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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
———————
FORM 10-Q
———————

þ
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the quarterly period ended: September 30, 2011
 
or
   
¨
 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the transition period from: _____________ to _____________

———————
STELLAR PHARMACEUTICALS INC.
 (Exact name of small business issuer as specified in its charter)
———————

ONTARIO, CANADA
 
0-31198
 
N/A
(State or Other Jurisdiction
 
(Commission
 
(I.R.S. Employer
of Incorporation)
 
File Number)
 
Identification No.)

544 Egerton St
London, Ontario Canada N5W 3Z8
 (Address of Principal Executive Office) (Zip Code)
(519) 434-1540
 (Issuer’s telephone number, including area code)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
———————
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer o
Non-accelerated filer   o
Smaller Reporting Company þ
                        (Do not check if a smaller reporting company)
   
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
 
The number of outstanding common shares, no par value, of the Registrant at: September 30, 2011: 24,610,042
 


 
 

 
STELLAR PHARMACEUTICALS INC.

TABLE OF CONTENTS
 
PART I – FINANCIAL STATEMENTS
 
 
Item 1.
Unaudited Condensed Interim Financial Statements
   
 
 
           
  Condensed Interim Balance Sheets     1  
           
 
Condensed Interim Statements of Operations and Comprehensive Income (Loss) and Deficit
    2  
           
 
Condensed Interim Statements of Cash Flows
    3  
           
  Notes to Condensed Interim Financial Statements     4  
           
Item 2.
Management’s Discussion and Analysis of Financial Conditions and Results of Operations
    18  
           
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
    24  
           
Item 4. Evaluation of Disclosure Controls and Procedures     24  
   
PART II – OTHER INFORMATION
 
           
Item 1.
Legal Proceedings
    25  
           
Item 1a.
Risk Factors     25  
           
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
    25  
           
Item 3.
Defaults Upon Senior Securities
    25  
           
Item 4.
Submission of Matters to a Vote of Security Holders
    25  
           
Item 5.
Other information
    25  
           
Item 6.
Exhibits
    25  
 
 
 

 
 
PART I –FINANCIAL STATEMENTS
 
ITEM 1.
CONDENSED INTERIM FINANCIAL STATEMENTS
 
STELLAR PHARMACEUTICALS INC.
CONDENSED INTERIM BALANCE SHEETS
(Expressed in Canadian dollars)
(Unaudited)
 
CURRENT
 
As at
September 30,
2011
   
As at
December 31,
2010
 
Cash and cash equivalents (Note 2)
  $ 3,511,390     $ 4,352,285  
Accounts receivable, net of allowance of $nil (2010 - $nil)
    364,792       493,370  
Inventories (Note 3)
    900,908       611,676  
Taxes recoverable
    38,760       -  
Loan receivable
    15,814       15,814  
Prepaids, deposits and sundry receivables (Note 4)
    121,047       99,433  
Total current assets
    4,952,711       5,572,578  
PROPERTY, PLANT AND EQUIPMENT, net (Note 5)
    1,498,114       1,568,729  
OTHER ASSETS (Note 6)
    159,212       139,287  
Total assets
  $ 6,610,037     $ 7,280,594  
LIABILITIES
               
CURRENT
               
Accounts payable
  $ 253,652     $ 236,420  
Accrued liabilities
    188,135       557,735  
Deferred revenues
    8,393       8,645  
Product returns liability (Note 10(c))
    -       112,500  
Total current liabilities
    450,180       915,300  
                 
LONG TERM WARRANT LIABILITY (Note 7(e))
    15,064       216,823  
         Total liabilities
    465,244       1,132,123  
                 
CONTINGENCIES AND COMMITMENTS (Note 10)
               
                 
SHAREHOLDERS’ EQUITY
               
CAPITAL STOCK
               
AUTHORIZED
               
Unlimited Non-voting, convertible redeemable and retractable preferred shares with no par value                            
Unlimited Common Shares with no par value                
                 
ISSUED  (Note 7)
               
24,610,042 Common Shares (2010 – 24,585,040)     9,046,206       9,055,982  
Additional Paid-in capital options - outstanding     287,885       211,781  
Additional Paid-in capital options -  expired     795,740       733,517  
      10,129,831       10,001,280  
DEFICIT
    (3,985,038 )     (3,852,809 )
Total shareholders’ equity
    6,144,793       6,148,471  
Total liabilities and shareholders’ equity
  $ 6,610,037     $ 7,280,594  
 
See accompanying notes to the condensed interim financial statements.
 
 
1

 
 
STELLAR PHARMACEUTICALS INC.
CONDENSED INTERIM STATEMENTS OF OPERATIONS, COMPREHENSIVE
INCOME (LOSS) AND DEFICIT
(Expressed in Canadian Dollars)
 
(Unaudited)
 
   
For the Three Month Period
Ended September 30
   
For the Nine Month Period
Ended September 30
 
   
2011
   
2010
   
2011
   
2010
 
                         
PRODUCT SALES (Note 14)
  $ 683,864     $ 690,881     $ 2,381,684     $ 2,052,144  
ROYALTY AND LICENSING REVENUES (Note 14)     5,298       1,546,044       14,226       2,018,472  
                                 
TOTAL REVENUES FROM ALL SOURCES
    689,162       2,236,925       2,395,910       4,070,616  
COST OF PRODUCTS SOLD     201,870       235,334       634,799       719,809  
                                 
 GROSS PROFIT     487,292       2,001,591       1,761,111       3,350,807  
                                 
EXPENSES                                
Selling, general and administrative (Notes 7(b), (d), 12 & 15)     621,641       566,371       2,024,640       1,726,890  
Research and development     12,196       45,606       45,966       81,560  
Change in warrant liability (Note 7(e))     (266,029 )       -       (201,759     -  
Amortization (non-manufacturing property, plant and equipment)     12,314       11,600       36,438       38,919  
      380,122       623,577       1,905,285       1,847,369  
INCOME (LOSS) FROM OPERATIONS
    107,170       1,378,014       (144,174 )     1,503,438  
INTEREST AND OTHER INCOME     5,091       2,827       11,945       5,949  
LOSS ON DISPOSAL OF EQUIPMENT     -       -       -       (15,308 )
                                 
INCOME (LOSS) AND COMPREHENSIVE INCOME FOR THE PERIOD BEFORE INCOME TAXES
    112,261       1,380,841       (132,229 )     1,494,079  
                                 
