|
|

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

---

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 March 31, 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: May 15, 2009 | Class: | Common Stock, par value $.01 per share
|                   |        | Shares Outstanding: 40,140,743        

|
|

Part I

DERMA SCIENCES, INC.

FORM 10-Q

INDEX

|                               |         |                                                                                                                        |   
|------------------------------ | ------- | ---------------------------------------------------------------------------------------------------------------------- | --
|Description                    | Page   
|Part I  Financial Information
|                               | Item 1. | Financial Statements                                                                                                   |   
|                               |         | Condensed Consolidated Balance
     Sheets - March 31, 2009 (Unaudited) andDecember 31, 2008                           | 3 
|                              
|                               |         | Condensed Consolidated Statements of
     Operations  Three months endedMarch 31, 2009 and March 31, 2008 (Unaudited) | 4 
|                              
|                               |         | Condensed Consolidated Statements of
     Cash Flows  Three months endedMarch 31, 2009 and March 31, 2008 (Unaudited) | 5 
|                              
|                               |         | Notes to Condensed Consolidated Financial
     Statements (Unaudited)                                                  | 6 
|                              
|                               | Item 2. | Management's Discussion and
     Analysis of Financial Condition and Results of Operations                             | 14
|                              
|                               | Item 4. | Controls and
     Procedures                                                                                           | 25
|                              
|Part II - Other Information   
|                              
|                               | Item 6. | Exhibits                                                                                                               | 26

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

---

Index

Part I  Financial
Information

Item 1. FINANCIAL
STATEMENTS

2

---



Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                                 |  |                |              |                |  
|---------------------------------------------------------------- |  | -------------- | ------------ | -------------- | -
|Condensed Consolidated Balance Sheets                           
|                                                                
|                                                                 |  | March 31,      |             
|ASSETS                                                           |  | 2009           | December 31,
|                                                                 |  | (Unaudited)    | 2008        
|                                                                
|Current Assets                                                  
|Cash and cash equivalents                                        |  | $      288,605 |              | $      391,038 |  
|Accounts receivable, net                                         |  | 2,818,283      |              | 3,892,523      |  
|Inventories                                                      |  | 11,728,833     |              | 12,423,042     |  
|Prepaid expenses and other current assets                        |  | 477,028        |              | 397,117        |  
|                                                                
|Total current assets                                             |  | 15,312,749     |              | 17,103,720     |  
|Cash  restricted                                                |  | 2,020,734      |              | 2,014,422      |  
|Equipment and improvements, net                                  |  | 3,696,866      |              | 3,977,853      |  
|Goodwill                                                         |  | 7,119,726      |              | 7,119,726      |  
|Other intangible assets, net                                     |  | 4,979,749      |              | 5,310,129      |  
|Other assets, net                                                |  | 643,765        |              | 681,472        |  
|                                                                
|Total Assets                                                     |  | $ 33,773,589   |              | $ 36,207,322   |  
|                                                                
|LIABILITIES AND SHAREHOLDERS' EQUITY                             | 
|                                                                
|Current Liabilities                                              | 
|Line of credit borrowings                                        |  | 3,534,113      |              | 3,446,605      |  
|Current maturities of long-term debt                             |  | 1,290,523      |              | 1,298,207      |  
|Accounts payable                                                 |  | 2,625,477      |              | 3,614,764      |  
|Accrued expenses and other current liabilities                   |  | 1,541,653      |              | 2,004,493      |  
|                                                                
|Total current liabilities                                        |  | 8,991,766      |              | 10,364,069     |  
|Long-term debt                                                   |  | 3,741,670      |              | 4,065,036      |  
|Other long-term liabilities                                      |  | 42,038         |              | 44,848         |  
|Deferred tax liability                                           |  | 315,095        |              | 340,871        |  
|                                                                
|Total Liabilities                                                |  | 13,090,569     |              | 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 March  31, 2009)        |  | 22,804         |              | 22,804         |  
|Common stock, $.01 par value; 150,000,000 authorized; issued and | 
|outstanding: 40,140,743                                          |  | 401,407        |              | 401,407        |  
|Additional paid-in capital                                       |  | 40,268,832     |              | 40,027,645     |  
|Accumulated other comprehensive income                          | 
|cumulative translation adjustments                               |  | 411,880        |              | 604,465        |  
|Accumulated deficit                                              |  | (20,421,903    | )            | (19,663,823    | )
|                                                                
|Total Shareholders' Equity                                       |  | 20,683,020     |              | 21,392,498     |  
|                                                                
|Total Liabilities and Shareholders' Equity                       |  | $ 33,773,589   |              | $ 36,207,322   |  
|                                                                

See accompanying consolidated notes.

