e10vk

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K


þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the fiscal year ended December 31, 2007


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from to

Commission file number: 000-51686

NUCRYST Pharmaceuticals Corp.

(Exact name of registrant as specified in its charter)


Alberta, Canada (State or other jurisdiction of incorporation or organization)		Not Applicable (I.R.S. Employer Identification No.)

50 Audubon Road, Suite B Wakefield, Massachusetts (Address of principal executive offices)		01880 (Zip Code)

(781) 224-1444

(Registrant’s telephone number, including area code)

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


Title of Each Class:		Name of Exchange on which registered:
Common shares, no par value		The NASDAQ Stock Market LLC

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (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 Act). Yes o No þ

As of June 30, 2007, the aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates of the registrant was $9,867,125 based on the closing price of the registrant’s common shares of U.S. $2.13, as reported on the NASDAQ Global Market on that date. Shares of the registrant’s common shares held by each officer and director and each person who owns 10% or more of the outstanding common shares of the registrant have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.


Class		Outstanding at February 11, 2008
Common Shares, no par value		18,367,563 shares

Documents incorporated by reference: None.

TABLE OF CONTENTS


Part I
Item 1.	Business	4
Item 1A.	Risk Factors	20
Item 2.	Properties	39
Item 3.	Legal Proceedings	39
Item 4.	Submission of Matters to a Vote of Security Holders	39

Part II
Item 5.	Market for the Registrant’s Common Equity; Related Stockholder Matters and Issuer Purchases of Equity Securities	40
Item 6.	Selected Financial Data	42
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	44
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	59
Item 8.	Financial Statements and Supplementary Data	60
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	78
Item 9A.	Controls and Procedures	78
Item 9B.	Other Information	78

Part III
Item 10.	Directors and Executive Officers and Corporate Governance	79
Item 11.	Executive Compensation	82
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	94
Item 13.	Certain Relationships and Related Transactions, and Director Independence	97
Item 14.	Principal Accountant Fees and Services	99

Part IV
Item 15.	Exhibits, Financial Statements Schedules	100
Signatures		105
Index to Exhibits
Exhibit 10.27
Exhibit 10.44
Exhibit 10.45
Exhibit 10.46
Exhibit 10.47
Exhibit 10.48
Exhibit 10.49
Exhibit 10.50
Exhibit 10.51
Exhibit 23.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

In this Form 10-K, unless otherwise specified, all monetary amounts are in United States dollars, all references to “$”, “U.S.$”, “U.S. dollars” and “dollars” mean U.S. dollars and all references to “C$”, “Canadian dollars” and “CDN$” mean Canadian dollars. To the extent that such monetary amounts are derived from our consolidated financial statements included elsewhere in this Form 10-K, they have been translated into U.S. dollars in accordance with our accounting policies as described therein. Unless otherwise indicated, other Canadian dollar monetary amounts have been translated into United States dollars at the December 31, 2007 noon buying rate reported by the Federal Reserve Bank of New York, being U.S. $1.00 = C$0.9881. For more detailed information on foreign exchange rates for 2005, 2006 and 2007, please refer to the table on page 58. The exchange rates for 2003 and 2004 were as follows:


Year Ended December 31,	Period End Rate		Period Average Rate		High Rate		Low Rate

2003		1.2923		1.4008		1.5750		1.2923
2004		1.2034		1.3017		1.3970		1.1775

FORWARD-LOOKING STATEMENTS

The information in this Annual Report on Form 10-K which includes Management’s Discussion and Analysis, include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and/or forward-looking information under applicable Canadian provincial securities laws (collectively “forward-looking statements”) which are subject to the “safe harbor” created by those sections. Forward-looking statements reflect our current views with respect to future events and financial performance. These statements include forward-looking statements both with respect to us specifically and the pharmaceutical and medical device industry and business, demographic and other matters in general. The words “expect,” “intend,” “plan,” “believe,” “project,” “estimate,” “anticipate,” “may,” “will,” “continue,” “further,” “seek,” and similar words or statements of a future or forward-looking nature are intended to identify forward-looking statements for purposes of the federal securities laws or otherwise, although not all forward-looking statements contain these identifying words.

All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results and other circumstances and events to differ materially from those indicated in these statements. We believe that these factors include but are not limited to those described under “Risk Factors” above and the following:


	•	our ability to succeed in the initiation, timing, progress and results of our preclinical and clinical trials, research and development programs;

	•	our reliance on and ability to succeed in maintaining our relationship with Smith & Nephew, plc (“Smith & Nephew”);

	•	our reliance on sales of Acticoat^tm products with our SILCRYST^tm coatings by Smith & Nephew;

	•	our ability to achieve cost savings sufficient to substantially or to completely offset the manufacturing cost rebate we have agreed to pay Smith & Nephew;

	•	our ability to successfully implement our business model, strategic plans for our business, product candidates and technology;

	•	our ability to successfully file supplementary 510(k) applications to broaden the indications cleared for our NPI 32101 barrier cream and obtain clearance from the U.S. Food and Drug Administration (“FDA”) as well as other applicable filings with the European Union and Canadian authorities;

	•	our ability to succeed at establishing a successful commercialization program for our NPI 32101 barrier cream through corporate collaborations or otherwise;

	•	the scope of protection we are able to establish and maintain for intellectual property rights covering our product candidates and technology;

	•	our ability to operate our business without infringing the intellectual property rights of others;

	•	estimates of our expenses, future revenues, capital requirements and our needs for additional financing;

	•	our ability to comply with applicable governmental regulations and standards;

	•	the timing or likelihood of regulatory filings and approvals;

	•	our financial performance;

	•	competitive companies, technologies, products and our industry;

	•	changes in regulation or tax laws applicable to us;

	•	changes in accounting policies or practices;

	•	changes in general economic conditions;

	•	other risks and uncertainties that have not been identified at this time; and

	•	management’s response to these factors.

The foregoing list should not be construed as exhaustive, and should be read in conjunction with the other cautionary statements that are included in this annual report. Other than as required by applicable law, we undertake no obligation publicly to update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Any forward-looking statements you read in this annual report reflect our current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity and the markets for our current and proposed products. You should specifically consider the factors identified in this annual report that could cause actual results to differ.

We may from time to time file further 510(k) applications with the FDA, as well as other applicable filings, with the European Union and Canadian authorities, in relation to our NPI 32101 barrier cream and for other potential new products in the ordinary course of our business. We may or may not disclose such filings in the future. There can be no assurance that any of these applications will lead to a commercially viable product.

Unless the context otherwise requires, all references to “NUCRYST”, “we”, “our”, “company” and “us” in this Annual Report on Form 10-K refer to NUCRYST Pharmaceuticals Corp. and its subsidiaries.

INDUSTRY AND MARKET DATA

This annual report includes industry and market data concerning our business and the markets for our current and proposed products, including data regarding the size of these markets and their projected growth rates, the incidence of certain medical conditions and sales of certain drugs and healthcare products. This information was obtained from our own research, industry and general publications and reports prepared by third parties, including Frost & Sullivan’s 2005 Global Advanced Wound Management Markets report. Although we believe that information from third-party sources is reliable, we have not independently verified any of this information and we cannot assure you that it is accurate. Similarly, our own research, while believed by us to be reliable, has not been verified by any independent sources.

PART I

ITEM 1. BUSINESS

Overview and Current Years’ Developments

We develop, manufacture and commercialize innovative medical products that fight infection and inflammation. Our patented technology enables us to convert silver’s microcrystalline structure into an atomically disordered nanocrystalline coating that we believe enhances silver’s natural antimicrobial properties by providing for the sustained release of an increased quantity of positively-charged particles called ions. We believe currently marketed wound care products with our nanocrystalline silver combat infection longer than other silver-based wound care products that we view as major competitors and offer a broader spectrum of antimicrobial activity than many topically applied antibiotics. In addition, our nanocrystalline silver structures have exhibited potent anti-inflammatory properties in preclinical studies. We produce our nanocrystalline silver as a coating for wound dressing products under the trademark SILCRYST^tm and as a powder, which we refer to as NPI 32101, for use in medical devices and as an active pharmaceutical ingredient (“API”).

Following our inception in 1997, we developed and sold advanced wound care products with our SILCRYST^tm coatings under the Acticoat^tm trademark until May 2001 when we entered a series of agreements with Smith & Nephew plc (“Smith & Nephew”), a global medical device company. Under these original agreements, we licensed to Smith & Nephew the exclusive right to market, distribute and sell products with our SILCRYST^tm coatings for use on non-minor skin wounds and burns on humans world-wide, and we agreed to manufacture these products and supply them exclusively to Smith & Nephew. We also sold various assets to Smith & Nephew in connection with the license and supply agreements, including the Acticoat^tm trade name and trademark, various regulatory approvals and certain manufacturing equipment, which we lease back. We have worked with Smith & Nephew to develop new Acticoat^tm wound care products with our SILCRYST^tm coatings. Smith & Nephew’s launch of Acticoat^tm Post-Op and Acticoat^tm Site products in April 2007 resulted from these efforts, increasing the number of wound care products with our SILCRYST^tm coating currently sold by Smith & Nephew to a total of six.

On September 30, 2007, we entered into amended license and supply agreements with Smith & Nephew. Smith & Nephew advised us, and, based on our own information, we believed that the advanced wound care market, including the silver dressing segment, had become significantly more competitive since the original agreements had been signed in 2001. Both parties recognized the need to restructure the agreements to better enable the parties to work jointly and individually to support both the continued growth of Acticoat^tm products and our respective businesses in the context of increasing competitive pressures. Pursuant to the amended agreements, a non-compete clause in the original agreements

was deleted to allow Smith & Nephew to broaden its wound care dressings product line to include other forms of silver. In exchange, Smith & Nephew’s exclusive license was limited in the new agreements to existing Acticoat^tm products and such new wound care or burn products that the parties agree to develop together using our nanocrystalline silver technology. As well, under the new agreements, we may develop our own wound care and burn products using our nanocrystalline silver technology provided that we offer such products to Smith & Nephew first. If Smith & Nephew refuses to purchase the new products, we are then free to pursue the commercialization of the products in any manner we choose.

Effective January 1, 2007, under the new supply agreement, the method by which we determine the price we charge for the products we manufacture and supply to Smith & Nephew changed from a fully allocated cost of manufacturing reimbursement mechanism to a system whereby we recover a fixed overhead charge plus all direct costs incurred in manufacturing Acticoat^tm products, including material, labor, labeling, testing and packaging costs. In addition, as part of the new pricing mechanism, we agreed to pay Smith & Nephew an annual manufacturing cost rebate in the amount of $4.5 million in each of 2007, 2008 and 2009 in anticipation of annual reductions we intend to achieve in our cost of goods manufactured for Smith & Nephew over the same time period. We recognize the manufacturing cost rebate as a reduction to wound care product revenue. We made adjustments to our manufacturing and research operations in 2007 to conserve cash and control expenses including reductions in our workforce of approximately 12% of our total employees. Through these workforce reductions together with the implementation of manufacturing production efficiencies and overhead cost reduction initiatives, we achieved actual reductions in our overhead costs in 2007 sufficient to partially offset the manufacturing cost rebate we paid to Smith & Nephew in 2007. We have also shifted the focus of our research and development efforts from clinical work towards preclinical work for gastrointestinal applications of our nanocrystalline technology and towards establishing a partnership for our NPI 32101 cream as a 510(k) prescription device.

Our results of operations currently depend solely on Acticoat^tm product sales generated by Smith & Nephew, which is our only customer and our sole source of revenue. The Acticoat^tm product line competes in the advanced wound care products market, which according to Frost & Sullivan, a market research firm, was an approximately $1.5 billion global market in 2005 and is projected to grow to approximately $2.6 billion by 2011. The Acticoat^tm product line targets the premium priced segments of the serious wound care dressings market. Acticoat^tm products with our SILCRYST^tm coatings have received FDA clearance and approval of other regulators for over 30 countries around the world and are used for a wide variety of wound types by hospitals, clinics, burn centers, doctors’ offices, home healthcare agencies and nursing homes. Smith & Nephew has reported that its sales of Acticoat^tm products were $49 million in 2005, $54 million in 2006 and $60 million in 2007.

We are continuing our efforts to develop pharmaceutical products containing our NPI 32101 silver to extend our nanocrystalline silver technology to the treatment of gastrointestinal conditions. We were also developing a pharmaceutical topical cream containing NPI 32101 for the treatment of dermatologic conditions until November 2006 when we announced the discontinuance of all plans to pursue the studied formulation for this disease. However, we still believe our NPI 32101 cream has the potential to treat a variety of skin conditions and we are exploring ways to bring this antimicrobial cream to market.

In furtherance of this initiative, in July 2007, we announced that the FDA granted 510(k) clearance for a topical prescription device containing our NPI 32101, as a broad spectrum antimicrobial barrier cream to organisms. Gaining FDA clearance is only the first step toward marketing our proprietary technology in this new formulation. We are continuing to explore commercialization options and, as part of this process, marketing plans and launch timing for this product. We have filed another 510(k) application with the FDA to expand the claims and indications for our barrier cream.

Based on the preclinical results in a variety of in vitro and in vivo models and the consistently favorable safety data generated in studies performed to date, we continue to believe that NPI 32101 has the potential to treat various inflammatory and infectious conditions. For example, we are conducting preclinical research for the use of NPI 32101 for the treatment of gastrointestinal conditions. In 2007, we shifted the focus of our research and development efforts from clinical work towards preclinical work for gastrointestinal applications of our nanocrystalline technology and towards establishing a partnership for our NPI 32101 cream as a 510(k) prescription device. In furtherance of these and other research and development activities, we incurred research and development costs of $6.3 million in 2007, $11.2 million in 2006 and $8.5 million in 2005. These amounts include research and development expenses we incurred in relation to Smith & Nephew-sponsored research activities relating to the development of new Acticoat^tm products with our SILCRYST^tm coatings or improvements to existing Acticoat^tm products. Up until September 30, 2007, we were

reimbursed by Smith & Nephew for all such expenses which reimbursement we recognized as research revenue. After September 30, 2007, as part of the amendments to our licensing agreement with Smith & Nephew, we agreed to limit the amount by which Smith & Nephew is required to reimburse us for such research and development expenses we incur in a given calendar year to only those amounts we incur in excess of 1.5% of net sales of Acticoat^tm products for that year. We received no reimbursements for research and development expense from Smith & Nephew in respect of 2007.

In August 2007, our Board of Directors announced that Mr. Thomas E. Gardner was appointed Chairman of the Board, President and Chief Executive Officer. Mr. Gardner is an experienced CEO with a track record of creating shareholder value. We believe that Mr. Gardner’s experience in managing emerging healthcare technology companies will benefit NUCRYST in the development and commercialization of our pipeline of medical products. A director of NUCRYST since May 2007, Mr. Gardner specializes in the strategic positioning of companies with particular emphasis on pharmaceuticals, medical devices and healthcare information. Prior to his current assignments, Mr. Gardner was CEO of a number of public and private companies including Songbird Hearing, Datamonitor, Base Ten Systems and Access Health. From 1970 to 1995, Mr. Gardner held senior marketing and general management positions at Procter & Gamble, Johnson & Johnson, Simon & Schuster and IMS Health.

Company Information

We were incorporated under the Alberta Business Corporations Act on December 18, 1997. We have one wholly owned subsidiary, NUCRYST Pharmaceuticals Inc. that was incorporated under the laws of the State of Delaware on November 20, 1997. Our principal executive offices are located at 50 Audubon Road, Suite B, Wakefield Massachusetts, and our telephone number at that address is (781) 224-1444. Our registered office is at 10102 — 114 Street, Fort Saskatchewan Alberta T8L 3W4.

We are a majority owned subsidiary of The Westaim Corporation (“Westaim”), a Canadian company incorporated in Alberta and the shares of which are listed on the Toronto Stock Exchange (“TSX”) and formerly listed on the NASDAQ Global Market (“NASDAQ”). On April 10, 2007, Westaim received notice from NASDAQ that for 30 consecutive business days the bid price of Westaim’s common shares listed on NASDAQ closed below U.S. $1.00, in contravention of NASDAQ’s marketplace rules. Westaim was given 180 calendar days to regain compliance by achieving a bid price at or above U.S. $1.00 per share for a minimum of ten consecutive days. Westaim did not regain compliance with the bid price requirement. Effective October 18, 2007, Westaim’s shares were delisted from the NASDAQ. Over the 12 months prior to the delisting, more than 80% of Westaim’s trading volume had occurred on the TSX and Westaim will continue to trade on the TSX under the symbol “WED”.

Our Nanocrystalline Technology

Silver, platinum and gold, which are elements of the noble metals group, have long been known to have medicinal properties. For example, platinum is the primary active ingredient in cisplatin, a prominent cancer drug. Similarly, gold is the active agent in some treatments for rheumatoid arthritis. We selected silver as the first noble metal for the application of our proprietary nanotechnology based on silver’s antimicrobial properties. Although silver’s medicinal properties have been well known for centuries, we believe its use in its microcrystalline form has been limited due to its slow release of relatively small quantities of silver ions and the widespread use of antibiotics. Silver is composed of large microcrystals, usually of one or two microns in diameter or greater. These microcrystals dissolve slowly, thereby limiting the rate and amount of silver released over time. By converting silver’s microcrystalline structure into an atomically disordered nanocrystalline structure, we believe that we enhance silver’s release and efficacy characteristics and thereby make it a more effective antimicrobial agent.

Antibacterial agents inhibit or kill bacterial cells by attacking one of the bacterium’s structures or processes. Common targets are the bacterium’s outer shell (called the “cell wall”) and the bacterium’s intracellular processes that normally help the bacterium grow and reproduce. However, since a particular antibiotic typically attacks one or a limited number of cellular targets, any bacteria with a resistance to that antibiotic’s killing mechanism could potentially survive and repopulate the bacterial colony. Over time, these bacteria could make resistance or immunity to this antibiotic widespread. Unlike antibiotics, silver has been shown to simultaneously attack several targets in the bacterial cell and therefore it is thought to be less likely that bacteria would become resistant to all of these killing mechanisms and thereby create a new silver-resistant strain of bacteria. This may be the reason that bacterial resistance to silver has not yet been widely observed despite its centuries-long use. This can be particularly important in hospitals, nursing homes and other healthcare institutions where patients are at risk of developing infections. As a result, we believe that our nanocrystalline

silver fulfills a large unmet need for effective, locally administered antimicrobial products that are not as susceptible to bacterial resistance.

Our SILCRYST^tm coatings exhibit rapid antimicrobial activity, killing many organisms within 30 minutes of application, which is faster than many other commercially-available forms of antimicrobial silver. These organisms include gram positive and gram negative bacteria, including some antibiotic resistant strains in both classes, as well as fungi and yeast. We have designed our SILCRYST^tm coatings to provide sustained antimicrobial activity for up to seven days.

We have demonstrated in non-clinical studies that our nanocrystalline silver exhibits anti-inflammatory properties in three ways. It suppresses two naturally occurring inflammatory agents, specifically IL-12b and TNF , and reduces the level of a naturally occurring enzyme called MMP-9. While helpful at the correct levels, excessive amounts of these substances are associated with inflammation. In addition, it increases the natural cell death of certain inflammatory cells, specifically polymorphonuclear leukocytes, or PMNs.

Our manufacturing technology is currently based on a physical vapor deposition, or PVD, process called magnetron sputtering. The process begins by bombarding silver with positive ions to liberate, or sputter, nanosized silver-containing particles. These nanosized silver-containing particles are then re-condensed to form new atomically disordered nanocrystalline structures on various materials, called substrates. For example, we use high-density polyethylene as the substrate for some of our non-adherent wound care dressings.

While the PVD process is generally used to produce films or continuous coatings, we have developed methods to coat inert substrates and also have developed a method to produce our nanocrystalline silver in powder form for use in medical devices and as an API in pharmaceutical products. This powder consists of aggregates of silver nanocrystals which can be used in various formulations, such as creams, gels, liquids, tablets, capsules, suppositories and aerosols, for treating a variety of infectious or inflammatory conditions, which are both present in some cases.

Market Overview

Wound Care Market

Acticoat^tm products with our SILCRYST^tm coatings compete in the advanced wound care market, which includes products for chronic wounds, serious burns and traumatic and surgical wounds. According to Frost & Sullivan, advanced wound care products was an approximately $1.5 billion global market in 2005 and the advanced wound care dressings market is projected to grow to approximately $2.6 billion by 2011. We believe that the aging population and growing incidence of diabetes and obesity in many of our markets are driving an increase in the incidence of serious and difficult-to-heal wounds. In addition, we believe that wound care technology is motivating physicians to increase their use of advanced wound care products.

Advanced wound care products are frequently used in the treatment of chronic wounds. Chronic wounds include pressure ulcers, diabetic foot ulcers and venous stasis ulcers. Pressure ulcers are caused by unrelieved pressure or by tissue layers sliding over each other. According to a 2002 presentation by Frost & Sullivan, there were approximately 2.4 million human pressure ulcers in the United States. In addition, according to a 2005 report by Frost & Sullivan, approximately 7% of the 19.4 million people with diabetes in the United States suffered from diabetic foot ulcers in 2004. We believe that diabetic foot ulcers are one of the most difficult types of chronic wounds to heal. In 2004, approximately 129,000 non-traumatic lower limb amputations occurred, according to data from the 2004 U.S. Hospital Discharge Report. Venous stasis ulcers typically affect the elderly and are caused by the inability of blood to circulate effectively through the venous system in the leg. According to information published in 2003 by the Cleveland Clinic, a leading healthcare institution, approximately 500,000 people in the United States have venous stasis ulcers.

Chronic wounds generally occur more frequently among diabetic, elderly, immobile or seriously ill people due to their diminished healing capabilities or immobility. It is often difficult to prevent pressure ulcers by repositioning patients due to the staffing limitations in hospitals, nursing homes and other healthcare facilities. In addition, it can be difficult to consistently prevent the formation of venous stasis or diabetic foot ulcers because of the patient’s chronic underlying disease or other health issues. Traditional gauze treatments for chronic wounds require frequent dressing changes that can disrupt the wound, which can retard or prevent the healing process. In addition, chronic wounds are often prone to infection.

Matrix metalloproteinases, or MMPs, are enzymes that digest tissue and that thereby regulate the formation of new tissue and blood vessels in a healing wound. MMP-9 is one of these enzymes. Studies of human tissue samples indicate

that excess levels of MMP-9 and other MMPs, particularly in wounds such as chronic ulcers, may contribute to non-healing or slow healing by digesting newly formed tissue faster than the wounds can heal. We have demonstrated in non-clinical studies that our nanocrystalline silver reduced the level of MMP-9.

According to a 2005 report of the National Institute of General Medical Sciences, each year in the United States approximately 1.1 million burn injuries require medical attention; approximately 45,000 of these require hospitalization, and roughly half of those burn patients are admitted to a specialized burn unit; up to 10,000 people in the United States die every year of burn-related infections; and complications following serious burns may occur long after the initial incident, often when the patient is in an intensive care unit. Prior to the introduction of Acticoat^tm in 1998, the standard of care for serious burns had been the use of antibacterial ointments or solutions, usually a form of silver, covered by sterile dressings. Because these creams and solutions are short acting forms of silver, these dressings generally needed to be changed at least daily or more frequently, which can be painful and can interfere with healing because of disruption of the wound bed. Acticoat^tm dressings with SILCRYST^tm coatings are generally non-adherent and provide for up to seven days of antimicrobial protection. Since its introduction, Acticoat^tm has been rapidly adopted to replace short acting creams and solutions.

Another important segment of the advanced wound care market is the treatment of traumatic wounds and surgical wounds. Traumatic wounds often have irregular edges and missing flesh, making them difficult to heal and prone to infection. According to the March-April 2005 Journal of the American Podiatric Medical Association, citing data published in 1988, approximately 10 million patients with traumatic wound injuries are seen in U.S. emergency departments each year. Surgical wounds, resulting from incisions, are more regular than traumatic wounds, but still have the potential to become infected. In the United States there were approximately 31 million surgical procedures performed in 2005 according to the 2005 National Hospital Discharge Survey, a survey conducted by the National Center for Health Statistics, a department of the United States Department of Health and Human Services. These procedures range from spinal taps with a needle incision to open heart surgeries, which require large chest incisions. With the increasing resistance of many infectious agents to systemic antibiotics, there is a need for products that can help prevent the entry of infectious agents into the body. We believe that this market segment presents a natural extension for our SILCRYST^tm coatings for wound care products.

Pharmaceutical Market

Following the cancellation in November 2006 of any further development of the pharmaceutical topical cream containing NPI 32101 for the treatment of atopic dermatitis, we are focusing our current pharmaceutical development activities on products containing NPI 32101 silver to treat gastrointestinal conditions.

The gastrointestinal market is composed of the drugs and other treatments for the many diseases causing heartburn, acid indigestion and bowel disorders. We have begun exploring the use of our nanocrystalline technology to treat inflammatory bowel disease, or IBD, consisting of ulcerative colitis and Crohn’s disease. Ulcerative colitis and Crohn’s disease are typically treated with anti-inflammatories, immunomodulators, corticosteroids, antibiotics or other treatments. According to IMS Health, prescription U.S. drug sales for the treatment of IBD were over $1 billion in 2006, including approximately $500 million for the treatment of ulcerative colitis.

Our first focus is on the development of products for the treatment of ulcerative colitis. Ulcerative colitis affects approximately half a million people in the United States alone and about 50% have mild symptoms. The first line of treatment for mild-to-moderate disease is typically a class of drugs known as the 5-ASAs (aminosalicylates). However, not all patients comply with dosing, tolerate the medication, or respond to treatment. If patients do not respond to the 5-ASAs, the other options include much stronger therapies such as biologics, immunomodulators or steroids, which carry potentially severe side effects and high cost in the case of the biologics.

We have completed promising pre-clinical research using NPI 32101 in ulcerative colitis. We have demonstrated in preclinical in vivo models of ulcerative colitis a positive dose response and demonstrated efficacy of NPI 32101 given both orally and rectally. These studies have been repeated with similar efficacy. We believe that NPI 32101 may hold significant potential as a new class of drug in the treatment of ulcerative colitis because it has a novel action and is not another 5-ASA.

A second focus area of development within gastroenterology is the treatment of Clostridium difficile (“C difficile”) associated disease (CDAD). Ulcerative colitis patients may be particularly at risk, however, C difficile is a growing problem in hospitals and a major cause of colitis and diarrhea. During 2007, we presented data at two medical meetings,

the Interscience Conference on Antimicrobial Agents and Chemotherapy and the American College of Gastroenterology on the antimicrobial activity of our nanocrystalline silver against both vegetative and spore forms of C difficile.

Acticoat^tm Products With Our SILCRYST^tm Coatings

We initially developed and received regulatory clearance to market, and then licensed to Smith & Nephew in May 2001, four products using our SILCRYST^tm coatings for the advanced wound care market. In April 2007, together with Smith & Nephew, we developed two new dressings, increasing the number of wound care products with our SILCRYST^tm coating currently sold by Smith & Nephew to a total of six. Pursuant to our amended agreements with Smith & Nephew, we have licensed to Smith & Nephew the exclusive worldwide rights to market, distribute and sell these six existing products with our SILCRYST^tm coatings and any new products that use our SILCRYST^tm coatings or powder technology for use on non-minor skin wounds and burns on humans that we develop together in accordance with the terms of the agreements. Smith & Nephew markets these products under its Acticoat^tm trademark to healthcare professionals in over 30 countries. Currently, we believe that the existing Acticoat^tm product line using our SILCRYST^tm coatings targets the premium price segments of the serious wound care dressings market.

In addition to the antimicrobial and anti-inflammatory effects of Acticoat^tm, Smith & Nephew is promoting the use of Acticoat^tm products with SILCRYST^tm coatings to help reduce the risk of methicillin-resistant Staphylococcus aureus, or MRSA, transmission. MRSA is one of the many antibiotic-resistant bacteria sometimes called “super bugs”. Our SILCRYST^tm products have proven efficacy in controlling MRSA in the laboratory and the clinic. An independent study sponsored by Smith & Nephew and published in the July 2005 issue of the Journal of Hospital Infection concluded that of all clinically observed wounds treated with Acticoat^tm dressings in the study, 67% showed a decrease in the MRSA load and 11% showed a complete eradication of MRSA load. The study consisted of using Acticoat^tm dressings as a cover for ten MRSA colonized wounds in a total of seven patients over the course of three days. Based on these findings, the authors of this study stated their belief that nanocrystalline silver dressings may become an important part of local MRSA management, with potential cost benefits to both patients and the healthcare system. In addition, the authors noted the possibility that nanocrystalline silver dressings may enhance effective antibiotic treatment and reduce therapeutic regimens in diabetics or other patients with conditions that often cause systemic antibiotics to fail to reach infected wounds.

Health care professionals select different types of dressings for different types of wounds. Some wounds are dry while others have excess fluid, or exudate. As a result, an effective portfolio of products must address various wound types. As described below, Smith & Nephew’s Acticoat^tm product family with our SILCRYST^tm coatings is designed to treat a wide variety of serious wounds. Each of these currently marketed products has been cleared by the FDA and Health Canada.

Acticoat^tm 3/Acticoat^tm Burn Dressings

Acticoat^tm 3 and Acticoat^tm Burn are dressings offering antimicrobial activity for up to three days. They were first sold in the United States in 1998 and in Europe in 2001, where they are sold under the brand name Acticoat^tm. Smith & Nephew currently sells these products in over 30 countries around the world, including the United States. Acticoat^tm 3 and Acticoat^tm Burn are used extensively in the in-patient burn segment of the wound dressing market. They consist of a rayon/polyester non-woven core between two layers of high-density polyethylene, or HDPE, mesh with SILCRYST^tm coatings that provides an antimicrobial barrier layer to protect wounds. A non-woven inner core retains moisture and improves handling characteristics.

Acticoat^tm 7 Dressings

Acticoat^tm 7 is a dressing offering antimicrobial activity for up to seven days. It was first sold in the United States in 2000 and in Europe in 2001. Smith & Nephew currently sells Acticoat^tm 7 in over 20 countries around the world, including the United States. Acticoat^tm 7 is used primarily in the chronic wound segment of the wound dressing market. Acticoat^tm 7 provides consistent seven-day sustained antimicrobial protection for patients with venous stasis ulcers, diabetic foot ulcers, pressure ulcers and other persistent wounds and allows up to seven days before wound dressings are required to be changed. Acticoat^tm 7 consists of two rayon/polyester non-woven inner cores laminated between three layers of HDPE mesh with SILCRYST^tm coatings.

Acticoat^tm Absorbent Dressings

The Acticoat^tm Absorbent Dressing is an alginate dressing for wounds with moderate to heavy exudate, providing antimicrobial activity for up to three days. This product was first sold in 2001 and is currently sold in the United States, Canada and Europe. Acticoat^tm Absorbent Dressing is used primarily in the chronic wound segment of the wound dressing market. The Acticoat^tm Absorbent Dressing consists of a calcium alginate fabric coated on both sides with SILCRYST^tm nanocrystals. Alginate dressings are derived from seaweed and are highly absorbent, biodegradable fibrous materials. Alginate dressings are commonly used in advanced wound care because they absorb exudate to help create a moist wound healing environment.

Acticoat^tm Moisture Control Dressings

The Acticoat^tm Moisture Control Dressing is a solid foam dressing for wounds with light to moderate exudate, providing antimicrobial activity for up to seven days. Smith & Nephew currently sells the Acticoat^tm Moisture Control Dressing in the United States and Canada, and introduced it in Europe in 2006. The Acticoat^tm Moisture Control Dressing is used primarily in the chronic wound segment of the wound dressing market. The Acticoat^tm Moisture Control Dressing consists of an absorbent foam sandwiched between an outer film and a non-adherent wound contact layer with SILCRYST^tm coatings. The Acticoat^tm Moisture Control Dressing was developed in collaboration with Smith & Nephew.

We developed two new Acticoat^tm products in collaboration with Smith & Nephew, which were introduced by Smith & Nephew into the United States market in 2007.

Acticoat^tm Site

Acticoat^tm Site is an antimicrobial absorbent 3-layer polyurethane foam dressing for use around vascular and nonvascular percutaneous device sites such as intravenous catheter and external fixation sites that provides an effective barrier to microbial contamination protecting the insertion site from invasive pathogenic microorganisms for up to seven days.

Acticoat^tm Post-Op

Acticoat^tm Post-Op is an absorbent post-operative dressing for light to moderate exudate, providing an antimicrobial activity for up to seven days. Acticoat^tm Post-Op consists of a SILCRYST^tm coated polyurethane layer, a white polyurethane foam pad, and an adhesive coated waterproof polyurethane film layer.

New Acticoat^tm Products

We have worked with Smith & Nephew to develop new Acticoat^tm wound care products in the form of line extensions and innovative new dressing designs using SILCRYST^tm coatings. We believe that new products will support Smith & Nephew’s efforts to continue to grow Acticoat^tm sales by offering dressings designed for specific wound types. Our intent is to continually improve our nanocrystalline coatings so that Acticoat^tm products reflect our latest developments in silver delivery technology. Since the introduction of the Acticoat^tm dressing in 1998, the product line has grown from one to six dressing designs with multiple sizes within each dressing design. Several new products are in various stages of development.

Since the execution of the new agreements with us, Smith & Nephew has introduced three new wound care products which use other forms of silver (Algisite Ag, Allevyn Ag and Biostep Ag). We believe that some of these new silver based wound care products will compliment the existing Acticoat^tm products marketed by Smith & Nephew without impacting sales of Acticoat^tm products, while others may be viewed by the advanced wound care market as alternatives to certain Acticoat^tm products, thereby potentially adversely affecting Acticoat^tm product sales and ultimately our operating revenues in the foreseeable future.

Our Other Products

We bear all costs relating to our research and development activities for our prospective products that are not developed in conjunction with Smith & Nephew. Operating income from our wound care products, which we define as revenue (including milestone payments) less manufacturing costs and other expenses associated with SILCRYST^tm products covered by our agreements with Smith & Nephew, funds a large portion of our product development costs.

Topical Formulation with NPI 32101

While the second Phase 2 clinical trial of the topical cream formulation containing NPI 32101 for the treatment of mild to moderate atopic dermatitis in children and adolescents that we completed in September 2006 did not meet its primary end points, it did demonstrate that treatment with NPI 32101 cream was well tolerated and that the incidence of all adverse events was low and was not different among the NPI 32101-treated groups and the placebo-treated patients. In addition, our NPI 32101 cream formulation has been shown to be stable, cosmetically-acceptable, and to have broad spectrum antimicrobial activity in in vitro testing. Therefore, we believe our NPI 32101 cream has the potential to treat a variety of skin conditions and we are exploring ways to bring this antimicrobial cream to market. In furtherance of this initiative, in July 2007 we obtained 510(k) clearance for a prescription topical device containing our NPI 32101, as a broad spectrum antimicrobial barrier cream to organisms including Pseudomonas aeruginosa and Staphyloccocus aureus, including strains resistant to methicillin — or MRSA. Gaining FDA clearance is only the first step toward marketing our proprietary technology in this new formulation. We are continuing to explore commercialization options and marketing plans and launch timing for this product. Samples of our antimicrobial barrier cream containing our NPI 32101 have been developed. We are currently working on scaling up of production to support the potential commercial opportunities for this product. We have filed another 510(k) application with the FDA to expand the claims and indications for our barrier cream. We have applied for a claim that NPI 321010 cream relieves the signs and symptoms of dermatoses. If our application is cleared by the FDA, we believe it will broaden the market for this potential new product.

Our Pre-Clinical Programs

We are also researching potential pharmaceutical products containing NPI 32101 for use in the treatment of gastrointestinal disorders. Our nanocrystalline silver has exhibited the ability to suppress the expression of several inflammatory cytokines including TNFα and IL-12/23. Over expression of these two cytokines has been linked to IBD such as ulcerative colitis and Crohn’s disease. We have conducted preclinical studies that demonstrate a favorable effect of NPI 32101 on symptoms of ulcerative colitis including a reduction in colon thickening and ulceration. We are continuing these studies in an effort to develop formulations of our API for the treatment of serious gastrointestinal disorders such as mild to moderate ulcerative colitis because we believe that many patients do not respond to currently available treatments for IBD and our API appears, based on preclinical studies, to have anti-inflammatory effects at least equal to sulfasalazine, a drug used to treat IBD.

Our Clinical Development Program

Since the cancellation in 2006 of our clinical program for our topical formulation of NPI 32101 as a pharmaceutical candidate, we have not engaged in further human clinical studies.

Smith & Nephew Agreements

Prior to May 2001, we manufactured, marketed and sold Acticoat^tm wound care products directly to end users. In May 2001, we entered into a number of agreements with Smith & Nephew providing greatly expanded sales and marketing resources to support the Acticoat^tm product line, including a license and development agreement under which we licensed to Smith & Nephew the exclusive right to market, distribute and sell products with our SILCRYST^tm coatings that are designed and indicated solely for use on non-minor skin wounds and burns on humans world-wide, and a supply agreement under which we agreed to manufacture these products and supply them exclusively to Smith & Nephew. We also sold various assets to Smith & Nephew in connection with the license and development agreement and the supply agreement, including certain manufacturing equipment (which we then leased back), the Acticoat^tm trade name and trademark and various regulatory approvals. Pursuant to these original agreements, Smith & Nephew commenced marketing and selling products with our SILCRYST^tm coatings under its Acticoat^tm trademark.

Amended License and Development Agreement

Under the amended license and development agreement, Smith & Nephew has the exclusive right to market, distribute and sell the six existing Acticoat^tm products using our SILCRYST^tm coatings, including improvements to those products, and any new products for use on non-minor skin wounds and burns on humans, which use our SILCRYST^tm coatings or powder technology that we develop together with Smith & Nephew in accordance with the terms of the

agreement. In addition, a non-compete clause in the original license and development agreement was deleted from the new agreement allowing Smith & Nephew to broaden its wound care dressings product line to include other forms of silver. In exchange, Smith & Nephew’s exclusive license was limited in the new license and development agreement to the six existing Acticoat^tm products and to such new wound care or burn products that we agree to develop together in accordance with the terms of the agreement and using our nanocrystalline silver technology. As well, under the new license and development agreement, we may develop our own wound care and burn products using our nanocrystalline silver technology provided that we offer the new products to Smith & Nephew first. If Smith & Nephew declines to purchase the new products, we may then pursue the commercialization of the products in any manner we choose. The license and development agreement expires in May 2026, although it may be terminated earlier by either party if the other party fails to cure its material breach of the agreement, suspends its operations or ceases to carry on its business, files for bankruptcy or takes other similar actions.

Smith & Nephew has agreed to work with us to develop new products with our SILCRYST^tm coatings or powder technology for use on non-minor skin wounds and burns on humans. We have established a new product development steering group that includes representatives from both NUCRYST and Smith & Nephew to oversee and manage the development of new Acticoat^tm products under the license and development agreement. Once NUCRYST and Smith & Nephew agree in writing to pursue the development of a new product, it is deemed to be a “New Product” for the purposes of the agreement. We are responsible for our internal costs and expense incurred in connection with the development of New Products up to an aggregate maximum of 1.5% of net sales of Acticoat^tm products per calendar year and thereafter Smith & Nephew is obligated to reimburse us for all costs and expenses incurred in connection with the development, commercialization, marketing, promotion and sale of all New Products. In 2007, we did not receive any such reimbursement from Smith & Nephew.

We have granted Smith & Nephew a right of first offer to seek a license of wound care or burn products for use on non-minor skin wounds and burns on humans that we develop using our nanocrystalline silver technology on our own outside of the new product development group. If Smith & Nephew declines the opportunity, we are then free to license and sell such products to any person in any manner we choose. The license and development agreement includes performance standards for Smith & Nephew based on its net sales of Acticoat^tm products and other measures. Under certain circumstances, if the standards are not met, we would be permitted to market, distribute and sell products with our SILCRYST^tm coatings for use on non-minor skin wounds and burns on humans to other parties, other than Acticoat^tm 3/Acticoat^tm Burn and Acticoat^tm 7 which would continue to be subject to the provisions of the license and development agreement giving Smith & Nephew the exclusive right to sell those products in the United States and Canadian markets.

We have granted to Smith & Nephew a non-exclusive royalty-free license to use our SILCRYST^tm trademark for use in marketing, distributing and selling Acticoat^tm products under our agreements with them. This license also applies to any other marks we develop to identify products that contain our nanocrystalline silver coating technology. Subject to certain exceptions, Smith & Nephew has agreed to include these trademarks in all product labels and sales and promotional literature for Acticoat^tm products.

Smith & Nephew pays us royalties based on their sales of Acticoat^tm products. We also receive payments upon the achievement of milestones relating to Smith & Nephew’s sales of Acticoat^tm products and regulatory matters specified in the license and development agreement. All payments under the license and distribution agreement are made in U.S. dollars. In calculating sales levels for milestone payment thresholds and other purposes under the license and development agreement, sales by Smith & Nephew in currencies other than the U.S. dollar are converted to the U.S. dollar based on the average exchange rate for the prior quarter. In May 2004, in accordance with the agreements, the contractual royalty rate increased and from that date has remained and, under the terms of the agreements, is to remain constant for the life of the agreements, subject only to: (i) the possibility of a negotiated or arbitrator-awarded reduction in royalty rates on sales in countries where patent protection has been lost and a competing product is being sold that would have infringed our patent rights had they been in effect; (ii) the possibility of a negotiated reduction in royalty rates on sales of a particular Acticoat^tm product where Smith & Nephew does not realize industry standard margins on sales of such products; or (iii) a reduced royalty rate in respect of sales of Acticoat^tm products in certain countries, including the United States, upon the expiration of patent rights to our SILCRYST^tm coatings in such country. In addition, under our amended agreements with Smith & Nephew, our previous right to receive increased royalty rates on sales of particular Acticoat^tm products in which Smith & Nephew realized gross profit margins over a specified threshold was eliminated.

We earned a $1.0 million milestone payment in 2001 for the first sale of product in Europe and a $3.0 million milestone payment in 2003 for the receipt of a regulatory approval in Europe. We earned a $5.0 million sales milestone

payment in the first quarter of 2004, another $5.0 million sales milestone payment in the third quarter of 2004 and a $5.0 million sales milestone payment during the third quarter of 2005. No milestone payment was earned in 2006. In 2007, we earned a $5 million milestone in the third quarter and another $5 million in the fourth quarter. The maximum amount of milestone payments that we may receive under the Smith & Nephew agreements, including the $29.0 million of milestone payments we have already received, is $56.5 million.

We have granted Smith & Nephew a right of first offer regarding our assets and technology used to manufacture and supply Acticoat^tm products. This right of first offer applies only if we desire to sell all or substantially all of these assets. We have also granted to Smith & Nephew a right of first refusal regarding these assets if we receive an offer to purchase them, which we wish to accept, from a competitor of Smith & Nephew’s in the wound care market.