Current income tax expense (Note 13)     -       (421,300 )     -       (435,100 )
Future income tax recovery (Note 13)
    -       421,300       -       435,100  
                                 
NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS) FOR THE PERIOD
    112,261       1,380,841       (132,229 )     1,494,079  
                                 
DEFICIT, beginning of period
    (4,097,299 )     (4,265,279 )     (3,852,809 )     (4,378,517 )
DEFICIT, end of period
  $ (3,985,038 )   $ (2,884,438 )   $ (3,985,038 )   $ (2,884,438 )
                                 
EARNINGS (LOSS) PER SHARE (Note 8) - Basic
  $ 0.00     $ 0.06     $ (0.01 )   $ 0.06  
                                 
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - Basic
    24,610,042       23,585,040       24,599,144       23,517,256  
                                 
EARNINGS (LOSS) PER SHARE (Note 8) - Diluted
  $ 0.00     $ 0.06     $ (0.01 )   $ 0.06  
                                 
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - Diluted
    24,610,042       23,594,579       24,599,144       23,518,390  
 
See accompanying notes to condensed interim financial statements.
 
 
2

 
 
STELLAR PHARMACEUTICALS INC.
CONDENSED INTERIM STATEMENTS OF CASH FLOWS
(Expressed in Canadian dollars)
(Unaudited)
 
   
For the Three Month Period
Ended September 30
   
For the Nine Month Period
Ended September 30
 
   
2011
   
2010
   
2011
   
2010
 
                         
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES-
                         
Net income (loss) for the period                       
  $ 112,261     $ 1,380,841     $ (132,229 )   $ 1,494,079  
Items not affecting cash
                               
Amortization
    23,826       21,474       78,889       79,053  
Current income tax expense
            (421,300 )     -       (435,100 )
Future income tax recovery
            421,300       -       435,100  
Loss on disposal of equipment
    -       -       -       15,308  
Change in warrant liability (Note 7(e))
    (266,029 )     -       (201,759 )     -  
Issuance of equity instruments for services rendered
    9,001       -       14,467       4,000  
Stock-based compensation (Note 7(d))
    47,330       66,689       138,327       118,079  
Change in non-cash operating asset and liabilities (Note 9)
    137,403       39,974       (686,148 )     (535,908 )
                                 
CASH FLOWS (USED IN) OPERATING ACTIVITIES
    63,792       1,508,978       (788,453 )     1,174,611  
                                 
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES -
                               
Additions to property, plant and equipment
    -       (28,052 )     (5,008 )     (290,194 )
Increase to other assets
    (3,710 )     (6,000 )     (23,191 )     (16,847 )
Proceeds from sale of equipment
    -       -       -       12,630  
                                 
CASH FLOWS USED IN INVESTING ACTIVITIES
    (3,710 )     (34,052 )     (28,199 )     (294,411 )
                                 
CASH FLOWS USED IN FINANCING ACTIVITIES -
                               
Stock options exercised
    -       -       -       69,000  
Share issuance costs (Note 7(a))
    (2,559 )     -       (24,243 )     -  
                                 
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
    (2,559 )     -       (24,243 )     69,000  
                                 
CHANGE IN CASH AND CASH EQUIVALENTS
    57,523       1,474,926       (840,895 )     949,200  
                                 
CASH AND CASH EQUIVALENTS,
                               
Beginning of period
    3,453,867       1,799,486       4,352,285       2,325,212  
CASH AND CASH EQUIVALENTS,
                               
 End of period   $ 3,511,390     $ 3,274,412     $ 3,511,390     $ 3,274,412  
 
See accompanying notes to condensed interim financial statements.
 
 
3

 

STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Expressed in Canadian dollars)
 (Unaudited)
SEPTEMBER 30, 2011
 
1.
BASIS OF PRESENTATION
 
 
These condensed unaudited interim financial statements should be read in conjunction with the financial statements for Stellar Pharmaceuticals Inc.’s (the "Company") most recently completed fiscal year ended December 31, 2010.  These condensed interim financial statements do not include all disclosures required in annual financial statements, but rather are prepared in accordance with recommendations for interim financial statements in conformity with accounting principles generally accepted in the United States of America.  These condensed interim financial statements have been prepared using the same accounting policies, and methods as those used by the Company in the annual audited financial statements for the year ended December 31, 2010.
 
The unaudited condensed interim financial statements contain all adjustments (consisting of only normal recurring adjustments) which are necessary to present fairly the financial position of the Company as at September 30, 2011, and the results of its operations and cash flows for the three and nine month periods ended September 30, 2011 and 2010.  Note disclosures have been presented for material updates to the information previously reported in the annual audited financial statements.
 
 
a)
Estimates
 
The preparation of these financial statements has required management to make estimates and assumptions that affect the amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of the revenues and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including those related to provision for doubtful accounts, accrued liabilities, income taxes, stock based compensation, warrant liability, revenue recognition and intangible assets. The Company bases its estimates on historical experiences and on various other assumptions believed to be reasonable under the circumstances. Actual results could differ from those estimates. As adjustments become necessary, they are reported in earnings in the period in which they become known.
 
 
b)
Fair Value
 
The Company follows Financial Accounting Standards Board (FASB) ASC 820-10-65-1 (formerly referred to as SFAS 157), “Fair Value Measurements” (SFAS 157). ASC 820-10-65-1 defines fair value, establishes a framework for measuring fair value and expands disclosures regarding fair value measurements. ASC 820-10-65-1 defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820-10-65-1 provides guidance on how to measure the fair value of financial instruments according to a fair value hierarchy that prioritizes the information used to measure fair value into three broad levels. ASC 820-10-65-1 broadly applies to most existing pronouncements that require or permit fair value measurements (including both financial and non-financial assets and liabilities) but does not require any new fair value measurements.
 
 
4

 
 
STELLAR PHARMACEUTICALS INC.

NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
1.
BASIS OF PRESENTATION (continued)
 
 
c)
Recently Adopted Accounting Standards
 
 
In October 2009, the FASB issued an accounting standards update that requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices, eliminates the use of the residual method of allocation, and requires the relative-selling-price method in all circumstances in which an entity recognizes revenue of an arrangement of deliverables.  This guidance became effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted.  The Company adopted the provisions of the guidance in the first quarter of 2011.  The adoption did not have a material impact on the Company’s financial statements.
 
