|
|

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-Q

(Mark One)

|                                             |                                                                                              | 
|-------------------------------------------- | -------------------------------------------------------------------------------------------- | 
|[X]                                          | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934
|                                            
|For the quarterly period ended June 30, 2009

|                                                         |                                                                                               | 
|-------------------------------------------------------- | --------------------------------------------------------------------------------------------- | 
|[  ]                                                     | 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 1-31070                          

Derma Sciences, Inc.(Exact name of small business issuer as specified in its charter)

|Pennsylvania                                                        | 23-2328753                               
|------------------------------------------------------------------- | -----------------------------------------
|(State or other jurisdiction of
     incorporation or organization) | (I.R.S. Employer Identification
     No.)

214 Carnegie Center, Suite 300Princeton, New Jersey
08540(Address of principal executive
offices)

(609) 514-4744(Issuer's telephone number)

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.þYes   oNo

Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted pursuant to Rule 405 of
Regulation S-T during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files).  
Yes oNo o

Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer,
or a smaller reporting company. See the definitions of large accelerated filer, accelerated
filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):

| |                         |   |                                               |                           |  
| | ----------------------- | - | --------------------------------------------- | ------------------------- | -
| | Large accelerated filer | o |                                               | Accelerated filer         | o
| | Non-accelerated filer   | o | (Do not check if a smaller reporting company) | Smaller reporting company | þ

Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act).  Yeso Noþ

Indicate the number of shares of each of the issuer's classes of
common equity, as of the latest practicable date.

|                      |        |                                       
|--------------------- | ------ | --------------------------------------
|Date: August 14, 2009 | Class: | Common Stock, par value $.01 per share
|                      |        | Shares Outstanding: 40,315,743        

|
|

Part I

DERMA SCIENCES, INC.

FORM 10-Q

INDEX

|                               |         |                                                                                                                      |   
|------------------------------ | ------- | -------------------------------------------------------------------------------------------------------------------- | --
|Description                    | Page   
|Part I  Financial Information
|                               | Item 1. | Financial Statements                                                                                                 |   
|                               |         | Condensed Consolidated Balance
     Sheets - June 30, 2009 (Unaudited) andDecember 31, 2008                          | 3 
|                              
|                               |         | Condensed Consolidated Statements of
     Operations  Three months endedJune 30, 2009 and June 30, 2008 (Unaudited) | 4 
|                              
|                               |         | Condensed Consolidated Statements of
     Operations  Six months endedJune 30, 2009 and June 30, 2008 (Unaudited)   | 5 
|                              
|                               |         | Condensed Consolidated Statements of
     Cash Flows  Six months endedJune 30, 2009 and June 30, 2008 (Unaudited)   | 6 
|                              
|                               |         | Notes to Condensed Consolidated Financial
     Statements (Unaudited)                                                | 7 
|                              
|                               | Item 2. | Management's Discussion and
     Analysis of Financial Condition and Results of Operations                           | 16
|                              
|                               | Item 4. | Controls and
     Procedures                                                                                         | 32
|                              
|Part II - Other Information   
|                              
|                               | Item 4. | Submission of Matters to a Vote of Security
        Holders                                                          | 33
|                              
|                               | Item 6. | Exhibits                                                                                                             | 34

Forward Looking Statements

This document includes certain
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements are based on managements current
expectations and are subject to uncertainty and changes in circumstances. Actual results
may differ materially from these expectations due to changes in political, economic,
business, competitive, market and regulatory factors.

1

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Index

Part I  Financial
Information

Item 1. FINANCIAL
STATEMENTS

2

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Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                                     |  |                |              |                |  
|-------------------------------------------------------------------- |  | -------------- | ------------ | -------------- | -
|Condensed Consolidated Balance Sheets                               
|                                                                    
|                                                                     |  | June 30,       |             
|ASSETS                                                               |  | 2009           | December 31,
|                                                                     |  | (Unaudited)    | 2008        
|                                                                    
|Current Assets                                                       |  |                |              |                |  
|Cash and cash equivalents                                            |  | $      167,040 |              | $      391,038 |  
|Accounts receivable, net                                             |  | 3,171,963      |              | 3,892,523      |  
|Inventories                                                          |  | 11,479,212     |              | 12,423,042     |  
|Prepaid expenses and other current assets                            |  | 359,117        |              | 397,117        |  
|                                                                    
|Total current assets                                                 |  | 15,177,332     |              | 17,103,720     |  
|Cash  restricted                                                    |  | 2,025,722      |              | 2,014,422      |  
|Equipment and improvements, net                                      |  | 3,789,741      |              | 3,977,853      |  
|Goodwill                                                             |  | 7,119,726      |              | 7,119,726      |  
|Other intangible assets, net                                         |  | 4,651,249      |              | 5,310,129      |  
|Other assets, net                                                    |  | 611,308        |              | 681,472        |  
|                                                                    
|Total Assets                                                         |  | $ 33,375,078   |              | $ 36,207,322   |  
|                                                                    
|LIABILITIES AND SHAREHOLDERS' EQUITY                                 | 
|                                                                    
|Current Liabilities                                                  | 
|Line of credit borrowings                                            |  | 3,781,381      |              | 3,446,605      |  
|Current maturities of long-term debt                                 |  | 1,787,278      |              | 1,298,207      |  
|Accounts payable                                                     |  | 2,596,861      |              | 3,614,764      |  
|Accrued expenses and other current liabilities                       |  | 1,049,480      |              | 2,004,493      |  
|                                                                    
|Total current liabilities                                            |  | 9,215,000      |              | 10,364,069     |  
|Long-term debt                                                       |  | 2,923,009      |              | 4,065,036      |  
|Other long-term liabilities                                          |  | 91,661         |              | 44,848         |  
|Deferred tax liability                                               |  | 333,300        |              | 340,871        |  
|                                                                    
|Total Liabilities                                                    |  | 12,562,970     |              | 14,814,824     |  
|                                                                    
|Shareholders' Equity                                                 | 
|Convertible preferred stock, $.01 par value; 11,750,000 shares       | 
|authorized; issued and outstanding: 2,280,407 shares                 | 
|(liquidation preference of $4,210,231 at June  30, 2009)             |  | 22,804         |              | 22,804         |  
|Common stock, $.01 par value; 150,000,000 authorized; issued and     | 
|outstanding: 40,315,743 at June 30, 2009; 40,140,743 at December 31, | 
|2008                                                                 |  | 403,157        |              | 401,407        |  
|Additional paid-in capital                                           |  | 40,517,884     |              | 40,027,645     |  
|Accumulated other comprehensive income                              | 
|cumulative translation adjustments                                   |  | 850,667        |              | 604,465        |  
|Accumulated deficit                                                  |  | (20,982,404    | )            | (19,663,823    | )
|                                                                    
|Total Shareholders' Equity                                           |  | 20,812,108     |              | 21,392,498     |  
|                                                                    
|Total Liabilities and Shareholders' Equity                           |  | $ 33,375,078   |              | $ 36,207,322   |  
|                                                                    

See accompanying consolidated notes.

3

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Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                                           |  |                             |      |                 |  
|-------------------------------------------------------------------------- |  | --------------------------- | ---- | --------------- | -
|Condensed Consolidated Statements of Operations (Unaudited)                | 
|                                                                           |  | Three months ended June 30,
|                                                                           |  | 2009                        | 2008
|                                                                          
|Net Sales                                                                  |  | $ 11,563,341                |      | $ 13,083,966    |  
|Cost of sales                                                              |  | 8,135,574                   |      | 9,552,991       |  
|                                                                          
|Gross Profit                                                               |  | 3,427,767                   |      | 3,530,975       |  
|                                                                          
|Operating expenses                                                         | 
|Selling, general and administrative                                        |  | 3,703,038                   |      | 4,483,556       |  
|Research and development                                                   |  | 87,580                      |      | 106,200         |  
|                                                                          
|Total operating expenses                                                   |  | 3,790,618                   |      | 4,589,756       |  
|                                                                          
|Operating  loss                                                            |  | (362,851                    | )    | (1,058,781      | )
|                                                                          
|Other expense, net:                                                        | 
|Interest expense                                                           |  | 239,600                     |      | 232,572         |  
|Other income                                                               |  | (42,252                     | )    | (29,092         | )
|                                                                          
|Total other expense                                                        |  | 197,348                     |      | 203,480         |  
|                                                                          
|Loss before provision for income taxes                                     |  | (560,199                    | )    | (1,262,261      | )
|Provision for income taxes                                                 |  | 303                         |      | 8,227           |  
|                                                                          
|Net Loss                                                                   |  | $   (560,502                | )    | $(1,270,488     | )
|                                                                          
|Loss per common share  basic and diluted                                  |  | $         (0.01             | )    | $         (0.03 | )
|                                                                          
|Shares used in computing loss per common
        share  basic and diluted |  | 40,234,974                  |      | 40,073,710      |  
|                                                                          

See accompanying consolidated notes.

4

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Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                                   |  |                           |      |                  |  
|------------------------------------------------------------------ |  | ------------------------- | ---- | ---------------- | -
|Condensed Consolidated Statements of Operations (Unaudited)        | 
|                                                                   |  | Six months ended June 30,
|                                                                   |  | 2009                      | 2008
|                                                                  
|Net Sales                                                          |  | $  21,995,232             |      | $  24,808,788    |  
|Cost of sales                                                      |  | 15,213,830                |      | 18,135,606       |  
|                                                                  
|Gross Profit                                                       |  | 6,781,402                 |      | 6,673,182        |  
|                                                                  
|Operating expenses                                                 | 
|Selling, general and administrative                                |  | 7,567,164                 |      | 8,803,971        |  
|Research and development                                           |  | 217,926                   |      | 154,308          |  
|                                                                  
|Total operating expenses                                           |  | 7,785,090                 |      | 8,958,279        |  
|                                                                  
|Operating  loss                                                    |  | (1,003,688                | )    | (2,285,097       | )
|                                                                  
|Other expense, net:                                                | 
|Interest expense                                                   |  | 411,070                   |      | 497,487          |  
|Other income                                                       |  | (43,789                   | )    | (20,478          | )
|                                                                  
|Total other expense                                                |  | 367,281                   |      | 477,009          |  
|                                                                  
|Loss before benefit for income taxes                               |  | (1,370,969                | )    | (2,762,106       | )
|Benefit for income taxes                                           |  | (52,388                   | )    | (81,830          | )
|                                                                  
|Net Loss                                                           |  | $ (1,318,581              | )    | $ (2,680,276     | )
|                                                                  
|Loss per common share  basic and diluted                          |  | $          (0.03          | )    | $          (0.07 | )
|                                                                  
|Shares used in computing loss per common share  basic and diluted |  | 40,188,119                |      | 37,055,958       |  
|                                                                  

See accompanying consolidated notes.

