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STELLAR INTERNATIONAL INC. 

FINANCIAL STATEMENTS (Canadian Funds)
DECEMBER 31, 2003 

**STELLAR INTERNATIONAL INC. 

DECEMBER 31, 2003 

CONTENTS** PAGE  **INDEPENDENT AUDITORS' REPORT**I  **FINANCIAL STATEMENTS**            Balance SheetII           Statement of Shareholders' EquityIII           Statement of OperationsIV           Statement of Cash FlowsV           Notes to Financial StatementsVI - XIX

PAGE 1**INDEPENDENT AUDITORS' REPORT**
To the Board of Directors and Shareholders of **STELLAR INTERNATIONAL INC.**

We have audited the balance sheet of **STELLAR INTERNATIONALINC.** as at December 31, 2003 and the statements of shareholders' equity,operations and cash flows for each of the two years ended December 31, 2003 and2002. These financial statements are the responsibility of the company'smanagement. Our responsibility is to express an opinion on these financialstatements based on our audit. 

We conducted our audit in accordance with auditing standardsgenerally accepted in the United States of America. Those standards require thatwe plan and perform an audit to obtain reasonable assurance whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudit provides a reasonable basis for our opinion. 

In our opinion, these financial statements present fairly, in all materialrespects, the financial position of the company as at December 31, 2003 and theresults of its operations and its cash flows for each of the two years endedDecember 31, 2003 and 2002 in conformity with accounting principles generallyaccepted in the United States of America. 

As discussed in Note 2(g), the Company changed its method of accounting forstock-based compensation in 2003. 

We also have reported separately on the financial statements of StellarInternational Inc. for the same period presented in accordance with accountingprinciples generally accepted in Canada. 
**KRAFT, BERGER,    GRILL, SCHWARTZ, COHEN & MARCH LLP****Chartered    Accountants** Toronto, OntarioFebruary 12, 2004,    except as to Note 12 which is as of February 23, 2004 

PAGE 2**STELLAR INTERNATIONAL INC.****BALANCE SHEET****(Canadian Funds)**     **DECEMBER 31, 2003****ASSETS****CURRENT**              Cash and cash equivalents $255,237          Accounts receivable (net of allowance of $366) 43,098          Investment tax credits receivable (Note 3)  117,708          Inventories (Note 4)  128,937          Deposits and sundry receivable  62,949    607,929     **PLANT AND      EQUIPMENT** (Note 5)  288,880**OTHER** (Note 6)  2,926        $899,735**LIABILITIES**CURRENT**              Accounts payable             Accrued liabilities             Deferred revenue       540,012**CONTINGENCIES AND      COMMITMENTS** (Note 10)       **SHAREHOLDERS' EQUITY**CAPITAL STOCK**      (Note 7)           AUTHORIZED   UnlimitedNon-voting,      convertible, redeemable and retractable Class "A"         preferred shares   UnlimitedNon-voting,      convertible, redeemable and retractable preferred         shares   Unlimited      Common shares         ISSUED             16,350,412      Common shares  2,624,239         88,750      Common shares to be issued  27,078
Paid-in capital options and warrants-      outstanding 239,945  -      expired 67,263    2,958,525     **DEFICIT**   (2,598,802)    359,723   $899,735   See      accompanying notes to financial statements.     **APPROVED ON BEHALF      OF THE BOARD:**       ./s/ Peter Riehl./s/ Steve Goldman  Director Director 

PAGE 3**STELLAR INTERNATIONAL INC.****STATEMENT OF SHAREHOLDERS'      EQUITY****(Canadian      Funds)****FOR THE YEAR      ENDED DECEMBER 31, 2003**       **Number of**     **Common****Common****Paid in Capital      Options**  **Shares****Shares****Outstanding****Expired****Deficit**  **$****$****$****$****BALANCE**,      beginning of year14,261,5772,051,50393,263-(999,825)      Options issued to consultants--41,300--      Options expired--(67,263)67,263-Net      loss for the year----(795,176)      **BALANCE**, December 31, 200214,261,5772,051,50367,30067,263(1,795,001)            Shares issued for cash1,431,335372,728---      Shares issued for services657,500189,724---      Options issued to consultants--95,470--      Options exercised-4,784(4,784)--      Options issued to employees--54,426--      Warrants issued to investors--33,033--      Warrants exercised-5,500(5,500)--Net      loss for the year----(803,801)      **BALANCE,** December 31, 200316,350,4122,624,239239,94567,263(2,598,802)      See accompanying notes to      financial statements. 