3

---



Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                                   |  |                              |      |                  |  
|------------------------------------------------------------------ |  | ---------------------------- | ---- | ---------------- | -
|Condensed Consolidated Statements of Operations (Unaudited)        | 
|                                                                   |  | Three months ended March 31,
|                                                                   |  | 2009                         | 2008
|                                                                  
|Net Sales                                                          |  | $ 10,431,891                 |      | $  11,724,822    |  
|Cost of sales                                                      |  | 7,078,255                    |      | 8,582,613        |  
|                                                                  
|Gross Profit                                                       |  | 3,353,636                    |      | 3,142,209        |  
|                                                                  
|Operating expenses                                                 | 
|Selling, general and administrative                                |  | 3,864,127                    |      | 4,320,417        |  
|Research and development                                           |  | 130,346                      |      | 48,108           |  
|                                                                  
|Total operating expenses                                           |  | 3,994,473                    |      | 4,368,525        |  
|                                                                  
|Operating  loss                                                    |  | (640,837                     | )    | (1,226,316       | )
|                                                                  
|Other expense, net:                                                | 
|Interest expense                                                   |  | 171,470                      |      | 264,915          |  
|Other (income) expense                                             |  | (1,536                       | )    | 8,614            |  
|                                                                  
|Total other expense                                                |  | 169,934                      |      | 273,529          |  
|                                                                  
|Loss before benefit for income taxes                               |  | (810,771                     | )    | (1,499,845       | )
|Benefit for income taxes                                           |  | (52,691                      | )    | (90,057          | )
|                                                                  
|Net Loss                                                           |  | $    (758,080                | )    | $ (1,409,788     | )
|                                                                  
|Loss per common share  basic and diluted                          |  | $          (0.02             | )    | $          (0.04 | )
|                                                                  
|Shares used in computing loss per common share  basic and diluted |  | 40,140,743                   |      | 34,038,207       |  
|                                                                  

See accompanying consolidated notes.

4

---



Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                            |  |                              |      |                |  
|----------------------------------------------------------- |  | ---------------------------- | ---- | -------------- | -
|Condensed Consolidated Statements of Cash Flows (Unaudited) | 
|                                                            |  | Three months ended March 31,
|                                                            |  | 2009                         | 2008
|                                                           
|Operating Activities                                        |  |                              |      |                |  
|Net loss                                                    |  | $ (758,080                   | )    | $ (1,409,788   | )
|Adjustments to reconcile net loss to net                    | 
|cash provided (used in) by operating activities:            | 
|Depreciation of equipment and improvements                  |  | 208,246                      |      | 230,840        |  
|Amortization of intangible assets                           |  | 330,380                      |      | 288,647        |  
|Amortization of deferred financing costs                    |  | 36,405                       |      | 21,709         |  
|Recovery of bad debts                                       |  | (27,576                      | )    | (3,000         | )
|Allowance for sales adjustments                             |  | 227,934                      |      | 207,702        |  
|Provision for inventory obsolescence                        |  | 56,731                       |      | 22,629         |  
|Deferred rent expense                                       |  | (10,872                      | )    | (11,196        | )
|Compensation charge for employee stock options              |  | 229,083                      |      | 187,344        |  
|Compensation charge for restricted stock                    |  | 12,105                       |      | 12,105         |  
|Gain on sale of equipment                                   |  | (59,031                      | )    | -              |  
|Deferred income taxes                                       |  | (14,616                      | )    | (90,057        | )
|Changes in operating assets and liabilities:                | 
|Accounts receivable                                         |  | 873,883                      |      | (279,947       | )
|Inventories                                                 |  | 524,218                      |      | (633,841       | )
|Prepaid expenses and other current assets                   |  | (84,353                      | )    | 470,511        |  
|Other assets                                                |  | (148                         | )    | (6,413         | )
|Accounts payable                                            |  | (964,772                     | )    | (996,996       | )
|Accrued expenses and other current liabilities              |  | (430,195                     | )    | (1,064,807     | )
|Other long-term liabilities                                 |  | 5,335                        |      | 9,576          |  
|                                                           
|Net cash provided by (used in) operating activities         |  | 154,677                      |      | (3,044,982     | )
|                                                           
|Investing Activities                                        | 
|Costs of acquiring businesses                               |  | -                            |      | (104,426       | )
|                                                            |  |                             
|Purchase of equipment and improvements                      |  | (19,655                      | )    | (134,428       | )
|Proceeds from sale of equipment                             |  | 61,000                       |      | -              |  
|                                                           
|Net cash provided by (used in) investing activities         |  | 41,345                       |      | (238,854       | )
|                                                           
|Financing Activities                                        | 
|Net change in bank line of credit                           |  | 87,508                       |      | 3,983,185      |  
|Deferred financing costs                                    |  | -                            |      | (262,776       | )
|Long-term debt repayments                                   |  | (331,050                     | )    | (320,160       | )
|Net change in restricted cash                               |  | (6,312                       | )    | -              |  
|Proceeds from issuance of stock, net of costs               |  | -                            |      | 89,177         |  
|                                                           
|Net cash (used in) provided by financing activities         |  | (249,854                     | )    | 3,489,426      |  
|                                                           
|Effect of exchange rate changes on cash                     |  | (48,601                      | )    | (71,024        | )
|                                                           
|Net (decrease) increase in cash and cash equivalents        |  | (102,433                     | )    | 134,566        |  
|Cash and cash equivalents                                   | 
|Beginning of period                                         |  | 391,038                      |      | 577,096        |  
|                                                           
|End of period                                               |  | $  288,605                   |      | $     711,662  |  
|                                                           
|Supplemental disclosures of cash flow information:          | 
|Equipment obtained with capital lease                       |  | $        -                   |      | $       96,324 |  
|Cash paid during the period for:                            | 
|Interest                                                    |  | $  150,845                   |      | $     253,931  |  
|                                                           