5

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Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                            |  |                           |      |                |  
|----------------------------------------------------------- |  | ------------------------- | ---- | -------------- | -
|Condensed Consolidated Statements of Cash Flows (Unaudited) | 
|                                                            |  | Six months ended June 30,
|                                                            |  | 2009                      | 2008
|                                                           
|Operating Activities                                        |  |                           |      |                |  
|Net loss                                                    |  | $ (1,318,581              | )    | $ (2,680,276   | )
|Adjustments to reconcile net loss to net                    | 
|cash provided (used in) by operating activities:            | 
|Depreciation of equipment and improvements                  |  | 416,163                   |      | 471,014        |  
|Amortization of intangible assets                           |  | 658,880                   |      | 577,293        |  
|Amortization of deferred financing costs                    |  | 72,458                    |      | 57,647         |  
|Recovery of bad debts                                       |  | (62,325                   | )    | (63,000        | )
|Allowance for sales adjustments                             |  | 386,851                   |      | 653,118        |  
|Provision for inventory obsolescence                        |  | 115,280                   |      | 93,415         |  
|Deferred rent expense                                       |  | 38,534                    |      | (27,502        | )
|Compensation charge for employee stock options              |  | 478,842                   |      | 406,971        |  
|Compensation charge for restricted stock                    |  | 18,148                    |      | 24,210         |  
|Gain on sale of equipment                                   |  | (59,031                   | )    | -              |  
|Deferred income taxes                                       |  | (22,704                   | )    | (81,830        | )
|Changes in operating assets and liabilities:                | 
|Accounts receivable                                         |  | 396,033                   |      | (1,259,203     | )
|Inventories                                                 |  | 957,665                   |      | (2,149,112     | )
|Prepaid expenses and other current assets                   |  | 44,824                    |      | 56,945         |  
|Other assets                                                |  | (299                      | )    | (6,934         | )
|Accounts payable                                            |  | (1,034,217                | )    | (6,478         | )
|Accrued expenses and other current liabilities              |  | (895,339                  | )    | (1,344,859     | )
|Other long-term liabilities                                 |  | 7,310                     |      | 20,548         |  
|                                                           
|Net cash provided by (used in) operating activities         |  | 198,492                   |      | (5,258,033     | )
|                                                           
|Investing Activities                                        | 
|Costs of acquiring businesses                               |  | -                         |      | (120,484       | )
|Purchase of equipment and improvements                      |  | (113,200                  | )    | (288,949       | )
|Refund of acquired business escrow funds                    |  | -                         |      | 1,193,187      |  
|Proceeds from sale of equipment                             |  | 61,000                    |      | -              |  
|                                                           
|Net cash (used in) provided by investing activities         |  | (52,200                   | )    | 783,754        |  
|                                                           
|Financing Activities                                        | 
|Net change in bank line of credit                           |  | 334,776                   |      | 3,226,926      |  
|Deferred financing costs                                    |  | -                         |      | (269,236       | )
|Long-term debt repayments                                   |  | (652,957                  | )    | (653,543       | )
|Net change in restricted cash                               |  | (11,300                   | )    | -              |  
|Proceeds from issuance of stock, net of costs               |  | (5,000                    | )    | 5,741,793      |  
|                                                           
|Net cash (used in) provided by financing activities         |  | (334,481                  | )    | 8,045,940      |  
|                                                           
|Effect of exchange rate changes on cash                     |  | (35,809                   | )    | (64,558        | )
|                                                           
|Net (decrease) increase in cash and cash equivalents        |  | (223,998                  | )    | 3,507,103      |  
|Cash and cash equivalents                                   | 
|Beginning of period                                         |  | 391,038                   |      | 577,096        |  
|                                                           
|End of period                                               |  | $     167,040             |      | $  4,084,199   |  
|                                                           
|Supplemental disclosures of cash flow information:          | 
|Equipment obtained with capital lease                       |  | -                         |      | $       96,324 |  
|Cash paid during the period for:                            | 
|Interest                                                    |  | $     303,613             |      | $     439,538  |  
|                                                           

See accompanying consolidated notes.

6

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|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

1.     Organization and
Summary of Significant Accounting Policies

Derma
Sciences, Inc. and its subsidiaries (the Company) is a full line provider of
wound care, wound closure and specialty securement devices and skin care products. The
Company markets its products principally through independent distributors servicing the
long-term care, home health and acute care markets in the United States, Canada and other
select international markets. The Companys U.S. distribution facilities are located
in St. Louis, Missouri and Houston, Texas, while the Companys Canadian distribution
facility is located in Toronto. The Company has manufacturing facilities in Toronto,
Canada and Nantong, China.

Basis
of Presentation

The
accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America
for interim financial information and with the instructions to Form 10-Q and Article 8 of
Regulation S-X. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of America for
complete financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation have been
included. Operating results for the three and six months ended June 30, 2009, are not
necessarily indicative of the results that may be expected for the year ending December
31, 2009. Information included in the condensed balance sheet as of December 31, 2008 has
been derived from the consolidated financial statements and footnotes thereto for the year
ended December 31, 2008, included in Form 10-K previously filed with the Securities and
Exchange Commission. For further information, refer to that Form 10-K.

Recent
Accounting Pronouncements

Effective
January 1, 2009, the Company adopted Emerging Issues Task Force (EITF)
Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to
an Entitys Own Stock (EITF 07-5). EITF 07-5 provides guidance
in assessing whether an equity-linked financial instrument (or embedded feature) is
indexed to an entitys own stock for purposes of determining whether the appropriate
accounting treatment falls under the scope of Statement of Financial Accounting Standards
(SFAS) No. 133, Accounting For Derivative Instruments and Hedging
Activities and/or EITF 00-19, Accounting For Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Companys Own Stock. The adoption of EITF
07-5 had no impact on the consolidated financial statements.

In
April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about
Fair Value of Financial Instruments (FSP 107-1), which the Company adopted for
the quarterly period beginning April 1, 2009. FSP 107-1 requires an entity to provide
the annual disclosures required by SFAS No. 107, Disclosures about Fair Value of
Financial Instruments, in its interim financial statements.  The adoption of FSP
107-1 had no material impact on the consolidated financial statements.

In
May 2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS
165), which establishes general standards of accounting for and disclosure of
events that occur after the balance sheet date but before financial statements are issued
or are available to be issued.  This statement sets forth the circumstances under
which an entity should recognize events or transactions occurring after the balance sheet
date in its financial statements. SFAS 165 also requires the disclosure of the date
through which an entity has evaluated subsequent events and the basis for that date  that
is, whether that date represents the date the financial statements were issued or were
available to be issued.  The Company adopted SFAS 165 during the three months ended
June 30, 2009. In accordance with SFAS 165, the Company evaluated subsequent events
through the date and time the financial statements were issued on August 14, 2009.

Net
Loss per Share  Net loss per common share  basic is computed by dividing net
loss by the weighted average number of common shares outstanding for the period. Net loss
per common share  diluted reflects the potential dilution of earnings by including
the effects of the assumed exercise, conversion or issuance of potentially issuable shares
of common stock (potentially dilutive securities), including those
attributable to stock options,

7

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|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

warrants, convertible preferred
stock and restricted common stock in the weighted average number of common shares
outstanding for a period, if dilutive. The effects of the assumed exercise of warrants
and stock options are determined using the treasury stock method. Potentially dilutive
securities have not been included in the computation of diluted loss per share for the
three and six months ended June 30, 2009 and 2008 as the effect would be anti-dilutive.

Potentially
dilutive shares excluded as a result of the effects being anti-dilutive are as follows:

|                          |  |            |  |            | 
|------------------------- |  | ---------- |  | ---------- | 
|                          |  | 2009       |  | 2008      
|Excluded dilutive shares: |  |            |  |            | 
|Preferred stock           |  | 2,280,407  |  | 2,280,407  | 
|Restricted common stock   |  | -          |  | 175,000    | 
|Stock options             |  | 9,415,625  |  | 8,316,480  | 
|Warrants                  |  | 8,795,259  |  | 11,405,259 | 
|                         
|Total dilutive shares     |  | 20,491,291 |  | 22,177,146 | 

Reclassifications
 Certain reclassifications have been made to prior period reported amounts to
conform with the 2009 presentation.

2.      Inventories

Inventories
include the following:

|                    |  |              |  |                  | 
|------------------- |  | ------------ |  | ---------------- | 
|                    |  | June 30,2009 |  | December 31,2008 | 
|                   
|Finished goods      |  | $  7,345,926 |  | $  9,001,269     | 
|Work in process     |  | 425,390      |  | 443,511          | 
|Packaging materials |  | 736,282      |  | 700,948          | 
|Raw materials       |  | 2,971,614    |  | 2,277,314        | 
|                   
|Total inventory     |  | $11,479,212  |  | $12,423,042      | 

3.      Line of Credit
Borrowings

In
November 2007, the Company entered into a new five-year revolving credit agreement
providing for maximum borrowings of $8,000,000 with a U.S. lender. Advances under the
revolving credit agreement may be drawn, from time to time, up to the amount of 85% of
eligible receivables (as defined) and 44% of eligible inventory (as defined). Interest on
outstanding advances under the revolving credit agreement was payable at the LIBOR monthly
rate (the Base Rate) plus 2.75% (the Base Rate Margin). In
addition, the Company pays a monthly unused line fee of 0.5% per annum on the difference
between the daily average amount of advances outstanding under the agreement and
$8,000,000 together with a monthly collateral management fee of $2,000. Outstanding
balances under the agreement are secured by all of the Companys and its
subsidiaries existing and after-acquired tangible and intangible assets located in
the United States and Canada.

On
March 31, 2009, the Companys U.S. lender agreed to amend the credit and security
agreement to allow the Company to enter into a forbearance agreement with Western Medical
to postpone payment of its promissory note due April 18, 2009 and to allow subsequent
payments on the subordinated debt beginning in April 2010 provided the Company achieves
predetermined liquidity and free cash flow (as defined) objectives and provided Western
Medical further extends for one year the payment of the principal balance, if any,
remaining on the

8

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|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

promissory note after giving effect
to the April, 2010 payment. In return for the amendment, the Company agreed to change its
base rate for interest charged to a three month LIBOR rate from a one month LIBOR rate.
Further, effective April 1, 2009 the base rate margin was increased 150 basis points on
the revolving line of credit from 2.75% to 4.25%, on the term loan from 4.25% to 5.75%
and on the portion of the term loan secured by restricted cash from 2.25% to 3.75%. In
addition, the Company is obligated to increase the revolving loan availability on its
revolving line of credit to a minimum of $3,000,000 by December 31, 2009. Failure to
achieve the minimum revolving loan availability amount will result in the base rate
changing to the greater of 3.00% or the actual rate in effect. At June 30, 2009 the
effective interest rate was 4.85% and the outstanding balance was $3,781,381 under the
amended credit and security agreement.

The
revolving credit agreement, as amended, is subject to financial covenants which require
maintaining a minimum cumulative EBITDA level and certain ratios of fixed charge coverage,
senior debt leverage and total debt leverage as defined in the agreement. Additional
covenants governing permitted investments, indebtedness and liens, together with payments
of dividends and protection of collateral, are also included in the agreement. The amended
revolving credit agreement contains a subjective acceleration provision whereby the lender
can declare a default upon a material adverse change in the Companys business
operations.

Effective
August 13, 2008, the Companys lender agreed to waive all prior financial and
reporting covenant defaults and amend the existing minimum EBITDA, fixed charge coverage,
senior debt leverage and total debt leverage covenants to allow the Company to continue to
implement its growth strategy in line with the lenders minimum liquidity terms.
Amendment of the covenants was predicated upon the Company segregating $2,000,000 in a
restricted account the use of which is subject to the approval of the lender. The
Companys maximum revolver borrowing capacity remained unchanged. The Company
incurred fees of $25,000 associated with the granting of the covenant amendment.

Effective
March 28, 2008, the Companys U.S. lender agreed to waive all prior financial and
reporting covenant defaults and amend the existing minimum EBITDA, fixed charge coverage,
senior debt leverage and total debt leverage covenants, to be measured on a quarterly
basis, to allow the Company to implement its growth strategy. Amendment of the covenants
was predicated upon the Companys commitment to raise a minimum of $3,000,000 by May
1, 2008 from the sale of equity and agreement to limit its maximum revolver borrowing to
the lesser of (a) the revolver loan commitment ($8,000,000) or (b) the borrowing base (as
defined), less $1,500,000. Not less than $3,000,000 of the equity infusion was required to
be applied to the outstanding revolver balance which amount is credited as a component of
EBITDA for covenant compliance purposes. The Company incurred fees of $250,000 associated
with the granting of the covenant amendment, together with related expenses of $10,829
which are included as additions to deferred financing costs. In March 2008, the equity
infusion requirement was met (see Note 5).

4.      Long-Term Debt

Long-term
debt consists of the following:

|                          |  |              |  |                  | 
|------------------------- |  | ------------ |  | ---------------- | 
|                          |  | June 30,2009 |  | December 31,2008 | 
|                         
|U.S. term loan            |  | $4,100,000   |  | $4,700,000       | 
|Promissory note           |  | 500,000      |  | 500,000          | 
|Capital lease obligations |  | 110,287      |  | 163,243          | 
|                         
|Total debt                |  | 4,710,287    |  | 5,363,243        | 
|                         
|Less: current maturities  |  | 1,787,278    |  | 1,298,207        | 
|                         
|Long-term debt            |  | $2,923,009   |  | $4,065,036       | 

9

---



|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

U.S.
Term Loan

In
November 2007, the Company entered into a five-year $6,000,000 term loan agreement with a
U.S. lender. On March 31, 2009 the term loan agreement was amended. Under the amended
agreement interest on the term loan is payable at the LIBOR three month rate plus 5.75%,
(6.35% at June 30, 2009) and on the portion of the term loan secured by restricted cash
3.75% (4.35% at June 30, 2009). Monthly payments of principal in the amount of $100,000
together with interest are due under the amended agreement. The amended agreement is
secured by all of the Companys and its subsidiaries existing and
after-acquired tangible and intangible assets located in the United States and Canada.