Supply Agreement

Our supply agreement with Smith & Nephew was amended on September 30, 2007. Pursuant to the amended agreement, Smith & Nephew has appointed us as its exclusive supplier of the existing Acticoat^tm products as well as any new products that we mutually agree to, and we have agreed not to sell these products to anyone else until such time as Smith & Nephew’s license to market, distribute and sell Acticoat^tm products containing our SILCRYST^tm coatings has terminated or expired. We are obligated to supply the quantity of Acticoat^tm product specified in a rolling demand forecast provided to us by Smith & Nephew on a monthly basis.

Effective January 1, 2007, the price paid for the products by Smith & Nephew under the revised supply agreement has been amended to recovery of a fixed overhead charge plus all direct costs incurred in manufacturing Acticoat^tm products, including material, labor, labeling, testing and packaging cost. This pricing mechanism will be used to establish the unit prices that we will charge for each Acticoat^tm product we supply to Smith & Nephew until the end of 2009. Unit prices will be set at the beginning of each year based on Smith & Nephew’s product forecast and may only be increased, with Smith & Nephew’s agreement, for actual cost increases we incur that are outside our reasonable control. Such cost increases are capped at the amount by which the local level of inflation has increased. The overhead component of the unit pricing mechanism has been fixed at a minimum floor amount equal to all indirect costs we incurred in 2007 related to the manufacture of Acticoat^tm products, including administration, labor, rent, insurance, utilities, repairs and quality control. Smith & Nephew is obligated to pay to us this fixed floor amount in each of 2007, 2008 and 2009 regardless of the actual volume of Acticoat^tm products ordered by Smith & Nephew and regardless of any actual overhead cost savings we achieve in those years. The new agreements provide for a reconciliation process such that if we have not received sufficient orders to cover the fixed overhead charge by a certain date each year, we are entitled to immediately invoice Smith & Nephew for the difference. On the other hand, if we have received orders in excess of that which is required to cover the fixed overhead charge by certain dates, Smith & Nephew is entitled to immediately invoice us for the difference. In each case, actual overhead is to be reconciled at December 31 of each year. All payments under the supply agreement are made in U.S. dollars.

Under the supply agreement, we lease certain manufacturing equipment from Smith & Nephew which represented approximately 50% of our total manufacturing capacity at December 31, 2007. If we suffer a material difficulty in supplying Acticoat^tm products and that difficulty is not cured on a timely basis, this lease would terminate and Smith & Nephew would have the right to take possession of the equipment it leases to us. In such case, Smith & Nephew would also receive the right to use our technology to manufacture, on its own, Acticoat^tm products for non-minor skin wounds and burns on humans. If within one year of Smith & Nephew commencing to manufacture Acticoat^tm products under these circumstances, we are able to demonstrate to the reasonable satisfaction of Smith & Nephew that we are once again able to manufacture products in accordance with our agreements with Smith & Nephew, our lease from Smith & Nephew of the previously leased manufacturing equipment would resume at a cost no greater than Smith & Nephew incurred during its period of manufacture, subject to our reimbursing Smith & Nephew for its costs incurred to establish and terminate its manufacturing operations and subject to any then-existing Smith & Nephew third party commitments, and the right of Smith & Nephew to use our manufacturing technology would cease.

Smith & Nephew is responsible for any product recalls, although we have agreed to reimburse Smith & Nephew for its out-of-pocket costs to the extent the adverse event or complaint resulting in the recall was attributable to us.

We have agreed not to use the manufacturing equipment that we lease from Smith & Nephew and use for producing Acticoat^tm products for other purposes. We have granted Smith & Nephew a right of first offer regarding our assets used to manufacture and supply Acticoat^tm products if we desire to sell all or substantially all of these assets. We have also granted to Smith & Nephew a right of first refusal regarding these assets if we receive an offer to purchase them, which we wish to

accept, from a competitor of Smith & Nephew’s in the wound care market. The supply agreement expires upon the expiration or termination of the license and development agreement (which is scheduled to expire in 2026), although it may be terminated earlier by either party if the other party fails to cure a material breach of the agreement, suspends its operations or files for bankruptcy or takes other similar actions.

Manufacturing and Technology Escrow Agreement

Under the manufacturing and technology escrow agreement, we have deposited with an escrow agent certain documentation and manuals that describe technology used to manufacture Acticoat^tm products. Upon the occurrence of certain release events, the documentation and manuals would be released by the escrow agent to Smith & Nephew as part of the right to use our technology to manufacture Acticoat^tm products designed and indicated solely for use on non-minor skin wounds and burns on humans. A release event is defined as a material difficulty supplying Acticoat^tm products under our supply agreement with Smith & Nephew that is not cured on a timely basis or the occurrence of certain events in connection with our insolvency or bankruptcy.

Security Trust Agreement and Trust Indenture

Under the security trust agreement and the trust indenture, we have granted to Smith & Nephew a security interest in our manufacturing technology and patent rights used in the manufacture of Acticoat^tm products. This security interest secures our obligations to Smith & Nephew under the manufacturing right that would be granted to Smith & Nephew as described above. Under the security trust agreement and trust indenture, Smith & Nephew may take possession of and use the manufacturing technology and patent rights upon the occurrence of a release event as described under “Smith & Nephew Agreements — Manufacturing and Technology Escrow Agreement.” Accordingly, Smith & Nephew would have the right, upon the occurrence of specified events, to use our manufacturing technologies and patent rights to manufacture Acticoat^tm products on its own or with a third party. Assignments with respect to the patent rights that are covered by the security interest have been deposited with a trustee under the security trust agreement and the indenture.

Indemnities

We and Smith & Nephew have agreed to indemnify each other in respect of claims resulting from any alleged physical injury or property damage as a result of our respective acts or omissions, the failure to perform our respective obligations under the license and development agreement and the supply agreement, our respective non-compliance with applicable law or regulation, any breach of our respective representations under these agreements, for so long as the particular representation survives. In addition, Smith & Nephew has agreed to indemnify us for claims arising out of its marketing and sale of Acticoat^tm products except to the extent attributable to us. Also, we have agreed to indemnify Smith & Nephew in respect of claims resulting from any actual or threatened action by any third party alleging our SILCRYST^tm coatings infringe that third party’s intellectual property rights, subject to Smith & Nephew’s remedy for such an infringement action being limited to withholding damages or royalties it must pay on account of the infringement action from amounts or royalties payable to us under the two agreements, unless we have breached any representation to Smith & Nephew in connection with that infringement.

Marketing

Under our revised agreements, Smith & Nephew remains responsible for all sales and marketing activities with respect to Acticoat^tm dressings. Smith & Nephew supports its local sales and marketing efforts with a marketing team that provides strategic and global market planning for the Acticoat^tm brand. To maximize the potential of our SILCRYST^tm technology and Smith & Nephew’s global reach, we have worked closely with Smith & Nephew to develop new Acticoat^tm wound care products with our SILCRYST^tm coatings.

Manufacturing

We manufacture Smith & Nephew’s Acticoat^tm products with our SILCRYST^tm coatings and our NPI 32101 powder in environmentally-controlled conditions. Our production facility is located in Fort Saskatchewan, Alberta, is ISO 9000 certified and subject to inspection from time to time by regulatory authorities from the United States, Canada and Europe.

We currently purchase most of our raw materials from single suppliers, which in certain circumstances are specified in Smith & Nephew’s product registrations thereby requiring us to obtain such raw materials and supplies from that particular source. The loss of any of these suppliers could result in a disruption in our production while we arrange for a replacement supplier. To reduce this risk, we maintain sufficient inventory levels to continue production for approximately six months. We also maintain approximately one month’s supply of finished goods in inventory to

accommodate fluctuations in Smith & Nephew’s demand for Acticoat^tm products and order lead times. Once we ship products to Smith & Nephew in accordance with an accepted purchase order, Smith & Nephew’s right to return products is governed by our supply agreement and is limited to circumstances where the products are found to be non-conforming with the agreed upon product specifications.

At February 11, 2008, our quality, operations and engineering staff was made up of 96 technicians, some of whom are professional engineers with expertise in quality systems, equipment design, logistics and production. Our Fort Saskatchewan, Alberta facility purchases and stores raw materials, coats wound care dressing components, assembles, labels and packages finished product for sterilization and finally, ships the products to Smith & Nephew.

Intellectual Property

Our success depends significantly on our ability to obtain and maintain intellectual property protection for our technology, including our materials, devices, compositions and methods of making and using the same. Our success also depends on our ability to operate without infringing the intellectual property rights of others and our ability to prevent others from infringing our intellectual property rights. We also rely on trade secrets to protect our know-how and continuing technological innovation.

Where possible, we pursue composition of matter patent claims. Such patent claims cover our materials, devices and compositions independent of the manner in which they are made and used. We also pursue device and method of manufacture, use and treatment claims.

As of February 11, 2008, we hold 23 United States patents having expiration dates ranging from 2011 to 2022. In addition, we are pursuing 22 United States patent applications. Our goal is to hold corresponding patents and applications in our most important target markets outside the United States. Accordingly, we hold 88 corresponding patents from jurisdictions such as European Union countries, Australia, Canada, China and Japan. Moreover, we are pursuing 25 corresponding patent applications outside of the United States, including two patent cooperation treaty applications, which may lead to the filing of additional foreign patent applications.

We believe our portfolio of issued patents prevents unlicensed parties from making, using, importing, selling and/or offering to sell our nanocrystalline silver material independent of its form and no matter how it is made or used in the United States and other important markets outside the United States. We believe our portfolio of pending patent applications, if and when issued, may help prevent unlicensed parties from making, using, importing, selling and/or offering to sell certain aspects of our technology in the United States and other important markets outside the United States.

Individual patents extend for varying periods depending on the date of filing of the patent application or the date of patent issuance and the term of patents in the countries in which they are obtained. Generally, patents issued in the United States are effective for the longer of 17 years from the issue date or 20 years from the earliest effective filing date if the patent application, from which the patent issued, was filed prior to June 8, 1995; and 20 years from the earliest effective filing date, if the patent application, from which the patent issued was filed on or after June 8, 1995. In addition, in certain instances, the term of a United States patent can be extended to recapture a portion of the term effectively lost as a result of the FDA regulatory review period (as defined in United States patent law). The duration of patents in other countries varies in accordance with provisions of applicable local law, but in countries with major markets typically is 20 years from the earliest effective filing date. Our patent estate, based on patents existing now and pending applications, will expire on dates ranging from 2011 to 2022.

The actual protection afforded by a patent varies from country to country and depends upon many factors, including the type of patent, the scope of its coverage, the availability of regulatory related extensions, the availability of legal remedies in a particular country and the validity and enforceability of the patent.

In addition to patents, we rely on trade secrets to protect our intellectual property where appropriate. The protection of our trade secrets relies on our ability to keep information confidential. Our policy is to keep information confidential by disclosing it only to those employees and third parties with a need to know and only to the extent warranted in specific circumstances and under confidentiality agreements, where appropriate.

Competition

The medical device and pharmaceutical industries are intensely competitive. There are numerous silver-containing advanced wound care dressings and silver-coated medical devices available from a variety of health care companies. Some of these products have been recently introduced and directly compete with Acticoat^tm dressings. We sell products

containing our SILCRYST^tm coatings to Smith & Nephew and Smith & Nephew markets and sells them under its Acticoat^tm trademark into a larger competitive environment. Smith & Nephew has introduced three new wound care products with other forms of silver (Algisite Ag, Allevyn Ag and Biostep Ag). We believe that some of these new silver based wound care products will serve to simply compliment the existing Acticoat^tm products marketed by Smith & Nephew without impacting sales of Acticoat^tm products while others may be viewed by the advanced wound care market as alternatives to certain Acticoat^tm products, thereby potentially adversely affecting Acticoat^tm product sales and ultimately our operating revenues in the foreseeable future.

Major competitors in the advanced wound dressing market in which Smith & Nephew’s Acticoat^tm products are sold include Convatec, a Bristol Myers Squibb company, Johnson & Johnson Wound Management, a division of Ethicon, Inc., Argentum Medical, LLC, Coloplast Corp., AcryMed, Inc., 3M Company, Kinetic Concepts Inc., Mölnlycke Health Care Group AB and Paul Hartmann AG. To the extent that we develop medical device and pharmaceutical products to treat dermatological and gastrointestinal conditions, we will face competition from medical device and pharmaceutical companies developing alternative products to treat these diseases. In addition, we face and will continue to face competition from other major multi-national pharmaceutical companies and medical device companies, specialty pharmaceutical companies, universities and other research institutions.

As previously discussed, under our amended license agreement, for the first time since May 2001, Smith & Nephew may now develop, manufacture and market advanced wound care products that use forms of silver other than our SILCRYST^tm coatings. This means we may now face competition from other silver based advance wound care product manufacturers for Smith & Nephew’s future product development needs. As this form of competition is new to us and in its very early stages, we have not yet identified our direct competitors in this regard and are not yet able to determine what impact, in any, such competition may have on Acticoat^tm product sales and ultimately our operating revenues in the foreseeable future.

Third-Party Reimbursement and Pricing Controls

In the United States and elsewhere, sales of pharmaceutical products and medical devices depend in significant part on the availability of reimbursement to the consumer from third-party payors, including government health authorities, managed care providers, public health insurers, private health insurers or other organizations. Third-party payors are increasingly challenging the prices charged for medical products and services and examining their cost-effectiveness. It can be time consuming and expensive to go through the process of seeking reimbursement approval from Medicare and private payors. Acticoat^tm dressings or other products from which we may receive revenue in the future may not be considered cost-effective, and reimbursement may not be available or sufficient to allow these products to be sold on a competitive and profitable basis.

In many foreign markets, including countries in the European Union and Canada, pricing of medical products, in particular reimbursed products, is subject to governmental control. In some countries of the European Union, a product must receive specific country pricing approval in order to be reimbursed in that country. In others, specific discounts will need to be granted on certain, in particular reimbursed, products. The pricing approval in those Member States of the European Union can take many months, and sometimes years, to obtain. In Canada, pricing must be approved by the Patented Medicine Prices Review Board, and government and third party payors. In addition, the Canadian provincial governments have the authority to assess the reimbursement status, if any, and the pricing of newly approved drugs, pharmaceutical products and pharmaceutical product indications. Obtaining price approval from the Patented Medicine Prices Review Board and provincial governments can take six to twelve months or longer after the receipt of the notice of compliance. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of a product to other available therapies.

In the United States, there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmental pricing controls. Although we do not expect the Medicare Prescription Drug Improvement and Modernization Act of 2003 to have a significant effect on pricing or reimbursement for Acticoat^tm products, we cannot predict what impact it may have on prices or reimbursement policies for pharmaceutical products, including the products we are developing.

Government Regulation

Government authorities extensively regulate the testing, manufacturing, labeling, storage, record-keeping, advertising, promotion, export, marketing and distribution, of medical devices and pharmaceutical products. Since

the United States and Europe are significant markets, we have described their regulatory systems. Many other countries have similar regulatory systems.

United States

In the United States, the FDA, under the Federal Food, Drug, and Cosmetic Act and other federal statutes and regulations, subjects medical products to rigorous review. If we do not comply with applicable requirements, we may be fined, the government may refuse to approve our marketing applications or allow us to manufacture or market our products, and we may be criminally prosecuted. The FDA has different approval processes for medical devices, such as our wound care dressings, and pharmaceutical products, such as the products we are developing using our NPI 32101 API.

Medical Device Regulation. Under the Federal Food, Drug, and Cosmetic Act, medical devices are classified into one of three classes — Class I, Class II or Class III — depending on the degree of risk associated with each medical device and the extent of control needed to ensure safety and effectiveness. Class I medical devices are subject to the FDA’s general controls, which include compliance with the applicable portions of the FDA’s Quality System Regulation, facility registration and product listing, reporting of adverse medical events, and appropriate, truthful and non-misleading labeling, advertising, and promotional materials. Class II devices are subject to the FDA’s general controls and may also be subject to other special controls as deemed necessary by the FDA to ensure the safety and effectiveness of the device. Class III medical devices are subject to the FDA’s general controls, special controls, and generally pre-market approval prior to marketing.

Acticoat^tm products with our SILCRYST^tm coatings require pre-market clearance by the FDA through the 510(k) pre-market notification process. When a 510(k) is required, the manufacturer must submit to the FDA a pre-market notification demonstrating that the device is “substantially equivalent” to either a device that was legally marketed prior to May 28, 1976, the date upon which the Medical Device Amendments of 1976 were enacted, or to another commercially available, similar device which was subsequently cleared through the 510(k) process. By regulation, the FDA is required to review a 510(k) within 90 days of submission of the application. As a practical matter, clearance often takes longer. All currently marketed Acticoat^tm products with our SILCRYST^tm coatings have been cleared for marketing pursuant to the 510(k) process.

The FDA has broad post-market regulatory and enforcement powers with respect to medical devices, similar to those for drug products. Failure to comply with the applicable U.S. medical device regulatory requirements could result in, among other things, warning letters, fines, injunctions, consent decrees, civil penalties, repairs, replacements, refunds, recalls or seizures of products, total or partial suspension of production, the FDA’s refusal to grant future pre-market clearances or approvals, withdrawals or suspensions of current product applications, and criminal prosecution.

New Drug Approval Process. To obtain approval of a new drug product from the FDA, we must, among other requirements, submit data supporting safety and efficacy as well as detailed information on the manufacture and composition of the product candidate and proposed labeling. The testing and collection of data and the preparation of necessary applications are expensive and time-consuming.

The process required by the FDA before a new drug may be marketed in the United States generally involves the following: completion of preclinical laboratory and animal testing in compliance with FDA regulations; submission of an investigational new drug application which must become effective before human clinical trials may begin; performance of adequate and well-controlled human clinical trials to establish the safety and efficacy of the proposed drug for its intended use; and submission of an NDA. The applicant typically conducts human clinical trials in three sequential phases, but the phases may overlap. In Phase 1 clinical trials, the product is tested in a small number of patients or healthy volunteers, primarily for safety at one or more doses. In Phase 2 clinical trials, in addition to safety risk, efficacy is assessed in a patient population. Phase 3 clinical trials typically involve additional testing of safety and clinical efficacy in an expanded population at geographically-dispersed test sites.

Clinical trials must be conducted in accordance with the FDA’s good clinical practices requirements. The FDA may order the temporary or permanent discontinuation of a clinical trial at any time or impose other sanctions if it believes that the clinical trial is not being conducted in accordance with FDA requirements or presents an unacceptable risk to the clinical trial patients. At each site where we sponsor a clinical trial, the Institutional Review Board, or IRB, for that site generally must approve the clinical trial design and patient informed consent form to be used at that site and may also require the clinical trial at that site to be halted, either temporarily or permanently, for failure to comply with that IRB’s requirements, or may impose other conditions.

The applicant must submit to the FDA the results of the preclinical and clinical trials, together with, among other things, detailed information on the manufacture and composition of the product and proposed labeling, in the form of an NDA, including payment of a user fee. The FDA reviews all NDAs submitted before it accepts them for filing and may request additional information rather than accepting an NDA for filing. The review process may be extended if the FDA requests additional information or clarification regarding information already provided in the submission. If the FDA’s evaluations of the safety and efficacy data in the NDA and the manufacturing procedures and facilities are favorable, the FDA may issue either an approval letter or an approvable letter, which contains the conditions that must be met in order to secure a final approval letter, authorizing commercial marketing of the drug for certain indications. If the FDA’s evaluation of the NDA submission and the manufacturing procedures and facilities is not favorable, the FDA may refuse to approve the NDA or issue a not approvable letter.

Manufacturing cGMP Requirements. If and when we manufacture pharmaceutical products, we will be required to comply with applicable FDA manufacturing requirements contained in the FDA’s current good manufacturing practices, or cGMP, regulations. cGMP regulations require among other things, quality control and quality assurance as well as the corresponding maintenance of records and documentation. The manufacturing facility for our products must meet cGMP requirements to the satisfaction of the FDA pursuant to a pre-NDA approval inspection before we can use them. We and some of our third party service providers are also subject to periodic inspections of facilities by the FDA and other authorities, including procedures and operations used in the testing and manufacture of our products to assess our compliance with applicable regulations.

Failure to comply with statutory and regulatory requirements subjects a manufacturer to possible legal or regulatory action, including the seizure or recall of products, injunctions, consent decrees placing significant restrictions on or suspending manufacturing operations, and civil and criminal penalties. Adverse experiences with the product must be reported to the FDA and could result in the imposition of market restriction through labeling changes or in product withdrawal. Product approvals may be withdrawn if compliance with regulatory requirements is not maintained or if problems concerning safety or efficacy of the product occur following the approval.

European Union Regulation

Marketing Authorizations for Drugs. In order to gain marketing approval of any of our drug products in Europe, we must submit for review an application similar to a U.S. NDA to the relevant authority. In contrast to the United States, where the FDA is the only authority that administers and approves NDAs, in Europe there are multiple authorities that administer and approve these applications. Marketing authorizations in Europe expire after five years but may be renewed.

We believe that our nanocrystalline silver drugs will be reviewed by the Committee for Medicinal Products for Human Use, or CHMP, on behalf of the European Medicines Agency, or EMEA. Based upon the review of the CHMP, the EMEA provides an opinion to the European Commission on the safety, quality and efficacy of the drug. The decision to grant or refuse an authorization is made by the European Commission.

Approval of applications can take several months to several years, or be denied. This approval process can be affected by many of the same factors relating to safety, quality and efficacy as in the approval process for NDAs in the United States. As in the United States, European drug regulatory authorities can require that additional nonclinical studies and clinical trials be performed. The need for such studies or trials, if imposed, may delay marketing approval and involve unbudgeted costs. Inspection of clinical investigation sites by a competent authority may also be required as part of the regulatory approval procedure. In addition, as a condition of marketing approval, regulatory agencies in Europe may require post-marketing surveillance to monitor for adverse effects, or other additional studies as deemed appropriate. The terms of any approval, including labeling content, may be more restrictive than expected and could affect the marketability of a product. In addition, after approval for the initial indication, further clinical studies are usually necessary to gain approval for any additional indications.

European GMP. In the European Union, the manufacture of pharmaceutical products and clinical trial supplies is subject to good manufacturing practice, or GMP, as set forth in the relevant laws and guidelines. Compliance with GMP is generally assessed by the competent regulatory authorities. They may conduct inspections of relevant facilities, and review manufacturing procedures, operating systems and personnel qualifications. In addition to obtaining approval for each product, in many cases each drug manufacturing facility must be approved. Further inspections may occur over the life of the product.

Medical Devices. All of Smith & Nephew’s Acticoat^tm products are classified as medical devices in the European Union. In order to sell its medical device products within the European Union, Smith & Nephew is required to achieve compliance with the requirements of the relevant Medical Devices Directive, or MDD, and its national implementations and affix CE markings on its products to attest to such compliance. Therefore, Smith & Nephew must meet the “Essential Requirements,” as defined under the MDD, relating to safety and performance of its products and, prior to their marketing, must successfully undergo verification of its regulatory compliance (“conformity assessment”) by a so-called Notified Body, which is usually a private entity that has been certified and equipped with respective rights by governmental regulators.

The nature of the assessment depends on the regulatory class of the product. Under European law, any medical device products we may develop are likely to be in class III. In the case of class III products, a company must follow the requirements set forth in Article 11 of the MDD and its relevant Annexes, which may impose the obligation to establish and maintain a complete quality system for design and manufacture as described in Annex II of the MDD (this corresponds to a quality system for design described in the standards ISO 9001 and EN 46001 as amended, in particular by EN ISO 13485: 2000 and EN ISO 13488: 2000). The Notified Body must audit this quality system and determine if it meets the requirements of the MDD. In addition, the Notified Body must approve the specific design of each device in class III. As part of the design approval process, the Notified Body must also verify that the products comply with the Essential Requirements of the MDD. In order to comply with these requirements, a company must, among other things, complete a risk analysis and present sufficient clinical data. The clinical data presented by a company must provide evidence that the products meet the performance specifications claimed by a company, provide sufficient evidence of adequate assessment of unwanted side effects and demonstrate that the benefits to the patient outweigh the risks associated with the device. A company will be subject to continued supervision by the Notified Body and competent authorities and will be required to report any serious adverse incidents to the appropriate authorities. A company will also be required to comply with additional national requirements that are beyond the scope of the MDD.

Smith & Nephew is entitled to affix a CE marking on all of its wound care products with our SILCRYST^tm coatings that are currently marketed in the European Union. There can be no assurance that we or Smith & Nephew will be able to maintain the requirements established for CE marking for any or all of these products or that we will be able to produce these products in a timely and profitable manner while complying with the requirements of the MDD and other regulatory requirements.

Environmental and Occupational Safety and Health Regulations

Our operations are subject to extensive federal, state, provincial and municipal environmental statutes, regulations and policies, including those promulgated by the Occupational Safety and Health Administration, the EPA, Environment Canada, Alberta Environment, the Department of Health Services, and the Air Quality Management District, that govern activities and operations that may have adverse environmental effects such as discharges to air and water, as well as handling and disposal practices for solid and hazardous wastes. Some of these statutes and regulations impose strict liability for the costs of cleaning up, and for damages resulting from, sites of spills, disposals, or other releases of contaminants, hazardous substances and other materials and for the investigation and remediation of environmental contamination at properties leased or operated by us and at off-site locations where we have arranged for the disposal of hazardous substances. In addition, we may be subject to claims and lawsuits brought by private parties seeking damages and other remedies with respect to similar matters. If we are subject to governmental or private claims, lawsuits or other actions alleging that we violated environmental laws or that our operations or facilities are not in compliance with environmental laws, we may incur substantial legal costs and we could be subject to fines, penalties and damage awards and we could be required to make substantial expenditures to clean up contaminated sites, any of which could have a material adverse effect on our business.

We have not to date needed to make material expenditures to comply with current environmental statutes, regulations and policies. However, we cannot accurately predict the impact and costs that future statutes, regulations and policies will impose on our business.

Employees

As of February 11, 2008, we had a total of 133 employees in Canada and the United States. Of these 133 employees, 24 were engaged in research and development, 80 in manufacturing and quality assurance and 29 in administration. We had 92, 151 and 158 employees at the end of 2004, 2005 and 2006, respectively. None of our employees are represented by a labor union or covered by a collective bargaining agreement. We believe our relationship with employees is good.

Financial Information by Business Segment and Geographic Data

We operate in one business segment consisting of the manufacturing, research, development and commercialization of medical products based on our proprietary noble metal nanocrystalline technology. For information regarding our geographic data, please refer to Note 18 — Segmented Information of our Notes to our Consolidated Financial Statements found in Item 8 of this annual report on Form 10-K.

ITEM 1A. RISK FACTORS

If any of the following risks materialize, then our business, financial condition, results of operations and future prospects would likely be materially and adversely affected.

Risks Related to Our Business and Industry

We have a history of net losses and negative cash flow from operations; this will likely continue in the future and our cash may not be adequate to accomplish our objectives.

We have a history of net losses. For the year ended December 31, 2003, we had a net loss of $2.3 million and negative cash flow from operations of $2.2 million. We would have realized a net loss and negative operating cash flow for the year ended December 31, 2004, but for the receipt of $10.0 million in milestone payments from Smith & Nephew. For the year ended December 31, 2005, we had negative operating cash flow of $2.1 million, and we would have realized a greater net loss but for the receipt of $5.0 million in milestone payments from Smith & Nephew. For the year ended December 31, 2006, we had a net loss of $10.5 million, negative operating cash flow of $12.6 million and an accumulated deficit of $34.1 million. For the year ended December 31, 2007, we had a net loss of $4.0 million, negative operating cash flow of $2.7 million and an accumulated deficit of $38.1 million. Our ability to generate revenue is dependent on our ability to successfully and in a timely fashion manufacture products for sale by Smith & Nephew and design, develop, obtain regulatory approval for, manufacture, and commercialize our product candidates. We expect to increase our operating expenses and capital expenditures over the next several years as we expand our research and development activities, scale up our manufacturing and quality control operations, develop or acquire new product candidates, and hire additional personnel. As a result, we expect to continue to incur net losses and negative cash flow from operations for the foreseeable future. Therefore, we will be required to obtain additional financing in the future, and additional financing may not be available at times, in amounts or on terms acceptable to us or at all, which would have a material adverse effect on our business. Because of the numerous risks and uncertainties associated with our product development efforts, we are unable to predict the extent of any future losses or when or if we will become profitable.

Prior to our initial public offering in December 2005, we were wholly dependent upon Westaim for financial support, and must now rely on third parties for financing.

In the past, all of our external financing was provided by Westaim and we have relied on Westaim for the ongoing financial support necessary to operate our business. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.” We repaid a portion of our debt to Westaim with a portion of the proceeds of our initial public offering and Westaim exchanged our remaining debt to it for additional common shares. As a result, Westaim does not currently provide us with financing or financial support, nor does it intend to provide us any financing or financial support in the future and to the extent we obtain financing to support our cash need, we will be entirely reliant on third parties for financing. We do not have any lines of credit or other financing arrangements in place with banks or other financial institutions. We will likely require additional external financing in the future and there can be no assurance that we will be able to obtain additional financing on commercially reasonable terms, which would have a material adverse effect on our business.

We are dependent on our relationship with Smith & Nephew.

In May 2001, we entered into a number of agreements with Smith & Nephew. The principal agreements were a license and development agreement under which we licensed to Smith & Nephew the exclusive right to market, distribute and sell products with our SILCRYST^tm coatings that are designed and indicated for use on non-minor skin wounds and burns on humans worldwide, and a supply agreement under which we agreed to manufacture these products and supply them to Smith & Nephew. In September 2007, we modified the terms of our arrangements with Smith & Nephew and entered into an amended and restated license and development agreement and supply agreement with Smith & Nephew. Our agreements with Smith & Nephew are described under the heading “Business — Smith & Nephew Agreements.”

Since May 2001, all of our revenues have been earned under our contracts with Smith & Nephew and Smith & Nephew is currently our only customer. Our revenues under our revised contracts are derived primarily from royalties, which are calculated as a percentage of Smith & Nephew’s sales of Acticoat^tm products, milestone payments, which are cash payments we receive upon the achievement by Smith & Nephew of certain sales goals or regulatory achievements relating to the Acticoat^tm products, and payment of our costs incurred in manufacturing Acticoat^tm products on a fixed price basis. As a result, our revenues generally vary in proportion to increases or decreases in Smith & Nephew’s sales of its Acticoat^tm products. We therefore depend and will continue to depend on Smith & Nephew to market and sell Acticoat^tm products successfully. Smith & Nephew reported Acticoat^tm sales growth of 7% in 2007, as compared to the year ended December 31, 2006 and 9% for the year ended December 31, 2006 as compared to the year ended December 31, 2005. However, Smith & Nephew has previously announced that market conditions in the advanced wound care market, including the silver dressing segment, appear to be becoming more difficult due in part to increased competition and customer cost containment efforts. If Smith & Nephew does not increase future sales of its Acticoat^tm products, this would likely have a material adverse effect on us and on the market price of our common shares.

The Smith & Nephew agreements expire in 2026. However, Smith & Nephew may terminate our agreements earlier if we fail to cure our material breach of the agreements or if we suspend operations, cease to carry on business or file for bankruptcy or take other similar actions. If Smith & Nephew were to terminate our agreements prior to their expiration, we would lose the benefit of our strategic collaboration and our only current source of revenue.

Smith & Nephew is our only customer for all of our existing products.

We have agreed to exclusively supply existing Acticoat^tm products to Smith & Nephew and any new products with our SILCRYST^tm coatings or powder that we develop together with Smith & Nephew for use in non-minor skin wounds and burns in humans. Our agreements with Smith & Nephew cover products that are used to treat non-minor skin wounds and burns on humans, which we sometimes collectively refer to as “serious” wounds, excluding consumer first-aid products designed for self-medication or use without advice from a health care professional. We currently do not have any other products being sold in the marketplace. Consequently, all of our revenue is received from Smith & Nephew and is principally comprised of cost reimbursement, royalty payments and milestone payments. The amount of our revenues is determined primarily by the level of sales of Acticoat^tm products achieved by Smith & Nephew. Moreover, Smith & Nephew is not required to purchase any significant amount of products from us. We are at risk of Smith & Nephew becoming less motivated to market Acticoat^tm products due to any one of a number of factors, including other products marketed by Smith & Nephew having better profit margins, or achieving greater acceptance or popularity with health care providers, than the Acticoat^tm products including other silver-based wound care products Smith & Nephew is now free to introduce under our revised agreements. We are also subject to the risk that sales of Acticoat^tm products will not grow or will decline due to factors outside Smith & Nephew’s control, including competition from products marketed by competitors having better characteristics or lower prices than Acticoat^tm products resulting in customers generally preferring the competitor’s products.

Smith & Nephew has the authority to unilaterally determine the selling price for Acticoat^tm products. Smith & Nephew may set a relatively low price for our products, or give discounts or rebates that effectively lower the price of the Acticoat^tm products, which in either case could reduce our revenues and delay or eliminate receipt of milestone payments.

If we lose our patent rights in a particular country and in respect of a particular SILCRYST^tm coated product and if someone else sells a competing product in that country that would have infringed on our patent rights had they been in effect, then we are obligated to negotiate in good faith with Smith & Nephew for the reduction of the royalty rate applicable to sales of the particular product in that country for so long as the competing product is being sold and we are without patent protection. If those negotiations do not result in any agreement, the matter would be referred to binding arbitration, although there is a limit on the maximum royalty reduction permitted. Any reduction in our royalties will adversely affect our results of operations and financial condition.

Decisions regarding key aspects of our relationship with Smith & Nephew and the pricing and marketing of Acticoat^tm products are made by a limited number of key Smith & Nephew executives. The departure or replacement of any of these executives could have a material adverse effect on our relationship with Smith & Nephew.

within Smith & Nephew’s discretion. Therefore, there can be no assurance that new products will be developed or launched at all or on the timeline or in a manner favorable to us.

We may be unable to sell our existing products to other parties, even if our agreements with Smith & Nephew expire or terminate.

We have agreed to exclusively supply existing Acticoat^tm products to Smith & Nephew and any new products with our SILCRYST^tm coatings or powder that we develop together with Smith & Nephew for use on non-minor skin wounds and burns on humans. We do not have the right to sell these products to other parties so long as Smith & Nephew has complied with the terms of our agreements. In addition, we do not have the right to sell the products marketed by Smith & Nephew as Acticoat^tm 3/ Acticoat^tm Burn and Acticoat^tm 7 in the United States or Canada under any circumstances.

If our agreements with Smith & Nephew were terminated or expire, or if we otherwise have the right to sell SILCRYST^tm-coated wound care products to customers other than Smith & Nephew, we may be unable to market, distribute and sell these products or to enter into a marketing, distribution and sales agreement with another distributor. We do not currently have a marketing, distribution or sales organization and we cannot assure you that we would be successful in marketing, distributing or selling our products were we to attempt to do so.

In addition, Smith & Nephew owns and uses the trademark Acticoat^tm to sell products with our SILCRYST^tm coatings and consequently end-users tend to have greater familiarity with the Acticoat^tm trademark as compared to the SILCRYST^tm trademark. If our agreements with Smith & Nephew were terminated or expire and we attempted to market products with our SILCRYST^tm coatings ourselves or through a distributor, we would not have the benefit of the Acticoat^tm trademark.

We may be unable to achieve the cost savings required to offset the manufacturing cost rebate we agreed to pay Smith & Nephew in 2007, 2008 and 2009.

On September 30, 2007, we entered into an amended and restated license and development agreement and a supply agreement with Smith & Nephew. Under the revised supply agreement, we agreed to pay Smith & Nephew, in each of 2007, 2008 and 2009, an annual manufacturing cost rebate of $4.5 million in anticipation of cost savings we expect to achieve in such years. If we are unable to achieve the cost savings required to substantially or completely offset the manufacturing rebate in each of the three years, our results of operations, financial condition and gross margin may be adversely affected in those years and possibly in the future. We did not completely offset the manufacturing rebate in 2007.

We are required to manufacture Acticoat^tm products according to Smith & Nephew’s forecasts and, if we suffer a material difficulty supplying Acticoat^tm products, Smith & Nephew would have the right to manufacture or cause a third party to manufacture Acticoat^tm products using our technology and facilities.

As discussed below, if we suffer a material difficulty in supplying Acticoat^tm products, Smith & Nephew may manufacture or cause a third party to manufacture Acticoat^tm products, and in such circumstances we will be subject to a number of risks, including, but not limited to, Smith & Nephew failing to comply with FDA-mandated current good manufacturing practices or similar regulations in other jurisdictions, resulting in mandated production halts or limitations, Smith & Nephew experiencing manufacturing quality or control issues which halt or limit Acticoat^tm production, and a greater risk that some of our proprietary manufacturing processes and trade secrets will become known to other third parties. Smith & Nephew has on several occasions requested that we increase our production capacity and, as a result, we completed in 2007 a significant expansion of our production capacity. However, we may not be able to do so in the future or to supply Smith & Nephew with the quantity or quality of products it requests. For a description of certain factors that may make it difficult to supply the quantity of Acticoat^tm products required by Smith & Nephew, see below.

We are obligated to provide the quantity of Acticoat^tm product specified by Smith & Nephew in its demand forecasts. Meeting anticipated demand for Acticoat^tm products estimated by Smith & Nephew may require significant scale-up expenses for new facilities and personnel. In setting the annual unit prices we can charge Smith & Nephew for the products we supply, we are permitted to recover the capital expenditures we make to acquire equipment through the inclusion in unit prices of an amount equal to our annual depreciation expense associated with the equipment. Since our depreciation expenses are typically spread out over a number of years, scaling up our manufacturing capability has required and may in the future require that we make substantial up-front cash expenditures for capital equipment for which we will not be reimbursed for a period of several years. Smith & Nephew is not required to reimburse us for any costs incurred in acquiring or improving owned real property, buildings or similar improvements and, as a result, we are

and will be required to obtain additional financing to fund any such expenditures we cannot assure you that we will be able to do so. Smith & Nephew’s obligation to reimburse us in any calendar year for increases in our fixed costs that are within our control other than costs incurred at the request of Smith & Nephew, is capped at the greater of a fixed percent and the increase in the Canadian Consumer Price Index. Moreover, we cannot assure you that we will be able to successfully increase our manufacturing capacity to meet anticipated demand or that we will be able to satisfy demand in a cost-effective manner. Further, the demand forecasts provided by Smith & Nephew may materially overstate actual demand for Acticoat^tm products, thereby resulting in excessive inventories and the potential for loss of product due to shelf-life expiration, or such forecasts may materially understate actual demand for Acticoat^tm products resulting in lost sales due to the inability to meet demand on a timely basis. Either situation would have a negative impact on our results of operations as would a decision by Smith & Nephew to significantly increase its worldwide inventory levels of Acticoat^tm products as it did in 2006. While we recognize manufacturing cost reimbursement as revenue upon shipment of Acticoat^tm products to Smith & Nephew, we do not recognize royalty revenues until Smith & Nephew sells these products to its customers, and consequently, increases in Smith & Nephew’s inventory levels, or changes in the relative contribution of manufacturing cost reimbursement and royalty revenues to our total revenues, has affected and may in the future affect our gross margins.

We lease certain manufacturing equipment from Smith & Nephew which represented approximately 50% of our total manufacturing capacity at December 31, 2007. If we suffer a material difficulty in supplying Acticoat^tm products (which would give Smith & Nephew the right to assume the manufacture of Acticoat^tm products as described below), and that difficulty is not cured on a timely basis, this lease would terminate and Smith & Nephew would have the right to take possession of the equipment it leases to us. In such case, Smith & Nephew would also receive the right to use our technology and this equipment to manufacture, on its own, Acticoat^tm products for non-minor skin wounds and burns on humans. If Smith & Nephew were to take possession of this equipment and manufacture Acticoat^tm products on its own or with a third party, even for a limited period of time, it would have a material adverse effect on our business.

We have deposited with an escrow agent certain documentation and manuals that describe the technology used to manufacture Acticoat^tm products. Upon the occurrence of certain release events, the documentation and manuals would be released by the escrow agent to Smith & Nephew as part of the right to use our technology to manufacture Acticoat^tm products for non-minor skin wounds and burns on humans. A release event is defined as a material difficulty in supplying Acticoat^tm products under our supply agreement with Smith & Nephew that is not cured on a timely basis or the occurrence of certain events in connection with our insolvency or bankruptcy. In addition, we have granted to Smith & Nephew a security interest in our manufacturing technology and patent rights used in the manufacture of Acticoat^tm products. This security interest secures our obligations to Smith & Nephew under the manufacturing right that would be granted to Smith & Nephew as described above. Under the security trust agreement and trust indenture, Smith & Nephew may take possession of and use our manufacturing technology and patent rights upon the occurrence of a release event as described above. Accordingly, Smith & Nephew would have the right, upon the occurrence of specified events, to use our manufacturing technologies and patent rights to manufacture Acticoat^tm products on its own or have them manufactured by a third party. If this were to occur, it would have a material adverse effect on our business and would pose a risk that some of our proprietary manufacturing processes and trade secrets will become known to third parties. In addition, the existence of these Smith & Nephew rights will likely make it more difficult for us to obtain debt and other forms of financing in the future and may also limit the amount investors are willing to pay for our common shares.

We rely on Smith & Nephew for regulatory filings for Acticoat^tm products and our results would be adversely affected if they do not fully comply with regulatory requirements.

Smith & Nephew is responsible for regulatory filings required for the marketing and sale of Acticoat^tm products. If Smith & Nephew does not fully comply with regulatory requirements related to these products, then we may be subject to risks which could adversely affect our results of operations and prospects, including but not limited to actions by the FDA or other regulatory authorities which may have the effect of restricting or preventing our ability to market and sell our products, or to have those products marketed or sold. It could also result in increased costs related to compliance with regulatory requirements.

Our agreements with Smith & Nephew may limit our ability to enter into agreements to transfer certain of our assets or to collaborate with third parties in new product development.

We have granted Smith & Nephew a right of first offer regarding our assets and technology used to manufacture and supply Acticoat^tm products if we desire to sell all or substantially all of these manufacturing assets. We have also granted Smith & Nephew a right of first refusal regarding these manufacturing assets if we receive an offer to purchase them from

an outside party, which we wish to accept, from a competitor of Smith & Nephew’s in the wound care market. The existence of these Smith & Nephew rights could limit our ability to enter into transactions involving the transfer of all or substantially all of these assets.

We have also granted Smith & Nephew a right of first refusal to seek a license of any new wound care or burn products we may develop using our silver nanocrystalline technology without Smith & Nephew’s involvement. If Smith & Nephew declines the opportunity, then we are free to license or sell these products. The existence of this Smith & Nephew right may limit our ability to enter into new wound care product development collaborations with third parties involving the use of our nanocrystalline silver technology. Third parties may be discouraged by Smith & Nephew’ right of right refusal from working with us on new product development to meet either their needs or the needs of the advanced wound care market.