PAGE 4**STELLAR INTERNATIONAL INC.****STATEMENT OF OPERATIONS****(Canadian      Funds)****FOR THE YEAR      ENDED DECEMBER 31, 2003**         **2003** **2002**      **REVENUE** $1,109,431$854,705      **COST OF GOODS SOLD**  216,609 177,651      **GROSS PROFIT**  892,822 677,054      **EXPENSES**               Selling, general and administrative 1,523,814 1,187,038          Research and development  100,106 271,201          Amortization  76,822 31,154   1,700,742 1,489,393      **LOSS****FROM      OPERATIONS** (807,920) (812,339)          Investment income  4,119 17,163      **NET LOSS FOR      THE YEAR**$(803,801)$(795,176)      **NET LOSS PER      SHARE**      (Note 8)              Basic and diluted $(0.05)$(0.06)      **WEIGHTED      AVERAGE NUMBER OF COMMON SHARES**    **      OUTSTANDING**                Basic and diluted  15,067,036 14,261,577      See      accompanying notes to financial statements.    

PAGE 5**STELLAR INTERNATIONAL INC.****STATEMENT OF CASH FLOWS****(Canadian Funds)****FOR THE YEAR ENDED      DECEMBER 31, 2003**      **2003****2002**    **OPERATING ACTIVITIES**             Net loss for the year $(803,801)$(795,176)          Amortization 76,82231,154          Issuance of options and warrants for services rendered 320,49841,300  (406,481)(722,722)       Change in non-cash components of working capital             (Increase) decrease in accounts receivable (16,624)332,994          Increase in investment tax credits receivable (117,708)-          Increase in inventories (57,565)(11,104)         (Increase) decrease in deposits and sundry receivable (1,473)6,684          Increase in accounts payable 24,67748,089          Increase in deferred revenue 299,846-  131,153376,663  (275,328)(346,059)    **INVESTING ACTIVITY**             Purchase of property and equipment (64,663)(306,082)    **FINANCING ACTIVITY**             Issuance of capital stock 405,760-    **CHANGE IN CASH AND CASH EQUIVALENTS** 65,769(652,141)**CASH AND CASH EQUIVALENTS,**beginning of year 189,468841,609**CASH AND CASH EQUIVALENTS,**end of year $255,237$189,468    **SUPPLEMENTARY DISCLOSURE OF NON-CASH FINANCING**   **          ACTIVITIES**             Issuance of options and warrants for services rendered $320,498$41,300    See accompanying      notes to financial statements.   

PAGE 6**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 
**1.**      DESCRIPTION OF BUSINESS**
Stellar International Inc. ("Stellar" or "Company") is a  Canadian pharmaceutical company involved in the development and marketing of  high quality, cost-effective, polysaccharide-based therapeutic products used  in a treatment of osteoarthritis and certain types of cystitis. 

Stellar also intends to develop additional healthcare products aimed at  niche pharmaceutical markets. 
**2.**      SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**
These financial statements have been prepared in accordance  with accounting principles generally accepted in United States of America. On  February 12, 2004, we reported on the financial statements for the same period  prepared in accordance with Canadian generally accepted accounting principles.  
**(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. Substantially, all cash and cash    equivalents are under the custodianship of one major Canadian institution.    
**(b)      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 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 agreement is    recognized when the milestone is achieved. Up-front fees and other amounts    received in excess of revenue recognized are recorded as deferred revenue.    
**(c)      Inventories**
Inventories are valued at the lower of cost and net realizable value,    determined on a first-in, first-out basis. 

PAGE 7**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 
**2.**     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

**(d)      Plant and Equipment**
Plant and equipment are stated at cost. Amortization is    being provided for on a straight-line basis over a five-year estimated    useful life of the assets. The Company periodically compares the carrying    value of plant and equipment to their net realizable value and charges    income with any impairment to net assets. 
**(e)     Other Assets**
Amortization of patents is being provided for on the straight-line basis    over 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. 
**(f)      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 the difference between the accounting values of assets and liabilities    and their related tax bases using current income tax rates. 
**(g)     Stock-based Compensation**
Effective January 1, 2003, the Company changed its method    of accounting for stock-based compensation and decided to adopt the fair    value based method of accounting for all its stock-based compensation. The    Company adopted these changes using the prospective method in accordance    with Financial Accounting Standards Board ("FASB") Statement of Financial    Accounting Standards No. 148. Accordingly, the fair value based method is    applied to awards granted, modified or settled on or after January 1, 2003.    Prior to the adoption of the fair value based method, the Company as    permitted by Accounting Principles Board Opinion No. 25, had chosen to    continue its existing policy of recording no compensation cost on the grant    of stock options to employees. 