In December 2010, the FASB issued an accounting standards update that requires an entity to disclose pro forma revenue and earnings of the combined entity for both the year in which a business combination occurred and the prior year as if the business combination had occurred as of the beginning of prior year only. This guidance became effective prospectively for business combinations occurring in fiscal years beginning after December 15, 2010. The Company adopted the provisions of the guidance in the first quarter of 2011. The adoption did not have a material impact on the Company’s financial statements.
 
 
d)
New Accounting Standards Not Yet Adopted
 
In June 2011, the FASB issued an accounting standards update that eliminates the option to present components of other comprehensive income as part of the statement of changes in equity and requires an entity to present items of net income and other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance also requires an entity to present on the face of the financial statements reclassification adjustments from other comprehensive income to net income. This guidance will be effective for fiscal years beginning after December 15, 2011, which will be the Company’s fiscal year 2012, with early adoption permitted. The Company does not expect that the adoption of the guidance will have a material impact on the Company’s financial statements.
 
In May 2011, the FASB issued an accounting standards update that clarifies and amends the existing fair value measurement and disclosure requirements. This guidance will be effective prospectively for interim and annual periods beginning after December 15, 2011, which will be the Company’s fiscal year 2012, with early adoption prohibited. The Company does not expect that the adoption of the guidance will have a material impact on the Company’s financial statements.
 
In September 2011, the FASB issued new accounting guidance that simplifies goodwill impairment tests. The new guidance states that a “qualitative” assessment may be performed to determine whether further impairment testing is necessary. The Company will adopt this accounting standard upon its effective date for periods beginning on or after December 15, 2011. The Company does not anticipate that this adoption will have a significant impact on our financial position or results of operations.
 
 
5

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
2.
CASH AND CASH EQUIVALENTS
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
Cash
  $ 2,511,341     $ 2,852,546  
Short-term investments
    1,000,049       1,499,739  
    $ 3,511,390     $ 4,352,285  
 
3.
INVENTORIES
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
Raw materials
 
$
206,332 
   
$
222,879 
 
Finished goods
   
137,454 
     
88,152 
 
Packaging materials
   
67,763 
     
79,905 
 
Work in process
   
489,359 
     
220,740 
 
   
$
900,908 
   
$
611,676 
 
 
4.
PREPAIDS, DEPOSITS AND SUNDRY RECEIVABLES
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
Prepaid operating expenses
  $ 97,905     $ 95,431  
Prepaid manufacturing
    18,465       -  
Interest receivable on investments
    4,677       4,002  
    $ 121,047     $ 99,433  
 
 
6

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
5.
PROPERTY, PLANT AND EQUIPMENT
 
             
September 30, 2011
 
           
Accumulated
   
Net Carrying
 
   
Cost
   
Amortization
   
Amount
 
Land
 
$
90,000
   
$
––
   
$
90,000
 
Building
   
618,254
     
200,332
     
417,922
 
Office equipment
   
44,308
     
41,940
     
2,368
 
Manufacturing equipment
   
1,469,980
     
598,948
     
871,032
 
Warehouse equipment
   
17,085
     
12,724
     
4,361
 
Packaging equipment
   
111,270
     
29,458
     
81,812
 
Computer equipment
   
156,363
     
125,744
     
30,619
 
   
$
2,507,260
   
$
1,009,146
   
$
1,498,114
 
.
             
December 31, 2010
 
           
Accumulated
   
Net Carrying
 
   
Cost
   
Amortization
   
Amount
 
Land
 
$
90,000
   
$
––
   
$
90,000
 
Building
   
618,254
     
177,148
     
441,106
 
Office equipment
   
44,308
     
41,203
     
3,105
 
Manufacturing equipment
   
1,469,980
     
565,562
     
904,418
 
Warehouse equipment
   
17,085
     
10,161
     
6,924
 
Packaging equipment
   
111,270
     
20,392
     
90,878
 
Computer equipment
   
151,355
     
119,057
     
32,298
 
   
$
2,502,252
   
$
933,523
   
$
1,568,729
 
 
 
7

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
6.
OTHER ASSETS
 
             
September 30, 2011
 
           
Accumulated
   
Net Carrying
 
   
Cost
   
Amortization
   
Amount
 
Patents
 
$
173,208
   
$
13,996
   
$
159,212
 
 
          December 31, 2010  
         
Accumulated
   
Net Carrying
 
   
Cost
   
Amortization
   
Amount
 
Patents
  $ 150,017     $ 10,730     $ 139,287  
 
The Company currently has patents of $108,152 at September 30, 2011 (December 31, 2010 - $84,963) which are not being amortized as these patents are currently pending.
 
7.
CAPITAL STOCK
 
 
(a)
Common Shares
 
During the nine month period ended September 30, 2011, the Company issued 25,002 Common Shares and recorded $14,467 for these default shares issued due to late registration of the Common Shares issued pursuant to the private placement offering during the year ended December 31, 2010.  The Common Shares were valued using the market price of the Common Shares at the date of issuance.  The Company also recorded $24,243 in fees related to the registration of the Common Shares issued pursuant to such private placement.
 
Authorized: An unlimited number of Common Shares, with no par value.
 
 
8

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
7.
CAPITAL STOCK (continued)
 
   
Number of
Shares
   
Amount
 
Balance, December 31, 2010 and March 31, 2011
   
24,585,040
   
$
9,055,982
 
Shares issued as default shares
   
25,002
     
5,466
 
Private placement registration fees
   
-
     
(21,684
)
Balance, June 30, 2011
   
24,610,042
     
9,039,764
 
Shares issued as default shares – value adjustment
   
-
     
9,001
 
Private placement registration fees
   
-
     
(2,559
)
Balance, September 30, 2011
   
24,610,042
   
$
9,046,206
 
 
 
(b)
Paid-in Capital Options – Outstanding
 
The activities in additional paid in-capital options are as follows:
 
   
Amount
 
Balance, December 31, 2010
 
$
211,781
 
Expense recognized for options issued to employees/ directors 
   
63,735
 
Options issued to employees/directors expired
   
(62,223
)
Balance, March 31, 2011
   
213,293
 
Expense recognized for options issued to employees/ directors
   
27,262
 
Balance, June 30, 2011
   
240,555
 
Expense recognized for options issued to employees/ directors
   
47,330
 
Balance, September 30, 2011
 
$
287,885
 
 
 
9

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
7.
CAPITAL STOCK (continued)
 
 
(c)
Paid-in Capital Options - Expired
 
The activities in additional paid in-capital options are as follows:
 
   
Amount
 
Balance, December 31, 2010
 
$
733,517
 
Options issued to employees/directors expired 
   
62,223
 
Balance, March 31, June 30 and September 30, 2011 
 
$
795,740
 
 
 
(d)
Stock Based Compensation
 
The Company’s stock-based compensation program ("Plan") includes stock options in which some options vest based on continuous service, while others vest based on performance conditions such as profitability and sales goals. For those equity awards that vest based on continuous service, compensation expense is recorded over the service period from the date of grant. For performance-based awards, compensation expense is recorded over the remaining service period when the Company determines that achievement is probable.
 