The
amended term loan agreement is subject to financial covenants which require maintaining a
minimum cumulative EBITDA level and certain ratios of fixed charge coverage, senior debt
leverage and total debt leverage as defined in the agreement. Additional covenants
governing permitted investments, indebtedness and liens, together with payments of
dividends and protection of collateral, are also included in the amended agreement. The
amended term loan agreement contains a subjective acceleration provision whereby the
lender can declare a default upon a material adverse change in the Companys business
operations.

Effective
August 13, 2008 and March 28, 2008, the foregoing financial covenants were amended as
described in the fourth and fifth paragraphs under the heading Line of Credit Borrowings
(see Note 3).

Promissory
Note

In
connection with the acquisition of Western Medical in April 2006, a portion of the
purchase price was paid via a three-year unsecured promissory note issued to the seller.
The promissory note originally provided for the payment of simple interest of 12% in 11
quarterly installments of $15,000 and a final payment of accrued interest of $15,000 and
the principal balance of $500,000 on April 18, 2009.

On
March 31, 2009, the Company entered into a Forbearance Agreement (the
Agreement) with Western Medical to postpone payment of its $500,000 promissory
note due April 18, 2009. The Company will continue to make interest payments when due and
a final payment of the principal plus accrued interest through the date of payment on
April 14, 2010. In consideration for the postponement, the Company agreed to grant Western
Medical warrants to purchase 50,000 shares of the Companys common stock at the
market price on the date of execution of the Agreement. The value of the warrants is being
recognized as interest expense over the postponement period.

Capital
Lease Obligations

The
Company has two capital lease obligations for certain office furniture and distribution
equipment totaling $110,287 as of June 30, 2009. The capital lease obligations bear
interest at annual rates ranging from 6.8% to 9.6% with the longest lease term expiring in
February 2011.

5.      Shareholders
Equity

Preferred
Stock

There
are 150,003 shares of series A convertible preferred stock outstanding at June 30, 2009.
The series A preferred stock is convertible into common stock on a one-for-one basis,
bears no dividend, maintains a liquidation preference of $4.00 per share, votes as a class
on matters affecting the series A preferred stock and maintains voting rights identical to
the common stock on all other matters.

There
are 440,003 shares of series B convertible preferred stock outstanding at June 30, 2009.
The series B preferred stock is convertible into common stock on a one-for-one basis,
bears no dividend, maintains a liquidation preference of $6.00 per share, votes as a class
on matters affecting the series B preferred stock and maintains voting rights identical to
the common stock on all other matters.

10

---



|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

There
are 619,055 shares of series C convertible preferred stock outstanding at June 30, 2009.
The series C preferred stock is convertible into common stock on a one-for-one basis,
bears no dividend, maintains a liquidation preference averaging $0.70 per share, votes as
a class on matters affecting the series C preferred stock and maintains voting rights
identical to the common stock on all other matters.

There
are 1,071,346 shares of series D convertible preferred stock outstanding at June 30, 2009.
The series D preferred stock is convertible into common stock on a one-for-one basis,
bears no dividend, maintains a liquidation preference averaging $0.50 per share, votes as
a class on matters affecting the series D preferred stock and maintains voting rights
identical to the common stock on all other matters.

Common
Stock

Effective
May 12, 2009, 175,000 shares of common stock were issued to outside directors upon vesting
of compensatory restricted stock granted on May 12, 2006.

In
March 2008, the Company raised $5,610,871 (net of $489,129 in commission and other
offering expenses) from the private sale of 6,100,000 shares of common stock at a price of
$1.00 per share, together with 3,050,000 five-year warrants to purchase one share of
common stock at a price of $1.20 per share. In addition, the placement agent for the
shares sold received 142,500 five-year warrants to purchase one share of common stock at
$1.20 per share. The proceeds were used to meet the minimum equity infusion requirements
associated with the Companys March 28, 2008 amended bank covenants, support the
Companys strategic growth initiatives and increase working capital.

In
January 2008, the Company issued 210,988 shares of common stock as follows: (a) 100,000
shares in consideration of $105,000 upon exercise of series G warrants, (b) 19,800 shares
in consideration of $12,375 upon exercise of 19,800 stock options, and (c) 91,188 shares
upon cashless exercise of 178,200 stock options.

Stock
Purchase Warrants

At
June 30, 2009, the Company had warrants outstanding to purchase 8,795,259 shares of the
Companys common stock as outlined below:

|       |  |                   |  |                |  |                 | 
|------ |  | ----------------- |  | -------------- |  | --------------- | 
|Series |  | Number ofWarrants |  | Exercise Price |  | Expiration Date | 
|      
|H      |  | 2,655,098         |  | $1.00          |  | April 30,2011   | 
|I      |  | 754,806           |  | $0.72          |  | April30, 2011   | 
|J      |  | 2,142,855         |  | $0.77          |  | May 31, 2013    | 
|K      |  | 3,192,500         |  | $1.20          |  | April 1, 2013   | 
|L      |  | 50,000            |  | $0.39          |  | March 31, 2014  | 
|      
|Total  |  | 8,795,259         | 

Stock
Options

The
Company has a stock option plan under which options to purchase a maximum of 10,000,000
shares of common stock may be issued. The plan permits the granting of both incentive
stock options and nonqualified stock options to employees and directors of the Company and
certain outside consultants and advisors to the Company. The option exercise price may not
be less than the fair market value of the stock on the date of the grant of the option.
The duration of each option may not exceed 10 years from the date of grant. Under the
plan, options to purchase 1,640,000 and 325,000 shares of common stock were granted to
officers, directors, agents and employees for the six months ended June 30, 2009 and 2008,
respectively, with exercise prices ranging from $0.36 to $1.11 per share. For the six
months ended June 30, 2009 and 2008, 10,000 plan options were forfeited and for the six
months ended June 30, 2008, 198,000 plan options were exercised. As of June 30, 2009,
options to purchase 7,759,625 shares of the Companys common stock were issued and
outstanding under the plan.

11

---



|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

The
Company has previously granted nonqualified stock options to officers, directors, agents
and employees outside of the stock option plan (non-plan options). All
non-plan options were granted at the fair market value at the date of grant. During the
six months ended June 30, 2009 and 2008, 237,000 and 24,000 non-plan options expired,
respectively. As of June 30, 2009, non-plan options to purchase 1,656,000 shares of the
Companys common stock were issued and outstanding.

A
summary of the Companys stock option activity and related information for the six
months ended June 30, 2009 and 2008 follows:

|                        |  |           |   |                               |  |           |   |                               | 
|----------------------- |  | --------- | - | ----------------------------- |  | --------- | - | ----------------------------- | 
|                        |  | 2009      |   | 2008                          | 
|                       
|                        |  | Options   |   | WeightedAverageExercise Price |  | Options   |   | WeightedAverageExercise Price | 
|                       
|Outstanding  January 1 |  | 8,022,625 |   | $0.69                         |  | 8,223,480 |   | $0.78                         | 
|Granted                 |  | 1,640,000 |   | $0.38                         |  | 325,000   |   | $0.92                         | 
|Forfeited               |  | (10,000   | ) | $0.75                         |  | (10,000   | ) | $1.22                         | 
|Expired                 |  | (237,000  | ) | $1.11                         |  | (24,000   | ) | $5.10                         | 
|Exercised               |  | -         |   | $  -                          |  | (198,000  | ) | $0.62                         | 
|                       
|Outstanding  June 30   |  | 9,415,625 |   | $0.63                         |  | 8,316,480 |   | $0.78                         | 
|                       
|Exercisable at June 30  |  | 6,590,625 |   | $0.68                         |  | 6,155,230 |   | $0.81                         | 

During
the six months ended June 30, 2009 and 2008 the fair value of each service and performance
based option award was estimated at the date of grant using the Black-Scholes option
pricing model. The weighted-average assumptions used during the three and six months ended
June 30, 2009 and 2008 were as follows:

|                             |                             |                           |       |      
|---------------------------- | --------------------------- | ------------------------- | ----- | -----
|                             | Three Months Ended June 30, | Six Months Ended June 30,
|                             | 2009                        | 2008                      | 2009  | 2008 
|                            
|Risk-free interest rate      | 2.34%                       | 3.26%                     | 2.30% | 3.05%
|Volatility factor            | 89.9%                       | 107.5%                    | 92.3% | 119% 
|Dividend yield               | 0%                          | 0%                        | 0%    | 0%   
|Expected option life (years) | 6.25                        | 6.25                      | 6.25  | 6.25 
|Contractual life (years)     | 10                          | 10                        | 10    | 10   

In
both 2009 and 2008, the risk-free rate utilized represents the U.S. Treasury yield curve
rate which approximates the risk-free rate for the expected option life at the time of
grant. In 2009 and 2008, the volatility factor was calculated based on the seventy-five
month-end closing prices of the Companys common stock preceding the month of stock
option grant. The Company uses a seventy-five month volatility period to coincide with the
expected stock option life. Based on guidance from Staff Accounting Bulletin 107 and 110,
a stock option life of 6.25 years was utilized under the simplified method. The dividend
yield is 0% since the Company does not anticipate paying dividends in the near future.
Based on the Companys historical experience of options that expire or are cancelled
before becoming fully vested, the Company assumed an annualized forfeiture rate of 1.0%
for all options. Under the true-up provision of SFAS 123R, the Company will record
additional expense if the actual forfeiture rate is lower than estimated, and will record
a recovery of prior expense if the actual forfeiture rate is higher than estimated.

12

---



|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

The
weighted average fair value per share of options granted during the six months ended June
30, 2009 and 2008 was $0.30 and $0.80, respectively. During the six months ended June 30,
2009 and 2008, stock option compensation expense was recorded using the fair value method
under SFAS 123R as follows:

|                                             |  |                             |  |                           |  |            |  |            | 
|-------------------------------------------- |  | --------------------------- |  | ------------------------- |  | ---------- |  | ---------- | 
|                                             |  | Three Months Ended June 30, |  | Six Months Ended June 30, | 
|                                             |  | 2009                        |  | 2008                      |  | 2009       |  | 2008       | 
|                                            
|Cost of sales                                |  | $   23,327                  |  | $   16,158                |  | $   50,437 |  | $   26,013 | 
|Selling, general and administrative expenses |  | 226,432                     |  | 203,469                   |  | 428,405    |  | 380,958    | 
|                                            
|Total stock option compensation expense      |  | $ 249,759                   |  | $ 219,627                 |  | $ 478,842  |  | $ 406,971  | 

As
of June 30, 2009, there was $689,126 of unrecognized compensation cost related to
nonvested service based awards and $353,378 related to nonvested market based awards
granted under the plan. That cost is expected to be recognized over the options
remaining weighted average vesting period of 1.50 years for service and performance based
options and 0.40 years for market based options.

For the six months ended June 30,
2009 and 2008, no income tax benefit was recognized related to stock option activity.

Restricted
Common Stock

On
May 11, 2006, the Company adopted a restricted common stock plan and reserved 2,500,000
shares of common stock for issuance.

On
May 12, 2006, 175,000 shares of restricted common stock were granted to non-employee
members of the Companys board of directors and vested three years from the date of
the grant. The fair market value at the date of grant, determined by the quoted market
price, was $145,250 or $0.83 per share. The fair market value of the grant was recognized
as compensation expense over the three-year service period. For the six months ended June
30, 2009 and 2008, $18,148 and $24,210 was recorded in operating expense respectively for
these grants. On May 12, 2009 all of the outstanding restricted common stock became fully
vested.

Shares
Reserved for Future Issuance

At
June 30, 2009, the Company had reserved the following shares of common stock for future
issuance:

|                                                 |            | 
|------------------------------------------------ | ---------- | 
|Convertible preferred shares (series A - D)      | 2,280,407  | 
|Common stock options available for grant         | 2,240,375  | 
|Common stock options outstanding                 | 9,415,625  | 
|Common stock warrants outstanding (series H - L) | 8,795,259  | 
|Restricted common stock available for grant      | 2,325,000  | 
|                                                
|Total common stock shares reserved               | 25,056,666

13

---



|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

6.      Comprehensive Loss

The
Companys comprehensive loss was as follows:

|                                        |  |                            |   |                          |   |              |   |              |  
|--------------------------------------- |  | -------------------------- | - | ------------------------ | - | ------------ | - | ------------ | -
|                                        |  | Three Months EndedJune 30, |   | Six Months EndedJune 30, |  
|                                        |  | 2009                       |   | 2008                     |   | 2009         |   | 2008         |  
|                                       
|Net loss as reported                    |  | $ (560,502                 | ) | $ (1,270,488             | ) | $ (1,318,581 | ) | $ (2,680,276 | )
|Other comprehensive income (loss):      | 
|Foreign currency translation adjustment |  | 438,787                    |   | 42,417                   |   | 246,202      |   | (187,482     | )
|                                       
|Comprehensive loss                      |  | $ (121,715                 | ) | $ (1,228,071             | ) | $ (1,072,379 | ) | $ (2,867,758 | )

7.      Operating Segments

The Company
consists of three operating segments: wound care, wound closure and specialty securement
devices and skin care. Products in the wound care segment consist of basic and advanced
dressings, adhesive strips, ointments and sprays. Wound closure and specialty securement
device products include wound closure strips, nasal tube fasteners and a variety of
catheter fasteners. The skin care segment consists of antibacterial skin cleansers, hair
and body soaps, lotions and moisturizers.