The compensation cost charged against income for this plan was $54,426    for the year ended December 31, 2003. The counterpart has been recorded as    additional paid-in capital. 

PAGE 8**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 

2.       SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES (Continued) 

(g)      Stock-based Compensation (Continued) 

The compensation cost was calculated using the Numa option pricing model    with the following assumptions: 
      Weighted-average grant date fair value of options$0.11      Assumptions:        Risk-free interest rate 6%      Dividend yield -0-      Expected volatility 35%      Expected life 3 years
When employees exercise their stock options, the capital    stock is credited by the sum of the consideration paid by employees together    with the related portion previously credited to additional paid-in capital    when compensation costs were charged against income. The prospective method    omits the effects of awards granted, modified or settled before January 1,    2003. 
**(h)     Foreign Currency Translation**
Monetary assets and liabilities are translated into    Canadian dollars 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 into    income. There were no significant foreign exchange gains or losses in 2003    and 2002. 
**(i)      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. 
**(j)      Concentration Risk**
Majority of the Company's cash and cash equivalents are    with one major Canadian banking institution. Deposits held with this bank    may exceed the amount of insurance provided on such deposits. Generally,    these deposits may be redeemed upon demand and, therefore, bear minimum    risk. 

PAGE 9**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 
**2.       SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES (Continued) 

(k)     Currency Risk 

The Company is subject to currency risk through its activities in the    United States of America. Unfavourable 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, dependent 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,    2003. 
**(l)      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 the    short-term maturity of these items. 
**(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 years ended December 31, 2003 and 2002, comprehensive    income was the same as net earnings. 
**(n)     Research and Development**
Research and development costs are expended as incurred. Approved    investment tax credits are netted against the related expenses. 
**(o)     Computations of Earnings (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 (loss) per common share are computed    using the weighted average number of common and dilutive common equivalent    shares outstanding during the year. Dilutive common equivalent shares    consist of shares issuable upon exercise of stock options and warrants and    conversion of preferred stock. For the years ended December 31, 2003 and    2002, common equivalent shares had no dilutive effect on earnings (loss) per    share. 

PAGE 10**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 
**2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 

(p)     Recent Accounting Pronouncements 

Under Staff Accounting Bulletin 74, the Company is    required to disclose certain information related to new accounting standards    which had not yet been adopted due to delayed effective dates. 
**- Statement of Financial Accounting Standard No. 146 (SFAS 146)**
In July 2002, the FASB issued SFAS 146, which addresses      significant issues regarding the recognition, measurement, and reporting      of costs that are associated with exit and disposal activities, including      restructuring activities that are currently accounted for pursuant to the      guidance that the Emerging Issues Task force ("EITF") has set forth in      EITF Issue No. 94-3, "Liability Recognition for Certain Employee      Termination Benefits and Other Costs to Exit an Activity (Including      Certain Costs Incurred in a Restructuring)." SFAS 146 revises the      accounting for certain lease termination costs and employee termination      benefits, which are generally recognized in connection with restructuring      activities. The adoption of this Statement did not have a material effect      on the Company's financial statements. 
**- Statement of Financial Accounting Standard No. 148 (SFAS 148)**
In December 2002, the FASB issued SFAS No. 148,      "Accounting for Stock-Based Compensation - Transition and Disclosure".      SFAS No. 148 amends the transition and disclosure provisions of SFAS No.      123. The Company adopted SFAS 148 and accounted for the Employee stock      options using the fair value method effective January 1, 2003 on the      prospective basis. 
**- Statement of Financial Accounting Standard No. 149 (SFAS 149)**
SFAS No. 149, "Amendment of Statement 133 on Derivative      Instruments and Hedging Activities," was issued in April 2003 to amend and      clarify accounting for hedging activities and derivative instruments,      including certain derivative instruments embedded in other contracts. The      statement is effective for contracts entered into or modified after      September 30, 2003. The Company did not enter into any derivative      instruments and hedging activities during the year. 

