used in
          Canada.
  **“Uracyst** **®** **”** -
          A
          sterile 2.0% sodium chondroitin sulfate solution. Uracyst products are
          the
          Company’s proprietary treatments for certain forms of IC and non-common
          cystitis. The products are instilled by catheter directly into a patient’s
          bladder.
  **“Uracyst** **®** **Test Kit”** -
          The
          Company’s proprietary test kit that confirms the existence of bladder lining
          defects in IC patients and identifies those patients who should respond
          positively to Uracyst.
  **Development
          Strategy**
  Stellar
          focuses its product development activity around naturally occurring,
          well-studied (human body) chemicals and seeks novel applications in markets
          where its products demonstrate cost-effective therapeutic advantages. By
          using
          this development strategy, management of Stellar believes it can bring
          products
          with niche applications to unsatisfied, under-serviced markets with relatively
          low regulatory risk. In addition, management of the Company believes that
          a
          focus on in-licensing additional products focused on these same niche
          pharmaceutical markets improves its ability to compete with larger companies
          and
          gain significant market share for its products and licensed-in products.
  **Competition
          Generally**
  The
          pharmaceutical industry is highly competitive and is characterized by rapidly
          changing technology. The Company competes with other companies to market
          its
          products aimed at treating similar conditions. Many of these companies
          have
          substantially greater resources than the Company. There can be no assurance
          that
          the Company will continue to be able to compete with such companies or
          that
          developments by others will not render the Company’s products or technologies
          non-competitive or obsolete. In order to maintain and improve its position
          in
          the industry, the Company must continue to enhance its current products,
          develop
          or acquire new products and product extensions and implement a comprehensive
          international sales and distribution marketing strategy. The Company’s
          competition comes from a variety of sources, including companies, which
          target
          all, or a portion of the Company’s current product offerings. See “- Products
          and Markets.” Also, many current and potential competitors of the Company may
          have greater name and brand recognition and more extensive customer bases
          that
          could be leveraged to gain market share to the Company’s detriment.
  
 
 In
          addition, competitors may be able to complete the regulatory approval process
          sooner than the Company, and therefore market their products earlier than
          the
          Company can market certain of its products. If the Company is not able
          to
          compete effectively against current and future competitors, such failure
          may
          result in fewer customer orders, reduced gross margins and profitability
          and
          loss of market share, any of which would materially adversely affect the
          Company.
   **Competitive
          Advantages of Stellar**
  Management
          believes that Stellar’s main competitive advantages include:
  (i)
                the
                    ability to conduct research and development and produce products
                    in a
                    cost-effective manner;
  (ii)
                a
                    focus on the development of formulations and technologies targeted
                    at
                    smaller market niches that larger multi-national pharmaceutical
                    companies
                    have largely ignored because of
                    size;
  (iii)
                the
                    ability to offer cost-effective pricing while maintaining acceptable
                    gross
                    profit margins;
  (iv)
          the
          patents it holds for certain of its products; and
  (v)
          the
          ability to identify market needs and develop new niche products.
   **Products
          and Markets**
  Stellar
          has developed and currently markets the following three medical products:
          (i)
          NeoVisc, (ii) Uracyst and (iii) the Uracyst Test Kit. Each
          of
          these products is presently approved for use in Canada and the Company’s sales
          are primarily in Canada. In addition, Stellar
          has signed an agreement for the distribution of two other medical products,
          Skelite  and
          BladderChek .  Stellar
          commenced selling Skelite in January
          2004 and BladderChek in October 2004.
  ***NeoVisc***
  NeoVisc
          is a 2 mL pre-filled syringe of sterile 1.0% sodium hyaluronate solution
          used
          for the temporary replacement of synovial fluid in osteoarthritic joints.
          NeoVisc is classified in Canada by the TPD as a “medical device” under the
          Medical Devices Regulations of the Food and Drugs Act (Canada). NeoVisc
          is
          packaged, sold and marketed as a three injection therapy. The product is
          administered weekly by injection directly into the affected joint. This
          type of
          injection is referred to as an intra-articular injection.
  This
          administration process, referred to as viscosupplementation, is a relatively
          new
          therapy for the treatment of osteoarthritis, having gained Canadian approval
          in
          1992 and United States approval in 1997. However, viscosupplementation
          has been
          used for many years in the veterinarian market. Replacing or supplementing
          the
          joint fluid provides symptomatic relief from the pain of osteoarthritis
          for up
          to 6 to 8 months before a repeat set of injections is required.
  Osteoarthritis
          and Treatment Options .
          Osteoarthritis is a degenerative disease associated with long-term wear
          on
          weight bearing joints. With no known cure, it is estimated that OA affects
          an
          estimated 33% of persons over 45 years of age, and approximately 85% over
          the
          age of 70. The Canadian Arthritis Association estimates that 3 million
          Canadians
          suffer from the “osteo” form of arthritis. Stellar estimates the number of
          American OA sufferers at over 30 million. The aggregate number of patients
          with
          OA is expected to grow significantly as the average age of the population
          increases.
  
  Current
          OA remedies focus on symptomatic relief and postponement of surgical
          intervention. These remedies include:
 (i)
                *Drugs:*Pain
                      killers such as aspirin, acetaminophen and other non-steroidal
                      anti-inflammatory drugs (NSAID), such as naproxen and diclofenac,
                      as well
                      as new COX/2 Inhibitors;  (ii)
                  *Steroidal*
                    *Anti-Inflammatory:* 
                         Corticosteroids
                        are also used to treat the inflammation associated with the
                        disease;
                        and
 (iii)
                *Joint
                    Replacement:*Surgical
                    replacement with artificial joints.
  Products
          such as NeoVisc have added a fourth non-pharmacological option in obtaining
          symptomatic improvements by supplementing the synovial fluid in the affected
          joint. NeoVisc can also be used in conjunction with drug treatments like
          NSAIDs,
          thereby reducing the overall cost of treatment, increasing clinical benefits
          and
          delaying or avoiding steroid use and joint replacement.
  Role
          of Hyaluronate .
          The
          active ingredient in NeoVisc is hyaluronate, also referred to as hyaluronic
          acid
          or HA. HA is a naturally occurring polysaccharide found throughout the
          human
          body, which has been shown to play an important role in such biological
          processes as cell differentiation, tissue hydration and proteoglycans
          organization. Injected HA also provides an anti-inflammatory and analgesic
          effect. HA also plays a fundamental role in human joints, where by virtue
          of its
          viscosity, elasticity and other rheological properties, acts as a lubricating
          and shock absorbing component in joint fluids, and as an ocular lubricant.
          HA
          products are currently being used in eye surgery, wound healing, intra-articular
          injections and as an adjunct to certain grafting procedures.
  Marketing
          Strategy .
          Purchase decisions in the prescription pharmaceutical market are influenced
          by
          the prescribing physician, pharmacist and end use patient/customer. State
          and
          private health care plans and patient user groups may also play a role
          in
          product/therapy selection, especially where the cost of therapy is high.
          In
          treating OA, it is typically the physician that decides which therapeutic
          option
          is best for the patient and which related products to use.
  Stellar’s
          marketing and sales strategy focuses on those physicians currently prescribing
          HA viscosupplements. Stellar has created a database focused on orthopaedic
          surgeons, rheumatologists, sports medicine specialists and select general
          practitioners in Canada. Direct marketing to the physicians in this database
          has
          been, and will continue to be, effective in persuading treating physicians
          and
          specialists already using viscosupplementation to convert to NeoVisc or
          recommend it to their patients. Management of the Company believes that
          NeoVisc
          is at least as effective as any other competitive product and is the lowest
          cost
          intra-articular therapy currently on the market. Stellar’s strategy is to
          demonstrate that NeoVisc is the most cost-effective viscosupplement therapy
          available.
  Competitive
          Analysis .
          The
          major competitive product to NeoVisc in Canada and the United States is
          Synvisc®, which is manufactured and sold by Genzyme Corp. Synvisc is a three
          injection dosage regime, which has been available in Canada since 1992
          and in
          the United States since 1997. Synvisc is the dominant product in the
          viscosupplementation market. Management of Stellar estimates Synvisc’s market
          share at over 70% in the United States and 55% in Canada.
  
 
 If
          approved for sale in the United States, NeoVisc would also compete with
          Fidia,
          SpA’s product, marketed under the trade name “Hyalgan®” by Sanofi-Synthelabo
          Inc. and Seikagaku’s product “Supartz®” marketed by Smith and Nephew,
          Orthovisc®, manufactured by Anika Therapeutics, Inc. and marketed by Johnson
& Johnson. In Canada, NeoVisc also competes with Suplasyn®, manufactured by
          Bioniche Life Sciences Inc ("Bioniche"). 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 penetrate the market and obtain a significant
          share
          in Canada and, if approved for sale, the United States.
  In
          June
          2003, Stellar entered into two distribution agreements. The first agreement
          is
          with CMI Canada Medical Inc. (located in Oshawa, Ontario Canada), to distribute
          NeoVisc in the Middle East. (Subsequently the distribution agreement with
          CMI
          was terminated due to performance issues. This allowed Stellar to move
          forward
          with pursuing other distribution agreements in Lebanon, Kuwait and Israel.)
          The
          second agreement is with BurnsAdler Pharmaceuticals (located in Charlotte,
          North
          Carolina), to distribute NeoVisc in Latin America and the Caribbean.
 
 In
          July
          2005, Stellar entered into a licensing agreement with Innogen Ilac for
          the sale
          of NeoVisc in Turkey. Later in August 2005, the Company signed a distribution
          agreement with TECHNIMED for the sale of NeoVisc in Lebanon.
 
 In
          November 2005, the Company signed a distribution agreement with Al-Mohab
          Co.
          (“Al-Mohab”) for the sale of NeoVisc® in Kuwait.
  ***Uracyst
          and the UracystTest Kit***
  Stellar
          developed Uracyst a sterile 2.0% sodium chondroitin sulfate solution available
          in a 20 mL vial and the Uracyst Test Kit, comprising Uracyst 2.0% and Solution
          K, a 3.0% potassium chloride solution. Uracyst and the Uracyst Test Kit
          are used
          in the diagnosis and treatment of certain forms of IC and non-common cystitis.
          The Uracyst Test Kit contains a 100 mL pouch of Solution K and a 20 mL
          vial of
          Uracyst. These products are instilled by catheter directly into a patient’s
          bladder.
  Uracyst
          provides symptomatic relief for patients suffering from IC and non-common
          cystitis (including radiation-induced cystitis and hemorrhagic cystitis)
          by
          supplementing and replenishing deficiencies in the glycosaminoglycan (“GAG”)
          lining of the bladder wall. This GAG lining acts as a protective barrier
          against
          irritants and toxins ( e . g .,
          micro
          crystals, carcinogens and acid) in the urine and serves as an important
          defense
          mechanism against bacterial adherence. Many researchers believe that a
          large
          number of IC patients (over 70%) have “leaky” or deficient GAG layers in their
          bladders.
  When
          Solution K is instilled in an IC patient’s bladder with GAG deficiencies, the
          patient experiences pronounced IC like symptoms. Instilling Uracyst into
          the
          bladder of those patients responding positively to the test neutralizes
          the
          irritations. This test allows the clinician to determine which IC patient
          has a
          leaking GAG layer and therefore determine which IC patient will more likely
          respond positively to Uracyst to control IC symptoms.
  Uracyst
          is typically instilled in patients weekly for 6 weeks, then once a month
          until
          symptoms resolve. Because these types of cystitis are typically chronic
          diseases
          of no known cause, patients will usually require re-treatment after a variable
          period of time when symptoms recur.
  The
          Company has been issued a patent in the United States and Canada for the
          use of
          the Uracyst Test Kit and Uracyst treatments and has international patents
          pending. Uracyst and the Uracyst Test Kit are both classified in Canada
          by TPD
          as medical devices under the Medical Devices Regulations of the Food and
          Drugs
          Act (Canada).
  
  In
          order
          to obtain the necessary clinical work for the approval of Uracyst, Stellar
          entered into an agreement with Dr. Gary Steinhoff of Vancouver, British
          Columbia. Under this agreement, Dr. Steinhoff agreed to perform such work,
          on
          behalf of Stellar, in consideration for a declining variable royalty payable
          until August 31, 2008. The royalty is based upon a percentage of Uracyst
          net
          sales. The royalty percentage for the period which began on September 1,
          2003
          and ends on August 31, 2008 is 2%. Dr. Steinhoff is not otherwise affiliated
          with Stellar or any of its officers, directors or principal
          shareholders.
  In
            December 2001, the Company entered into a license agreement (the “European
            License”) with Pohl-Boskamp of Hohenlockstedt, Germany. Under the European
            License, Pohl-Boskamp was granted the exclusive right to manufacture
            market and
            sell the Company’s Uracyst product line in Europe. In consideration for the
            grant of such exclusive right, Pohl-Boskamp made cash payment to Stellar
            upon
            execution of the European License and at the time of Pohl-Boskamp’s first sale
            of Uracyst products in Europe, which occurred in December of 2003. Pohl-Boskamp
            is also obligated to pay the Company a royalty based on the quarterly
            net sales
            of Uracyst products by Pohl-Boskamp and its affiliates and sub-licensees.
            Subject to extension in the case of patented improvements to the Uracyst
            product
            line, the term of the European License is scheduled to expire on
            December 21, 2008.
 In
          September 2005, the company entered into a licensing agreement with Shanghai
          Ya
          Jun Medical for the sale of Uracyst in China. Stellar also entered into
          a
          licensing agreement in December 2005 with Mega Pharm for the sale of Uracyst
          in
          Israel.
  **Interstitial
          Cystitis and Treatment Options** .
          Interstitial cystitis is a chronic inflammation of the bladder wall. Unlike
          common cystitis, IC is not caused by bacteria and does not respond to
          conventional antibiotic therapy. IC can affect people of any age, race
          or sex,
          but is more frequently diagnosed in women.
  Interstitial
          cystitis causes some or all of the following symptoms:
  *Frequency* : Day
          and/or night frequency of urination (up to 60 times a day in severe cases).
          In
          early or very mild cases, frequency is sometimes the only symptom.
  *Urgency* : Pain,
          pressure or spasms may also accompany the sensation of having to urinate
          immediately.
  *Pain* :  Can
          be
          abdominal, urethral or vaginal. Pain is also frequently associated with
          sexual
          intercourse.
  *Other* :  Some
          patients also report experiencing symptoms such as muscle and joint pain,
          migraines, allergic reactions, colon and stomach problems, as well as the
          more
          common symptoms of IC described above.
  At
          present, there is no cure for IC nor is there an effective treatment, which
          works for everyone. The following treatments have been used to relieve
          the
          symptoms of IC in some people: (i) diet, (ii) bladder distention, (iii)
          instilled dimethylsulfoxide (DMSO), heparin or HA, (iv) anti-inflammatory
          drugs,
          (v) antispasmodic drugs, (vi) antihistamines and (vii) muscle
          relaxants.
  In
          severe
          cases, several types of surgery have been performed including bladder
          augmentation and urinary diversion. Products available for treating IC
          vary in
          their effectiveness. Most work for short periods of time and, in general,
          are
          effective in about 30% to 40% of patients. Some therapies can take up to
          6
          months of active treatment before patients start to show symptomatic
          improvement.
  
 
  Market
          For Uracyst and the Uracyst Test Kit .
          Data on
          the number of IC patients being treated and the method of treatment is
          not
          readily available in Canada or the United States. Many products such as
          dimethylsulfoxide (DMSO) and heparin are not used exclusively to treat
          IC. This
          lack of detailed end-use product and prescription data make it difficult
          to
          define the size of the IC market. A United States epidemiology study published
          in February 1999 conservatively estimates the number of people with interstitial
          cystitis in the United States at approximately 700,000. The number of people
          in
          Canada with IC is estimated by Stellar to be 70,000. In 2005, the size
          of the
          market in the United States is estimated to be approximately 1,500,000
          and the
          Canadian market is estimated to be 150,000 patients.
  Marketing
          Strategy .
          Stellar
          currently markets Uracyst and Uracyst Test Kits directly to physicians
          and
          pharmacies (although in many cases the patient is the ultimate purchaser)
          in
          Canada. Stellar focuses its promotion to a core group of urologists currently
          treating interstitial cystitis, largely in major Canadian urban centers
          (i.e.,
          all Provincial capitals and cities with medical teaching centers). Management
          estimates that there are over 550 practicing urologists in Canada and 7,500
          in
          the United States. This well-defined target audience makes direct marketing
          an
          effective strategy for Stellar. Pursuant to the European License, Stellar
          markets its Uracyst product line in Europe through the European
          Licensee.
  Stellar’s
          sales efforts emphasize the patented Uracyst Test Kit’s ability to determine
          those IC patients who are GAG deficient, and then demonstrate the potential
          to
          treat these same patients with Uracyst. This ability is important as GAG
          replenishment therapy can take up to 6 months before patients start to
          show
          substantial symptomatic improvement. Sales efforts also promote the ongoing
          clinical work that Stellar has undertaken with Uracyst, which shows a response
          rate of over 60% and an excellent safety profile.
  Management
          believes that the monthly maintenance therapy cost of Uracyst is less than
          that
          of all other active treatments. Stellar expects to gain acceptance more
          readily
          from both physicians and patients as the most cost-effective therapy for
          treating GAG-deficient IC patients. Cost is an important factor in selecting
          a
          treatment option, as most patients will be on and off GAG replacement therapy
          for an indeterminate amount of time. In addition, Stellar’s unique test kit
          provides Stellar with a substantial competitive advantage over its competitors.
  Competitive
          Analysis .
          The
          treatment of IC is a relatively small niche market supplied by smaller
          pharmaceutical companies. Because of low efficacy rates and relatively
          expensive
          treatment costs, management believes the treatment of IC remains an unsatisfied
          market with no dominant competitive product. Ortho McNeil Pharmaceutical,
          Inc
          and Shire Pharmaceutical Corporation are the two major suppliers to the
          IC
          market.
  Ortho
          McNeil Pharmaceutical, Inc (Alza Corporation) has marketed Elmiron® (pentosan
          polysulfate sodium) in Canada since 1993. Elmiron is used as an oral GAG
          replenishment therapy. Alza Corporation has been active in the market providing
          comprehensive materials and services to physicians and IC patients. Side
          effects
          from the use of Elmiron are difficult to manage for some patients and can
          include hair loss, diarrhea and extreme to mild gastrointestinal discomfort.
  Shire
          Pharmaceutical Corporation’s RIMSO 50 Ò (also
          known as DMSO) was previously a market leader for urinary tract diseases,
          but
          has seen its market eroded by generic DMSO selling for a fraction of its
          price.
          Since DMSO may be used in treatments for diseases or symptoms other than
          IC, it
          is difficult to find exact usage data for DMSO in the treatment of IC.
          DMSO
          works to desensitize the bladder wall and has numerous negative side effects.
          The principal side effects include discomfort and an emission of a strong,
          unpleasant odor (similar to garlic) for up to 48 hours after an instillation.
          DMSO, although not favored by patients, remains a product of choice for
          many
          urologists.
  
 
  Elmiron
          has a typical cost of about $150 month as compared to $80 month for DMSO
          and $65
          month for Uracyst.
  ***Skelite***
  Stellar
          has acquired the exclusive Canadian marketing and distribution rights to
          Skelite  from
          Millenium Biologix Inc. Skelite has been approved by both the FDA in the
          United
          States and TPD in Canada, as synthetic bone void filler. Stellar’s right to
          market and distribute Skelite expires on December 31, 2007, and may be
          renewed
          by Stellar for an additional three-year period.
  Skelite
          is a novel, 100% synthetic, resorbable bone void filler consisting of 67%
          silicon stabilized tricalcium phosphate (TCP) + 33% hydroxyapatite. Skelite
          contains a multi-directional, interconnected porosity similar in structure
          to
          human cancellous bone allowing for the integration of tissue and fluids.
          This
          product provides a bone void filler that is resorbed by the natural remodeling
          process and replaced with new bone during the healing period. Orthopedic
          surgeons use this product, with or without bone marrow, to pack into bony
          voids
          or gaps of the skeletal system (i.e., the extremities, spine and pelvis).
          The
          defects may be surgically created osseous defects or osseous defects created
          from traumatic injury to the bone.
  **Bone
          Graft Treatment Options** .
          Bone
          grafting materials are primarily divided into three categories: autologous,
          allograft and synthetics.
  For
          more
          than a century, bone fracture repair has been augmented with the use of
          autologous (taken from patient’s own body) cancellous bone grafting. The
          advantages are that autologous grafts provide the three requisite properties:
          the scaffolds for osteoconduction, the growth factors for osteoinduction
          and the
          progenitor stem cells for osteogenesis. The disadvantages are procurement
          (harvesting) site morbidity, longer operating times and limited
          availability.
  Allograft
          (taken from other human donors) bone material is processed bone taken from
          cadavers. Many countries have some form of bone donor programs whereby
          bone
          material is harvested upon death from patients who have given prior consent.
          However, to combat the risks of disease transmission and histoincompatible
          response, this bone material is subject to harsh processing techniques
          that
          diminish the mechanical properties (osteoconduction) and the biological
          (osteoinductive) properties. There are national bone banks and many hospitals
          have instituted their own bone bank. The costs for allograft range from
          minimal
          to extensive and the supply of material is still limited.
  Synthetic
          alternatives for bone graft procedures have been available since the 1990s.
          These new materials, currently used in about 10% of the 2.2 million bone
          graft
          procedures worldwide, offer the advantages of unlimited availability and
          safety.
          Newer materials offer the improved osteoconductive characteristics necessary
          for
          bone and tissue integration.
  **Marketing.** The
          rising cost of healthcare in hospitals has resulted in purchasers (i.e.,
          materials management departments and state/provincial/private plans) reducing
          the number of products covered and restricting the entry of new products.
          New
          products must offer real competitive benefits and cost advantages. Skelite
          is
          expected to offer the high quality that is important to orthopedic surgeons
          and
          the cost attractiveness demanded by the purchaser. While orthopaedic surgeons
          can use Skelite  in
          many
          procedures, it is expected that Skelite  will
          be
          initially used in trauma and hip/knee revisions. Stellar has had limited
          success
          in the Canadian market with Skelite. Larger hospital formularies generally
          are
          slow to add new products and require more evidence based clinical work
          for
          products such as Skelite. Unfortunately, Millenium Biologix Inc has not
          performed large clinical trials and the smaller case studies performed
          by
          Stellar are not sufficient for this purpose. Stellar’s focus on smaller
          hospitals has been more effective in generating interest with respect to
          Skelite.
  