We have agreed to indemnify Smith & Nephew for claims under our agreements, which could result in significant costs to us.

We have agreed to indemnify Smith & Nephew in respect of claims resulting from any alleged physical injury or property damage as a result of our acts or omissions, the failure to perform our obligations under the license and development agreement and the supply agreement, our non-compliance with applicable law or regulation, or any breach of our representations under these two agreements for so long as the particular representation survives. Also, we have agreed to indemnify Smith & Nephew in respect of claims resulting from any actual or threatened action by any third party alleging our SILCRYST^tm coatings infringe that third party’s intellectual property rights. Smith & Nephew’s remedy for such an infringement action is limited to withholding damages or royalties it must pay on account of the infringement action from amounts or royalties payable to us under the two agreements, unless we have breached any representation to Smith & Nephew in connection with that infringement.

Our ability to develop and sell future products, particularly our gastrointestinal and future wound care products, is critical to our success, and if we fail to do so, our business and financial condition will suffer.

We have invested and will continue to invest a significant portion of our time and financial resources in the development of future products including products for wound care and gastrointestinal applications. With the discontinuance in 2006 of our clinical trial program for our pharmaceutical product candidate for the treatment of dermatological conditions, we have experienced a setback in the timeline for the development and introduction of potential new products. We are now refocusing our research efforts on preclinical work in gastrointestinal applications of our nanocrystalline technology and we are pursuing the introduction of the NPI 32101 cream formulation as a medical device. The development of medical devices and pharmaceutical products is risky because we cannot be sure that products will be as effective as we anticipate or will receive regulatory approval, and the development of new products is extremely costly and typically extends over many years. Even if we receive regulatory approval, other companies may be able to market similar products prior to the launch of our products, during which time their products may gain a significant marketing advantage. We expect to incur substantial capital expenditures in connection with the development of future products. If we fail to successfully develop and sell our future products then we will not earn any return on our investment in these future products, which will adversely affect our results of operations and could adversely affect the market price of our common shares. It would also adversely affect our financial condition. In addition, if we are unable to develop future products, we will remain dependent on Smith & Nephew’s ability to market and sell Acticoat^tm products successfully.

Our success in developing and selling new products will depend upon multiple factors, including:


	•	our ability to develop safe and effective products;

	•	our ability to obtain regulatory approval in the United States, the European Union and other markets and the scope of such approval;

	•	our ability to add sufficient manufacturing capacity and capability at an acceptable cost and in compliance with regulatory requirements;

	•	our ability to generate commercial sales of our products;

	•	acceptance of the product by the medical community and by patients and third-party payors;

	•	inherent development risks, such as the product proving to be unsafe or unreliable, or not having the anticipated effectiveness;


	•	preclusion or obsolescence resulting from third parties’ proprietary rights or superior or equivalent products;

	•	our ability to enter into favorable and effective marketing and distribution agreements, or to be able to effectively market and distribute on our own;

	•	our ability to develop repeatable processes to manufacture new products in sufficient quantities;

	•	our ability to raise on acceptable terms the substantial additional capital expected to be necessary to successfully develop and commercialize such products; and

	•	general economic conditions.

If we cannot overcome any of these factors, we may not be able to develop and introduce new products in a timely or cost-effective manner, which could adversely affect our future growth and results of operations. Our failure to develop new products could adversely affect the market price of our common shares.

We may face increased risk of product liability due to the nanocrystalline nature of our technology. If product liability lawsuits are brought against us, they could result in costly litigation and significant liabilities.

Materials made in the nanoscale size range can often have chemical or physical properties that are different from those of their larger counterparts. Such differences include altered magnetic properties, altered electrical or optical activity, increased structural integrity, and increased chemical and biological activity. Because of these properties, nanotechnology materials have great potential for use in a vast array of products. However, because of some of their special properties, they may pose different safety issues than their larger counterparts. Our nanocrystalline technology may present safety risks which are unknown at this time, and which may result in claims against us. Any claims, with or without merit, could result in costly litigation, reduced sales, significant liabilities and diversion of our management’s time and attention.

Our use of products in clinical trials, and our or Smith & Nephew’s marketing and sale of products, may expose us to product liability claims and associated adverse publicity. Additionally, the manufacture and sale of medical or pharmaceutical products or devices exposes us to an inherent risk of product liability claims, and the industries in which our products are sold or are likely to be sold have been subject to significant product liability litigation. Any claims, with or without merit, could result in costly litigation, reduced sales, significant liabilities and diversion of our management’s time and attention.

We have product liability insurance coverage in an amount that we believe is adequate for a company of our size in our industry under a policy maintained by Westaim, which covers Westaim and other entities it controls, and we expect to have this coverage at least until June 30, 2007 when Westaim’s coverage expires at which time we intend to obtain our own insurance policies or continue our coverage under Westaim’s renewed policies, unless Westaim no longer holds more than 50% of our outstanding common shares, and subject to the earlier termination of the services agreement we entered into with Westaim or that portion of the services agreement relating to the provision of insurance to us by Westaim. See “Certain Relationships and Related Party Transactions — Relationship with Westaim — Services Agreement.” Once we are no longer covered by Westaim’s insurance policies, we will have to obtain our own insurance policies, which could result in increased costs or reduced insurance coverage. In addition, our insurance coverage may not protect us against any or all of the product liability claims which could be brought against us in the future, and there can be no assurance that we will be able to obtain product liability insurance in the future at a cost that we deem acceptable, or at all. In the event a product liability claim is brought against us, we may be required to pay legal and other expenses to defend the claim and, if such a claim is successful, damage awards may not be covered, in whole or in part, by our insurance. We may not have sufficient capital resources to pay a judgment, in which case our creditors could levy against our assets. We may also be obligated to indemnify our collaborators and make payments to other parties with respect to product liability damages and claims. Defending any product liability claims, or indemnifying others against those claims, could require us to expend significant financial and managerial resources.

The market for advanced wound care and pharmaceutical products is intensely competitive and many of our competitors have significantly more resources and experience than we do, which may limit our commercial opportunities and revenues.

our SILCRYST^tm coatings to Smith & Nephew and Smith & Nephew markets and sells them under its Acticoat^tm trademark into a larger competitive environment.

We may not be able to compete successfully. Major competitors in the advanced wound dressing market in which Smith & Nephew’s Acticoat^tm products are sold include Convatec, a Bristol Myers Squibb company; Johnson & Johnson Wound Management, a division of Ethicon, Inc.; Argentum Medical, LLC; Coloplast Corp.; AcryMed, Inc.; 3M Company; Kinetic Concepts, Inc.; Mölnlycke Health Care Group AB and Paul Hartmann AG. To the extent that we develop pharmaceutical products to treat gastrointestinal conditions, we will face competition from pharmaceutical companies developing alternative drugs to treat this disease. In addition, we face and will continue to face competition from other major multi-national pharmaceutical companies, medical device companies, specialty pharmaceutical companies, universities and other research institutions.

Products or treatments of our competitors that exist now or that may be developed in the future may reduce the marketability of the current SILCRYST^tm coatings and any of our future products, particularly to the extent such products:


	•	are more effective;

	•	have fewer or less severe adverse side effects;

	•	have better patient compliance;

	•	receive better reimbursement terms;

	•	are accepted by more physicians;

	•	have better distribution channels;

	•	are easier to administer;

	•	are less expensive; or

	•	are more cost effective.

We cannot assure you that our competitors will not succeed in developing alternative technologies and products that are more effective, easier to use or more economical than those which have been or are being developed by us or that would render our technology and products obsolete and noncompetitive in these fields.

Some of our competitors, either alone or together with their collaborators, have substantially greater financial, sales and marketing, manufacturing, and other resources and larger research, development and regulatory staffs than we do. In addition, many of our competitors, either alone or together with their collaborators, have significantly greater experience than we do in discovering, developing, manufacturing and marketing products and may also have greater experience in conducting clinical trials and obtaining regulatory clearances or approvals. As a result, they may be able to devote greater resources to the development, manufacture, marketing or sale of their products, initiate or withstand substantial price competition or development costs, or more readily take advantage of acquisitions or other opportunities. Additional mergers and acquisitions, collaborations or other transactions, or the emergence or growth of other competitors in the medical device and pharmaceutical industries, may result in our competitors having even more resources.

Smith & Nephew, who previously was restricted by a non-competition clause, may now introduce other silver based products that compete with Acticoat^tm products.

Since May 2001, all of our revenues have been earned under our contracts with Smith & Nephew and Smith & Nephew is currently our only customer. We currently do not have any other products being sold in the marketplace other than the Acticoat^tm products marketed by Smith & Nephew. Consequently, all of our revenue is received from Smith & Nephew and is principally comprised of royalties, which are calculated as a percentage of Smith & Nephew’s sales of Acticoat^tm products, milestone payments, which are cash payments we receive upon the achievement by Smith & Nephew of certain sales goals or regulatory achievements relating to the Acticoat^tm products, and payment of our costs incurred in manufacturing Acticoat^tm products on a fixed price basis. The amount of our revenues is determined primarily by the level of sales of Acticoat^tm products achieved by Smith & Nephew and, as a result, our revenues generally vary in proportion to increases or decreases in Smith & Nephew’s sales of its Acticoat^tm products. We therefore depend and will continue to depend on Smith & Nephew to market and sell Acticoat^tm products successfully.

We are at risk of Smith & Nephew becoming less motivated to market Acticoat^tm products due to any one of a number of factors, including other products marketed by Smith & Nephew having better profit margins, or achieving greater acceptance or popularity with health care providers, than the Acticoat^tm products. On September 30, 2007, with the

execution of revised agreements with Smith & Nephew, the magnitude of this risk increased due to the fact that a non-compete provision was removed from the revised agreements allowing Smith & Nephew to introduce other silver based serious wound care products, which it was previously restricted from doing, that could have an adverse effect on the sales of Acticoat^tm products by Smith & Nephew. Since the execution of the new agreements with us, Smith & Nephew has introduced three new wound care products which use other forms of silver (Algisite Ag, Allevyn Ag and Biostep Ag). We believe that some of these new silver based wound care products will compliment the existing Acticoat^tm products marketed by Smith & Nephew without impacting sales of Acticoat^tm products, while others may be viewed by the advanced wound care market as alternatives to certain Acticoat^tm products, thereby potentially adversely affecting Acticoat^tm product sales and ultimately our operating revenues in the foreseeable future. We are now at risk of the sales of Acticoat^tm products failing to grow as they have in the past or declining due to the introduction by Smith & Nephew of new silver based serious wound care products especially to the extent that the new products have or are perceived to have better characteristics, lower prices or better profit margins than Acticoat^tm products resulting in customers generally preferring the new products and Smith & Nephew generally focusing its sales and marketing efforts on the new products to the detriment of Acticoat^tm products. If Smith & Nephew does not increase future sales of its Acticoat^tm products, this would likely have a material adverse effect on us and on the market price of our common shares.

Our future success depends in part on the launch of new Acticoat^tm products by Smith & Nephew. We have worked in the past and intend to work in the future with Smith & Nephew on the development of such new products; however, the decision to develop or launch a new product, the timing of the development and launch and all related matters are entirely within Smith & Nephew’s discretion. In view of Smith & Nephew’s new ability to introduce other silver based serious wound care products under the revised agreements signed with Smith & Nephew as discussed above, Smith & Nephew may become less motivated to develop new Acticoat^tm products with us and choose to focus instead on developing other silver based serious wound products. Therefore, while under the previous agreements in place with Smith & Nephew there could be no assurance that new products would be developed or launched at all or on the timeline or in a manner favorable to us, there can be even less assurance regarding those matters under the revised agreements entered into with Smith & Nephew on September 30, 2007.

If we are unable to effectively manage our expected future growth, we may develop too much production capacity resulting in too high of a cost structure to continue to produce Acticoat^tm products cost effectively or we may develop production capacity too slowly and be unable to meet demand for Acticoat^tm products with our SILCRYST^tm coatings and, in either event, we may be unable to develop or commercialize future products successfully.

We currently manufacture Acticoat^tm products with our SILCRYST^tm coatings in our manufacturing facility in Fort Saskatchewan, Alberta. At the end of the third quarter of 2005, we began construction of an expansion of our production facility with an estimated cost of approximately $5.7 million. We also hired additional employees to increase our production capacity. We are funding the up-front costs of the capital expenditures required to acquire the new production equipment associated with this expansion. Once we complete the expansion and start using the new equipment to produce Acticoat^tm products, we are entitled to recoup these costs over time from Smith & Nephew through reimbursement for depreciation expense, the payment of which are typically spread over a number of years. The capacity expansion is expected to become operational in the first quarter of 2008.

We began this expansion based on forecasted production volumes of Acticoat^tm products provided to us by Smith & Nephew but cannot guarantee that the production volumes will grow as forecasted or that we will be able to expand production capacity as planned, or at all. In this regard, Smith & Nephew has announced recently that market conditions in the advanced wound care market, including silver dressings segment, has become more competitive due to increased competition and customer cost containment efforts. We are uncertain as to whether or the extent to which this increased competition will have a negative impact on Acticoat^tm product sales growth. If we complete the expansion and production volumes do not grow as forecasted by Smith & Nephew, we may not need the equipment, and therefore, may not be able to begin recouping our up-front investment through reimbursement of depreciation expense from Smith & Nephew which could have a material adverse effect on our business and results of operation.

Conversely, to the extent that we are successful in expanding production capacity, our ability to manage our operations and expected growth will require us to continue to improve our operational, financial and management controls, reporting systems and procedures. We may not be able to make such improvements in an efficient or timely manner and may discover deficiencies in existing systems and controls. Our ability to develop and commercialize future products and compete effectively, and our future financial performance will depend, in part, on production volumes

growing as forecasted and on our ability to manage any future growth effectively. However, there can be no assurance that we will be able to achieve sufficient manufacturing capabilities to satisfy demand for our current or new products in a cost-effective manner or to produce and sell the quantities necessary for us to operate profitably.

We depend on our executive officers and scientific and technical personnel, and if we are not able to retain them or recruit additional qualified personnel, we may be unable to successfully develop or commercialize future products.

Our success depends upon the continued contributions of our executive officers and scientific and technical personnel. Due to the specialized knowledge each of our executive officers possesses with respect to our operations, the loss of service of any of our executive officers could delay or prevent the successful completion of the clinical trials necessary for the commercialization of present or future products.

We rely substantially upon the services of Thomas E. Gardner, our Chairman, President and Chief Executive Officer; Katherine J. Turner, our Vice President, Research & Development; Eliot M. Lurier, our Vice President, Finance and Administration and Chief Financial Officer; David C. McDowell, our Vice President, Manufacturing Operations and Edward Gaj, our Vice President, Corporate Development. Although these individuals have employment agreements with us, we cannot assure you that we will be able to retain their services. In the event Dr. Turner or Messrs. Gardner, Lurier, McDowell or Gaj is terminated without cause, we will be required to make severance payments to such officers under the terms of their respective employment agreements. See “Executive Compensation — Employment Agreements.” We do not currently maintain key man life insurance policies with respect to any of our employees.

Our success also depends in part on our ability to attract and retain highly qualified scientific, commercial and administrative personnel. In order to pursue our product development and commercialization strategies, we will need to retain existing personnel or hire new personnel with experience in a number of disciplines, including product development, manufacturing, quality, clinical testing, government regulation, sales and marketing, drug reimbursement and information systems. There is intense competition for personnel in the fields in which we operate. If we are unable to retain existing employees or attract new employees, we may be unable to continue our development and commercialization activities.

We currently purchase most of our raw materials from single suppliers. If we are unable to obtain raw materials and other products from our suppliers that we depend on for our operations, our ability to deliver our products to market may be impeded.

We depend on suppliers for raw materials and other components that are subject to stringent regulatory requirements. We currently purchase most of our raw materials from single suppliers and the loss of any of these suppliers could result in a disruption in our production. If this were to occur, it may be difficult to arrange a replacement supplier, because certain of these materials may only be available from one or a limited number of sources. Our suppliers may encounter problems during manufacturing due to a variety of reasons, including failure to follow specific protocols and procedures, failure to comply with applicable regulations, equipment malfunction and environmental factors. In addition, establishing additional or replacement suppliers for these materials may take a substantial period of time, as certain of these suppliers must be approved by regulatory authorities.

If we are unable to secure on a timely basis sufficient quantities of the materials we depend on to manufacture Acticoat^tm products, if we encounter delays or contractual or other difficulties in our relationships with these suppliers, or if we cannot find replacement suppliers at an acceptable cost, then the manufacture of Acticoat^tm products may be disrupted, which could increase our costs and have a materially adverse effect on our revenues.

If we are not successful in establishing collaborations with prominent health care companies, we may not be able to grow our business.

Our long-term success depends upon our ability to identify, develop and commercialize products, potentially including new device coatings and products for dermatological and gastrointestinal applications. We cannot assure you that we will be successful in developing new products. However, if we do develop new products, we will need to either market and sell such products ourselves or collaborate with one or more other companies that have the required marketing and sales capabilities. New collaborations are a key part of our growth strategy. If we are unable to enter into collaborations respecting new products or market and sell such products ourselves, we will continue to be dependent upon Smith & Nephew for all of our revenues, and we may be limited in our ability to grow our business. The terms and conditions of any future collaboration agreements may be less favorable than our agreements with Smith & Nephew.

If a natural or man-made disaster strikes one or more of our facilities, or facilities upon which we depend, we may be unable to manufacture certain products for a substantial amount of time and our revenue could decline.

Our facilities and the facilities of others on which we depend may be affected by natural or man-made disasters, which may include terrorist activities. We depend on our manufacturing facility and research laboratories, as well as our critical information systems, for the continued operation of our business. Our sole manufacturing facility is located in Fort Saskatchewan, Alberta, Canada. This facility and the manufacturing equipment that we use to produce our products, as well as our critical information systems, would be difficult to replace and could require substantial lead time to repair or replace. In the event that our manufacturing facility was affected by a natural or man-made disaster, we would be forced to construct new manufacturing facilities and may not be able to produce our products in sufficient quantities, or at all, during the period of construction. In that regard, due to the specialized nature of our manufacturing equipment, we anticipate that it would take a substantial period of time to construct new manufacturing facilities. Moreover, we would need to secure regulatory approval to manufacture our products at a new facility. Accordingly, construction of new facilities and regulatory approvals could take years to complete and could result in significant costs to us.

We have historically had internal controls and accounting processes in place and have modified these controls and processes over time as the need has arisen. However, if our internal controls and accounting processes are insufficient, we may not detect in a timely manner misstatements that could occur in our financial statements in amounts that could be material.

As a result of our initial public offering and the subsequent listing of our common shares on NASDAQ and the Toronto Stock Exchange, we need to devote substantial efforts to the reporting obligations and internal controls required of a public company in the United States and Canada, which will result in substantial costs, and a failure to properly meet these obligations could cause investors to lose confidence in us and have a negative impact on the market price of our common shares. Because, prior to our initial public offering, we had a small accounting staff and relied on Westaim to provide certain accounting services to us, these obligations will be more taxing on our resources than if we were a larger organization.

We will be required to devote significant resources to the documentation and testing of our operational and financial systems for the foreseeable future. In connection with our initial public offering we took a number of steps to prepare for quarterly financial reporting and we have had only limited operating experience with the improvements we made. We will need to make continued efforts with respect to the documentation of our internal controls in order to meet the requirements of being a public company in the United States and Canada, including the rules under Section 404 of the Sarbanes-Oxley Act of 2002 in the United States and Multilateral Instrument 52-109 — Certification Disclosure in Issuers’ Annual and Interim Filings. However, the improvements we have made to date and the efforts with respect to our accounting processes that we will need to continue to make may not be sufficient to ensure that we maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could cause us to fail to meet our reporting obligations in the United States or Canada or result in misstatements in our consolidated financial statements in amounts that could be material. Insufficient internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our shares and may expose us to litigation risk.

We will incur significant expenses as a result of being a public company.

We have incurred and will continue to incur significant expenses as a result of being a public company. We completed our initial public offering in December 2005 and we have incurred and will continue to incur significant legal, accounting, insurance and other expenses as a result of being a public company. The Sarbanes-Oxley Act of 2002, as well as related rules implemented by the SEC and the NASDAQ Global Market, and National Policy 58-201 — Corporate Governance Guidelines implemented by the Canadian securities administrators, have required changes in corporate governance practices of public companies. Compliance with these laws, rules and regulations has substantially increased and will continue to substantially increase our expenses, including our legal and accounting costs, and makes some activities more time-consuming and costly. We also expect that these laws, rules and regulations will make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as officers. Consequently, we have

experienced and expect to continue to experience a substantial increase in legal, accounting, insurance and certain other expenses in the future, which will negatively impact our results of operations and financial condition.

We may incur losses associated with currency fluctuations and may not be able to effectively hedge our exposure.

The Smith & Nephew sales revenues on which our royalty and milestone revenues are determined are reported to us in U.S. dollars. Sales by Smith & Nephew in other currencies will result in fluctuations in their revenue as reported in U.S. dollars. Our accounts receivable from Smith & Nephew are denominated in U.S. dollars. The functional currency that we use for accounting purposes is the Canadian dollar and, as a result, accounts receivable recorded in Canadian dollars are exposed to changes in the exchange rate between the Canadian and U.S. dollars until these receivables are collected. We do not maintain derivative instruments to mitigate our exposure to fluctuations in exchange rates.

Risks Related to Regulatory Matters

Smith & Nephew may be unable to maintain existing regulatory approvals or obtain new regulatory approvals for the Acticoat^tm products that it currently sells, which would negatively affect our results of operations. Our future products may not be approved by the regulatory agencies, and any failure or delay associated with our product development and clinical trials or the agencies’ approval would increase our product development costs and time to market.

Smith & Nephew is required to maintain regulatory approvals to sell the Acticoat^tm products that it currently sells and to obtain additional regulatory approvals for those current products to sell them in any new markets. All of our future products will also require regulatory approval before we or any collaborator are allowed to market and sell them. We expect the regulatory approval process to be lengthy and expensive and we will have the burden of proving that our products are safe and effective. Satisfying regulatory requirements may cause our products to become prohibitively expensive. We cannot assure you that Smith & Nephew will be able to maintain existing regulatory approvals for the Acticoat^tm products it now sells or obtain new regulatory approvals, or that the conditions imposed by regulators will not adversely affect Smith & Nephew’s ability to market those products. Regulatory requirements imposed on products could limit Smith & Nephew’s ability to commercialize its product and our ability to test, manufacture and commercialize our products. Loss of these approvals or an inability to obtain approvals could have a material adverse effect on our business, financial condition or results of operations.

Preclinical studies and clinical trials are expensive, can take many years and have uncertain outcomes. In addition, the regulatory approval procedures vary among countries and additional testing may be required in some jurisdictions. It usually takes at least several years to complete the requisite pre-clinical studies and clinical trials, and a product candidate may fail at any stage of testing. Difficulties and risks associated with pre-clinical studies and clinical trials may result in failure to receive regulatory approval or inability to commercialize products for new indications. Clinical trials may be suspended or terminated at any time due to the actions of the FDA, other regulatory authorities, our collaborators, or due to our own actions. The commencement and completion of our clinical trials could be delayed or prevented by several factors, including:


	•	delays in obtaining regulatory approvals, including approvals by the competent institutional review board, or IRB, or ethics committee, or EC, to commence or continue a study;

	•	delays in identifying and reaching agreement on acceptable terms with prospective clinical trial sites;

	•	insufficient quantities of the study product;

	•	scheduling conflicts with participating clinicians and clinical institutions;

	•	slower than expected rates of patient recruitment and enrollment or the inability to reach full enrollment;

	•	improper enrollment practices resulting in protocol management problems and statistical analysis problems;

	•	inconclusive or negative interim results during clinical trials, including lack of effectiveness or unforeseen safety issues;

	•	death of, or serious adverse effects experienced by, one or more patients during a clinical trial even if the reasons are not related to the study product candidate, including the advanced stage of the patient’s disease or medical condition;

	•	uncertain dosing issues;


	•	inability to monitor patients adequately during and after treatment;

	•	inability or unwillingness of contract laboratories to follow good laboratory practices or of our clinical investigators and us to follow good clinical practices;

	•	the occurrence of adverse events during the clinical trials;

	•	inability or unwillingness of clinical investigators to follow our clinical protocols or good clinical practices generally;

	•	inability or unwillingness of patients to follow our clinical protocols; and

	•	inability or unwillingness of other third parties to perform data collection and analysis in a timely or accurate manner.

Delays or failures in obtaining regulatory approvals may:


	•	delay or prevent the commercialization of any product that we develop for new indications or any product within an already approved indication for which the submission of additional clinical trial data is required;

	•	in the case of delays, materially and adversely increase the cost of completing the development of such product and obtaining regulatory approval to market it;

	•	diminish any competitive advantages; and

	•	adversely affect our ability to attract new collaborators.

Completion of clinical trials does not guarantee successful commercialization of future products.

Completion of clinical trials does not guarantee successful commercialization, for a variety of reasons, including, but not limited to the following factors:


	•	clinical trials can have negative or inconclusive results;

	•	regulators may not agree with our results or our analysis of the safety or the efficacy of our products;

	•	there is a risk of unsuccessful commercialization even after a product has been launched into the market, for example due to unexpected side effects of the product which were not discovered during clinical trials; and

	•	the market may fail to respond positively to a product for a variety of factors outside our control, including but not limited to inadequate or unsuccessful marketing efforts by third parties on which we depend but cannot control, competition from other products, cost, reimbursement policies of third-party payors or the buying decisions of consumers for a variety of unforeseen reasons, including those unrelated to efficacy.

In the case of products that have already received regulatory approval or products for which we may receive regulatory approval in the future, we, Smith & Nephew and any companies with which we may collaborate in the future may still face development and regulatory difficulties that may delay or impair future sales.

Current Acticoat^tm products are subject to extensive regulation by the FDA, other federal authorities and certain state, provincial, territorial and foreign regulatory authorities. If we, Smith & Nephew or any companies with which we may collaborate in the future obtain regulatory approval for any future products, we, Smith & Nephew and any such collaborators will also be subject to extensive regulation by the FDA, other federal authorities and certain state, provincial, territorial and foreign regulatory authorities. These regulations will impact and do impact in the case of Acticoat^tm products many aspects of our operations, including manufacturing, record keeping, quality control, adverse event reporting, storage, labeling, advertising, promotion, sale and distribution, export and personnel. The FDA and state, provincial, territorial and foreign agencies may conduct periodic inspections to assess compliance with these requirements. We, together with Smith & Nephew and any companies with which we may collaborate in the future, will be required to conduct post-marketing surveillance of the products. We also may be required to conduct post-marketing studies and safety monitoring. Any failure by us, Smith & Nephew or any companies with which we may collaborate in the future to comply with applicable FDA and other regulatory requirements, or the discovery of previously unknown problems, may result in problems including:


	•	delays in commercialization;

	•	refusal by the FDA or other regulatory agencies to review pending applications or supplements to approved applications;


	•	product recalls or seizures; warning letters; suspension of manufacturing;

	•	withdrawals of previously approved marketing applications;

	•	fines and other civil penalties;

	•	injunctions, suspensions or revocations of marketing licenses;

	•	refusals to permit products to be imported to or exported from the United States and other countries; and

	•	civil litigation and criminal prosecutions.

See “Business — Government Regulation — United States — Manufacturing cGMP Requirements.”

If government and third-party payors fail to provide coverage and adequate reimbursement rates for Acticoat^tm products or our future products, our revenues and potential for profitability will be reduced.

Our revenues currently depend in part and will continue to depend upon the reimbursement rates established by third-party payors, including government health administration authorities, managed-care providers, public health insurers, private health insurers and other organizations. These third-party payors are increasingly challenging the price, and examining the cost-effectiveness, of medical products and services. Cost control initiatives could decrease the established reimbursement rates that we receive for any products in the future, which would limit our revenues. Legislation and regulations affecting the pricing of pharmaceutical products or medical devices, including the Acticoat^tm products, may change at any time, which could limit or eliminate reimbursement rates for Acticoat^tm or other products. If physicians, hospitals and other users of Acticoat^tm products or any products we develop in the future fail to obtain sufficient reimbursement from healthcare payors for these products, or if adverse changes occur in governmental and private third-party payors’ policies toward reimbursement for these products, it could negatively affect the demand for these products, which could have a material adverse effect on our results of operations. Significant uncertainty exists as to the reimbursement status, if any, of newly approved pharmaceutical or medical device products, and we have no assurance that adequate or any third-party coverage will be provided for any new products introduced by us. If our new products do not receive adequate coverage and reimbursement, the market acceptance of these products would be adversely affected, which would have a material adverse effect on our results of operations.

We may need to conduct post-marketing clinical trials in order to demonstrate the cost-effectiveness of products. Such studies may require us to commit a significant amount of management time and financial and other resources. Future products may not be reimbursed or covered by any of these third-party payors for our targeted indications.

In many foreign markets, particularly countries in the European Union and Canada, the pricing of medical products is subject to governmental control. In these countries, obtaining pricing approval from governmental authorities can take many months and sometimes years to obtain. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of a product to other available therapies. If reimbursement of such products is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory levels, then our revenues could be reduced.

In the United States, there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmental pricing controls. We cannot assure you that the Medicare Prescription Drug Improvement and Modernization Act of 2003 will not have a significant effect on pricing or reimbursement for the pharmaceutical products that we are developing.

Our business involves the use, handling, storage and disposal of hazardous materials and may subject us to environmental liability, and any future environmental liability could seriously harm our financial condition. We do not maintain insurance covering these risks.

Our research and development and manufacturing activities involve the use, handling, storage and disposal of various materials commonly used in conducting these activities in the pharmaceutical industry, such as alcohols and acids. These materials are considered hazardous because they may be toxic, corrosive or flammable under certain conditions. We are subject to federal, state, provincial, local and foreign laws, regulations and policies governing the use, manufacture, storage, handling, and disposal of these materials. Some of our facilities are located in areas that may experience environmental contamination due to the activities of third parties.

We cannot completely eliminate the risk of accidental injury or contamination from the use, manufacture, storage, handling, and disposal of materials we use. In the event of an accident or contamination, we could be liable for damages or costs of clean-up or remediation or be penalized with fines. This liability could be substantial and exceed our resources,

which could have a material adverse effect on our financial condition. We do not maintain insurance for environmental liabilities. We may have to incur significant costs to comply with future environmental laws and regulations. Accordingly, we cannot assure you that costs and expenses relating to environmental matters or our use of hazardous materials will not have a material adverse effect on our business.

We perform and manage our clinical trials rather than relying on third-party clinical research organizations, or CROs, and since we do not have extensive experience in this area, there may be delays in completing, or a failure to complete, clinical trials that comply with regulatory requirements.

We may not have the experience or the capability to take a product through the entire research and development process. Specifically, we may not be able to take a product through pre-clinical development, clinical trials management, clinical data management, study design, biostatistical analysis, central laboratory and regulatory affairs. Thus, we may be unable to obtain regulatory approval for, or successfully commercialize, our product candidates.

Further, we may not perform our clinical trials in accordance with good clinical and laboratory practices, as required by the applicable regulatory authorities. If our clinical trials fail to comply with these regulatory practices, we may be unable to use the data from those trials. Consequently, our clinical trials may be extended, delayed or terminated.

We also may not be able to run our clinical trials as efficiently as a CRO and therefore we may experience a longer and more costly product development phase. This increase in the product development phase may subsequently reduce our period of patent exclusivity, and in turn diminish our potential economic returns.

Failure to comply with workplace safety legislation could seriously harm our financial condition.

If we fail to comply with workplace safety legislation applicable to our employees, we may be subject to sanctions, fines and penalties including but not limited to closure of our manufacturing facility, as well as litigation risks, all of which would harm our financial condition.

Risks Related to Intellectual Property

The protection of our intellectual property rights is critical to our success and any failure on our part to adequately protect those rights would materially adversely affect our business.

Patents. Our commercial success will depend in part on the patent rights we own or may license in the future. As of January 4, 2008, our patent portfolio was comprised of 23 patents and 22 pending patent applications in the United States and 88 corresponding patents and 25 corresponding patent applications in the other major markets around the world. Our success depends on maintaining these patent rights against third-party challenges to their validity, scope or enforceability. In general, our patent position is subject to the risk that a governmental agency, such as the U.S. Patent and Trademark Office, or PTO, or the courts may deny, narrow or invalidate patent claims.

We may not be successful in securing or maintaining proprietary or patent protection for our products and candidates, and any protection that we do secure may be challenged and possibly lost. Our competitors may develop products similar to ours using compositions, methods and technologies that are beyond the scope of our intellectual property rights. In addition, if we are unable to maintain our proprietary rights, other companies may be able to copy our products or manufacturing processes. For example, although we believe that we have valid patent protection for our current products until at least 2014, it is possible that, prior to the expiration of our patents, competitors will attempt to introduce products similar to ours outside of the scope of our patents. Intellectual property protection is highly uncertain and involves complex legal and technical questions. Our patents and any patent that we may license in the future may be challenged, narrowed, invalidated, or circumvented. Our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products, or provide us with any competitive advantage.

The PTO, the PTO’s counterparts in other nations and the courts in the United States and elsewhere have not established a consistent policy regarding the breadth of claims allowed related to pharmaceutical patents. The allowance of broader claims may increase the incidence and cost of patent interference proceedings and the risk of infringement litigation. On the other hand, the allowance of narrower claims may limit the value of our proprietary rights.

Failure to obtain or maintain patent or trade secret protection, for any reason, could adversely affect our competitiveness in the marketplace.

Additionally, the laws of some countries do not protect our intellectual property rights to the same extent as do the laws of the United States and Canada. For example, enforcing patents in countries such as China and Japan may be

difficult due to the structures of their patent systems. In addition, litigation in these or other countries may not be cost effective when balanced against the benefit that may be obtained. Further, there may be substantial global markets in which we do not have or may not be able to secure patent protection. There are also countries where our patents may not provide us with a financial or commercial benefit due to that country’s tolerance of patent violations.

In addition, our competitors or other third parties, including generic drug companies, may challenge the validity of our patent claims. As a result, these patents may be narrowed in scope or invalidated and may fail to provide us with any market exclusivity or competitive advantage even after our investment of significant amounts of money. We also may not be able to protect our intellectual property rights against third-party infringement, which may be difficult to detect. In addition, we cannot assure you that third parties will not claim that we are infringing upon their patents or other intellectual property rights. If we become involved in any dispute regarding our intellectual property rights, regardless of whether we prevail, we could be required to engage in costly, distracting and time-consuming litigation that could harm our business and that could result in substantial expense. Likewise, if we were found to infringe the patents or other intellectual property rights of others, we might be required to make substantial royalty or other payments to third parties or otherwise cease manufacturing and marketing the product that is alleged to be infringing such third party patent or other intellectual property right, which in either case could materially adversely affect our results of operations.

Trade Secrets and Proprietary Know-how. We also rely upon trade secrets and unpatented proprietary know-how and continuing technological innovation in developing our products, especially where we do not believe patent protection is appropriate or obtainable. We seek to protect this intellectual property, in part, by generally requiring our employees, consultants and current and prospective business partners to enter into confidentiality agreements. We may lack the financial or other resources to successfully monitor and detect, or to enforce our rights in respect of, infringements of our rights or breaches of these confidentiality agreements. In the case of any such undetected or unchallenged infringements or breaches, these confidentiality agreements may not provide us with meaningful protection of our trade secrets and unpatented proprietary know-how or adequate remedies. In addition, others may independently develop technology that is similar or equivalent to our trade secrets or know-how. If any of our trade secrets, unpatented know-how or other confidential and proprietary information is divulged to third parties, including our competitors, our competitive position in the marketplace could be harmed and our ability to successfully sell products in our target markets could be severely compromised.

Trademarks. We have received trademark registrations for the words NUCRYST^tm and SILCRYST^tm as well as associated designs, in many jurisdictions that we consider major markets. We have pending trademark applications in other major market jurisdictions, including the United States.

If we do not adequately protect our rights in our various trademarks from infringement, any goodwill that has been developed in those marks could be lost or impaired. If the marks we use are found to infringe upon the trademark or service mark of another company, we could be forced to stop using those marks and, as a result, we could lose any goodwill which has been developed in those marks and could be liable for damages caused by any such infringement.

The ability to market Acticoat^tm products and any other products we develop is subject to the intellectual property rights of third parties.

Acticoat^tm products, and the product candidates we currently are developing and those we may develop in the future, may infringe patent and other rights of third parties. In addition, our competitors, many of which have substantially greater resources than us and have made significant investments in competing technologies or products, may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use and sell products either in North America or international markets. Intellectual property litigation in the pharmaceutical industry is common, and we expect this to continue.

If we or our collaborators are found to be infringing or to have infringed upon the intellectual property rights of third parties, we may be required to license the disputed rights, if the holder of those rights is willing, or to cease marketing the challenged products, or, if possible, to modify our products to avoid infringing upon those rights. Moreover, we could be liable for royalties on past sales and significant damages, and we could be required to obtain and pay for licenses if we are to continue to manufacture our products. These licenses may not be available and, if available, could require us to pay substantial upfront fees and future royalty payments. Any patent owner may seek preliminary injunctive relief in connection with an infringement claim, as well as a permanent injunction, against us or our collaborators and, if successful in the claim, may be entitled to lost profits from infringing sales, legal fees and interest and other amounts. Any damages could be increased if there is a finding of willful infringement. Even if we and our collaborators are successful in

defending an infringement claim, the expense, time delay and burden on management of litigation could have a material adverse effect on our business.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of their former employers.

Many of our employees were previously employed at universities or other medical device or pharmaceutical companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying money damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to commercialize product candidates, which could harm our business.

We may become involved in expensive intellectual property litigation or other proceedings related to intellectual property rights.

We may deem it necessary or advisable to commence litigation to enforce our intellectual property rights. Others may claim that we have infringed upon their intellectual property rights and commence litigation against us. We believe that we will be subject to an increasing number of infringement claims to the extent we produce more products.

Our commercial success depends in part on our ability to operate without infringing the patents and other proprietary rights of third parties. Infringement proceedings in the pharmaceutical industry are lengthy, costly and time-consuming and their outcome is uncertain.

We may also be forced to engage in litigation to enforce any patents issued or licensed to us, or to determine the scope and validity of third party proprietary rights. Moreover, if our competitors prepare and file patent applications in the United States to claim technology that is also claimed by us, we may be forced to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine priority of invention. In addition, in Europe, any patents issued to us may be challenged by third parties in opposition proceedings. Litigation and participation in such proceedings could result in substantial costs and diversion of our efforts, even if the eventual outcome is favorable to us. Litigation could also subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties or require us to cease using certain technology.

If we become involved in any patent litigation, interference, opposition or other administrative proceedings, we will incur substantial expense and the efforts of our technical and management personnel will be significantly diverted. As a result of such litigation or proceedings we could lose our proprietary position and be restricted or prevented from developing, manufacturing and selling the affected products, incur significant damage awards, including punitive damages, or be required to seek third-party licenses that may not be available on commercially acceptable terms, if at all. In addition, we may lack the resources, whether financial or otherwise, to monitor, prosecute and enforce our intellectual property rights. Moreover, our collaborators may choose not to enforce or maintain their intellectual property rights, and we may be forced to incur substantial additional costs to maintain or enforce such rights or may incur additional risks should we choose not to maintain or enforce such rights.

Risks Related to Our Common Shares

There has been limited trading in our common shares and, as a result, our common share price may be highly volatile.

There has been low trading volume in our common shares since our initial public offering in December 2005. We cannot predict the extent to which an active trading market will develop or how liquid any market that may develop might become. An active trading market for our common shares may never develop or may not be sustained, which could adversely affect your ability to sell your shares and the market price of your shares.

Our stock price is volatile. Since our public offering on December 22, 2005 and through February 11, 2008, our common shares have traded on the NASDAQ between $1.27 and $16.88 per share. While our common shares are also traded on the Toronto Stock Exchange, the majority of trading in our common shares has taken place on the NASDAQ. The stock market in general, and the market for stocks of medical devices and pharmaceutical companies in particular, have experienced high volatility. As a result, the market price of our common shares is likely to continue to be volatile,

and investors in our common shares may experience a decrease, which could be substantial, in the value of their shares, including decreases unrelated to our operating performance or prospects. The market price of our common shares could be subject to wide fluctuations in response to a number of factors, including those listed elsewhere in this “Risk Factors” section and others such as:


	•	variations in our operating performance and the performance of our competitors or companies that are perceived to be similar to us;

	•	actual or anticipated fluctuations in our quarterly or annual operating results;

	•	results of pre-clinical and clinical trials by us and our competitors;

	•	matters relating to our agreements with Smith & Nephew, including fluctuations in sales of Smith & Nephew’s Acticoat^tm products;

	•	assertions that our intellectual property infringes on the intellectual property rights of others or other matters calling into question our intellectual property;

	•	changes in estimates or recommendations by securities analysts;

	•	publication of research reports by securities analysts about us or our competitors or our industry;

	•	our failure or the failure of our competitors to meet analysts’ projections or guidance that we or our competitors may give to the market;

	•	additions and departures of key personnel;

	•	strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic collaborations or investments or changes in business strategy;

	•	the passage of legislation or other regulatory developments affecting us or our industry;

	•	speculation in the media or investment community;

	•	changes in accounting principles;

	•	litigation;

	•	terrorist acts, acts of war or periods of widespread civil unrest; and

	•	changes in general market and economic conditions.

In the past, securities class action litigation has often been initiated against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs and divert our management’s attention and resources, and could require us to make substantial payments to satisfy judgments or to settle litigation.

Future sales of currently restricted shares could cause the market price of our common shares to decrease significantly, even if our business is doing well.

Prior to the issuance of our common shares in our initial public offering, Westaim held 100% of our outstanding common shares. As of February 11, 2008, Westaim holds approximately 75% of our outstanding common shares. Pursuant to the terms of a registration rights agreement between Westaim and us, Westaim may require us, on no more than two occasions, to use reasonable best efforts to register all or a portion of their registrable securities for resale in the public markets in the United States and to file a prospectus qualifying the common shares they own for resale in Canada, so long as the anticipated aggregate proceeds from the sale of such registrable securities, net of underwriting discounts and expenses would exceed $5.0 million and subject to our right to defer filing under certain circumstances. Sales of a significant number of our common shares, or the perception that these sales could occur, could materially and adversely affect the market price of our common shares and impair our ability to raise capital through the sale of additional equity securities.