During the three and nine month periods ended September 30, 2011, there were nil and 305,000 options granted (2010 – nil and nil). Of the options granted, 180,000 were granted to directors/officers of the Company at $0.41 (US$0.42).  These options vest as to 25% on each of September 30 and December 31, 2011, and March 31 and June 30, 2012.  The remaining 125,000 options were granted to employees at $0.68 (US$0.71) and vest (25% per quarter in 2012) upon achieving certain financial objectives. As at September 30, 2011, 10,000 of these options were cancelled due to the departure of certain employees. Since share-based compensation is recognized only for those awards that are ultimately expected to vest, the Company has applied an estimated forfeiture rate (based on historical experience and projected employee turnover) to unvested awards for the purpose of calculating compensation expense.  For the three and nine month periods ended September 30, 2011, the Company recorded $47,330 and $138,327, respectively (2010 – $66,689 and $118,079, respectively), as compensation expense for options issued to directors, officers and employees based on continuous service.  This expense was recorded as selling, general and administrative expense.
 
     
Options Outstanding
   
Options Exercisable
 
Range of
Exercise Price
   
Number
of Shares
   
Weighted
Average Remaining Contractual
Life (Years)
   
Weighted
Average
Exercise Price
   
Number
of Shares
   
Weighted Average
Exercise
Price
 
$ 0.40 to $0.59       180,000       4.5     $ 0.41       45,000     $ 0.41  
$ 0.60 to $0.79       115,000       4.7       0.68       -       -  
$ 0.80 to $0.89       77,000       3.1       0.84       67,000       0.84  
$ 0.90 to $0.99       510,000       3.8       0.95       212,500       0.95  
$ 1.00 to $1.09       147,500       3.1       1.00       147,500       1.00  
          1,029,500       3.8     $ 0.83       472,000     $ 0.92  
 
 
10

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
7.
CAPITAL STOCK (continued)
 
On June 22, 2011, pursuant to resolutions by the Board of Directors and shareholders, the Company amended the Plan to change the maximum number of Common Shares from a fixed number of 4,629,452 to a floating amount equivalent to 10% of the issued and outstanding Common Shares. As at September 30, 2011, the maximum number of options that may be issued under the plan is 2,461,004 (December 31, 2010 – 4,629,452).

The total number of options outstanding as at September 30, 2011 was 1,029,500 (December 31, 2010 – 876,500). The total number of options exercisable as at September 30, 2011 was 472,000 (December 31, 2010 – 324,000).  The weighted average fair value of options expensed during the nine month period ended September 30, 2011 was estimated at $0.85 (2010 - $0.93).
 
(e)
Warrants
 
As at September 30, 2011, the following compensation warrants were outstanding:
 
 
Expiry Date
 
Number of
   
Weighted Average
Exercise
   
 
Fair
 
   
warrants
   
Price
   
Value
 
April 8, 2012
    500,000       US$1.50 ($1.44)     $ 8,831  
April 8, 2012
    500,000       US$2.00 ($1.93)     $ 4,155  
April 8, 2012
    500,000       US$2.50 ($2.41)     $ 2,078  
      1,500,000       US$2.00 ($1.93)     $ 15,064  
 
In connection with a private placement offering in October 2010, the Company granted 1,500,000 warrants to the participants, each exercisable into one Common Share as follows: 500,000 at US$1.50 ($1.56), 500,000 at US$2.00 ($2.07) and 500,000 at US$2.50 ($2.59) each for a period of 18 months, ending on April 8, 2012. The exercise price of the 1,500,000 warrants is denominated in US dollars while the Company’s functional and reporting currency is the Canadian dollar.  As a result, the fair value of the warrants fluctuates based on the current stock price, volatility, the risk free interest rate, time remaining until expiry and changes in the exchange rate between the US and Canadian dollar.
 
The fair value of the warrant liability at the date of grant was $206,774 and was estimated using the Black-Scholes option pricing model, based on the following assumptions: expected dividend yield of 0%; expected volatility of 85%; risk free interest rate of 1.45%; and expected term of 1.5 years.
 
ASC 815 “Derivatives and Hedging” (formerly referred to as SFAS133) indicates that warrants with exercise prices denominated in a different currency than an entity’s functional currency should not be classified as equity. As a result, these warrants have been treated as derivatives and recorded as liabilities carried at their fair value, with period-to-period changes in the fair value recorded as a gain or loss in the statement of operations. The Company treated the compensation warrants as a liability upon their issuance.
 
As at September 30, 2011, the fair value of the warrant liability of $15,064 (December 31, 2010 - $216,823) was estimated using the Black-Scholes option pricing model based on the following assumptions: expected dividend yield of 0% expected volatility of 114% risk-free interest rate of 0.92% and expected term of 6 months.
 
For the three and nine month periods ended September 30, 2011, the Company recorded ($266,029) and ($201,759), respectively (2010 - $nil and $nil) as change in warranty liability expense.
 
 
11

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
8.
EARNINGS (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 diluted earnings per share is not computed when the effect of such calculation is anti-dilutive.
 