Products
in all three operating segments are marketed to long-term care facilities, hospitals,
physicians, clinics, home health care agencies and other healthcare institutions. Basic
and advanced wound care products are manufactured both internally and outsourced, while
the manufacture of skin care products is completely outsourced. Wound closure-specialty
securement devices are significantly manufactured in-house. Internally, the segments are
managed at the gross profit level. The aggregation or allocation of other costs by segment
is not practical.

Segment
sales, gross profit and other related information for 2009 and 2008 are as follows:

|               |  |                                  |   |                                          |  |           |  |             |   |                  |  
|-------------- |  | -------------------------------- | - | ---------------------------------------- |  | --------- |  | ----------- | - | ---------------- | -
|               |  | Three Months Ended June 30, 2009 |   |                                          |  |          
|              
|               |  | Wound Care                       |   | Wound Closure-SpecialtySecurementDevices |  | Skin Care |  | Other Costs |   | Total    Company |  
|              
|Net sales      |  | $ 10,934,794                     |   | $436,690                                 |  | $191,857  |  | -           |   | $ 11,563,341     |  
|              
|Gross profit   |  | 3,144,448                        |   | 236,713                                  |  | 46,606    |  | -           |   | 3,427,767        |  
|Total expenses |  | -                                |   | -                                        |  | -         |  | $(3,988,269 | ) | (3,988,269       | )
|              
|Net loss       |  | $    (560,502                    | )

14

---



|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

|               |  |                                  |   |                                          |  |           |  |             |   |                  |  
|-------------- |  | -------------------------------- | - | ---------------------------------------- |  | --------- |  | ----------- | - | ---------------- | -
|               |  | Three Months Ended June 30, 2008 |   |                                          |  |          
|              
|Net sales      |  | $ 12,364,003                     |   | $518,324                                 |  | $201,639  |  | -           |   | $ 13,083,966     |  
|              
|Gross profit   |  | 3,194,590                        |   | 282,341                                  |  | 54,044    |  | -           |   | 3,530,975        |  
|Total expenses |  | -                                |   | -                                        |  | -         |  | $(4,801,463 | ) | (4,801,463       | )
|              
|Net loss       |  | $(1,270,488                      | )
|              
|              
|               |  | Six Months Ended June 30, 2009   |   |                                          |  |          
|              
|               |  | Wound Care                       |   | Wound Closure-SpecialtySecurementDevices |  | Skin Care |  | Other Costs |   | Total    Company |  
|              
|Net sales      |  | $ 20,734,277                     |   | $897,762                                 |  | $363,193  |  | -           |   | $ 21,995,232     |  
|              
|Gross profit   |  | 6,205,071                        |   | 482,737                                  |  | 93,594    |  | -           |   | 6,781,402        |  
|Total expenses |  | -                                |   | -                                        |  | -         |  | $(8,099,983 | ) | (8,099,983       | )
|              
|Net loss       |  | $(1,318,581                      | )
|              
|              
|               |  | Six Months Ended June 30, 2008   |   |                                          |  |          
|              
|Net sales      |  | $ 23,459,058                     |   | $969,407                                 |  | $380,323  |  | -           |   | $ 24,808,788     |  
|              
|Gross profit   |  | 6,033,210                        |   | 535,172                                  |  | 104,800   |  | -           |   | 6,673,182        |  
|Total expenses |  | -                                |   | -                                        |  | -         |  | $(9,353,458 | ) | (9,353,458       | )
|              
|Net loss       |  | $(2,680,276                      | )

The
following table presents net sales by geographic region.

|              |                             |                           |      |     
|------------- | --------------------------- | ------------------------- | ---- | ----
|              | Three Months Ended June 30, | Six Months Ended June 30,
|             
|              | 2009                        | 2008                      | 2009 | 2008
|             
|United States | 72%                         | 70%                       | 73%  | 69% 
|Canada        | 24%                         | 25%                       | 22%  | 26% 
|Other         | 4%                          | 5%                        | 5%   | 5%  

For the
six months ended June 30, 2009, the Company has a major U.S. customer comprising 14% of
U.S. sales and 9% of U.S. operations trade accounts receivable at June 30, 2009. The
Companys wholly owned Canadian subsidiary sells to one customer who serves as its
exclusive third party distributor and comprises 100% of Canada operations trade accounts
receivable at June 30, 2009.

8.      Income Taxes

The
Company recorded a $52,388 and $81,830 foreign income tax benefit for the six months
ended June 30, 2009 and 2008 respectively, based on the operating results of the Companys
wholly owned Canadian subsidiary. The 2009 benefit was comprised of of $29,684 current
foreign tax benefit and $22,704 deferred foreign tax

15

---



|                                                                     
|---------------------------------------------------------------------
|Index                                                                
|DERMA SCIENCES, INC. AND
     SUBSIDIARIES                           
|Notes To Condensed
     Consolidated Financial Statements (Unaudited)

benefit while the 2008 benefit was all deferred. No benefit
was realized for the Companys net loss from U.S. operations in the six months ended
June 30, 2009 and 2008 due to uncertainties surrounding the Companys ability to
utilize its net operating loss carry forwards.

Due
to uncertainties surrounding the Companys ability to use its U.S. net operating loss
carry forwards and net deferred assets, a full valuation allowance has been provided. The
Companys wholly owned Canadian subsidiary, based on recent operating profitability
and the prospect of future profitable operations, realized its net operating loss carry
forward and deferred tax assets and liabilities.

16

---



Index

Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations

Quarter Ended June 30, 2009 Compared
to Quarter Ended June 30, 2008

Overview of Consolidated Operating
Results

The
2009 and 2008 operating results include Derma Sciences, Inc. and its subsidiaries. Unless
otherwise indicated by the context, the terms U.S. operations and Canadian operations are
used throughout this discussion in reference to the Companys U.S. operations and the
operations of Derma Sciences Canada Inc., respectively.

The
following table highlights the quarter ended June 30, 2009 versus 2008 operating results:

|                                            |  |                        |   |              |   |             |   |     |     
|------------------------------------------- |  | ---------------------- | - | ------------ | - | ----------- | - | --- | ----
|                                            |  | Quarter Ended June 30, |  
|                                            |  | 2009                   |   | 2008         |   | Variance   
|                                           
|Gross Sales                                 |  | $ 13,709,673           |   | $ 15,780,523 |   | $(2,070,850 | ) | (13 | .1%)
|Sales adjustments                           |  | (2,146,332             | ) | (2,696,557   | ) | (550,225    | ) | (20 | .4%)
|                                           
|Net sales                                   |  | 11,563,341             |   | 13,083,966   |   | (1,520,625  | ) | (11 | .6%)
|Cost of sales                               |  | 8,135,574              |   | 9,552,991    |   | (1,417,417  | ) | (14 | .6%)
|                                           
|Gross profit                                |  | 3,427,767              |   | 3,530,975    |   | (103,208    | ) | (2  | .9%)
|                                           
|Selling, general and administrative expense |  | 3,703,038              |   | 4,483,556    |   | (780,518    | ) | (17 | .4%)
|Research and development expense            |  | 87,580                 |   | 106,200      |   | (18,680     | ) | (17 | .5%)
|Interest expense                            |  | 239,600                |   | 232,572      |   | 7,028       |   | 3   | .0% 
|Other income, net                           |  | (42,252                | ) | (29,092      | ) | (13,160     | ) | 45  | .2% 
|                                           
|Total expenses                              |  | 3,987,966              |   | 4,793,236    |   | (805,270    | ) | (16 | .8%)
|                                           
|Loss before income taxes                    |  | (560,199               | ) | (1,262,261   | ) | (702,062    | ) | 55  | .6% 
|                                           
|Provision for income taxes                  |  | 303                    |   | 8,227        |   | (7,924      | ) | (96 | .3%)
|                                           
|Net loss                                    |  | $    (560,502          | ) | $(1,270,488  | ) | $  (709,986 | ) | 55  | .9% 

Gross to Net Sales Adjustments

Gross
sales are adjusted for trade rebates, distributor fees (in Canada), sales incentives,
returns and allowances and cash discounts to derive net sales. Trade rebates are trued-up
monthly based upon an analysis of historical sales subject to rebate and actual rebates
received from distributors. Non-exclusive distributors generally carry one months
inventory. The Companys exclusive distributor in Canada normally carries two and
one-half to three and one-half months inventory. As distributor inventory is
depleted via sales, it is replenished via purchases from the Company. Rebates are
processed and submitted for credit on a timely basis consistent with distributor sales. To
minimize their cash outflow invested in rebates, distributors generally strive to optimize
the rebate credit submission process.

Historical
trends of sales subject to rebate and rebates received are evaluated monthly, by
distributor, on a three month, six month and twelve month rolling basis to update the
continued reasonableness of the assumptions used to quantify the trade rebate accrual
balance. Deviations in the trends resulting, among other causes, from distributors not
submitting their rebates on a timely basis are analyzed and factored in determining the
required accrual balance.

The
Company currently pays its exclusive Canadian distributor a fixed fee of 10% on net sales
subject to the fee (as defined) for distribution services in Canada. The distributor fee
is accrued each month based on net sales to the distributor times the ratio of estimated
percentage of distributor fee expense to net sales based on past history. The percentage
of distributor fee expense to net sales is re-evaluated quarterly for reasonableness.

17

---



Index

Sales
incentives are credits granted to specific customers based upon attainment of
pre-determined sales objectives. The agreements are generally for a period of one year.

Returns
and allowances and cash discounts are accrued monthly based on recent historical activity.

Gross
to net sales adjustments comprise the following:

|                       |  |                        |   |              |  
|---------------------- |  | ---------------------- | - | ------------ | -
|                       |  | Quarter Ended June 30, |  
|                       |  | 2009                   |   | 2008         |  
|                      
|Gross Sales            |  | $ 13,709,673           |   | $ 15,780,523 |  
|                      
|Trade rebates          |  | (1,604,132             | ) | (1,966,641   | )
|Distributor fees       |  | (238,459               | ) | (310,455     | )
|Sales incentives       |  | (130,875               | ) | (142,250     | )
|Returns and allowances |  | (80,549                | ) | (176,675     | )
|Cash discounts         |  | (92,317                | ) | (100,536     | )
|                      
|Total adjustments      |  | (2,146,332             | ) | (2,696,557   | )
|                      
|Net sales              |  | $ 11,563,341           |   | $ 13,083,966 |  

Trade rebates
decreased in 2009 versus 2008 due principally to lower Canadian sales subject to rebate
which, in turn, resulted from lower demand as a result of the exclusive Canadian
distributor reducing its inventory, unfavorable exchange and a slight increase in sales
not subject to rebate. U.S. rebates increased slightly due to an increase in regular and
private label sales subject to rebate, partially offset by an overall decrease in the
percentage of rebates to sales due to sales mix. The decrease in distribution fee expense
is commensurate with the change in Canadian net sales upon which it is based, coupled with
a small increase in the amount of sales not subject to the fee. The decrease in sales
incentive expense relates principally to lower incentive related traditional wound care
sales. The sales returns and allowances decrease is principally due to the non-recurrence
of higher FAD transition related returns and allowances in 2008. The decrease in cash
discounts reflects lower U.S. sales subject to cash discount as the percentage of cash
discounts to sales were comparable quarter to quarter.