We have also registered all common shares that we may issue under our amended equity incentive plan and upon exercise of our outstanding share options and share appreciation rights for resale in the public markets in the United States. Shares issued under our amended equity incentive plan and upon the exercise of our outstanding share options and share appreciation rights may be sold without restriction in the Canadian public markets, provided there is compliance with National Instrument 45-102. As of December 31, 2007, 39,200 common shares were issuable on the vesting of restricted share units outstanding under our amended equity incentive plan and 1,405,638 common shares were issuable upon the exercise of options to purchase our common shares outstanding under our amended equity incentive plan. In

addition, as of December 31, 2007, 579,299 common shares were reserved for future awards under our amended equity incentive plan.

Westaim controls and will continue to control us and may have conflicts of interest with us or you in the future.

As of December 31, 2007, Westaim owned approximately 75% of our outstanding common shares. In addition, certain of our directors also serve as directors of Westaim.

For as long as Westaim continues to own more than 50% of our common shares, Westaim will be able to direct the election of all of the members of our board of directors. For as long as Westaim owns a significant percentage of our outstanding common shares, even if less than a majority, Westaim will be able to control or exercise a controlling influence over our business and affairs, including the incurrence of indebtedness by us, the issuance of any additional common shares or other equity securities, the repurchase of common shares and the payment of dividends, if any, and will have the power to determine or significantly influence the outcome of matters submitted to a vote of our shareholders, including mergers, consolidations, sales or dispositions of assets, other business combinations and amendments to our articles. Westaim may take actions with which you do not agree, including actions that delay, defer or prevent a change in control of our company or that could adversely affect the market price of our common shares. In addition, Westaim may take other actions that might be favorable to Westaim but not favorable to our other shareholders. Also, if Westaim sells all or a portion of its interest remaining in us, it may cause the value of your investment to decrease.

The amount of our net operating loss carryovers may be limited.

The amount of net operating loss carryovers, or NOLs, which may be used by us for U.S. federal income tax purposes in any future year could be limited by Section 382 of the Internal Revenue Code of 1986, as amended. In general, Section 382 would limit our ability to use NOLs for U.S. federal income tax purposes in the event of certain changes in ownership of our company, including as a result of sales of our common shares by Westaim and future offerings of common shares by us or as a result of certain changes in ownership of Westaim including as a result of future offerings of common shares of Westaim. If such limitations were triggered as a result of future shifts in ownership of us or Westaim, the use of our NOLs for U.S. federal income tax purposes would be limited. Any limitation of our use of NOLs could (depending on the extent of such limitation and the amount of NOLs previously used) result in us retaining less cash after payment of U.S. federal income taxes during any year in which we have taxable income (rather than losses) than we would be entitled to retain if such NOLs were available as an offset against such income for U.S. federal income tax reporting purposes. As noted elsewhere, we expect to incur losses on a quarterly and annual basis for the foreseeable future. Accordingly, we cannot predict when or if we will generate taxable income.

If we are classified as a passive foreign investment company, it could have adverse tax consequences to investors.

Special rules apply to certain U.S. holders that own shares in a non-U.S. corporation that is classified as a passive foreign investment company, or PFIC. We do not believe that we will be a PFIC for the current taxable year and, based on our current business plan, we do not expect to be a PFIC in the foreseeable future. Since the determination as to whether or not a corporation is a PFIC is highly factual, however, there can be no assurance that we will not become a PFIC in future taxable years. The PFIC rules are extremely complex and could, if they apply, have significant adverse effects on the taxation of dividends received and gains realized by a U.S. holder of our common shares. Accordingly, prospective U.S. holders are strongly urged to consult their tax advisers concerning the potential application of the PFIC rules to their particular circumstances.

We do not intend to pay dividends, which may adversely affect the market price of our common shares.

We currently intend to retain all available cash to finance our operations and the expansion of our business and do not intend to declare or pay cash dividends on our common shares for the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our board of directors and will depend on our results of operations, financial condition, current and anticipated cash needs, contractual restrictions, restrictions imposed by applicable law and other factors that our board of directors deems relevant. You should not rely on an investment in our company if you require or are seeking dividend income from your investment. The success of your investment will likely depend entirely upon any future appreciation of the market price of our common shares, which is uncertain and unpredictable. There is no guarantee that our common shares will appreciate in value or that the value of the common shares will not decline, perhaps substantially.

As a foreign private issuer, we are subject to different United States securities laws and rules than a domestic United States issuer, which may limit the information publicly available to our shareholders.

As a foreign private issuer we are not required to comply with all the disclosure requirements of the Securities Exchange Act of 1934 such as proxy statements and therefore there may be less publicly available information about NUCRYST than if we were a United States domestic issuer. In addition, our officers, directors and principal shareholders are exempt from the reporting and “short-swing” profit recovery provisions of Section 16 of the Securities Exchange Act of 1934 and the rules thereunder. Therefore, our shareholders may not know on a timely basis when our officers, directors and principal shareholders purchase or sell our common shares. All of our directors, officers and principal shareholders will be subject to the insider reporting rules under Canadian securities legislation and are required to file reports in electronic format through the System for Electronic Disclosure by Insiders, or SEDI, disclosing changes in beneficial ownership, or control or direction over, our common shares and other securities. Our shareholders can access such reports at www.sedi.ca.

You may be unable to enforce actions against us or certain of our directors and officers under United States federal securities laws.

We are a corporation organized under the laws of Alberta, Canada. One half of our directors and certain of our officers reside outside of the United States. Service of process upon such persons may be difficult or impossible to effect within the United States. Furthermore, because a substantial portion of our assets, and substantially all of the assets of our non-United States directors and officers and the Canadian experts named herein, are located outside of the United States, any judgment obtained in the United States, including a judgment based upon the civil liability provisions of United States federal securities laws, against us or any of such persons may not be collectible within the United States. In addition, there is doubt as to the applicability of the civil liability provisions of United States federal securities law to original actions instituted in Canada. It may be difficult for an investor, or any other person or entity, to assert United States securities laws claims in original actions instituted in Canada. Therefore, it may not be possible to enforce those actions against us or certain of our directors and officers.

We have outstanding share options that have the potential to dilute shareholder value and cause the price of our common shares to decline.

In the past, we have offered, and we expect to continue to offer, share options, or other forms of share-based compensation to our directors, officers and employees. Share options issued prior to our initial public offering have per share exercise prices below the initial public offering price per share. As of December 31, 2007, we had options outstanding to purchase 1,405,638 of our common shares at a weighted average exercise price of $3.93 per share. The exercise price of some of our outstanding share options are stated in Canadian dollars, and the foregoing weighted average exercise prices, which are stated in United States dollars, are based upon the noon buying rate reported by the Federal Reserve Bank of New York on December 31, 2007. If some or all of these options are exercised and such shares are sold into the public market, the market price of our common shares may decline.

Our articles and certain Canadian laws could delay or deter a change of control.

Our authorized preferred shares are available for issuance from time to time at the discretion of our board of directors, without shareholder approval. Our board of directors may amend our articles to fix the number of preferred shares in, and determine the designation of the shares of, each series of preferred shares and may create, define and attach voting, dividend and other rights and restrictions to the shares of each series, subject to the rights and restrictions attached to our preferred shares as a class. The economic, voting and other rights attaching to a particular series of our preferred shares may be superior to those of our common shares and may dilute or otherwise adversely affect the voting and economic interests of the holders of our common shares.

Limitations on the ability to acquire and hold our common shares may be imposed by the Competition Act (Canada). This legislation permits the Commissioner of Competition of Canada, or Commissioner, to review any acquisition of a significant interest in us. This legislation grants the Commissioner jurisdiction, for up to three years, to seek a remedial order, including an order to prohibit the acquisition, from the Canadian Competition Tribunal, which order may be granted where the Competition Tribunal finds that the acquisition substantially prevents or lessens, or is likely to prevent or lessen, competition in any market in Canada.

The Investment Canada Act (Canada), or Investment Act, requires each “non-Canadian,” as determined in the Investment Act, who commences a new business activity in Canada or acquires control of an existing Canadian business,

where the establishment or acquisition of control is not a reviewable transaction by Canadian authorities under the Investment Act, to file a notification in prescribed form. Subject to certain exceptions, a transaction that is reviewable under the Investment Act may not be implemented until an application for review has been filed and the responsible Minister of the federal cabinet has determined that the investment is likely to be of “net benefit to Canada” taking into account the factors, where relevant, set out in the Investment Act. An investment in our common shares by a non-Canadian would be reviewable under the Investment Act if it were an investment to acquire control of us and the value of our assets was C$5.0 million or more as determined pursuant to the Investment Act.

Any of the foregoing may make it more difficult for shareholders to replace our management, and could prevent or delay a change of control of our company and deprive or limit strategic opportunities for our shareholders to sell their shares.

ITEM 2. PROPERTIES

Our Fort Saskatchewan, Alberta facility is leased and consists of manufacturing, laboratory and office space. We lease office and laboratory space in Wakefield, Massachusetts for administration, marketing, sales and pharmaceutical research and development.

We estimate that our existing production facility in Fort Saskatchewan has the capacity to produce Acticoat^tm products with a value, expressed in terms of the sales price to end users, of approximately $75 million, based on existing product mix and current sales prices. Our current capacity is utilized for customer demand for Smith & Nephew sales and inventory requirements and research and development. We estimate that with the completion of this expansion of our Fort Saskatchewan production facility in the first quarter of 2008, our manufacturing capacity will be increased by approximately 30%, depending on product mix. This expanded manufacturing capacity is expected to be sufficient to meet our immediate production capacity needs required in connection with our development of additional products and the satisfaction of current Smith & Nephew demand for Acticoat^tm products and is expected to be adequate to meet its near-term forecasted production growth. This estimate is based on a number of assumptions and uncertainties, and actual increases in capacity may be different.

We believe that our leased facilities in Alberta and Massachusetts are generally in good condition, are well maintained, and are generally suitable to carry on our business. In 2007, the Alberta manufacturing facility operated moderately below capacity. We consolidated our research and development activities in our Wakefield facility, which resulted in excess office and laboratory space, because of our suspension of all plans for future clinical trials of the studied formulation NPI 32101 for the treatment of atopic dermatitis.

ITEM 3. LEGAL PROCEEDINGS

In the normal course of business, we may be subject to litigation and claims from third parties. We are not currently a party to any material legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of 2007.

PART II


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

Market Price

Our common shares are traded on the NASDAQ under the symbol “NCST” and on the TSX under the symbol “NCS.” Our common shares began trading on December 22, 2005. The table below sets forth, for the calendar quarter indicated, the high and low sales prices of NUCRYST’s common shares as reported by the NASDAQ and the TSX for the years ended December 31, 2007 and 2006.


	NASDAQ				TSX
	High		Low		High		Low
	(U.S.$)		(U.S.$)		(CDN$)		(CDN$)

2007
First Quarter	$	5.58	$	3.15	$	6.50	$	3.67
Second Quarter	$	3.62	$	1.95	$	5.92	$	1.99
Third Quarter	$	5.84	$	1.91	$	5.92	$	2.01
Fourth Quarter	$	2.95	$	1.40	$	2.96	$	1.41
2006
First Quarter	$	11.72	$	8.88	$	13.87	$	10.39
Second Quarter	$	16.88	$	10.56	$	18.75	$	12.25
Third Quarter	$	16.03	$	6.60	$	18.25	$	7.41
Fourth Quarter	$	7.78	$	3.76	$	8.00	$	4.36

Number of Shareholders

On February 11, 2008, there were approximately 12 holders of record of our common shares, one of which was Cede & Co., a nominee for Depository Trust Company, or DTC, and one of which was The Canadian Depository for Securities Limited, or CDS. All of our common shares held by brokerage firms, banks and other financial institutions in the United States and Canada as nominees for beneficial owners are considered to be held of record by Cede & Co. in respect of brokerage firms, banks and other financial institutions in the United States, and by CDS in respect of brokerage firms, banks and other financial institutions located in Canada. Cede & Co. and CDS are each considered to be one shareholder of record.

Dividends

We did not pay any cash dividends on our share capital in 2007 or 2006 and have no current plans to pay any cash dividends. We currently intend to retain all available cash to finance our operations and the expansion of our business and do not anticipate paying dividends in the foreseeable future. Any determination to pay dividends to holders of our common shares in the future will be at the discretion of our board of directors and will depend on many factors, including our financial condition, earnings, legal requirements and other factors as our board of directors deems relevant. In addition, we may in the future become subject to debt instruments or other agreements that further limit our ability to pay dividends.

Recent Sales of Unregistered Securities

None.

Repurchases of Equity Securities

None.

Information regarding our equity compensation plans required by Item 201(d) of Regulation S-K may be found under “Item 12 — Securities Authorized for Issuance Under Equity Compensation Plans.”

ITEM 6. SELECTED FINANCIAL DATA

We have derived the selected consolidated financial data as of December 31, 2007 and 2006 and for the years ended December 31, 2007, 2006 and 2005 from our audited consolidated financial statements that are included elsewhere in this annual report. We have derived the selected consolidated financial data as of December 31, 2005 and 2004 and for the years ended December 31, 2004 and 2003 from our audited consolidated financial statements. Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America or GAAP. Historical results are not necessarily indicative of the results to be expected in future periods.

You should read the following selected consolidated financial data together with our audited consolidated financial statements, including the related notes, and “Management’s Discussion and Analysis of Financial Condition and Results of Operation” included elsewhere in this annual report.


	Year Ended December 31,
	2007			2006			2005			2004			2003

Results of Operations Data:
Revenue:
Wound care product revenue		$20,092			$ 24,369			$18,636			$14,682			$ 8,404
Milestone revenue⁽¹⁾		10,000			—			5,000			10,000			3,000

Total revenue		30,092			24,369			23,636			24,682			11,404
Costs:
Manufacturing		14,477			16,053			10,015			7,141			4,430
Research and development		6,303			11,162			8,520			8,971			5,704
General and administrative		9,067			6,723			3,945			3,901			2,797
Depreciation and amortization		355			430			300			221			158
Write down of capital assets		1,173			1,049			—			—			—

(Loss) income from operations		(1,283	)		(11,048	)		856			4,448			(1,685	)
Other income (expenses):
Foreign exchange (losses) gains		(3,283	)		(298	)		193			82			(230	)
Interest income		685			1,123			12			66			47
Interest expense⁽²⁾		—			(310	)		(3,540	)		(3,229	)		(414	)

(Loss) income before income taxes and cumulative effect of a change in accounting principle		(3,881	)		(10,533	)		(2,479	)		1,367			(2,282	)
Current income tax (expense) recovery⁽³⁾		(140	)		41			(162	)		(19	)		(19	)

(Loss) income before cumulative effect of a change in accounting principle		(4,021	)		(10,492	)		(2,641	)		1,348			(2,301	)
Cumulative effect of a change in accounting principle		—			(7	)		—			—			—
Net (loss) income		$(4,021	)		$(10,499	)		$(2,641	)		$ 1,348			$ (2,301	)

Net (loss) income per common share — basic and diluted		$ (0.22	)		$ (0.58	)		$ (0.27	)		$ 0.14			$ (0.24	)

Weighted average number of common shares outstanding
— basic		18,333,810			17,964,332			9,764,486			9,727,500			9,727,500
— diluted		18,333,810			17,964,332			9,764,486			9,905,464			9,727,500


(1)	Certain milestone revenue may relate in part to sales activity in prior periods.

(2)	Prior to our initial public offering, Westaim provided all of the external funding necessary to operate our business, and all of the indebtedness reflected on our consolidated balance sheets for periods through December 31, 2005 reflects funding from Westaim. In 2003, Westaim did not charge interest on substantially all of our indebtedness to Westaim. Accordingly, interest expense for the years ended December 31, 2003 is substantially less than the interest expense that would have been incurred had we been charged interest on all of our indebtedness.


(3)	Although we are currently a majority owned subsidiary of Westaim, Canadian tax laws do not allow for the filing of a consolidated income tax return with Westaim. Accordingly, we have filed our own tax returns and the income tax expenses reflected in the above financial data reflect our actual consolidated income tax expense for the applicable periods.


	As of December 31,
	2007			2006			2005			2004			2003

Consolidated Balance Sheet Data:
Cash and cash equivalents	$	17,841		$	18,926		$	35,901		$	948		$	201
Current assets		37,618			33,591			48,992			8,002			4,655
Total assets		51,299			45,892			59,460			15,597			10,042
Current liabilities⁽¹⁾		3,828			2,306			45,691			37,181			31,273
Working capital (deficiency)		33,790			31,285			3,301			(29,179	)		(26,618	)
Common shares		82,776			82,672			42,629			3,534			3,534
Accumulated other comprehensive income (loss)		557			(5,490	)		(5,281	)		(4,180	)		(2,479	)
Accumulated deficit		(38,099	)		(34,078	)		(23,579	)		(20,938	)		(22,286	)
Total shareholders’ equity (deficit)		46,745			43,586			13,769			(21,584	)		(21,231	)


(1)	Includes indebtedness to Westaim of $0, $0, $39,642, $33,482, $29,612 as of December 31, 2007, 2006, 2005, 2004, and 2003 respectively.


	Year Ended December 31
	2007			2006		2005		2004		2003

Wound care product revenue	$	24,592		$	24,369	$	18,636	$	14,682	$	8,404
Manufacturing cost rebate		(4,500	)		—		—		—		—

Net wound care product revenue	$	20,092		$	24,369	$	18,636	$	14,682	$	8,404
Milestone revenue⁽¹⁾		10,000			—		5,000		10,000		3,000

Total revenue	$	30,092		$	24,369	$	23,636	$	24,682	$	11,404
Manufacturing costs	$	14,477		$	16,053	$	10,015	$	7,141	$	4,430
Gross margin excluding milestone revenue⁽²⁾	$	5,615		$	8,316	$	8,621	$	7,541	$	3,974
Gross margin percent excluding milestone revenue⁽²⁾		27.9%			34.1%		46.3%		51.4%		47.3%


(1)	Certain milestone revenue may relate in part to sales activity in prior periods.

(2)	Gross margin excluding milestone revenue is equal to wound care product revenue minus manufacturing costs. Gross margin percent excluding milestone revenue is equal to gross margin excluding milestone revenue divided by wound care product revenue.


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

In this management’s discussion and analysis, unless otherwise specified, all monetary amounts are in thousands of United States dollars, all references to “$”, “U.S.$”, “U.S. dollars” and “dollars” mean U.S. dollars and all references to “C$”, “Canadian dollars” and “CDN$” mean Canadian dollars. To the extent that such monetary amounts are derived from our consolidated financial statements attached to this management’s discussion and analysis, they have been translated into U.S. dollars in accordance with our accounting policies as described therein. Unless otherwise indicated, other Canadian dollar monetary amounts have been translated into United States dollars at the December 31, 2007 noon buying rate reported by the Federal Reserve Bank of New York, being U.S. $1.00 = C$0.9881

Overview & Current Developments

We develop, manufacture and commercialize innovative medical products that fight infection and inflammation based on our noble metal nanocrystalline technology. Our patented technology enables us to convert silver’s microcrystalline structure into an atomically disordered nanocrystalline coating. We believe that this conversion can enhance silver’s natural antimicrobial properties and that currently marketed products with our SILCRYST^tm coatings meet important patient needs. In addition, our nanocrystalline silver has exhibited potent anti-inflammatory properties in preclinical studies. We produce our nanocrystalline silver as a coating for wound care products under the trademark SILCRYST^tm and as a powder, which we refer to as NPI 32101, for use in medical devices and as an active pharmaceutical ingredient.

We developed and sold advanced wound care products with our SILCRYST^tm coating under the Acticoat^tm trademark until May 2001 when we entered into a series of agreements with Smith & Nephew plc (“Smith & Nephew”), a global medical device company. Under these original agreements, we licensed to Smith & Nephew the exclusive right to market, distribute and sell products with our SILCRYST^tm coatings for use on non-minor skin wounds and burns on humans world-wide, and agreed to manufacture these products and supply them exclusively to Smith & Nephew. We also sold various assets to Smith & Nephew in connection with the license and supply agreements, including the Acticoat^tm trade name and trademark, various regulatory approvals and certain manufacturing equipment, which we lease back. Advanced wound care products with our SILCRYST^tm coatings have received FDA clearance and approval of other regulators and are now sold by Smith & Nephew in over 30 countries around the world, including the United States, under its Acticoat^tm trademark. We work with Smith & Nephew to develop new Acticoat^tm wound care products with our SILCRYST^tm coating. Smith & Nephew’s recently launched Acticoat^tm Post-Op and Acticoat^tm Site products resulted from these efforts, increasing the number of wound care products with our SILCRYST^tm coating currently sold by Smith & Nephew to a total of six.

On September 30, 2007, we entered into amended license and supply agreements with Smith & Nephew that were restructured to better enable the parties to work jointly and individually to support both the continued growth of Acticoat^tm products and our respective businesses in the context of increasing competitive pressures. Pursuant to the amended agreements, a non-compete clause in the original agreements was deleted to allow Smith & Nephew to broaden its wound care dressings product line to include other forms of silver. In exchange, Smith & Nephew’s exclusive license was limited in the new agreements to existing Acticoat^tm products and such new wound care or burn products that the parties agree to develop together using our nanocrystalline silver technology. As well, under the new agreements, we may develop our own wound care and burn products using our nanocrystalline silver technology provided that we offer such products to Smith & Nephew first. If Smith & Nephew declines to adopt and market the new products, we are then free to pursue the commercialization of the products in any manner we choose.

Effective January 1, 2007, under the new supply agreement, the method by which we determine the price we charge for the products we manufacture and supply to Smith & Nephew has been changed from a fully allocated cost of manufacturing reimbursement mechanism to a system whereby we recover a fixed overhead charge plus all direct costs incurred in manufacturing Acticoat^tm products, including direct material, direct labor, labeling, testing and packaging. In addition, as part of the new pricing mechanism, we agreed to pay Smith & Nephew an annual manufacturing cost rebate in the amount of $4.5 million in each of 2007, 2008 and 2009 in anticipation of annual reductions we intend to achieve in our cost of goods manufactured for Smith & Nephew over the same time period. We recognize the manufacturing cost rebate as a reduction to wound care product revenue. We made adjustments to our manufacturing and research operations in 2007 to conserve cash and control expenses including reductions in our workforce of approximately 12% of our total employees. Through these workforce reductions together with the implementation of manufacturing production

efficiencies and overhead cost reduction initiatives, we achieved actual reductions in our overhead costs in 2007 sufficient to partially offset the manufacturing cost rebate we paid to Smith & Nephew in 2007.

Our results of operations currently depend solely on Acticoat^tm product sales generated by Smith & Nephew under our revised agreements. The Acticoat^tm product line competes in the advanced wound care products market, which according to Frost & Sullivan, a market research firm, was an approximately $1.5 billion global market in 2005 and is projected to grow to approximately $2.6 billion by 2011. The Acticoat^tm product line targets the premium-priced segments of the serious wound care dressings market. Acticoat^tm products are used for a wide variety of wound types by hospitals, clinics, burn centers, doctors’ offices, home healthcare agencies and nursing homes.

Since the execution of the new agreements, Smith & Nephew has introduced three new wound care products with other forms of silver (Algisite Ag, Allevyn Ag and Biostep Ag). We believe that some of these new silver based wound care products will serve to simply compliment the existing Acticoat^tm products marketed by Smith & Nephew without impacting sales of Acticoat^tm products while others may be viewed by the advanced wound care market as alternatives to certain Acticoat^tm products, thereby potentially adversely affecting Acticoat^tm product sales and ultimately our operating revenues in the foreseeable future.

Outside of our Smith & Nephew agreements, we are continuing our efforts to extend our nanocrystalline silver technology to develop pharmaceutical products and other medical devices to combat infection and inflammation. We are conducting preclinical research for the use of NPI 32101 for the treatment of gastrointestinal conditions and we are exploring commercialization avenues for a topical barrier cream containing NPI 32101.

Our Board of Directors was pleased to announce that Mr. Thomas E. Gardner was appointed Chairman of the Board, President and Chief Executive Officer. Mr. Gardner is an experienced CEO with a track record of creating shareholder value. We determined that Mr. Gardner’s experience in managing emerging healthcare technology companies would benefit NUCRYST in the development and commercialization of our pipeline medical products. A director of NUCRYST since May 2007, Mr. Gardner specializes in the strategic positioning of companies with particular emphasis on pharmaceuticals, medical devices and healthcare information. Prior to his current assignments, Mr. Gardner was CEO of a number of public and private companies including: Songbird Hearing, Datamonitor, Base Ten Systems and Access Health. From 1970 to 1995, Mr. Gardner held senior marketing and general management positions at Procter & Gamble, Johnson & Johnson, Simon & Schuster and IMS Health.

We are a majority owned subsidiary of The Westaim Corporation (“Westaim”), a Canadian company incorporated in Alberta and the shares of which are listed on the Toronto Stock Exchange. Westaim owns approximately 75% of our outstanding common stock as of the date of filing of this annual report. Prior to our initial public offering, all of our external financing was provided by Westaim and we relied upon Westaim for the ongoing financial support necessary to operate our business. We are now entirely reliant on third parties for financing necessary to satisfy any future need we may have for cash in excess of that which is generated by Smith & Nephew sales of Acticoat^tm products. We do not have any lines of credit or other financing arrangements in place with banks or other financial institutions. We will likely require additional external financing in the future and there can be no assurance that we will be able to obtain additional financing as and when required.

Revenue Recognition

We currently do not have any products being sold in the marketplace other than Acticoat^tm wound care products being sold by Smith & Nephew. Consequently, our results of operations depend solely on Acticoat^tm product sales generated by Smith & Nephew under our amended agreements with Smith & Nephew. The amount of our revenues in general and royalty revenues in particular, is determined primarily by the level of sales of Acticoat^tm products achieved by Smith & Nephew. We believe that the demand for Acticoat^tm products with our SILCRYST^tm coatings licensed to Smith & Nephew is and will be driven by demographic factors, including population aging, the incidence of medical conditions such as diabetes and obesity; by the displacement of traditional wound care products that we believe are clinically less effective than products using our SILCRYST^tm coatings; by the introduction of Acticoat^tm products using our SILCRYST^tm coatings to new countries and for new applications; and by the degree to which Smith & Nephew is successful in selling and marketing these products in view of increasing competition from other silver-based wound care products, including any such products that Smith & Nephew may now introduce pursuant to its new freedom to do so under our amended agreements. On February 7, 2008, Smith & Nephew reported its annual 2007 results for wound care. Smith & Nephew reported Acticoat^tm sales growth of 7% in the year ended December 31, 2007 as compared to the year ended December 31, 2006 and 9% for the year ended December 31, 2006 as compared to the year ended December 31,

2005. However, we believe that market conditions in the advanced would care market, including the silver dressing segment, have become more competitive due in part to increased competition and customer cost containment efforts. We are uncertain as to whether or the extent to which this increased competition or Smith & Nephew’s new ability to introduce other silver-based serious wound care products will have a negative impact on Acticoat^tm product sales growth and our revenues in the near future, as it will depend on future events, including Smith & Nephew’s response to market conditions. Any termination of or significant disruptions in our agreements or relationship with Smith & Nephew, or a significant reduction in sales of Acticoat^tm products, would likely have a material adverse effect on our business and results of operations.

Our revenues under our amended license and supply agreements with Smith & Nephew consist of manufacturing cost reimbursements on a fixed price basis, royalties, payments upon the achievement of specified milestones and reimbursement of a portion of the costs we incur in connection with the development of and improvement to SILCRYST^tm coated products covered by the agreements. Smith & Nephew previously reimbursed us for our fully allocated costs of manufacturing the products we sell to them, including both direct and indirect costs. Under the new supply agreement, effective January 1, 2007, the price we char for the Acticoat^tm products we manufacture and supply to Smith & Nephew has been amended to recovery of a fixed overhead charge plus all direct costs incurred in manufacturing Acticoat^tm products, including direct material, direct labor, labeling, testing and packaging. This pricing mechanism will be used to establish the unit prices that we will charge for each Acticoat^tm product we supply to Smith & Nephew until the end of 2009. Unit prices will be set at the beginning of each year based on Smith & Nephew’s product forecast and may only be increased, with Smith & Nephew’s agreement, for any actual cost increases we incur that are outside our reasonable control and which increases are capped at the amount by which the local level of inflation has increased. The overhead component of the unit pricing mechanism has been fixed at a minimum floor amount equal to all indirect costs we incur in 2007 related to the manufacture of Acticoat^tm products, including administration, labor, rent, insurance, utilities, repairs and quality control. This fixed floor amount is payable by Smith & Nephew in each of 2007, 2008 and 2009 regardless of the actual volume of Acticoat^tm products ordered by Smith & Nephew and regardless of any actual overhead cost savings we achieve in those years. The new agreements provide for a reconciliation process such that if we have not received sufficient orders to cover the fixed overhead charge by a certain date each year, we are entitled to immediately invoice Smith & Nephew for the difference. On the other hand, if we have received orders in excess of that which is required to cover the fixed overhead charge by certain dates, Smith & Nephew is entitled to immediately invoice us for the difference. In any event, actual overhead will be reconciled at December 31 of each year.

As part of the new pricing mechanism, we agreed to pay Smith & Nephew an annual manufacturing cost rebate in the amount of $4.5 million in each of 2007, 2008 and 2009 in anticipation of annual reductions we intend to achieve in our cost of goods manufactured for Smith & Nephew over the same time period. We recognize the manufacturing cost rebate as a reduction to wound care product revenue. We achieved actual reductions in our overhead costs in 2007 and expect to maintain these reductions and achieve further reductions through 2009. We expect the cost reductions will substantially and possibly even completely offset the impact of the manufacturing cost rebate on our wound care product revenues received from Smith & Nephew. In addition, if we are able to achieve cost savings such that our actual total cost of goods manufactured for Smith & Nephew in any of the three years is less than 18% of net sales of Acticoat^tm products, we have agreed to reimburse Smith & Nephew 70% of the amount by which our total cost of goods manufactured differs from the eighteen percent of net sales. In 2010, the revised agreements contemplate that we will determine a new cost recovery structure that takes into account actual cost savings we achieve in the previous three years.

Our manufacturing costs are recorded both as expense and revenue items on the consolidated statement of operations to the extent they are directly reimbursable by Smith & Nephew. Reductions in overhead costs will be reflected as a reduction of expense and may benefit our gross margin upon shipment to Smith & Nephew. In addition, although we are required to fund the up-front costs of capital expenditures to acquire equipment used to manufacture Acticoat^tm products, we are entitled under our agreements to recoup those costs over time through reimbursement for depreciation expense. At the end of the third quarter of 2005, based on Smith & Nephew’s demand forecasts, we began construction of an expansion of our Fort Saskatchewan facility with an estimated cost of approximately $5.7 million. As of December 31, 2007, this expansion was substantially complete. We expect the expansion to be operational in the first quarter of 2008. Under the previous agreements, we would not have been entitled to begin recouping these costs over time from Smith & Nephew through reimbursement for depreciation expense until we began using the equipment to produce Acticoat^tm products. At the current rate of Acticoat^tm product sales growth, we did not anticipate needing the new manufacturing capacity as early as we had previously expected when we undertook the expansion and possibly not for the foreseeable future, such that we did not expect to be in a position to begin recovering depreciation expense from Smith & Nephew for some time.

However, under the new amended agreements, commencing January 1, 2008, we will be entitled to include partial depreciation of the new production facility and equipment in the cost of goods sold to Smith & Nephew. Once we begin using the equipment to produce Acticoat^tm products, inclusion of full depreciation in the cost of goods sold to Smith & Nephew will commence (subject to any proportionate use we make of the equipment for our own purposes).

The royalty rates under the new agreements have been maintained except for the elimination of a supplemental royalty that was payable to us only if certain gross profit margins were achieve on sales of Acticoat^tm products over a specified threshold. We record our royalty revenues upon the sale of our products by Smith & Nephew to its customers. Our royalty revenue varies in proportion to increases or decreases in Smith & Nephew’s sales of its Acticoat^tm products. In that regard, Smith & Nephew has authority to unilaterally determine the selling price for its Acticoat^tm products. Moreover, although Smith & Nephew has agreed to use reasonable commercial efforts to market Acticoat^tm products, Smith & Nephew is not required to purchase any significant amount of product from us. In May 2004, in accordance with the agreements, the contractual royalty rate increased and from that date has remained and, under the terms of the agreements, is to remain constant for the life of the agreements, subject only to: (i) the possibility of a negotiated arbitrator-awarded reduction in royalty rates on sales in countries where patent protection has been lost and a competing product is being sold that would have infringed our patent rights had they been in effect; (ii) the possibility of a negotiated reduction in royalty rates on sales of a particular Acticoat^tm product where Smith & Nephew does not realize industry standard gross profit margins on sales of such products; or (iii) a reduced royalty rate in respect of sales of Acticoat^tm products in certain countries, including the United States, upon the expiration of patent rights to our SILCRYST^tm coating in such country. Upon the expiration of certain patents beginning in 2014, we may be required to implement royalty reductions in respect of certain products in certain countries in which the patents have expired. It is also possible that, from time to time, certain products may fall within category (ii) above on a temporary basis and, while we are not obligated to agree to royalty reductions in those circumstances, we may choose to do so if we determine it is appropriate under the circumstances.

We also receive milestone payments upon Smith & Nephew’s achievement of specified sales levels of Acticoat^tm products and upon the achievement of regulatory events specified in our agreements with Smith & Nephew. The achievement of both of these events is out of our control and, therefore, it is uncertain as to whether or when we will earn future milestone payments. The new agreements amended the criteria for the achievement of the next milestone such that we immediately earned a milestone payment of $5.0 million during the quarter ended September 30, 2007. We earned an additional $5.0 million milestone in the fourth quarter of 2007. The achievement criteria for the remaining milestone payments remain unchanged under the new agreements. The maximum amount of milestone payments that we may receive under the Smith & Nephew agreements, including the $29.0 million of milestone payments we have already received, is $56.5 million. The timing and receipt of a milestone payment affects the comparability of period-to-period results and may have a material effect on financial results. Smith & Nephew previously reimbursed us for all costs and expenses incurred in connection with approved research and development activities for the development of new products and improvements to existing products covered by our agreements with Smith & Nephew. Under the new agreements, we will now cover our own internal development costs incurred in the joint development of new products with Smith & Nephew up to a maximum amount per year equivalent to 1.5% of Smith & Nephew’s net sales of Acticoat^tm products in the year. Thereafter, Smith & Nephew will be required to once again reimburse us for all costs and expenses we incur in the joint development of new products with Smith & Nephew in the year. During the year ended December 31, 2007, no reimbursement for research and development costs was received from Smith & Nephew. All payments under our agreements with Smith & Nephew are made to us in U.S. dollars. In calculating sales levels for milestone payments, and for other purposes under the agreements, sales by Smith & Nephew in currencies other than the U.S. dollar are converted to the U.S. dollar based on the average exchange rate for the prior quarter.

We currently purchase most of our raw materials from single suppliers. The loss of any of these suppliers could result in a disruption in our production while we arrange for a replacement supplier. To reduce this risk, we maintain sufficient inventory levels to continue production for approximately six months.

The exclusive right we granted to Smith & Nephew to market, distribute or sell existing Acticoat^tm products with our SILCRYST^tm coatings in the field of serious wounds and burns does not apply to other types of products that we may develop for use outside of the field using our technology, including, among other things, the products we are developing using NPI 32101 or our SILCRYST^tm coating, except that, to the extent that any new products using our nanocrystalline silver have commercial value in the field of serious wounds and burns, we have agreed, as discussed above, to offer the new products to Smith & Nephew for use in the field. If Smith & Nephew declines the new products, we are then free to commercialize the products in any manner we choose in any field.

New Product Development

We bear all costs relating to our research and development activities for our prospective products outside of our agreements with Smith & Nephew.

In the future, to expand our product line, we may consider acquisitions of intellectual property or companies engaged in the development or production of drugs or devices. Any acquisitions may require that we obtain additional financing.

Pharmaceutical Products

We are developing pharmaceutical products using NPI 32101 to extend our nanocrystalline silver technology to the treatment of infectious and inflammatory conditions. We are currently focusing our research and development efforts on conducting preclinical work for pharmaceutical applications of our nanocrystalline technology.

Medical Devices

We have developed a topical cream formulation containing our NPI 32101 which has been shown in clinical studies to be stable and cosmetically-acceptable. In vitro testing has also shown the cream formulation to have broad spectrum antimicrobial activity. We announced on July 19, 2007 that the FDA granted 510(k) clearance for a prescription topical device containing our NPI 32101, as a broad-spectrum antimicrobial barrier cream to organisms including Pseudomonas aeruginosa, Staphyloccocus aureus, including strains resistant to methicillin — or MRSA. Gaining FDA clearance is a first step toward marketing our proprietary technology in this new formulation. We are actively exploring commercialization options and, as part of this process, market plans and timing for this product will be determined. We expect that the market potential for this potential new product will be largely determined by the distribution channel decisions we are currently in the process of evaluating.

We have recently filed another 510(k) submission to the FDA to expand the claims and indications for our barrier cream. We have applied for a claim that NPI 32101 cream relieves the signs and symptoms of dermatoses. If our application is cleared by the FDA, we believe it will broaden this potential new product’s market potential.

Results of Operations


	Year Ended December 31
	2007			2006		2005
	(in thousands)

Wound Care Product Revenue	$	24,592		$	24,369	$	18,636
Manufacturing Cost Rebate		(4,500	)		—		—

Net Product Related Revenue	$	20,092		$	24,369	$	18,636
Milestone Revenue		10,000			—		5,000

Total Revenue	$	30,092		$	24,369	$	23,636
Manufacturing Costs		14,477			16,053		10,015
Gross Margin Excluding Milestone Revenue	$	5,615		$	8,316	$	8,621
Gross Margin Percent Excluding Milestone Revenue		27.9%			34.1%		46.3%


(1)	Certain milestone revenue may relate in part to sales activity in prior periods.

(2)	Gross margin excluding milestone revenue is equal to wound care product revenue minus manufacturing costs. Gross margin percent excluding milestone revenue is equal to gross margin excluding milestone revenue divided by wound care product revenue.

Year Ended December 31, 2007 and December 31, 2006

Revenue. Total revenue which consists of wound care product revenue (less the manufacturing cost rebate) and milestone revenue for the year ended December 31, 2007 was $30.1 million compared to $24.4 million for the year ended December 31, 2006. The increase of $5.7 million is attributable primarily to $10.0 million in milestone payments that were earned from Smith & Nephew. The impact of these milestones were partially offset by the combined impact of the new manufacturing cost rebate we agreed to pay Smith & Nephew in 2007 under the revised supply agreement; and the impact of an increase in wound care product revenue experienced in the year as compared to the same period in 2006. Under the revised supply agreement, we are to pay Smith & Nephew an annual $4.5 million manufacturing cost rebate in 2007, 2008 and 2009 in anticipation of annual reductions we intend to achieve in our cost of goods manufactured for Smith & Nephew over the same time frame. Wound care product revenue which consists of royalty revenues and manufacturing cost reimbursements from Smith & Nephew increased by approximately $0.2 million to $24.6 million for

the year ended December 31, 2007 compared to $24.4 million for the year ended December 31, 2006 due to increased product orders received from and shipped to Smith & Nephew and increased royalty revenue received from Smith & Nephew.

Manufacturing Costs. Manufacturing costs for the year ended December 31, 2007 were $14.5 million compared to $16.1 million for the year ended December 31, 2006. The decrease of $1.6 million is primarily attributable to the combined effect of manufacturing cost savings realized in the period through the implementation of efficiencies in our manufacturing process, together with the effect of the shipment to Smith & Nephew in 2007 of products out of our finished goods inventory that were produced in 2006 at a lower cost per unit than products produced in 2007. At the end of 2007, we had finished goods inventory of $0.2 million as compared to $2.8 million at December 31, 2006. During 2007, we recognized significant cost reductions in our manufacturing process and overhead structure to partially offset the $4.5 million manufacturing cost rebate paid to Smith & Nephew in 2007. These cost reductions were achieved primarily through lower headcount, manufacturing process improvements and leased space consolidations. We expect to continue to manage our manufacturing costs to achieve further reductions in 2008.

Gross Margin. Gross margin excluding milestone revenue for the year ended December 31, 2007 was $5.6 million or 27.9% compared to $8.3 million or 34.1% for the year ended December 31, 2006. The decrease of $2.7 million or 32.5% is attributable primarily to a $4.5 million manufacturing cost rebate that was recognized in 2007 as a reduction to wound care product revenue. No such cost rebate amount was recognized in the year ended December 31, 2006. The effect of the manufacturing cost rebate on gross margin was only partially offset by manufacturing cost reductions realized in the period and the shipment of finished goods out of our inventory at the beginning of 2007 which had a lower cost per unit than goods subsequently produced and shipped to Smith & Nephew in 2007. Pursuant to our revised agreements with Smith & Nephew, we have agreed to pay a $4.5 million manufacturing cost rebate in each of 2008 and 2009. We expect the manufacturing cost rebate to continue to affect our gross margin in 2008 and 2009 to the extent that we are unable to realize and maintain manufacturing cost overhead reductions sufficient to offset the rebate in each of 2008 and 2009.

We recognize manufacturing revenue when we ship our products to Smith & Nephew and recognize royalty income when Smith & Nephew sells our products to its customers. Consequently, our gross margin percent may vary from period to period due to differences in timing of when we ship our products to Smith & Nephew and when Smith & Nephew sells our products to its customers. In the year ended December 31, 2007, we manufactured lower volumes of Acticoat^tm products as compared to the year ended December 31, 2006, due in part to the completion of Smith & Nephew’s program to increase world-wide inventory levels in 2006. Smith & Nephew did not build further inventory levels in 2007. Lower production volumes in 2007 were also due to the fact that we ended 2006 with $2.8 million of finished goods inventory which we used to satisfy product orders received from Smith & Nephew in 2007.

Research and Development Costs. Research and development costs for the year ended December 31, 2007 were $6.3 million compared to $11.2 million for the year ended December 31, 2006. The decrease of $4.9 million from 2007 to 2006 is due in part to the fact that in the third quarter of 2006 we completed the only clinical study we had underway, our Phase 2 dermatological clinical study, and no new clinical studies were initiated in 2007. The decrease is also partly due to the reductions we made to our research operations and staff in 2007 to conserve cash and control expenses.

General and Administrative Costs. General and administrative costs for the year ended December 31, 2007 were $9.1 million compared to $6.7 million for the year ended December 31, 2006. The increase of $2.4 million is attributable primarily to stock option compensation expense recognized in the year, severance costs relating to the resignation of our former Chief Executive Officer on August 22, 2007, consulting services relating to business development, placement fees for our new Chief Executive Officer and design services for the consolidation of our leased manufacturing facility in Fort Saskatchewan, Alberta.