See accompanying consolidated notes.

5

---



|                                                                     
|---------------------------------------------------------------------
|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 months ended March 31, 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.

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, 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 months ended March 31, 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:

|                          |  |                              |  |            | 
|------------------------- |  | ---------------------------- |  | ---------- | 
|                          |  | Three Months Ended March 31, | 
|                          |  | 2009                         |  | 2008      
|Excluded dilutive shares: |  |                              |  |            | 
|Preferred stock           |  | 2,280,407                    |  | 2,280,407  | 
|Restricted common stock   |  | 175,000                      |  | 175,000    | 
|Stock options             |  | 8,675,625                    |  | 8,065,480  | 
|Warrants                  |  | 8,795,259                    |  | 8,212,759  | 
|                         
|Total dilutive shares     |  | 19,926,291                   |  | 18,733,646 | 

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

6

---



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

2.     Inventories

Inventories
include the following:

|                    |  |               |  |                  | 
|------------------- |  | ------------- |  | ---------------- | 
|                    |  | March 31,2009 |  | December 31,2008 | 
|                   
|Finished goods      |  | $  7,864,711  |  | $  9,001,269     | 
|Work in process     |  | 384,835       |  | 443,511          | 
|Packaging materials |  | 802,819       |  | 700,948          | 
|Raw materials       |  | 2,676,468     |  | 2,277,314        | 
|                   
|Total inventory     |  | $11,728,833   |  | $12,423,042      | 

3.     U.S. Line of Credit

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 42% of eligible inventory (as defined). Interest on
outstanding advances under the revolving credit agreement is payable at the LIBOR monthly
rate (the Base Rate) plus 2.75% (the Base Rate Margin) (3.27% at
March 31, 2009). 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. At March 31, 2009 the Company had an outstanding balance of
$3,534,113 under this agreement.

The
revolving credit 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 agreement. The 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.

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 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.

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

7

---



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

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 then existing revolver balance which amount will be 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

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. Interest on the term loan is payable at the LIBOR monthly rate plus 4.25%,
(4.77% at March 31, 2009). Monthly payments of principal in the amount of $100,000
together with interest are due under the agreement. The 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
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 agreement. The 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 third and fourth paragraphs under the heading Line of Credit Borrowings
(see Note 3).

Long-term
debt includes the following:

|                          |  |               |  |                  | 
|------------------------- |  | ------------- |  | ---------------- | 
|                          |  | March 31,2009 |  | December 31,2008 | 
|                         
|U.S. term loan            |  | $4,400,000    |  | $4,700,000       | 
|Promissory note           |  | 500,000       |  | 500,000          | 
|Capital lease obligations |  | 132,193       |  | 163,243          | 
|                         
|Total debt                |  | 5,032,193     |  | 5,363,243        | 
|                         
|Less:  current maturities |  | 1,290,523     |  | 1,298,207        | 
|                         
|Long-term debt            |  | $3,741,670    |  | $4,065,036       | 

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

8

---



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

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 are
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 $132,193 as of March 31, 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 March 31, 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 March 31, 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.