Rebate Reserve Roll Forward

A
three month roll forward of the trade rebate accruals at June 30, 2009 and 2008 is
outlined below:

|                             |  |                        |   |             |  
|---------------------------- |  | ---------------------- | - | ----------- | -
|                             |  | Quarter Ended June 30, |  
|                             |  | 2009                   |   | 2008        |  
|                            
|Beginning balance  March 31 |  | $ 2,673,350            |   | $ 2,740,531 |  
|Rebates paid                 |  | (1,968,178             | ) | (1,656,870  | )
|Rebates accrued              |  | 1,604,132              |   | 1,966,641   |  
|                            
|Ending balance  June 30     |  | $ 2,309,304            |   | $ 3,050,302 |  

The
$364,046 decrease in the trade rebate reserve balance for the three months ended June 30,
2009 reflects a catch up in payment of U.S. private label rebates during the quarter.
There has been no other discernable change in the nature of the Companys business as
it relates to the accrual and subsequent payment of rebates.

18

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Index

Net Sales and Gross Margin

The
following table highlights the June 30, 2009 versus 2008 product line net sales and gross
profit:

|               |  |                        |  |              |  |             |   |     |     
|-------------- |  | ---------------------- |  | ------------ |  | ----------- | - | --- | ----
|               |  | Quarter Ended June 30, | 
|               |  | 2009                   |  | 2008         |  | Variance   
|              
|Net Sales      |  | $11,563,341            |  | $13,083,966  |  | $(1,520,625 | ) | (11 | .6%)
|              
|Cost of sales  |  | 8,135,574              |  | 9,552,991    |  | (1,417,417  | ) | (14 | .8%)
|              
|Gross Profit   |  | $  3,427,767           |  | $  3,530,975 |  | $  (103,208 | ) | (2  | .9%)
|              
|Gross Profit % |  | 29.6%                  |  | 27.0%        | 

Consolidated
net sales decreased $1,520,625, or 11.6% (8.3% adjusted for exchange), in 2009 versus
2008. Canadian net sales decreased $505,052, or 15.5%, to $2,744,282 in 2009 from
$3,249,334 in 2008. This decrease was driven by unfavorable exchange of $438,911
associated with a 16.1% weakening of the Canadian dollar and lower sales of $66,141.
Inventory rationalization on the part of the Companys exclusive Canadian distributor
is principally responsible for the lower sales. Real growth as measured by sales of the
Companys products reported by its exclusive distributor, unadjusted for foreign
exchange, approximated 15.6%. U.S. net sales decreased $1,015,573, or 10.3%, to $8,819,059
in 2009 from $9,834,632 in 2008. The decrease was driven by lower FAD sales of $1,651,989
and traditional wound care sales of $100,369, partially offset by higher advanced wound
care sales of $759,157. Sales of the balance of the Companys core line of products
were essentially flat quarter to quarter. The lower FAD sales reflect the non-recurrence
of higher sales in 2008 due to transition related backorder fulfillment, customers
rationalizing their inventory in 2009 in response to the economy and lost business. The
decreased traditional wound care sales reflect lower demand. The higher advanced wound
care sales reflect continued growth of MEDIHONEY together with the balance of the
product line in response to the Companys focused sales and marketing effort. Gross
U.S. MEDIHONEY sales increased $394,451, or 125.1%, to $664,766 in 2009 versus
$295,315 in 2008. BIOGUARD, the Companys new novel anti-microbial advanced wound
care product, was launched in June and recorded gross sales of $58,458. Excluding FAD,
U.S. sales increased $636,326, or 12.5%.

Consolidated
gross profit decreased $103,208, or 2.9%, in 2009 versus 2008. The consolidated gross
profit margin percentage increased to 29.6% in 2009 from 27.0% in 2008. Canadian gross
profit decreased $305,260, or 31.5%, to $664,486 in 2009 from $969,746 in 2008. The
Canadian gross profit margin percentage decreased to 24.2% in 2009 from 29.8% in 2008. The
decrease in Canadian 2009 gross profit dollars reflects the lower sales and gross profit
margin percentage. The decrease in Canadian gross profit margin percentage principally
reflects the adverse effect of price erosion coupled with higher product costs partially
offset by the favorable impact of higher production volumes on labor efficiency and
overhead absorption and lower overhead spending in 2009 versus 2008. U.S. gross profit
increased $202,052, or 7.9%, to $2,763,281 in 2009 from $2,561,229 in 2008. The U.S. gross
profit margin percentage increased to 31.3% in 2009 from 26.0% in 2008. The increase in
U.S. gross profit dollars reflects the increase in gross profit margin percentage,
partially offset by the lower sales. The increase in gross profit margin percentage is
principally attributable to the improvement in FAD margin due to the discontinuation of
higher cost domestic manufacturing in the fourth quarter 2008, growth of the higher
margined advanced wound care business and lower freight costs, partially offset by higher
product costs. Excluding FAD, favorable product mix served to increase U.S. margin dollars
$357,130, or 21.5%, and the gross profit percentage to 35.2% from 32.6%.

19

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Index

Selling, General and Administrative
Expenses

The
following table highlights June 30, 2009 versus 2008 operating expenses by type:

|                           |  |                        |  |             |  |           |   |     |     
|-------------------------- |  | ---------------------- |  | ----------- |  | --------- | - | --- | ----
|                           |  | Quarter Ended June 30, | 
|                           |  | 2009                   |  | 2008        |  | Variance 
|                          
|Distribution               |  | $   459,741            |  | $   542,194 |  | $(82,453  | ) | (15 | .2%)
|Marketing                  |  | 438,855                |  | 613,399     |  | (174,544  | ) | (28 | .5%)
|Sales                      |  | 1,221,821              |  | 1,509,265   |  | (287,444  | ) | (19 | .0%)
|General and administrative |  | 1,582,621              |  | 1,818,698   |  | (236,077  | ) | (13 | .0%)
|                          
|Total                      |  | $3,703,038             |  | $4,483,556  |  | $(780,518 | ) | (17 | .4%)

Selling,
general and administrative expenses decreased $780,518, or 17.4%, in 2009 versus 2008,
including a decrease of $104,999 in Canadian selling, general and administrative expenses
attributable to exchange.

Distribution
expense decreased $82,453, or 15.2%, in 2009 versus 2008. Expenses in Canada decreased
$74,604 (including a $17,179 benefit related to exchange) while expenses in the U.S
decreased $7,849. The decrease in Canada was driven by the non-recurrence of incremental
expense related to the buy out of the former distribution center lease in 2008. The U.S.
decrease was driven by the non-recurrence of incremental FAD related transition expenses
in Houston incurred in 2008, partially offset by higher lease costs in St. Louis and
Houston.

Marketing
expense decreased $174.544, or 28.5%, in 2009 versus 2008. The decrease is attributable to
a U.S. decrease of $175,191 coupled with an increase in Canada of $647. The U.S. decrease
stems from the planned reduction in advanced wound care clinical personnel, trade show and
promotion expense in 2009 in order to align costs with available financial resources.

Sales
expense decreased $287,444, or 19.0%, in 2009 versus 2008. Expenses in Canada decreased
$64,605 (including a $30,725 benefit related to exchange) while expenses in the U.S.
decreased $222,839. Expenses in Canada decreased due to lower direct representative and
distributor sales incentive program expenses (due to a change in the program in 2009),
partially offset by higher group purchasing organization expenses. The U.S. decrease was
attributable to lower compensation expenses associated with open (timing related) sales
representative positions, the non-recurrence of incremental transition related
compensation expenses in customer service, lower FAD broker commissions due to lower
sales, lower travel expenses due to cost reduction initiatives, lower recruiting expense
and the non-recurrence in 2009 of transition related FAD expenses. Offsetting these
decreases were higher regional show related expenses and higher sales tracing expense
associated with implementation of a more structured sales tracing program in 2008.

General
and administrative expense decreased $236,077, or 13.0%, in 2009 versus 2008. Expenses in
Canada decreased $76,436 (including a $52,662 benefit related to exchange) while expenses
in the U.S. decreased $159,640. The decrease in Canada reflects lower compensation due a
change in staffing, travel, recruiting and operating expenses, partially offset by higher
equity based compensation and accounting expenses. The U.S. decrease principally reflects
lower compensation and benefit expenses, travel, investor relations and other operating
expenses due to cost reduction initiatives, the non-recurrence of 2008 FAD transition
related information technology expense, the non-recurrence of legal expenses and the
timing of bad debt expenses, partially offset by higher FAD acquisition related
amortization expense and higher accounting expense.

Research and Development Expense

Research
and development expense decreased $18,620 to $87,580 in 2009 from $106,200 in 2008. The
decrease reflects the timing of expenses associated with the ongoing patent related and
development costs associated with the DSC127 Phase II clinical trial initiated in the
first quarter 2008.

Interest Expense

Interest
expense increased $7,028 to $239,600 in 2009 from $232,572 in 2008. The increase is
attributable to the non-recurrence of a holdback interest reversal associated with the
settlement of the Nutramax acquisition

20

---



Index

escrowed funds in 2008, partially
offset by lower interest rates coupled with lower line of credit and term loan borrowing
levels in 2009 versus 2008.

Other Income

Other
income increased $13,160 to $42,252 income in 2009 from $29,092 income in 2008. The main
driver for the increase was higher exchange gains in Canada, partially offset by lower
royalty and miscellaneous net income.

Income Taxes

The
Company recorded a $303 tax provision for 2009 consisting of a $8,872 current foreign tax
provisions and a $8,569 deferred foreign tax benefit based on the Companys Canadian
subsidiarys operating results. No tax benefit was made for the Companys U.S.
operations in 2009 due to uncertainty surrounding its ability to use available net
operating loss carry forwards and net deferred tax assets. The Company recorded a $8,227
deferred foreign tax expense in 2008 related to its Canadian subsidiarys operating
results.

Due
to uncertainties surrounding the Companys ability to use its U.S. net operating loss
carry forwards and net deferred tax assets, a full valuation allowance for the U.S. net
deferred tax assets has been provided.

Net Loss

The
Company generated a net loss of $560,502, or $0.01 per share (basic and diluted), in 2009
compared to a net loss of $1,270,488, or $0.03 per share (basic and diluted), in 2008.

21

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Index

Six Months Ended June 30, 2009
Compared to Six Months Ended June 30, 2008

Overview

The
following table highlights the six months ended June 30, 2009 versus 2008 operating
results:

|                                            |  |                           |   |              |   |             |   |     |     
|------------------------------------------- |  | ------------------------- | - | ------------ | - | ----------- | - | --- | ----
|                                            |  | Six Months Ended June 30, |  
|                                            |  | 2009                      |   | 2008         |   | Variance   
|                                           
|Gross Sales                                 |  | $ 26,311,433              |   | $ 30,043,720 |   | $(3,732,287 | ) | (12 | .4%)
|Sales adjustments                           |  | (4,316,201                | ) | (5,234,932   | ) | (918,731    | ) | (17 | .6%)
|                                           
|Net sales                                   |  | 21,995,232                |   | 24,808,788   |   | (2,813,556  | ) | (11 | .3%)
|Cost of sales                               |  | 15,213,830                |   | 18,135,606   |   | (2,921,776  | ) | (16 | .1%)
|                                           
|Gross profit                                |  | 6,781,402                 |   | 6,673,182    |   | 108,220     |   | 1   | .6% 
|                                           
|Selling, general and administrative expense |  | 7,567,164                 |   | 8,803,971    |   | (1,236,807  | ) | (14 | .0%)
|Research and development expense            |  | 217,926                   |   | 154,308      |   | 63,618      |   | 41  | .2% 
|Interest expense                            |  | 411,070                   |   | 497,487      |   | (86,417     | ) | (17 | .4%)
|Other income, net                           |  | (43,789                   | ) | (20,478      | ) | (23,311     | ) | 113 | .8% 
|                                           
|Total expenses                              |  | 8,152,371                 |   | 9,435,288    |   | (1,282,917  | ) | (13 | .6%)
|                                           
|Loss before income taxes                    |  | (1,370,969                | ) | (2,762,106   | ) | 1,391,137   |   | 50  | .4% 
|                                           
|Provision for income taxes                  |  | (52,388                   | ) | (81,830      | ) | (29,442     | ) | (36 | .0%)
|                                           
|Net loss                                    |  | $(1,318,581               | ) | $(2,680,276  | ) | $ 1,361,695 |   | 50  | .8% 

Gross to Net Sales Adjustments

Gross
to net sales adjustments comprise the following:

|                       |  |                           |   |              |  
|---------------------- |  | ------------------------- | - | ------------ | -
|                       |  | Six Months Ended June 30, |  
|                       |  | 2009                      |   | 2008         |  
|                      
|Gross Sales            |  | $ 26,311,433              |   | $ 30,043,720 |  
|                      
|Trade rebates          |  | (3,113,426                | ) | (3,891,165   | )
|Distributor fees       |  | (445,197                  | ) | (596,477     | )
|Sales incentives       |  | (288,720                  | ) | (185,601     | )
|Returns and allowances |  | (266,048                  | ) | (332,106     | )
|Cash discounts         |  | (202,830                  | ) | (229,583     | )
|                      
|Total adjustments      |  | (4,316,201                | ) | (5,234,932   | )
|                      
|Net sales              |  | $ 21,995,232              |   | $ 24,808,788 |  

Trade rebates
decreased in 2009 versus 2008 due principally to lower Canadian sales subject to rebate
which, in turn, resulted from lower demand as a result of the exclusive Canadian
distributor reducing its inventory, unfavorable exchange, and a slight increase in sales
not subject to rebate. U.S. rebates increased due to an increase in regular and private
label sales subject to rebate, coupled with an increase in the percentage of rebates to
sales due to list price increases (without a commensurate increase in contract pricing). The
decrease in distribution fee expense is commensurate with the change in Canadian net sales
upon which it is based. The increase in sales incentive expense relates principally to an
expansion of the FAD sales incentive program together with an increase

22

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Index

in the level of sales subject to
incentives. The sales returns and allowances decrease is principally due to the
non-recurrence of higher FAD transition related returns and allowances in 2008. The
decrease in cash discounts reflects lower U.S. sales subject to cash discount as the
percentage of cash discounts to sales were comparable period to period.