PAGE 11**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 
**2.**     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**
- FASB      Interpretation No. 45 (FIN 45)  
In November 2002, the FASB issued FIN 45, which expands      previously issued accounting guidance and disclosure requirements for      certain guarantees. FIN 45 requires the Company to recognize an initial      liability for the fair value of an obligation assumed by issuing a      guarantee. The provision for initial recognition and measurement of the      liability will be applied on a prospective basis to guarantees issued or      modified after December 31, 2002. The adoption of FIN 45 did not have a      material effect on the Company's financial statements. 
**- FASB Interpretation No. 46 (FIN 46)**
In January 2003, FASB issued FIN 46, "Consolidation of      Variable Interest Entities" which requires the consolidation of variable      interest entities, as defined. FIN 46 is applicable to financial      statements to be issued by the Company after 2002, however, disclosures      are required currently if the Company expects to consolidate any variable      interest entities. The adoption of FIN 46 did not have a material effect      on the Company's financial statements. 
 - Statement of Financial Accounting Standard No. 150 (SFAS 150) 
 
SFAS No. 150, "Accounting for Certain Financial      Instruments with Characteristics of both Liabilities and Equity," was      issued in May 2003. It establishes standards for classifying and measuring      certain financial instruments with characteristics of both debt and      equity. It requires many financial instruments previously classified as      equity to be reclassified as liabilities and is generally effective for      financial instruments entered into or modified after May 31, 2003 and      otherwise at the beginning of the first interim period beginning after      June 15, 2003. The adoption of SFAS 150 did not have a material effect on      the Company's financial statements. 
 
(q)      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. 
**3.**      INVESTMENT TAX CREDITS RECEIVABLEAND MEASUREMENT UNCERTAINTY**
Investment tax credits are earned in connection with research and  development activities. The receivable balance of the recognized portion is  $117,708. 

PAGE 12**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 

The research and development claim for 2001 has been accepted as filed and  the amount approved by the tax authorities has been recorded as a credit to  related expenses. 

The unrecorded research and development claims for 2002 and  2003 will be filed in due course. The extent of the overall claim is dependent  upon the qualification of each individual project under strict technical  criteria, and amounts may vary upon review of Canada Revenue Agency.  Adjustments to the claim, if any, will be accounted for in the year of  assessment. 
**4.**     INVENTORIES**  **2003** **2002**Raw      material$1,178$3,068      Finished goods 105,332 46,151      Packaging material 22,427 22,153      $128,937$71,372**5.**     PLANT AND EQUIPMENT**    **2003****2002**   **Accumulated**    **Cost****Amortization****Net****Net**              Equipment $  414,491        $  125,611        $  288,880$  300,651
 
**6.**      OTHER ASSETS**       **2003****2002**    **Accumulated**    **Cost****Amortization****Net****Net**      Patents $  3,884  $  959$  2,925$  3,313      Goodwill 1 -11  $  3,885  $  959$  2,926$  3,314

PAGE 13**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 
**7.**     CAPITAL STOCK**

**(a)      Common Shares** **Number of****$** **Shares****Amount**      Balance, December 31, 200214,261,5772,051,503      Issued for cash consideration1,431,335379,012      Issued for consulting services657,500193,724      Balance, December 31, 200316,350,4122,624,239**(b)     Shares to be Issued 

These represent 88,750 common shares to be issued for consulting services    rendered to the Company at prices ranging from $0.26 to $0.33 per share,    totaling $27,078. 
**(c)      Paid-in Capital Options and Warrants**
The changes to the paid-in capital options and warrants are as follows:    
         Balance, December 31, 2002$67,300      Options issued to consultants 95,470      Options issued to employees 54,426      Warrants issued in connection with private placement 33,033      Options exercised (4,784)      Warrants exercised (5,500)      Balance, December 31, 2003$239,945**(d)        Warrants** **Number of** **Exercise** **Shares** **Price**      Balance, December 31, 2002-$-      Issued to private placement investors660,667 0.35 to 0.45      Exercised(110,000) 0.35      Balance, December 31, 2003550,667$0.45
The warrants are exercisable at $0.35 per share in the first year and    $0.45 per share in the second year, and will expire at the end of the second    year. 