There
are 619,055 shares of series C convertible preferred stock outstanding at March 31, 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 March 31,
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

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.

9

---



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

Stock
Purchase Warrants

At
March 31, 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          |  | April 30, 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 900,000 and 50,000 shares of common stock were granted to
officers, directors, agents and employees for the three months ended March 31, 2009 and
2008, respectively, with exercise prices ranging from $0.39 to $1.11 per share. For the
three months ended March 31, 2009 and 2008, 10,000 plan options were forfeited and for the
three months ended March 31, 2008, 198,000 plan options were exercised. As of March 31,
2009, options to purchase 7,019,625 shares of the Companys common stock were issued
and outstanding under the plan.

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
three months ended March 31, 2009, 237,000 non-plan options expired. As of March 31, 2009,
non-plan options to purchase 1,656,000 shares of the Companys common stock were
issued and outstanding.

For
the three months ended March 31, 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 for the three months ended March
31, 2009 and 2008 were as follows:

|                             |  |       |  |       | 
|---------------------------- |  | ----- |  | ----- | 
|                             |  | 2009  |  | 2008  | 
|                            
|Risk-free interest rate      |  | 2.27% |  | 2.14% | 
|Volatility factor            |  | 94.3% |  | 162%  | 
|Dividend yield               |  | 0%    |  | 0%    | 
|Expected option life (years) |  | 6.25  |  | 6.25  | 
|Contractual life (years)     |  | 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

10

---



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

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.

A
summary of the Companys stock option activity and related information for the three
months ended March 31, 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                 |  | 900,000   |   | $0.39                         |  | 50,000    |   | $1.11                         | 
|Forfeited               |  | (10,000   | ) | $0.75                         |  | (10,000   | ) | $1.22                         | 
|Expired                 |  | (237,000  | ) | $1.11                         |  | -         |   | $   -                         | 
|Exercised               |  | -         |   | $   -                         |  | (198,000  | ) | $0.62                         | 
|                       
|Outstanding  March 31  |  | 8,675,625 |   | $0.68                         |  | 8,065,480 |   | $0.79                         | 
|                       
|Exercisable at March 31 |  | 6,391,875 |   | $0.65                         |  | 6,081,730 |   | $0.83                         | 

The
weighted average fair value per share of options granted during the three months ended
March 31, 2009 and 2008 was $0.30 and $1.02, respectively.

For
the three months ended March 31, 2009 and 2008, no income tax benefit was recognized
related to stock option activity.

During
the three months ended March 31, 2009 and 2008, stock option compensation expense was
recorded using the fair value method under SFAS 123R as follows:

|                                             |  |           |  |            | 
|-------------------------------------------- |  | --------- |  | ---------- | 
|                                             |  | 2009      |  | 2008       | 
|                                            
|Cost of sales                                |  | $  27,110 |  | $    9,855 | 
|Selling, general and administrative expenses |  | 201,973   |  | 177,489    | 
|                                            
|Total stock option compensation expense      |  | $229,083  |  | $187,344   | 

As
of March 31, 2009, there was $646,433 of unrecognized compensation cost related to
nonvested service based awards and $437,251 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 1.61 years for service and performance based
options and 0.65 years for market based options.

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 will vest 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 is being
recognized to compensation expense over the three-year service period. For the three
months ended March 31, 2009 and 2008, $12,105 for each period was recorded in operating
expenses for these grants.

11

---



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

Shares
Reserved for Future Issuance

At
March 31, 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         |  | 3,055,375  | 
|Common stock options outstanding                 |  | 8,675,625  | 
|Common stock warrants outstanding (series H - L) |  | 8,795,259  | 
|Restricted common stock available for grant      |  | 2,325,000  | 
|Restricted common stock grants                   |  | 175,000    | 
|                                                
|Total common stock shares reserved               |  | 25,306,666 | 

6.     Comprehensive Loss

The
Companys comprehensive loss was as follows:

|                                        |  |                             |   |              |  
|--------------------------------------- |  | --------------------------- | - | ------------ | -
|                                        |  | Three Months EndedMarch 31, |  
|                                        |  | 2009                        |   | 2008         |  
|                                       
|Net loss as reported                    |  | $ (758,080                  | ) | $ (1,409,788 | )
|Other comprehensive loss:               | 
|Foreign currency translation adjustment |  | (192,585                    | ) | (229,899     | )
|                                       
|Comprehensive loss                      |  | $ (950,665                  | ) | $ (1,639,687 | )

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.