  **Competitive
          Analysis** .
          Skelite
          competes directly with other synthetic bone graft products.
          ProOsteon Ò (Interpore Cross), DynaGraft Ò (GenSci)
          and Osteoset Ò (Wright
          Medical Technology) are available in Canada. Stellar management feels that
          the
          animal studies and more recent case studies for Skelite have not kept pace
          with
          the competitive clinical work. Skelite’s cost advantage has been the key factor
          in its acceptance to date.
  ***BladderChek***
  Stellar
          has licensed BladderChek for the Canadian market from Matritech, USA. The
          initial term of this licence began on January 1, 2004 and expires on December
          31, 2008. Stellar may extend the term of the agreement for an additional
          one-year period. The BladderChek test is a simple to use, point-of-care,
          in
          vitro diagnostic test for bladder cancer, and provides results (within
          30
          minutes) while the patient is in the physician's office. By placing four
          drops
          of urine on the BladderChek test cassette, a physician is able to detect
          the
          presence of elevated NMP22.
  The
          scientists that developed BladderChek, discovered that high levels of the
          nuclear matrix protein, NMP22, in urine frequently indicated the presence
          of
          cancer. This protein is found in the nuclei of cells where they contribute
          to
          nuclear structure and regulate important cell functions. NMP22 is elevated
          in
          bladder cancer cells 20 to 80 fold and is released into the urine of bladder
          cancer patients.
  **Market
          Overview:** In
          the
          United States, more than one million patients receive a diagnostic work
          up for
          bladder cancer each year. Another 10 million are at risk for the disease.
          According to data released by the American Cancer Society in 2001, 54,300
          new
          cases of bladder cancer (2.5:1 men: women) are diagnosed each year.
  If
          diagnosed in its early stages, the five-year bladder cancer survival rate
          exceeds 90 percent. However, 12,400 people in the United States died of
          bladder
          cancer in 2001. Many died because the disease was not caught in its earliest
          stages
  The
          estimate for Canada is 270,000 opportunities for use (diagnosis and monitoring)
          for BladderChek.
  **Market
          Growth:** BladderChek,
          a third generation urine based biomarker, was able to correctly identify
          cancers
          not seen by cystoscopy and provides more accurate and clinically useful
          information than cytology. Stellar commenced selling BladderChek in October
          2004
          directly to hospitals and urology clinics where the overall value of a
          point of
          care device has been well received.
  BladderChek
          is being sold at a competitive price to cytology, which is an important
          selling
          feature, given that BladderChek is 3 to 5 times more effective than cytology.
          The excellent clinical support combined with BladderChek ease of use and
          price
          point has been key to its early adoption in most centres. Stellar is currently
          working on moving BladderChek through the bureaucratic red tape of the
          large
          teaching hospitals. Stellar expects to see a faster adoption as reimbursement
          issues are resolved in these larger hospitals.
   **Sales
          and Distribution**
  Stellar
          currently has six commissioned and salaried sales representatives, promoting
          its
          products in key Canadian centres. These sales representatives primarily
          target
          medical physicians, pharmacies, hospitals and patient support groups. Stellar
          is
          building a sales network across Canada to generate NeoVisc and Uracyst
          sales.
          See “- Human Resources.” Marketing and sales efforts are coordinated from
          Stellar’s London, Ontario main office. One of Stellar’s immediate corporate
          goals is to establish a stronger network of representatives selling its
          products
          and in-licensed products in Canada.
  
  As
          discussed above, Stellar’s product line has been out-licensed to companies in
          the United States, Europe, China, Middle East, Latin America, Caribbean,
          Malaysia, Singapore and Brunei.
   **Customers**
  The
          Company has historically derived the majority of its revenues from a small
          number of major customers, although the composition of this group of customers
          has changed from year to year. In the event that one or more of these major
          customers significantly reduce or terminate their purchases of the Company’s
          products, the Company’s results of operations and financial condition could be
          materially affected. The Company has not, however, received any indication
          from
          any of its current major customers that it intends to discontinue its
          relationship with the Company or to reduce its purchases of the Company’s
          products.
   **Human
          Resources**
  Stellar
          currently employs fourteen full-time employees and eight of the Company’s
          full-time employees are located at the Company’s main office in London Ontario,
          Canada. The other six full-time employees of the Company sell the Company’s
          products in major urban areas throughout Canada. The Company plans to add
          additional staff in the areas of sales, marketing, regulatory affairs and
          administration over the next 18 to 24 months. Management of the Company
          believes
          that its relations with its employees are good.
  The
          Company is substantially dependent on the services of its key senior management
          personnel. The Company has entered into an employment agreement with Peter
          Riehl, the Chief Executive Officer. See “Item 10 - Executive Compensation” of
          this annual report. Loss of the services of Mr. Riehl, or any other key
          management employee, would have a material adverse effect on the Company.
          The
          Company does not maintain key man life insurance on the life of Mr. Riehl.
          In
          addition, the Company’s future success will depend in part upon its continuing
          ability to hire, train, motivate and retain key senior management and skilled
          technical and marketing personnel. The market for qualified personnel has
          historically been, and the Company expects that it will continue to be,
          intensely competitive.
   **Manufacturing**
  Stellar
          currently out sources the manufacturing of its products, other than Uracyst
          offered for sale in Europe, to a special sterile facility, operated by
          Dalton
          Pharmaceutical Services ("Dalton"). This facility, which is in compliance
          with
          applicable Health Canada, TPD division medical device guidelines and current
          Good Manufacturing Practice ("cGMP") regulations, has sufficient excess
          capacity
          at present to meet the Company’s short and long term objectives. The Company’s
          products offered for sale in Europe are manufactured by Pohl-Boskamp and
          its
          sub-licensees. See “Products and Markets.”
  Under
          this supply agreement (the "Supply Agreement") with Dalton, Stellar started
          to
          source product from Dalton’s facility during the second quarter of 2004. The
          Supply Agreement provides for Dalton to supply all of the Company’s clinical and
          commercial production requirements well into the future. Dalton is a cGMP
          manufacturing facility that has the capability to meet domestic and
          international manufacturing regulations. Stellar believes the Supply Agreement
          will cause its production costs to improve based on the economies of scale
          projected. Dalton will be used as Stellar’s manufacturer for the United States
          market once in receipt of the necessary FDA approvals. A significant
          interruption in the supply of any of the Company’s products could impair the
          successful marketing of such products.
  
  Dalton
          is
          a contract pharmaceutical manufacturer that supplies chemistry and analytical
          services to the biotechnology and pharmaceutical industries in the areas
          of
          medicinal chemistry, fine chemical manufacturer customer peptides and antisense
          oligo production. Dalton has a site establishment license and provides
          cGMP
          manufacturing and sterile filling capabilities to its customers
          at any stage of the regulatory process (Phase I, II, III or
          commercial).
  The
          Company has established non-contractual supply arrangements for its raw
          materials with several sources. Stellar currently purchases the HA used
          in
          NeoVisc from Lifecore Biomedical and the chondroitin sulfate used in the
          formulation of Uracyst from Bioiberica, a Spanish supplier. In the event
          of an
          interruption in the supply of these raw materials from such suppliers,
          Stellar
          believes that it would be able to secure similar raw materials at competitive
          prices from other suppliers located worldwide.
  The
          manufacture of the Company’s products involves the handling and use of
          substances that are subject to various environmental laws and regulations
          that
          impose limitations on the discharge of pollutants into the soil, air and
          water,
          and establish standards for their storage and disposal. The Company believes
          that the manufacturers of its products are in material compliance with
          such
          environmental laws and regulations.
  The
          sale
          and use of the Company’s products entails risk of product liability and the
          Company presently carries product liability insurance. There can be no
          assurance
          that, despite testing by the Company, as well as testing in use by current
          and
          potential customers and regulatory agencies, defects will not be found
          in new
          products after commencement of commercial shipments. The occurrence of
          such
          defects could result in the loss of, or delay in, market acceptance of
          the
          Company’s products, which could have a material adverse effect on the Company.
          Furthermore, litigation, regardless of its outcome, could result in substantial
          costs to the Company, divert management’s attention and resources from the
          Company’s operations and result in negative publicity that might impair the
          Company’s on-going marketing efforts.
   **Patent
          and Proprietary Protection**
  Where
          deemed appropriate, Stellar may file patent applications for technologies,
          which
          it owns or in respect of which it has acquired a license and, if necessary,
          then
          further developed to make such technologies marketable. Such applications
          may
          cover composition of matter, the production of active ingredients and their
          novel applications.
  The
          Company retains independent patent counsel where appropriate. Management
          of the
          Company believes that the use of outside patent specialists ensures prompt
          filing of patent applications, as well as the ability to access specialists
          in
          various areas of patents and patent law to ensure complete patent
          filing.
  The
          patent position relating to medical devices and drug development is uncertain
          and involves many complex legal, scientific and factual questions. While
          the
          Company intends to protect its valuable proprietary information and believes
          that certain of its information is novel and patentable, there can be no
          assurance that: (i) any patent application owned by or licensed to the
          Company
          will issue to patent in all countries; (ii) proceedings will not be commenced
          seeking to challenge the Company’s patent rights or that such challenges will
          not be successful; (iii) proceedings taken against a third party for
          infringement of patent rights will be successful; (iv) processes or products
          of
          the Company will not infringe upon the patents of third parties; or (v)
          the
          scope of patents issued to or licensed by the Company will successfully
          prevent
          third parties from developing similar and competitive products. It is not
          possible to predict how any litigation may affect the Company’s efforts to
          develop, manufacture or market products. The cost of litigation to uphold
          the
          validity and prevent infringement of the patents owned by or licensed to
          the
          Company may be significant.
  
  Issues
          may arise with respect to claims of others to rights in the patents or
          patent
          applications owned by or licensed to the Company. As the industry expands,
          and
          more patents are issued, the risk increases that the Company’s processes and
          products may give rise to claims that they infringe the patents of others.
          Actions could be brought against the Company or its commercial partners
          claiming
          damages or an accounting of profits and seeking to enjoin them from clinically
          testing, manufacturing and marketing the affected product or process. If
          any
          such action were successful, in addition to any potential liability for
          damages,
          the Company or its commercial partners could be required to obtain a license
          in
          order to continue to manufacture or market the affected product or use
          the
          affected process. There can be no assurance that the Company or its commercial
          partners could prevail in any such action or that any license required
          under any
          such patent would be made available or, if available, would be available
          on
          acceptable terms. If no license is available, the Company’s ability to
          commercialize its products may be negatively affected. There may be significant
          litigation in the industry regarding patents and other intellectual property
          rights and such litigation could consume substantial resources. If required,
          the
          Company may seek to negotiate licenses under competitive or blocking patents,
          which it believes are required for it to commercialize its
          products.
  Although
          the scope of patent protection ultimately afforded by the patents and patent
          applications owned by or licensed to the Company is difficult to quantify,
          management of the Company believes that such patents will afford adequate
          protection for it to ensure exclusivity in the conduct its business operations
          as described herein. The Company also intends to rely upon trade secrets,
          confidential and unpatented proprietary know-how, and continuing technological
          innovation to develop and maintain its competitive position. To protect
          these
          rights, the Company whenever possible requires all employees and consultants
          to
          enter into confidentiality agreements with the Company. There can be no
          assurance, however, that these agreements will provide meaningful protection
          for
          the Company’s trade secrets, know-how or other proprietary information in the
          event of any unauthorized use or disclosure. Further, in the absence of
          patent
          protection, the Company’s business may be adversely affected by competitors who
          independently develop substantially equivalent or superior
          technology.
   **Regulatory
          Considerations**
  ***Product
          Regulation***
  The
          Canadian health care industry is regulated by TPD. This agency has a role
          similar to that of the FDA and has responsibility for regulating drugs
          for both
          human and animal use, cosmetics, radiation-emitting and other medical devices,
          and other products affecting human health. A manufacturer is required to
          follow
          the cGMP regulations in the manufacture of such products. Regulations imposed
          by
          federal, provincial, state and local authorities in Canada and the United
          States
          are a significant factor in the conduct of the development, manufacturing
          and
          eventual marketing activities for any proposed product.
  Stellar
          has received a license to manufacture and sell NeoVisc, Uracyst and the
          Uracyst
          Test Kit in Canada from the TPD. These products are regulated under the
          Medical
          Devices Regulations of the Food and Drugs Act (Canada) and the regulations
          promulgated thereunder by TPD to ensure the safety and efficacy of medical
          devices for the Canadian public. The Company is in material compliance
          with all
          such regulations and was audited and approved ISO 13485:2003 certification
          on
          March 3, 2006.
  
  Under
          the
          European License, Pohl-Boskamp is required to cause all Uracyst products
          offered
          for sale in Europe to be manufactured in accordance with all applicable
          laws
          including, without limitation, Council Directive 90/385/EEC of 20 June
          1990 and
          Council Directive 93/42/EEC of 14 June 1993 concerning medical devices.
          See “
Products and Markets.”
  Stellar
          intends to market its products 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. The Company intends to apply to have
          NeoVisc, Uracyst and the Uracyst Test Kit approved 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.
  Management
          of Stellar believes that the best strategic approach for the Company to
          take,
          with respect to the initiation of its United States approvals, is to take
          advantage of the pre-consultation process with the FDA reviewers, prior
          to the
          submission of the PMA application. A detailed and comprehensive scientific
          and
          medical package will be prepared by the Company for this consultation process
          and will include, among other things, the safety and efficacy information
          collected from the Canadian market. It is expected that substantial evidence
          to
          establish the chemical and physical equivalency of the Company’s products to
          existing products marketed in the United States will also be included.
          The FDA
          requires the completion of the clinical trials for the safety and efficacy
          of
          each therapeutic product before it will issue a PMA. Accordingly, the Company
          with its United States licensee has filed for and received an Investigational
          Device Exemption (“IDE”), from the FDA and expects to start clinical trials in
          the United States as soon as possible for NeoVisc and Uracyst once the
          current
          road blocks have been resolved.
  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 clinic to perform additional
          services.
  Stellar
          anticipates that the FDA approvals required to market NeoVisc and Uracyst
          in the
          United States will be obtained around the end of 2008. There can be no
          assurance, however, that such FDA approvals will be obtained or that Stellar
          will be able to successfully market its products in the United States.
          Stellar
          expects that the costs associated with obtaining such FDA approvals will
          be
          approximately $4,000,000 (Cdn.) and $3,500,000 (Cdn.), respectively. As
          discussed below under “Future Product Development,” funding of these FDA
          approvals was the responsibility of Leitner.
  ***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 for its NeoVisc and Uracyst related products. The
          United
          States submissions will be a priority for the Company, as management believes
          that the United States market offers significant opportunities for the
          sale of
          the Company’s products. The registration for all current products will likely
          require completion of clinical trials. Clinical work, done in Canada and
          the
          United States, can then be used for submissions for entry into other countries.
          In March 2004, Stellar entered into licence and supply agreements with
          Leitner
          for the development, marketing and sale of NeoVisc and Uracyst products
          in the
          United States. Under these agreements, Leitner also was required to fund
          the
          cost of the Company’s FDA approval process for NeoVisc and Uracyst.
  For
          the
          years ended December 31, 2005 and 2004, the Company expensed approximately
          $608,957 and $659,759, respectively on in-house research and development
          activities.
   **Item
                  2.**
                **Description
                    of Property.**
  During
          October 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 incurred additional
          costs of
          $168,989 for renovations to the office, packaging and warehouse space of
          approximately 10,600 square feet in the aggregate contained in the building. Stellar
          believes that its existing property is in good condition and suitable for
          the
          conducting of its business.
   **Item
                  3.**
                **Legal
                    Proceedings.**
  Stellar
          may periodically become subject to legal proceedings and claims arising
          in
          connection in business. The Company does not believe that there were any
          claims
          outstanding against it as of March 27, 2006 that will have a material adverse
          effect on the Company’s results of operations, financial condition and
          liquidity.
 **Item
                  4.**
                **Submission
                    of Matters to a Vote of Security
                    Holders.**
  Not
        applicable 
 
 
 **PART
          II**
   **Item
                  5.**
                **Market
                    for Common Equity and Related Stockholder
                    Matters.**
  **Market
          Information**
  Since
          December 2002, the Company’s common shares (“Common Shares”) have traded on the
          OTC Bulletin Board service of the National Association of Securities Dealers,
          Inc. (the “OTC Bulletin Board”). The Common Shares currently trade thereon under
          the symbol “SLXCF.” The following table sets forth the high and low per share
          sale price expressed in United States Dollars for the Common Shares as
          reported
          by the OTC Bulletin Board.
 
 ($)
                      (USD)High
                  
                  Low2005
                  First
                      Quarter
                  2.10
                  
                  1.50Second
                      Quarter
                  1.80
                  
                  1.10Third
                      Quarter
                  1.40
                  
                  1.01Fourth
                      Quarter
                  1.07
                  
                  0.762004
                  First
                      Quarter
                  1.78
                  
                  0.64Second
                      Quarter
                  2.27
                  
                  1.35Third
                      Quarter
                  2.19
                  
                  0.86Fourth
                      Quarter
                  2.02
                  
                  1.192003
                  First
                      Quarter
                  0.34
                  
                  0.21Second
                      Quarter
                  0.41
                  
                  0.15Third
                      Quarter
                  0.45
                  
                  0.23Fourth
                      Quarter
                  0.68
                  
                  0.25
 On
          March
          27, 2006, the last reported per share sale price for the Common Shares
          on the
          OTC Bulletin Board was $1.01 (USD).
 
 Since
          December 2000, the Common Shares have been listed and traded on the TSX
          Venture
          Exchange. The Common Shares are currently listed and trade on Tier 2 of
          the TSX
          Venture Exchange under the symbol “SLX.” The following table sets forth the high
          and low per share sale price expressed in Canadian Dollars for the Common
          Shares
          as reported by the TSX Venture Exchange.
        
 ($)
                    (Cdn.)High
                
                Low2005
                First
                    Quarter
                2.45
                
                1.80Second
                    Quarter
                2.00
                
                1.35Third
                    Quarter
                1.50
                
                1.20Fourth
                    Quarter
                1.20
                
                0.85
 
 
 ($)
                      (Cdn.)High
                  
                  Low2004
                  First
                      Quarter
                  2.28
                  
                  0.85Second
                      Quarter
                  3.00
                  
                  1.90Third
                      Quarter
                  2.80
                  
                  1.95Fourth
                      Quarter
                  2.44
                  
                  1.752003
                  First
                      Quarter
                  0.48
                  
                  0.30Second
                      Quarter
                  0.54
                  
                  0.28Third
                      Quarter
                  0.60
                  
                  0.31Fourth
                      Quarter
                  0.87
                  
                  0.33
  **Holders**
  As
          at
          January 1, 2006, there were 29 holders of record of the Common Shares.
  **Dividends**
  The
          Company currently intends to retain future earnings, if any, for use in
          its
          business. The Company does not anticipate paying dividends on the Common
          Shares
          in the foreseeable future. Any determination to pay any future dividends
          will
          remain at the discretion of the board of directors of the Company (the
“Board of
          Directors”) and will be made taking into account Stellar’s financial condition
          and other factors deemed relevant by the Board of Directors.
  **Equity
          Compensation Plan Information**
  The
          table
          set forth below provides information as of December 31, 2005 with respect
          to
          Common Shares that may be issued under the Company’s existing equity plans. For
          additional information, see “Item 10 - Executive Compensation.”
  Plan
                    category
                Number
                    of securities to be issued upon exercise of outstanding options,
                    warrants
                    and rights
                  
                  
                  
                  *(a)*
                Weighted-average
                    exercise price of outstanding options, warrants and rights
                  in
                    Canadian Dollars
                  
                  
                  *(b)*
                Number
                    of securites remaining available for future issuance under equity
                    compensation plans (excluding securities reflected in column
                    (a))
                  
                  
                  *(c)*Equity
                    compensation plans approved by security holders
                1,540,000
                ****1.56
                896,635Equity
                    compensation plans not approved by
                  security
                    holders
                **__**
                **__**
                **__**Total
                1,540,000
                1.56
                896,635
  
 
 **Exchange
          Controls and Other Limitations Affecting Security Holders.**
  Canada
          has no system of exchange controls. There are no exchange restrictions
          on
          borrowing from citizens or residents of foreign countries nor on the remittance
          of dividends, interest, royalties or similar payments, management fees,
          loan
          repayments, settlement of trade debts or the repatriation of capital.
  Under
          the
          Investment Canada Act (the “ICA Act”), a Canadian federal statute, certain
“non-Canadian” individuals, governments, corporations or other entities who wish
          to acquire a “Canadian business” (as defined in the ICA Act) or establish a “new
          Canadian business” (as defined in the ICA Act) may be required to file either a
          notification or an application for review with a governmental agency known
          as
“Industry Canada”. The ICA Act further requires that certain acquisitions of
          control of a Canadian business by a “non-Canadian” must be reviewed and approved
          by the Minister responsible for the ICA Act on the basis that he is satisfied
          that the acquisition is “likely to be of net benefit to Canada”. Only
          acquisitions of control are reviewable under the ICA Act; however, the
          ICA Act
          provides detailed rules for the determination of whether control has been
          acquired and, pursuant to those rules, the acquisition of one-third or
          more of
          the voting shares of the Company may, in some circumstances, be considered
          to
          constitute an acquisition of control. Failure to comply with the review
          provisions of the ICA Act could result in, among other things, an injunction
          or
          a court order directing disposition of assets or shares.
  There
          are
          no limitations on the rights of non-Canadian residents or non-Canadian
          shareholders to hold or vote the Common Shares contained in the Company’s
          Articles of Incorporation, as amended, or By-Laws, as amended.
  **Taxation**
  ***Dividends***
  In
          general, dividends paid by a corporation resident in Canada to non-residents
          of
          Canada are subject to Canadian withholding tax. The rate of withholding
          tax
          under the Income Tax Act (Canada) (the “Tax Act”) on dividends is twenty-five
          percent (25%). Such rate may be reduced under the provisions of a relevant
          international tax treaty to which Canada is a party. The Canada-United
          States
          Income Tax Convention (1980) (the “U.S. Treaty”) provides for a general
          reduction in the rate of Canadian withholding tax to fifteen percent (15%)
          on
          dividends paid on shares of a corporation resident in Canada to residents
          of the
          United States, and also provides that where the beneficial owner of the
          dividends is a corporation resident in the United States. Notwithstanding
          the
          foregoing, a reduced rate of (i) ten percent (10%) applies to dividends
          from a non-resident owned investment corporation if the recipient is a
          corporation that is the beneficial owner of at least ten percent (10%)
          of the
          voting shares of the corporation paying the dividends and (ii) five percent
          (5%) applies if the recipient is a corporation resident in the United States
          that is the beneficial owner of at least ten percent (10%) of the voting
          shares
          of the corporation paying the dividends.
  ***Capital
          Gains***
  A
          non-resident of Canada is not subject to tax under the Tax Act in respect
          of a
          capital gain realized upon the disposition of a share of a public corporation
          for purposes of the Tax Act unless the share represents taxable Canadian
          property to the holder thereof. A share of a public corporation will be
          taxable
          Canadian property to the holder thereof if, at any time during the period
          of
          sixty (60) months immediately preceding a disposition, the non-resident,
          persons
          with whom the non-resident did not deal at arm’s length, or the non-resident
          together with persons with whom he did not deal at arm’s length, owned (or had
          an option in respect of or had an interest in) twenty-five percent (25%)
          or more
          of the issued shares of any class or series of the corporation or if, upon
          ceasing to be a resident of Canada, the holder elected that the share be
          taxable
          Canadian property. The Company is a public corporation for purposes of
          the Tax
          Act.
  