The following table sets forth the computation of earnings per share based on the treasury method:
 
   
For the Three Month
Period
   
For the Nine Month
Period
 
For the periods ended September 30
 
2011
   
2010
   
2011
   
2010
 
Numerator - net earnings available to common shareholders
                   
Net earnings
  $ 112,261     $ 1,380,841     $ (132,229 )   $ 1,494,079  
Denominator - Weighted average
                               
# of Common Shares outstanding - basic
    24,610,042       23,585,040       24,599,144       23,517,256  
Dilutive effect of stock options
    -       263,750       -       263,750  
Repurchase of shares under
                               
treasury stock method
    -       (254,211 )     -       (262,616 )
Denominator - Weighted average
                               
# of Common Shares outstanding - diluted
    24,610,042       23,594,579       24,599,144       23,518,390  
Earnings (loss) per share - basic
  $ 0.00     $ 0.06     $ (0.01 )   $ 0.06  
Earnings (loss) per share - diluted
    0.00     $ 0.06     $ (0.01 )   $ 0.06  
 
 
12

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
9.
STATEMENT OF CASH FLOWS
 
Changes in non-cash balances related to operations are as follows:
 
     
For the Three Month Period
     
For the Nine Month Period
 
For the periods ended  September 30     2011       2010       2011      
2010
 
Accounts receivable
  $ 202,324     $ 131,725     $ 128,578     $ (314,948 )
Inventories
    (175,442 )     (112,622 )     (289,232 )     (78,764 )
Prepaids, deposits and sundry receivables
    33,587       20,152       (21,615 )     38,698  
Taxes recoverable
    (20,304 )     (5,998 )     (38,760 )     (4,497 )
Loan receivable
    -       -       -       4  
Accounts payable and accrued liabilities
    98,488       9,481       (352,367 )     (177,984 )
Product returns liability
    -               (112,500 )     -  
Deferred revenues
    (1,250 )     (2,764 )      (252 )     1,583  
 
  $ 137,403     $ 39,974     $ (686,148 )   $ (535,908 )

During the three and nine month periods ended September 30, 2011, there was no interest or taxes paid (2010 – $nil).
 
 
13

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS

10.
CONTINGENCIES AND COMMITMENTS
 
 
(a)
Consulting Royalty Agreements
   
The Company has consultant royalty agreements in place for several of its international license agreements.   These agreements provide for royalty payments to consultants who assisted in locating licensees who have signed license agreements with the Company.
 
The royalty fees recorded for consultants include 10% of the upfront fees received from the licensees and 10% of any future milestone payments received.  In addition, royalty payments are also based on 4 to 5% of the total sales of Uracyst at a declining rate of 1% per year over a three to five year period, declining to a 1% rate effective in the final year. The expenses recorded in regards to royalty fees for the three and nine month periods ended September 30, 2011 were $2,617 and $12,533, respectively (2010 - $21,006 and $66,010, respectively). These amounts have been recorded as royalty expense in selling, general and administrative expense.
 
 
(b)
Lease Agreements
 
The Company presently leases office and warehouse equipment under operating leases. For the three and nine month periods ended September 30, 2011, the total expense related to leases were $952 and $2,850, respectively (2010 - $949 and $3,497, respectively). At September 30, 2011, the remaining future minimum lease payments under operating leases are $8,296 (December 31, 2010 - $5,183).
 
 
(c)
Product Returns Liability
 
During the year ended December 31, 2010, the Company was advised that a licensee was planning to exercise its contractual rights to return a quantity of NeoVisc product.  The Company subsequently has made a provision for the licensee to receive a quantity of product at no charge and in addition, all contractual rights to return product now and in the future have been removed. The liability for the Company for this return was eliminated at September 30, 2011 (December 31, 2010 - $112,500).
 
 
(d)
Executive Termination Agreement
       
The Company currently has an employment agreement with an executive officer of the Company that contains change of control benefits. The agreement provides that in the event that the officer’s employment is terminated by the Company other than for cause, or for good reason or within six months of a change of control of the Company, the officer is entitled to (i) a lump sum payment equal to $202,500 (based on current base salary), (ii) all outstanding and accrued regular and vacation pay and expenses and (iii) the immediate vesting of options which would continue to be available for exercise for a period of 30 days following the date of termination.  As the likelihood of this event taking place is not determinable, the contingent payment has not been reflected in these financial statements.
 
 
14

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
11.
SIGNIFICANT CUSTOMERS
 
During the three month period ended September 30, 2011, the Company had two significant customers that represented 48.3% (one major wholesaler-37.8% and one international customer – 10.5%) of product sales (2010 - two significant customers that represented 72% (one major wholesaler – 12%; and one international customer – 60%). During the nine month period ended September 30, 2011, the Company had one significant customer that represented 31.3% (a major wholesaler) of product sales (2010 – three significant customers that represented 64% (one major wholesaler – 19%; and two international customers – 33% and 12%).   The Company believes that its relationship with these customers is satisfactory.
 
12.
RELATED PARTY TRANSACTIONS
 
The Company entered into a fiscal advisory and consulting agreement with LMT Financial Inc. ("LMT") (a company beneficially owned by a director and interim officer of the Company and his spouse) for services provided in the normal course of business. Advisory and consulting fees under this agreement were $6,600 per month.  This agreement was cancelled on January 17, 2011. During the three and nine month periods ended September 30, 2011, the Company recorded and paid $3,300 (2010 - $19,800 and $58,800, respectively) as selling, general and administrative expense pursuant to this agreement.
 
 
On January 17, 2011, the Company retained Arnold Tenney, through LMT, as a consultant to act as Interim President and Interim Chief Executive Officer of the Company. Under the terms of this agreement, LMT will cease being paid under the fiscal advisory and consulting agreement until the appointment of a permanent CEO and President. In consideration for the services provided by Mr. Tenney, LMT is paid $16,700 per month. During the three and nine month periods ended September 30, 2011, the Company has recorded and paid $50,100 and $141,950, respectively (2010 - $nil and $nil) as selling, general and administrative expense.
 
During the three and nine month periods ended September 30, 2011, the Company recorded $41,574 and $62,586, respectively, for various legal services (2010 – $nil and $nil) to a law firm in which one of the directors of the Company is a partner, which have been recorded as selling, general and administrative expense.
 
13.
INCOME TAXES
 
The Company has no taxable income under the Federal and Provincial tax laws for the three and nine month periods ended September 30, 2011 and 2010. The Company has non-capital loss carry-forwards at September 30, 2011 totaling approximately $1,970,000, which may be offset against future taxable income.  If not utilized, the loss carry-forwards will expire between 2014 and 2029.  The cumulative carry-forward pool of scientific research and experimental development (SR&ED) expenditures that may be offset against future taxable income, with no expiry date, is $1,798,300.
 
The non-refundable portion of the tax credits as at September 30, 2011 was $338,500.  All taxable benefits are fully allowed for because the realization of the assets is undeterminable.
 