12

---



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

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

|               |  |                                   |   |                                          |  |           |  |             |   |                  |  
|-------------- |  | --------------------------------- | - | ---------------------------------------- |  | --------- |  | ----------- | - | ---------------- | -
|               |  | Three Months Ended March 31, 2009 |   |                                          |  |          
|              
|               |  | Wound Care                        |   | Wound Closure-SpecialtySecurementDevices |  | Skin Care |  | Other Costs |   | Total    Company |  
|              
|Net sales      |  | $   9,799,483                     |   | $461,072                                 |  | $171,336  |  | -           |   | $ 10,431,891     |  
|              
|Gross profit   |  | 3,060,653                         |   | 246,188                                  |  | 46,795    |  | -           |   | 3,353,636        |  
|Total expenses |  | -                                 |   | -                                        |  | -         |  | $(4,111,716 | ) | (4,111,716       | )
|              
|Net loss       |  | $    (758,080                     | )
|              
|              
|               |  | Three Months Ended March 31, 2008 |   |                                          |  |          
|              
|Net sales      |  | $ 11,094,973                      |   | $450,986                                 |  | $178,863  |  | -           |   | $ 11,724,822     |  
|              
|Gross profit   |  | 2,840,168                         |   | 251,728                                  |  | 50,313    |  | -           |   | 3,142,209        |  
|Total expenses |  | -                                 |   | -                                        |  | -         |  | $(4,551,997 | ) | (4,551,997       | )
|              
|Net loss       |  | $(1,409,788                       | )

The
following table presents net sales by geographic region.

|              |  |                             |  |      | 
|------------- |  | --------------------------- |  | ---- | 
|              |  | Three Months EndedMarch 31, | 
|              |  | 2009                        |  | 2008 | 
|             
|United States |  | 73%                         |  | 59%  | 
|Canada        |  | 21%                         |  | 36%  | 
|Other         |  | 6%                          |  | 5%   | 

For the
three months ended March 31, 2009, the Company has a major U.S. customer comprising 15% of
U.S. sales and 16% of U.S. operations trade accounts receivable at March 31, 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 March 31, 2009.

8.     Income Taxes

The
Company recorded a $52,691 and $90,057 foreign income tax benefit for the three months
ended March 31, 2009 and 2008 respectively, based on the operating results of the
Companys wholly owned Canadian subsidiary. The 2009 benefit was comprised of $38,075
currently payable and $14,616 deferred while the 2008 benefit was all deferred. No benefit
was realized for the Companys net loss from U.S. operations in the three months
ended March 31, 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.

13

---



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

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

Quarter Ended March 31, 2009
Compared to Quarter Ended March 31, 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 March 31, 2009 versus 2008 operating results:

|                                            |  |                         |   |              |   |              |   |        |  
|------------------------------------------- |  | ----------------------- | - | ------------ | - | ------------ | - | ------ | -
|                                            |  | Quarter Ended March 31, |  
|                                            |  | 2009                    |   | 2008         |   | Variance     |  
|                                           
|Gross Sales                                 |  | $ 12,601,759            |   | $ 14,263,197 |   | $(1,661,438  | ) | (11.6% | )
|Sales adjustments                           |  | (2,169,868              | ) | (2,538,375   | ) | 368,507      |   | 14.5%  |  
|                                           
|Net sales                                   |  | 10,431,891              |   | 11,724,822   |   | (1,292,931   | ) | (11.0% | )
|Cost of sales                               |  | 7,078,255               |   | 8,582,613    |   | (1,504,358   | ) | (17.5% | )
|                                           
|Gross profit                                |  | 3,353,636               |   | 3,142,209    |   | 211,427      |   | 6.7%   |  
|                                           
|Selling, general and administrative expense |  | 3,864,127               |   | 4,320,417    |   | (456,290     | ) | (10.6% | )
|Research and development expense            |  | 130,346                 |   | 48,108       |   | 82,238       |   | 170.9% |  
|Interest expense                            |  | 171,470                 |   | 264,915      |   | (93,445      | ) | (35.3% | )
|Other (income) expense, net                 |  | (1,536)                 |   | 8,614        |   | (10,150      | ) | -      |  
|                                           
|                                            |  |                        
|Total expenses                              |  | 4,164,407               |   | 4,642,054    |   | (477,647     | ) | (10.3% | )
|                                           
|Loss before income taxes                    |  | (810,771                | ) | (1,499,845   | ) | 689,074      |   | 45.9%  |  
|                                           
|Provision for income taxes                  |  | (52,691                 | ) | (90,057      | ) | (37,366      | ) | (41.5% | )
|                                           
|Net loss                                    |  | $    (758,080           | ) | $(1,409,788  | ) | $    651,708 |   | 46.2%  |  