  The
          U.S.
          Treaty provides that, in general, a resident of the United States will
          not be
          subject to tax on any capital gains realized by him on the disposition
          of shares
          that are taxable Canadian property unless (i) such resident has or had
          (within the twelve-month period preceding the disposition) a permanent
          establishment in Canada and such shares formed part of the business property
          of
          that permanent establishment, (ii) such shares formed part of the personal
          property pertaining to a fixed base which is or was available (within a
          twelve-month period preceding the disposition) to such resident for the
          purpose
          of performing independent personal services, (iii) the value of the shares
          is
          derived principally from real property situated in Canada or (iv) the
          shareholder is an individual who was resident in Canada for 120 months
          in any
          twenty-year period preceding the disposition and at any time during the
          ten-year
          period immediately preceding the disposition and who owned the shares of
          the
          corporation at the time he or she ceased to be a resident of
          Canada.
  ***Estate
          and Gift Tax***
  At
          present, Canada does not impose any estate or gift tax.
  **Recent
          Sales of Unregistered Securities**
  In
          February 2004, Stellar issued 4,088,794 Common Shares to SJ Strategic
          Investments LLC, a Tennessee limited liability company ("SJ"), for aggregate
          gross proceeds of approximately $4 million. At such time, this issuance
          represented approximately 19.9% of the issued and outstanding Common Shares,
          on
          a non-diluted basis.
 
 In
          connection with the aforesaid issuance, SJ also obtained the right to subscribe
          for additional Common Shares in the future from time to time in order to
          maintain its percentage equity ownership interest in Stellar, subject to
          adjustment in certain circumstances and regulatory approval. SJ was further
          granted the right to participate as a selling shareholder in future offerings
          of
          Common Shares. In addition, Peter Riehl, Stellar’s President and Chief Executive
          Officer and his spouse, entered into an agreement with SJ pursuant to which
          they
          have granted rights of first refusal to SJ in respect of the sale of securities
          in Stellar owned by them.
 
 The
          Common Shares were acquired by SJ for investment purposes only, and not
          with the
          purpose of influencing control or direction over Stellar. SJ has advised
          Stellar
          that it may acquire further Common Shares or dispose of its holdings of
          Common
          Shares as investment conditions warrant.
 
 Exemption
          from the registration provisions of the United States Securities Act of
          1993, as
          amended (the “Securities Act”), for the issuance described above was claimed
          under Section 4(2) of the Securities Act and the rules and regulations
          promulgated thereunder on the basis that such issuance did not involve
          any
          public offering, the purchaser was sophisticated with access to the kind
          of
          information registration would provide and that such purchaser acquired
          such
          securities without a view towards distribution thereof.
 
 In
          December 2003, Stellar entered into a financial advisory and consulting
          agreement with LMT Financial Inc., a company beneficially owned by a director
          and his spouse. Mr. Tenney currently serves as Chairman of the Board of
          Stellar.
          In consideration for services provided under this agreement, LMT Financial
          Inc.
          earned a fee of $72,000 (Cdn.) in 2005. This fee was satisfied in full
          through
          12 monthly payments of $6,000 during 2005.
  
 
 **Issuer
          Purchases of Equity Securities.**
  During
          the fourth quarter of 2005, neither Stellar nor any “affiliated purchaser” (as
          defined in Rule 10b-18 promulgated under the United States Securities Exchange
          Act of 1934, as amended) (the “Exchange Act”) purchased any Common
          Shares.
   **Item
          6.**   **Management’s
          Discussion and Analysis or Plan of Operation**
  **General**
  The
          following discussion and analysis should be read in conjunction with the
          Company’s financial statements and notes thereto appearing elsewhere in this
          annual report. Such discussion and analysis contains forward-looking statements.
          The Company’s actual results may differ significantly from those projected in
          the forward-looking statements. The Company’s consolidated financial statements
          have been prepared in accordance with United States generally accepted
          accounting principles (“GAAP”). All dollar amounts are expressed in Canadian
          dollars.
  **Critical
          Accounting Policies and Estimates**
  The
          preparation of financial statements in conformity with United States GAAP
          requires management to make estimates and assumptions that affect the reported
          amounts of assets and liabilities and disclosure of contingent assets and
          liabilities at the date of the financial reporting period. Actual results
          could
          differ from those estimates. These estimates are reviewed periodically,
          and, as
          adjustments become necessary, they are reported in earnings in the period
          in
          which they become known.
  **Recent
          Accounting Pronouncements**
 
 Recent
          accounting pronouncements followed by the Company under United States.
          GAAP are
          summarized below.
 
 Recent
          accounting pronouncements followed by the Company under U.S. GAAP are summarized
          below.
 
 (i)
                SFAS
                    No. 123(R).
                    SFAS No. 123(R), Share-Based Payment, issued in December 2004,
                    is a
                    revision of FASB Statement 123, Accounting for Stock-Based Compensation
                    and supersedes APB Opinion No. 25, Accounting for Stock Issued
                    to
                    Employees, and its related implementation guidance. The Statement
                    focuses
                    primarily on accounting for transactions which an entity obtains
                    employee
                    services in share-based payment transactions. SFAS No. 123 (Revised
                    2004)
                    requires a public entity to measure the cost of employee services
                    received
                    in exchange for an award of equity instruments based on the grant-date
                    fair value of the award. That cost will be recognized over the
                    period
                    during which an employee is required to provide service in exchange
                    for
                    the award. Effective January 1, 2003, the Company adopted the
                    statement to
                    account for its employee stock options under the fair market
                    value method.
                    See Note 8 - Capital Stock.
 
 (ii)
                SFAS
                    No. 151.
                    SFAS No. 151, “Inventory Costs,” an amendment to Accounting Research
                    Bulletin No. 43, Inventory Pricing, to clarify the accounting
                    for abnormal
                    amounts of idle facility expense, freight, handling costs and
                    wasted
                    material. This Statement requires that those items be recognized
                    as
                    current-period charges regardless of whether they meet the criterion
                    of
                    “so normal.” Additionally, this Statement requires that allocation of
                    fixed production overheads to the costs of conversion be based
                    on the
                    normal capacity of the production facilities. The provisions
                    of SFAS No.
                    151 will become effective for fiscal years beginning after June
                    15, 2005.
                    The Company has not determined the impact of adopting this
                    standard.
 
 
  (iii)
                SFAS
                    No. 153.SFAS No. 153, “Exchanges of Nonmonetary Assets,” an amendment to
                    Accounting Principles Board Opinion No. 29. “Accounting for Nonmonetary
                    Transactions,” is based on the principle that exchanges of nonmonetary
                    assets should be measured based on the fair value of the assets
                    exchanged.
                    The guidance in that Opinion, however, included certain exceptions
                    to that
                    principle. This Statement amends Opinion 29 to eliminate the
                    exception for
                    nonmonetary exchanges of similar productive assets and replaces
                    it with a
                    general exception for exchanges in which the future cash flows
                    of the
                    entity are not expected to change significantly as a result of
                    the
                    exchange. The provisions of SFAS No. 153 will become effective
                    for
                    nonmonetary asset exchanges in fiscal periods beginning after
                    June 15,
                    2005. The Company has not determined the impact of adopting this
                    standard.
  
 ***Year
          Ended December 31, 2005 Compared to Year Ended December 31,
          2004***
 ***(in
          Canadian Dollars)***
   **Revenues**
  For
          the
          year ended December 31, 2005, total revenues from all sources increased
          6.0% to
          $1,942,251 compared to $1,832,325 in the same period during 2004. When
          revenue
          for 2004 is adjusted for a onetime licensing fee of $267,220 the revenue
          growth
          for 2005 is 24.1%.
  This
          growth was negatively impacted by a NeoVisc batch recall in the fourth
          quarter.
          In November of 2005, the company experienced higher than anticipated reports
          of
          side effects with a NeoVisc batch. Since the NeoVisc process is relatively
          new,
          the Company chose to react on the side of caution and withdrew this batch
          from
          sale. This was a costly step in the short term but Stellar believed the
          right
          step to maintain Stellar’s excellent track record and reputation in the market.
          This batch was thoroughly reviewed by Stellar’s quality management team and was
          found to be within specifications for all control factors. A new batch
          of
          NeoVisc was released for sale in mid December has not experienced any abnormal
          responses. The marketing strategies implemented earlier this year are now
          having
          a positive impact on sales and we expect this to continue into
          2006.
  BladderChek
          sales remain flat as we continue to work on in market reimbursement issues.
          Strong clinical support out of the United States and growing physician
          support
          in Canada is expected to help turn this a round
          in
          2006.
  During
          2005, the Company’s operating loss was $1,840,187 as compared to $1,441,226 in
          2004.
 
 **Cost
          of Sales**
  For
          the
          year ended December 31, 2005, cost of sales were $450,591 (without the
          effect of
          the $159,390 for other product costs and the write-down) compared to $340,123
          for the same period in 2004 or 27.7% of product sales, compared to 23.9%
          in
          2004. The Company incurred costs of $159,390 associated with a product
          recall
          and obsolete inventory. During the last quarter of 2005, the cost of sales
          was
          negatively affected by the NeoVisc recall. Continued improvements in the
          manufacturing process have caused a marginal increase in the cost of goods
          sold,
          going forward the Company expects to see benefits from these processes,
          with
          these benefits showing in 2006.
 
 
  **Research
          and Development**
  Stellar
          continues to invest in research necessary to advancing its products into
          international markets. In 2005, the Company incurred $608,957 in research
          costs
          compared to $659,759 in 2004. These costs are amortized in Stellar’s Canadian
          statement as deferred manufacturing development costs, but under United
          States
          GAAP they cannot be amortized.
  During
          2005, the Company incurred costs of $550,471 for the continued development
          of
          manufacturing processes focused on the production of the high molecular
          weight
          NeoVisc. These expenditures incurred over the last two years on process
          development, will improve Stellar’s competitiveness in the global
          viscosupplement market. In the first quarter of 2005, Stellar began the
          process
          of implementing an open-label, community-based, clinical trial for Uracyst,
          which will assist the Company in demonstrating the effectiveness of Uracyst
          to
          physicians in the treatment of GAG deficient cystitis, such as IC. In 2005,
          the
          Company has incurred cost of $51,235 in developing this trial as well as
          $7,251
          was issued to a consultant for services provided for a Uracyst study being
          conducted.
  **Business
          Development**
  Progress
          continues to be made as Stellar focuses on a number of business development
          activities associated with out-licensing Stellar’s current products in other
          international markets, in-licensing products for the Canadian market and
          developing additional products. As previously referenced to in the overview,
          Stellar entered into five new out-licensing distribution agreements for
          its
          products in 2005; these include the distribution of NeoVisc in Turkey,
          Lebanon,
          and Kuwait and Uracyst agreements for distribution in China and Israel.
          The
          Company anticipates revenue from these agreements to commence during
          2006.
  In
          2005,
          $20,000 was incurred in business and development to conduct a pharmico-economic
          review of BladderChek, for use in assisting the Company in attaining
          reimbursement programs for the product. These costs are included in selling,
          general and administrative expenses.
  **Selling,
          general and administrative expenses**
  Selling,
          general and administrative expenses for the year ended December 31, 2005
          were
          $2,418,918, compared to $2,185,329 for the same period in 2004. This increase
          includes the cost of $257,279 related to non-cash expenses for options
          issued to
          acquire common shares ("Common Shares") in the capital of the Company to
          consultants and the directors of the Company. In addition, the Company
          had costs
          of $212,098 related to consulting agreements, as well as legal costs associated
          to the Company’s name change. During this period, the Company incurred fee
          expenses to members of the board of directors, which totaled $42,666.
  The
          Company’s ongoing commitment to increase sales and marketing activity in order
          to improve in-market sales has resulted in direct selling costs and marketing
          cost to increase by $36,922 over the same period in 2004. In addition,
          there
          have also been increased costs associated with business development and
          investor
          relations activities with $496,438 being expensed in 2005, in comparison
          to
          $287,553 in 2004, for a total increase of $163,485. These expenditures
          were in
          furtherance of the Company’s growth and are expected to aid Stellar considerably
          in attaining its long-term goals.
  Change
          in the Company’s name, which became effective
          in January 2005 added non re-occurring legal costs of $7,795 to the selling,
          general and administrative expenses.
 
 
  **Interest
          income and expense**
  Interest
          revenue was $99,689 for the year ended December 31, 2005 as compared to
          $96,117
          for 2004. These amounts include the investment of dividends, interest received
          on a short-term loan and the gain on a sale of short term investments.
          Cash will
          be maintained in liquid investments.
  ***Year
          Ended December 31, 2004 Compared to Year Ended December 31, 2003***
 ***(in
          Canadian Dollars)***
   ***Revenues***
  For
          the year ended December 31, 2004, total revenues from all sources increased
          65.2% to $1,832,325 compared to $1,109,431 in the same period during 2003.
          Included in total revenues were licensing fee revenues of $267,220
          ($2003-$13,400) and royalty revenues of $139,754 (2003-$269), which brings
          actual sales of Stellar products for 2004, to $1,422,160 (2003-$1,095,129),
          an
          increase of 30.0% over 2003.
  During
          2004, the Company’s operating loss was $1,345,109 as compared to $807,920 in
          2003.
  ***Cost
          of Sales***
  For
          the year ended December 31, 2004, cost of sales were $340,123 compared
          to $
          216,609 for the same period in 2003 or 24.0% of product sales, compared
          to 19.9%
          in 2003. The increase in cost of goods sold is directly related to the
          move in
          our manufacturing and the normal transitional costs associated in the startup.
          The Company does not expect this to be an ongoing increase and expects
          to derive
          cost benefits in 2005 from its new manufacturing processes.
  ***Research
          and Development***
  Stellar
          continues to invest in research necessary to expand its products into
          international markets. In 2004, the Company incurred $718,878 in manufacturing
          development costs associated with the move of its manufacturing processes
          to
          Dalton. These costs are amortized in Stellar’s Canadian statement as deferred
          manufacturing development costs, but under United States GAAP they cannot
          be
          amortized.
  Many
          of the Company’s clinical programs were put on hold until out-licensing
          agreements were in place and manufacturing validations completed. Stellar’s
          agreements with Leitner will need clinical trials for Stellar’s products to be
          conducted in order to obtain regulatory approvals in the United States
          for both
          Uracyst and NeoVisc. Stellar expects these clinical trials to start early
          in
          2005 at Leitner’s cost.
  ***Business
          Development***
  For
          the year ended December 31, 2004, the Company had one-time costs of $26,984
          which related directly to the launch of Stellar’s two new in-licensed products,
          Skelite and BladderChek, in the Canadian market. The costs for business
          development increased to $40,305 in 2004 from $19,360 in 2003. These costs
          have
          been expensed to selling, general and administrative.
 
 
  ***Selling,
          general and administrative expenses***
   Selling,
          general and administrative expenses for the year ended December 31, 2004
          were
          $2,185,329 compared to $1,523,815 for 2003. This increase includes the
          costs of
          non-cash expenses for Common Shares issued to consultants of $184,142 and
          options granted to employees, directors and consults for $179,688. In addition,
          the Company had non-recurring costs of $68,788, of which $41,444 was related
          to
          licensing and consulting agreements, the remaining $27,344 related to the
          move
          to the Company’s new manufacturing site. During 2004, the Company started cash
          reimbursement to members of the Board of Directors, which totaled
          $32,667.
  In
          2004, the Company made a commitment to increase sales and marketing activity
          to
          improve in-market sales. This resulted in direct selling costs increasing
          by
          $154,575, which includes costs for increased market sales development and
          the
          addition of sales representatives in the Canadian market. These costs have
          all
          been expensed to selling, general and administrative.
  The
          management of Stellar felt these expenditures were essential for the Company’s
          growth and will aid in meeting Stellar’s long-term goals. In addition, there
          have also been increased costs associated with investor relations activities
          with $167,819 being expensed in 2004, in comparison to $54,627 in 2003,
          for a
          total increase of $113,192.
  Change
          in the formats of Stellar’s  Uracyst
          and NeoVisc products, necessitated revisions of new marketing and sales
          materials, which added non re-occurring costs of $19,198 to the selling,
          general
          and administrative expenses.
  ***Interest
          income and expense***
  Interest
          revenue was $96,117 for the year ended December 31, 2004 as compared to
          $4,119
          for 2003. These amounts include reinvestment of dividends and interest
          received
          on a short-term loan. Funds will be maintained in liquid
          investments.
  ***Year
          Ended December 31, 2003 Compared to Year Ended December 31, 2002***
 ***(in
          Canadian Dollars)***
  ***Revenues***
  For
          the year ended December 31, 2003, total revenue increased 29.8% to $1,109,431,
          compared to $854,705 in 2002. In-market growth for current products was
          negatively impacted by the SARS outbreak. Stellar conservatively estimates
          lost
          sales in March, April, May and June 2003 to be in excess of $250,000. Sales
          force activities continued to have a positive impact on product revenues.
          NeoVisc gross sales grew by 27.2% and Uracyst gross sales grew by 43.7%.
 
 The
          operating loss for the year 2003 was $807,920 as compared to a net loss
          in 2002
          of $812,339. During 2003, Stellar incurred non-cash expenses for consulting
          of
          $312,273 (issued Common Shares), up 656.1% over 2002. In 2003, Stellar
          also had
          increased expenses associated with its in-licensing and out-licensing efforts
          including business development and legal fees. These fees increased by
          87.3%
          over 2002. Stellar also incurred ongoing expenses for improvements to its
          manufacturing facility, which included upgrading our quality systems. These
          expenditures were necessary for the Company to continue to grow and meet
          its
          long term goals.
 
 
  ***Cost
          of Sales***
 
 During
          2003, cost of sales amounted to 19.5% of product sales. This represented
          a 1.2%
          reduction when compared to 2002, as Stellar continued to benefit from improved
          efficiencies in its manufacturing processes.
  ***Research
          and Development***
 
 Stellar
          continued to invest in research necessary to expand its products into
          international markets. However, clinical trial investment was put on hold
          due to
          out-licensing discussions. In June 2003, Stellar announced two in-licensing
          agreements for the distribution of the Company’s products in Latin America,
          Mexico, the Caribbean, and the Middle East. These agreements are not expected
          to
          have a major impact on income until the products covered thereby, have
          received
          specific country regulatory approval. These approvals are expected by mid-2004.
 
 Uracyst
          was launched in Europe in December of 2003 resulting in a second milestone
          payment. Royalty revenues from this agreement are expected throughout
          2004.
 
 In
          September 2003, Stellar in-licensed BladderChek for the Canadian market
          Stellar
          expects to launch this product in early 2004, once Canadian regulatory
          approval
          has been completed.
 
 In
          December of 2003, all validations were completed with Skelite, an in-licensed
          product from Millenium Biologix Inc. This product was launched in Canada
          on
          January 29, 2004. Stellar has been encouraged with the early physician
          interest
          in Skelite and expects it to perform well in 2004. During 2003, Stellar
          worked
          with Dr. Robert Hurst of the University of Oklahoma on animal studies involving
          Uracyst. Dr. Hurst produced experimental evidence to further the understanding
          of certain properties of Uracyst. These results are expected to be published
          by
          Dr. Hurst in 2004.
  ***Selling,
          general and administrative expenses***
 
 For
          the year ended December 31, 2003, selling, general and administrative expenses
          increased by $336,776 mainly due to $312,272 in non-cash expenses, share
          issuance fees, legal fees and consulting fees, which increased by over
          $53,000
          compared to 2002. In addition, Stellar continued to make expenditures to
          expand
          its infrastructure to support long-term commercial objectives. A portion
          of
          these expenses were incurred to meet necessary quality standards that resulted
          in Stellar receiving its ISO 13485 registration in July 2003.
  ***Interest
          income and expense***
  Stellar
          has managed its current positive cash position generating over $4,119 in
          investment income in 2003 as compared to $17,100 in 2002.
  **Liquidity
          and Capital Resources**
 
 Cash,
          cash equivalents and short-term investments totaled $2,108,755 at December
          31,
          2005 as compared with $3,172,870 at December 31, 2004. During 2005, the
          Company
          received aggregate exercise proceeds of $324,064 for 667,817 Common Shares
          issued upon the exercise of options for cash. There are 1,540,000 stock
          options
          outstanding.
  At
          March 27, 2005, the Company did not have any outstanding indebtedness for
          borrowed money.
 