 
15

 
 
STELLAR PHARMACEUTICALS INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
14.           SEGMENTED INFORMATION
 
Revenue for the three and nine month periods ended September 30 2011 and 2010 includes products sold in Canada and international sales of products.  Revenue earned is as follows:
 
The Company is engaged in the sale of three lines of product:
 
   
September 30
 
   
Unaudited
 
   
For the Three Month Period
   
For the Nine Month Period
 
Product Sales
 
2011
   
2010
   
2011
   
2010
 
NeoVisc
    67.9 %     17.7 %     62.8 %     32.9 %
Uracyst
    30.3 %     12.6 %     35.7 %     16.6 %
BladderChek
    0.8 %     0.5 %     0.7 %     0.8 %
     Subtotal
    99.0 %     30.8 %     99.2 %     50.3 %
Licensing & Royalty Fees
    0.8 %     69.1 %     0.5 %     49.5 %
Other
    0.2 %     0.1 %     0.3 %     0.2 %
      100.0 %     100.0 %     100.0 %     100.0 %
 
Royalty and licensing revenues for the three and nine month periods ended September 30, 2011 and 2010 includes royalties earned during these periods, as well as license fee milestones.  Revenues earned are as follows:
 
   
September 30
 
   
Unaudited
 
   
For the Three Month Period
   
For the Nine Month Period
 
Product Sales
 
2011
   
2010
   
2011
   
2010
 
Domestic sales
  $ 464,610     $ 448,932     $ 1,415,024     $ 1,382,135  
International sales
    217,368       239,814       960,799       663,730  
Other revenues
    1,885       2,135       5,861        6,279  
  Total Product Sales
  $  683,864     $ 690,881     $ 2,381,684     $ 2,052,144  
 
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 Austria, the Caribbean, Germany, Italy, Lebanon, Malaysia, Kuwait, Portugal, Romania, Spain, South Korea, the United Arab Emirates and Turkey.  The continuing operations reflected in the statements of operations include the Company’s activities in these markets.
 
 
16

 
 
STELLAR PHARMACEUTICALS INC.
 
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
 
14.           SEGMENTED INFORMATION (continued)
 
   
September 30
 
   
Unaudited
 
   
For the Three Month Period
   
For the Nine Month Period
 
Royalties & Licensing Revenues
 
2011
   
2010
   
2011
   
2010
 
Licensing fees
  $ -     $ 1,446,168     $ -     $ 1,849,960  
Royalty payments
     5,298        99,376        14,226       168,512  
  Total Royalty & Licensing Revenues
  $  5,298     $ 1,546,044     $  14,226     $ 2,018,472  
 
15.           FOREIGN CURRENCY GAIN (LOSS)
 
The Company enters into foreign currency transactions in the normal course of business.  During the three and nine month periods ended September 30, 2011, the Company had a foreign currency gain of $58,765 and $3,574, respectively (2010 – gain of $12,015 and loss of $3,461, respectively).  These amounts have been included in selling, general and administrative expenses.
 
 
17

 
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
 
This report was prepared on November 6, 2011 and should be read in conjunction with the September 30, 2011 financial statements of Stellar Pharmaceuticals Inc. ("Stellar" or the "Company").  All amounts are stated in Canadian dollars and have been rounded to the nearest one hundredth dollar.
 
FORWARD-LOOKING STATEMENTS
 
Readers are cautioned that actual results may differ materially from the results projected in any "forward-looking" statements (within the meaning of Section 27A of the Exchange Act (as defined below)) included in this report, which involve a number of risks or uncertainties.  Forward-looking statements are statements that are not historical facts, and include statements regarding the Company’s planned research and development programs, anticipated future losses, revenues and market shares, planned clinical trials, expected future expenditures, the Company’s intention to raise new financing, sufficiency of working capital for continued operations, and other statements regarding anticipated future events and the Company’s anticipated future performance.  Forward-looking statements generally can be identified by the words "expected", "intends", "anticipates", "feels", "continues", "planned", "plans", "potential", "with a view to", and similar expressions or variations thereon, or that events or conditions "will", "may", "could" or "should" occur, or comparable terminology referring to future events or results.
 
The Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of numerous factors, 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.
 
CRITICAL ACCOUNTING POLICIES

There have been no material changes to the Company’s Critical Accounting Policies and Assumptions filed in the Company’s 2010 Annual Report on the Form 10-K.

RECENT ACCOUNTING PRONOUNCEMENTS
 
In October 2009, the FASB issued an accounting standards update that requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices, which eliminates the use of the residual method of allocation, and requires the relative-selling-price method in all circumstances in which an entity recognizes revenue of an arrangement of deliverables.  This guidance became effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted.  The Company adopted the provisions of the guidance in the first quarter of 2011.  The adoption did not have a material impact on the Company’s financial statements.
 
In December 2010, the FASB issued an accounting standards update that requires an entity to disclose proforma revenue and earnings of the combined entity for both the year in which a business combination occurred and the prior year as if the business combination had occurred as of the beginning of prior year only. This guidance became effective prospectively for business combinations occurring in fiscal years beginning after December 15, 2010. The Company adopted the provisions of the guidance in the first quarter of 2011. The adoption did not have a material impact on the Company’s financial statements.
 
 
18

 
 
NEW ACCOUNTING STANDARDS NOT YET ADOPTED
 
In September 2011, the FASB issued new accounting guidance that simplifies goodwill impairment tests. The new guidance states that a “qualitative” assessment may be performed to determine whether further impairment testing is necessary. We will adopt this accounting standard upon its effective date for periods beginning on or after December 15, 2011. The Company does not anticipate that this adoption will have a significant impact on our financial position or results of operations.
 
In June 2011, the FASB issued an accounting standards update that eliminates the option to present components of other comprehensive income as part of the statement of changes in equity and requires an entity to present items of net income and other comprehensive income either in a single continuous statement of comprehensive income or in two separate, but consecutive statements. This guidance also requires an entity to present on the face of the financial statements reclassification adjustments from other comprehensive income to net income. This guidance will be effective for fiscal years beginning after December 15, 2011, which will be the Company’s fiscal year 2012, with early adoption permitted. The Company does not expect the adoption of the guidance will have a material impact on the Company’s financial statements.
 
In May 2011, the FASB issued an accounting standards update that clarifies and amends the existing fair value measurement and disclosure requirements. This guidance will be effective prospectively for interim and annual periods beginning after December 15, 2011, which will be the Company’s fiscal year 2012, with early adoption prohibited. The Company does not expect the adoption of the guidance will have a material impact on the Company’s financial statements.
 