PAGE 14**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 

7.**    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, 2003,    the maximum number of common shares that may be issued under the Plan was    2,852,000. 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, the Company issued 480,000 options to    employees, officers and directors. Each option entitles the holder to    purchase one common share of the Company for price ranging from $0.27 to    $0.75 per share at any time and from time to time until December 17, 2006.    Compensation expense amounting to $54,426 has been recognized based on the    fair value of the options granted. The Company also issued 605,000 options    to four consultants. Each option entitles the holder to purchase one common    share of the Company for price ranging from $0.40 to $0.75 per share at any    time and from time to time until November 19, 2006. Consulting expense    amounting to $49,270 has been recognized based on the fair value of the    options issued in the year the services were rendered. 

In 2002, the Company issued 300,000 options to employees,    officers and directors. Each option entitles the holder to purchase one    common share of the Company for price ranging from $0.23 to $0.38 per share    at any time and from time to time until July 23, 2005. The Company also    issued 360,000 options to three consultants. Each option entitles the holder    to purchase one common share for price ranging from $0.23 to $0.55 at any    time and from time to time until March 8, 2005. Consulting expense amounting    to $41,300 has been recognized based on the fair value of the options issued    in the period the services were rendered. 

As part of its initial public offering, the Company    issued 356,158 options to the agent. Each option entitled the holder to    purchase one common share of the Company for $0.52 per share. The options    expired on May 30, 2002. The Company also issued 142,616 options to a    consultant. Each option entitled the holder to purchase one common share of    the Company for $0.52 per share. The options expired on November 30, 2002.    Consulting expense amounting to $51,628 has been recognized in these    financial statements based on the fair value of the options issued in the    period the services were rendered. 

PAGE 15**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 

7.**    CAPITAL STOCK (Continued)**

**(e)       Stock Options (Continued)**

The changes in    options outstanding are as noted below:
  **Weighted**  **Average**  **Exercise** **Shares****Price**      Balance, December 31, 20011,877,0130.52      Granted660,0000.34      Expired(937,013)0.52      Balance, December 31, 20021,600,0000.46      Granted1,085,0000.53      Exercised(110,000)0.37      Expired(35,000)0.52      Balance, December 31, 20032,540,0000.50
The following table presents information relating to stock options    outstanding and exercisable at December 31, 2003. 
  **Weighted**     **Average** **Number**   **Remaining****Weighted****Exercisable at****Weighted****Range of****Number****Contractual****Average****December 31,****Average****Exercise Price****Outstanding****Life****Exercise Price****2003****Exercise Price**$0.27- 0.752,540,0001.14 years0.502,540,0000.50
Prior to 2003, the Company was accounting for the    recognition of compensation for its employee stock option plan using the    intrinsic value, which is the difference between the market value of the    underlying common stock and the exercise price of the option at the grant    date. 

Pro-forma information regarding net loss and loss per    share for fiscal year 2002 was required by SFAS No. 123 and had been    determined as if the Company had accounted for its employee stock options    under the fair value method. Effective January 1, 2003, compensation expense    was recorded based on the fair value of the options issued to employees. The    weighted average fair value of options granted during the year ended    December 31, 2003 was estimated to be $0.11 (2002 - $0.10). 

The fair value of these options was estimated at the date of grant using    the Numa option-pricing model with the following assumptions. 
 **2003****2002**      Risk-free interest rate6%6%
 

PAGE 16**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 
      Expected life3 years3 years      Expected volatility35%40%      Dividend yield0%0
 

PAGE 17**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 

7.**    CAPITAL STOCK (Continued)**

**(e)       Stock Options (Continued)**

Had compensation and other service costs for the    Company's stock options and warrants been determined in fiscal year 2002    based upon the fair value at the grant date for awards under the plans    consistent with the methodology prescribed under SFAS No. 123, the Company's    net loss and net loss per share would be as follows. 
 **2003****2002****Net loss**        Historical$ (803,801)$ (795,176)      Pro-forma(803,801)(823,176)**Basic and diluted loss per share**        Historical(0.05)(0.06)      Pro-forma(0.05)(0.06)**8.**      LOSS PER SHARE**
The treasury stock method assumes that proceeds received  upon the exercise of all warrants and options outstanding in the period are  used to repurchase the Company's shares at the average share price during the  period. 