 
  The
          Company entered into an agreement to acquire a building for $450,000. In
          addition, renovations to the building were $160,989. The Company moved
          into the
          upper office area of the building on October 22, 2004. The Company has
          delayed
          incurring expenses in relation to start up the packaging plant area until
          the
          demand for Stellar’s products in international markets increases and requires
          this investment. The Company financed the purchase from its own available
          cash
          resources.
  While
          the Company has generated royalty revenue and revenue from the distribution
          of
          pharmaceutical products in Canada, such revenue has not been sufficient
          to fund
          the Company’s research, development and marketing activities. Accordingly, the
          Company continued to incur losses in 2004 and drew from its holdings of
          cash,
          cash equivalents and short-term investments. However the Company does expect
          to
          be profitable in 2006 and to be able to fund its future growth from the
          sale of
          its products, milestone payments and royalty income resulting from out-licensing
          agreements for at least the next 24 months.
  The
          Company may seek additional funding, primarily by way of one or more equity
          offerings, to carry out its business plan and to minimize risks to its
          operations. The market for equity financings for companies such as Stellar
          is
          challenging, and there can be no assurance that additional funding by way
          of
          equity financing will be available. Any additional equity financing may
          result
          in significant dilution to the existing shareholders at the time of such
          financing. The Company may also seek additional funding from other sources,
          including technology licensing, co-development collaborations, and other
          strategic alliances, which, if obtained, may reduce the Company’s interest in
          its projects or products. There can be no assurance, however, that any
          alternative sources of funding will be available.
  **Risks
          and Uncertainties**
 
 Stellar
          is subject to risks, events and uncertainties, or "risk factors", associated
          with being both a publicly-traded company operating in the biopharmaceutical
          industry, and as an enterprise with several projects in the research and
          development stage. Such risk factors could cause reported financial information
          to not necessarily be indicative of future operating results or of 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 the Company’s 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 future actual results.
 
 Some
          of the risks and uncertainties affecting the Company, its business, operations
          and results include, but are not limited to, the Company’s dependence on a few
          customers and a few suppliers, the loss of any of which would negatively
          impact
          the Company’s operations; the need to develop and commercialize new products
          which will require further time consuming and costly research and development,
          the success of which cannot be assured; the Company’s dependency on third
          parties for manufacturing, materials and for research, development and
          commercialization assistance and support; the Company’s dependency on assurances
          from third parties regarding licensing of proprietary technology owned
          by
          others; government regulation and the need for regulatory approvals for
          both the
          development and commercialization of products, which are not assured;
          uncertainty that the Company’s products will be accepted in the marketplace;
          rapid technological change and competition from pharmaceutical companies,
          biotechnology companies and universities, which may make the Company’s
          technology or products obsolete or uncompetitive; the need to attract and
          retain
          skilled employees; risks associated with claims of infringement of intellectual
          property and of proprietary rights; risks inherent in manufacturing (including
          upscaling) and marketing; product liability and insurance risks; risks
          associated with clinical trials, including the possibility that trials
          may be
          terminated early, delayed or unsuccessful; exchange rate fluctuations;
          political, economic and environmental risks; the need for performance by
          buyers
          and suppliers of products; the Company’s dependency on performance by its
          licensees regarding the sale of our licensed out products NeoVisc and Uracyst;
          and the risk of unanticipated expenses or unanticipated reductions in revenue,
          or both, any of which could cause the Company to reduce, delay or divest
          one or
          more of its research, development or marketing programs.
 
 
  **Off-Balance
          Sheet Arrangements**
  The
          Company, as part of its ongoing business, does not participate in transactions
          that generate relationships with unconsolidated entities or financial
          partnerships, such as entities often referred to as structured finance
          or
          special purpose entities ("SPEs"), which would have been established for
          the
          purpose of facilitating off-balance sheet arrangements or other contractually
          narrow or limited purposes. As of March 27, 2006, the Company was not involved
          in any material unconsolidated SPE transactions.
  Item
          7.Financial
          Statements.
  The
          financial statements of the Company for 2005 and 2004, including the notes
          thereto, together with the report thereon of Mintz & Partners, LLP Chartered
          Accountants are attached to the end of this annual report and are hereby
          incorporated herein by reference.
   **Item
          8.**  **Changes
          In and Disagreements with Accountants on Accounting and Financial
          Disclosure.**
  Not
                    applicable.
   **Item
                    8A.**
                **Controls
                    and
                    Procedures****.**
  Within
          the 90-day period prior to the Company’s filing of this annual report, an
          evaluation was carried out under the supervision and with the participation
          of
          the Company’s management, including its Chief Executive Officer and Chief
          Financial Officer, of the effectiveness of the design and operation of
          the
          Company’s disclosure controls and procedures (as defined in Rule 13a-15 and
          15d-15 under the Exchange Act. Based upon that evaluation, the Chief Executive
          Officer and Chief Financial Officer concluded that those disclosure controls
          and
          procedures were adequate to ensure that information required to be disclosed
          by
          the Company in the reports that it files or submits under the Exchange
          Act is
          recorded, processed, summarized and reported, within the time periods specified
          in the rules and regulations promulgated there under. There have been no
          significant changes in the Company’s internal controls or in other factors that
          could significantly affect these controls subsequent to the date of their
          evaluation.
   **Item
          8B.**  **Other
          Information** **.**
  Not
          applicable.
 
 
  PART
          III
  **Item
                  9.**
                **Directors,
                    Executive Officers, Promoters and Control Persons; Compliance
                    with Section
                    16(a) of the Exchange Act.**
  **Directors
          and Executive Officers**
  The
          following table sets forth certain information with respect to the directors
          and
          executive officers of Stellar as of March 27, 2006.
 Name
                  Age
                  PositionsPeter
                      Riehl
                  60
                  Director,
                      President and Chief Executive OfficerArnold
                      Tenney
                  63
                  Chairman
                      of the Board and Financial AdvisorJohn
                      J. Kime
                  63
                  DirectorDavid
                      A. Rosenkrantz
                  48
                  DirectorRobert
                      H. Kayser
                  63
                  DirectorJanice
                      M. Clarke
                  45
                  Chief
                      Financial Officer
  Set
          forth below are brief biographies of the Company’s directors and officers. All
          of the directors and executive officers of the Company have held their
          principal
          occupations indicated below for the past five years unless otherwise
          noted.
  **Peter
          Riehl, President, Chief Executive Officer and Director** .
          Peter Riehl joined the Company in 1996. Mr. Riehl has over 30 years experience
          in the Canadian and international pharmaceutical markets. He was a former
          director of sales and marketing for Fisons Corp. Ltd. in Canada responsible
          for
          the commercial side of their pharmaceutical business in Canada. His experience
          covers sales, marketing, business development and logistics in the
          pharmaceutical industry. In 1993, Mr. Riehl was Chairman of the prescription
          drug sector of the Canadian Wholesale Drug Association. He is also a former
          director of sales and marketing for Bioniche Life Sciences Inc. Mr. Riehl
          has
          been involved in numerous professional and industry related training programs
          and has a Diploma in Business Administration from Conestoga College, Kitchener
          and studied marketing at York University, Toronto.
  **Arnold
          Tenney, Chairman of the Board and Financial Advisor.** Since
          2002, Arnold S.. Tenney has been a financial consultant at Devine Entertainment
          Corporation ("Devine"), a children and family film production and development
          company. Proir to his position at Devine Mr. Tenney was Chief Executive
          Officer
          of ARC International Corporation from 1978 to 2000. ARC International
          Corporation was a developer of indoor ice arenas and tennis clubs, as well
          as an
          investment company involved in entertainment and cable television whose
          shares
          were traded on the American Stock Exchange until its liquidation in 2000.
          Mr.
          Tenney was a director and Chairman of the Board of Cabletel Communications
          from
          1985 to 2000, which is a leading supplier of broadband equipment to the
          cable
          television industry whose shares currently trade on both the Toronto and
          American Stock Exchanges. Mr. Tenney was a director of Ballantyne of Omaha,
          Inc.
          from 1988 to 2000 and served as Chairman of the Board from 1992 to 2000.
          Ballantyne of Omaha, Inc. is a leading manufacturer of commercial motion
          picture
          projection equipment whose shares trade on the American Stock Exchange.
          Mr.
          Tenney served as a director for Phillip Services Inc., a Canadian metal
          recycling company, from 1998 to 2000. He served in the capacity as a
          representative of Mr. Carl Icahn.
  
 
 **Robert
          H. Kayser, Director.** Robert
          H.
          Kayser spent 29 years in positions of increasing  responsibility
          with Medtronic, Inc., the world's leading medical technology company providing
          lifelong solutions for people with chronic disease. He retired in 2001
          as
          Director of Global Marketing, Cardiac Surgery Products, in Grand Rapids,
          MI.
          During his four-year tenure in this position, Mr. Kayser introduced more
          than 20
          new products, and increased product revenue and market share. Prior to
          this, he
          served as Vice President, Pacing and Customer Education in Lausanne,
          Switzerland, where he implemented brand strategies and European customer
          education activities that resulted in higher market share for Medtronic’s
          cardiac pacing and electrophysiology product lines. From 1993-1996, he
          was
          General Manager, Medtronic UK, where he was responsible for all businesses
          and
          functions.
  **John
          J. Kime, Director.** John J. Kime has been a director of the Company since December 2000. Mr.
          Kime
          has been the President and Chief Executive Officer of the London Economic
          Development Corporation since 1998. The London Economic Development Corporation
          is a public/private partnership with primary responsibility for economic
          development activities in London, Ontario, Canada. From 1991 to 1998, Mr.
          Kime
          served as Director of International Development for Big ‘O’ Incorporated, a
          company primarily engaged in the design and manufacture of control and
          containment systems for water, chemicals and other substances. Mr. Kime
          has a
          B.A. from the University of Western Ontario and is a chartered accountant.
          Mr.
          Kime is also a director of Cancer Care Ontario, Canada.
  **David
          A. Rosenkrantz, Director.** Mr. Rosenkrantz is Chairman of Patica Corporation, a small-cap merchant
          bank
          based in Toronto, which focuses on junior growth companies and President
          of
          Patica Securities Ltd. He has over fifteen years experience in investment
          and
          merchant banking. Mr. Rosenkrantz has been involved in private and public
          financing and merger and acquisition transactions involving health care,
          real
          estate, oil and gas, and high technology companies. Mr. Rosenkrantz is a
          graduate of Carleton University and obtained his MBA from York University.
  **Janice
          M. Clarke, Chief Financial Officer.** Ms **.** Clarke has over twenty years of office administration and financial management
          e xperience
          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 five members. Directors serve for terms of one
          year or
          until their successors are duly elected or appointed.
  **Committees
          of the Board of Directors**
  The
          Company has established an Audit Committee and a Compensation Committee
          of the
          Board of Directors.
  ***Audit
          Committee***
  The
          Audit
          Committee consists of Messrs. Rosenkrantz, Kayser and Kime, and is responsible
          for recommending the firm to be appointed as auditors to audit financial
          statements and to perform services related to the audit; reviewing the
          scope and
          results of the audit with the auditors, reviewing with management and the
          auditors the Company’s annual operating results; and considering the adequacy of
          the internal accounting procedures and the effect of such procedures on
          the
          auditors’ independence. Mr. Kime who chairs this committee is a chartered
          accountant and provides financial expertise to the Audit Committee. Each
          Audit
          Committee member is an independent director of the Company.
  
  ***Compensation
          Committee***
  The
          Compensation Committee consists of Messrs. Rosenkrantz and Kime, and is
          responsible for evaluating, reviewing and supervising the procedures of
          the
          Company with regard to human resources; assessing the performance of the
          officers of the Company; reviewing annually the remuneration of the officers;
          and recommending to the Board of Directors general remuneration policies
          regarding salaries, bonuses and other forms of remuneration for the directors
          and executive officers of the Company.
   **Audit
          Committee Financial Expert**
  The
          Board
          of Directors has determined that Mr. Kime is an audit committee financial
          expert
          as defined by Item 401(h) of Regulation S-K of the Exchange and is independent
          within the meaning of Item 7(d)(3)(iv) of Schedule 14A of the Exchange
          Act.
   **Compliance
          with Section 16(a) of the Exchange Act**
  Section
          16(a) of the Exchange Act, requires Stellar’s executive officers, directors and
          persons who beneficially own more than 10% of the Common Shares ("reporting
          persons") to file initial reports of ownership and reports of changes of
          ownership with the United States Securities and Exchange Commission. Executive
          officers, directors and greater than 10% beneficial owners are required
          to
          furnish Stellar with copies of all Section 16(a) forms they file.
  The
          Company believes that certain of its officers and directors failed to file
          reports required by Section 16 (a) of the Exchange Act during 2005. The
          Company
          expects that these reports will be filed during 2006.
   **Code
          of Ethics**
  The
          Company has not adopted a code of ethics in light of its limited number
          of
          executive officers.
   **Item
                  10.**
                **Executive
                    Compensation.**
  **Summary
          Compensation Table**
  The
          Company does not have a long-term incentive plan or pension plan and has
          never
          granted stock appreciation rights to any of its directors, officers or
          employees.
  The
          following table sets forth all compensation earned during each of the three
          years included in the period ended December 31, 2005 by the Chief Executive
          Officer of Stellar, such individual being the only executive officer of
          Stellar
          whose total annual salary, bonus and other annual compensation exceeded
          $100,000
          (USD).
 
 
  **Name
                    and Principal Position**
                **Year**
                **Annual
                    Compensation**
                **Long
                    Term**
                  **Compensation****Salary**
                  **($)(Cdn.)**
                **Bonus**
                  **($)(Cdn.)**
                **Other
                    Annual Compensation****($)(Cdn.)**
                **Securities
                    Underlying Options (#)**Peter
                    Riehl, President & Chief Executive Officer
                2005
                  2004
                  2003
                  2002
                175,000
                  140,000
                  100,000
                  100,000
                -
                  -
                  -
                  -
                -
                  -
                  -
                  -
                35,000
                  35,000
                  25,000
                  25,000
 
  **Employment
          Agreements and Termination of Employment**
  Effective
          as of September 1, 2000, Stellar entered into an employment agreement with
          Peter
          Riehl. Under Mr. Riehl’s employment agreement, Mr. Riehl agreed to serve as a
          director of Stellar and is employed as the President and Chief Executive
          Officer
          of Stellar.
  Effective
          September 1, 2004, Mr. Riehl’s employment agreement provides for a gross annual
          remuneration of $175,000, plus standard dental and life insurance benefits.
          Mr.
          Riehl is also entitled to be reimbursed for all Company-related travel
          and other
          out-of-pocket expenses. Pursuant to his employment agreement, Mr. Riehl
          is
          further entitled to receive an annual bonus, at the discretion of the Board
          of
          Directors, in the form of cash and/or stock options, based upon the achievement
          of certain performance goals to be established by the Compensation Committee
          of
          the Board of Directors. The employment agreement is automatically renewable
          for
          successive one year terms unless and until notice of intent to terminate
          is
          given by either Mr. Riehl or Stellar at least three months prior to the
          expiration of the term. Notwithstanding the foregoing, in the event that
          Mr.
          Riehl’s employment is terminated, other than for cause, by the Company, Mr.
          Riehl is entitled to a lump sum payment equal to 200% of his then current
          base
          salary. In the event of any such termination, any unvested stock options
          held by
          the Mr. Riehl will immediately vest. Mr. Riehl has agreed to not compete
          with
          the Company for a period of two years from the date of the termination
          of his
          employment, irrespective of the cause of such termination.
   **Stock
          Option Plan**
  The
          Company has established a stock option plan for the directors, executive
          officers, employees and consultants of the Company and any subsidiaries
          of the
          Company that may be formed (the “Plan”) in order to attract and retain competent
          persons motivated to work toward ensuring the Company’s success and to encourage
          such persons to acquire Common Shares. Individuals who are eligible to
          be
          selected to receive options under the Plan are directors, executive officers,
          employees and consultants of the Company and subsidiaries of the Company.
          The
          Board of Directors administers the Plan and has the power to amend, modify,
          suspend or terminate the Plan, subject to any necessary regulatory
          approvals.
  All
          of
          the options granted under the Plan may be exercised within a maximum period
          of
          three and one-half years following the date of grant thereof. Subject to
          the
          Plan, the Board of Directors designates the recipients of options and determines
          the number of Common Shares covered by each option, the date of vesting
          of each
          option, the exercise price of each option, the expiry date and any other
          terms
          relating thereto, in each case, in accordance with applicable legislation
          and
          the rules and policies of the applicable securities regulatory authorities.
          The
          price at which the Common Shares may be purchased pursuant to the Plan
          may not
          be lower than the closing price of the Common Shares on the principal stock
          exchange where the Common Shares are listed on the date of grant. On June
          29,
          2005, the Company increased the number of options in the plan to 4,629,452
          from
          4,157,841; the maximum number of Common Shares that were issuable under
          the Plan
          may not exceed 4,629,452. The maximum number of Common Shares that may
          be
          granted to any person may not exceed 5% of the outstanding Common
          Shares.
  
  As
          at
          March 27, 2006 the number of Common Shares which remain available for issuance
          under the Plan is 2,436,635, of which 896,635 Common Shares remain available
          for
          option grants.
  The
          Plan
          has been approved by the Company’s shareholders.
   **Option
          Grants in Last Fiscal Year**
  An
          option
          to purchase 70,000 Common Shares was granted to Mr. Riehl during the fiscal
          year
          ended December 31, 2005. Of these options 35,000 were issued on May 12,
          2005
          with an exercise price of $1.66 expiring on May 12, 2008; the remaining
          35,000
          were issued on December 21, 2005 with an exercise price of $0.91 expiring
          on
          December 31, 2008.
   **Compensation
          of Directors**
  In
          2005,
          the directors of the Company were entitled to receive cash compensation
          for
          serving in such capacity. The director acting as Chairman of the Board
          receives
          $10,000 annually. All other directors receive $6,000 annually. In addition,
          members of the Audit Committee receive $4,000 annually and members of the
          Compensation Committee receive $1,000 annually. Board members are eligible
          to
          participate in the Plan.
  Each
          of
          Messrs. Tenney, Riehl, Kime, Rosenkrantz and Kayser has been granted options
          under the Plan to purchase 25,000 Common Shares in consideration for serving
          as
          a director of the Company. In addition Messrs. Tenney and Riehl received
          additional options to purchase 10,000 Common Shares for their duties as
          Chairman
          of the Board and Chief Executive Officer, respectively. These options were
          granted on May 12, 2005 with an exercise price of $1.66 and expire on May
          12,
          2008. In addition, on December 21, 2005 the company issued to the board
          members
          options to purchase additional Common Shares which is based on the same
          purchase
          quantities as those granted on May 12, 2008. These options have an exercise
          price of $0.91 and expire on December 31, 2008.
   **Aggregated
          Option Exercises and Fiscal Year-End Option Value Table**
  The
          following table sets forth information concerning each exercise of options
          by
          Mr. Riehl during the year ended December 31, 2005.
  **Name**
                **Securities
                    Acquired on Exercise (#)**
                **Value
                    Realized ($) (Cdn.)**
                **Unexercised
                    Options at December 31, 2005 (#)**
                  **Exercisable/**
                  **Unexercisable**
                **Value
                    of Unexercised In-the-Money Options at December 31, 2005 ($)
                    (Cdn.)**
                  **Exercisable/**
                  **Unexercisable**Peter
                    Riehl
                25,000
                $5,750
                71,667/58,333
                $8,250
                    / -$0 -
  **Indemnification
          of Directors**
  The
          Company has agreed to indemnify each of its directors to the fullest extent
          permitted by
  
 
 Ontario,
          Canada corporate law for all costs, liabilities and expenses incurred by
          each
          director, including legal fees, in respect of claims to which a director
          is made
          a party by reason of being or having been a director of the Company or
          any
          subsidiary thereof, provided such director acted honestly and in good faith
          with
          a view to the best interests of the Company and, in the case of a criminal
          or
          administrative proceeding enforced by monetary penalty, such director had
          reasonable grounds for believing that his conduct was lawful.
   **Directors’
          and Officers’ Liability Insurance**
  The
          Company maintains insurance for the benefit of its directors and officers
          against liability in their respective capacities as directors and officers.
          The
          annual premium payable by the Company in respect of such insurance is $30,780
          for 2006 compared to $38,610 in 2005. The total amount of insurance purchased
          for the directors and officers as a group in 2006 is $2,000,000 compared
          to
          $1,000,000 in 2005. The directors and officers are not required to pay
          any
          premium in respect of the insurance. The insurance policy does not contain
          deductibility provisions .
   **Item
                  11.**
                **Security
                    Ownership of Certain Beneficial Owners and
                    Management.**
  The
          following table sets forth, as at March 27, 2006, certain information as
          to (i)
          each person, who to the knowledge of the Company, is the beneficial owner
          of
          more than five percent (5%) of any class of the Company’s voting securities and
          (ii) each class of equity securities of the Company or any of its subsidiaries
          (other than directors qualifying shares) beneficially owned by (A) each
          director
          of the Company and the Chief Executive Officer and (B) all directors and
          executive officers of the Company as a group.
  Title
                    of Class
                Name
                    and Address of
                  Beneficial
                    Owner
                Amount
                    and
                  Nature
                    of Beneficial
                  Ownership
                Percent
                    of ClassCommon
                    Shares
                Peter
                    Riehl
                  14
                    Exmoor Pl.
                  London,
                    Ontario
                  Canada
                    N5X 3W2
                3,569,741(1)
                15.1%Common
                    Shares
                Arnold
                    Tenney
                  31
                    Maple Avenue
                  Toronto,
                    Ontario
                  Canada
                    M4W 2T8
                989,200(2)
                4.2%Common
                    Shares
                Robert
                    H. Kayser
                  156
                    McGarrel Drive
                  London,
                    Ontario
                  Canada
                    N6G 5E7
                50,000(3)
                0.2%Common
                    Shares
                John
                    J. Kime
                  138
                    Hunt Club Dr.
                  London,
                    Ontario
                  Canada
                    N6H 3Y7
                200,000(4)
                0.8%
  