OVERVIEW
 
Stellar, founded in 1996, 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’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®, 3 injection treatment for osteoarthritis;
(ii)  
NeoVisc® Single Dose, a single injection treatment for osteoarthritis: and
(iii)  
Uracyst®; for the treatment of GAG deficient forms of Cystitis (IC)

Stellar also has acquired the exclusive Canadian marketing and distribution rights for: Matritech’s NMP22® BladderChek® ("BladderChek"), a proteomics-based diagnostic test for the diagnosis and monitoring of bladder cancer.  Stellar began selling BladderChek in Canada in October 2004.
 
 
19

 
 
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 thereby allowing Stellar to fund its own in-house product development for future growth and stability.

Stellar currently has out-licensing agreements for NeoVisc and Uracyst in 58 countries.  For an overview of these out-licensing agreements, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.
 
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2011
 
For the three month period ended September 30, 2011, total revenues from all sources decreased by 69.2% to $689,200, compared to $2,236,900 in the same period during 2010.  This differential for the three month period ended September 30, 2011, were due primarily to one-time licensing and milestone revenues of $1,446,200 recorded in the same period in 2010.  Product sales for both domestic and international markets for the three month period ended September 30, 2011 decreased by 1.0% to $682,000 from $688,700, while the nine month period product sales increased by 16.1%, to $2,375,800 from $2,045,900, compared to the same periods in 2010.
 
For the nine month period ended September 30, 2011, total revenues from all sources decreased by 41.1% to $2,395,900, compared to $4,070,600 for the same period in 2010. The 2010 revenues included a one-time milestone payment received from Watson Pharmaceuticals for $1,345,200 and one-time licensing fees of $504,800.
 
Total expenses for the three month period ended September 30, 2011 decreased 39.0% or $243,500, compared to the same period in 2010.  Total expenses for the nine month period end September 30, 2011 increased 3.1% or $57,900, compared to the same period in 2010.
 
The Company’s net income (loss) for the three and nine month periods ended September 30, 2011 were $112,300 and ($132,200), respectively, compared to $1,380,800 and 1,494,100, respectively, for the same periods in 2010.  As noted above, the net income for the three month period ended September 30, 2010 included $1,446,200 of royalty and licensing revenues, compared to $nil for the same periods in 2011, which accounted for a significant portion of the differential in profit. Although these one-time revenues constituted an important part of the Company’s business, the Company is encouraged by the increases noted in both the international and domestic markets.
 
Factors contributing to the net loss of $132,200 for the nine month period ended September 30, 2011, compared to the same period in 2010, were several non-cash transactions, including:

·  
share option expense of $138,300 (2010 – $118,100), of which $21,700 (2010 - $nil) related to options which fully vested upon the retirement of an officer of the Company, and
·  
amortization expense of $36,400 (2010 - $38,900)

Factors causing a reduction in the net loss for the nine month period ended September 30, 2011, were the following non-cash transactions:

·  
warrant liability expense of ($201,800) (2010 - $nil) related to the re-valuation of warrants issued in the October 2010 private placement, and
·  
foreign currency exchange expense of ($3,600) (2010 - $3,500). The Company currently holds $43,300 in U.S. currency and $48,100 in Euro funds. At September 30, 2011, the currency exchange rate for the U.S. dollar to the Canadian dollar was $1.0389 compared to $1.0298 at September 30, 2010. As at September 30, 2011 the currency exchange rate for Euro funds to the Canadian dollar was $1.3971 compared to $1.4006 at September 30, 2010.
 
 
20

 
 
Gross Profit and Cost of Products Sold
 
Gross profit for the third quarter of 2011, decreased by 75.7% to $487,300, compared to a gross profit of $2,001,600 for the same period in 2010.  Gross profit for the nine months period ended September 30, 2011 decreased by 47.4% to $1,761,100 compared to $3,350,800, compared to the same period in 2010. The decrease in gross profit is primarily due to decreased royalty and licensing revenues from those recorded in 2010.
 
Cost of products sold as a percentage of sales for the three and nine month periods ended September 30, 2011 were 29.5% and 26.7% respectively, as compared to 34.1% and 35.7% respectively, for the same periods in 2010. The decrease in cost of products sold is primarily due to improved manufacturing yields in 2011.
 
Research and Development
 
Stellar continues to invest in research and development of its products in Canada and in international markets. For the three and nine month periods ended September 30, 2011, the Company incurred $12,200 and $46,000, respectively, in research and development costs, compared to $45,600 and $81,600 for the same period in 2010. During 2011, the Company continued its development of manufacturing processes to improve yields from both Uracyst and NeoVisc production.
 
Selling, General and Administrative Expenses
 
Selling, general and administrative expenses for the three month period ended September 30, 2011 were $621,600 compared to $566,400 for the same period in 2010. The total increase of $55,300 or 9.8% includes $35,600 of additional expense related to increased sales and marketing initiatives in both domestic and international markets, $111,300 related to business development activities and ($46,800) for converted foreign currency.
 
Selling, general and administrative expenses for the nine month period ended September 30, 2011 was $2,024,600 compared to $1,726,900 for the same periods in 2010. The total increase of $297,700 or 17.2% includes $21,700 being an additional expense recorded for options which fully vested upon retirement of an officer of the Company, $100,300 of additional expenses related to increased sales and marketing initiatives in both domestic and international markets, $205,600 related to professional fees related to business development and $20,000 in legal costs associated with the termination of the Watson Pharma, Inc. licensing and supply agreements.
 
Stellar continues to pursue 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.
 
Warrant Liability
 
The revaluation of the warrant liability at September 30, 2011 has resulted in a positive effect on warrant expense recorded for the three and nine month periods ended September 30, 2011, with a credit of $266,000 and $201,800, respectively (2010 - $nil and $nil, respectively) being recorded. Since the warrants are denominated in US dollars and the Company’s functional currency is in Canadian dollars, the fair market value of warrants fluctuates from period to period.  The fair market value is based on the current stock price, volatility, the risk free interest rate, time remaining until expiry and changes in the exchange rate between the US and Canadian dollar.
 
Interest and Other Income
 
Interest and other income during the three and nine month periods ended September 30, 2011 were $5,100 and $11,900, respectively (2010 - $2,900 and $5,900, respectively). These amounts include interest received on short-term investments for both 2011 and 2010.  In 2011, interest earned on the Company’s short-term investments was an average of 0.76% compared to an average of 0.67% in 2010.
 