Income Taxes. Income taxes are recognized for future income tax consequences attributed to estimated differences between the financial statement carrying values of existing assets and liabilities and their respective income tax bases. We have net operating loss carry forward for income tax purposes of approximately $35.0 million at December 31, 2007 compared to $32.3 million at December 31, 2006 and unclaimed scientific research and experimental development expenditures of approximately $8.6 million at December 31, 2007 compared to $5.7 million at December 31, 2006 that can be used to offset taxable income, if any, in future periods. We also have accumulated capital losses of approximately $2.1 million at December 31, 2007 compared to $1.8 million at December 31, 2006 as well as research and development tax credits of approximately $4.6 million at December 31, 2007 compared to $3.4 million at December 31, 2006. Recognized losses and credits have been fully offset by a valuation allowance. The net operating losses and research and development tax credits will expire at various times to the end of 2027.

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income, and there can be no assurance when or if this will occur. Management will continue to provide a full valuation allowance until it determines that it is more likely than not the deferred tax assets will be realized.

Our tax pools are subject to review and potential disallowance, in whole or in part, by the Canada Revenue Agency (“CRA”) in Canada and the Internal Revenue Service (“IRS”) in the United States upon audit of our federal income tax returns, and we cannot predict the results of any such review. In 2005, the CRA commenced an examination of our Canadian income tax returns for 2001 and 2002, and in December, 2007, we received correspondence from the CRA proposing certain transfer pricing adjustments with respect to income allocations between our Canadian and U.S. entities for those years. These proposed adjustments, if processed, will not result in any cash tax liability. Although the CRA has not commenced any transfer pricing review for taxation years beyond 2002, the proposed adjustments, based on the CRA’s primary position, are expected to be extended to subsequent taxation years. We are currently evaluating the CRA’s proposal and awaiting reports from the CRA which should provide greater details of the basis of their proposed adjustments. Following receipt of these reports, we will be better able to make an informed assessment of the CRA’s position. Any reassessments to be issued by the CRA, on an aggregate basis, could result in a material effect on our consolidated financial statements, although at this time, the potential impact cannot be reasonably estimated. We have provided notification to the IRS of our intention to seek competent authority assistance with respect to the 2001 and 2002 taxation years.

We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likelihood of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. FIN 48 also provides guidance on the accounting for and disclosure of unrecognized tax benefits, interest and penalties.

The implementation of the provisions of FIN 48 did not have a material impact on our financial position or results of operations, and did not result in any adjustment to our beginning tax positions. As at January 1, 2007, we did not have any unrecognized tax benefits. During the year ended December 31, 2007, changes in the amount of our unrecognized tax benefits related to tax positions of prior years. The additions were offset by reductions, resulting in no unrecognized tax benefits at the end of the year. Although we believe in the merit of our tax filing positions and intend to rigorously defend our transfer pricing policies, it is reasonably possible that the amount of unrecognized tax benefits could significantly increase or decrease within the next twelve months. As this time, an estimate of the range of reasonably possible outcomes cannot be made. Any increase or decrease in the unrecognized tax benefits will not likely have a significant impact on our effective tax rate due to the existence of the valuation allowance. Future changes in our assessment of the sustainability of tax filing positions may impact our income tax liability.

The amount of net operating loss carryovers, or NOLs, which may be used by us for U.S. federal income tax purposes in any future year could be limited by Section 382 of the Internal Revenue Code of 1986, as amended. In general, Section 382 would limit our ability to use NOLs for U.S. federal income tax purposes in the event of certain changes, either directly or indirectly, in ownership of our Company, including as a result of sales of our common shares by Westaim, future offerings of common shares by us, and changes in ownership of Westaim. If such limitations were triggered as a result of future shifts in ownership of us, the use of our NOLs for U.S. federal income tax purposes would be limited. Any limitation of our use of NOLs could (depending on the extent of such limitation and the amount of NOLs previously used) result in us retaining less cash after payment of U.S. federal income taxes during any year in which we have taxable income (rather than losses) than we would be entitled to retain if such NOLs were available as an offset against such income for U.S. federal income tax reporting purposes.

For alternative minimum tax purposes in the United States, NOLs can be used to offset no more than 90 percent of alternative minimum taxable income, or AMTI. Thus, to the extent our NOLs are used to offset regular taxable income, if any, alternative income tax will still be required to be paid on 10 percent of AMTI at the alternative minimum tax rate of 20 percent.

As noted elsewhere, we expect to incur losses on a quarterly and annual basis for the foreseeable future. Accordingly, we cannot predict when or if we will generate taxable income and whether and to what extent we will be able to use our NOLs to offset any such taxable income.

Year Ended December 31, 2006 and December 31, 2005

Revenue. Total revenue for the year ended December 31, 2006 was $24.4 million compared to $23.6 million for the year ended December 31, 2005. Wound care product revenue which consists of royalty revenues and manufacturing cost reimbursements from Smith & Nephew increased approximately 30.8% to $24.4 million for 2006 compared to $18.6 million for 2005 due entirely to increased orders from Smith & Nephew to support Acticoat^tm product sales growth and Smith & Nephew’s decision to increase world-wide inventory levels of Acticoat^tm products. No milestone payment was earned in the year ended December 31, 2006 and one $5.0 million milestone payment was earned in 2005. Our revenue in 2006 was reduced by an adjustment of $0.8 million of manufacturing cost reimbursements that were determined to be non-reimbursable.

Manufacturing Costs. Manufacturing costs for the year ended December 31, 2006 were $16.1 million compared to $10.0 million for the year ended December 31, 2005. The increase of $6.1 million, or 60.3%, is attributable primarily to higher production volumes of Acticoat^tm wound care products driven by increased orders from Smith & Nephew to support its Acticoat^tm worldwide inventory levels and to support its Acticoat^tm sales growth. In addition, the weakening of the U.S. dollar against the Canadian dollar contributed to the increase in manufacturing costs.

Gross Margin. Gross margin excluding milestone revenue for the year ended December 31, 2006 was $8.3 million or 34.1% compared to $8.6 million or 46.3% for the year ended December 31, 2005. We recognize manufacturing revenue when we ship product to Smith & Nephew and recognize royalty income when Smith & Nephew sells our products to its customers. Consequently, our gross margin percent may vary from period to period due to differences in timing of when we ship product to Smith & Nephew and when Smith & Nephew sells product to its customers. In the year ended December 31, 2006, we shipped substantially higher volumes of Acticoat^tm products to Smith & Nephew as compared to the year ended December 31, 2005, and for which the related royalties were not earned. This was due, in part, to Smith & Nephew’s program to increase world-wide inventory levels in 2006. We do not earn royalties on products shipped to Smith & Nephew and held in inventory until Smith & Nephew sells our products to customers. Therefore, our gross margin percent for the year ended December 31, 2006 was lower compared to the percent for the year ended December 31, 2005.

Research and Development Costs. Research and development costs for the year ended December 31, 2006 were $11.2 million compared to $8.5 million for the year ended December 31, 2005. The increase of $2.7 million from 2005 to 2006 is attributable to the Phase 2 dermatological clinical study that was undertaken in 2005 and completed in the third quarter of 2006.

General and Administrative Costs. General and administrative costs for the year ended December 31, 2006 were $6.7 million compared to $3.9 million for the year ended December 31, 2005. The increase of $2.8 million is attributable primarily to the administrative costs associated with being a publicly-traded company, including directors’ fees and expenses and higher legal and compliance costs.

Interest Expense. Interest expense was $0.3 million for the year ended December 31, 2006 compared to $3.5 million for the year ended December 31, 2005. Interest expense decreased because we had no debt owing to Westaim after the conversion of the remaining debt of $39.6 million to 3.96 million common shares on January 27, 2006.

Liquidity and Capital Resources

On December 29, 2005, we completed our initial public offering of 4.5 million common shares for gross proceeds of $45.0 million. We used $6.9 million of net proceeds to partially repay debt owed to Westaim and retained the remaining net proceeds of $35.0 million to fund our operations. From our inception through the closing of our initial public offering, we financed our operations through various financing arrangements with Westaim. Because Westaim no longer provides us with any additional financing or other financial support, we are now required to obtain any necessary financing from third parties. We currently have no third party debt or lines of credit or other financing arrangements in place with banks or

other financial institutions, but we may enter into a line of credit or other financing arrangement in the future. There can be no assurance that we will be able to obtain additional financing as and when required, which would have a material adverse effect on our business.

We were indebted to Westaim for a term loan in the amount of $39.6 million, which bore interest at a rate of 10% per annum. On January 27, 2006, this debt was converted to 3.96 million common shares at $10.00 per share. As a result, as at December 31, 2007, we owe no debt to Westaim and Westaim owns approximately 75.0% of our common shares.

At the end of the third quarter of 2005, we began construction of an expansion of our Fort Saskatchewan production facility with an estimated cost of approximately $5.7 million. We have substantially completed the expansion as of December 31, 2007 and expect the equipment to be operational during the first quarter of 2008. We also intend to continue pharmaceutical product development and expect to have increased working capital requirements to the extent we are successful in increasing our revenues. In addition, we do not expect at this time to have capital expenditures for pharmaceutical development capital equipment in 2008. At December 31, 2007, we had cash and cash equivalents of $17.8 million, as compared to $18.9 million at December 31, 2006 and $35.9 million at December 31, 2005. All cash and cash equivalents are held in the form of treasury bills.

Cash (used in) provided from operations amounted to $(2.7) million for the year ended December 31, 2007, $(12.6) million for the year ended December 31, 2006 and $(2.1) million for the year ended December 31, 2005. Cash from operations included the receipt of a $5.0 million milestone revenue in the third quarter of 2007 and an additional $5.0 million earned at December 31, 2007 reflected in accounts receivable at December 31, 2007, $nil in 2006 and $5.0 million in 2005. Cash (used in) provided from operations is primarily impacted by operating results and changes in working capital, particularly the timing of the collection of receivables from Smith & Nephew, inventory levels and the timing of payments to suppliers. Finished goods inventory was reduced by $2.5 million as compared to December 31, 2006 due to orders placed by Smith & Nephew late in 2006 and which shipped in 2007 as part of their 2006 worldwide inventory build. In 2007, excess silver raw material inventory was sold for proceeds of $0.8 million which is reflected in accounts receivable with a corresponding reduction in the cost of inventory of $0.5 million.

Cash used in investing activities amounted to $2.0 million for the year ended December 31, 2007, $4.6 million for the year ended December 31, 2006 and $3.9 million for the year ended December 31, 2005. In each of these years, the most significant use of cash was for capital expenditures, which were $1.9 million for the year ended December 31, 2007, $5.0 million for the year ended December 31, 2006 and $3.8 million for the year ended December 31, 2005. The increase in capital spending in the year ended December 31, 2006, compared to the year ended December 31, 2005, was due to a major production expansion at our manufacturing facility in Fort Saskatchewan, Alberta, which was completed in the first half of 2005. During 2006, we spent approximately $1.0 million on the design of a production facility to manufacture our active pharmaceutical ingredient, NPI 32101, that meets Good Manufacturing Practices at our Fort Saskatchewan manufacturing plant. Subsequent to our second Phase 2 clinical trial results, we determined that a facility to manufacture NPI 32101, was not warranted at the time and decided not to proceed with the construction. The design costs of $1.0 million were written off in 2006 and recorded as a write down of capital assets in our consolidated statement of operations. During 2007, we determined that approximately $1.2 million of capital equipment was obsolete. The costs were written off in 2007 and recorded as a write down of capital assets in our consolidated statement of operations. In the third quarter of 2007, we substantially completed the plant expansion begun in 2006. We expect the expansion to be operational in the first quarter of 2008. No short-term securities were purchased in 2007 whereas the most significant use of cash in 2006 was for the purchase of short-term investments in the amount of $22.2 million offset by maturity of short-term investments of $22.7 million. No purchases or maturities of investments occurred in any other period prior to December 31, 2006.

Cash provided from (used in) financing activities amounted to $0.8 million for the year ended December 31, 2007, $0.3 million for the year ended December 31, 2006 and $41.0 million for the year ended December 31, 2005. Cash provided from (used in) financing activities resulted from proceeds from issuance of common shares as a result of exercises of stock options and from our initial public offering as well as funds paid to and received from Westaim. We had nominal proceeds from the issuance of common shares and from the exercises of stock options for the year ended December 31, 2007 as compared to $0.3 million for the year ended December 31, 2006. Net proceeds from our initial public offering in 2005 after fees and expenses, amounted to $39.1 million. Payment of $0.8 million was received from Westaim for the year ended December 31, 2007 as compensation for our agreement to surrender a portion of the space we leased from Westaim to facilitate the sale of their Fort Saskatchewan, Alberta buildings in which we are a tenant. No such payments were received in any previous year. With no further debt owed to Westaim after the January 26, 2006 conversion

to common shares of the $39.6 million balance owed to Westaim, there were no payments or amounts owing to Westaim for the years ended December 31, 2007 and 2006. For the year ended December 31, 2005, net advances from Westaim amounted to $1.7 million.

We expect to continue to make investments in our product pipeline and to prepare for regulatory approval and commercial launch of new products. Consequently, we expect to incur losses on a quarterly and annual basis for the foreseeable future as we continue to develop and commercialize existing and future products. We also expect to incur increased general and administrative expenses in the future, due in part to the legal, accounting, insurance and other expenses that we will incur as a result of being a public company, and expenses relating to filing, prosecution, defense and enforcements of patent and intellectual property rights.

We expect that our available cash resources and the revenue from our agreements with Smith & Nephew, will be sufficient to support our current and expected operations, our product development initiatives, including additional pharmaceutical development capital equipment, for at least the next 18 months. However, we will likely be required to obtain additional financing within the next 18 months or afterwards if our cash resources are insufficient to satisfy our liquidity requirements or if we decide to pursue new product development initiatives collaborations, acquisitions or strategies. The adequacy of our available funds to meet future operating and capital requirements will depend on many factors, including sales performance of Smith & Nephew’s Acticoat^tm products, the number, breadth and prospects of our discovery and development programs, the costs and timing of obtaining regulatory approvals for any of our product candidates and the occurrence of unexpected developments. We may seek to raise additional financing through the sale of equity, equity-related or debt securities or loans. The sale of additional equity or equity-related securities may result in additional dilution to our shareholders. Debt financing will expose us to risks of leverage, including the risk that we may be unable to pay the principal of and interest on our indebtedness when due, and that we may be required to pledge our assets as collateral for any debt financing that we obtain. Moreover, additional financing may not be available at times, in amounts or on terms acceptable to us or at all, particularly because we have granted a first priority security interest in certain critical patents and other intellectual property to Smith & Nephew. If we are unable to obtain additional financing as and when required, we may be forced to reduce the scope of, or delay or eliminate, some or all of our planned research, development and commercialization activities and we may also be required to reduce the scale of our operations, any of which could have a material adverse effect on our business.

Contractual Commitments and Obligations at December 31, 2007

The table below reports commitments and obligations that have been recorded on our consolidated balance sheet as of December 31, 2007. Certain other obligations and commitments, while not required under generally accepted accounting principles (“GAAP”) to be included in the consolidated balance sheets, may have a material impact on liquidity. These items, all of which have been entered into in the ordinary course of business, are also included in the table below in order to present a more complete picture of our financial position and liquidity.


	Cash Payments Due by Period
	Less than						More than
	1 year		1-3 years		3-5 years		5 years		Total
	(in millions)

Consolidated Obligations and Commitments as of December 31, 2007:
Facilities operating leases:
Third Parties	$	1.0	$	1.4	$	1.2	$	1.5	$	5.1
Contractual Obligations:
Third Parties⁽¹⁾		—		9.1		—		—	$	9.1
Purchase Obligations:
Capital		—		—		—		—		—
Operations		0.9		—		—		—		0.9

Total obligations and commitments	$	1.9	$	10.5	$	1.2	$	1.5	$	15.1


(1)	This commitment relates primarily to our obligation, under our supply agreement to pay Smith & Nephew a manufacturing cost rebate in the amount of $4.5 million in 2008 and 2009.

Related Party Transactions

We obtain certain corporate and administrative services from Westaim and we paid rent and operating expenses on our manufacturing facility in Fort Saskatchewan, Alberta to Westaim until Westaim sold the buildings on May 8, 2007. Our leases were assigned to the purchaser of such facility. The total cost of the services, rent and operating expenses paid to Westaim was $1.1 million for the year ended December 31, 2007, $2.6 million for the year ended December 31, 2006 and $2.1 million in 2005. We have historically reimbursed Westaim for the cost of providing (or, in certain cases, for the cost of paying a third party to provide) certain corporate and administrative services to us. These services have included insurance and risk management, cash management, legal, human resources, payroll processing, environmental health and safety, tax and accounting and intellectual property services. These costs have been reflected in our consolidated financial statements. Westaim continues to supply certain services to us pursuant to a services agreement which provides that we reimburse Westaim for the fully allocated costs of providing (or for the cost of paying a third party to provide) those services. During 2007, our internal staff began to perform many of the services previously provided by Westaim. At December 31, 2007, we continue to receive insurance and risk management services and tax and accounting services from Westaim.

With limited exceptions, we do not maintain any insurance policies in our own name. Instead, Westaim provides insurance coverage to us under its policies, which cover Westaim and other entities it controls, and we expect to have this coverage until the termination of the services agreement or that portion of it relating to the provision of insurance to us by Westaim or until such time as Westaim owns less than 50% of our common shares. We reimburse Westaim for the costs of that coverage under the arrangements described earlier in this paragraph. In the event we are no longer covered by Westaim’s insurance policies, we would have to obtain our own insurance policies, which could result in increased costs or reduced insurance coverage.

Off-Balance Sheet Commitments as of December 31, 2007

As of December 31, 2007, our future minimum commitments and contractual obligations included two facilities operating leases. These items are not required to be recorded on our balance sheet under GAAP. They are disclosed in the table presented above and described more fully in the following paragraphs in order to provide a more complete picture of our financial position and liquidity as of December 31, 2007. Our Fort Saskatchewan, Alberta facility was originally rented from Westaim under two separate leases covering a total of 82,223 square feet of space until May 8, 2007 when Westaim sold the buildings and assigned the leases to the purchaser. As part of that transaction, Westaim paid us $0.8 million as compensation for entering into agreements to amend the leases and our surrender of portions of the leased premises on or before September 30, 2008. On June 30, 2007, we entered into a lease surrender agreement with the purchaser pursuant to which we surrendered a portion of the leased premises and adjusted our rent and operating costs accordingly. On September 30, 2007, we entered into a second lease surrender agreement with the purchaser pursuant to which we surrendered the final portion of the leased premises we had agreed to surrender and adjusted our rent and operating costs accordingly. After two lease surrenders, the total space now covered under our leases assigned to the purchaser is 69,589 square feet. Our future minimum commitments under the Fort Saskatchewan, Alberta lease are approximately $0.6 million for each of the twelve-month periods commencing from January 1, 2007 to the expiry of the lease.

Our Wakefield, Massachusetts offices and laboratory facility are leased from a third party. The lease term began on July 27, 2001 and will expire on July 30, 2009. There are options to extend for two terms of five years each. Our future minimum commitments under the Wakefield, Massachusetts lease are $0.4 million for 2008 and $0.3 million for 2009 and are included in the table presented above.

In the normal course of operations, we may provide indemnifications that are contractual terms to counterparties in transactions such as purchase and sale agreements, service agreements, director/officer contracts and leasing transactions. These indemnification agreements may require us to compensate the counterparties for costs incurred as a result of various events, such as litigation claims of statutory sanctions that may be suffered by the counterparty as a consequence of the transaction. The terms of the indemnification agreements will vary based upon the agreement, the nature of which prevents us from making a reasonable estimate of the maximum potential amount that we could be required to pay counterparties. Historically, we have not made any payments under such indemnifications and no amounts have been accrued in the consolidated financial statements with respect to these indemnification guarantees. In addition, we have entered into indemnification agreements with our officers and directors.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as at the date of the consolidated financial statements as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate estimates and judgments, including those related to revenue recognition, inventory valuation, and useful lives of capital and intangible assets. Estimates are based on historical experience and on various other factors that are believed to be appropriate under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources and the methodology is consistent with prior years. Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition

We recognize revenue from the sale of products based upon our licensing and supply agreements with Smith & Nephew in accordance with GAAP. The agreements provide for payment to us of manufacturing costs on a fixed price basis, and partial reimbursement of new product development costs, and for royalties and milestone payments. We recognize chargeable manufacturing costs as revenue upon shipment of product from our manufacturing facility. We record our royalty revenues upon the sale of products by Smith & Nephew to its customers. Up to September 30, 2007, we were also eligible to earn additional royalties when specified gross margin thresholds have been achieved by Smith & Nephew. Additional royalties are recognized by us in the period of sale by Smith & Nephew to its customers. After September 30, 2007, with the revision to the license and development agreement, we agreed to delete the obligation of Smith & Nephew to pay additional royalties. Milestone payments are recognized as revenue when Smith & Nephew achieves the agreed sales levels or receives the agreed regulatory approvals.

Revenue also includes reimbursement for costs and expenses we incur above a certain threshold in connection with the development of new products and improvements to products covered by our agreements with Smith & Nephew. Our employees may perform work for Smith & Nephew to develop new products and the revenue from such work is recognized in the period the work is performed.

Research and Development Costs

The cost of materials and equipment that are acquired or constructed for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) are expensed as research and development costs at the time the costs are incurred. Research and development expenditures, which include the cost of materials consumed in research and development activities, salaries, wages and other costs of personnel engaged in research and development, costs of services performed by others for research and development on behalf of us, depreciation on equipment used for research and development and indirect costs are expensed as research and development costs when incurred. We have made, and continue to make, substantial investments in research and development activities to expand our product portfolio and grow our business.

Income Taxes

We use the assets and liability method of accounting for income taxes. Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year end, based on enacted tax laws and statutory tax rates applicable to the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that, in the opinion of management, is more likely than not to be realized. The effect of changes in tax rates is recognized in the year in which the rate change occurs. Changes to these interpretations could have a material effect on income tax provisions in future periods.

Intangible Assets

Our definite life intangible assets consist of the prosecution and applications costs of patents and trademarks and are amortized on a straight-line basis over their estimated useful lives to a maximum of 10 years. The cost of maintaining patents and trademarks are expensed as incurred. We assess the carrying value of definite life intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Any impairment in the carrying value is charged to expense in the period that impairment has been determined.

Translation of Foreign Currencies

Our functional currency is the Canadian dollar. The functional currency of our wholly owned subsidiary, NUCRYST Pharmaceuticals, Inc., is the United States dollar. The balance sheet accounts of the subsidiary are translated into Canadian dollars at the period end exchange rate, while income, expense and cash flows are translated at the average exchange rate for the period. Translation gains or losses related to net assets of such operations are shown as a component of accumulated other comprehensive loss in shareholders’ equity. Gains and losses resulting from foreign currency transactions, which are transaction denominated in a currency other than our functional currency, are included in the consolidated statement of operations. We use the U.S. dollar as our reporting currency to be consistent with other companies in our industry peer group. The Canadian functional currency consolidated financial statements are translated to the U.S. dollar reporting currency using the current rate method of translation.

The table on the following page summarizes the foreign exchange rates used in the preparation of our consolidated financial statements using period end and period average noon buying rates reported by the U.S. Federal Reserve Bank of New York as stated as the number of Canadian dollars to one U.S. dollar. High and low noon buying rates are also included.


Year Ended December 31,	Period End Rate		Period Average Rate		High Rate		Low Rate

2005		1.1656		1.2115		1.2703		1.1507
2006		1.1652		1.1340		1.1726		1.0989
2007		0.9881		1.0742		1.1852		0.9168

Monthly 2007
January		1.1792		1.1763		1.1824		1.1647
February		1.1700		1.1710		1.1852		1.1586
March		1.1530		1.1682		1.1810		1.1530
April		1.1068		1.1350		1.1583		1.1068
May		1.0701		1.0951		1.1136		1.0701
June		1.0634		1.0651		1.0727		1.0579
July		1.0656		1.0502		1.0689		1.0372
August		1.0560		1.0578		1.0754		1.0497
September		0.9959		1.0252		1.0546		0.9959
October		0.9496		0.9751		1.0002		0.9496
November		1.0007		0.9661		1.0007		0.9168
December		0.9881		1.0021		1.0216		0.9784

Stock Based Compensation

On January 1, 2006, we adopted SFAS 123(R), “Share-Based Payment” (“SFAS 123(R)”), which requires that all share-based payments to directors and employees, including grants of stock options, be recognized in the consolidated financial statements based on their fair values.

We adopted SFAS 123(R) using the modified prospective transition method, which required the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. Our consolidated financial statements as of and for the year ended December 31, 2007 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the year ended December 31, 2007 was $1,121 which consisted of stock-based compensation expense of $973 related to director and employee stock options and $148 related to RSUs and SARs, with a corresponding increase to additional paid-in-capital, or APIC, of $1,029 and share capital of $92. In addition, stock based compensation of $73 was recognized related to restricted share units awarded to the independent directors.

of our stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

SFAS 123(R) requires that liability classified awards such as SARs be revalued to estimated fair value at each reporting date using an option-pricing model. Prior to the adoption of SFAS 123(R), we valued SARs at the amount by which the market value exceeded the exercise price at each measurement date. As a result of implementing SFAS 123(R) on January 1, 2006, we increased our SAR liability from $90 to $97, with the increase recorded as a cumulative effect of a change in accounting principle in the condensed consolidated statement of operations.

We continue to use the Black-Scholes option-pricing model for valuation of share-based payment awards which was previously used for our pro forma information required under SFAS 123. Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected common share price volatility over the term of the awards, and actual and projected employee share option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Although the fair value of employee stock options is determined in accordance with SFAS 123(R) and SAB 107 using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer /willing seller market transaction.

Recently Adopted Accounting Pronouncements

FIN 48

In June 2006, the FASB issued FIN 48, an interpretation of FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires that the Corporation recognize the impact of a tax position in the financial statements if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 were effective beginning January 1, 2007 and are incorporated into the December 31, 2007 consolidated financial statements. (Note 11)

Recently Pending Accounting Pronouncements

SFAS 157

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Corporation is currently evaluating the impact of SFAS 157 and it is not expected to have a material impact on its consolidated financial statements.

SFAS 159

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once elected. SFAS 159 is effective for fiscal years beginning after November 15, 2007, and early application is allowed under certain circumstances. The Corporation is currently evaluating the impact of SFAS 159 and it is not expected to have a material impact on its consolidated financial position.

EITF 07-1

In September 2007, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 07-1 “Collaborative Arrangements” (“EITF 07-1”). EITF 07-1 addresses the accounting for arrangements in which two companies work together to achieve a commercial objective, without forming a separate legal entity. The nature and purpose of a company’s collaborative arrangements are required to be disclosed, along with the accounting policies applied and the classification and amounts for significant financial activities related to the arrangements. EITF 07-1 is effective for fiscal years beginning after December 15, 2008. The Company is currently assessing the impact EITF 07-1 will have on its results of operations and financial position.

EITF 07-3

In June 2007, the EITF issued EITF Issue No. 07-3, “Accounting for Non Refundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities” (“EITF 07-3”). EITF 07-3 requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities be deferred and capitalized and recognized as an expense as the goods are delivered or the related services are performed. EITF 07-3 is effective for fiscal years beginning after December 15, 2007 and will be adopted in the first quarter of 2008 and is not expected to have a material impact on the Corporation’s financial position or results of operations.

FASB Business Combinations

The FASB recently completed the second phase of its business combinations project, to date the most significant convergence effort with the International Accounting Standards Board (“IASB”), and issued the following two accounting standards:


	i	Statement No. 141(R), Business Combination; and

	ii	Statement No. 160, Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51.

These statements dramatically change the way companies account for business combinations and non-controlling interests (minority interests in current U.S. GAAP). Compared with their predecessors, Statements 141(R) and 160 will require:


	•	More assets acquired and liabilities assumed to measured at fair value as of the acquisition date;

	•	Liabilities related to contingent consideration to be re-measured at fair value in each subsequent reporting period;

	•	An acquirer in pre-acquisition periods to expense all acquisition related costs; and

	•	Non-controlling interests in subsidiaries initially to be measure at fair value and classified as a separate component of equity.

Statements 141(R) and 160 should both be applied prospectively for fiscal years beginning on or after December 15, 2008. However, Statement 160 requires entities to apply the presentation and disclosure requirements retrospectively (e.g., by reclassifying non-controlling interests to appear in equity) to comparative financial statements if presented. Both standards prohibit early adoption. The Company is currently assessing the impact these new standards will have on its consolidated financial statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

We are exposed to various market risks, including variability in currency exchange rates. The Smith & Nephew sales revenues on which our royalty and milestone revenues are determined are reported to us in U.S. dollars. Sales by Smith & Nephew in other currencies will result in fluctuations in their revenue as reported in U.S. dollars. The Smith & Nephew contracts ensure recovery of certain manufacturing costs, which reduces our susceptibility to production cost variances resulting from foreign exchange fluctuations. Our accounts receivable from Smith & Nephew are denominated in U.S. dollars. The functional currency that we use for accounting purposes is the Canadian dollar and as a result, accounts receivable and other liabilities recorded in Canadian dollars are exposed to changes in the exchange rate between the Canadian and U.S. dollars until these receivables are collected. We do not maintain derivative instruments to mitigate our exposure to fluctuations in currency exchange rates.

We are exposed to currency risks as a result of our export to foreign jurisdictions of goods produced in Canada. These risks are partially covered by purchases of goods and services in the foreign currency. For 2007, a 1.0% increase in the exchange rate from the United States dollar to the Canadian dollar (meaning a 1% appreciation in the value of the United States dollar compared to the Canadian dollar) would have decreased our loss before income taxes by less than $0.1 million. Conversely, a 1.0% decrease in the exchange rate would have increased our 2007 loss before taxes by a similar amount.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Chartered Accountants

To the Board of Directors and Shareholders of NUCRYST Pharmaceuticals Corp.

We have audited the consolidated balance sheets of NUCRYST Pharmaceuticals Corp. as at December 31, 2007 and 2006 and the consolidated statements of operations, shareholders’ equity and cash flow for each of the years in the three-year period ended December 31, 2007. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of NUCRYST Pharmaceuticals Corp. as at December 31, 2007 and 2006 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007 in accordance with accounting principles generally accepted in the United States of America.

The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion.

/s/ Deloitte & Touche LLP

Independent Registered Chartered Accountants

Calgary, Canada

February 11, 2008

NUCRYST Pharmaceuticals Corp.

Consolidated Balance Sheets

(In US thousands, except share data)


	December 31			December 31
	2007			2006

ASSETS
Current
Cash and cash equivalents	$	17,841		$	18,926
Accounts receivable — net (note 4)		14,924			7,041
Inventories (note 5)		4,426			7,297
Other		427			327

		37,618			33,591
Restricted cash (note 2g)		140			135
Capital assets — net (note 6)		12,734			11,350
Intangible assets — net (note 7)		807			816

	$	51,299		$	45,892


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current
Accounts payable and accrued liabilities (note 8)	$	3,650		$	2,261
Accounts payable and accrued liabilities to related party (note 12)		67			45
Deferred lease inducement (note 2m)		111			—

		3,828			2,306
Long term deferred lease inducement (note 2m)		726			—

		4,554			2,306

Guarantees (note 13)
Commitments (note 14)

SHAREHOLDERS’ EQUITY
Common shares no par value, unlimited shares authorized:
issued and outstanding — 18,367,563 and 18,309,613 shares at December 31, 2007 and 2006, respectively (note 10)		82,776			82,672
Additional paid-in capital		1,511			482
Accumulated other comprehensive income (loss) (note 2d)		557			(5,490	)
Accumulated deficit		(38,099	)		(34,078	)

Total shareholders’ equity		46,745			43,586

	$	51,299		$	45,892

The accompanying notes are an integral part of these consolidated financial statements.

NUCRYST Pharmaceuticals Corp.

Consolidated Statement of Operations

(In US thousands, except share data)


	Year Ended			Year Ended			Year Ended
	December 31			December 31			December 31
	2007			2006			2005

Revenue
Wound care product revenue (note 3)	$	20,092		$	24,369		$	18,636
Milestone revenue (note 3)		10,000			—			5,000

		30,092			24,369			23,636
Costs
Manufacturing (note 6)		14,477			16,053			10,015
Research and development (note 6)		6,303			11,162			8,520
General and administrative		9,067			6,723			3,945
Depreciation and amortization (note 6)		355			430			300
Write down of capital assets (note 6)		1,173			1,049			—

(Loss) income from operations		(1,283	)		(11,048	)		856
Foreign exchange (loss) gain		(3,283	)		(298	)		193
Interest income		685			1,123			12
Interest expense (note 9)		—			(310	)		(3,540	)

Loss before income taxes and cumulative effect of a change in accounting principle		(3,881	)		(10,533	)		(2,479	)
Current income tax (expense) recovery (note 11)		(140	)		41			(162	)

Loss before cumulative effect of a change in accounting principle		(4,021	)		(10,492	)		(2,641	)
Cumulative effect of a change in accounting principle (note 2p)		—			(7	)		—

Net loss	$	(4,021	)	$	(10,499	)	$	(2,641	)

Loss per common share (note 17)
Net loss — basic and diluted	$	(0.22	)	$	(0.58	)	$	(0.27	)
Weighted average number of common shares outstanding:
— basic		18,333,810			17,964,332			9,764,486
— diluted		18,333,810			17,964,332			9,764,486

The accompanying notes are an integral part of these consolidated financial statements.

NUCRYST Pharmaceuticals Corp.

Consolidated Cash Flow Statements

(In US thousands, except share data)


	Year Ended			Year Ended			Year Ended
	December 31			December 31			December 31
	2007			2006			2005

Operating activities
Net loss	$	(4,021	)	$	(10,499	)	$	(2,641	)
Items not affecting cash
Depreciation and amortization		1,638			1,656			1,282
Stock-based compensation expense		1,121			496			—
Amortized lease inducement		(71	)		—			—
Write down of capital assets		1,173			1,049			—
Foreign exchange loss		—			(356	)		—
Cumulative effect of a change in accounting principle		—			7			—
Changes in non cash working capital
Accounts receivable		(7,009	)		(606	)		(2,000	)
Inventories		4,001			(777	)		(3,612	)
Other		(13	)		(212	)		22
Accounts payable and accrued liabilities		668			(2,376	)		1,191
Accounts payable and accrued liabilities to related party (note 12)		(177	)		(969	)		1,058
Accrued interest on indebtedness to related party (note 9)		—			—			2,589

Cash used in operating activities		(2,690	)		(12,587	)		(2,111	)

Investing activities
Restricted cash		(5	)		(5	)		(2	)
Purchase of short-term investments		—			(22,191	)		—
Maturity of short-term investments		—			22,748			—
Capital expenditures		(1,920	)		(4,978	)		(3,784	)
Intangible assets		(66	)		(153	)		(127	)

Cash used in investing activities		(1,991	)		(4,579	)		(3,913	)

Financing activities
Issuance of common shares, net of share issuance costs (note 10)		12			286			39,095
Deferred lease inducement		822			—			—
Net advances from related party (note 9)		—			—			1,662

Cash provided from financing activities		834			286			40,757

Effect of exchange rate changes on cash and cash equivalents		2,762			(95	)		220

Net (decrease) increase in cash and cash equivalents		(1,085	)		(16,975	)		34,953
Cash and cash equivalents at beginning of year		18,926			35,901			948

Cash and cash equivalents at end of year	$	17,841		$	18,926		$	35,901

Cash and cash equivalents is comprised of:
Cash	$	7,563		$	1,324		$	2,071
Cash equivalents	$	10,278		$	17,602		$	33,830
Supplemental disclosure of cash flow information:
Non-cash capital asset additions included in accounts payable and accrued liabilities at end of year	$	458		$	243		$	590
Cash paid for interest	$	—		$	310		$	1,699
Cash paid for income taxes	$	—		$	72		$	121
Deferred share issuance costs (accrued and not paid)	$	—		$	—		$	925

The accompanying notes are an integral part of these consolidated financial statements.

NUCRYST Pharmaceuticals Corp.

Consolidated Statement of Shareholders’ Equity

(In US thousands, except share data)


							Accumulated
	Common Shares				Additional		Other						Total			Total
			Stated		Paid-in		Comprehensive			Accumulated			Comprehensive			Shareholders’
	Number		Amount		Capital		Income (Loss)			Deficit			Loss			Equity

December 31, 2004		9,727,500	$	3,534	$	—	$	(4,180	)	$	(20,938	)				$	(21,584	)
Issuance of common shares		4,500,000		39,095		—		—			—		$	—			39,095
Foreign currency translation adjustments		—		—		—		(1,101	)		—			(1,101	)		(1,101	)
Net loss		—		—		—		—			(2,641	)		(2,641	)		(2,641	)

December 31, 2005		14,227,500		42,629		—		(5,281	)		(23,579	)		(3,742	)		13,769
Issuance of common shares upon conversion of indebtedness to related party (note 9)		3,964,200		39,642		—		—			—			—			39,642
Issuance of common shares in connection with restricted shares and exercises of stock options and share appreciation rights		117,913		401		—		—			—			—			401
Stock-based compensation		—		—		482		—			—			—			482
Foreign currency translation adjustments		—		—		—		(209	)		—			(209	)		(209	)
Net loss		—		—		—		—			(10,499	)		(10,499	)		(10,499	)

December 31, 2006		18,309,613		82,672		482		(5,490	)		(34,078	)		(10,708	)		43,586
Issuance of common shares in connection with restricted shares and exercises of stock options		57,950		104		—		—			—			—			104
Stock-based compensation		—		—		1,029		—			—			—			1,029
Foreign currency translation adjustments		—		—		—		6,047			—			6,047			6,047
Net loss		—		—		—		—			(4,021	)		(4,021	)		(4,021	)

December 31, 2007		18,367,563	$	82,776	$	1,511	$	557		$	(38,099	)	$	2,026		$	46,745

The accompanying notes are an integral part of these consolidated financial statements.

NUCRYST Pharmaceuticals Corp.

Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006 and 2005
All amounts are expressed in thousands of U.S. dollars, except share and per share data


1	DESCRIPTION OF BUSINESS

NUCRYST Pharmaceuticals Corp. (the “Corporation”) was incorporated on December 18, 1997 by articles of incorporation under the Business Corporations Act (Alberta) as a wholly owned subsidiary of The Westaim Corporation (the “Parent”). On December 29, 2005, the Corporation completed an initial public offering for the sale of 4,500,000 common shares. Following the initial public offering, the Parent continues to own a controlling interest in the Corporation.

The Corporation develops, manufactures and commercializes innovative medical products that fight infection and inflammation based on its noble metal nanocrystalline technology. The Corporation produces nanocrystalline silver as a coating for wound care products under the trademark SILCRYST^tm and as a powder, that the Corporation refers to as NPI 32101, for use in medical devices and as an active pharmaceutical ingredient.

Advanced wound care products with the Corporation’s SILCRYST^tm coatings were developed and sold by the Corporation under the Acticoat^tm trademark until May 2001 when a series of agreements were completed with Smith & Nephew plc (“Smith & Nephew”), a global medical device company. Under the original agreements, the Corporation licensed to Smith & Nephew the exclusive right to market, distribute and sell products with SILCRYST^tm coatings for use on non-minor skin wounds and burns in humans world-wide. The Corporation also sold various assets to Smith & Nephew, including the Acticoat^tm trade name and trademark, various regulatory approvals and certain manufacturing equipment, that the Corporation then leased back. Under the original agreements, the Corporation manufactures Acticoat^tm products and supplies them exclusively to Smith & Nephew and has agreed to work with Smith & Nephew to develop new Acticoat^tm wound care products made with the Corporation’s SILCRYST^tm coatings. Smith & Nephew markets and sells products with the Corporation’s SILCRYST^tm coatings under its Acticoat^tm trademark. On September 30, 2007 the Corporation signed amended agreements with Smith & Nephew. A summary of material changes to these agreements is included in Note 3.

The Corporation’s revenue comprises wound care product revenue, which includes manufacturing cost reimbursement on the sale of product to Smith & Nephew and royalties on the further sale of that product by Smith & Nephew to third parties, as well as milestone revenue which are payments earned upon the achievement of specified Smith & Nephew sales thresholds or regulatory events. All of the Corporation’s revenues since May 2001 have been derived from sales of product to Smith & Nephew, royalties on the further sale of that product and milestone payments from Smith & Nephew.

The Corporation is also developing pharmaceutical products based on its nanocrystalline technology to address medical conditions that are characterized by both infection and inflammation. The Corporation has developed NPI 32101 for use as an active pharmaceutical ingredient. The Corporation ceased its development of a pharmaceutical topical cream containing NPI 32101 for the treatment of dermatological conditions in November 2006, following the results of its second Phase 2 clinical trial. As a statistically significant difference is required to gain approval as a drug, the Corporation decided to cease the drug development program for atopic dermatitis and submitted a 510(k) application to market NPI 32101 cream as a broad-spectrum antimicrobial barrier. The 510(k) application was cleared by the US Food and Drug Administration on July 19, 2007 for this use. The Corporation is currently conducting preclinical research for the use of NPI 32101 in the treatment of other conditions.


2	SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES


	*a) Basis of presentation*

The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

The financial statements of entities which are controlled by the Corporation through voting equity interests, referred to as subsidiaries, are consolidated. Entities which are not controlled but over which the Corporation has the ability to exercise significant influence are accounted for using the equity method. Investments in other entities are accounted for using the cost method. Variable interest entities (“VIEs”), as defined by the Financial Accounting Standards Board (“FASB”) in FASB Interpretation No. (“FIN”) 46 (Revised 2003), “Consolidation of Variable Interest Entities — an Interpretation of Accounting Research Bulletin No. 51” (“FIN 46R”), are entities in which equity investors do not have the characteristics of a “controlling financial interest” or there is not sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. VIEs are consolidated by the Corporation when it is determined that it will, as the primary beneficiary, absorb the majority of the VIEs expected losses and/or expected residual returns. The Corporation currently does not have any VIEs.

These consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiary, NUCRYST Pharmaceuticals Inc., which was incorporated in 1998 under the laws of the state of Delaware. All intercompany balances and transactions are eliminated upon consolidation.


	*b) Use of estimates*

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses during the year. Actual results could differ from those estimates. Significant estimates include the useful lives of capital assets and intangible assets, inventory valuation, deferred tax asset valuation, uncertain tax positions, financial instrument valuation and the fair value of stock-based compensation.


	*c) Translation of foreign currencies*

The Corporation’s functional currency is the Canadian dollar. The functional currency of the Corporation’s wholly owned subsidiary, NUCRYST Pharmaceuticals Inc., is the United States dollar (“U.S. dollar”). The balance sheet accounts of the subsidiary are translated into Canadian dollars at the period end exchange rate, while income, expense and cash flows are translated at the average exchange rate for the period. Translation gains or losses related to net assets of such operations are shown as a component of accumulated other comprehensive loss in shareholders’ equity. Gains and losses resulting from foreign currency transactions, which are transactions denominated in a currency other than the entity’s functional currency, are included in the consolidated statements of operations.