  Title
                    of Class
                Name
                    and Address of
                  Beneficial
                    Owner
                Amount
                    and
                  Nature
                    of Beneficial
                  Ownership
                Percent
                    of ClassCommon
                    Shares
                David
                    A. Rosenkrantz
                  105
                    Adelaide Street West
                  Toronto,
                    Ontario
                  Canada
                    M5H 1P9
                645,833(5)
                2.7%Common
                    Shares
                Janice
                    Clarke
                  8664
                    Parkhouse Drive
                  Mt.
                    Brydges, Ontario
                  Canada
                    N0L 1W0
                122,222(7)
                0.5%Common
                    Shares
                SJ
                    Strategic Investments LLC
                  340
                    Edgemont Ave
                  Suite
                    500
                  Bristol,
                    Tennessee
                  U.S.A
                    37620
                5,188,794(6)
                22.1%Common
                    Shares
                All
                    directors and executive officers
                  (6
                    individuals)
                5,576,996(8)
                23.1%
 
 (1)
                Includes
                    (i) 1,690,714 Common Shares owned by Mr. Riehl’s wife and (ii) currently
                    exercisable options on 71,667 Common Shares granted under the
                    Plan - See
                    “Item 10. Executive Compensation. - Stock Option
                    Plan.”
  (2)
                Includes
                    (i) 622,700 Common Shares owned by LMT Financial Inc, a company
                    beneficially owned by Mr. Tenney and his spouse ; (ii) 126,500
                    Common
                    Shares owned by Arnmart Investments Limited, a company in which
                    Mr. Tenney
                    holds and equity interest; (iii) 85,000 Common Shares owned by
                    Mr.
                    Tenney’s spouse; (iv) currently exercisable options on 105,000 Common
                    Shares granted under the Plan; (v) currently exercisable options
                    on 50,000
                    Common Shares which were granted outside of the Plan. see “Item 12.
                    Certain Relationships and Related Transactions.” See “Item 10. Executive
                    Compensation. - Stock Option Plan,”
  (3)
                Includes
                    (i) currently exercisable options on 50,000 Common Shares granted
                    under
                    the Plan. See “Item 10. Executive Compensation. - Stock Option
                    Plan,”
  (4)
                Includes
                    currently exercisable options on 115,000 Common Shares granted
                    under the
                    Plan. See “Item 10. Executive Compensation. - Stock Option
                    Plan.”
  (5)
                Includes
                    (i) 453,333 Common Shares owned by Mr. Rosenkrantz’s wife and (ii)
                    currently exercisable options on 180,000 Common Shares granted
                    under the
                    Plan. See “Item 10. Executive Compensation. - Stock Option
                    Plan”
  (6)
                Shares
                    are directly owned by SJ, with John M. Gregory as the managing
                    member
                    deemed to have sole voting and dispositive power over the shares.
                    Joan P.
                    Gregory, Susan Gregory and James M. Gregory are deemed to be
                    indirect
                    beneficial owners of shares due to their financial interest in
                    SJ.
  (7)
                Includes
                    (i) currently exercisable options on 80,000 Common Shares granted
                    under
                    the Plan. See “Item 10. Executive Compensation. - Stock Option
                    Plan,”
  (8)
                Includes
                    (i) currently exercisable options on 374,167 Common Shares granted
                    under
                    the Plan and (ii) currently exercisable options on 50,000 Common
                    Shares
                    granted outside of the Plan. See “Item 10. Executive Compensation. - Stock
                    Option Plan” and “Item 12. Certain Relationships and Related
                    Transactions.”
  
 
 Certain
          Relationships and Related Transactions.
  As
          discussed in Item 5 of this annual report, the Company entered a fiscal
          advisory
          and consulting agreement on December 17, 2003, with LMT Financial Inc.
          (a
          company benefically owned by a director and his spouse) for services provided
          in
          2005. Mr. Tenney currently serves as Chairman of the Board of Stellar.
   **Item
                  12.**
                **Exhibits
                    and Reports on Form 8-K.**
  (a)  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
                  
                  
                  10.10
                Amending
                    Consulting Agreement dated December 10, 2004 between the
                  Company
                    & LMT
                  Financial
                    Inc.
                  Option
                    Plan
                ***
                  
                  
                  ***10.11
                  10.12
                  10.13
                Amendment
                    to Option Plan - 2001
                  Amendment
                    to Option Plan - 2004
                  Amendment
                    to Option Plan - 2005
                ***
                  ***
                  ***99.1
                  99.2
                Certification
                    of Chief Executive Officer
                  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 2005 Annual Report Form 10-KSB dated March 31,
                    2005.
  (b)  Reports
          on Form 8-K
  Filed
                    January 13, 2006 - 1stQtr 2004 Financial Results
 Filed
                    January 13, 2006 - 2ndQtr 2004 Financial Results
 Filed
                    January 13, 2006 - 3rdQtr 2004 Financial Results
   **Item
                    14.**
                **Principal
                    Accountant Fees and Services**.
  **Fees
          for Services Provided by Independent Auditors**
  Fees
          for
          all services provided by Mintz & Partners, LLP the Company’s independent
          auditors, for 2005 and 2004 were as follows:
  **Audit
          Fees** .
  Fees
          for
          services for fiscal years 2005 related to the annual financial statement
          audits
          and reviews of quarterly financial statements filed in the reports on Form
          10-Q
          and statutory audits were approximately $72,000, compared to $65,000 in
          2004.
  **Audit-Related
          Fees** .
  In
          addition to the Audit Fees, the company paid Kraft, Berger, Grill, Swartz
&
Cohen LLP approximately $4,500 in 2005 for tax advice services and review
          issues
          with regards to employee benefit issues and research & development
          credits.
  **Tax
          Fees.**
  Mintz
          & Partners, LLP fees for tax services for 2005 and 2004 are estimated to
          be
          $2,500. Kraft, Berger, Grill, Swartz & Cohen LLP fees for tax services in
          2003 and 2002 were $1,500 and $1,750, respectively.
 
 
  **All
          Other Fees.**
  The
          Company generally does not engage Mintz & Partners, LLP for "other"
          services.
  **Pre-Approval
          Policy for Services of Independent Auditors**
  As
          part
          of its duties, the Audit Committee is required to pre-approve audit and
          non-audit services preformed by the independent auditors in order to assure
          that
          the provision of such services does not impair the auditors’ independence. On an
          annual basis, the Audit Committee will review and provide pre-approval
          for
          certain types of services that may be provide by the independent auditors
          without obtaining specific approval from the Audit Committee. If a type
          of
          service to be provided by the independent auditors has not received pre-approval
          during this annual process, it will require specific pre-approval form
          the Audit
          Committee. The Audit Committee does not delegate to management its
          responsibilities to pre-approve services performed by the independent
          auditors.
 
 The
          Audit
          Committee of the board has recommended that Mintz & Partners, LLP be
          appointed as the company’s independent auditors for the fiscal year ending
          December 31, 2005.
 
 
 
 **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:
                    March30, 2006
                Stellar
                    Pharmaceuticals Inc.
                  
                  
                  By:
                    /s/Arnold Tenney
                  ______________________________________
                  Name:
                    Arnold Tenney
                  Title:
                    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 30, 2006
                By:
                    /s/Arnold Tenney
                  ______________________________________
                  Name:
                    Arnold Tenney
                  Title:
                    Chairman of the BoardDate:
                    March 30, 2006
                By:
                    /s/Peter Riehl
                  _____________________________________
                  Name:
                    Peter Riehl
                  Title:
                    President, Chief Executive Officer
                  and
                    DirectorDate:
                    March 30, 2006
                By:
                    /s/David A. Rosenkrantz
                  ______________________________________
                  Name:
                    David A. Rosenkrantz
                  Title:
                    DirectorDate:
                    March 30, 2006
                By:
                    /s/Robert H. Kayser
                  _______________________________
                  Name:
                    Robert H. Kayser
                  Title:
                    Secretary and DirectorDate
                    : March 30, 2006
                By:
                    /s/John J. Kime
                  _______________________________
                  Name:
                    John J. Kime
                  Title:
                    DirectorDate:
                    March 30, 2006
                By:
                    /s/Janice M. Clarke
                  _______________________________
                  Name:
                    Janice M. Clarke
                  Title:
                    Chief Financial Officer
  
 
 **CERTIFICATION**
 **Pursuant
          to Rule 13a-14**
 
 I,
          Peter
          Riehl, the Chief Executive Officer of Stellar Pharmaceuticals Inc. (the
          “Company”), certify that:
 
 1.
                I
                    have reviewed this annual report on Form 10-KSB of Stellar International
                    Inc.
 
 2.
                Based
                    on my knowledge, this annual report does not contain any untrue
                    statement
                    of a material fact or omit to state a material fact necessary
                    to make the
                    statements made, in light of the circumstances under which such
                    statements
                    were made, not misleading with respect to the period covered
                    by this
                    annual report;
 
 3.
                Based
                    on my knowledge, the financial statements, and other financial
                    information
                    included in this annual report, fairly present in all material
                    respects
                    the financial condition, results of operations and cash flows
                    of the
                    registrant as of, and for, the periods presented in this annual
                    report;
 
 4.
                The
                    registrant’s other certifying officer and I, are responsible for
                    establishing and maintaining disclosure controls and procedures
                    (as
                    defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
                    and we
                    have:
 
 a)
                Designed
                    such disclosure controls and procedures to ensure that material
                    information relating to the registrant, including its consolidated
                    subsidiaries, is made known to us by others within those entities,
                    particularly during the period in which this annual report is
                    being
                    prepared;
 b)
                Evaluated
                    the effectiveness of the registrant’s disclosure controls and procedures
                    as of a date within 90 days prior to the filing date of this
                    annual report
                    (the “Evaluation Date”); and
 c)
                Presented
                    in this annual report our conclusions about the effectiveness
                    of the
                    disclosure controls and procedures based on our evaluation as
                    of the
                    Evaluation Date;
 
 5.
                The
                    registrant’s other certifying officer and I have disclosed, based on our
                    most recent evaluation, to the registrant’s auditors and the audit
                    committee of registrant’s board of directors (or persons performing the
                    equivalent function):
 
 a)
                All
                    significant deficiencies in the design or operation of the internal
                    controls which could adversely affect the registrant’s ability to record,
                    process, summarize and report financial data and have identified
                    for the
                    registrant’s auditors any material weaknesses in internal controls;
                    and
 b)
                Any
                    fraud, whether or not material, that involves management or other
                    employees who have a significant role in the registrant’s internal
                    controls; and
 
 6.
          The
          registrant’s other certifying officer and I have indicated in this annual report
          whether or not there were significant changes in internal controls or in
          other
          factors that could significantly affect internal controls subsequent to
          the date
          of our most recent evaluation, including any corrective actions with regard
          to
          significant deficiencies and material weaknesses.
 
  Date: Date:
                  March
                  30, 2006
                By:
                /s/ Peter
                  RiehlPeter
                  RiehlTitle Chief
                  Executive Officer
  
  **CERTIFICATION**
 **Pursuant
          to Rule 13a-14**
 
 I,
          Janice
          Clarke, the Chief Financial Officer of Stellar Pharmaceuticals Inc. (the
          “Company”), certify that:
 
 1.
                I
                    have reviewed this annual report on Form 10-KSB of Stellar International
                    Inc.
 
 2.
                Based
                    on my knowledge, this annual report does not contain any untrue
                    statement
                    of a material fact or omit to state a material fact necessary
                    to make the
                    statements made, in light of the circumstances under which such
                    statements
                    were made, not misleading with respect to the period covered
                    by this
                    annual report;
 
 3.
                Based
                    on my knowledge, the financial statements, and other financial
                    information
                    included in this annual report, fairly present in all material
                    respects
                    the financial condition, results of operations and cash flows
                    of the
                    registrant as of, and for, the periods presented in this annual
                    report;
 
 4.
                The
                    registrant’s other certifying officer and I are responsible for
                    establishing and maintaining disclosure controls and procedures
                    (as
                    defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
                    and we
                    have:
 
 a.
                Designed
                    such disclosure controls and procedures to ensure that material
                    information relating to the registrant, including its consolidated
                    subsidiaries, is made known to us by others within those entities,
                    particularly during the period in which this annual report is
                    being
                    prepared;
 b.
                Evaluated
                    the effectiveness of the registrant’s disclosure controls and procedures
                    as of a date within 90 days prior to the filing date of this
                    annual report
                    (the “Evaluation Date”); and
 c.
                Presented
                    in this annual report our conclusions about the effectiveness
                    of the
                    disclosure controls and procedures based on our evaluation as
                    of the
                    Evaluation Date;
 
 5.
                The
                    registrant’s other certifying officer and I have disclosed, based on our
                    most recent evaluation, to the registrant’s auditors and the audit
                    committee of registrant’s board of directors (or persons performing the
                    equivalent function):
 
 a.
                All
                    significant deficiencies in the design or operation of the internal
                    controls which could adversely affect the registrant’s ability to record,
                    process, summarize and report financial data and have identified
                    for the
                    registrant’s auditors any material weaknesses in internal controls;
                    and
 b.
                Any
                    fraud, whether or not material, that involves management or other
                    employees who have a significant role in the registrant’s internal
                    controls; and
 
 6.
          The
          registrant’s other certifying officer and I have indicated in this annual report
          whether or not there were significant changes in internal controls or in
          other
          factors that could significantly affect internal controls subsequent to
          the date
          of our most recent evaluation, including any corrective actions with regard
          to
          significant deficiencies and material weaknesses.
 
 Date: Date:
                  March
                  30, 2006
                By:
                /s/ Janice
                  M. ClarkeJanice
                  M. ClarkeTitle Chief
                  Financial Officer
  
  **STELLAR
          PHARMACEUTICALS INC.**
 
 **(Formerly
          Stellar International Inc.)**
  **FINANCIAL
          STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
  
  **STELLAR
          PHARMACEUTICLAS INC.**
  **(Formerly
          Stellar International Inc.)**
  **DECEMBER
          31, 2005**
  **CONTENTS**
  PAGE**FINANCIAL
                    STATEMENTS****AUDITORS’
                    REPORT**
                **1****BALANCE
                    SHEETS**
                **2****STATEMENTS
                    OF CHANGES IN SHAREHOLDERS’ EQUITY**
                **3****STATEMENTS
                    OF OPERATIONS**
                **4****STATEMENTS
                    OF CASH FLOWS**
                **5****NOTES
                    TO FINANCIAL STATEMENTS**
                **6****-23**
  
 AUDITORS’
REPORT
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **BALANCE
          SHEETS**
  **(Canadian
          Funds)**
  **AS
          AT DECEMBER 31**
 **ASSETS****2005**
                  
                  **2004****CURRENT**Cash
                      and cash equivalents (Note 3)
                  
                  $
                  2,108,755
                  
                  $
                  3,172,870Accounts
                      receivable
                  
                  
                  157,749
                  
                  
                  143,629Inventories
                      (Note 4)
                  
                  
                  288,337
                  
                  
                  336,491Tax
                      recoverable
                  
                  
                  
                  
                  
                  38,131Prepaid,
                      deposits and sundry receivables (Note 5)
                  
                  
                  152,514
                  
                  
                  155,9722,707,355
                  
                  
                  3,847,093**PROPERTY,
                      PLANT AND EQUIPMENT**(Note
                      6)
                  
                  
                  959,999
                  
                  
                  951,860**OTHER
                      ASSETS**(Note
                      7)
                  
                  
                  46,187
                  
                  
                  16,431$
                  3,713,541
                  
                  $
                  4,815,384
 **LIABILITIES****CURRENT**Accounts
                        payable
                    
                    $
                    487,359
                    
                    $
                    342,624Accrued
                        liabilities
                    
                    
                    122,999
                    
                    
                    32,503Deferred
                        revenues
                    
                    
                    43,397
                    
                    
                    221,320653,755
                    
                    
                    596,447
  **CONTINGENCIES
                      AND COMMITMENTS**(Note
                      13)**SHAREHOLDERS'
                      EQUITY****CAPITAL
                      STOCK**(Note
                      8)AUTHORIZEDUnlimitedNon-voting,
                      convertible, redeemable and retractable preferredshares
                      with no par valueUnlimitedCommon
                      shares with no par value
 
 ISSUED23,470,190Common
                      shares (2004 - 22,802,373)
                  
                  
                  8,100,253
                  
                  
                  7,720,873Paid-in
                      capital options and warrants - outstanding
                  
                  
                  
                  
                  
                  545,025
                  
                  
                  374,712-
                      expired
                  
                  
                  
                  
                  
                  98,913
                  
                  
                  67,2638,744,191
                  
                  
                  8,162,848**DEFICIT**
                  
                  
                  
                  
                  
                  (5,684,405
                  )
                  
                  (3,943,911
                  )3,059,786
                  
                  
                  4,218,937$
                  3,713,541
                  
                  $
                  4,815,384
 
 See
                      accompanying notes to financial
                      statements.
 **Approved
              on behalf of the Board:**
   /s/ Peter
                      Riehl
                    
                    
                    /s/
                      Arnold TenneyDirector
                    
                    
                    Director
  Page
                  1
 **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **STATEMENT
          OF CHANGES IN SHAREHOLDERS’ EQUITY**
  **(Canadian
          Funds)**
  **FOR
          THE YEAR** **S
          ENDED DECEMBER 31, 2005 AND 2004**
 Number
                      of
                  
                  
                  
                  Paid
                      in Capital OptionsCommon
                  
                  CommonShares
                  
                  Shares
                  
                  Outstanding
                  
                  Expired
                  
                  Deficit#
                  
                  $
                  
                  $
                  
                  $
                  
                  $**BALANCE,**December
                      31, 2003
                  
                  
                  16,350,412
                  
                  
                  2,624,238
                  
                  
                  239,945
                  
                  
                  67,263
                  
                  
                  (2,598,802
                  )Shares
                      issued for cash
                  
                  
                  6,054,461
                  
                  
                  4,867,571
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Shares
                      issued for services
                  
                  
                  397,500
                  
                  
                  184,142
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Options
                      issued to consultants
                  
                  
                  -
                  
                  
                  -
                  
                  
                  25,688
                  
                  
                  -
                  
                  
                  -Options
                      exercised
                  
                  
                  -
                  
                  
                  17,388
                  
                  
                  (17,388
                  )
                  
                  -
                  
                  
                  -Options
                      issued to employees
                  
                  
                  -
                  
                  
                  -
                  
                  
                  154,000
                  
                  
                  -
                  
                  
                  -Warrants
                      exercised
                  
                  
                  -
                  
                  
                  27,533
                  
                  
                  (27,533
                  )
                  
                  -
                  
                  
                  -Net
                      loss for the year
                  
                  
                  -
                  
                  
                  -
                  
                  
                  
                  
                  
                  -
                  
                  
                  (1,345,109
                  )**BALANCE,**December
                      31, 2004
                  
                  
                  22,802,373
                  
                  
                  7,720,873
                  
                  
                  374,712
                  
                  
                  67,263
                  
                  
                  (3,943,911
                  )Shares
                      issued for cash
                  
                  
                  667,817
                  
                  
                  324,064
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Shares
                      to be issued for services
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Options
                      issued to consultants
                  
                  
                  -
                  
                  
                  -
                  
                  
                  204,303
                  
                  
                  -
                  
                  
                  -Options
                      exercised
                  
                  
                  -
                  
                  
                  55,316
                  
                  
                  (55,316
                  )
                  
                  -
                  
                  
                  -Options
                      issued to employees
                  
                  
                  -
                  
                  
                  -
                  
                  
                  52,976
                  
                  
                  -
                  
                  
                  -Options
                      issued to employeesforfeited
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (26,650
                  )
                  
                  26,650
                  
                  
                  -Options
                      issued to consultantsexpired
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (5,000
                  )
                  
                  5,000
                  
                  
                  -Net
                      loss for the year
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (1,740,494
                  )**BALANCE,**December
                      31, 2005
                  
                  
                  23,470,190
                  
                  
                  8,100,253
                  
                  
                  545,025
                  
                  
                  98,913
                  
                  
                  (5,684,405
                  )
  Page
              2
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **STATEMENTS
          OF OPERATIONS**
  (Canadian
          Funds)
 **Years
                      Ended December 31,****2005**
                  
                  **2004****PRODUCT
                      SALES**(Note
                      9)
                  
                  $
                  1,627,670
                  
                  $
                  1,425,351**COST
                      OF GOODS SOLD**
                  
                  
                  450,591
                  
                  
                  340,123**MARGIN
                      ON PRODUCT SOLD**
                  
                  
                  1,177,079
                  
                  
                  1,085,228**ROYALTIES
                      & LICENSING REVENUE**(Note
                      9**)**
                  
                  
                  314,581
                  
                  
                  406,974**WRITE-DOWN
                      OF OBSOLETE INVENTORY**
                  
                  
                  (36,238
                  )
                  
                  -**OTHER
                      PRODUCT COST**(Note
                      10)
                  
                  
                  (123,152
                  )
                  