Rebate Reserve Roll Forward

A
six month roll forward of the trade rebate accruals at June 30, 2009 and 2008 is outlined
below:

|                              |  |                           |   |             |  
|----------------------------- |  | ------------------------- | - | ----------- | -
|                              |  | Six Months Ended June 30, |  
|                              |  | 2009                      |   | 2008        |  
|                             
|Beginning balance  January 1 |  | $ 2,660,086               |   | $ 2,407,709 |  
|Rebates paid                  |  | (3,464,208                | ) | (3,248,572  | )
|Rebates accrued               |  | 3,113,426                 |   | 3,891,165   |  
|                             
|Ending balance  June 30      |  | $ 2,309,304               |   | $ 3,050,302 |  

The
$350,782 decrease in the trade rebate reserve balance for the six months ended June 30,
2009 reflects a catch up in payment of U.S. private label rebates coupled with a reduction
in the Canadian reserve due to lower sales to the exclusive Canadian distributor in
response to the distributors plan to reduce its investment in inventory. There has
been no other discernable change in the nature of the Companys business as it
relates to the accrual and subsequent payment of rebates.

Net Sales and Gross Margin

The
following table highlights the June 30, 2009 versus 2008 product line net sales and gross
profit:

|               |  |                           |  |              |  |              |   |     |     
|-------------- |  | ------------------------- |  | ------------ |  | ------------ | - | --- | ----
|               |  | Six Months Ended June 30, | 
|               |  | 2009                      |  | 2008         |  | Variance    
|              
|Net Sales      |  | $21,995,232               |  | $24,808,788  |  | $(2,813,556  | ) | (11 | .3%)
|              
|Cost of sales  |  | 15,213,830                |  | 18,135,606   |  | (2,921,776   | ) | (16 | .1%)
|              
|Gross Profit   |  | $  6,781,402              |  | $  6,673,182 |  | $    108,220 |   | 1   | .6% 
|              
|Gross Profit % |  | 30.8%                     |  | 26.9%        | 

Consolidated
net sales decreased $2,813,556, or 11.3% (7.0% adjusted for exchange), in 2009 versus
2008. Canadian net sales decreased $1,546,439, or 23.8%, to $4,949,687 in 2009 from
$6,496,126 in 2008. This decrease was driven by unfavorable exchange of $1,070,113
associated with a 19.7% weakening of the Canadian dollar and lower sales of $476,326.
Inventory rationalization on the part of the Companys exclusive Canadian distributor
is principally responsible for the lower sales. Real growth as measured by sales of the
Companys products reported by its exclusive distributor, unadjusted for foreign
exchange, approximated 9.3%. U.S. net sales decreased $1,267,117, or 6.9%, to $17,045,545
in 2009 from $18,312,662 in 2008. The decrease was driven by lower FAD sales of $2,458,218
and traditional wound care sales of $306,999, partially offset by higher advanced wound
care sales of $1,022,592 and private label sales of $553,723. Specialty fixation, burn
care and skin care and bathing sales were down $78,215, or 6.3%, period to period. The
lower FAD sales reflect the non-recurrence of higher sales in 2008 due to transition
related backorder fulfillment, customers rationalizing their inventory in 2009 in response
to the economy and lost business. The lower traditional wound care sales reflect the
non-recurrence of a spot sale (customers normal supplier was unable to supply)
realized in 2008 and lower demand. The higher advanced wound care sales reflect continued
growth of MEDIHONEY together with the balance of the product line in response to the
Companys focused sales and marketing effort. Gross U.S. MEDIHONEY sales
increased $555,042, or 94.3%, to $1,143,944 in 2009 versus $588,902 in 2008. BIOGUARD, the
Companys new novel anti-microbial advanced wound care product, was launched in June
and recorded gross sales of $58,458. The increase in private label sales reflects
incremental sales from a new product being manufactured for an existing customer in the
first

23

---



Index

quarter 2009, together with improved
demand from a number of the Company's other customers.  Excluding FAD, U.S. sales
increased $1,191,101, or 12.2%.

Consolidated
gross profit increased $108,220, or 1.6%, in 2009 versus 2008. The consolidated gross
profit margin percentage increased to 30.8% in 2009 from 26.9% in 2008. Canadian gross
profit decreased $426,395, or 23.7%, to $1,373,849 in 2009 from $1,800,244 in 2008. The
Canadian gross profit margin percentage increased slightly to 27.8% in 2009 from 27.7% in
2008. The decrease in Canadian 2009 gross profit dollars reflects the lower sales. The
change in Canadian gross profit margin percentage principally reflects the adverse effect
of price erosion coupled with higher product costs, essentially offset by the favorable
impact of higher production volumes on labor efficiency and overhead absorption and lower
overhead spending in 2009 versus 2008. U.S. gross profit increased $534,614, or 11.0%, to
$5,407,553 in 2009 from $4,872,939 in 2008. The U.S. gross profit margin percentage
increased to 31.7% in 2009 from 26.6% in 2008. The increase in U.S. gross profit dollars
reflects the increase in gross profit margin percentage, partially offset by the lower
sales. The increase in gross profit margin percentage is principally attributable to the
improvement in FAD margin due to the discontinuation of higher cost domestic manufacturing
in the fourth quarter 2008, growth of the higher margined advanced wound care business and
lower freight costs, partially offset by higher product costs. Excluding FAD, favorable
product mix partially offset by higher product costs served to increase U.S. margin
dollars $550,824, or 16.6%, and the gross profit percentage to 35.3% from 33.9%.

Selling, General and Administrative
Expenses

The
following table highlights June 30, 2009 versus 2008 operating expenses by type:

|                           |  |                           |  |            |  |             |   |     |     
|-------------------------- |  | ------------------------- |  | ---------- |  | ----------- | - | --- | ----
|                           |  | Six Months Ended June 30, | 
|                           |  | 2009                      |  | 2008       |  | Variance   
|                          
|Distribution               |  | $   887,474               |  | $1,022,181 |  | $  (134,707 | ) | (13 | .2%)
|Marketing                  |  | 829,787                   |  | 1,009,389  |  | (179,602    | ) | (17 | .8%)
|Sales                      |  | 2,436,862                 |  | 2,783,287  |  | (346,425    | ) | (12 | .4%)
|General and administrative |  | 3,413,041                 |  | 3,989,114  |  | (576,073    | ) | (14 | .4%)
|                          
|Total                      |  | $7,567,164                |  | $8,803,971 |  | $(1,236,807 | ) | (14 | .0%)

Selling,
general and administrative expenses decreased $1,236,807, or 14.0%, in 2009 versus 2008,
including a decrease of $261,579 in Canadian selling, general and administrative expenses
attributable to exchange.

Distribution
expense decreased $134,707, or 13.2%, in 2009 versus 2008. Expenses in Canada decreased
$96,090 (including a $33,796 benefit related to exchange) while expenses in the U.S
decreased $38,617. The decrease in Canada was driven by the non-recurrence of incremental
expense related to the buy out of the former distribution center lease in the second
quarter 2008. The U.S. decrease was driven by the non-recurrence of incremental FAD
related transition expenses in Houston incurred in 2008, partially offset by higher lease
costs in Houston and St. Louis together with slightly higher personnel and operating costs
in St. Louis in support of the growing non-FAD business.

Marketing
expense decreased $179,602, or 17.8%, in 2009 versus 2008. The decrease is attributable to
a U.S. decrease of $182,858 coupled with an increase in Canada of $3,256 (including a
$10,293 benefit related to exchange). The U.S. decrease stems from a planned reduction in
advanced wound care clinical personnel, trade show and promotion expense in 2009 in order
to align costs with available financial resources, partially offset by an increase in FAD
related marketing reflecting implementation of a full marketing plan in 2009 versus a
partial transition related plan in 2008. The Canada expense increase reflects higher
advanced wound care product sampling expenses.

Sales
expense decreased $346,425, or 12.4%, in 2009 versus 2008. Expenses in Canada decreased
$113,298 (including a $69,963 benefit related to exchange) while expenses in the U.S.
decreased $233,127. Expenses in Canada decreased principally due to lower direct
representative commission, timing related bid and tender expenses and distributor sales
incentive program expenses due to a change in the program in 2009. The U.S. decrease was
attributable to lower compensation and commission expenses associated with open (timing
related) sales representative positions and the non-recurrence of incremental transition
related compensation expenses in

24

---



Index

customer service, lower FAD broker
commissions due to lower sales, lower travel expenses due to cost reduction initiatives,
lower recruiting expenses together with the non-recurrence in 2009 of FAD transition
related expenses. Offsetting these decreases were higher equity based compensation,
regional show and sales tracing expenses associated with the implementation of a more
structured sales tracing program in 2008.

General
and administrative expense decreased $576,073, or 14.4%, in 2009 versus 2008. Expenses in
Canada decreased $197,641 (including a $147,528 benefit related to exchange) while
expenses in the U.S. decreased $378,434. The decrease in Canada reflects lower
compensation due a change in staffing, travel, recruiting and operating expenses,
partially offset by higher equity based compensation and accounting expenses. The U.S.
decrease principally reflects lower travel expense of $122,000 and investor relations
expense of $88,000 due to cost reduction initiatives, non-recurring and lower legal
expenses of $72,000 and non-recurring recruiting expense of $40,000, non-recurring
transition related and lower information technology expense of $36,000 together with lower
bad debt expense of $76,000, other professional service fees of $40,000 and other net
operating costs of $14,900 partially offset by incremental intangible amortization expense
of $110,400 related to the FAD acquisition.

Research and Development Expense

Research
and development expense increased $63,618 to $217,926 in 2009 from $154,308 in 2008. The
increase reflects higher ongoing patent related and development costs associated with the
DSC127 Phase II clinical trial initiated in the first quarter 2008, partially offset by
lower consulting expenses.

Interest Expense

Interest
expense decreased $86,417 to $411,070 in 2009 from $497,487 in 2008. The decrease is
principally attributable to lower interest rates coupled with lower line of credit and
term loan borrowing levels in 2009 versus 2008.

Other Income

Other
income increased $23,311 to $43,789 income in 2009 from $20,478 income in 2008. The main
drivers for the increase were $66,500 of gains on miscellaneous asset sales associated
with the closure of the FAD manufacturing operation together with lower exchange losses,
partially offset by lower royalty income and other miscellaneous income in 2009 versus
2008.

Income Taxes

The
Company recorded a $52,388 tax benefit for 2009 consisting of a $29,684 current foreign
tax benefit and a $22,704 deferred foreign tax benefit based on the Companys
Canadian subsidiarys operating results. No tax benefit was made for the Companys
U.S. operations in 2009 due to uncertainty surrounding its ability to use available net
operating loss carry forwards and net deferred tax assets. The Company recorded a $81,830
deferred foreign tax benefit in 2008 related to its Canadian subsidiarys operating
results.