The Corporation uses the U.S. dollar as its reporting currency to be consistent with other companies in its industry peer group. The Canadian functional currency consolidated financial statements are translated to the U.S. dollar reporting currency using the current rate method of translation.


	*d) Accumulated other comprehensive income (loss)*

Comprehensive income (loss) is comprised of net loss and other comprehensive income (loss).

Other comprehensive income (loss) consists of foreign currency translation adjustments for the year, which arise from the conversion of the Canadian dollar functional currency consolidated financial statements to the U.S. dollar reporting currency consolidated financial statements. Accumulated other comprehensive income of $557 (2006 loss — $5,490) consists of foreign currency translation adjustments.


	*e) Revenue recognition*

Revenue from direct sales to third parties is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price to the buyer is fixed or determinable, and collection is reasonably assured. The Corporation’s revenues under its agreements with Smith & Nephew consist primarily of product revenue, royalties and payments upon the achievement of specific milestones. Product revenue and royalties are reported as wound care product revenue in the consolidated statements of operations as they relate directly to the sale of the Corporation’s products to Smith & Nephew. For products manufactured under agreements with Smith & Nephew, revenue is recorded by the Corporation at the date of shipment. Royalty revenue is earned based on a percentage of Smith & Nephew’s sales to third parties. Manufacturing cost rebate is recorded as a reduction to wound care revenue evenly throughout the year. Revenue relating to the achievement of milestones under agreements with Smith & Nephew is recognized when the milestone event has occurred and is recorded separately as milestone revenue. The Corporation also derives fees from research activities under agreements with Smith & Nephew and this revenue is recognized as services are performed. (Note 3)


	*f) Product warranty*

Wound care products currently sold by the Corporation carry a limited short term product warranty. No provision for product warranty claims was required for the years ended December 31, 2007, 2006 and 2005 as the Corporation’s claims experience has been negligible.


	*g) Cash and cash equivalents*

Cash and cash equivalents consist of cash on deposit and highly liquid short-term investments with original maturities at the date of acquisition of 90 days or less and are recorded at cost.

At December 31, 2007 the Corporation had $140 (2006 — $135) on deposit as collateral for the lease of its Wakefield, Massachusetts facility.


	*h) Short-term investments*

Short-term investments consist of money-market instruments with original maturities of greater than 90 days but less than one year and are classified as held-to-maturity financial assets. Held-to-maturity classification will be restricted to fixed maturity instruments that the Corporation intends, and is able, to hold to maturity and will be accounted for at amortized cost. As at December 31, 2007 and 2006, the Corporation did not hold any short-term investments.


	*i) Allowance for doubtful accounts*

The Corporation evaluates the collectibility of accounts receivable and records an allowance for doubtful accounts, which reduces the accounts receivable to the amount management reasonably believes will be collected. A specific allowance is recorded against customer receivables that are considered to be impaired based on the Corporation’s knowledge of the financial condition of its customers. In determining the amount of the allowance, the Corporation considers factors, including the length of time the receivables have been outstanding, customer and industry concentrations, the current business environment and historical experience.


	*j) Inventories*

Finished product, raw materials and materials in process are valued at the lower of average cost and market. Inventories include direct labour and an application of direct and indirect overhead.


	*k) Capital assets*

Capital assets are stated at cost. Internal labour costs directly relating to capital projects are included in the cost of the specific capital assets. Depreciation is calculated using a straight-line method based on estimated useful lives of the particular assets as follows:


Machinery and equipment		5 to 10 years
Computer hardware and software		2 to 5 years
Leasehold improvements		Term of lease — 5 to 20 years

Leasehold improvements are depreciated using the straight-line method over the lesser of the term of the lease or the estimated useful life of the asset. The Corporation evaluates the carrying value of capital assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable, and recognizes an impairment charge when estimated future non-discounted cash flows of the underlying assets are less than the carrying value of the assets. Where there is an impairment, the Corporation measures the charge based on the fair value of the assets using various valuation techniques.


	*l) Intangible assets*

The Corporation’s definite life intangible assets consist of the prosecution and application costs of patents and trademarks and are amortized on a straight-line basis over their estimated useful lives to a maximum of 10 years. The cost of maintaining patents and trademarks are expensed as incurred. The Corporation evaluates the carrying value of definite life intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Any impairment in the carrying value which is based on the fair value of the intangible assets is charged to expense in the period that impairment has been determined.

Indefinite life intangible assets are recorded at fair value. On a regular basis, the Corporation reviews the carrying value of these assets for impairment. As at December 31, 2007 and 2006, the Corporation had no indefinite life intangible assets.


	*m) Deferred lease inducement*

Deferred lease inducement represents a lease allowance received from the Parent and is amortized over the term of the lease using the straight line method. During the second quarter of 2007, the Corporation received $822 from the Parent related to its Fort Saskatchewan facility. There was a foreign exchange adjustment of $86 for the year ended December 31, 2007 and amortization of $71 was recorded as a reduction of general and administrative expenses.


	*n) Research and development costs*

The costs of materials, equipment, or facilities that are acquired or constructed for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) are expensed as research and development costs at the time the costs are incurred. Research and development expenditures, which include the cost of materials consumed in research and development activities, salaries, wages and other costs of personnel engaged in research and development, costs of services performed by others for research and development on behalf of the Corporation, depreciation on equipment used for research and development and indirect costs are expensed as research and development costs when incurred.


	*o) Income taxes*

The Corporation uses the asset and liability method of accounting for income taxes. Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year end, based on enacted tax laws and statutory tax rates applicable to the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that, in the opinion of management, is more likely than not to be realized. The effect of changes in tax rates is recognized in the year in which the rate change occurs. Research and development investment tax credits are accounted for as a reduction of income taxes in accordance with Accounting Principle Board Opinion No. 4, “Accounting for the Investment Credit”. On January 1, 2007 the Corporation adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). (Note 2s)


	*p) Stock-based compensation plans*

On January 1, 2006, the Corporation adopted SFAS 123(R), “Share-Based Payment” (“SFAS 123(R)”) utilizing the modified prospective transition method, that requires all share-based payments to directors and employees, including grants of stock options, be recognized in the financial statements based on their fair values.

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Corporation’s consolidated statements of operations. Prior to the adoption of SFAS 123(R), the Corporation accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), as allowed under SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Under the intrinsic value method, no stock-based compensation expense had been recognized in the Corporation’s consolidated statements of operations because the exercise price of the Corporation’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

For fiscal years 2007 and 2006 forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the Corporation’s pro forma information required under SFAS 123(R) for the period prior to fiscal year 2006, the Corporation accounted for forfeitures as they occurred.

SFAS 123(R) requires that liability classified awards such as stock appreciation rights (“SARs”) be revalued to estimated fair value at each reporting date using an option-pricing model. Prior to the adoption of SFAS 123(R), the Corporation valued SARs at the amount by which the market value exceeded the exercise price at each measurement date. As a result of implementing SFAS 123(R) on January 1, 2006, the Corporation increased its SAR liability from $90 to $97, with the increase recorded as a cumulative effect of a change in accounting principle in the consolidated statements of operations.

The Corporation continues to use the Black-Scholes option-pricing model for valuation of share-based payment awards which was previously used for the Corporation’s pro forma information required under SFAS 123. The Corporation’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Corporation’s stock price as well as

assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Corporation’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Although the fair value of employee stock options is determined in accordance with SFAS 123(R) and Staff Accounting Bulletin 107, “Share-Based Payment” (“SAB 107”) using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.


	*q) Earnings per share*

Basic earnings per common share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated on the basis of the average number of shares outstanding during the period plus the additional common shares that would have been outstanding if potentially dilutive common shares had been issued using the “treasury stock” method.


	*r) Employee future benefits*

The Corporation maintains a defined contribution pension plan (Note 16). All employee future benefits are accounted for on an accrual basis.


	*s) Recently adopted accounting pronouncements*


	FIN 48


	*t) Recently pending accounting pronouncements*


	SFAS 157


	SFAS 159


	EITF 07-1


	EITF 07-3


	FASB Business Combinations

i. Statement No. 141(R), Business Combination; and

ii. Statement No. 160, Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51.


	•	More assets acquired and liabilities assumed to measured at fair value as of the acquisition date;

	•	Liabilities related to contingent consideration to be re-measured at fair value in each subsequent reporting period;

	•	An acquirer in pre-acquisition periods to expense all acquisition related costs; and

	•	Non-controlling interests in subsidiaries initially to be measure at fair value and classified as a separate component of equity.


3	AGREEMENTS WITH SMITH & NEPHEW

On September 30, 2007, the Corporation and Smith & Nephew signed amended agreements for the sale to Smith & Nephew of Acticoat^tm wound care dressings manufactured by the Corporation. The new agreements amended the criteria for the achievement of sales milestones that resulted in a $5,000 sales milestone earned by the Corporation in the third quarter of 2007. The cost to manufacture Acticoat^tm products was previously fully reimbursed by Smith & Nephew to the Corporation. The cost recovery structure has been amended so that the parties will annually come to an agreement on the fixed overhead costs and direct costs for manufacturing these products. A manufacturing cost rebate of $4,500, relating to 2007, became due to Smith & Nephew on September 30, 2007 under the terms of the agreements. The Corporation has also committed to similar payments of $4,500 in each of the years 2008 and 2009. The manufacturing cost rebate is recorded as a reduction in wound care product revenue. After 2009, additional amounts may become due under the terms of the agreements.

Milestone revenue for the year ended December 31, 2007 was $10,000 (2006 — $Nil) with a corresponding increase in cash and cash equivalents of $5,000 and accounts receivable of $5,000. Wound care product revenue for the year ended December 31, 2007 was reduced by $4,500 (2006 — $Nil) with a decrease in cash and cash equivalents of $4,500 (2006 — $Nil) relating to the 2007 manufacturing cost rebate.


4	ACCOUNTS RECEIVABLE

As at December 31, 2007 and 2006, no allowance for doubtful accounts was required.


5	INVENTORIES


	December 31,		December 31,
	2007		2006

Raw materials	$	2,793	$	3,888
Materials in process		1,394		649
Finished product		239		2,760

	$	4,426	$	7,297


6	CAPITAL ASSETS


			Accumulated		Net
December 31, 2007	Cost		Depreciation		Book Value

Machinery and equipment	$	9,044	$	2,875	$	6,169
Leasehold improvements		2,734		1,542		1,192
Computer hardware and software		880		632		248
Construction in progress		5,125		—		5,125

	$	17,783	$	5,049	$	12,734


			Accumulated		Net
December 31, 2006	Cost		Depreciation		Book Value

Machinery and equipment	$	9,814	$	3,529	$	6,285
Leasehold improvements		2,265		956		1,309
Computer hardware and software		588		348		240
Construction in progress		3,516		—		3,516

	$	16,183	$	4,833	$	11,350

Included in capital assets is construction in progress which is not currently subject to depreciation. Depreciation related to capital assets for the year ended December 31, 2007 was $1,429 (2006 — $1,445; 2005 — $1,096), of which $449 (2006 — $470; 2005 — $447) was included in research and development costs and $834 (2006 — $756; 2005 — $535) relating to manufacturing assets was included in manufacturing costs in the consolidated statements of operations. Depreciation expense for the year ended December 31, 2007 was comprised of $146 (2006 — $219; 2005 — $114) relating to other assets.

During the year, certain capital assets previously used for the production of wound care dressings and NPI 32101 powder were replaced by existing production equipment that runs more efficiently and economically. As a result, the Corporation recorded a write down of the obsolete equipment in an amount of $1,173. For the year ended December 31, 2006, construction in progress included in capital assets relating to the design and

implementation of an active pharmaceutical ingredient production facility in the amount of $1,049 was written off. As a result of the outcome of the Corporation’s second Phase 2 clinical trial for topical NPI 32101 in the treatment of dermatological conditions, it was determined that the facility not be built.


7	INTANGIBLE ASSETS


	December 31,			December 31,
	2007			2006

Patents and trademarks	$	2,642		$	2,180
Less accumulated amortization		(1,835	)		(1,364	)

	$	807		$	816

Amortization related to intangible assets for the year ended December 31, 2007 was $209 (2006 — $211; 2005 — $186).

The following is the estimated amortization expense of intangible assets for each of the five fiscal years commencing with 2008:


2008	$	193
2009		165
2010		141
2011		105
2012		203

Total	$	807


8	ACCOUNTS PAYABLE AND ACCRUED LIABILITIES


	December 31,		December 31,
	2007		2006

Compensation liabilities	$	1,737	$	517
Royalty liability		340		245
Current income tax liability		140		—
Administrative services		179		483
Production liability		311		304
Capital projects		458		243
Facility related		236		12
Research related		80		389
Other trade payables and accrued liabilities		169		68

	$	3,650	$	2,261


9	INDEBTEDNESS TO RELATED PARTY

The Corporation was indebted to the Parent for a term loan with a five-year maturity which bore interest at a rate of 10%. The Corporation repaid $6,850 of the term loan with net proceeds from the initial public offering. In accordance with the terms of the prospectus of the initial public offering on December 29, 2005, the remaining balance owing in the amount of $39,642 was converted into 3,964,200 common shares of the Corporation on January 27, 2006. For the year ended December 31, 2006, interest paid on the term loan amounted to $310 (2005 — $1,669).

The Corporation incurred interest expense on indebtedness to related party as follows:


	Year ended		Year ended		Year ended
	December 31,		December 31,		December 31,
	2007		2006		2005

Shareholder advances	$	—	$	—	$	1,936
Promissory note		—		—		653
Term loan		—		310		1,500

		—		310		4,089
Less: interest expense included in manufacturing costs		—		—		(549	)

	$	—	$	310	$	3,540


10	SHARE CAPITAL

The Corporation’s authorized share capital consists of an unlimited number of voting common shares and preferred shares.


a)	*Common shares issued and outstanding*

Changes in the Corporation’s common shares outstanding during 2007 and 2006 are as follows:


	Number				Stated Capital
	2007		2006		2007		2006

Balance at beginning of year		18,309,613		14,227,500	$	82,672	$	42,629
Stock options exercised		4,540		105,303		12		286
SARs Exercised		—		7,610		—		83
Conversion of term loan (Note 9)		—		3,964,200		—		39,642
Restricted shares		53,410		5,000		92		32

Balance at end of year		18,367,563		18,309,613	$	82,776	$	82,672

On January 27, 2006, 3,964,200 common shares were issued upon the conversion of $39,642 of the outstanding term loan owed to the Parent at $10.00 per share in accordance with the terms of the initial public offering prospectus.

During the year ended December 31, 2007, 4,540 (2006 — 105,303; 2005 — Nil) options were exercised at a weighted average price of CDN$3.08 (2006 — CDN$3.09; 2005 — Nil). During the year, 53,410 (2006 — 5,000; 2005 — Nil) restricted shares with a fair value of $92 (2006 — $32; 2005 — Nil) were issued.

The Corporation had no SARs outstanding at December 31, 2007 and 2006. During 2006, 10,376 SARs were exercised and settled with 7,610 shares of the Corporation. No SARs were issued, exercised or forfeited in 2005.


b)	*Stock-based compensation plans*

The Corporation maintains an equity incentive plan for employees under which stock options and SARs and restricted share units (“RSUs”) may be granted for up to 2,200,000 common shares of the Corporation. A total of 579,299 common shares were available for grant under the Corporation’s stock-based compensation plans as of December 31, 2007. The exercise price of each stock option, SAR and RSU is set at an amount not less than the market value of the common shares of the Corporation at the date of grant. Prior to the initial public offering, the market value of the common shares was determined by the Parent at the time of issuance of each stock option, SAR and RSU. Stock options and SARs generally vest evenly over a three-year period. Certain option grants are subject to immediate vesting as to one-third of the grant, with the remaining two-thirds of the options vesting evenly over a two-year period. All stock options and SARs expire ten years from the date of grant. RSUs vest evenly over a period of between two to three years. Awards that expire or are forfeited generally become available for issuance under the plan.

Independent directors who were appointed to the Corporation’s board of directors prior to May 2, 2006 were granted an initial award of 20,000 options. Effective May 2, 2006, independent directors are granted an initial award of 8,000 options upon appointment to the board. Each independent director is entitled to a subsequent annual award of 2,000 options. Effective May 2, 2006, independent directors are also granted 5,000 restricted share units upon appointment to the board. These units vest immediately and are subject to trading restrictions, with 1,000 restricted shares available for sale on the first anniversary date and the remaining 4,000 restricted shares upon retirement from the board. Each independent director is entitled to a subsequent annual grant of 3,000 restricted share units, 50% of which is subject to a one-year vesting and the remaining 50% to a two-year vesting. Employees are granted options in the quarter of their hire and subsequently upon the approval by the board of directors.

Total stock-based compensation expense recognized under SFAS 123^® for the year ended December 31, 2007 was $1,121 (2006 — $464), of which $1,121 (2006 — $460) was included in general and administrative expense and $Nil (2006 — $4) was included in research and development expense. Stock-based compensation expense consisted of $973 (2006 — $482) related to director and employee stock options and $148 (2006 — recovery of $18) related to RSUs and SARs, with a corresponding increase in additional paid-in capital of $1,029 (2006 — $482), share capital of $92 (2006 — $Nil) and a decrease in accounts payable and accrued liabilities of $Nil (2006 — $18). There was no stock based compensation expense related to employee stock options recognized for the year ended December 31, 2005.

If compensation costs for the Corporation’s stock option plans in 2005 had been determined based on the fair value methodology over the vesting period consistent with SFAS 123, the Corporation’s net loss and loss per share for the year ended December 31, 2005 would have been increased to the pro forma amounts indicated below:


Net loss applicable to common shareholders	$	(2,641	)
Total stock-based employee compensation expense determined under fair-value based method for awards net of tax effects		(96	)

Pro forma net loss applicable to common shareholders	$	(2,737	)

Net loss per common share — basic and diluted	$	(0.27	)

Pro forma net loss per common share — basic and diluted	$	(0.28	)

A summary of the status of the Corporation’s stock option plans as at December 31, 2007, 2006 and 2005 and changes during the years ended on those dates is presented below:


	Number of Options									Weighted Average Exercise Price (CDN$)
	December 31									December 31
	2007			2006			2005			2007		2006		2005

Balance at beginning of year		766,352			713,770			625,057		$	5.75	$	3.47	$	3.32
Granted		821,757			209,849			92,571			2.87		14.40		4.50
Exercised		(4,540	)		(105,303	)		—			3.08		3.09		—
Forfeited		(177,931	)		(51,964	)		(3,858	)		4.88		14.73		3.51

Balance at end of year		1,405,638			766,352			713,770		$	3.93	$	5.75	$	3.47

Options granted prior to January 1, 2006 were denominated in Canadian dollars while options granted on or after January 1, 2006 are denominated in U.S. dollars. For the year ended December 31, 2007, options granted in U.S. dollars totaled 821,757 (2006 — 209,849) with a weighted average exercise price of U.S.$2.90 (2006 — $12.35). The exercise price has been converted to Canadian dollars for reporting purposes at the year-end exchange rate.

The weighted average remaining contractual life of options outstanding at December 31, 2007 was 7.46 years (2006 — 6.37 years; 2005 — 6.50 years).

The following table summarizes information regarding stock options outstanding as at December 31, 2007:


	Options Outstanding								Options Exercisable
			Weighted-
			Average		Weighted-						Weighted-
	Number		Remaining		Average				Number		Average
Range of	Outstanding at		Contractual		Exercise		Aggregate		Exercisable at		Exercise		Aggregate
Exercise Prices	December 31,		Life		Price		Intrinsic		December 31,		Price		Intrinsic
(CDN$)	2007		(Years)		(CDN$)		Value		2007		(CDN$)		Value

$1.38 to $2.07		83,593		9.50	$	1.91	$	—		—	$	—	$	—
$2.08 to $3.12		728,147		8.50	$	2.69	$	—		374,328	$	2.84	$	—
$3.13 to $4.70		408,687		4.92	$	3.80	$	—		269,257	$	3.68	$	—
$4.71 to $7.06		55,463		7.71	$	5.25	$	—		33,234	$	5.22	$	—
$7.07 to $9.50		10,000		8.21	$	9.05	$	—		3,333	$	9.05	$	—
$9.51 to $14.26		60,000		7.99	$	9.88	$	—		40,000	$	9.88	$	—
$14.27 to $21.40		59,748		8.40	$	14.78	$	—		19,916	$	14.78	$	—

$1.38 to $21.40		1,405,638		7.46	$	3.93	$	—		740,068	$	3.98	$	—

The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value based on the Corporation’s closing stock price of U.S.$1.40 as of December 31, 2007 which would have been received by the stock option holders had all stock option holders exercised their options as of that date. There were no in-the-money options as of December 31, 2007, based on the closing market value of the Corporation’s common shares at that date.

The Corporation’s non-vested stock options consist of options granted under the Corporation’s stock option plans. The fair value of each non-vested option is calculated using the stock price at the date of grant. A summary of the status of non-vested stock options as at December 31, 2007 and changes during the year is presented below.


	Number of			Weighted-Average
	Non-Vested			Grant Date Fair Value
	Options			(CDN$)

Balance at December 31, 2006		247,586		$	5.75
Granted		821,757		$	2.17
Vested		(285,320	)	$	2.82
Forfeited		(118,453	)	$	4.34

Balance at December 31, 2007		665,570		$	2.83

The fair value of each stock-based award is estimated on the date of grant using the Black-Scholes option pricing model and the assumptions are noted in the table below. The Corporation’s common shares have a public trading history of only two years. As a result, certain assumptions for options granted prior to 2007 were based on assumptions used by the Parent company to value its stock-based compensation expense. The amounts computed according to the Black-Scholes pricing model may not be indicative of the actual values realized upon the exercise of the options by the holders. The weighted average fair value of options granted for the year ended December 31, 2007 was CDN$2.17 (2006 — CDN$8.50; 2005 — CDN$2.58). As at December 31, 2007, total compensation cost related to non-vested stock options not yet recognized was $1,382, which is expected to be recognized over the next 36 months on a weighted-average basis.

The expected volatility of stock options is currently based upon the historical volatility of the Corporation. The dividend yield reflects the Corporation’s intention not to pay cash dividends in the foreseeable future. The life of options is based on observed historical exercise patterns of

the Corporation. Groups of directors and employees that have similar historical exercise patterns are being considered separately for valuation purposes. The risk free interest rate is based on the yield of a U.S. Government zero-coupon issue with a remaining life approximately equal to the expected term of the option.


	Year ended December 31
Stock options	2007		2006		2005

Expected volatility		66.3%		58.1%		57.7%
Dividend yield		—		—		—
Expected life		7 years		7 years		7 years
Risk free rate		4.63%		3.89%		4.33%

A summary of the Corporation’s non-vested restricted share units as at December 31, 2007 and 2006 and changes during the years ended on those dates is presented below:


						Weighted Average Grant
	Number of RSUs					Date Fair Value
	December 31					December 31
	2007			2006		2007		2006

Balance at beginning of year		9,000			—	$	3.85	$	—
Granted		49,700			9,000		3.27		3.85
Exercised		(4,500	)		—		3.85		—
Forfeited		(15,000	)		—		4.08		—

Balance at end of year		39,200			9,000	$	3.02	$	3.85

The RSUs vest evenly over a period between two to three years. Unvested RSUs held by directors are subject to forfeiture upon termination from the board.

Compensation expense recorded for the year ended December 31, 2007 related to non-vested RSUs was $73 (2006 — $Nil) with a corresponding increase in additional paid-in capital (“ APIC”). During the year ended December 31, 2007 4,500 (2006 — Nil) RSUs were exercised and resulted in a reclassification of $17 (2006 — $Nil) from APIC to share capital. Total unrecognized non-cash stock-based compensation expense related to non-vested RSUs was $56 that is expected to be recognized over the remaining vesting period of between two and three years. The Corporation measures fair value of the non-vested RSUs based upon the market price of its common stock as of the date of grant.

During the year ended December 31, 2007, 48,910 (2006 — 5,000) fully vested RSUs with a fair value of $75 (2006 — $32) were granted to new directors and executives resulting in a compensation expense of $75 (2006 — $32) with a corresponding increase in share capital.


11	INCOME TAXES

The following is a reconciliation of income taxes, calculated at the statutory income tax rate, to the income tax provision included in the consolidated statements of operations.


	Year Ended December 31
	2007			2006			2005

Loss before income taxes and cumulative effect of a change in accounting principle	$	(3,881	)	$	(10,533	)	$	(2,479	)
Statutory income tax rate		32.12%			32.12%			33.62%

Expected income tax recovery		(1,247	)		(3,383	)		(833	)
Losses and temporary differences — valuation allowance		1,387			3,347			937
Large corporations tax		—			(5	)		58

Income tax (recovery) expense	$	140		$	(41	)	$	162

Income taxes are recognized for future income tax consequences attributed to estimated differences between the financial statement carrying values of existing assets and liabilities and their respective income tax bases.

The net deferred income tax asset is comprised of:


	December 31,			December 31,
	2007			2006

Deferred income tax assets:
Tax benefit of loss carry-forwards and tax credits	$	21,138		$	18,078
Less valuation allowance		(20,896	)		(17,305	)
		242			773

Deferred income tax liabilities:
Capital, intangible and other assets		(242	)		(773	)

Deferred income tax assets, net	$	—		$	—

The deferred income tax asset valuation allowance is in respect of tax loss carry-forwards and tax credits.

The Corporation had net accumulated operating losses for income tax purposes at December 31, 2007 of approximately $35,047 (2006 — $32,256; 2005 — $22,547) and unclaimed scientific research and experimental development expenditures of approximately $8,612 (2006 — $5,720; 2005 — $4,738) that can be used to offset taxable income, if any, in future periods. At December 31, 2007, the Corporation also had capital losses of approximately $2,133 (2006 — $1,809; 2005 — $2,133) as well as research and development tax credits of approximately $4,579 (2006 — $3,368; 2005 — $2,469). The net accumulated operating losses and research and development tax credits will expire at various times to the end of 2027.

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At December 31, 2007, the Corporation’s deferred tax assets were offset by a valuation allowance. Management will continue to provide a full valuation allowance until it determines that it is more likely than not the deferred tax assets will be realized.

The Corporation files federal and provincial income tax returns in Canada and its U.S. subsidiary files federal and state income tax returns in the U.S. The Corporation is no longer subject to income tax examinations by Canadian and U.S. tax authorities for years before 2001. The Canada Revenue Agency (“CRA”) commenced an examination of the Corporation’s Canadian income tax returns for 2001 and 2002 in the second quarter of 2005. In December, 2007, the CRA proposed certain transfer pricing adjustments with respect to income allocations between the Corporation and its U.S. subsidiary for the 2001 and 2002 taxation years. These proposed adjustments, if processed, will not result in any cash tax liability for the Corporation. Although the CRA has not commenced any transfer pricing review for taxation years beyond 2002, the proposed adjustments, based on the CRA’s primary position, are expected to be extended to later taxation years. The Corporation is currently evaluating the CRA’s proposal and awaiting reports from the CRA which should provide greater details of the basis of their proposed adjustments. Following receipt of these reports, the Corporation will be better able to make an informed assessment of the CRA’s position. Any reassessments to be issued by the CRA, on an aggregate basis, could result in a material effect on the Corporation’s consolidated financial statements, although at this time, the potential impact cannot be reasonably estimated by the Corporation. The Corporation has provided notification to the U.S. Internal Revenue Service of its intention to seek competent authority assistance with respect to the 2001 and 2002 taxation years.

The Corporation adopted the provisions of FIN 48 on January 1, 2007. The implementation of FIN 48 did not result in any adjustment to the Corporation’s beginning tax positions. As at January 1, 2007, the Corporation did not have any unrecognized tax benefits.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:


	(in thousands)

Balance at January 1, 2007	$	—
Additions based on tax positions related to the current year		—
Additions for tax positions of prior years		7,429
Reductions for tax positions of prior years		(7,429	)
Settlements		—

Balance at December 31, 2007	$	—

Notwithstanding management’s belief in the merit of the Corporation’s tax filing positions and its intention to rigorously defend its transfer pricing policies, it is reasonably possible that the amount of unrecognized tax benefits could significantly increase or decrease within the next twelve months. These changes cannot be estimated at this time and may result from the settlement of ongoing examinations or other regulatory developments. Any increase or decrease in the unrecognized tax benefits will not likely have a significant impact on the Corporation’s effective tax rate due to the existence of the valuation allowance. Future changes in management’s assessment of the sustainability of tax filing positions may impact the Corporation’s income tax liability.

The Corporation recognizes any interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses. During the years ended December 31, 2007, 2006 and 2005, there was no such interest or penalty.


12	RELATED PARTY TRANSACTIONS

The Corporation engaged in the following related party transactions with the Parent that have not been disclosed elsewhere in these consolidated financial statements:


	Year Ended December 31
	2007		2006		2005

Building rent, including operating costs	$	593	$	1,606	$	1,399
Services:
Information technology		—		—		58
Legal		98		170		204
Insurance		306		644		289
Other		126		219		154

	$	1,123	$	2,639	$	2,104

The Corporation leased its Fort Saskatchewan, Alberta facility from the Parent until May 8, 2007 when the Parent sold the buildings and assigned the leases to the purchaser. The Corporation was charged building rent at a rate which, in management’s view, approximates current market rates, plus actual operating costs. Corporate and administrative services are provided by the Parent on a fully-allocated cost recovery basis.

At December 31, 2007, accounts payable and accrued liabilities to related party of $67 (2006 — $45) were owed by the Corporation to the Parent for services rendered by the Parent and invoices paid by the Parent on behalf of the Corporation.


13	GUARANTEES

The Corporation has not provided for product warranty obligations as products presently sold to the Corporation’s customer carry a limited short term warranty and the Corporation’s claims experience has been negligible.

In the normal course of operations, the Corporation may provide indemnifications that are often standard contractual terms to counterparties in transactions such as purchase and sale agreements, service agreements, director/officer contracts and leasing transactions. These indemnification agreements may require the Corporation to compensate the counterparties for costs incurred as a result of various events, such as litigation claims or statutory sanctions that may be suffered by the counterparty as a consequence of the transaction. The terms of these indemnification agreements will vary based upon the agreement, the nature of which prevents the Corporation from making a reasonable estimate of the maximum potential amount that it could be required to pay to counterparties. Historically, the Corporation has not made any payments under such indemnifications and no amounts have been accrued in the consolidated financial statements with respect to these indemnification guarantees.


14	COMMITMENTS

The Corporation is committed to capital expenditures of $42 (2006 — $537) and to future annual payments under operating leases for office and facility space and equipment as follows:


2008		2009		2010		2011		2012

$	5,549	$	5,287	$	590	$	581	$	586


15	FINANCIAL INSTRUMENTS

Financial instruments include accounts receivable and other like amounts which will result in future cash receipts and accounts payable and accrued liabilities and other like amounts which will result in future outlays. Indebtedness to related party is not included in financial instruments due to the unique terms and conditions attached to this item.


	*Fair value of financial instruments*

The carrying values of the Corporation’s interests in financial instruments approximate their fair value. The estimated fair value approximates the amount for which the financial instruments could currently be exchanged in an arm’s length transaction between willing parties who are under no compulsion to act.

Certain financial instruments, including indebtedness to related party, lack an available trading market and, therefore, fair value amounts should not be interpreted as being necessarily realizable in an immediate settlement of the instrument.


	*Foreign currency risk*

The Corporation is exposed to currency risks as a result of its export to foreign jurisdictions of goods produced in Canada. These risks are partially covered by purchases of goods and services in the foreign currency.


	*Concentration of credit risk*

The Corporation’s financial instruments that are exposed to concentrations of credit risk consist primarily of accounts receivables. This risk is limited due to the contractual relationship with Smith & Nephew.


16	EMPLOYEE BENEFIT PLAN

The Corporation has a 401(k) retirement plan (the “Plan”) for the benefit of permanent United States employees. These employees may elect to contribute to the Plan through payroll deductions of up to $16 of their annual compensation, subject to statutory limitations. The Corporation may declare discretionary matching contributions of up to 50% of employees’ contributions up to a maximum of 3% of employee earnings. The Corporation’s matching contributions for the year ended December 31, 2007 were $37 (2006 — $58; 2005 — $46).

The Corporation also participated in a defined contribution pension plan for its Canadian employees that was administrated by the Parent until December 31, 2007. Effective January 1, 2008, the Corporation commenced administration of its own employee pension plan. In 2007, the Corporation matched employee contributions of up to 4% of their annual compensation. The Corporation’s contributions to this plan for the year ended December 31, 2007 amounted to $261(2006 — $274; 2005 — $149).


17	LOSS PER SHARE

In calculating loss per share under the treasury stock method, the numerator remains unchanged from the basic loss per share calculation as the assumed exercise of the Corporation’s stock options does not result in an adjustment to income.

The reconciliation of the denominator in calculating diluted loss per share is as follows:


	Year Ended December 31
	2007		2006		2005

Weighted average number of common shares outstanding — basic		18,333,810		17,964,332		9,764,486
Effect of dilutive securities		—		—		—

Weighted average number of common shares outstanding — diluted		18,333,810		17,964,332		9,764,486

The impact of all dilutive securities on loss per share is anti-dilutive for the years ended December 31, 2007, 2006 and 2005, including the dilutive impact of the remaining term loan (Note 9) and all outstanding options, SARs and RSUs.


18	SEGMENTED INFORMATION

The Corporation operates in one reportable segment consisting of the manufacturing, research, development and commercialization of medical products based on its proprietary noble metal nanocrystalline technology. The Corporation currently manufactures wound care products and all the Corporation’s revenues are earned through long-term agreements with Smith & Nephew. The Corporation exports the manufactured wound care products directly to Smith & Nephew for resale in international markets.

a) Assets by geographic segment


	December 31,		December 31,
	2007		2006

Canada	$	37,251	$	42,440
United States		14,048		3,452

	$	51,299	$	45,892

a) Capital assets and intangible assets by geographic segment


	December 31,		December 31,
	2007		2006

Canada	$	12,800	$	11,130
United States		741		1,036

	$	13,541	$	12,166

All of the Corporation’s revenues in 2007, 2006 and 2005 were earned through long-term agreements with Smith & Nephew for the sale and marketing of the Corporation’s wound care products manufactured exclusively for Smith & Nephew. The agreements expire in 2026.


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

None.


ITEM 9A.	CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures.

We maintain “disclosure controls and procedures” (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Vice President, Finance and Administration and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.

In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Our management, with the participation of our Chief Executive Officer and Vice President, Finance and Administration and Chief Financial Officer, has carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2007. Based on this evaluation our management concluded that, as of December 31, 2007, our disclosure controls and procedures were effective.

Management’s annual report on internal control over financial reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our management, with the participation of our Chief Executive Officer and Vice President, Finance and Administration and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on that assessment under such criteria, our management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2007.

Attestation report of the registered public accounting firm

Under current SEC rules, the Company is not required to file an auditor’s attestation report on our management’s assessment of the Company’s internal control over financial reporting until we file our annual report on Form 10-K for the fiscal year ended December 31, 2008. Accordingly, this annual report on Form 10-K for the fiscal year ended December 31, 2007 does not include an auditor’s attestation report on our management’s assessment of the Company’s internal control over financial reporting set forth above, and our auditor, Deloitte & Touche LLP, has not attested to such report.

Changes in internal control over financial reporting

There has been no change in our internal control over financial reporting during the fiscal quarter ended December 31, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


ITEM 9B.	OTHER MATTERS

None.

PART III


ITEM 10.	DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The following table sets forth certain information, as of December 31, 2007, regarding our executive officers and directors:


Name	Age		Position

Thomas E. Gardner		60	President, Chief Executive Officer and Chairman of the Board
Eliot M. Lurier		49	Vice President, Finance Administration and Chief Financial Officer
Carol L. Amelio		46	Vice President, General Counsel and Corporate Secretary
David C. McDowell		52	Vice President, Manufacturing Operations
Katherine J. Turner, Ph.D.		56	Vice President, Research & Development
Edward Gaj, Jr. R.Ph.		51	Vice President, Corporate Development
Barry M. Heck		45	Director
Neil Carragher^(1)(2)(3)		69	Director
Roger G.H. Downer, Ph.D.⁽²⁾⁽³⁾		65	Director
David Poorvin, Ph.D.^(1)(2)(3)		61	Director
Richard W. Zahn⁽¹⁾⁽³⁾		56	Director


(1)	Member of our audit committee.

(2)	Member of our human resources and compensation committee.

(3)	Member of our corporate governance and nominating committee.

Thomas E. Gardner has been our President, Chief Executive Officer and Chairman of the Board since August 22nd, 2007 and became a director on May 14, 2007. Prior to his current assignments, Mr. Gardner was CEO of a number of public and private companies including Songbird Hearing from July 2002 to November 2004, Datamonitor, Base Ten Systems and Access Health. From 1970 to 1995, Mr. Gardner held senior marketing and general management positions at Procter and Gamble, Johnson & Johnson, Simon & Schuster and IMS Health. He currently holds board seats at several privately held companies, including IntegriChain, VisiLED and Virium Pharmaceuticals. He holds a B.A. in Economics / Mathematics from the University of St. Thomas in Minnesota. Mr. Gardner resides in Princeton, New Jersey.

Eliot M. Lurier has been our Vice President, Finance and Administration, Chief Financial Officer since April 2005. From 2004 to 2005, he served as Consulting Chief Financial Officer to Bridge Pharmaceuticals, Inc., a spin off of SRI International focusing on drug development services in Asia. From 2002 to 2004, Mr. Lurier served as Consulting Chief Financial Officer to Linden Bioscience Inc., a venture backed integrator of functional genomics technology. From 2000 to 2002, he served as Chief Financial Officer and Treasurer of Admetric Biochem, Inc., a venture backed company. From 1998 to 2000, Mr. Lurier was Chief Financial Officer and Vice President Finance of Ascent Pediatrics, Inc., a publicly traded pediatric pharmaceutical company. He holds a B.S. in Accounting from Syracuse University and is a certified public accountant in Massachusetts. Mr. Lurier resides in Natick, Massachusetts.

Carol L. Amelio has been our General Counsel and Corporate Secretary since February 2006. From May 2001 to January 2006, she served as legal counsel for Westaim, our parent company. From 1992 to 2001, she held senior legal and management positions with TELUS Communications, a telecommunications company. Ms. Amelio holds a B.Comm. and LL.B. from the University of Alberta and was admitted to the bar of the Province of Alberta in 1987. Ms Amelio resides in Edmonton, Alberta.

David C. McDowell has been our Vice President, Manufacturing Operations since July 2005. From January 2003 to July 2005, he was General Manager Sterile Manufacturing and Head of Lens Care Products Global Supply of Novartis’ CIBA Vision where he was responsible for global manufacturing and supply of lens care and ophthalmic products. From June 1984 to January 2003, he held senior positions with GlaxoSmithKline and Sterling Winthrop. Mr. McDowell has a B.A.Sc. in Industrial Engineering from the University of Toronto. Mr. McDowell resides in Edmonton, Alberta.

Katherine J. Turner, Ph.D. has been our Vice President, Research since June 2006. From July 2001 to November 2005, she served as Vice President of Validation Biology at Biogen Idec, Inc. a pharmaceutical company. Prior to 2001, she held senior management and research positions at Genetics Institute, Inc. and Wyeth Pharmaceuticals both of which are pharmaceutical companies. Dr. Turner resides in Acton, Massachusetts.

Edward Gaj Jr., R. Ph. has been our Vice President, Corporate Development since June 2007. From 1998 to June 2007, Mr. Gaj held a series of progressively senior positions at Anika Therapeutics, including Director and Executive

Director, Marketing and Business Development and most recently, Franchise Director, Aesthetics. Previously, Mr. Gaj was with B&E Consulting, where he was responsible for new business opportunity assessment and development for clients. He also held positions at Immunologic Pharmaceutical Corp., Biogen, Alpha Therapeutics Corp., and Lederle Laboratories. He started his career as an oncology pharmacist at the New England Deaconess Hospital and a staff pharmacist at the Lahey Clinic. Mr. Gaj earned Bachelor of Science and Master of Science degrees at the Massachusetts College of Pharmacy and is a registered pharmacist. Mr. Gaj resides in Andover, Massachusetts.

Barry M. Heck has served as a director since December 1997. Mr. Heck was the President, Chief Executive Officer and a director of Westaim, our parent company, from January 2003 to May 2007. From January 1997 to January 2003, Mr. Heck served as a Senior Vice President of Westaim. Mr. Heck is a director of Kereco Energy Ltd. Mr. Heck holds an LL.B. from the University of Alberta. Mr. Heck resides in Calgary, Alberta.

Neil Carragher has served as a director since December, 2005. Mr. Carragher has been the Chairman of The Corporate Partnership Ltd., a management consulting group, for more than five years. Mr. Carragher is a director of Westaim, our parent company, and Agrium Inc. Mr. Carragher holds a B.Sc. from the University of Glasgow and an M.Sc. from the University of London. Mr. Carragher resides in Toronto, Ontario.

Roger G.H. Downer, Ph.D. has served as a director since December 2005. Dr. Downer has been the President and Vice-Chancellor of the University of Limerick, Ireland since 1998 until his retirement in 2006 when he became President Emeritus. From 1996 to 1998 Dr. Downer was President of the Asian Institute of Technology. Dr. Downer is a director of Westaim, our parent company. Dr. Downer holds a B.Sc. and M.Sc. from Queen’s University Belfast and a Ph.D. from the University of Western Ontario. Dr. Downer resides in Killaloe, Ireland.

David Poorvin, Ph.D. has served as a director since May 2006. Dr. Poorvin has been a consultant for Poorvin Enterprises, a health care consulting company and has served as Executive-in-Residence for Oxford Biosciences Partners a venture capital firm since May 2004. Dr. Poorvin is a director of Enanta Pharmaceuticals and Repros Therapeutics Inc. From 1981 to 2003, Dr. Poorvin held numerous senior management positions with Schering-Plough Corporation, a global research-based company engaged in the discovery, development, manufacturing and marketing of pharmaceutical, biotechnology and health care products, including Vice President of Business Development Operations from 1993 until 2003, and Director of Cardiovascular Clinical Research from 1986 to 1989. Dr. Poorvin holds a B.A. from Hunter College of the City University of New York, and a Ph.D. from Rutgers University. Dr. Poorvin resides in New Jersey.

Richard W. Zahn has served as a director since December 2005. From 1992 to 2003, Mr. Zahn held numerous senior management positions within the Schering Plough Corporation, a global research-based company engaged in the discovery, development, manufacturing and marketing of pharmaceutical biotechnology products and health care products, including President of Schering Laboratories from 1996 until July 2003, and Corporate Vice President of Schering-Plough Corporation, from 2001 to December 2003. Schering Laboratories is the U.S. prescription marketing arm for Schering Plough. Mr. Zahn is a director of Norwood Abbey, Ltd. Mr. Zahn holds a B.S. in Business Administration from Kansas State Teachers College. Mr. Zahn resides in Oldwick, New Jersey.