 
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SUMMARY OF QUARTERLY RESULTS

Quarter Ended
 
Revenues
   
Net Income
(loss)
   
Earnings
(loss) per share
 
September 30, 2011
  $ 689,200     $ 112,300     $ 0.00  
June 30, 2011
    1,072,700       58,400       0.00  
March 31, 2011
    634,000       (302,895 )     (0.01 )
December 31, 2010
    666,700       (968,400 )     (0.03 )
September 30, 2010
    2,236,900       1,380,800       0.06  
June 30, 2010
    1,255,800       360,800       0.02  
March 31, 2010
    577,900       (247,500 )     (0.01 )
December 31, 2009
    907,600       23,200       0.00  
 
LIQUIDITY AND CAPITAL RESOURCES
 
Cash and cash equivalents totaled $3,511,400 at September 30, 2011 as compared with $4,352,300 at December 31, 2010.
 
At September 30, 2011, the Company did not have any outstanding indebtedness.
 
The Company may seek additional funding, primarily by way of one or more equity offerings, to carry out its business plan and to minimize risks to its operations.  The market for equity financing for companies such as Stellar is challenging and there can be no assurance that additional funding will become available by way of equity financing. Any additional equity financing may result in significant dilution to the existing shareholders at the time of such financing.  The Company may also seek additional funding from other sources, including technology licensing, co-development collaborations, and other strategic alliances. Such funding, if obtained, may reduce the Company’s interest in its projects or products.  Regardless, there can be no assurance that any alternative sources of funding will be available to the Company.
 
OFF-BALANCE SHEET ARRANGEMENTS
 
The Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
 
RELATED PARTY TRANSACTIONS
 
The Company entered into a fiscal advisory and consulting agreement with LMT Financial Inc. ("LMT") (a company beneficially owned by a director and interim officer of the Company and his spouse) for services provided in the normal course of business. Advisory and consulting fees under this agreement were $6,600 per month.  This agreement was cancelled on January 17, 2011. During the three and nine month periods ended September 30, 2011, the Company recorded and paid $3,300 (2010 - $19,800 and $58,800, respectively) as selling, general and administrative expense on account of this agreement.
 
 
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On January 17, 2011, the Company retained Arnold Tenney, through LMT, as a consultant to act as Interim President and Interim Chief Executive Officer of the Company. Under the terms of this agreement, LMT will cease being paid under the fiscal advisory and consulting agreement until the appointment of a permanent CEO and President. In consideration for the services provided by Mr. Tenney, LMT is paid $16,700 per month. During the three and nine month periods ended September 30, 2011, the Company has recorded and paid $50,100 and $142,000, respectively (2010 - $nil) as selling, general and administrative expense.
 
During the three and nine month periods ended September 30, 2011, the Company recorded $41,600 and $62,600, respectively, for various legal services (2010 – $nil) provided by a law firm in which one of the directors of the Company is a partner, which have been recorded as selling, general and administrative expense.
 
CAPITAL STOCK
 
The Company has authorized an unlimited number of Common Shares, without par value.  There are no other classes of shares issued.  During the three month period ended September 30, 2011, no Common Shares (2010 – 105,000) were issued.  During the nine month periods ended September 30, 2011, the Company issued 25,002 Common Shares  as default shares due to late registration of the Common Shares subject to the private placement offering completed in October 2010 (2010 – 105,000 (100,000 to directors, officers and employee’s for options exercised and 5,000 to consultants for services rendered) .  As of the date of this report, the Company has 24,610,042 Common Shares issued and outstanding.
 
As of the date of this report, the Company had 1,029,500 Common Share options outstanding with an average exercise price of $0.83 per option.
 
SIGNIFICANT CUSTOMERS
 
During the three month period ended September 30, 2011, the Company had two significant customers that represented 48.3% (one major wholesaler –37.8% and one international customer – 10.5%) of product sales (2010 - two significant customers that represented 72% (one major wholesaler – 12%; and one international customer – 60%). During the nine month period ended September 30, 2011, the Company had one significant customer that represented 31.3% (a major wholesaler) of product sales (2010 – three significant customers that represented 64% (one major wholesaler – 19%; and two international customers – 33% and 12%).   The Company believes that its relationship with this customer is satisfactory.
 
OUTLOOK
 
As at November 9, 2011, the Company is debt free and had working capital of $3,638,900.  The Company believes, although there can be no assurance, that it can continue to fund its ongoing operations from several sources, including the sale of its products and royalty income resulting from out-licensing agreements for at least the next 12 months.
 
As discussed above under the heading "Liquidity and Capital Resources", the Company may seek additional funding, primarily by way of one or more equity offerings, to carry out its business plan and to minimize risks to its operations.
 
 
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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Stellar is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information required under this Item.
 
ITEM 4.  EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
 
(a)     Evaluation of Disclosure Controls and Procedures
 
Based on an evaluation of the Company’s disclosure controls and procedures performed by the Company’s Chief Executive Officer and Chief Financial Officer as of the end of the period covered by this report, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.
 
As used herein, “disclosure controls and procedures” means controls and other procedures of the Company that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms issued by the SEC.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.
 
(b)     Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by this report that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

ADDITIONAL INFORMATION
 
The Company makes available free of charge through our website, www.stellarpharma.com, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as soon as reasonably practicable after those reports are filed with or furnished to the Securities and Exchange Commission (“SEC”).
 
The public may read any of the items we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549.  The public may obtain information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding the Company and other issuers that file electronically with the SEC at http://www.sec.gov.
 
 
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PART II.   OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS.
 
None.

ITEM 1A.  RISK FACTORS.

Stellar is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide information required under this Item.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 
None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

None.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
None.

ITEM 5.  OTHER INFORMATION.
 
None.
 
ITEM 6.    EXHIBITS.
 
Exhibit No.
Description     
 
Certificate of the Chief Executive Officer pursuant Section 302 of the Sarbanes-Oxley Act of 2002
 
Certificate of the Chief Financial Officer pursuant Section 302 of the Sarbanes-Oxley Act of 2002
 
Certificate of the Chief Executive Officer pursuant Section 906 of the Sarbanes-Oxley Act of 2002
 
Certificate of the Chief Financial Officer pursuant Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
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SIGNATURES
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed by the undersigned thereunto duly authorized.
 
 
STELLAR PHARMACEUTICALS INC.
     
     
 
By:
/s/ Arnold Tenney
 
   
Arnold Tenney
Chief Executive Officer
   
 
Date: November 14, 2011
 
 
 
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