Due
to uncertainties surrounding the Companys ability to use its U.S. net operating loss
carry forwards and net deferred tax assets, a full valuation allowance for the U.S. net
deferred tax assets has been provided.

Net Loss

The
Company generated a net loss of $1,318,581, or $0.03 per share (basic and diluted), in
2009 compared to a net loss of $2,680,276, or $0.07 per share (basic and diluted), in
2008.

Liquidity and Capital Resources

Cash Flow and Working Capital

The
Company reported a $1,318,581 net loss for the first half of 2009 versus a $2,680,276 net
loss in the first half of 2008. While sales declined, gross profit dollars and margin
percentage increased due to a favorable sales mix (principally reflecting the growth of
the higher margined advanced wound care business), the elimination of higher cost FAD
domestic manufacturing in the fourth quarter 2008 and improved manufacturing performance
in

25

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Index

Canada, partially offset by higher
product costs. Operating expenses were reduced to better align costs with revenues.

The
launch of a number of new products bodes well for the future growth of the Companys
higher-margined advanced wound care product line. While overall FAD sales declined in the
first half of 2009 versus 2008, the Company considers that the FAD product line represents
a solid growth opportunity. Sales for the balance of the Companys product lines are
expected to remain relatively stable. Further, the Company continues to actively pursue
distributors in numerous countries to increase its international sales.

Improving
financial performance and other steps taken to improve cash management have served to
improve the Companys liquidity as reflected in the adjusted earnings before
interest, taxes, depreciation and amortization and equity based compensation (Adjusted
EBITDA) and operating cash flow table below:

|                          |  |               |   |               |  
|------------------------- |  | ------------- | - | ------------- | -
|                          |  | 2009June YTD  |   | 2008Year      |  
|                         
|Adjusted EBITDA          
|                         
|Net loss                  |  | $ (1,318,581  | ) | $ (3,961,937  | )
|Interest                  |  | 411,070       |   | 940,148       |  
|Taxes                     |  | (52,388       | ) | 58,815        |  
|Depreciation              |  | 416,163       |   | 855,609       |  
|Amortization              |  | 658,880       |   | 1,427,524     |  
|Equity based compensation |  | 496,990       |   | 821,556       |  
|                         
|Total adjusted EBITDA     |  | $     612,134 |   | $     141,715 |  

The
Company has improved its Adjusted EBITDA in the first six months of 2009 versus the full
year 2008 due to the reduction of its net loss, which has decreased significantly over
2008s performance. This trend is expected to continue over the next twelve months as the
Company works towards reducing its operating losses. Interest and the non-cash charges are
expected to remain constant over the balance of the year. Taxes will fluctuate in
accordance with Canadas operating performance, but are not expected to change
significantly.

The
Company defines Adjusted EBITDA as net loss before interest expense, taxes, depreciation
and amortization and equity based compensation. The Company believes that net income
(loss) is the most directly comparable GAAP measurement to Adjusted EBITDA. Adjusted
EBITDA is presented because the Company believes it is useful to investors as a widely
accepted financial indicator of a companys ability to service and/or incur
indebtedness and because such disclosure provides investors with additional criteria used
by the Company to evaluate operating performance. Adjusted EBITDA is not defined under
GAAP, should not be considered in isolation or as a substitute for a measure of our
liquidity or performance prepared in accordance with GAAP and is not indicative of income
from operations as determined under GAAP. Adjusted EBITDA and other non-GAAP financial
measures have limitations which should be considered before using these measures to
evaluate the Companys liquidity or financial performance. Adjusted EBITDA does not
include interest expense, income tax expense, depreciation and amortization expense or
equity based compensation expense, which may be necessary in evaluating the Companys
operating results and liquidity requirements. The Companys management compensates
for these limitations by using Adjusted EBITDA as a supplement to GAAP results to provide
a more comprehensive understanding of the factors and trends affecting the business. The
Companys computation of Adjusted EBITDA may not be comparable to other similarly
titled measures provided by other companies, because not all companies calculate this
measure in the same fashion.

26

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Index

|                               |  |              |   |             |  
|------------------------------ |  | ------------ | - | ----------- | -
|                               |  | 2009June YTD |   | 2008Year    |  
|                              
|Operating cash flow           
|                              
|Net loss                       |  | $(1,318,581  | ) | $(3,961,937 | )
|Depreciation                   |  | 416,163      |   | 855,609     |  
|Amortization                   |  | 658,880      |   | 1,427,524   |  
|Equity based compensation      |  | 496,990      |   | 821,556     |  
|Other net loss adjustments     |  | 469,063      |   | 1,351,324   |  
|Change in operating assets and | 
|liabilities                    |  | (524,023     | ) | (5,238,043  | )
|                              
|Total operating cash flow      |  | $    198,492 |   | $(4,743,967 | )

Operating
cash flow has improved significantly in the first six months of 2009 versus the full year
2008. This is attributable to a significant reduction in operating assets and liablilites requirements and
a lower net loss. In 2008, the Company increased its investment in inventory approximately
$3,600,000. In 2009 this trend was reversed. Through June 2009 inventories have been
reduced approximately $960,000. Operating cash flow
is expected to continue to improve over the next twelve months given the expected
improvement in financial performance and continuation of the initiative to reduce
inventory.

At
June 30, 2009 and December 31, 2008, the Company had cash and cash equivalents on hand of
$167,040 and $391,038, respectively. The $223,998 decrease in cash reflects net cash used
in financing activities of $334,481, cash used in investing activities of $52,200 and cash
used as a result of exchange rate changes of $35,809, less cash provided by operating
activities of $198,492.

Net
cash provided by operating activities of $198,492 stems from $730,906 cash provided from
operations (net loss plus non-cash items), together with $532,414 cash used from the net
change in operating assets and liabilities. The increase in cash provided from operations
reflects the non-cash items, partially offset by the operating loss. Lower receivable and
inventory levels coupled with reductions in accounts payable and accrued expenses were the
main drivers behind the net change in operating assets and liabilities. The change in
receivables reflects lower sales and improved collections. The reduced investment in
inventory reflects a plan to reduce inventory levels while maintaining customer service
requirements. The decrease in accounts payable reflects a significant reduction in
payables related to inventory purchases (consistent with the plan to reduce inventory),
lower overall spending levels and timing. The decrease in accrued expenses and other
current liabilities principally reflects payment of 2008 year end accruals and timing
related changes.

Net
cash used in investing activities of $52,200 reflects capital expenditures of $113,200,
less receipt of $61,000 cash from the sale of assets associated with the discontinuation
of FAD domestic manufacturing. Capital expenditures are down in 2009 versus 2008 and no
significant expenditures are anticipated over the balance of the year.

Net
cash used in financing activities of $334,481 reflects regularly scheduled debt payments
of $652,957, an increase in restricted cash of $11,300 and costs related to the issuance
of stock of $5,000, partially offset by increased line of credit borrowings of $334,776.

Working
capital decreased $777,320, or 11.5%, at June 30, 2009 to $5,962,331 from $6,739,651 at
December 31, 2008. Excluding the reclassification of the $500,000 promissory note from
long term to current debt in the second quarter 2009, working capital decreased $277,320
in the first six months of 2009 and increased by $141,348 in the second quarter. Working
capital of this magnitude is considered sufficient to support ongoing operations.

Financing Arrangements

On
March 31, 2009, the Companys U.S. lender agreed to amend the credit and security
agreement to allow the Company to enter into a forbearance agreement with Western Medical
to postpone payment of its $500,000 promissory note due April 2009, for one year until
April 2010 and to allow subsequent payments on the subordinate

27

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Index

debt beginning in April 2010. The
Western Medical note payments are conditioned on the Companys achieving
predetermined liquidity and free cash flow (as defined) objectives and Western Medicals
further extending for one year the payment of the principle balance, if any, remaining on
the promissory note after giving effect to the April 2010 payment. In return for the
amendment, the Company agreed to change its base rate for interest charged to a three
month LIBOR rate from a one month LIBOR rate (an estimated increase of approximately 50
basis points) and increase its base rate margin by 150 basis points effective April 1,
2009. Using market rates as of the date of the amendment, the estimated cost of the
change in interest rates is approximately $15,000 per month.

In
August 2008, the Company and its lender modified the terms of the Companys five-year
revolving credit and security agreement. The modified terms amend the existing minimum
EBITDA, fixed charge coverage, senior debt coverage and total debt coverage covenants.
Amendment of the covenants was predicated on the Company depositing $2,000,000 in a
blocked account controlled by the Companys lender. The Companys maximum
revolver borrowing capacity remained unchanged at the lesser of (a) the revolver loan
commitment ($8,000,000) or (b) the borrowing base (as defined), less $1,500,000.

With
the cash on hand at June 30, 2009, together with available revolver capacity of $495,766,
the Company has $662,806 of available liquidity at June 30, 2009.

Prospective Assessment

The
Companys strategic objective is to in-license, develop and launch novel higher
margined advanced wound care products while utilizing its core business (to the extent
possible) to fund this objective. In addition, the Company will continue to evaluate
external opportunities to leverage its core capabilities for growth. To the extent the
Company determines that it cannot finance its growth initiatives internally, it will
evaluate the feasibility of doing so via the sale of equity.

As
a result of these efforts, the Company launched ALGICELL® Ag in November 2006. The
Company launched its first MEDIHONEY product in October 2007. This product
represents the first of its kind and interest in the product has been high. Sales have
increased steadily and current indications are that the planned MEDIHONEY based line
of products could result in significant incremental sales. The Company recently launched
four new products, the MedEfficiency line of Total Contact Cast systems (October 2008),
XTRASORB (November 2008), MOBILITY 1 (January 2009) and BIOGUARD, the Companys novel
anti-microbial infection control product in June 2009. All four products have received
interest in the marketplace and complement the Companys existing advanced wound care
product line. The Company continues to work on its pipeline and has identified several
products that are capable of contributing to future sales growth. The Company anticipates
its core business sales will remain relatively stable over the near term.

In
recognition of its current financial condition, the Company initiated the following
actions beginning in the last quarter of 2008:

| | 1. |  | While
not compromising the overall integrity of the advanced wound care growth strategy,
prospective plans in terms of sales and marketing resources were scaled back to more
affordable levels resulting in an immediate reduction of expense. The Company has
implemented a process to better measure the ongoing return on sales and marketing
resources deployed. Assuming the existing resources in place are generating the expected
return, the Company will prospectively expand its investment in sales and marketing
resources in support of its advanced wound care growth strategy, as financial conditions
allow.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. |  | The
FAD business represents a growth opportunity for the Company. In addition to its core
business opportunities, the FAD business will serve as a platform for introducing the
Companys existing advanced and traditional wound care products to new customers and
markets, especially the retail market. The FAD is presently working on a number of
opportunities for sales growth. The Company began to realize the savings associated with
discontinuing its higher cost U.S. production in the fourth quarter 2008. In addition,
the FAD is working to firm up a cost effective supply chain for its adhesive bandages and
first aid related products. Initial shipments from the new supply chain were received
during the second quarter of 2009 and is expected to be fully functioning by year end, at
which time the Company expects to be able to further reduce its product costs and improve
liquidity by reducing the level of inventory required to support the ongoing business.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

28

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Index

| | 3. |  | Steps
were taken to identify and eliminate all non-essential operating costs. No salary
increases or bonuses are planned until the Companys performance and liquidity
improves. Expected savings resulting from these measures were factored into the Companys
2009 operating plan.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. |  | The
Company made a significant investment in DSC 127 beginning in December 2007. While the
launch of DSC 127 is several years away, the market potential for this product is
considered to be considerable. The product began phase II trials in early 2008 to achieve
proof of principle in a human model. The phase II trials are expected to be completed by
the third quarter of 2010. The projected cost to complete the phase II trials is
approximately $1,700,000, including $1,001,598 incurred through June 2009. The Company
plans to continue with this investment and anticipates spending approximately $698,402 to
complete the Phase II trial over the next fifteen months.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | The results
of the phase II trial will determine the efficacy and safety of the product and further
refine its market potential. The cost of the phase III trial and bringing the product to
market are expected to be significant. Should the Company decide to proceed with the DSC
127 development plan after completion of phase II, it plans to fund the additional
development costs out of available cash flow or the sale of equity. Alternatively, the
Company may determine to sublicense or sell the rights to the compound.
| |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

With
the planned improvement in operations and reduction in working capital requirements
(associated with a reduction in FAD inventory), together with the available cash on hand
and additional borrowing capacity as of June 30, 2009, the Company anticipates having
sufficient liquidity in place to meet its operating needs and debt covenants through the
next twelve months.