The following table sets forth the computation of basic and diluted loss  per share: 
  **2003** **2002**      Numerator for basic and diluted loss per share available to common             shareholders$(803,801)$(795,176)           Denominator for basic loss per share - weighted average shares             outstanding 15,067,036 14,261,577      Effect of dilutive securities:             Warrants - 550,667 (2002- Nil) - -         Stock options - 2,540,000 (2002 - 1,600,000) - -  15,067,036 14,261,577     Loss      per share - basic and diluted$(0.05)$(0.06)**9.**      INCOME TAXES**
Deferred income taxes reflect the net effects of temporary differences  between the carrying amounts of 

PAGE 18**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 

assets and liabilities for financial reporting purposes. Significant  components of net future tax assets are as noted below. 
  **2003** **2002**Net      operating loss carry-forward$672,800$666,300      Valuation allowance (672,800) (666,300) $-$-
The valuation allowance was provided against the net future tax assets at  December 31, 2003 and 2002 due to uncertainties as to their ultimate  realization. The tax losses expire as follows: 
 $4,8002005 106,1002008 175,5002009 280,8002010 1,049,400 $1,616,600**10.     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. 

A motion was brought by the claimant for an interim    injunction against the Company which was dismissed. A leave to appeal motion    was brought by the claimant which was also dismissed. As at year-end, the    claimant has paid a total of $27,000 of costs to the Company. In the opinion    of the Company's legal counsel, the competitor's claim against the Company    is without merit and the outstanding counterclaim, if pursued by the    Company, would likely result in damages in excess of the competitor's claim.    Therefore, no provision has been made in the financial statements. 
**(b)     Royalty Agreement

The Company entered into a royalty agreement on sales of    one of its products. The agreement runs through September 30, 2008 with    payments ranging from 5% of sales to September 30, 2000 to 2% by October 1,    2003. 
**10.     CONTINGENCIES AND COMMITMENTS (Continued) 

(c)     License Agreement**

PAGE 19**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 

During the year, the Company entered into two licence    agreements to grant the exclusive rights and license to use the methods and    technical know-how for the purposes of manufacturing, marketing and selling    Neovisc and Uracysts products in the specified territory. As provided in one    of the agreements, the Company received a non-recurring, non-refundable    license fee which has been recognized as income during the fiscal year 2003,    and the remaining licence fees will be recognized into income upon    achievement of the specified milestones. The agreements will expire seven to    ten years after December 31, 2003, or unless earlier terminated by the    parties in accordance with agreement. 

On December 28, 2001, the Company entered into a license    agreement 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 the specified territory. 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 has been recognized in the income during the fiscal year 2001    and the remaining license fees will be recognized into income upon    achievement of the specified milestones. 

The royalties, which equal to 17.5% of net sales of each    calendar month 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 agreement. 
**(d)**    Distribution Agreement**

On October 20, 2003, the Company entered into an    exclusive distribution agreement with an American company to 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 cure a material default under the agreement. The    American company may terminate the agreement immediately in the event of any    conditions specified in the agreement occurs. 

The Company is subject to an annual minimum product    purchases and annual marketing plan which will be approved by the American    company. The Company agreed to spend a minimum amount of $10,000 in Canadian    funds in marketing the products in each of the first two calendar years    covered by the agreement. 

The technology access fee was waived and the initial order amounting to    US$38,202 was delivered to the Company in December 2003. 

PAGE 20**STELLAR INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS (Canadian Funds) 
DECEMBER 31, 2003 
**10.     CONTINGENCIES AND COMMITMENTS (Continued) 

(e)     Operating Lease 

The Company entered into an agreement to lease its    premises for the term of two years, which expired on May 31, 2003. The    Company is currently renegotiating the terms of the renewal. Rent expense    for the year amounted to $28,800 (2002 - $22,950). 
**11.     SIGNIFICANT CUSTOMERS**
During the year, the Company had one customer that represented 42.9% (2002  - one customer representing 33.7%) of total revenues for the year. 
**12.     SUBSEQUENT EVENT**
On February 18, 2004, the Company signed a Securities  Purchase and Piggy-back Rights agreement with an American company ("Investor")  to issue 4,088,784 common shares in the capital of the Company at a price of  US$0.74 per share, representing 19.9% of the total issued and outstanding  shares on a non-diluted basis. The agreement provides further that the  investor has the right to acquire additional common shares at any time to  maintain the above equity interest. 
**13.     SEGMENTED INFORMATION**
The Company is engaged in one line of business which is in  the development and marketing of polysaccharide-based therapeutic products  used in a treatment of osteoarthritis and certain types of cystitis.  Currently, all direct sales take place in Canada. Licensing arrangements have  been obtained to sell the Company's products in Europe, the Middle East and  South America in the future.**********************************************************************