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. The normal rebate cycle is one month. Non-exclusive
distributors generally carry one months inventory. The Companys exclusive
distributor in Canada normally carries three to four 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. If the normal rebate cycle were one-half month less than estimated at
March 31, 2009, the trade rebate reserve would be overstated by approximately $217,500. If
the normal rebate cycle were one month greater than estimated at March 31, 2009, the trade
rebate reserve would be understated by approximately $435,000. To minimize its cash
outflow invested in rebates, distributors generally strive to optimize the rebate credit
submission process.

Given
the nature of the Companys products and business, there is no external information
available to further validate the reasonableness of the trade rebate accrual balance.
Historical trends of sales subject to rebate and rebates received are evaluated monthly,
by distributor, on a 3 month, 6 month and 12 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.

14

---



Index

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.

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 March 31, |  
|                       |  | 2009                    |   | 2008         |  
|                      
|Gross Sales            |  | $ 12,601,759            |   | $ 14,263,197 |  
|                      
|Trade rebates          |  | (1,509,291              | ) | (1,924,525   | )
|Distributor fees       |  | (206,739                | ) | (286,022     | )
|Sales incentives       |  | (157,825                | ) | (43,352      | )
|Returns and allowances |  | (185,500                | ) | (155,430     | )
|Cash discounts         |  | (110,513                | ) | (129,046     | )
|                      
|Total adjustments      |  | (2,169,868              | ) | (2,538,375   | )
|                      
|Net sales              |  | $ 10,431,891            |   | $ 11,724,822 |  

Trade rebates
decreased in 2009 versus 2008 due principally to lower Canadian sales subject to rebate
which, in turn, resulted from lower demand and unfavorable exchange, partially offset by
an increase in U.S. regular and private label sales subject to rebate. There was no
discernable change in Canadian rebates as a percentage of sales quarter to quarter. 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 sales incentive program together with an increase in the level of sales
subject to incentives. The sales returns and allowances increase is due principally to a
large first aid division (FAD) return during the quarter. U.S. sales subject
to cash discount were essentially flat quarter to quarter. Cash discounts decreased in
response to a tightening of the Companys cash discount policy which resulted in
lower cash discounts as a percentage of sales in 2009 versus 2008.

Rebate Reserve Roll
Forward

A
three month roll forward of the trade rebate accruals at March 31, 2009 and 2008 is
outlined below:

|                              |  |                         |   |             |  
|----------------------------- |  | ----------------------- | - | ----------- | -
|                              |  | Quarter Ended March 31, |  
|                              |  | 2009                    |   | 2008        |  
|                             
|Beginning balance  January 1 |  | $ 2,660,086             |   | $ 2,407,709 |  
|Rebates paid                  |  | (1,496,027              | ) | (1,591,703  | )
|Rebates accrued               |  | 1,509,291               |   | 1,924,525   |  
|                             
|Ending balance  March 31     |  | $ 2,673,350             |   | $ 2,740,531 |  

The
$13,264 increase in the trade rebate reserve balance for the three months ended March 31,
2009 reflects growth of the rebate intensive U.S. private label and regular business
coupled with a timing related delay in the payment of the corresponding private label
rebates. These increases were for the most part offset by a reduction in the Canadian
reserve due to lower sales to the exclusive Canadian distributor in response to the
distributors plan

15

---



Index

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 March 31, 2009 versus 2008 product line net sales and gross
profit:

|               |  |                         |  |              |  |              |   |        |  
|-------------- |  | ----------------------- |  | ------------ |  | ------------ | - | ------ | -
|               |  | Quarter Ended March 31, | 
|               |  | 2009                    |  | 2008         |  | Variance     |  
|              
|Net Sales      |  | $10,431,891             |  | $11,724,822  |  | $(1,292,931  | ) | (11.0% | )
|              
|Cost of sales  |  | 7,078,255               |  | 8,582,613    |  | (1,504,358   | ) | (17.5% | )
|              
|Gross Profit   |  | $  3,353,636            |  | $  3,142,209 |  | $    211,427 |   | 6.7%   |  
|              
|Gross Profit % |  | 32.1%                   |  | 26.8%        | 