The
Common Stock of the Company is traded on the OTC Bulletin Board under the symbol
DSCI.OB. The Company has paid no cash dividends in respect of its Common Stock
and does not intend to pay cash dividends in the near future.

Additional Financial Information

Forward Looking Statements

Statements
that are not historical facts, including statements about the Companys confidence,
strategies, expectations about new or existing products, technologies, opportunities,
market demand or acceptance of new or existing products are forward-looking statements
that involve risks and uncertainties. These uncertainties include, but are not limited to,
product demand and market acceptance risk, impact of competitive products and prices,
product development, commercialization or technological delays or difficulties, and trade,
legal, social, financial and economic risks.

Critical Accounting Policies

Estimates
and assumptions are required in the determination of sales deductions for trade rebates,
sales incentives, discounts and allowances. Significant estimates and assumptions are also
required in determining the appropriateness of amortization periods for identifiable
intangible assets, the potential impairment of goodwill and the valuation of inventory.
Some of these judgments can be subjective and complex and, consequently, actual results
may differ from these estimates. For any individual estimate or assumption made by the
Company, there may also be other reasonable estimates or assumptions. The Company
believes, however, that given current facts and circumstances, it is unlikely that
applying any such other reasonable judgment would cause a material adverse effect on the
consolidated results of operations, financial position or cash flows for the periods
presented. The Companys most critical accounting policies are described below.

Revenue Recognition and Adjustments
to Revenue

Revenue
is recognized when product is shipped and title passes to the customer and collectability
is reasonably assured. When the Company recognizes revenue from the sale of its products,
it simultaneously adjusts revenue for estimated trade rebates and distribution fees (in
Canada). A trade rebate represents the difference

29

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Index

between the invoice price to the
wholesaler and the indirect customers contract price. These rebates are estimated
based on historical experience, estimated future trends, estimated customer inventory
levels, current contract sales terms with wholesale and indirect customers and other
competitive factors. The Company pays its exclusive Canadian distributor a fixed fee
based on sales subject to the fee (as defined) for distribution services in Canada. The
distribution fee is accrued monthly based on the estimated percentage of distribution fee
expense to net sales. If the assumptions used to calculate these rebates and fees do not
appropriately reflect future activity, the Companys financial position, results of
operations and cash flows could be impacted. The Company continually monitors the factors
that influence these rebates and fees and makes adjustments as necessary.

Goodwill

At
June 30, 2009, the Company had $7,119,726 of goodwill consisting of $4,679,684 relating to
the FAD acquisition in November 2007 and $2,440,042 relating to the Western Medical
acquisition in April 2006. The goodwill is included in the wound care segment for
reporting purposes. The Company tests goodwill for impairment in the fourth quarter of
each year or when impairment indicators are present. The process of evaluating the
potential impairment of goodwill is highly subjective and requires significant judgments
and assumptions in estimating future cash flows to determine the fair value of each
reporting unit. These assumptions include future growth rates, discount factors, future
tax rates and other factors. The Companys cash flow forecasts are based on
assumptions that are consistent with the plans and estimates used to manage the underlying
business. In addition, the Company makes certain judgments about allocating shared assets
to the balance sheet for this segment. If the expected cash flows are not realized,
impairment losses may be recorded in the future.

Inventory

The
Company writes down the value of inventory by the estimate of the difference between the
cost of the inventory and its net realizable value. The estimate takes into account
projected sales of the inventory on hand and the age of the inventory in stock. If actual
future demand or market conditions are less favorable than those projected by management,
additional inventory write-downs may be required. The provision for the write-down of
inventory is recorded in cost of sales.

Stock-Based Compensation

Effective
January 1, 2006 the Company adopted Statement of Financial Accounting Standards No. 123R,
Share-Based Payment (SFAS 123R). SFAS 123R requires that
share-based payment transactions with employees, such as grants of stock options and
restricted stock, be recognized in the financial statements based on their fair value at
the grant date and recognized as compensation expense over their vesting periods. The
Company estimates the fair value of stock options as of the date of grant using the
Black-Scholes or binomial/lattice pricing model (as applicable) and restricted stock based
on the quoted market price. SFAS 123R requires significant judgment and the use of
estimates to value equity-based compensation, particularly surrounding Black-Scholes or
binomial/lattice pricing model assumptions such as stock price volatility and expected
option lives, as well as expected option forfeiture rates.

Update of Factors Affecting Future
Prospects

The
following factors affecting future prospects update the related factors set forth in the
Companys annual report on Form 10-K filed with the Securities and Exchange
Commission on June 30, 2009:

The Company has generated only
nominal income and it cannot guarantee future profitability.

The
Company earned net income of $668,739 in 2006, $22,241 in 2003, $61,368 in 2002 and
$192,398 in 2001 and incurred losses of $1,318,581 for the six months ended June 30, 2009
(unaudited), $3,961,937 in 2008, $2,284,605 in 2007, $1,099,990 in 2005, $2,338,693 in
2004, $2,581,337 in 2000 and $2,998,919 in 1999. At June 30, 2009, the Company had an
accumulated deficit of $20,982,405 (unaudited). Although the Company achieved
profitability in 2006, 2003, 2002 and 2001, the Company cannot offer any assurance that it
will be able to generate sustained or significant earnings.

30

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Index

The potential increase in common
shares due to the conversion, exercise or vesting of outstanding dilutive securities may
have a depressive effect upon the market value of the Companys shares.

Up
to 20,491,291 shares of the Companys common stock are potentially issuable upon the
conversion, exercise or vesting of outstanding convertible preferred stock, warrants and
options (dilutive securities). The shares of
common stock potentially issuable upon conversion, exercise or vesting of dilutive
securities are substantial compared to the 40,315,743 shares of common stock currently
outstanding.

Earnings
per share of common stock may be substantially diluted by the existence of these dilutive
securities regardless of whether they are converted, exercised or issued. This dilution of
earnings per share could have a depressive effect upon the market value of the
Companys common stock.

The Companys stock price has
been volatile and this volatility is likely to continue.

Historically,
the market price of the Companys common stock has been volatile. The high and low
prices for the years 2004 through 2008 and the first half of 2009 are set forth in the
table below:

| |                                                           |  |       |  |       | 
| | --------------------------------------------------------- |  | ----- |  | ----- | 
| | Derma Sciences, Inc.
        Trading Range  Common Stock | 
|
| | Year                                                      |  | Low   |  | High  | 
|
| | 2004                                                      |  | $0.43 |  | $1.90 | 
| | 2005                                                      |  | $0.42 |  | $0.78 | 
| | 2006                                                      |  | $0.45 |  | $0.90 | 
| | 2007                                                      |  | $0.58 |  | $1.40 | 
| | 2008                                                      |  | $0.20 |  | $1.35 | 
| | 2009(*)                                                   |  | $0.24 |  | $0.67 | 
| |                                                           |  |       |  |       | 
| | (*) January 1 through June 30.                            | 

Events
that may affect the Company's common stock price include:

| |  |  | Quarter
to quarter variations in its operating results;
| | - |  | -------------------------------------------------------

| |  |  | Changes
in earnings estimates by securities analysts;
| | - |  | -----------------------------------------------------

| |  |  | Changes
in interest rates or other general economic conditions;
| | - |  | ---------------------------------------------------------------

| |  |  | Changes
in market conditions in the wound care and skin care industries;
| | - |  | ------------------------------------------------------------------------

| |  |  | The
introduction of new products either by the Company or by its competitors; and
| | - |  | ---------------------------------------------------------------------------------

| |  |  | The
loss of a major customer.
| | - |  | -----------------------------

Although
all publicly traded securities are subject to price and volume fluctuations, it is likely
that the Companys common stock will experience these fluctuations to a greater
degree than the securities of more established and better capitalized organizations.

31

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Index

Item 4. CONTROLS AND PROCEDURES

The
Companys management, with the participation of the Companys Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys
disclosure controls and procedures as of June 30, 2009. Based on this evaluation, the
Companys Chief Executive Officer and Chief Financial Officer concluded that the
Companys disclosure controls and procedures are effective for gathering, analyzing
and disclosing the information the Company is required to disclose in the reports it files
under the Securities Exchange Act of 1934, within the time periods specified in the
SECs rules and forms.

During
the six months ended June 30, 2009, there was no change in the Companys internal
controls over financial reporting that materially affected, or is reasonably likely to
materially affect, the Companys internal controls over financial reporting.

32

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Index

Part II  Other Information

Item 4. Submission of Matters to a
Vote of Security Holders

The
annual meeting of shareholders of the Company was held on May 20, 2009. At the annual
meeting, the following matters were submitted to a vote of the Companys security
holders with the results indicated:

Proposal
1  Election of Directors

The
following director-nominees, consisting of all director-nominees, were elected directors
to serve as such for one year or until their successors have been elected and qualify:
Edward J. Quilty, Stephen T. Wills, CPA, MST, Srini Conjeevaram, James T. OBrien,
Richard J. Keim, C. Richard Stafford, Esq., Robert G. Moussa and Bruce F. Wesson. Details
concerning the votes relative to each director-nominee are set forth below:

|                           |            |         |             |                 
|-------------------------- | ---------- | ------- | ----------- | ----------------
|Director-Nominee           | In Favor   | Against | Abstentions | Broker Non-Votes
|                          
|Edward J. Quilty           | 30,665,675 | 0       | 403,521     | 0               
|Srini Conjeevaram          | 30,758,821 | 0       | 310,375     | 0               
|Stephen T. Wills, CPA, MST | 30,742,825 | 0       | 326,371     | 0               
|James T. O'Brien           | 30,758,989 | 0       | 310,207     | 0               
|C. Richard Stafford, Esq.  | 30,723,218 | 0       | 345,978     | 0               
|Richard J. Keim            | 30,670,947 | 0       | 398,249     | 0               
|Robert G. Moussa           | 30,672,096 | 0       | 397,100     | 0               
|Bruce F. Wesson            | 30,673,068 | 0       | 396,128     | 0               

Proposal
2  Ratification of Appointment of Independent Registered Public Accounting Firm

Shareholders
ratified the appointment of Ernst & Young LLP as the Companys independent
registered public accounting firm for the year ending December 31, 2009. Details
concerning the vote on proposal 2 are set forth below:

| |                  |            | 
| | ---------------- | ---------- | 
| | In Favor         | 30,801,307 | 
| | Against          | 126,130    | 
| | Abstentions      | 141,759    | 
| | Broker Non-Votes | 0          | 

The
Company solicited proxies relative to each of the foregoing proposals and, as to proposal
1, each director-nominee pursuant to Regulation 14A under the Securities Exchange Act of
1934. No proxies were solicited in opposition to either of the proposals.

33

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Index

Item 6. Exhibits

All
exhibits required by Item 601 of Regulation S-K and required hereunder, as filed with the
Securities and Exchange Commission in Form 10-K on April 1, 2009, are incorporated herein
by reference.

| |         |                                                                                                                                                          
| | ------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | Exhibit | Description                                                                                                                                              
|
| | 31.1    | Certification of the Principal Executive Officer pursuant to Section
     302 of theSarbanes-Oxley Act of 2002                                           
| | 31.2    | Certification of the Principal Financial Officer pursuant to Section
     302 of theSarbanes-Oxley Act of 2002                                           
| | 32.1    | Certification of the Principal Executive Officer pursuant to U.S.C.
     Section1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
| | 32.2    | Certification of the Principal Financial Officer pursuant to U.S.C.
     Section1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.

|                        |                      |                                            | 
|----------------------- | -------------------- | ------------------------------------------ | 
|                        | DERMA SCIENCES, INC. |                                           
|Dated:  August 14, 2009 | By:                  | /s/ John E. Yetter                         | 
|                        |                      | John E. Yetter, CPAChief Financial Officer | 

34

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Index

EXHIBIT INDEX

| |         |                                                                                                                                                          
| | ------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | Exhibit | Description                                                                                                                                              
|
| | 31.1    | Certification of the Principal Executive Officer pursuant to Section
     302 of theSarbanes-Oxley Act of 2002                                           
| | 31.2    | Certification of the Principal Financial Officer pursuant to Section
     302 of theSarbanes-Oxley Act of 2002                                           
| | 32.1    | Certification of the Principal Executive Officer pursuant to U.S.C.
     Section1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
| | 32.2    | Certification of the Principal Financial Officer pursuant to U.S.C.
     Section1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002