There are no family relationships between any of our executive officers or directors. The business address of each of our executive officers and directors is 50 Audubon Road, Suite B, Wakefield, Massachusetts 01880.

Code of Ethics

Our board of directors has adopted a Code of Conduct and Ethics for Directors, Officers and Employees (the “Code of Conduct”). The original Code of Conduct was filed on and is accessible through SEDAR at www.sedar.com and EDGAR at www.edgar-online.com. A copy of the most recent version of our Code of Conduct is available on our website at www.nucryst.com and may also be obtained by any person without charge, upon written request delivered to NUCRYST at 10102 — 114th Street, Fort Saskatchewan, AB T8L 3W4, Attention: Vice President, General Counsel and Corporate Secretary.

Composition of our Board of Directors

Our board of directors currently consists of six directors. Our directors are elected at each annual general meeting of our shareholders and serve until their successors are elected or appointed, unless their office is earlier vacated. Our articles currently provide that the number of directors may be between three and 15; provided that, between annual general meetings of our shareholders, the directors may appoint one or more additional directors, but the number of additional directors may not at any time exceed one-third of the number of directors who held office at the expiration of the last

meeting of our shareholders. Under the Business Corporations Act (Alberta), at least 25% of our directors must be resident Canadians.

Audit Committee and Financial Expert

The members of our audit committee are Neil Carragher, Richard W. Zahn, and David W. Poorvin each of whom is a non-employee member of our board of directors. Mr. Carragher chairs the committee. Our board has determined that Neil Carragher is an audit committee financial expert (as defined under SEC rules implementing Section 407 of the Sarbanes-Oxley Act of 2002). In addition, our board has determined that each member of our audit committee is financially literate and at least one member of our audit committee meets the financial sophistication requirements of the NASDAQ. Our board of directors has determined that Messrs. Carragher and Zahn and Dr. Poorvin are independent members of our board of directors based on the director independence criteria adopted by our board and based on the current requirements of the NASDAQ, the TSX and the rules and regulations of the SEC and Canadian provincial securities regulatory authorities. A copy of our audit committee’s charter is available on our website at www.nucryst.com.

Nomination of Directors

Our board of directors has determined not to adopt policies and procedures by which shareholders may recommend nominees to our board of directors other than those that currently exist at law. Pursuant to the Business Corporations Act (Alberta), a registered shareholder entitled to vote at our annual meeting of shareholders, or a beneficial owner of shares, may, subject to the provisions of that Act, submit a proposal for nominations for the election of directors for consideration at our annual meeting if the proposal is signed by one or more registered holders of shares representing in the aggregate not less than 5% of our issued common shares that have the right to vote at the meeting to which the proposal is to be presented, or by beneficial owners of shares representing in the aggregate the same percentage. To be eligible to make a proposal, a person must: (i) be a registered shareholder or beneficial owner of the prescribed number of shares or have the prescribed level of support of other shareholders or beneficial owners of shares; (ii) provide NUCRYST with his or her name and address and the names and addresses of those registered holders or beneficial owners of shares who support the proposal; (iii) and continue to hold or own the prescribed number of shares up to and including the day of the meeting at which the proposal is made. The proposal must be in writing and received by our offices at 10102 114th Street, Fort Saskatchewan, AB T8L 3W4, Attention: Vice President, General Counsel and Corporate Secretary by February 3, 2008. However, nothing in the provisions of the Act relating to shareholder proposals precludes nominations for the election of directors made at a meeting of shareholders by registered shareholders or proxyholders (provided the proxy stipulates the proxy holder has such authority).

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities and Exchange Act of 1934, requires a registrant’s directors and executive officers, and persons who beneficially own more than 10% of a registered class of a registrant’s securities, to file with the SEC initial reports of changes in ownership of common shares and other equity securities of the registrant. As we are a “foreign private issuer” pursuant to Rule 3a12-3 of the Securities Exchange Act of 1934, NUCRYST and persons referred to above are exempt from the reporting and liability provisions of Section 16(a). However, under Canadian provincial securities laws, the persons referred to above are required to file reports in electronic format through the System for Electronic Disclosure by Insiders, or SEDI, disclosing changes in beneficial ownership of or control or direction over, our common shares and other securities. Our shareholders can access such reports at www.sedi.ca.

Scientific Advisory Board

As at December 31, 2007, we have decided to temporarily disband our existing scientific advisory board as we re-evaluate the optimal composition of the board to assist us with our research and development plans. In the meantime, we have retained certain members of the board on an individual basis to continue providing us with advice and guidance.


ITEM 11.	EXECUTIVE COMPENSATION

Compensation Disclosure

For 2007, we are providing compensation disclosure that complies with the requirements of the Canadian Securities Administrators, together with certain additional disclosure, without compromising required Canadian disclosure. As a foreign private issuer (as defined under the applicable SEC rules), we are permitted by Item 402(a)(i) of SEC Regulation S-K to respond to this Item 11 by providing the information required by Items 6.B. and 6.E.2 of Form 20-F. This compensation disclosure describes the material elements of compensation awarded to, earned by, or paid to each of our executive officers who served as named officers during the last completed fiscal year. This compensation discussion focuses on the information contained in the following tables and related footnotes and narrative for the last completed fiscal year./LS

Summary Compensation Table

The following table sets forth the compensation awarded to, or earned by, our current President and Chief Executive Officer, our former President and Chief Executive Officer who served in that capacity for a portion of 2007, our Vice President, Finance and Administration and Chief Financial Officer and our next three most highly compensated executive officers who were employed by us as of December 31, 2007 and whose salary and bonus exceeded $100,000 during 2007. We refer to these individuals elsewhere in this annual report as our “named executive officers” or “named executives.”

Summary Compensation Table


									Long-Term Compensation
			Annual Compensation						Securities⁽⁷⁾ Under		Shares or⁽⁸⁾ Units
	Fiscal						Other Annual		Options / SARS		Subject to Resale		All Other⁽⁹⁾
Name and Principal Position	Year		Salary ($)		Bonus⁽⁵⁾($)		Compensation⁽⁶⁾		Granted (#)		Restrictions ($)		Compensation ($)

Thomas E. Gardner⁽¹⁾		2007	$	145,641		—		—		500,000	$	107,000	$	9,137
Chairman, President &
Chief Executive Officer
Scott H. Gillis⁽²⁾		2007	$	177,163		—	$	12,885		75,000		—	$	432,815
Former President &		2006	$	250,000	$	25,000	$	20,000		—		—	$	6,000
Chief Executive Officer		2005	$	249,375	$	98,004	$	20,000		—		—	$	6,850
Eliot M. Lurier, CPA		2007	$	171,000	$	89,775		—		40,000	$	20,500	$	8,550
Vice President, Finance and		2006	$	145,000	$	14,500		—		—		—		—
Administration,		2005	$	105,297	$	41,277		—		19,455		—		—
Chief Financial Officer
David C. McDowell⁽³⁾		2007	$	211,049	$	107,635		—		30,000	$	20,500	$	35,603
Vice President,		2006	$	189,589	$	33,178		—		—		—	$	39,470
Manufacturing Operations		2005	$	74,967	$	28,509		—		38,910		—	$	1,979
Katherine J. Turner, Ph.D.⁽⁴⁾		2007	$	207,556	$	85,372		—		20,000	$	11,070	$	6,227
Vice President, Research		2006	$	110,833	$	3,325		—		25,000		—	$	3,325
and Development
Carol L. Amelio⁽³⁾		2007	$	181,564	$	78,980		—		35,000	$	20,500	$	7,671
Vice President, General		2006	$	129,458	$	10,219		—		10,000				—
Counsel and Corporate Secretary


(1)	Mr. Gardner became our Chairman, President and Chief Executive Officer on August 22, 2007 at an annual salary of $400,000.

(2)	Mr. Gillis’ employment ceased on August 22, 2007.

(3)	Mr. McDowell’s and Ms. Amelio’s compensation is denominated in Canadian dollars and has been translated into U.S. dollars for purposes of this table at an average 2007 exchange rate of U.S. $1.00= C$1.074, C$1.134 in 2006 and C$1.1873 in 2005.

(4)	Ms. Turner was appointed Vice President, Research and Development of NUCRYST on July 1, 2007 at which time her annual base salary was increased from $195,000 to $220,000.

(5)	Amounts in this column reflect amounts earned in each year under our Employee Variable Pay Incentive Program. The awards are paid to the executive in the following calendar year. A discussion of the material terms of our Employee Variable Pay Program can be found in the Compensation Discussion and Analysis section of this document.

(6)	Mr. Gillis received cash allowances in lieu of perquisites in 2007 in the amount of $12,885 and in the amount of $20,000 in each of 2006 and 2005.

(7)	Reflects the grants of Options in the year pursuant to our Incentive Plan. Particulars of the grants of Options and RSUs made in 2007 are provided in the table Option Grants During the Year Ended December 31, 2007 below.

(8)	In lieu of receiving a bonus under our variable pay program, Mr. Gardner was granted 38,910 restricted share units (“RSUs”) on August 22, 2007 at an issue price of $2.75. The RSUs vested immediately, but are restricted from sale until Mr. Gardner is no longer an executive officer or director of NUCRYST. On February 21, 2007, Messrs. Lurier and McDowell and Ms. Amelio were each granted 5,000 RSUs vesting each as to 1/3 on February 21, 2008, 2009 and 2010. Ms. Turner was granted 2,700 RSUs on February 21, 2007 with the same vesting schedule. Mr. Gillis was also granted 10,000 RSUs on the same date, all of which terminated on the date he ceased to be employed with NUCRYST and, therefore, the value was not included in the table. Mr. Gardner’s RSUs are valued at the closing NASDAQ price on August 22, 2007 of $2.75. All other RSUs are valued at the closing NASDAQ share price of $4.10 on February 21, 2007.

(9)

Mr. Gardner received reimbursement for living expenses amounting to $9,137. As part of his severance agreement, Mr. Gillis received $5,000 in lieu of any future perquisites, payment for vacation earned in the amount of $27,500, payment of severance in the amount of $295,000, $108,065 of which was accrued at December 31, 2007 as part of a $150,000 payment due to Mr. Gillis in February 2008 as payment for his continued assistance in accordance with the terms of his severance agreement. $17,011 was also accrued for Mr. Gillis’ health benefits. Mr. Lurier received a payment for vacation earned in the amount of $8,550. Mr. McDowell received reimbursement for living expenses amounting to $27,667 (CDN). All other compensation reflected in this column for all named executive officers consisted of contributions to NUCRYST’s defined contribution pension plan for employees located in Canada or 401(k) plan for employees located in the United States.

Option Granted During the Year Ended December 31, 2007 to Named Executive Officers

The following table sets forth each option to purchase our common shares granted during the year ended December 31, 2007 to our named executive officers.


							Market Value of
			% of Total				Securities
	Securities,		Options Granted		Exercise		Underlying Options
	Under Options		to Employees		Price		on the Date of
Name and Principal Position	Granted⁽²⁾		in Financial Year		($/Security)		Grant ($/Security)		Expiration Date

Thomas E. Gardner Chairman, President & Chief Executive Officer		500,000		62.3%	$	2.57	$	1,285,000	August 22, 2017
Scott H. Gillis⁽¹⁾Former President & Chief Executive Officer		75,000		9.4%	$	4.08	$	306,000	February 21, 2017
Eliot M. Lurier, CPA Vice President, Finance and Administration, Chief Financial Officer		40,000		5.0%	$	4.08	$	163,200	February 21, 2017
David C. McDowell Vice President, Manufacturing Operations		30,000		3.8%	$	4.08	$	122,400	February 21, 2017
Katherine J. Turner, Ph.D. Vice President, Research and Development		20,000		2.5%	$	4.08	$	81,600	February 21, 2017
Carol L. Amelio Vice President, General Counsel and Corporate Secretary		35,000		4.4%	$	4.08	$	142,800	February 21, 2017


(1)	Mr. Gillis’s employment ceased on August 22, 2007. According to the terms of his severance agreement, Mr. Gillis has one year or until August 22, 2008 to exercise any options that had vested as of his termination date. As none of the 75,000 options granted to Mr. Gillis in 2007 had vested as of the termination date of his employment, all of those options automatically terminated on August 22, 2007.

(2)	These awards were made in options to purchase common shares of NUCRYST pursuant to the Incentive Plan and, in the ordinary course, are exercisable for a period ending 10 years of the date of grant. With the exception of the options award made to Mr. Gardner, these awards were granted on the basis that in the ordinary course they will be exercisable as to one third of the grant on each of the first, second and third anniversaries of the date of grant. Mr. Gardner was granted an option to purchase 500,000 shares of our common stock on August 22, 2007 upon becoming our Chief Executive Officer. The options vest 1/3 immediately on the date of grant and 1/3 each on August 22, 2008 and 2009.

Aggregated Option Exercises During the Year Ended December 31, 2007 And Financial Year-End Option Values

The following table shows all outstanding equity awards held by each named executive officer as of December 31, 2007. No options to purchase our common shares were exercised by our named executive officers during the year ended December 31, 2007.


				Value of Unexercised⁽¹⁾
				in-the-Money Options at
	Securities,	Aggregate	Options at Fiscal Year-	Fiscal Year-End
	Acquired on	Value	End Exercisable/	Exercisable/
Name and Principal Position	Exercise	Realized	Unexercisable	Unexercisable

Thomas E. Gardner Chairman, President & Chief Executive Officer	Nil	Nil	166,667 / 333,333		$0 / $0
Scott H. Gillis Former President & Chief Executive Officer	Nil	Nil	272,270 / 0		$0 / $0
Eliot M. Lurier, CPA Vice President, Finance and Administration, Chief Financial Officer	Nil	Nil	12,970 /46,485		$0 / $0
David C. McDowell Vice President, Manufacturing Operations	Nil	Nil	25,940 / 42,970		$0 / $0
Katherine J. Turner, Ph.D. Vice President, Research and Development	Nil	Nil	8,333 / 36,667		$0 / $0
Carol L. Amelio Vice President, General Counsel and Corporate Secretary	Nil	Nil	3,333 / 41,667		$0 / $0


(1)	Based on the December 31, 2007 closing price of the Common Shares on the NASDAQ of $1.40.

Employment Agreements

Thomas E. Gardner

On August 22, 2007, we entered into an employment agreement with Mr. Gardner, our Chairman of the Board, President and Chief Executive Officer and a member of our board. Mr. Gardner currently receives an annual base salary of $400,000 with an annual target bonus of no less than 50% of his base salary based on meeting financial and performance targets set by our board. In lieu of receiving a bonus in 2007, Mr. Gardner was granted 38,910 restricted stock units (“RSUs”) on August 22, 2007 at an issue price of $2.75. The RSUs vested immediately but are restricted from sale until Mr. Gardner is no longer employed by or a director of NUCRYST. Mr. Gardner was also granted options to purchase 500,000 shares of our common stock on August 22, 2007. 1/3 of the options vest immediately on the date of grant and an additional 1/3 vest on the first and second anniversaries of the grant date. The employment agreement has an initial term ending December 31, 2008 and provides for automatic extensions for successive one year periods on the same terms and conditions unless either party gives the other written notice at least 60 days prior to the then scheduled date of expiration of the term. If Mr. Gardner is still employed by NUCRYST on December 31, 2008 and has performed satisfactorily, he is entitled stock options to purchase an additional 161,090 common shares pursuant to our 1998 Equity Incentive Plan, as amended, vesting over a two-year period. If we terminate Mr. Gardner’s employment without “cause” (as defined in the employment agreement) or we elect not to extend the employment agreement at the end of any one-year period, we will be obligated to pay Mr. Gardner an amount equal to one year’s annual base salary (at the annualized rate in effect on the termination date) and a pro-rata performance bonus payment for the year of termination, and any stock options or RSUs then scheduled to vest prior to the first anniversary of the termination date will vest and remain exercisable until the first anniversary of the termination date. We are subject to the same obligations if Mr. Gardner’s employment is constructively terminated without cause, which includes the termination by Mr. Gardner of his employment due to a material diminution of his duties or authorities, or the failure to retain him as a director of NUCRYST, or the appointment of any employee of NUCRYST as the Chair of our board. Mr. Gardner is also entitled to a severance payment equal to two years’ annual base salary and to accelerated vesting of all stock options and RSUs if he is terminated or constructively terminated without cause or due to non-extension of the employment agreement in connection with a “change in control” (as defined in the employment agreement). We are also obligated to provide Mr. Gardner with post-termination directors’ and officers’ liability insurance coverage.

Scott H. Gillis

On August 22, 2007, we announced the resignation of Mr. Gillis’ employment as our President and Chief Executive Officer. On September 25, 2007, we entered into a Separation Agreement and General Release with Mr. Gillis. Pursuant to the previously disclosed employment agreement we entered into with Mr. Gillis dated December 6, 1999, upon the termination of his employment without cause, Mr. Gillis was entitled to a lump-sum payment equal to twelve months salary and continued benefits under all applicable benefit plans for 12 months. In accordance with this employment agreement and the Separation Agreement, we were obligated to pay Mr. Gillis a lump sum payment equal to $295,000 less applicable withholding and deductions within 30 days following the execution of the Separation Agreement. In addition, pursuant to the terms of the Separation Agreement, we are further obligated to pay an additional $150,000 to Mr. Gillis less applicable withholding deductions, within 30 days after a six-month period beginning February 22, 2008. In addition, we are required to pay the costs associated with Mr. Gillis’s continued participation in the NUCRYST benefit plans for a total period of eighteen months following the date of termination of his employment. We have agreed to pay Mr. Gillis $5,000 representing reimbursement of expenses he incurred related to other benefits he received prior to the date of termination of his employment.

Eliot M. Lurier

In March 2005, we entered into an employment agreement with Eliot M. Lurier, our Vice President, Finance and Administration. Mr. Lurier currently receives an annual base salary of $171,000. As discussed under “Elements of Our Compensation Program — Performance-Based Incentive Compensation”, Mr. Lurier was also eligible in 2007 for non-equity incentive compensation under our variable pay program of up to 70% of his annual base salary. Under the agreement, either we or Mr. Lurier may terminate his employment at any time. However, on January 17, 2008, we entered into a severance agreement with Mr. Lurier that provides if we terminate his employment without cause, we are obligated to pay him a lump sum of an amount equal to six months of his then current base salary, less applicable taxes and withholdings.

David C. McDowell

In June 2005, we entered into an employment agreement with David C. McDowell, our Vice President, Manufacturing Operations. Mr. McDowell currently receives an annual base salary of C$240,000. As discussed under “Elements of Our Compensation Program — Performance-Based Incentive Compensation”, Mr. McDowell was also eligible in 2007 for non-equity incentive compensation under our variable pay program of up 70% of his annual base salary. Under the agreement, either we or Mr. McDowell may terminate his employment at any time. However, on January 17, 2008, we entered into a severance agreement with Mr. McDowell that provides if we terminate his employment without cause, we are obligated to pay him a lump sum of an amount equal to twelve months of his then current base salary, less applicable taxes and withholdings.

Katherine, J. Turner, Ph.D.

In June 2006, we entered into an employment agreement with Katherine J. Turner, Ph.D., our Vice President, Research. Dr. Turner currently receives a base annual salary of $220,000. As discussed under “Elements of Our Compensation Program — Performance-Based Incentive Compensation”, Dr. Turner was also eligible in 2007 for non-equity incentive compensation under our variable pay program of up to 70% of her annual base salary. Under the agreement, either we or Dr. Turner may terminate her employment at any time. However, on January 17, 2008, we entered into a severance agreement with Dr. Turner that provides if we terminate her employment without cause, we are obligated to pay her a lump sum of an amount equal to six months of her then current base salary, less applicable taxes and withholdings.

Carol L. Amelio

In February 2006, we entered into an employment agreement with Carol L. Amelio, our Vice President, General Counsel and Corporate Secretary. Ms. Amelio currently receives and annual base salary of C$195,000. As discussed under “Elements of Our Compensation Program — Performance-Based Incentive Compensation”, Ms. Amelio was also eligible in 2007 for non-equity incentive compensation under our variable pay program of up to 70% of her annual base salary in 2007. Under the agreement, either we or Ms. Amelio may terminate her employment at any time.

Composition of the Compensation Committee

The members of our Human Resources and Compensation Committee, which we refer to as the compensation committee or committee in this section of the report are Messrs. Roger G.H. Downer, David W. Poorvin and Neil Carragher, each of whom is an independent director. No member of the compensation committee is employed by NUCRYST or its affiliates and no member is a former officer or employee of NUCRYST or its affiliates.

Mr. Gardner joined the compensation committee on May 14, 2007 but left the committee in September 2007 after his appointment as President and Chief Executive Officer of NUCRYST in August 2007.

HUMAN RESOURCES AND COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION

Oversight of Executive Compensation Program

The compensation committee assists our board in determining and administering:


	•	key compensation policies;

	•	our executive compensation program for our President and Chief Executive Officer and the other executives officers, including those named in the Summary Compensation Table; and

	•	executive management succession and development.

We refer to our President and Chief Executive Officer as our CEO and the other executives named in the summary compensation table together with our CEO as our named executives. Our committee has the responsibility of reviewing and approving named executive compensation, including base salary, bonuses and stock-based compensation for recommendation to our board of directors for approval. Our committee also reviews and recommends to our board of directors the specific performance targets for use in our annual non-equity incentive program.

Executive Compensation Objectives and Philosophy

The key objectives of our executive compensation program are:


	•	to attract, retain and reward highly qualified executives that demonstrate the ability to achieve business success; and

	•	to motivate those individuals to create and enhance long-term shareholder value.

To that end, our executive compensation program is designed to reward performance and the creation or enhancement of shareholder wealth by providing to our named executives short-term cash incentives that reward the meeting or exceeding of challenging annual corporate goals. The cash incentives are reduced or eliminated if the goals are not achieved. Stock-based compensation is used in our program as another mechanism for rewarding long-term performance, aligning our executives’ interests with those of our shareholders, and retaining skilled executives.

Role of Committee and Executive Officers in Compensation Decisions

When establishing base salaries and equity grants for each named executive for recommendation to our board, our committee considers the recommendations of our CEO (for compensation other than his own). While our committee does give significant consideration to the recommendations of our CEO, it may accept or adjust such recommendations based on its own judgment. Our committee also considers each named executive’s current salary and the appropriate balance between incentives for long-term and short-term performance. There is no pre-established policy or target for the allocation between cash and non-cash or short-term and long-term incentive compensation. Rather, our committee relies upon its own judgment — and not on rigid formulas — in determining the amount and mix of compensation elements and whether each particular payment or award provides an appropriate incentive and reward for performance. Our committee’s philosophy is that the allocation should remain flexible to recognize the shifting trends in the marketplace and variations by executive role. Key factors affecting our committee’s judgment in determining an executive’s compensation package as a whole and each element individually include:


	•	the executive’s performance;

	•	the nature, scope and level of the executive’s responsibilities;

	•	level of experience of the executive in his or her respective field; and

	•	the prevailing market rates for individuals performing similar functions at comparable companies.

Compensation Consultant

In 2006, our committee engaged the services of an independent compensation consultant, ORC Worldwide (“ORC”), to provide research, analysis and recommendations to our committee regarding named executives’ and outside directors’ compensation for 2006 and 2007. During 2006, ORC participated in three of our committee meetings. ORC has not provided any other services to us and has received no compensation other than with respect to the services provided to our committee. ORC provided guidance to our committee to assist it in determining:


	•	competitive base salaries, short term cash incentive and long-term incentives in the form of equity awards for seven executive officer positions;

	•	short-term and long-term incentive plan design; and

	•	trends and issues in executive compensation.

ORC provided our committee with comparative market data on executive base salary and total cash compensation practices based on an analysis of three executive compensation surveys conducted by national organizations and a sample of data from filed proxies of companies in our and related industries and within a revenue range of $0 to $150 million. In completing its analysis, ORC’s approach was to use multiple sources for executive compensation data in order to avoid a reliance on a single source of information. In developing its recommendations, ORC adjusted these data sources to reflect our relative size, nature of our business and the particular job functions of each named executive.

In addition, ORC provided advice to our committee with respect to revising the structure of fees paid to our non-management directors as well as other equity and non-equity compensation awarded to non-management directors, including designing and determining minimum equity ownership levels for these directors.

Our committee received ORC’s recommendations regarding director’s compensation in May 2006 and those regarding executive compensation in December 2006. Our committee took these recommendations into consideration when revising director’s compensation in 2006 and in setting executive compensation for 2007.

As discussed under CEO Compensation, our committee retained ORC in 2007 to prepare a report of confidential market data and compensation recommendations to assist our committee in determining the components of a competitive compensation package in connection with the appointment of Mr. Gardner to the combined position of President, Chief Executive Officer and Chairman of the board.

Elements of Our Compensation Program

For the fiscal year ended December 31, 2007, the principal components of our compensation for named executives were base salary, a cash incentive bonus under our Employee Variable Pay Incentive Program which we refer to as our variable pay program, stock options under our 1998 Equity Incentive Plan, and other benefits.

The elements of our compensation program are described as follows:

Base Salary. We provide named executives and other employees with base salary to compensate them for services rendered during the fiscal year. Base salary levels are typically reviewed annually as part of our performance review process as well as upon a promotion or other change in job responsibility. Increases to base salaries of our named executives for cost of living increases and other changes are based on our committee’s assessment of the individual’s performance, their position within the salary range, and the recommendation of our CEO (for compensation other than his own). In determining base salary, our committee also considers other factors such as skill set, prior experience, the executive’s time in his/her position, internal consistency regarding pay levels for similar positions or skill levels, external pressures to attract and retain key talent, and market conditions generally. Our committee also reviews the performance of our CEO and establishes his/her base salary for recommendation to our board of directors. We intend to periodically review executive compensation base salary using comparative North American industry data provided by our independent professional compensation consultant. Such a review was undertaken by our committee’s compensation consultant in 2006 when it conducted an independent review of our named executives’ compensation. The results were received by our committee in December 2006 and were used by our committee in determining named executive compensation for 2007.

For fiscal 2007, our CEO made recommendations to our committee with respect to the proposed salaries for fiscal 2007 for each of the named executives other than himself based, in part, on the recommendations of the compensation consultant. In determining whether adjustments should be made to the base salaries of any of our named executives, our committee considered our CEO’s recommendations in conjunction with the results of the executive compensation survey conducted by the compensation consultant and an overall review of the factors discussed above. Through this analysis,

and with particular attention given to the competitive market place for compensation and the demand for executive talent, our committee recommended and our board approved increases to each of our named executive’s base salaries, effective January 1, 2007, in the amount of approximately 10 percent to the base salary of Mr. Gillis, 18 percent to that of Mr. Lurier, 18 percent to Ms. Amelio’s base salary, 2 percent to that of Mr. McDowell and 3 percent to the base salary of Dr. Turner. Dr. Turner’s base salary was subsequently increased to $220,000 effective July, 2007 when she was promoted to Vice President, Research and Development. The base salaries paid to our CEO and other named executives during fiscal year 2007 are shown in the Summary Compensation Table.

Performance-Based Incentive Compensation. While we view competitive base pay as a critical component of total compensation, an equally important component is linking compensation to company performance. This is accomplished through our variable pay program. The variable pay program is an annual cash incentive program and provides all of our employees, including named executives, the opportunity to earn cash incentive bonuses based on the achievement of specific company or function performance goals. The bonuses paid to named executives for 2007 appear in the Summary Compensation Table under the “Bonus” column.

In the first quarter of each year, following approval of the business plan for the year by our board of directors, senior management develops specific financial and non-financial performance metrics for all levels in our organization (including named executives) that are designed to motivate the achievement of the objectives set out in business plan. Each performance metric has a weight within the plan, and the sum of the weights is 100%.

There are three performance levels established for the goals: Threshold, Target, and Stretch, defined below:


Threshold		• the minimum level of performance necessary to receive a payout
		• there is no payout for performance below Threshold
		• we believe there is a greater than 50% probability of attaining at least Threshold performance measures

Target		• the expected level of performance
		• we believe there is a good probability of attaining target performance measures

Stretch		• performance beyond Target
		• we believe there is a low probability of attaining Stretch performance measures

Although specific goals are established annually for each of the three levels, actual results may come in at any number — from below the minimum Threshold level through to the maximum Stretch level. Typically, the Incentive Program will interpolate between the three levels: Threshold, Target and Stretch. However, if the business unit measure is defined as a milestone, where the unit must hit a definitive goal at each of the three levels, no interpolation is made.

For 2007, all of our named executives except Mr. Gardner had their payout ranges under the variable pay program set as a percentage of base salary for 2007 at 20% at Threshold, 40% at Target and 70% at Stretch. These ranges were adjusted in 2007 based on job responsibilities, internal relativity, and competitive market guidance from our compensation consultant. Our committee believes these ranges in the context of the overall mix of performance measures encourage named executives to focus appropriately on improving shareholder value. For 2007, pursuant to the terms of his employment agreement, Mr. Gardner received restricted stock units in lieu of an annual bonus under our variable pay program.

Corporate Performance. On the corporate side, one of the 2007 goals was share price appreciation, which is measured by calculating the weighted average increase in our NASDAQ share price as compared to a medical index. Since we have a limited trading history, we measure share price appreciation against a medical index. The Target for this performance measure was set at the weighted average increase in our share price exceeding the medical index by 20 percentage points; Threshold was exceeding it by 10 percentage points, and Stretch was exceeding it by 30 percentage points.

This corporate measure of share price appreciation accounted for 10% of the total incentive payout for all named executives. The corporate measure can result in a payout, regardless of the business unit/department performance. In respect of this performance goal for 2007, Threshold was not achieved and, therefore, there was no incentive variable payout to our named executives under this performance target.

Named Executive Performance Targets. For fiscal 2007, we set 10 goals in addition to the corporate performance goal discussed above. One was a financial objective to control total company expenses (excluding cost of goods),

depreciation, amortization, foreign exchange gain or loss, interest expense, income taxes and accounting charges to no more than of $14.8 million at Threshold, $14.6 million at Target and $14.1 million at Stretch. We achieved stretch in respect of this objective. Six of the objectives were related to achievement of milestones concerning new product development projects; another was related to the completion of research objectives and the last two related to manufacturing process improvement objectives.

Each of our named executives had different weights assigned to the various financial and non-financial metrics depending on their department performance goals to which each named executive was expected to contribute. These overall corporate performance objectives accounted between 40% and 50% of the total incentive payout for each named executives. In addition, in 2007, each named executive set individual performance objectives related to job specific goals that were assigned weights of between 20% and 70% of the total incentive payout for each named executive depending on the total of the corporate performance target weighting.

Our board of directors can exercise discretion to pay compensation even if performance does not meet our performance goals. Our board did not exercise this discretion in 2007 in respect of any of our named executives. We have not established a policy to address the adjustment or recovery of performance based awards if we restate or otherwise adjust the relevant performance measures in a manner that would reduce the size of an award or payment to a named executive.

Long-Term Equity Incentive Compensation. We provide long-term equity incentive compensation to named executives through awards under our 1998 Equity Incentive Plan (as amended) of stock options and, commencing in 2007, restricted stock units both of which generally vest over multiple years. Our board of directors, upon the recommendation of our committee, administers our equity incentive plan. Our equity incentive compensation program as a component of total named executive compensation is intended to assist us in:


	•	enhancing the link between the interests of our named executives and those of our shareholders by creating an incentive for our named executives to maximize shareholder value;

	•	providing an opportunity for increased equity ownership by named executives and fostering a long term business perspective; and

	•	retaining our named executives despite very competitive labor markets by maintaining competitive levels of total compensation.

The determination by our board of directors of equity grant amounts are not made according to a strict formula, but rather are based on an objective review of several factors in respect of each of our named executives including the recommendation of our CEO (for equity awards other than to himself); job responsibilities, an evaluation of the executives’ past performance; competitive market guidance from our compensation consultant; corporate performance; and vested and unvested equity holdings.

Stock option grants are made to new executives upon commencement of employment as part of the executive’s negotiated total compensation package. Our committee considers the recommendation of our CEO, other than for himself, in determining the amount of options granted to any new named executive and may accept or adjust such recommendations based on its own judgment. Our committee also considers the amount of the recommended grant as it relates to the overall mix of the initial total compensation package offered; internal consistency; and the nature of the new executives’ roles and responsibilities. Our board of directors also grants stock options to executives on a periodic basis following a review of the above elements. We typically grant options to our named executives with 10 year expiry periods and upon terms that provide that they will become exercisable (or “vest”) in annual or other periodic installments (most commonly, 1/3 per year over 3 years), so that if an executive’s employment is terminated, whether by us or the executive, prior to the full vesting of the options, the unvested portion terminates automatically, thereby creating and incentive for the executive to remain in our employ for at least the vesting period. The exercise price of each option is set under the Incentive Plan as the fair market price of our common shares on the date of grant which is defined in the plan as the market closing price of our common shares on the NASDAQ for the trading day immediately preceding the date on which the granting of the option is approved by our board of directors. In addition, in 2006, our board of directors adopted a policy to only grant options during open trading windows. In accordance with this policy, if the date of an equity grant falls within a trading black-out period, then the grant date will be set as the second trading day after the trading black-out period ends. This policy was adapted to ensure that when options are granted the stock price at the time can reasonably be expected to fairly represent the market’s view of our then-current results and prospects.

In February 2007, upon the recommendation of the compensation consultant following the completion of the independent review of our named executive compensation undertaken by the consultant, our board of directors considered the outstanding share options currently held by named executives and, using the principles outlined above and considering the confidential market data and report presented by the compensation consultant, our board approved the granting of additional stock option awards and restricted stock units to each of the named executives. The options and restricted stock units granted to our named executives in 2007 appear in the Option Grants During the Year Ended December 31, 2007 Table and the Summary Compensation Table under the “Shares or Units Subject to Resale Restriction” column.

Upon the recommendation of the compensation consultant, our board of directors considered the long-term equity incentive program in light of market changes and the importance of employee retention and decided to add restricted stock units to the mix of long-term equity incentive granted to named executives as a means of increasing our named executives’ equity ownership and fostering a long term business perspective. The restricted stock units vest as to 1/3 each over 3 years and if an executive’s employment is terminated, whether by us or the executive, prior to the full vesting of the restricted stock units, the unvested portion terminates automatically, thereby creating and incentive for the executive to remain in our employ for at least the vesting period.

Other Benefits. We provide various employee benefit programs to our named executives, including medical, dental and life insurance benefits, our 401 (k) plan for employees located in the United States and our defined contribution pension plan for employees located in Canada. Except for a relocation allowance provided to Mr. McDowell, these benefits are generally available to all our employees.

Tax Deductibility Considerations

Section 162(m) of the Internal Revenue Code generally prohibits us from deducting the annual compensation in excess of $1 million paid to any of our five most highly compensated officers. However, amounts that constitute “performance-based compensation” are not counted toward the $1 million limit under Section 162(m) of the Code, and it is expected that, generally, options and restricted stock units granted under the Incentive Plan will satisfy the requirements for “performance-based compensation”.

Our Equity Incentive Plan is not subject to the U.S. Employee Retirement Income Security Act of 1974, as amended, or qualified under Section 401(a) of the Code.

Compensation Committee Interlocks and Insider Participation

During fiscal 2007, the following directors have at one time been members of our committee: Barry M. Heck, Richard W. Zahn, Neil Carragher, Roger G.H. Downer, David Poorvin and Thomas E. Gardner. With the exception of Mr. Gardner and Mr. Heck, none of the committee’s current or former members has at any time been one of our officers or employees. Mr. Heck had served on our compensation committee until December 2006. After he left the committee, Mr. Heck was appointed to Executive Chair of NUCRYST from May 23, 2007 to August 22, 2007. He did not, however, serve on the compensation committee at any time while he held the position of Executive Chair nor has he served on the committee since he held that position. Mr. Gardner was a member of the compensation committee at the time he was appointed Chairman of our board, President and Chief Executive Officer and left the committee in September 2007. Mr. Gardner excused himself from all committee discussions and meetings at which his appointment as our President and CEO and all related compensation matters were discussed by the committee. While there was a short period of time during which Mr. Gardner was both an employee of NUCRYST and a member of our committee, the committee held no meetings and conducted no business during that period of time.

None of our named executives serves, or in the past fiscal year, has served, as a member of the board of directors or compensation committee of any entity that has one or more of its executive officers serving on our board of directors or committee.

Human Resources and Compensation Committee Report

The information contained in this report shall not be deemed to be “soliciting material” or “filed” with the SEC or subject to the liabilities of Section 18 of the Exchange Act, except to the extent that we specifically incorporate it by reference into any document filed under the Securities and Exchange Act.

Our committee has reviewed and discussed with our management the Report on Executive Compensation for fiscal 2007. Based on the review and discussions, our committee recommended to our board of directors, and our board of directors has approved, that the Report on Executive Compensation be included in our annual report on Form 10-K for 2007.

This report is submitted by our committee.

Roger G.H. Downer
Neil Carragher
David W. Poorvin

Limitation of Liability and Indemnification of Directors and Officers

Under the ABCA, we may indemnify an individual who:


	•	is or was our director or officer; or

	•	is or was a director or officer of another corporation, of which we are or were a shareholder or creditor, at our request;


	•	against all costs, charges and expenses, including an amount paid to settle an action or satisfy a judgment, reasonably incurred by the director or officer in respect of any civil, criminal or administrative action or proceeding, in which such eligible party is involved because of that association with us or the other entity.

However, indemnification is prohibited under ABCA if:


	•	such eligible party did not act honestly and in good faith with a view to our best interests (or the best interests of the other entity, as the case may be); and

	•	in the case of a criminal or administrative proceeding that is enforced by monetary penalty, such eligible party did not have reasonable grounds for believing that such person’s conduct was lawful.

Subject to the foregoing, we may, with the approval of the Court of Queen’s Bench of Alberta, indemnify or pay all costs, charges and expenses reasonably incurred by an eligible party in respect of an action brought against the eligible party by or on behalf of us to which the eligible party is made a party by reason of being or having been a director or officer of us (or the other entity as the case may be).

The ABCA provides that we may purchase and maintain insurance for the benefit of an eligible party (or their heirs and personal or other legal representatives or the eligible party) against any liability that may be incurred by reason of the eligible party being or having been a director or officer, or in an equivalent position of ours or that of an associated corporation. Our directors and officers are insured against certain losses under liability insurance obtained and maintained by Westaim for the protection of all the directors and officers of Westaim and NUCRYST against liability incurred by them in their capacities as directors and officers of Westaim and NUCRYST and their respective past and present subsidiaries. The policy also insures Westaim and NUCRYST against certain obligations to indemnify their respective officers and directors. Under the policy of insurance, there is a deductible of CDN$250,000 per occurrence payable by NUCRYST. We expect to be covered by Westaim’s policy at least until May 31, 2008 when Westaim’s coverage expires at which time we intend to obtain our own insurance policies or continue our coverage under Westaim’s renewed policies, unless Westaim no longer holds more than 50% of our outstanding common shares, and subject to the earlier termination of the services agreement we entered into with Westaim or that portion of the services agreement relating to the provision of insurance to us by Westaim.

We have entered into indemnity agreements with all of our directors and executive officers to effectuate the provisions described above. Under these agreements, we have agreed to indemnify our directors and executive officers against all costs and liabilities arising out of or incurred in respect of any action suit, proceeding, investigation or claim, or pursuant to any statute, in connection with our affairs or the affairs of any subsidiary, or the exercise of the powers of the performance of the duties of the director or officer, unless it is finally determined by a court that in so acting the director or officer was not acting honestly and in good faith with a view to the best interests of us or any affiliated entity or, in the case

of a criminal or administrative action or proceeding that is enforced by a monetary penalty, that the director or officer did not have reasonable grounds for believing that his conduct was lawful.

Compensation of Directors

Our director compensation currently includes annual retainers, meeting fees, fees for additional duties and extra-ordinary travel and equity-based compensation in the form of stock option and restricted stock unit grants. As discussed above, all of the elements of our director compensation underwent an independent review by our compensation consultant in 2006, and based on the recommendations of the compensation consultant our board adopted the existing director compensation plan.

Director Fees

Annual board and committee retainers are paid quarterly, in advance, and are pro-rated for partial service, if appropriate. All of the directors are also reimbursed for reasonable out-of-pocket expenses incurred in attending board and committee meetings. From January 1, 2007, non-executive directors (excluding Mr. Heck, as described below) were paid the following fees:


	•	each non-employee director (other than Mr. Heck) receives an annual retainer of $15,000 and $2,000 for each board meeting attended (attendance for purposes of the policy includes attendance in person, by teleconference or by video);

	•	the chairman of our audit committee receives a $7,500 retainer and $1,500 for each committee meeting attended and each other member of such committee receives $1,200 per committee meeting attended; and

	•	the chairmen of each of the human resources and compensation committee and corporate governance and nominating committee receives a $5,000 retainer and $1,000 per committee meeting attended and each other member of such committees receives $800 per committee meeting attended.

Our board made the following adjustments to the compensation plan set forth above:


	•	effective February 14, 2007, each non-employee director will receive a daily fee of $1,500 when carrying out, at the request of our board or committees of our board, additional directors duties or services on behalf of our board or committees; and

	•	effective June 14, each non-employee director will receive payment of $1,000 if the director is required to travel more than four hours by air one-way in North America to attend a board meeting and payment of $2,000 if required to travel from another continent.

Mr. Heck was not eligible to receive fees as a director or equity grants made to directors while he held the position of President and Chief Executive Officer of Westaim. Upon his resignation from that position on May 23, 2007, Mr. Heck was appointed Executive Chair of our board and as such was not entitled to receive payment of director fees. Upon his resignation as our Executive Chair on August 22, 2007, Mr. Heck continued as a director of NUCRYST and then become entitled to receive payment of director fees.

Director 2007 Retainer and Fees

The following table sets forth all fees paid to our non-employee directors in 2007:

Annual

Annual Board

Committee

Board

Committee

Additional

Travel

Total Fees

Retainer

Meeting Fees

Duty Fees

Fees⁽⁶⁾

Earned

Name

($)

Neil Carragher

15,000

7,500

20,000

⁽³⁾

12,4000

N/A

54,900

Roger G.H. Downer

15,000

5,000

20,000

⁽³⁾

8,200

N/A

3,000

51,200

Richard W. Zahn

15,000

5,000

20,000

⁽³⁾

7,200

15,100

N/A

62,300

David W. Poorvin

15,000

N/A

20,000

⁽³⁾

13,200

N/A

46,200

Barry M. Heck

5,363

⁽¹⁾

N/A

4,000

⁽⁴⁾

N/A

2,000

11,363

Thomas E. Gardner

5,685

⁽²⁾

N/A

6,000

⁽⁵⁾

1,600

⁽⁵⁾

N/A

13,286


(1)	The Annual Board Retainer Fee paid to Mr. Heck was prorated for the year commencing August 22, 2007 which was the date upon which Mr. Heck resigned as Executive Chair of NUCRYST, and continued as a director thereby entitling him to payment of director fees.