                  -**GROSS
                      PROFIT**
                  
                  
                  1,332,270
                  
                  
                  1,492,202**EXPENSES**Selling,
                      general and administrative
                  
                  
                  2,418,918
                  
                  
                  2,185,329Research
                      and development
                  
                  
                  608,957
                  
                  
                  659,759Amortization
                  
                  
                  144,582
                  
                  
                  88,3403,172,457
                  
                  
                  2,933,428**LOSS
                      FROM OPERATIONS**
                  
                  
                  (1,840,187
                  )
                  
                  (1,441,226
                  )**INTEREST
                      AND OTHER INCOME**
                  
                  
                  99,689
                  
                  
                  96,117**NET
                      LOSS FOR THE YEAR**
                  
                  $
                  (1,740,498
                  )
                  $
                  (1,345,109
                  )**LOSS
                      PER SHARE**(Note
                      11)
                  
                  $
                  (0.08
                  )
                  $
                  (0.06
                  )**WEIGHTED
                      AVERAGE NUMBER OF COMMON SHARES****OUTSTANDING**
                  
                  
                  23,182,107
                  
                  
                  21,197,674
 See
              accompanying notes to financial statements.
 Page
                3
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **STATEMENTS
          OF CASH FLOWS**
  **(Canadian
          Funds)**
 
 **Years
                    Ended December 31,****2005**
                
                **2004****CASH
                  FLOW PROVIDED BY (USED IN)****OPERATING
                  ACTIVITIES**Net
                    loss for the year
                
                $
                (1,740,498
                )
                $
                (1,345,109
                )Amortization
                
                
                144,582
                
                
                88,340Issuance
                    of equity instruments for services rendered
                
                
                257,279
                
                
                336,752(1,338,637
                )
                
                (920,017
                )Change
                    in non-cash operating assets and liabilitiesIncrease
                    in accounts receivable
                
                
                (14,120
                )
                
                (100,531
                )(Increase)
                    decrease in inventories
                
                
                48,154
                
                
                (207,554
                )Decrease
                    (increase) in tax recoverable
                
                
                38,131
                
                
                79,577(Increase)
                    decrease in prepaid, deposits andsundry
                    receivables
                
                
                3,458
                
                
                (93,023
                )Increase
                    in accounts payable andaccrued
                    liabilities
                
                
                235,231
                
                
                134,962Decrease
                    in deferred revenues
                
                
                (177,923
                )
                
                (78,526
                )(1,205,707
                )
                
                (1,185,112
                )**INVESTING
                  ACTIVITIES**Additions
                    to property, plant andequipment
                
                
                (151,558
                )
                
                (750,620
                )Increase
                    in other assets
                
                
                (30,915
                )
                
                (14,207
                )(182,473
                )
                
                (764,827
                )**FINANCING ACTIVITIES**Issuance
                    of common stock
                
                
                324,064
                
                
                4,867,572324,064
                
                
                4,867,572**CHANGE
                  IN CASH AND CASH
                  EQUIVALENTS**
                
                
                (1,064,115
                )
                
                2,917,633**CASH
                  AND CASH EQUIVALENTS,  begining
                  of year**
                
                
                3,172,870
                
                
                255,237**CASH
                  AND CASH EQUIVALENTS,  end of
                  year**
                
                $
                2,108,755
                
                $
                3,172,870
   See
          accompanying notes to financial
          statements.
 Page
                4
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **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. **** Effective
          January 1, 2005 the Company changed its name from Stellar International
          Inc. to
          Stellar Pharmaceuticals Inc. This name change is being made so that the
          Company’s name better reflects it underlying business.
  Stellar
          also intends to develop additional healthcare products aimed at niche
          pharmaceutical markets.
  The
          Company currently markets its products in Canada; however, its objective
          is to
          expand its sales and marketing efforts to the United States. Accordingly,
          the
          Company’s USA licensee is expected to conduct clinical trials necessary to
          obtain the required regulatory approvals for NeoVisc and Uracyst.
  **2.**
                **SUMMARY
                    OF SIGNIFICANT ACCOUNTING POLICIES**
  These
          financial statements have been prepared in accordance with accounting principles
          generally accepted in the
          United States of America.
  (a)
                CASH
                    AND CASH EQUIVALENTS
  Cash
                    and cash equivalents include cash and all highly liquid investments
                    purchased with an original or remaining maturity of three months
                    or less
                    at the date of purchase or are otherwise highly liquid. All cash
                    and cash
                    equivalents are under the custodianship of two major Canadian
                    financial
                    institutions.
  (b)
                ACCOUNTS
                    RECEIVABLES
  The
                    Company routinely assesses the recoverability of all material
                    trade and
                    other receivables to determine their collectibility by considering
                    factors
                    such as historical experience, credit quality, the age of the
                    accounts
                    receivable balances, and current economic conditions that may
                    affect a
                    customer's ability to pay. Therefore, the Company considers all
                    its
                    receivables to be fully collectible and accordingly no allowance
                    for
                    doubtful accounts is required.
 (c)
                  REVENUE
                      RECOGNITION
 Sales
          are recognized when legal title to the goods has been passed to the customer
          and
          collection is reasonably assured. The Company has a "No Return" policy
          on the
          sale
          of its goods. Revenue from non-refundable up-front fees for the licensing
          of
          technology and products under agreements which do not require the Company
          to
          perform research or development activities or other significant future
          performance obligations is recognized at the time the agreement is executed.
          Revenue resulting from the achievement of milestone events stipulated in
          the
          agreements is recognized when the milestone is achieved. Up-front fees
          and other
          amounts received in excess of revenue recognized are recorded as deferred
          income.
  Page
              5
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
  **2.**
                  **SUMMARY
                      OF SIGNIFICANT ACCOUNTING POLICIES (c**ontinued**)**
 Royalty **** revenue
          is recognized when the Company has fulfilled the terms in accordance with
          the
          contractual agreement and has no future obligation, the amount of the royalty
          fee is determinable and collection is reasonably assured.
  (d)
                INVENTORIES
 
 Inventories
          are valued at the lower of cost and net realizable value with cost being
          substantially determined on a first-in, first-out basis.
 (e)
                  PROPERTY, PLANT AND EQUIPMENT
  Property,
          plant and equipment are stated at cost. Amortization is being provided
          for on
          a  straight-line
          basis over the estimated useful life of the assets. The Company periodically
          compares the carrying value of property, plant and equipment to their net
          realizable values and charges income with any impairment to net assets.
          The
          estimated useful lives of the assets are as follows:
  Asset Classification
                Useful
                    LifeBuilding
                20
                    yearsComputer and office equipment
                5
                    yearsManufacturing equipment
                5
                    years
  (f)
                    OTHER ASSETS
 Amortization
          of other assets is being provided for on the straight-line basis as noted
          below.
  Asset Classification
                  Useful
                      LifePatents
                  17
                      years
 Patents
          represent capitalized legal costs incurred in connection with applications
          for
          patents. For patents and applications that are abandoned, the company charges
          any remaining accumulated costs to expenses.
 (g)
                      USE OF ESTIMATES
 The
          preparation of financial statements in conformity with United States generally
          accepted accounting principles requires management to make estimates and
          assumptions that affect the reported amounts of assets and liabilities
          and
          disclosure of contingent assets and liabilities at the date of the financial
          statements and the reported amounts of revenues and expenses during the reporting
          period. Actual results could differ from those estimates. These estimates
          are
          reviewed periodically, and, as adjustments become necessary, they are reported
          in earnings in the period in which they become known.
 
 Page
              6
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **2.**
                  **SUMMARY
                      OF SIGNIFICANT ACCOUNTING POLICIES (continued)**
  (h)
                DEFERRED INCOME TAXES
 
 The
          Company accounts for income taxes using the asset and liability method.
          Deferred
          tax assets and liabilities are recognized based on the difference between
          the
          accounting values of assets and liabilities and their related tax bases
          using
          current income tax rates.
  (i)
                STOCK-BASED COMPENSATION
  The
            Company uses fair value based method of accounting for all its stock-based
            compensation in accordance with Financial Accounting Standards Board
            ("FASB")
            Statement of Financial Accounting
 Standards
            No. 123.
  (j)
                FOREIGN
                    CURRENCY TRANSACTIONS****
 
 F oreign
          currency transactions are recorded at the exchange rate in effect on the
          date of
          the transaction.
 (k)
                  FOREIGN
                      CURRENCY TRANSLATION
 Monetary
          assets and liabilities are translated into Canadian dollars which is the
          functional currency of the company at the year-end exchange rate, while
          foreign
          currency revenues and expenses are translated at the exchange rate in effect
          on
          the date of the transaction. The resultant gains or losses are included
          in
          income. Non-monetary items are translated at historical rates.
  (l)
                    RESEARCH
                        AND DEVELOPMENT****
 Research
          and development costs are expen sed
          as
          incurred. Approved investment tax credits are netted against the related
          expenses.
  (m)
                      COMPREHENSIVE
                          INCOME
  Statement
          of Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive
          Income", establishes standards for the reporting and display of comprehensive
          income and its components and requires restatement of all previously reported
          information for comparative purposes. For the year ended December 31, 2004
          and
          2005, comprehensive income was the same as net earnings.
  Page
              7
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **2.**
                      **SUMMARY
                          OF SIGNIFICANT ACCOUNTING POLICIES (continued)**
  (n)
                        LOSS
                            PER SHARE
 Basic
          earnings (loss) per share are computed by dividing the net earnings (loss)
          by
          the weighted average number of common shares outstanding during the year,
          adjusted for any subdivision or consolidation.
 
 Diluted
          earnings per share would be computed using the weighted average number
          of common
          and dilutive common equivalent shares outstanding during the year. Dilutive
          common equivalent shares consist of shares issuable upon exercise of stock
          options and warrants and conversion of preferred stock. Diluted loss per
          share
          is not calculated when the effect would be antidilutive.
 (o)
                        NON-MONETARY
                            TRANSACTIONS
 Shares
          issued for commercial transactions are valued based on the value of services
          provided.
 
  **3.**
                    **CASH
                        AND CASH EQUIVALENTS**
 Consists
                      of -
                  
                  December
                      31,2005
                  
                  
                  2004Cash
                  
                  $
                  169,974
                  
                  $
                  2,145,387Short-term
                      investments
                  
                  
                  1,938,781
                  
                  
                  1,027,483$
                  2,108,755
                  
                  $
                  3,172,870
   **4.**
                      **INVENTORIES**
  Consists
                      of -
                  
                  December
                      31,2005
                  
                  
                  2004Raw
                      material
                  
                  $
                  71,131
                  
                  $
                  135,922Finished
                      goods
                  
                  
                  44,331
                  
                  
                  38,545Packaging
                      materials
                  
                  
                  27,457
                  
                  
                  45,299Work
                      in process
                  
                  
                  145,418
                  
                  
                  116,725**$**
                  **288,337**
                  
                  **$**
                  **336,491**
  Page
              8
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **5.**
                **PREPAID,
                    DEPOSITS AND SUNDRY
                    RECEIVABLES**
  December
                      31,2005
                  
                  
                  2004Prepaid
                      operating expenses
                  
                  $
                  81,761
                  
                  $
                  19,476Deposit
                      on manufactured goods
                  
                  
                  -
                  
                  
                  38,025Materials
                      for use in clinical trials
                  
                  
                  47,138
                  
                  
                  82,138Director’s
                      fees
                  
                  
                  -
                  
                  
                  16,333Interest
                      Receivable on Investments
                  
                  
                  23,615
                  
                  
                  -$
                  152,514
                  
                  $
                  155,972
  **6.**
                  **PROPERTY,
                      PLANT AND EQUIPMENT**
  Cost
                  
                  December
                      31, 2005
                    Accumulated
                    Amortization
                  
                  Net
                      Carrying
                    AmountLand
                  
                  $
                  90,000
                  
                  **$**
                  
                  
                  $
                  $90,000Building
                  
                  
                  536,759
                  
                  
                  30,663
                  
                  
                  506,096Office
                      Equipment
                  
                  
                  39,394
                  
                  
                  26,019
                  
                  
                  13,375Manufacturing
                      Equipment
                  
                  
                  542,061
                  
                  
                  267,889
                  
                  
                  274,172Computer
                      Equipment
                  
                  
                  108,454
                  
                  
                  32,098
                  
                  
                  76,356**$**
                  1,316,668
                  ****
                  **$**
                  356,669
                  ****
                  **$**
                  959,999
  Cost
                  
                  December
                      31, 2005
                    Accumulated
                    Amortization
                  
                  Net
                      Carrying
                    AmountLand
                  
                  $
                  90,000
                  
                  $
                  -
                  
                  $
                  90,000Building
                  
                  
                  520,989
                  
                  
                  4,286
                  
                  
                  516,703Office
                      Equipment
                  
                  
                  39,394
                  
                  
                  22,554
                  
                  
                  16,840Manufacturing
                      Equipment
                  
                  
                  480,476
                  
                  
                  166,787
                  
                  
                  313,689Computer
                      Equipment
                  
                  
                  34,252
                  
                  
                  19,624
                  
                  
                  14,628**$**
                  1,165,111
                  
                  $
                  213,251
                  
                  $
                  951,860
  Page
              9
 **7.**
                    **OTHER
                        ASSETS**
  Cost
                      
                      December
                          31, 2005
                        Accumulated
                        Amortization
                      
                      Net
                          Carrying
                        AmountPatents
                      
                      $
                      49,006
                      
                      $
                      2,820
                      
                      $
                      46,186Goodwill
                      
                      
                      1
                      
                      
                      -
                      
                      
                      1**$**
                      49,007
                      
                      $
                      2,820
                      
                      $
                      46,187
  Cost
                        
                        December
                            31, 2005
                          Accumulated
                          Amortization
                        
                        Net
                            Carrying
                          AmountPatents
                        
                        $
                        **18,091**
                        
                        $
                        **1,661**
                        
                        $
                        **16,430******Goodwill
                        
                        
                        1
                        
                        
                        -
                        
                        
                        1**$**
                        **18,092**
                        
                        **$**
                        **1,661**
                        
                        **$**
                        **16,431**
 **8.**
                      **CAPITAL
                          STOCK**
  **(a)**
                **Common
                    Shares**
  During
                    the year, the Company issued 667,817 Common Shares that were
                    issued to
                    consultants, employees and directors, who exercised stock options,
                    with an
                    average price per share of approximately $0.49 for cash.
  Page
              10
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **8.**
                        **CAPITAL
                            STOCK
                            (continued)**
 Number
                      of
                    Shares
                  
                  $
                    AmountBalance,
                      December 31, 2003
                  
                  
                  16,350,412
                  
                  $
                  2,264,238Issued
                      for cash consideration
                  
                  
                  6,054,461
                  
                  
                  4,912,493Issued
                      for consulting services
                  
                  
                  397,500
                  
                  
                  184,142Balance,
                      December 31, 2004
                  
                  
                  22,802,373
                  
                  
                  7,720,873Issued
                      for cash consideration
                  
                  
                  667,817
                  
                  
                  379,380Balance,
                      December 31, 2005
                  
                  
                  23,470,190
                  
                  $
                  8,100,253
 **(b)**
                  **Shares
                      to be Issued**
  Subsequent
          to the year end 2005
          there were 2,500 Common Shares issued for consulting services rendered
          during
          2005, with a value $2,275, which were outstanding for issuance at December
          31,
          2005 (2004 - $0).
  **(c)**
                **Paid-in
                    Capital Options and
                    Warrants**
  The
          activities in the paid-in capital options and warrants are as
          follows:
  Balance,
                      December 31, 2003
                  
                  $
                  239,945Options
                      issued to consultants
                  
                  
                  25,688Options
                      issued to employees
                  
                  
                  154,000Options
                      exercised
                  
                  
                  (17,388
                  )Warrants
                      exercised
                  
                  
                  (27,533
                  )Balance,
                      December 31, 2004
                  
                  
                  374,712Options
                      issued to consultants
                  
                  
                  204,303Options
                      exercised
                  
                  
                  (55,316
                  )Options
                      issued to employees
                  
                  
                  52,976Options
                      issued to employees forfeited
                  
                  
                  (26,650
                  )Options
                      issued to consultants expired
                  
                  
                  (5,000
                  )Balance,
                      December 31, 2005
                  
                  $
                  545,025
 **(d)**
                  **Warrants******
  Number
                      of
                  
                  ExerciseShares
                  
                  
                  PriceBalance,
                      December 31, 2003
                  
                  
                  550,667
                  
                  $
                  0.35
                      to 0.45Exercised
                  
                  
                  (550,667)
                  
                  $
                  0.35Balance,
                      December 31, 2004 and 2005
                  
                  
                  0
 All
          outstanding warrants were exercised in 2004.
  Page
              11
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
  **8.**  **CAPITAL
          STOCK (continued)**
  **(e)**
                    **Stock
                        Options**
 Under
          the terms of the Company's stock option plan ("Plan"), the Company is authorized
          to grant directors, officers, employees and others options to purchase
          Common
          Shares at prices based on the market price of shares as determined on the
          date
          of grant. On December 31, 2005, the maximum number of Common Shares that
          may be
          issued under the Plan was 4,629,452 (2004 - 4,157,841). Stock options become
          exercisable at dates determined by the Board or the Compensation Committee
          of
          the Board, with the term of an option not to exceed three and one-half
          years
          from the date of the grant of the option.
  During
            the year ended December 31, 2005, the Company issued a total of 775,000
            options.
            The Company issued 405,000 of these options to employees, officers and
            directors, which entitles the holder to purchase one Common Share of
            the Company
            for a price ranging from $0.91 to $1.66 per share at any time and from
            time to
            time until December 31, 2008. Compensation expense of $52,976 has been
            recognized in 2005 for services provided as selling, general and administrative
            expense, for 145,000 of these options, based on the fair value of the
            options.
            These options vest 1/6 th at the
            end of each fiscal quarter in 2005, the remainder vest in 2006. In addition,
            remaining 260,000 of these options were granted at the end of the year
            for the
            service period beginning on January 1, 2006 and ending on December 31,
            2006.
            These options will vest over a period of 18 months, with 50% vesting
            in 2006 and
            the remaining 50% vesting in 2007. Compensation expense for these options
            will
            be recorded in 2006 based on the fair value of the options. The Company
            also
            issued 370,000 options to consultants, which will vest on a quarterly
            basis over
            a 2 year term, of which 260,000 have vested in 2005. Each option entitles
            the
            holder to purchase one Common Share of the Company with prices ranging
            from
            $2.08 to $3.52 per share at any time and from time to time up to June
            1, 2007.
            Consulting expense amounting to $204,303 has been recognized for services
            provided in 2005 as selling, general, and administrative expense based
            on the
            fair value of the options. The total number of options outstanding as
            at
            December 31, 2005 was 1,540,000.
  The
                    fair value of options in 2005 was estimated as $0.57 at the date
                    of grant
                    using the Black-Scholes option-pricing model with the following
                    assumptions:
   Risk-free interest rate
                2.93%
                    - 3.47%Expected life
                3
                    yearsExpected volatility
                54%
                    - 58.9%Dividend yield
                0%
 
 During
          the year ended December 31, 2004, the Company issued a total
          of 465,000 options. The Company issued 315,000 of these options to employees,
          officers and directors, which entitles the holder to purchase one Common
          Share
          of the Company for a price ranging from $2.00 to $2.05
  Page
              12
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **8.**
                **CAPITAL
                    STOCK (continued)**
  per
                    share at any time and from time to time until April 2, 2007 .
                    Compensation
                    expense, amounting to $154,000, has been recognized for services
                    provided
                    in selling, general and administrative expense based on the fair
                    value of
                    the options issued.
  The
                    Company also issued 150,000 options to a consultant, which will
                    vest on a
                    quarterly basis over a 2 year term, of which 18,750 have vested
                    in 2004.
                    Each option entitles the holder to purchase one Common Share
                    of the
                    Company for price of $1.85 US per share at any time and from
                    time to time
                    up to September 1, 2006. Consulting expense amounting to $25,688
                    has been
                    recognized based on the fair value of the options issued in the
                    year for
                    the services rendered and has been recorded to selling, general
                    and
                    administrative expense for 2004. The total number of options
                    outstanding
                    as at December 31, 2004 were 1,590,000.
  The
          fair value of options in 2004 ranged from $0.28 to $1.37 estimated at the
          date
          of grant using the Black-Scholes option-pricing model with the following
          assumptions:
  Risk-free interest rate
                  2
                      .75%Expected life
                  3
                      yearsExpected volatility
                  36%Dividend yield
                  0%
 On
          June 29, 2005, pursuant
          to a resolution by the Board of Directors, the Company increased the number
          of
          options in the plan to 4,629,452 from 4,157,841.
  The
          following table presents information relating to stock options outstanding
          and
          exercisable at December 31, 2005.
  **Range
                    of**
                  ******Exercise
                    Price**
                **Number**
                  **Outstanding**
                
                **Weighted**
                  **Average**
                  **Remaining**
                  **Contractual****Life**
                
                **Weighted**
                  **Average**
                  **Exercise
                    Price**
                
                **Number**
                  **Exercisable
                    at**
                  **December
                    31,**
                  **2005**
                
                **Weighted**
                  **Average****Exercise**
                  **Price**$0.33
                    to $0.79
                
                375,000
                
                
                .56
                    years
                
                $
                0.47
                
                
                375,000
                
                $
                0.47$0.80
                    to $1.99
                
                400,000
                
                
                2.5
                    years
                
                
                1.18
                
                
                48,334
                
                
                1.66$2.00
                    to $3.54
                
                765,000
                
                
                1.13
                    years
                
                
                2.29
                
                
                765,000
                
                
                2.291,540,000
                
                
                1.35
                    years
                
                $
                1.56
                
                
                1,188,334
                
                $
                0.85
  The
          following table presents information relating to stock options outstanding
          and
          exercisable at December 31, 2004.
  **Range
                    of**
                  ******Exercise
                    Price**
                