Consolidated
net sales decreased $1,292,931, or 11.0%, in 2009 versus 2008. Canadian net sales
decreased $1,041,387, or 32.1%, to $2,205,405 in 2009 from $3,246,792 in 2008. This
decrease was driven by lower sales of $416,439 and unfavorable exchange of $624,948
associated with a 23.8% weakening of the Canadian dollar. Inventory rationalization on the
part of the Companys exclusive Canadian distributor is principally responsible for
the sales decrease. Real growth as measured by sales of the Companys products
reported by its exclusive distributor, unadjusted for foreign exchange, approximated 3.0%.
U.S. net sales decreased $251,544, or 3.0%, to $8,226,486 in 2009 from $8,478,030 in 2008.
The decrease was driven by lower FAD sales of $806,229 and traditional wound care sales of
$206,683, partially offset by higher private label sales of $501,689 and advanced wound
care sales of $263,386. Specialty fixation and skin care and bathing sales were comparable
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 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 sales and marketing support. Gross U.S. Medihoney sales increased
$185,591 to $479,178 in 2009 versus $293,587 in 2008. The increase in private label sales
reflects incremental sales from a new product being manufactured for an existing customer
in the first quarter 2009, together with improved demand from a number of the
Companys others customers.

Consolidated
gross profit increased $211,427, or 6.7%, in 2009 versus 2008. The consolidated gross
profit margin percentage increased to 32.1% in 2009 from 26.8% in 2008. Canadian gross
profit decreased $121,134, or 14.6%, to $709,364 in 2009 from $830,498 in 2008. The
Canadian gross profit margin percentage increased to 32.2% in 2009 from 25.6% in 2008. The
decrease in Canadian 2009 gross profit dollars reflects the lower sales, partially offset
by the higher gross profit margin percentage. The increase in Canadian gross profit margin
percentage principally reflects a favorable sales mix coupled with 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 $332,561, or 14.4%, to
$2,644,272 in 2009 from $2,311,711 in 2008. The U.S. gross profit margin percentage
increased to 32.1% in 2009 from 27.3% 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, lower freight costs and the non-recurrence of incremental FAD
integration related transition expense incurred in 2008. Excluding FAD, margins on the
balance of the U.S. business were essentially flat as favorable product mix and lower
freight costs served to effectively balance the adverse impact of higher product costs.

16

---



Index

Selling, General and
Administrative Expenses

The
following table highlights March 31, 2009 versus 2008 operating expenses by type:

|                       |  |                         |  |             |  |           |   |        |  
|---------------------- |  | ----------------------- |  | ----------- |  | --------- | - | ------ | -
|                       |  | Quarter Ended March 31, | 
|                       |  | 2009                    |  | 2008        |  | Variance  |  
|                      
|Distribution           |  | $   427,734             |  | $   479,987 |  | $(52,253  | ) | (10.9% | )
|Marketing              |  | 390,932                 |  | 395,990     |  | (5,058    | ) | (1.3%  | )
|Sales                  |  | 1,215,041               |  | 1,274,023   |  | (58,982   | ) | (4.6%  | )
|General administrative |  | 1,830,420               |  | 2,170,417   |  | (339,999  | ) | (15.7% | )
|                      
|Total                  |  | $3,864,127              |  | $4,320,417  |  | $(456,290 | ) | (10.6% | )

Selling,
general and administrative expenses decreased $456,290, or 10.6%, in 2009 versus 2008,
including a decrease of $155,825 in Canadian selling, general and administrative expenses
attributable to exchange.

Distribution
expense decreased $52,253, or 10.9%, in 2009 versus 2008. Expenses in Canada decreased
$21,487 (including a $15,038 benefit related to exchange) while expenses in the U.S
decreased $30,766. The decrease in Canada relates to lower real estate tax allocation and
maintenance expense. 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
personnel and operating costs in St. Louis in support of the non-FAD business.