(2)	The Annual Board Retainer Fee paid to Mr. Gardner was prorated to cover the period between May 14, 2007, the date upon which Mr. Gardner was appointed to our board, and August 22, 2007, the date upon which Mr. Gardner was appointed as our Chairman of the Board, President and CEO.


(3)	Messrs. Carragher, Downer, Poorvin & Zahn attended 10 of 10 board meetings and were paid a fee of $2,000 per meeting.

(4)	Mr. Heck received payment for his attendance as a director at two board meetings that took place following his resignation as Executive Chair on August 22, 2007.

(5)	Mr. Gardner received payment for his attendance as a director at three board meetings and two Corporate Governance and Nominating Committee meetings that took place after his appointment to our board and the committee on May 14, 2007 and prior to his appointment as our President and CEO on August 22, 2007.

(6)	Following approval by our board of the payment of a travel fees to directors effective June 14, 2007, Mr. Downer received payment of a travel fee of $2,000 for travel from another continent to attend a board meeting and a travel fee of $1,000 for travel over 4 hours one-way in North America. Mr. Heck received payment of the $1,000 fee for travel over 4 hours in North America on two occasions following approval of the fee by our board.

Director Equity-Based Compensation

Each non-employee director will receive, upon their election to the board, a grant of 5,000 RSUs and a stock option grant to purchase 8,000 of our common shares. The RSUs vest immediately, with 1,000 shares available for sale in one year and 4,000 shares to be held for the duration of board service. The stock options will vest in equal annual installments on the first three anniversaries of the date of grant. Messrs. Carragher, Downer and Zahn each received an initial grant of options under the prior directors’ compensation policy in connection with the initial public offering. These options covered 20,000 common shares each, had an exercise price of $10.00 per common share and vest in equal annual installments on the first three anniversaries of the date of grant.

Our board of directors has adopted a policy that each member of the board is required to hold minimum equity in NUCRYST equal in value to 2.5 times the annual retainer, or $37,500 at the current retainer level. Directors have three years from the later of the date of the adoption of this policy or their initial appointment to our board to achieve this minimum ownership threshold.

Options and Restricted Stock Units Granted to Directors in 2007


	RSUs		Options
Name	Granted⁽¹⁾		Granted⁽²⁾

Neil Carragher		3,000		2,000
Roger G.H. Downer		3,000		2,000
Richard W. Zahn		3,000		2,000
David W. Poorvin		3,000		2,000
Barry M. Heck⁽³⁾		—		—
Thomas E. Gardner		5,000		8,000


(1)	Messrs. Carragher, Poorvin & Zahn were each granted 3,000 Restricted Stock Units (“RSUs”) on the anniversary date of their appointment to our board being December 21, 2007, 50% of which vest on the first anniversary of the grant date and the remaining 50% on the second anniversary date of the grant date. The trading price of our common shares on NASDAQ on the grant date was $1.42. Messrs. Gardner was granted 5,000 RSUs upon first being appointed to our board on May 14, 2007, all of which vested immediately upon the date, 1,000 of which are restricted from sale until the first anniversary of the grant date and the remaining 4,000 are restricted from sale until he leaves our board. Mr. Poorvin was granted 3,000 RSUs on the anniversary of his appointment to the Board being May 30, 3007, 50% of which vest on the first anniversary of the grant date and 50% of which vest on the second anniversary of the grant date. The trading price of our common shares on the date of grant of the RSUs to Mr. Poorvin was $1.96.

(2)	Pursuant to our board compensation plan, Messrs. Carragher, Downer and Zahn were each granted 2,000 options to purchase our common shares on the anniversary date of their appointment to our board, being December 21, 2007. The options vest each as to 1/3 on the first, second and third anniversary of the grant date and have an exercise price of $1.40. Mr. Poorvin was granted 2,000 options on May 30, 2007 with the same vesting schedule and with an exercise price of $2.13.

(3)	Mr. Heck was granted 5,000 RSUs and 8,000 options in 2007 but they were granted to him upon being appointed an executive of NUCRYST and not in his capacity as a director.

Our Board has established a Deferred Share Unit Plan, or DSU plan, to accommodate those directors who have stated that they would be willing to take all or a portion of their cash directors’ fees in the form of Deferred Share Units, or DSUs, in order to increase their exposure to our share price performance. Under the DSU plan, eligible directors may elect to receive all or a portion of their fees in the form of DSUs. A DSU will be attributed a value based on the closing price of our common shares on the NASDAQ for the trading day immediately preceding the date of grant, which we refer to in this paragraph as the market price. The DSUs may be granted at attributed values that are less than, equal to, or greater than the market price. All DSUs will be paid out in cash only. The value of each DSU, when converted into cash, will be equivalent to the market price of a common share at the time the conversion takes place. Under the DSU plan, a DSU cannot be converted to cash until the director ceases to be a member of our board. As of February 11, 2008, we have not granted any DSUs to our directors.


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

The following table sets forth information regarding beneficial ownership of our common shares as of December 31, 2007 by:


	•	each person known by us to be the beneficial owner of more than 5% of our common shares;

	•	our named executive officers;

	•	our directors; and

	•	our directors and executive officers as a group.

Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. As required by those rules, the number of common shares beneficially owned by any person includes any shares the individual has the right to acquire within 60 days of February 11, 2008. For purposes of calculating each person’s or group’s percentage ownership, stock options exercisable within 60 days are included for that person or group, but not for the share ownership of any other person or group.

Except as noted by footnote, and subject to community property laws where applicable, the persons named in the table below have sole voting and investment power with respect to all common shares shown as beneficially owned by them.

The table below lists the applicable percentage ownership based on 18,686,859 common shares outstanding as of February 11, 2008.


	Number of		Percentage of
	Shares Beneficially		Shares Beneficially
Name and Address of Beneficial Owner	Owned		Owned⁽²⁾

The Westaim Corporation 10102 — 114 Street Fort Saskatchewan, Alberta T8L 3W4		13,691,700		73.27	%
Royce & Associates LLC 1414 Avenue of the Americas New York, NY 10019		1,422,400		7.61	%
Thomas E. Gardner		210,577		1.13	%
Scott H. Gillis⁽¹⁾		272,370		1.46	%
Eliot M. Lurier⁽¹⁾		34,455		*
David C. McDowell⁽¹⁾		37,607		*
Katherine J. Turner, Ph.D.		15,900		*
Carol L. Amelio		20,000		*
Barry M. Heck		5,000		*
Neil Carragher⁽¹⁾		20,500		*
Roger G.H. Downer, Ph.D.⁽¹⁾		16,500		*
Richard W. Zahn⁽¹⁾		15,500		*
David Poorvin, Ph.D.		7,667		*
All directors and executive officers as a group (10 persons)		656,076		3.51	%


	*	Less than one percent.


(1)	Includes options to purchase common shares exercisable within 60 days of February 11, 2008 as follows: 272,370 shares for Mr. Gillis; 32,788 shares for Mr. Lurier; 35,940 shares for Mr. McDowell; 14,000 shares for Mr. Carragher; 14,000 shares for Dr. Downer; 14,000 shares for Mr. Zahn, 2,667 shares for Mr. Poorvin.

(2)	For each person and group included in this table, percentage ownership is calculated by dividing the number of shares beneficially owned by such person or group by the sum of 18,367,563 common shares outstanding at February 11, 2008, plus the number of common shares that such person or group had the right to acquire within 60 days after February 11, 2008.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides certain information with respect to our Equity Incentive Plan in effect as of December 31, 2007:

Number of securities to be

Weighted-average

issued upon exercise of

exercise price of

Number of securities remaining

Equity compensation plans

outstanding options,

available for future issuance

approved by security holders

warrants and rights

under equity compensation plans

1998 Equity Incentive Plan

579,299

a) Options

1,405,638

CAD $

3.93

b) Restricted Stock Units

39,200

1998 Equity Incentive Plan (as amended)

Our 1998 equity incentive plan was amended and restated prior to the completion of our initial public offering. We refer to the 1998 incentive plan as the amended plan or the plan. The plan is administered by our board, upon the recommendation of the human resources and compensation committee. Under the plan, the human resources and compensation committee may grant options to purchase our common shares, share appreciation rights, restricted share units, or RSUs, other share-based awards and incentive awards.

Eligible Participants. The eligible participants under the plan include certain of our directors, officers, employees, consultants and other service providers of NUCRYST or its subsidiaries, which we refer to as participants.

Grant Committee. On May 2, 2006, our board of directors appointed a non-executive option grant committee consisting of our President & Chief Executive Officer, our Vice President, Finance and Administration and Chief Financial Officer, and our Vice President, General Counsel and Corporate Secretary. We refer to this committee as the grant committee. The grant committee has the power and authority to grant awards (as that term is defined in the plan), subject to the terms and upon the conditions of the plan, to a participant provided that the participant is neither a director nor an executive officer of NUCRYST. We refer to such participants as permitted participants. Each member of the grant committee is authorized to enter into award agreements for and on behalf of NUCRYST with permitted participants in respect of awards approved by the grant committee. Grants of any awards under the plan by the grant committee are subject to the following restrictions:


	•	The aggregate number of all awards granted to any one permitted participant shall not exceed 5,000 per annum; and

	•	The aggregate number of all awards granted to all permitted participants shall not exceed 54,000 per annum.

The grant committee does not have the power or authority to grant any awards under the plan to (i) directors or executive officers of NUCRYST; or (ii) any permitted participant that would result in the aggregate number of all awards granted to the permitted participant to exceed 5,000 in any calendar year (each, a prohibited grant).

Options. Under the plan, we may grant options intended to qualify as incentive stock options under Section 422 of the U.S. Internal Revenue Code of 1986, as amended, or the Code, and non-qualified stock options. The exercise price of options granted under the plan will be established by the human resources and compensation committee or the grant committee at the time of grant. However, the exercise price at the time of grant will not be lower than the “fair market price” per common share on the date of grant. The fair market price shall be the closing price of the common shares on the exchange (as described below) for the trading day immediately preceding the date on which the granting of the option is approved by the human resources and compensation committee or grant committee. The “exchange” means the NASDAQ or, if the common shares are not then listed and posted for trading on the NASDAQ, on such stock exchange or quotation system on which such shares are listed, posted for trading or quoted.

Share Appreciation Rights. Share appreciation rights may entitle the holder to a payment in cash, common shares or both, at our option, valued by reference to, or otherwise based on or related to the value of, our common shares. The following three types of SARs are authorized for issuance under the plan:


	•	Tandem Rights. A “tandem right” is a SAR granted in connection with an option that is subject to the same terms and conditions applicable to the particular option grant to which it pertains with the following exceptions: the tandem right shall require the holder to elect between the exercise of the underlying option to purchase common shares and the surrender, in whole or in part, of such option in exchange for a payment of cash or, if provided in the award agreement, at our option in common shares, in an amount equal to the excess of (A) the fair


		market price of the number of common shares covered by that portion of the surrendered option in which the optionholder is vested over (B) the aggregate exercise price payable for such vested shares. For the purposes of tandem rights, fair market price shall be equal to the closing price immediately preceding the date of the option surrender.


	•	Concurrent Rights. A “concurrent right” is a SAR granted in connection with an option that applies to all or a portion of common shares subject to the underlying option and which is subject to the same terms and conditions applicable to the particular option grant to which it pertains with the following exceptions: a concurrent right shall be exercised automatically at the same time the underlying option is exercised with respect to the common shares to which the concurrent right pertains and, on exercise, entitles the holder to receive a payment of cash or, if provided in the award agreement, at our option in common shares, in an amount equal to the excess of (A) the aggregate fair market price of the common shares purchased under the underlying option over (B) the aggregate exercise price paid for such shares. For the purposes of concurrent rights, fair market price shall be equal to the closing price immediately preceding the date of the exercise of the concurrent right.

	•	Independent Rights. An “independent right” means a SAR granted independently of any option but that is subject to the same terms and conditions applicable to an option with the following exceptions: an independent right shall be denominated in share equivalents. Upon exercise, independent rights will be payable in cash or, if provided in the award agreement, at our option in common shares, in an amount equal to the excess of (A) the aggregate fair market price of a number of common shares equal to the number of share equivalents in which the holder is vested under such independent right, and with respect to which the holder is exercising the independent right on such date, over (B) the aggregate exercise price for the independent right exercised. For the purposes of independent rights, fair market price shall be equal to the closing price immediately preceding the date of exercise of the independent right.

Restricted Share Units. Restricted share units are grants of common shares that are subject to vesting based upon the passage of time or other criteria specified in the award agreement and which entitle the holder to the issuance of common shares upon the vesting of RSUs. RSUs may be granted in consideration of the performance of services or payments by a participant. Depending on the terms of the award agreement, participants may be entitled to dividends declared by us on our common shares and to vote the restricted common shares during the restricted period. Depending on the terms of the award agreement, the common shares issued upon vesting of the RSUs may themselves be subject to restrictions, such as restrictions on disposition for certain periods of time.

Other Stock-Based Awards. Other stock based awards are awards other than options, SARs or RSUs that are denominated in, valued in whole or in part by reference to, or otherwise based on or related to our common shares.

Incentive Awards. Incentive awards are performance based awards that are denominated in dollars. Both annual and long-term incentive awards may be granted under the plan. Performance goals for incentive awards under the plan will be established by the human resources and compensation committee administering the plan. Performance goals for awards intended to constitute performance-based compensation under Section 162(m) of the Code may include a wide variety of specified measures of our operating results or other criteria established by the human resources and compensation committee at the time of grant.

Shares Reserved; Plan Limits. The aggregate number of common shares reserved for issuance under the plan is 2,200,000 shares. The plan provides that the aggregate number of common shares issued to any one participant pursuant to the plan, within a one-year period, shall not exceed 2,200,000 common shares. The plan provides that the aggregate number of common shares issued to any one participant pursuant to the plan, within a one-year period, shall not exceed 5% of the outstanding issue on a non-fully diluted basis, and the number of common shares reserved for issuance to any one participant pursuant to the plan may not exceed 5% of the outstanding issue on a non-fully diluted basis. Common shares issuable upon the exercise of awards granted under the plan but not exercised prior to expiration are not available for subsequent grants under the plan.

Adjustment. The human resources and compensation committee is authorized to adjust the number, character and value of common shares underlying awards granted under the plan to reflect sub-divisions, consolidations or re-classification of our common shares or other changes in our authorized or issued capital, or our payment of stock dividends or other dividends-in-kind.

Other Terms. If the recipient of an option or SAR ceases to be an eligible participant under the plan for any reason other than death or permanent disability, the rights under the awards held by such a recipient will terminate either 30 days after they cease to be an eligible participant or the expiration of such awards, whichever is earlier.

If the recipient of an option or SAR ceases to be an eligible participant under the plan by reason of death or permanent disability, the rights under the awards held by such a recipient will terminate either 180 days after they cease to be an eligible participant or the expiration of such award, whichever is earlier.

Under the plan, awards, including currently outstanding options and RSUs, may be settled only in common shares of NUCRYST or, if applicable, cash.

The period during which an option may be exercised shall not extend beyond 10 years from the date of the grant of the option. The human resources and compensation committee may, however, provide that options granted under the plan be exercisable in whole or in part only after specified periods designated by the human resources and compensation committee.

Amendments. Our board of directors shall have the right, in its sole discretion, to alter, amend or discontinue the plan from time to time and at any time, subject to, as applicable, requisite stock exchange approval and any requisite regulatory approvals; provided however that no such amendment or alteration may, without the consent of the participant, alter or impair any award previously granted to a participant. Any amendment to the plan may require the prior approval of the exchange and applicable regulatory authorities and may require the approval of our shareholders, such approval to be obtained from a majority of the holders of common shares (excluding the votes of common shares held directly or indirectly by insiders benefiting from the amendment) present, in person or by proxy, at a duly constituted meeting of the holders of the common shares, in respect of any amendment to the plan which seeks to (i) reduce the exercise price or the purchase price paid for any optioned shares, or (ii) extend the vesting period.

Transferability. Except as otherwise provided by the human resources and compensation committee, awards granted under the plan are not transferable or assignable by the recipient other than by the recipient’s will or applicable law in the event of the death or permanent disability of such a recipient.

A U.S. income tax deduction will generally be unavailable for us in regard to annual compensation in excess of $1.0 million paid to any of our five most highly compensated officers. However, amounts that constitute “performance-based compensation” are not counted toward the $1.0 million limit under Section 162(m) of the Code, and it is expected that, generally, options and SARs granted under the plan will satisfy the requirements for “performance-based compensation.”

The plan is not subject to the Employee Retirement Income Security Act of 1974, as amended, or qualified under Section 401(a) of the Code.

No financial assistance is provided by NUCRYST to participants to facilitate the purchase of common shares under the incentive plan.


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

Certain Relationships and Related Transactions

We have entered into the following agreements with our named executive officers, our directors and Westaim.

Employment Agreements

We have entered into employment agreements with our executive officers. For more information regarding these agreements, see “Executive Compensation—Employment Agreements.”

Director and Officer Indemnification

Our by-laws contain provisions for the indemnification of our directors and officers. Additionally we have entered into indemnity agreements with all of our directors and executive officers. See “Executive Compensation—Limitation of Liability and Indemnification of Directors and Officers.”

Relationship with Westaim

We have entered into the following agreements and arrangements with Westaim, our parent company. The following summary of certain provisions of the agreements described below is not complete. For more detailed information, please see the copies of forms of these agreements that are incorporated by reference as exhibits to this annual report.

Lease Agreements. Our Fort Saskatchewan, Alberta facility was leased from Westaim pursuant to two separate leases until May 8, 2007 when Westaim sold the buildings and assigned the leases to the purchaser. As part of that transaction, Westaim paid us $0.8 million as compensation for entering into agreements that amended the leases and for our surrender of portions of the leased premises on or before September 30, 2008, which amending agreements were also assigned to the purchaser. Prior to the completion of the sale of the buildings by Westaim, we paid $0.8 million of rent and operating expenses to Westaim in 2007.

Services Agreement. Pursuant to a services agreement we have entered into with Westaim, Westaim provided specified corporate and administrative services, including, but not limited to, insurance and risk management; cash management; legal services; human resources services; payroll processing services; environmental, health and safety services; specified tax and accounting services; and intellectual property licensing services. We reimburse Westaim for its fully allocated costs (or in the case of services provided by third parties, for the amount it pays to third parties) for providing those services. In 2007, these services cost approximately $0.5 million. During 2007, we brought most services in-house which were absorbed by our staff. At December 31, 2007, we continue to receive insurance and risk management services, as well as tax and accounting services from Westaim. Additional services may be agreed upon between the parties from time to time. The agreement may be terminated at any time, in whole or part, (1) by agreement between us and Westaim, (2) upon six months written notice from either party given on or after the first anniversary of the date of the agreement, (3) by Westaim if it wishes to discontinue provision of any service due to the resignation or termination of any key employee or contractor reasonably necessary for the performance of such service or (4) upon written notice from either party in the event of a breach of the agreement not remedied for ten business days following written notice of the breach.

Master Separation Agreement. In connection with our initial public offering, we entered into a Master Separation Agreement with Westaim providing for the separation of our business from the business of Westaim. The agreement sets forth certain covenants relating to the ongoing relationship between Westaim and us with respect to intellectual property, access to information, retention of records and confidentiality of certain information exchanged between Westaim and us. The agreement requires us to indemnify Westaim for certain losses that may occur as a result of any claims brought by third parties relating to our initial public offering. The agreement also contains mutual releases with respect to certain claims and liabilities arising prior to the completion of our initial public offering.

Registration Rights Agreement. We entered into an agreement with Westaim pursuant to which Westaim has, among other things, registration rights under the Securities Act with respect to their common shares and the right to cause us to file a prospectus qualifying the common shares it owns in Canada under applicable Canadian securities laws.

Westaim Directors and Officers. Two of our directors are also directors of Westaim and one director served as President and Chief Executive Officer of Westaim up until May 23, 2007 when he resigned his position with Westaim.

Policies and Procedures for Review, Approval or Ratification of Transactions with Related Persons

The Charters of our Audit Committee and Corporate Governance and Nominating Committee require that the members of the Audit Committee and the Corporate Governance and Nominating Committee, all of whom are independent directors, review and approve related party transactions as defined under the applicable rules of the SEC. NUCRYST’s By-Laws also require that a director or officer who is a party to a material contract or proposed material contract with NUCRYST, or is a director or an officer of or has a material interest in any person who is a party to a material contract or proposed material contract with NUCRYST shall disclose the nature and extent of his interest at the

time and in the manner provided in the Business Corporations Act (Alberta). NUCRYST’s By-laws further provided that, except as provided in that Act, no such director shall vote on any resolution to approve such contract.

In addition, under NUCRYST’s Code of Conduct, all directors, officers and employees of NUCRYST are expected to avoid any apparent or actual conflicts of interest between their personal and professional relationships and are prohibited from:

Any violations of NUCRYST’s Code of Conduct are to be promptly reported to our Chief Financial Officer. Pursuant to our Code, our Board, Audit Committee or Corporate Governance and Nominating Committee may waive compliance with our Code, subject to the disclosure and other provisions of the applicable Canadian and U.S. securities legislation and the applicable rules of the stock exchanges upon which our shares trade from time to time.

Director Independence

Our board has determined that Messrs. Carragher and Zahn, Dr. Poorvin and Dr. Downer are independent members of our board of directors under the current requirements of the NASDAQ, the TSX and the rules and regulations of the SEC and Canadian provincial securities regulatory authorities.


ITEM 14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES

During 2007, we retained our principal accountants, Deloitte & Touche LLP, to provide services in the following categories and amounts:


	2007		2006
	(in thousands)

Audit Fees	$	200	$	300
Audit-Related Fees		26		67
Tax Fees		39		37
All Other Fees		—		—

Audit-Related Fees

Amounts paid under “Audit-Related Fees” in 2007 were $26,000 and $67,000 in 2006, which related to SOX 404 readiness assistance. No amounts were paid under “Audit-Related Fees” in 2005.

Tax Fees

Amounts paid under “Tax Fees” were $39,000 in 2007, $37,000 in 2006 and $12,000 in 2005 for tax compliance and consulting.

All Other Fees

There were no amounts paid under “All Other Fees” in 2007 and 2006 and nominal amounts were paid in 2005.

The Audit Committee has considered the compatibility of the non-audit services and audit related services provided by Deloitte & Touche LLP with their independence.

The Audit Committee is required to pre-approve the audit and non-audit services performed by our independent auditors in order to assure that the provision of such services does not impair the auditors’ independence. Unless a type of service to be provided by the independent auditors has received general pre-approval, it requires specific pre-approval by the Audit Committee. Any proposed services exceeding pre-approved cost levels require specific pre-approval by the Audit Committee. The Audit Committee at least annually reviews and pre-approves the services that may be provided by the independent auditors without obtaining specific pre-approval from the Audit Committee. The Audit Committee does not delegate its responsibilities to pre-approve services performed by the independent auditors to management. The Audit Committee may delegate pre-approval authority to one or more of its members. The annual Audit services engagement terms and fees are subject to the specific pre-approval of the Audit Committee.

PART IV


ITEM 15.	EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES

1. Consolidated Financial Statements

The following documents are filed as part of this Annual Report on Form 10-K:

Report of Deloitte & Touche LLP, Independent Registered Chartered Accountants

Financial Statements

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Cash Flows Statements

Consolidated Statements of Shareholders’ Equity (Deficit)

Notes to Consolidated Financial Statements

2. Financial Statement Schedules

None.

3. Exhibits


Exhibit									Filed
No.			Description	Form	SEC File No.	Exhibit		Date	Herewith

	2	.1†	Asset Purchase Agreement, dated May 8, 2001, between the Registrant and Smith & Nephew, Inc.	Form F-1 Amendment No. 3	333-130073		2.1	19-12-05
	3	.1	Articles of the Registrant	Form F-1 Amendment No. 2	333-130073		3.1	16-12-05
	3	.2	Articles of Amendment	Form F-1 Amendment No. 2	333-130073		3.2	16-12-05
	3	.3	By-laws of the Registrant	Form F-1 Amendment No. 2	333-130073		3.3	16-12-05
	4	.1	Specimen certificate evidencing common shares	Form F-1 Amendment No. 2	333-130073		4.1	16-12-05
	10	.1	Form of Master Separation Agreement between the Registrant and The Westaim Corporation (“Westaim”)	Form F-1 Amendment No. 2	333-130073		10.1	16-12-05
	10	.2	Form of Services Agreement between the Registrant and Westaim	Form F-1 Amendment No. 2	333-130073		10.2	16-12-05
	10	.3	Form of Registration Rights Agreement between the Registrant and Westaim	Form F-1 Amendment No. 3	333-130073		10.3	19-12-05
	10	.4†	Amended and Restated License and Development Agreement, dated as of February 20, 2002, among the Registrant, NUCRYST Pharmaceuticals Inc., Smith & Nephew, Inc. and T.J. Smith & Nephew Limited	Form F-1 Amendment No. 3	333-130073		10.6	19-12-05
	10	.5†	Letter Agreement, dated March 14, 2002, among the Registrant, NUCRYST Pharmaceuticals Inc., Smith & Nephew, Inc. and T.J. Smith & Nephew Limited	Form F-1 Amendment No. 3	333-130073		10.7	19-12-05

100


Exhibit									Filed
No.			Description	Form	SEC File No.	Exhibit		Date	Herewith

	10	.6†	Amending Agreement, dated November 3, 2003, among the Registrant, NUCRYST Pharmaceuticals Inc., Smith & Nephew, Inc. and T.J. Smith & Nephew Limited	Form F-1 Amendment No. 3	333-130073		10.8	19-12-05
	10	.7†	Supply Agreement, dated May 8, 2001, among the Registrant, Smith & Nephew, Inc. and T.J. Smith & Nephew Limited	Form F-1 Amendment No. 3	333-130073		10.9	14-12-05
	10	.8	Manufacturing Technology Escrow Agreement, dated May 8, 2001, among the Registrant, Smith & Nephew, Inc., T.J. Smith & Nephew Limited and Montreal Trust Company of Canada, as escrow agent	Form F-1 Amendment No. 1	333-130073		10.10	14-12-05
	10	.9	Security Trust Agreement, dated as of May 8, 2001, between the Registrant and Montreal Trust Company of Canada, as trustee	Form F-1 Amendment No. 1	333-130073		10.11	14-12-05
	10	.10†	Trust Indenture, dated May 8, 2001, among the Registrant, NUCRYST Pharmaceuticals Inc. and Montreal Trust Company of Canada, as trustee	Form F-1 Amendment No. 3	333-130073		10.12	19-12-05
	10	.11	Subordination and Non-Disturbance Agreement, dated as of May 8, 2001, among the Registrant, NUCRYST Pharmaceuticals Inc., Smith & Nephew, Inc., T.J. Smith & Nephew Limited and Montreal Trust Company of Canada	Form F-1 Amendment No. 1	333-130073		10.13	14-12-05
	10	.12	Memorandum of Lease Agreement, dated as of July 1, 2005, between the Registrant and The Westaim Corporation	Form F-1 Amendment No. 2	333-130073		10.14	16-12-05
	10	.13	Commercial Lease, dated as of September 1, 2001, between NUCRYST Pharmaceuticals Inc. and Cummings Properties, LLC	Form F-1 Amendment No. 2	333-130073		10.15	16-12-05
	10	.14	AIMS I Amending Lease Agreement with The Westaim Corporation, which amended that certain Memorandum of Lease Agreement effective December 1, 2005	Form 8-K	000-51686		99.1	22-12-06
	10	.15*	1998 Equity Incentive Plan	Form F-1 Amendment No. 2	333-130073		10.16	16-12-05
	10	.16*	Form of Stock Option Agreements under the 1998 Equity Incentive Plan	Form F-1 Amendment No. 2	333-130073		10.17	16-12-05
	10	.17*	Form of Amended and Restated 1998 Equity Incentive Plan	Form F-1 Amendment No. 2	333-130073		10.18	16-12-05
	10	.18*	Form of Stock Option Agreement under the Amended and Restated 1998 Equity Incentive Plan	Form F-1 Amendment No. 3	333-130073		10.19	19-12-05
	10	.19*	Employment Agreement, dated December 6, 1999, between NUCRYST Pharmaceuticals Inc. and Mr. Scott H. Gillis	Form F-1 Amendment No. 2	333-130073		10.20	16-12-05

101


Exhibit									Filed
No.			Description	Form	SEC File No.	Exhibit		Date	Herewith

	10	.20*	Stock Option Agreement, dated December 6, 1999, among the Registrant, Westaim and Mr. Scott H. Gillis	Form F-1 Amendment No. 2	333-130073		10.21	16-12-05
	10	.21*	Letter Agreement, dated March 16, 2005, between the Registrant and Mr. Eliot M. Lurier	Form F-1 Amendment No. 2	333-130073		10.22	16-12-05
	10	.22*	Letter Agreement, dated June 15, 2005, between the Registrant and Mr. David C. McDowell	Form F-1 Amendment No. 2	333-130073		10.23	16-12-05
	10	.23*	Letter Agreement, dated March 14, 2002, between the Registrant and Dr. Paul J. Schechter	Form F-1 Amendment No. 2	333-130073		10.24	16-12-05
	10	.24*	Summary of Non-Employee Director Compensation	Form F-1 Amendment No. 3	333-130073		10.25	19-12-05
	10	.25	Form of Indemnification Agreement	Form F-1 Amendment No. 2	333-130073		10.26	16-12-05
	10	.26*	Change of Control Agreement, dated December 6, 1999, between NUCRYST Pharmaceuticals Inc. and Mr. Scott H. Gillis	Form F-1 Amendment No. 2	333-130073		10.27	16-12-05
	10	.27*	Summary of Changes to 2008 Compensation of Named Executive Officers						X
	10	.28	Fourth Amending Lease Agreement, AIMS I Second Amending Lease Agreement and Letter Agreement entered into with The Westaim Corporation	Form 8-K	000-51686		99.1 99.2 99.3	14-05-07
	10	.29*	Summary of Employment arrangement between Registrant and Mr. Barry M. Heck, effective May 23, 2007	Form 10-Q/A	000-51686		10.2	7-11-07
	10	.30*	Letter Agreement dated June 26, 2007 between Registrant and Dr. Paul J. Schechter, effective June 30, 2007	Form 10-Q/A	000-51686		10.3	7-11-07
	10	.31*	Letter Agreement between Registrant and Dr. Katherine Turner dated May 19, 2006	Form 10-Q/A	000-51686		10.4	7-11-07
	10	.32*	Summary of Amendments made effective July 1, 2007 to Letter Agreement between Registrant and Dr. Katherine Turner dated May 19, 2006	Form 10-Q/A	000-51686		10.5	7-11-07
	10	.33*	Summary of Non-Employee Director Compensation, as amended effective May 2, 2006	Form 10-Q/A	000-51686		10.6	7-11-07
	10	.34*	Deferred Share Unit Plan adopted by Registrant effective March 16, 2006	Form 10-Q/A	000-51686		10.7	7-11-07
	10	.35*	Summary of Non-Employee Director Compensation, as amended effective June 14, 2007	Form 10-Q/A	000-51686		10.8	7-11-07

102


Exhibit									Filed
No.			Description	Form	SEC File No.	Exhibit		Date	Herewith

	10	.36*	Summary of 2007 Named Executive Performance Targets under Registrant’s variable pay program	Form 10-Q/A	000-51686		10.9	7-11-07
	10	.37*	Form of Director Restricted Stock Unit Award Agreement	Form 8-K	000-51686		99.1	20-12-06
	10	.38*	Form of Restricted Stock Unit Award Agreement — Executive Officer	Form 10-Q/A	000-51686		10.12	7-11-07
	10	.39*	Employment Agreement between the Registrant and Mr. Thomas E. Gardner dated Aug 21, 2007	Form 8-K	000-51686		10.29	23-08-07
	10	.40*	Summary of Termination of employment arrangement with Mr. Barry M. Heck effective August 22, 2007	Form 10-Q	000-51686		10.6	7-11-07
	10	.41*	Separation Agreement and General Release between the Registrant and Mr. Scott H. Gillis, effective September 25, 2007	Form 10-Q	000-51686		10.7	7-11-07
	10	.42†	Amended and Restated Supply Agreement, dated September 30, 2007, among the Registrant, Smith & Nephew, Inc. and T.J. Smith & Nephew Limited, effective January 1, 2007	Form 8-K/A	000-51686		99.1	6-11-07
	10	.43†	Second Amended and Restated License and Development Agreement, dated September 30, 2007, among the Registrant, NUCRYST Pharmaceuticals Inc., Smith & Nephew, Inc., and T.J. Smith & Nephew Limited	Form 8-K/A	000-51686		99.2	6-11-07
	10	.44	Surrender of Lease with Sherritt International Corporation dated June 30, 2007 for surrender of the first floor of the AIMS I Building						X
	10	.45	Surrender of Lease with Sherritt International Corporation dated September 30, 2007 for surrender of the third floor of the AIMS I Building						X
	10	.46*	Letter Agreement made effective September 1, 2007 amending the Letter Agreement between the Registrant and Mr. David C. McDowell dated June 15, 2005						X
	10	.47*	Letter Agreement made effective January 1, 2008 amending the Letter Agreement between the Registrant and Mr. Eliot Lurier dated March 16, 2005						X
	10	.48*	Letter Agreement made effective January 1, 2008 amending the Letter Agreement between the Registrant and Dr. Katherine Turner dated May 19, 2006						X

103

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf of the registrant by the undersigned, thereunto duly authorized in the town of Wakefield, Massachusetts on February 28, 2008.

NUCRYST PHARMACEUTICALS CORP.


	By:	/s/ Thomas E. Gardner

Thomas E. Gardner

President, Chief Executive Officer and

Chairman of the Board

POWER OF ATTORNEY

We, the undersigned officers and directors of NUCRYST Pharmaceuticals Corp., hereby severally constitute and appoint Thomas E. Gardner and Eliot M. Lurier, and each of them singly, our true and lawful attorneys, with full power to them and each of them singly, to sign for us in our names in the capacities indicated below, all amendments to this Annual Report on Form 10-K, and generally to do all things in our names and on our behalf in such capacities to enable NUCRYST Pharmaceuticals Corp. to comply with the provisions of the Securities Act of 1934, as amended, and all requirements of the Securities and Exchange Commission. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and effective February 28, 2008.


Name				Title

/s/ Thomas E. Gardner Thomas E. Gardner				President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)

/s/ Eliot M. Lurier Eliot M. Lurier				Vice President — Finance and Administration, Chief Financial Officer (Principal Financial and Accounting Officer)

/s/ Barry M. Heck Barry M. Heck				Director

/s/ Neil Carragher Neil Carragher				Director

/s/ Roger G. H. Downer Roger G. H. Downer				Director

/s/ David Poorvin David Poorvin				Director

/s/ Richard Zahn Richard Zahn				Director

105


	NASDAQ
Date	Healthcare Index		NASDAQ		NCST

2005		100.00		100.00		100.00
2006		100.09		109.52		47.16
2007		111.01		109.81		29.54


†	Confidential treatment has been granted for portions of this exhibit.

*	Indicates management compensatory plan, contract or arrangement.


1.	an increase of the base salary of David C. McDowell, Vice President, Manufacturing Operations to $250,000 CDN, effective January 1, 2008;

2.	the granting to Mr. McDowell of 100,000 options to purchase our common shares, effective February 21, 2008, provided, however, should the grant date fall within a trading blackout of NUCRYST, the effective date of the grant will be the second business day following the expiration of the blackout period (the “Option Grant Date”). The options shall be exercisable as to one third of such grant on each of the first, second and third anniversaries of the Option Grant Date and will expire 10 years after the Option Grant Date;

3.	an increase of the base salary of Carol L. Amelio, Vice President, General Counsel and Corporate Secretary to $210,000 CDN, effective January 1, 2008; and

4.	the granting to Ms. Amelio of 50,000 options to purchase our common shares, effective February 21, 2008, provided, however, should the grant date fall within a trading blackout of NUCRYST, the effective date of the grant will be the second business day following the expiration of the blackout period (the “Option Grant Date”). The options shall be exercisable as to one third of such grant on each of the first, second and third anniversaries of the Option Grant Date and will expire 10 years after the Option Grant Date.


SHERRITT INTERNATIONAL CORPORATION		NUCRYST PHARMACEUTICALS CORP.

Per:	/s/ Cresia Rosichuk for Peter Cordingley	Per:	/s/ Eliot M. Lurier

	Name: Cresia Rosichuk		Eliot M. Lurier
	Title: Purchasing Supervisor		Vice President, Finance & Administration, Chief Financial Officer

		Per:	/s/ Carol L. Amelio

			Carol L. Amelio
			Vice President, General Counsel & Corporate Secretary


NUCRYST Pharmaceuticals Corp.
Per: /s/ Thomas E. Gardner
Thomas E. Gardner
President & CEO Chairman of the Board


NUCRYST Pharmaceuticals Inc.
Per: /s/ Thomas E. Gardner
Thomas E. Gardner
President & CEO Chairman of the Board


•	Plan Objective

•	Performance Period

•	Corporate Performance Measure

•	Performance Levels


•	Who’s Eligible

•	Who’s Eligible to Receive a Payout

•	Sale of Part of Business

•	The Last Word

•	Key Dates


Threshold		• the minimum level of performance necessary to earn a payout
		• there will be no payout for performance below Threshold
		• there is an 80% probability of attaining at least Threshold performance measures
Target		• the expected level of performance
Stretch		• the level of performance beyond Target that earns the maximum payout
		• the largest payout opportunity; there is a 20% probability of attaining Stretch performance measures


	Incentive Payout
	(as a % of base salary)
	Threshold	Target	Stretch

Vice Presidents	20%	40%	70%
Directors/Associate Directors	10%	20%	40%
Manager/Professional	5%	10%	20%
• includes those who have attained full professional status, or are employed in a profession and have equivalent knowledge through direct field experience
Technical/Operating	2.5%	5%	10%
• includes technologists, technicians, operators, clerks, secretaries, analysts, material processors, production assistants and developing professionals


Corporate Performance Measures Set		Fourth Quarter for next Program year
Individual Performance Measures Set		Fourth Quarter for next Program year
Performance Updates		Quarterly
Incentive Program Payouts		Prior to February 28


	•	Employees: Designated employees of the Company

	•	New hires: prorated based on start date

	•	Regular part-time: prorated based on time worked in a given year

	•	Leave of Absence: prorated based on time worked in a given year

	•	Involuntary Leave-Short Term Disability: prorated for any absence that exceeds 2 months of continuous absence or 40 working days in a calendar year

	•	Eligible Retirement: prorated based on time worked

	•	Resignation or Termination (with or without cause): no payout

	•	Death: prorated based on time worked during the year; payout to eligible beneficiary or estate

	•	Employment: must be on company payroll on payout date

	•	Temporary and casual, including summer students: not eligible to participate

	•	Contract employees: not eligible to participate (the incentive may be built into a long term contract at the time of hire)


A:	Yes. If the Threshold corporate measure is not attained in respect of each Annual Goal, you will not receive a payout.


A:	The payout will be a percentage of your base salary and will be determined based on the level of results attained for each of the Annual Goals set by the Company and on your position within NUCRYST, as follows:


A	Your regular earnings as reported on your paystub will be used to calculate your payout. Regular earnings at the end of the year will have taken into account any changes to your regular earnings, such as a salary increase. Regular earnings excludes any overtime, premiums, bonuses or taxable benefits.


A	Your payout will be prorated for the time spent at each level. So, if you were at a 5% Technical/Operating level and were increased to the Manager/Professional Level of 10% on July 1st, your payout would be prorated 6 months at the 5% level and 6 months at the 10% level.


A:	The percentage payout will be calculated using 1 decimal point. Eg. (5.32% will be 5.3%) and (5.35% will be 5.4%).


A:	If we hit at least the minimum Threshold level and there is a payout, the amount each employee receives will depend on their position within the Company. This decision was made based on comparative market practices. We went to the external market and looked at our comparator companies to see what they were doing in terms of distributing a payout.


A:	The measures are set based on input from a variety of sources: industry data, financial reports, past performance, senior business leaders, the Executive team, the Board of Directors and, of course, employees.


	•	Threshold — there is an 80% probability the measure will be attained

	•	Target — the expected outcome

	•	Stretch — there is a 20% probability the measure will be attained


A:	As an example, if the goal is to increase revenue by 5% (Threshold), 10% (Target), and 25% (Stretch), we see that the plan will payout as long as the revenue increases anywhere from 5% to 25%. The plan is designed so that performance levels attained between the Threshold, Target and Stretch measures will be interpolated to determine the payout levels.


A:	Most Likely. As our business strategy changes, it may be necessary to change the corporate measure to support our corporate objectives. The intent is to set measures that are appropriate for the business strategy, measures that may change as the strategy changes.


A:	We are committed to timely, effective communication to ensure that all employees know exactly where we stand relative to our targets. Business unit/subsidiaries will provide updates with respect to their performance. In this way, we can support our collective efforts to reach our maximum payout targets.


A:	Payout will be cash paid out by separate cheque in addition to your regular paycheque. Applicable income taxes will be withheld.


A:	NUCRYST will make every effort to pay out before the end of February following the completion of the previous year’s plan. This will allow enough time for the financial results to be calculated and cheques to be issued before the close of the RRSP season.


A:	If you take a voluntary leave of absence, retire as defined by the Company pension plans, or die during the Program year, you will receive a payout based on your regular earnings as reported on your pay stub.


A:	You must be actively at work on the Company payout date. If you have resigned or you have been terminated, whether with or without cause, from employment prior to the payout date you will not receive any payout. The exceptions are outlined in the previous question.


A:	You will receive a payout at the Target level. The payout will be for the portion of the year you were an employee of NUCRYST. For example, if the sale or spin out transaction is effective May 1, you will receive 4/12 X the Target level X your regular earnings as on your pay stub.


A:	The plan and its outcomes will be reviewed at the end of each year by the Executive Team to ensure it continues to reflect business performance and priorities.


Position:		General Counsel and Corporate Secretary

Reporting To:		Scott Gillis, President

Start Date:		February 1, 2006

Base Salary:		$160,000.00 per annum, payable in equal semi-monthly installments.

Variable Pay:		An annual bonus based on the Company’s variable pay program, utilizing the following percentages of base salary:


		Variable Pay under the Nucryst program for 2006 will be calculated from January 1, 2006.

Long Term Incentives:		You will participate in the NUCRYST Pharmaceuticals Corp. 1998 Equity Incentive Plan, as amended, (“Plan”) whereby you will be granted 10,000 stock options. Your options will have an exercise price equal to the exercise price for options issued under the Plan in effect on your commencement date.