                **Number****Outstanding**
                
                **Weighted**
                  **Average**
                  **Remaining**
                  **Contractual****Life**
                
                **Weighted**
                  **Average**
                  **Exercise
                    Price**
                
                **Number**
                  **Exercisable
                    at**
                  **December
                    31,**
                  **2005**
                
                **Weighted**
                  **Average****Exercise**
                  **Price**$0.23
                    to $0.52
                
                
                660,000
                
                
                1.02
                    years
                
                $
                0.36
                
                
                660,000
                
                $
                0.36$0.52
                    to $0.75
                
                
                465,000
                
                
                .93
                    years
                
                
                0.71
                
                
                465,000
                
                
                0.71$2.00
                    to $2.40
                
                
                465,000
                
                
                2.22
                    years
                
                
                2.15
                
                
                336,750
                
                
                2.051,590,000
                
                
                1.35
                    years
                
                $
                0.98
                
                
                1,458,750
                
                $
                0.85
  Page
              13
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
 **8.**
                  **CAPITAL
                      STOCK (continued)**
  The activities
          in options outstanding are as noted below:
 **Options**
                
                **Weighted**
                  **Average**
                  **Exercise**
                  **Price**Balance,
                    December 31, 2003
                
                
                2,540,000
                
                $
                0.50Granted
                
                
                465,000
                
                
                2.03Exercised
                
                
                (1,415,000
                )
                
                0.48Balance,
                    December 31, 2004
                
                
                1,590,000
                
                
                0.98Granted
                
                
                775,000
                
                
                1.18Exercised
                
                
                (667,817
                )
                
                0.49Forfeited
                
                
                (157,183
                )
                
                1.33Balance,
                    December 31, 2005
                
                
                1,540,000
                
                $
                1.56
  When
          employees or non-employees exercise their stock options, the capital stock
          is
          credited by the sum of the consideration paid together with the related
          portion
          previously credited to additional paid-in capital when compensation costs
          were
          charged against income.
  The
          weighted average fair value of options granted during the year ended December
          31, 2005 was estimated to be $0.52 (2004 - $0.33).
 **9.**
                    **REVENUES**
 Revenue
          for the year includes products sold in Canada and, international sales
          of
          products and raw materials sold at cost to our European licensee. Revenue
          earned
          is as follows:
 December
                      31,Products
                      Sales
                  
                  2005
                  
                  2004Domestic
                      sales
                  
                  $
                  1,528,352
                  
                  $
                  1,378,369International
                      sales
                  
                  
                  86,346
                  
                  
                  41,622Raw
                      materials
                  
                  
                  2,132
                  
                  
                  2,169Other
                      revenue
                  
                  
                  10,840
                  
                  
                  3,191Total
                      Product Sales
                  
                  $
                  1,627,670
                  
                  $
                  1,425,351Royalties
                      & licensing revenueLicensing
                      fees
                  
                  $
                  2,923
                  
                  $
                  267,220Royalty
                      payments
                  
                  
                  311,658
                  
                  
                  139,754Total
                      Royalties & licensing revenue
                  
                  $
                  314,581
                  
                  $
                  406,974
  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, Lebanon, Malaysia, and Turkey. The
          continuing operations reflected in the statements of operations include
          Stellar’s activity in these markets.
  Page
              14
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
  **10.**
                  **OTHER
                      **PRODUCT
                      COST****
 In
                    November of 2005, the Company experienced higher thananticipated
                    reports of side effects with one of its products, NeoVisc and
                    withdrew
                    this batch from sale. The Company has recorded $123,152 as other
                    product
                    cost.
  **11.**
                **INCOME
                    TAXES**
  Rate
          reconciliation
  A
          reconciliation of income tax expense (benefit) computed at the statutory
          income
          tax rate included in the statement of income follows:
  Income
                      tax expense (benefit) are comprised of:
                  
                  2005
                  
                  2004Tax
                      recovery at statutory rate at 36.12%
                  
                  $
                  (628,668
                  )
                  $
                  (485,853
                  )Tax
                      deferral from timing differences on expenses
                  
                  
                  128,150
                  
                  
                  249,440Non-deductible
                      expenses
                  
                  
                  96,751
                  
                  
                  67,397Non-recognition
                      of tax benefit from net losses
                  
                  
                  403,767
                  
                  
                  169,016$
                  -
                  
                  $
                  -
  Deferred
          tax assets and liabilities reflect the net effects of temporary differences
          between the carrying amounts of assets and liabilities for financial reporting
          purposes and their corresponding tax basis. Significant component of net
          deferred tax assets and liabilities is as
          listed below:
  2005
                  
                  2004Net
                      operating loss carry-forward
                  
                  $
                  1,217,000
                  
                  $
                  948,000Valuation
                      allowance
                  
                  
                  (1,217,000
                  )
                  
                  (948,000
                  )$
                  0
                  
                  $
                  0
 Page
              15
 The
            valuation allowance was provided against the net deferred tax assets
            at December
            31, 2005 due to uncertainties as to their ultimate realization.
  Company
              has non-capital losses carry-forward for income tax purposes in the
              amount of
              $3,433,050 which may be applied against future years’ taxable income. The losses
              expire as follows:
 2007
                  
                  $
                  178,4252008
                  
                  
                  298,1872009
                  
                  
                  705,4902010
                  
                  
                  542,2242014
                  
                  
                  706,2701,002,454$
                  3,433,050
  Page
              16
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **12.**
                **LOSS
                    PER SHARE**
 
 The
          treasury stock method assumes that proceeds received upon the exercise
          of all
          warrants and options outstanding in the year are used to repurchase the
          Company's shares at the average share price during the period.
  The
                    following table sets forth the computation of loss per
                    share:
  **2005**
                
                **2004**Numerator
                    for loss per share available to common shareholders
                
                $
                (1,740,498
                )
                $
                (1,345,109
                )Denominator
                    for loss per share - weighted average shares outstanding
                
                
                23,182,107
                
                
                21,197,674Loss
                    per share
                
                $
                (0.08
                )
                $
                (0.06
                )
  **1****3.**
                **CONTINGENCIES
                    AND COMMITMENTS**
  **(a)**  **Legal
          Action**
 
 On
          May 2,
          1997, a competitor claimed injunctive relief against the Company, as well
          as
          damages including aggravated, exemplary and punitive damages of $20,000,000
          for
          breach of fiduciary duty breach of contract, misuse of confidential information,
          including breach of contract, interference with contractual interests,
          conversion, detinue and an accounting for the profits from such activities.
          In
          turn, the Company counterclaimed for a dismissal of the action and damages
          in
          the amount of $500,000, interest and costs.
  During
          2004, the lawsuit and counterclaim were dismissed on consent without costs
          by
          the Ontario Superior Court of Justice.
  **(b)**  **Royalty
          Agreements**
  In
          September 2000, the Company entered into a royalty agreement for sales
          of
          Uracyst® product.  The agreement involves royalty payments, which initially
          were based on 5% of the total sales of Uracyst at a declining rate of 1%
          per
          year over a three-year period, declining to 2% rate effective October 1,
          2003
          and this royalty will remain at 2% until the end of the agreement on September
          30, 2008.
  In
          February 2002, the Company entered into a royalty agreement for products
          which
          were introduced to the Company by a consultant. The agreement involves
          royalty
          payments, which will be paid based on gross dollar sales. The schedule
          for
          royalty payments is presently calculated on Skelite® sales as:
  First
          $1,000,000 in sales - 3%
 Second
          $1,000,000 in sales - 2%
 All
          sales
          over $2, 000,000 - 1% out to the 5 th year.
  Page
              17
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **1****3.**
                **CONTINGENCIES
                    AND COMMITMENTS
                    (continued)**
  **(c)  
                    License Agreements**
  During
          the year ,
          the
          Company entered into the following new license agreements:
 
 In
          July
          2005, the Company entered into a license agreement with Innogen Ilac for
          the
          sale of NeoVisc in Turkey. In August 2005, the Company entered into a
          distribution agreement with TECHNIMED for the sale of NeoVisc in Lebanon.
          In
          September 2005, the Company entered into a license agreement with Shanghai
          Ya
          Jun Medical for the sale of Uracyst in China. Each of these agreements
          is for a
          period of 3 years.
 
 In
          November 2005, the Company entered into a license agreement with Al-Mohab
          Trading & Contracting for the sale of NeoVisc in Kuwait. This agreement is
          for a period of three years.
 
 The
          Company also entered into a license agreement with Mega Pharm for the sale
          of
          Uracyst in Israel in December 2005. This agreement is for a period of five
          years.
 
 On
          June
          30, 2004, the Company signed a NeoVisc® license agreement with Triptibumis Sdn.
          Bhd. ("Triptibumis") for Malaysia, Singapore and Brunei. The Company will
          supply
          Triptibumis with NeoVisc in Canadian packaging at a set price for this
          market.
          The term of this agreement will continue for a period of three years and
          will be
          renewable for an additional three years, unless earlier terminated by either
          party in accordance with the agreement.
 
 On
          August
          17, 2004, the Company entered into a license agreement with Pharmore GmbH
          to
          sell NeoVisc in the German market. The Company will supply NeoVisc in a
          German
          package format at a set price. This agreement will require Pharmore to
          pay a 5%
          royalty on their net sales (gross sales less allowances and returns) in
          the
          German market. Pharmore will be responsible for all costs incurred in obtaining
          both German regulatory approval and registering the CE mark for NeoVisc,
          plus
          all sales, marketing and distribution costs. The term of this agreement
          is for a
          period of three years and will be renewable for an additional three years,
          unless earlier terminated by either party in accordance with the
          agreement.
  The
          Company entered into two license agreements to grant the exclusive rights
          and
          license to use the methods and technical know-how for the purposes of
          developing, marketing and selling NeoVisc and 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 2004. These
          agreements commenced on March 24, 2004.
  Page
              18
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **1****3.**
                **CONTINGENCIES
                    AND COMMITMENTS
                    (continued)**
 
 On
          December 28, 2001, the Company entered into a license agreement with G.
          Pohl-Boskamp GmbH & Co. ("Pohl-Boskamp"), to grant the exclusive rights and
          license to use the methods and technical know-how for the purposes of
          manufacturing, marketing and selling Uracyst-S products in specified territories
          in Europe. In consideration, the Company is to receive a combination of
          non-recurring, non-refundable license fees and royalty payments. The license
          fees are due upon the achievement of specified milestones.
 
 One
          of
          the license fees was due upon signing of the agreement and was recognized
          as
          income during the fiscal year 2001, and the remaining license fees are
          recognized in income upon achievement of the specified milestones.
 
 The
          royalties, which equal 17.5% of net sales of each quarter, are to be paid
          in
          arrears on or before the 45th day of each quarter with respect to net sales
          in
          the preceding quarter. Until such time as there are net sales aggregating
          three
          million dollars, only 7.5% of the 17.5% royalty will be paid to the Company
          with
          the balance of 10% of the royalty being credited against the license fee.
          The
          agreement will expire seven years after December 21, 2001 or unless earlier
          terminated by the parties in accordance with the agreement.
 
 **(d)**
                **Distribution
                    Agreement**
  In
          October 2003, the Company entered into an exclusive agreement with a company
          in
          the United States, to manufacture and distribute bladder cancer test kit
          products within the field and territory as defined in the agreement, for
          a five
          year period commencing January 1, 2004, in consideration for a technology
          access
          fee of US$10,000 and an initial order. Either party may terminate the agreement
          30 days after delivery of written notice for failure to correct a material
          default under the agreement. The Company may terminate the agreement
          immediately, in the event that any conditions specified in the agreement
          are not
          satisfied.
 
 The
          Company is subject to annual minimum product purchases and an annual marketing
          plan which will be approved by the United States company. The Company agreed
          to
          spend a minimum amount of $10,000, in marketing the products in each of
          the
          first two calendar years covered by the agreement.
  **(e)**
                  **Manufacturing
                      Agreement**
 On
              April
              20, 2004, the Company signed a manufacturing agreement with Dalton
              Chemical
              Laboratories, Inc. in Toronto, Ontario, Canada, to manufacture Stellar’s
              NeoVisc® product. The agreement is for five years and may be renewed only by
              a
              written agreement between the parties. This agreement, along with the
              agreement
              to manufacture Uracyst® previously made with Dalton, will allow the Company to
              expand the sale of its products in international markets.
 Page
                19
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **1****3.**
                **CONTINGENCIES
                    AND COMMITMENTS
                    (continued)**
  **(f)**
                **Leases**
  The
          Company presently leases office equipment under operating leases. At December
          31, 2005, the future minimum lease payments under operating leases are
          $4,429
          (2004 - $5,600).
  **(g)**
                **Consulting
                    Agreements**
  In
          December 2004, the Company entered into two consulting agreements with
          investor
          relations firms, which included services, which would be rendered in 2005
          and
          2006. Under the terms of the agreements options of 250,000 were issued
          to the
          Equity Group and are exercisable at $2.07 per share with such options vesting
          quarterly in equal portions. Of these options 125,000 were for services
          provided
          in 2005 and the remaining 125,000 were granted for services to be provided
          in
          2006. These options have a term expiring on June 1, 2007. In addition,
          120,000
          options were issued to FF Investors LLC. Of these 120,000 options, 40,000
          are
          exercisable at $2.69 per share, 40,000 are exercisable at $3.11 per share
          and
          the final 40,000 options are exercisable at $3.52 per share. All of these
          120,000 options vest quarterly in equal portions over the two years following
          the day of grant and have a term expiring on April 4, 2007.
 
 In
          June
          2004, the Company entered into an agreement with Basic Investors to provide
          management and financial consulting services to the Company. The term of
          this
          agreement is for a period of six months, which will continue until February
          2006. This agreement will be satisfied in full by the issuance of monthly
          payments of $4,000US in cash, in arrears.
 
 In
          May
          2005, the Company entered into a research agreement with a major United
          States
          University. This program is on Bladder Urothelial research in interstitial
          cystitis and will cost the company $ 195,350 US dollars for the period
          May 2005
          to May 2007. This cost will be divided into equal monthly payments for
          the term
          of the agreement.
 **14.**
                  **SIGNIFICANT
                      CUSTOMERS**
 During
                    the year, the Company had one customer that represented 34.4%
                    of sales
                    (2004 - 38.3%).
  **15.**
                **RELATED
                    PARTY TRANSACTIONS**
  The
          Company entered a fiscal advisory and consulting agreement on December
          10, 2004,
          with LMT Financial Inc. (“LMT”) (a company beneficially owned by a director and
          his spouse) for services to be provided in 2005. In consideration for the
          services, LMT was to be paid an annual fee of $72,000, which was
          satisfied in full by the issuance of monthly payments of $6,000 in cash.  In
            March 2005, the Company entered into Supply and Licensing Agreements
            with Leitner
            Pharmaceuticals LLC (formerly SJ Pharmaceuticals, Inc.), for NeoVisc
            and Uracyst
            in the United States.
 
 Page
                20
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
   **1****5.**
                **RELATED
                    PARTY TRANSACTIONS
                    (continued)**
  In
          2005, there was no revenue recognized from these agreements.
  Leitner’s
          parent company, SJ Strategic Investments LLC, presently holds 22.1% of
          the
          Common Shares of the Company, which were acquired through private placements.
  **1****6.**
                **FINANCIAL
                    RISKS**
 **(a)**
                **Credit
                    Risk**
                  The
                    Company is engaged in the sale of pharmaceutical products, typically
                    to a
                    small number of major customers, although the composition of
                    this group of
                    customers has changed from year to year. The Company performs
                    ongoing
                    credit evaluation of its customers' financial condition and,
                    generally,
                    requires no collateral.**(b)**
                **Concentration
                    Risk**
                  
                  The
                    Company's cash and cash equivalents are maintained with two Canadian
                    banking institutions. Deposits held with these bank may exceed
                    the amount
                    of insurance provided on such deposits . ($60,000 per bank).
                    Generally,
                    these deposits may be redeemed upon demand and, therefore, bear
                    minimum
                    risk.
                  
                  As
                    at December 31, 2005 the Company had one customer which made
                    up 40.5% of
                    the outstanding accounts receivable, in comparison to two customers
                    which
                    made up 44.6% at December 31, 2004.
  **(c)**  **Currency
          Risk**
  The
          Company is subject to currency risk through its activities in the United
          States
          of America.
 
 Unfavorable
          changes in the exchange rate may affect the operating results of the
          Company.
 
 The
          Company does not actively use derivative instruments to reduce its exposure
          to
          foreign currency risk. However, dependant on the nature, amount and timing
          of
          foreign currency receipts and payments, the Company may enter into forward
          exchange contracts to mitigate the associated risks. There were no forward
          exchange contracts outstanding at December 31, 2005 and 2004.
 
 **(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.
 
 Page
                21
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
  
 **17.**
                **RECONCILATION
                    OF CANADIAN AND UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
                    ("GAAP")**
  These
          financial statements where prepared in accordance with GAAP in the United
          States. The Company  has
          included the significant differences which would result if the Canadian
          GAAP
          were applied in the preparation of the Statement of Operations,  the
          Balance Sheet and the Statement of Cash Flows. These statements are as
          follows:
  **Statement
          of Operations**
  For
                      the Year Ended December 31
                  
                  
                  
                  2005
                  
                  2004Net
                      income (loss), as reported under United States GAAP
                  
                  
                  
                  
                  $
                  (1,740,498
                  )
                  $
                  (1,345,109
                  )Adjustments
                      to arrive at Canadian GAAPResearch
                      and development expense
                  
                  
                  
                  
                  
                  490,694
                  
                  
                  718,878Amortization
                      expense
                  
                  
                  
                  
                  
                  (135,901
                  )
                  
                  (28,290
                  )Net
                      income (loss) based on Canadian GAAP
                  
                  
                  
                  
                  $
                  (1,385,705
                  )
                  $
                  (654,521
                  )Earnings
                      per share  -
                      United States GAAP net loss
                  
                  
                  
                  
                  $
                  (0.08
                  )
                  $
                  (0.06
                  )-
                      Impact on accounting change
                  
                  
                  
                  
                  
                  0.01
                  
                  
                  0.03-
                      Canadian GAAP net loss
                  
                  
                  
                  
                  
                  (0.07
                  )
                  
                  (0.03
                  )
  **Balance
          Sheet**
 As
                      at December 31
                  2005
                  
                  2004United
                      States
                  
                  Increase
                  
                  Canadian
                  
                  United
                      States
                  
                  Increase
                  
                  CanadianGAAP
                  
                  
                  (Decrease)
                  
                  
                  GAAP
                  
                  
                  GAAP
                  
                  
                  (Decrease)
                  
                  
                  GAAPCurrent
                      assets
                  
                  $
                  2,707,355
                  
                  $
                  -
                  
                  $
                  2,707,355
                  
                  $
                  3,847,093
                  
                  $
                  -
                  
                  $
                  3,847,093Property
                      plant and equipment
                  
                  
                  959,999
                  
                  
                  -
                  
                  
                  959,999
                  
                  
                  951,860
                  
                  
                  -
                  
                  
                  951,860Other
                      assets
                  
                  
                  46,187
                  
                  
                  1,180,521
                  
                  
                  1,226,708
                  
                  
                  16,431
                  
                  
                  825,728
                  
                  
                  842,159$
                  3,713,541
                  
                  $
                  1,180,521
                  
                  $
                  4,894,062
                  
                  $
                  4,815,384
                  
                  $
                  825,728
                  
                  $
                  5,641,112Current
                      liabilities
                  
                  
                  653,755
                  
                  
                  -
                  
                  
                  653,755
                  
                  
                  596,447
                  
                  
                  -
                  
                  
                  596,447Shareholders’
                      equity
                  
                  
                  3,059,786
                  
                  
                  1,180,521
                  
                  
                  4,240,307
                  
                  
                  4,218,937
                  
                  
                  825,728
                  
                  
                  5,044,665$
                  3,713,541
                  
                  $
                  1,180,521
                  
                  $
                  4,894,062
                  
                  $
                  4,815,384
                  
                  $
                  825,728
                  
                  $
                  5,641,112
  **Statements
          of Cash Flows**
 For
                      the Year Ended December 31
                  
                  2005
                  
                  2004Cash
                      flows for operating activities, as reported under United States
                      GAAP
                  $
                  (1,205,707)
                  
                  (1,185,112)Development
                      costs deferred for Canadian purposes
                  
                  
                  490,694
                  
                  
                  718,878Cash
                      flows for operating activities, Canadian GAAP
                  $
                  
                  (715,013
                  )
                  $
                  (466,234
                  )Cash
                      flows for investing activities, as reported under United States
                      GAAP
                  $
                  
                  (182,473
                  )
                  $
                  (764,827
                  )Development
                      costs deferred for Canadian GAAP purposes
                  
                  
                  (490,694
                  )
                  
                  (718,878
                  )Cash
                      flows for investing activities, Canadian GAAP
                  $
                  
                  (673,167
                  )
                  $
                  (1,483,705
                  )
   For
                      the Year Ended December 31
                  
                  2005
                  
                  2004Cash
                      flows for financing activities, as reported under United States
                      GAAP
                  
                  $
                  324,064
                  
                  $
                  4,867,572Change
                      in cash and cash equivalents
                  
                  
                  (1,064,115)
                  
                  
                  2,917,633Cash
                      and cash equivalents, opening
                  
                  
                  3,172,870
                  
                  
                  255,237Cash
                      and cash equivalents, closing
                  
                  $
                  2,108,755
                  
                  $
                  3,172,870
  Page
                22
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
  **1****7.**
                **RECONCILATION
                    OF CANADIAN AND UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
                    (continued)**
  Amortization
          of certain other assets is being provided for on the straight-line basis
          as
          noted below:
   Asset Classification
                Useful
                    LifeDeferred development costs - products
                  available for sale
                5
                    yearsIncorporation expenses
                10
                    years
  Deferred
          development costs relate to the development of the products, all of which
          were
          available for sale by the end of 2005. The
          Company continues to invest in research necessary to expand its products’
revenues. In 2005, the Company incurred manufacturing development costs
          associated with the development of its NeoVisc high molecular weight product.
          These costs are amortized as deferred manufacturing development costs for
          Canadian GAAP purposes but under United States GAAP they cannot be capitalized.
          Amortization in regards to these development costs starts once the product
          is
          ready for sale in the market.
  **1****8.**
                **RECENT
                    ACCOUNTING PRONOUNCEMENTS**
  Recent
          accounting pronouncements followed by the Company under U.S. GAAP are summarized
          below.
 
 (a)
                SFAS
                    No. 123(R).
                    SFAS No. 123(R), Share-Based Payment, issued in December 2004,
                    is a
                    revision of FASB Statement 123, Accounting for Stock-Based Compensation
                    and supersedes APB Opinion No. 25, Accounting for Stock Issued
                    to
                    Employees, and its related implementation guidance. The Statement
                    focuses
                    primarily on accounting for transactions which an entity obtains
                    employee
                    services in share-based payment transactions. SFAS No. 123 (Revised
                    2004)
                    requires a public entity to measure the cost of employee services
                    received
                    in exchange for an award of equity instruments based on the grant-date
                    fair value of the award. That cost will be recognized over the
                    period
                    during which an employee is required to provide service in exchange
                    for
                    the award. Effective January 1, 2003, the Company adopted the
                    statement to
                    account for its employee stock options under the fair market
                    value method.
                    See Note 8 - Capital Stock.
 
 (b)
                SFAS
                    No. 151.
                    SFAS No. 151, “Inventory Costs,” an amendment to Accounting Research
                    Bulletin No. 43, Inventory Pricing, to clarify the accounting
                    for abnormal
                    amounts of idle facility expense, freight, handling costs and
                    wasted
                    material. This Statement requires that those items be recognized
                    as
                    current-period charges regardless of
                    whether
                      they meet the criterion of “so normal.” Additionally, this Statement
                      requires that allocation of fixed production overheads to the
                      costs of
                      conversion be based on the normal capacity of the production
                      facilities.
                      The provisions of SFAS No. 151 will become effective for fiscal
                      years
                      beginning after June 15, 2005. For fiscal years 2005 and 2004,
                      the Company
                      has not determined the impact of adopting this
                      standard.
  Page
              23
  **STELLAR
          PHARMACEUTICALS INC.**
  **(Formerly
          Stellar International Inc.)**
  **NOTES
          TO FINANCIAL STATEMENTS**
  **(Canadian
          Funds)**
  **DECEMBER
          31, 2005**
  **1****8.**
                  **RECENT
                      ACCOUNTING PRONOUNCEMENTS
                      (continued)**
  (c)
                SFAS
                    No. 153.SFAS No. 153, “Exchanges of Nonmonetary Assets,” an amendment to
                    Accounting Principles Board Opinion No. 29. “Accounting for Nonmonetary
                    Transactions,” is based on the principle that exchanges of nonmonetary
                    assets should be measured based on the fair value of the assets
                    exchanged.
                    The guidance in that Opinion, however, included certain exceptions
                    to that
                    principle. This Statement amends Opinion 29 to eliminate the
                    exception for
                    nonmonetary exchanges of similar productive assets and replaces
                    it with a
                    general exception for exchanges in which the future cash flows
                    of the
                    entity are not expected to change significantly as a result of
                    the
                    exchange. The provisions of SFAS No. 153 will become effective
                    for
                    nonmonetary asset exchanges in fiscal periods beginning after
                    June 15,
                    2005. For fiscal years 2005 and 2004, the Company has not determined
                    the
                    impact of adopting this standard.
  **19****.**
                    **SUBSEQUENT
                        EVENTS**
 On
          March 27, 2006 Leitner Pharmaceuticals, LLC has relinquished their license
          rights for NeoVisc and Uracyst to Stellar.
  **20****.**
                **COMPARATIVE
                    FIGURES**
  Certain
          comparative figures have been reclassified to conform to the current year's
          presentation.




**MANAGEMENT'S
      DISCUSSION AND ANALYSIS**




This
      document was prepared on March 27, 2006 and should be read in conjunction with
      the December 31, 2005 financial statements of the Company.




**FORWARD-LOOKING
      STATEMENTS**




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




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




**OVERVIEW**




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




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


(i) NeoVisc®,
      for the treatment of osteoarthritis;


(ii) Uracyst®;
      for the treatment of IC, and;


(iii) Uracyst®
      Test Kit, Stellar’s patented technology for the diagnosis of IC.




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


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


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




Stellar
      began selling Skelite to the Canadian market in February 2004 and NMP22
      BladderChek in Canada, in October 2004. NMP22 BladderChek has had a small impact
      on 2005 sales but is expected to play a larger part in the sales mix going
      forward.




Effective
      December 2001, Stellar entered into a strategic licensing agreement with G.
      Pohl-Boskamp GmbH & Co. ("Pohl-Boskamp") for the sale of Uracyst products in
      Europe. In December of 2003, Pohl-Boskamp received approval to begin selling
      Uracyst in Europe. Stellar is pleased to report that Pohl-Boskamp continues
      to
      make excellent sales progress in the European markets in which it currently
      sells Uracyst (Germany, Netherlands, Austria, UK and Scandinavian countries).





-1-




In
      June
      2003, Stellar entered into distribution agreements with CMI Canada Medical
      Inc.
      and BurnsAdler Pharmaceuticals to sell Stellar’s products in the Middle East,
      Latin America and the Caribbean. Subsequently the distribution agreement with
      CMI was terminated due to performance issues. This allowed Stellar to move
      forward with other distribution agreements in this area as described
      below.




In
      March
      2004, Supply and License Agreements were signed with Leitner Pharmaceuticals,
      LLC (formerly SJ Pharmaceuticals, Inc.) of Bristol, Tennessee for NeoVisc and
      Uracyst in the United States markets. Leitner has since returned these licensed
      rights to Stellar so that the Company may pursue agreements with companies
      that
      have a stronger focus in these niche markets.




In
      June
      2004, Stellar entered into a NeoVisc licensing agreement with Triptibumis Sdn.
      Bhd. for Malaysia, Singapore and Brunei. The first shipment to this market
      was
      initiated in October 2004. Although a smaller market, this agreement adds to
      Stellar’s global expansion.





An
      additional licensing agreement for NeoVisc was signed with Pharmore GmbH in
      August 2004 for NeoVisc in the German market. In July 2005, Stellar agreed
      to
      release Pharmore from this licensing agreement due to a significant change
      in
      Pharmore’s business environment. Pharmore agreed to pay a portion of the costs
      to continue the registration process in Germany and Stellar expects to have
      a
      German registration and a CE mark in early 2006. The CE mark is expected to
      allow NeoVisc to quickly enter other European markets.





In
      June
      2005, Stellar entered into an exclusive licensing agreement with INNOGEN İ LAÇ
SAN.
      T İ C.
      LTD .
      ŞTİ .
      ("Innogen") for the sale of NeoVisc in Turkey. Sales of NeoVisc will not
      commence until Innogen is in receipt of all required approvals from Turkish
      authorities. Stellar believes that sales of NeoVisc in Turkey should commence
      in
      late 2006, with Stellar recognizing revenues from such sales in the fourth
      quarter of 2006. Viscosupplementation therapy is well established in Turkey,
      representing a market value in excess of US $12,000,000 per year.




In
      August
      2005, Stellar
      signed a Licensing Agreement with TECHNIMED of Anteljas, Lebanon in respect
      of
      the distribution
      and sale of NeoVisc in Lebanon.




In
      September 2005, the Company entered into a licensing agreement with Shanghai
      Ya
      Jun Medical for the sale of Uracyst in China. Stellar also entered into a
      licensing agreement with Mega Pharm for the sale of Uracyst in Israel in
      December 2005.




In November
      2005, the Company signed a distribution agreement with Al-Mohab Co. (“Al-Mohab”)
      for the sale of NeoVisc® in Kuwait.




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




**FOURTH
      QUARTER 2005 HIGHLIGHTS**




Revenues
      for the three month period ended December 31, 2005, from all sources increased
      4.7% to $522,823 compared to $499,192 in the same period during 2004. This
      growth was negatively impacted by a NeoVisc batch recall in the 4th quarter.
      In
      November of 2005, the Company experienced higher than normal reports of side
      effects with a NeoVisc batch. Since the process being used was relatively new,
      the Company chose to react on the side of caution and withdrew this batch from
      sale. This was a costly step in the short term but Stellar believed the right
      step to maintain the Company’s excellent track record and reputation in the
      market. This batch was thoroughly reviewed by the Company’s quality management
      team and was found to be within specifications for all control factors. The
      Company is continuing its review of this batch. A new batch of NeoVisc was
      released for sale in mid-December 2005 and has not experienced any abnormal
      responses. The result of this incident dramatically depressed NeoVisc sales
      in
      the fourth quarter showing a decrease in sales in the Canadian market of 9.1%
      over the previous year. Furthermore, total revenue from product sales for the
      quarter was only up 2.9% compared to growth of 31.5% in the previous quarter
      due
      mainly to the NeoVisc recall in November. International NeoVisc sales, which
      were not impacted by this recall, increased 320.9% over the same quarter in
      2004
      driven by orders from newly licensed markets.





-2-




Uracyst
      sales grew by 10.9% for the quarter as the Canadian marketing focus on Uracyst
      has shown good results with Canadian sales growth of 7.1% for the quarter.
      Pohl-Boskamp, Stellar’s European licensee, continues to grow Uracyst sales in
      the European market and this growth is expected to accelerate with UK sales
      activity finally in place.





During
      this quarter, business development activities continue to focus on negotiations
      for in-licensing and out-licensing opportunities. In December 2005, Stellar
      entered into a licensing agreement with Mega Pharm for the sale of Uracyst
      in
      Israel and worked on an agreement with Al-Mohab Co. for the sale of NeoVisc
      in
      Kuwait (this agreement was signed in January 2006).  It
      is
      important to note the Company continues to experience costs associated with
      such
      negotiations for licensing agreements, with little off-setting revenues to
      date.
      Stellar expects an inflow of revenue from many of these agreements with initial
      revenues recorded in 2005 and building in 2006.




**RESULTS
      OF OPERATIONS FOR THE TWELVE MONTH PERIOD ENDED DECEMBER 31,
      2005**




For
      the
      year ended December 31, 2005, total revenues from all sources increased 6.0%
      to
      $1,942,251 compared to $1,832,325 in the same period during 2004. When revenue
      for 2004 is adjusted for a one-time licensing fee of $267,220 the revenue growth
      for 2005 is 24.1%. This growth was negatively impacted by the NeoVisc batch
      recall as discussed above in the above review of the fourth quarter highlights.
      However, NeoVisc sales for the 12 month period ended Dec 31, 2005 still grew
      by
      16.2 % compared to the same period for 2004.




In
      2005,
      Uracyst revenue grew by 48.9% over 2004 due mainly to expanding sales in Europe.
      Canadian sales have returned to positive numbers in the later part of 2005,
      in
      Canada, due to a more focused marketing effort and this trend is expected to
      continue into 2006.




BladderChek
      sales growth remains as The Company continues to work on in-market reimbursement
      issues. Strong clinical support out of the United States and growing physician
      support in Canada is expected to help turn this trend around in
      2006.




Gross
      profit for 2005 was up 8.8% to $1,332,270 compared to $1,224,982 (with a
      $267,220 one time license payment deduction) for 2004.




The
      Company’s operating loss increased to $1,840,187 in 2005 as compared to
      $1,708,446, (when adjusted for a $267,220 one time license
      payment deduction) for 2004.




During
      2005, the Company incurred non-cash expenses totaling $257,279, of which
      $204,303 were for share options issued to consultants; this cost has been
      expensed to consulting fees in the period. The balance of $52,976 was related
      to
      share options granted to the Company’s directors and has been expensed to
      compensation. Stellar also incurred non-recurring costs of $159,390, which
      includes $22,516 for obsolete materials and $13,722 for expired product, which
      were recorded as write-down of obsolete inventory, respectively. The balance
      of
      these expenditures was related to the NeoVisc recall and was recorded as Other
      Product Costs on the statements.




Contributing
      to the increased costs were: R&D expenses of $608,957 for development work
      which includes $58,486 for Uracyst trials which started in May 2005;
      non-recurring cost of administrative fees of $7,975 associated with the
      Company’s name change and consulting fees of $145,190. Amortization cost
      increased in 2005 by $56,242, which is associated with manufacturing, computer
      systems and building improvements.




**Cost
      of Sales**




Cost of goods sold for the twelve month period ended December
      31, 2005, was $450,591(without the affect of the 159,390 for other products
      cost
      right-down) or 27.7% of product sales compared to $340,123 or 23.9% of
      product sales in 2004. During the fourth quarter of 2005, the cost of sales
      was
      negatively affected by the NeoVisc recall. Continued improvements in the
      manufacturing process have caused a marginal increase in the cost of goods
      sold
      and going forward the Company expects to see benefits from these processes
      in
      2006.





-3-




**Research
      and Development**




Stellar
      continues to invest in research, which is essential to advancing the use of
      its
      products in Canada and in international markets. In the twelve month period
      ended December 31, 2005, the Company incurred $608,957, in research costs
      compared to $659,759 in 2004.




During
      2005, the Company incurred costs of $550,471 primarily on the continued
      development of manufacturing processes focused on the production of high
      molecular weight NeoVisc. Expenditures incurred over the last two years on
      process development are expected to improve Stellar’s competitiveness in the
      global viscosupplement market. In the first quarter of 2005, Stellar began
      the
      process of implementing an open-label, community-based, clinical trial for
      Uracyst, which will assist Stellar in demonstrating the effectiveness of Uracyst
      to physicians in the treatment of GAG deficient cystitis, such as IC. To date,
      Stellar has spent $51,235 in developing this trial, which is being conducted
      by
      Queen’s University.




**Business
      Development**




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




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




**Selling,
      General and Administrative expenses**




Selling,
      general and administrative expenses for the year
      ended December 31, 2005 were $2,418,918, compared to $2,185,329 for the same
      period in 2004. This increase includes the cost of $257,279 related to non-cash
      expenses for options to acquire common shares ("Common Shares") in the capital
      of the Company issued to consultants and the directors of the Company. In
      addition, the Company had non-recurring costs of $153,160 related to consulting
      agreements, as well as legal costs associated to the Company’s name change.
      During this period, the Company incurred fee expenses to members of the board
      of
      directors, which totaled $42,666.




The
      Company’s ongoing commitment to increase sales and marketing activity in order
      to improve in-market sales has resulted in direct selling costs and marketing
      costs increasing by $36,922 over the same period in 2004. These expenditures
      were in furtherance of the Company’s growth and are expected to aid Stellar
      considerably in attaining its long-term goals.




**INTEREST
      AND** **OTHER
      INCOME**




Interest and
      other
      income for the year ended December 31, 2005 was $99,689 as compared to $96,117
      during the same period in 2004. This amount includes the investment of
      dividends; interest received on a short-term loan and the gain on a sale of
      short term investments. Cash will be maintained in liquid
      investments.





-4-




**SUMMARY
      OF QUARTERLY RESULTS**





**Quarter
                Ended**
            **Revenues**
            **Net
                loss**
            **Loss
                per share**December
                31, 2005
            522,823
            (486,385)
            (0.02)September
                30,
                2005
            497,789
            (453,165)
            (0.02)June
                30, 2005
            496,341
            (347,312)
            (0.02)March
                31, 2005
            425,298
            (454,655)
            (0.02)December
                31, 2004
            499,192
            (374,488)
            (0.02)September
                30, 2004
            378,441
            (564,487)
            (0.03)June
                30, 2004
            393,532
            (372,427)
            (0.01)March
                31, 2004
            561,160
            (33,707)
            (0.002)




**SELECTED
      FINANCIAL RESULTS AND HIGHLIGHTS**




A
      discussion of the reasons behind the variations in the following numbers can
      be
      found under the heading “Results of Operations for the Twelve Month Period Ended
      December 31, 2005”.




**Income
                  Statement for the year ended**
              
              **2005**
              
              **2004**
              
              **2003**Total
                  Revenue
              
              $
              1,942,251
              
              $
              1,832,325
              
              $
              1,109,431Cost
                  of Goods Sold
              
              
              450,591
              
              
              340,123
              
              
              216,609Other
                  Costs
              
              
              159,390
              
              
              -Expenses
              
              
              3,027,875
              
              
              2,845,088
              
              
              1,623,920Loss
                  before interest, amortization
              
              
              
              
              
              
              
              
              (731,098)and
                  other income/expense
              
              
              (1,695,605)
              
              
              (1,352,886)Net
                  loss(1)
              
              $
              (1,740,498
              )
              $
              (1,345,109
              )
              $
              (803,801
              )-
                  basic
              
              
              (0.08)
              
              
              0.06
              
              
              (0.05)-
                  fully diluted
              
              
              n/a
              
              
              n/a
              
              
              n/a




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




**Balance
                Sheet as at**
            
            **Dec.
                31, 2005**
            
            **Dec.
                31, 2004**
            
            **Dec.
                31, 2003**Cash
                and cash equivalents
            
            $
            2,108,755
            
            $
            3,172,870
            
            $
            255,237Total
                assets
            
            
            3,713,541
            
            
            4,815,384
            
            
            899,735Total
                liabilities
            
            
            653,755
            
            
            596,447
            
            
            540,012Cash
                Dividend declared per share
            
            
            -
            
            
            -
            
            
            -Shareholders’
                Equity-
                options and warrants
            
            
            643,938
            
            
            441,975
            
            
            307,208-
                capital stock
            
            
            8,100,253
            
            
            7,720,873
            
            
            2,651,317-
                deficit
            
            
            (5,684,405
            )
            
            (3,943,911
            )
            
            (2,598,802
            )Total
                Liabilities and shareholders equity
            
            $
            3,713,541
            
            $
            4,815,384
            
            $
            899,735




**LIQUIDITY
      AND CAPITAL RESOURCES**




Cash,
        cash equivalents and short-term investments totaled $2,108,755 at December
        31,
        2005 as compared with $3,172,870 at December 31, 2004. During the year ended
        December 31, 2005, the Company received aggregate proceeds of $324,064 in
        respect of 667,817 Common Shares issued upon the exercise of previously granted
        options.





-5-




At
      December 31, 2005, the Company did not have any outstanding
      indebtedness.




In
      June
      2004, the Company entered into an agreement to acquire land and a building
      for
      $450,000, and the purchase was financed from its available cash resources.
      The
      Company moved into the upper office area of the building on October 22, 2004.
      Renovations to the building have totaled $176,759. The Company has delayed
      incurring expenses in relation to the start up the packaging plant area until
      the demand for Stellar’s products in international markets increases and
      requires this investment.




While
      the
      Company has generated royalty revenue and revenue from the distribution of
      pharmaceutical products in Canada, this revenue has been insufficient to fund
      the Company’s research, development and marketing activities. The Company
      continued to incur losses in 2005 and drew from its holdings of cash, cash
      equivalents and short-term investments; however, the Company expects to reach
      a
      profitable status by the end of 2006, thereby funding its future growth from
      the
      sale of its products, from milestone payments and from the royalty income
      resulting from out-licensing agreements for at least the next 24
      months.




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




**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 (SPE), 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 on December 10,
      2004,
      with LMT Financial Inc. ( "LMT")
      (a
      company beneficially owned by a director and his spouse) for services to be
      provided in 2005. Compensation under the agreement is $6,000 per month or $
      72,000 for fiscal 2005. Pursuant to this agreement LMT, assisted the Company
      in
      assessing available methods of financing the operations of the Company and
      the
      impact on the market for Common Shares in the United States created by
      developments in Stellar’s business.




**CAPITAL
      STOCK**




The
      Company has authorized an unlimited number of Common Shares, without par value.
      There are no other classes of shares. During the year ended December 31, 2005,
      the Company issued for cash 667,817 Common Shares to employees, directors,
      and
      consultants, who exercised stock options, with an approximate average price
      per
      share of $0.49. As of t he
      date
      of this report, the Company had 23,470,190 Common Shares
      outstanding.




As
      of the
      date of this report, the Company had 1,540,000 Common Share options outstanding
      at various exercise prices and expiry dates.





-6-




**SIGNIFICANT
      CUSTOMERS**




During 2005,
      the
      Company had one significant customer, a national wholesaler, which represented
      34.4% of sales, in comparison to 38.3% in the same period for 2004.




**OUTLOOK**




As
      at
      March 27, 2006, the Company is debt free and had working capital of $1,782,521.
      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
      24
      months.




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




**RISKS
      AND UNCERTAINTIES**




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





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





-7-




**SUBSEQUENT
      EVENT**




On
      March
      27, 2006 the Company was informed by Leitner Pharmaceuticals, LLC that it would
      relinquish their rights under the March 24, 2004 Licence Agreements. This will
      now allow Stellar to pursue Agreements with companies that have a stronger
      focus
      in these niche markets.






**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.




- 8 -













**REPORT
      OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS**




To
      the
      Stockholders of




Stellar
      Pharmaceuticals Inc. (Formerly Stellar International Inc.)






We
      have
      audited the accompanying balance sheets of Stellar Pharmaceuticals Inc.
      (Formerly Stellar International Inc.) as of December 31, 2005 and December
      31,
      2004, and the related statements of operations, shareholders’ equity, and cash
      flows for each of the years ended December 31, 2005 and December 31, 2004.
      These
      financial statements are the responsibility of the company’s management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audits.




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




In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of Stellar Pharmaceuticals Inc.
      (Formerly Stellar International Inc.) as of December 31, 2005 and December
      31,
      2004, and the results of its operations and its cash flows for each of the
      years
      ended December 31, 2005 and December 31, 2004 in conformity with accounting
      principles generally accepted in the United States of America.






Toronto, Ontario
            /S/ MINTZ & PARTNERS
              LLPMarch 23, 2006, except for Note 19 as
              to which
            CHARTERED ACCOUNTANTSthe date is March 27, 2006