Marketing
expense decreased $5,058, or 1.3%, in 2009 versus 2008. The decrease is attributable to a
U.S. decrease of $7,667 coupled with an increase in Canada of $2,609 (including a $5,693
benefit related to exchange). The U.S. decrease stems from a $72,136 planned reduction in
clinical personnel, trade show and advanced wound care promotion expense to more
affordable levels, partially offset by an increase in FAD expense of $64,468 reflecting a
higher level of marketing activity in 2009 versus 2008. The Canada expense increase
reflects higher new advanced wound care product sampling costs, partially offset by lower
timing related new product promotion expenses.

Sales
expense decreased $58,982, or 4.6%, in 2009 versus 2008. Expenses in Canada decreased
$48,692 (including a $37,997 benefit related to exchange) while expenses in the U.S.
decreased $10,289. Expenses in Canada decreased principally due to lower group purchasing
organization (GPO) and distributor sales incentive program expenses. The U.S.
decrease was attributable to lower customer service expense of $39,620, partially offset
by higher non-FAD expense of $27,086 and FAD related expense of $2,246. The reduction in
customer service expense was driven by the non-recurrence of FAD related integration
costs. The increase in non-FAD expense reflects the incremental cost of implementing a
formal sales tracing program beginning in the second half of 2008 coupled with lower
timing related commission expense and lower cost reduction driven travel and consulting
expense. FAD expenses related to a sales support position added in the second quarter 2008
and higher travel costs, partially offset by the non-recurrence of relocation expense.

General
administrative expense decreased $339,999, or 15.7%, in 2009 versus 2008. Expenses in
Canada decreased $121,205 (including a $97,098 benefit related to exchange) while expenses
in the U.S. decreased $218,794. The decrease in Canada reflects lower compensation due a
change in staffing, travel and operating expenses, partially offset by higher equity based
compensation expense. The U.S. decrease principally reflects lower cost reduction driven
travel expense of $64,000 and investor relations expense of $33,000, non-recurring legal
expense of $50,000 and non-recurring recruiting expense of $40,000, together with bad debt
expense of $56,000 and other professional service fees of $57,000, partially offset by
incremental intangible amortization expense of $56,000 related to the FAD acquisition,
equity based compensation of $16,000 and other net operating costs (insurance, rent,
depreciation and other) of $9,000.

Research and Development
Expense

Research
and development expense increased $82,238 to $130,346 in 2009 from $48,108 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.

17

---



Index

Interest Expense

Interest
expense decreased $93,445 to $171,470 in 2009 from $264,915 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/Expense

Other
income increased $10,150 to $1,536 income in 2009 from $8,614 expense in 2008. The main
drivers for the increase were higher net miscellaneous income of $64,004 consisting
principally of gains on miscellaneous asset sales associated with the closure of the FAD
manufacturing operation, for the most part offset by lower royalty income of $29,945 and
higher exchange losses of $23,909.

Income Taxes

The
Company recorded a $52,691 tax benefit for 2009 consisting of a $36,075 current foreign
tax benefit and a $14,616 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 carryforward and net deferred tax assets. The Company
recorded a $90,057 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
$758,080, or $0.2 per share (basic and diluted), in 2009 compared to a net loss of
$1,409,788, or $0.04 per share (basic and diluted), in 2008.

Liquidity and Capital
Resources

Operational Overview

Net
sales decreased 11.0% (5.7% adjusted for exchange) in 2009 versus 2008. This decline was
driven by a sales decrease in the U.S. of 3.0%, together with a decrease in Canadian sales
of 32.1% (12.8% adjusted for exchange). Sales in the U.S. were adversely impacted by lower
FAD sales. Excluding FAD, U.S. sales increased 11.8% driven by private label and advanced
wound care sales increases, partially offset by lower traditional wound care sales.
Specialty fixation, skin care and bathing and burn care sales were comparable quarter to
quarter. Despite its first quarter performance, FAD sales continue to represent a growth
opportunity for the Company. This is evidenced by the incremental business the FAD has
generated recently, together with the new character bandages that are to be launched in
the near future. Gross U.S. sales of Medihoney continue to grow. Monthly U.S. Medihoney
gross sales exceeded $200,000 in March and April. In the fourth quarter 2008, the Company
launched the MedEfficiency line of Total Contact Cast systems and XTRASORB. In January
2009, the Company launched MOBILITY 1. Each of these products exhibited sales growth in
the quarter. In February 2009, the Company received clearance from the Food and Drug
Administration for the marketing and sale of BIOGUARD, the Companys new novel
infection control product. The launch and approval of these promising new products bodes
well for the future growth of the Companys higher-margin advanced wound care product
line. Private label sales are expected to grow by virtue of anticipated increases in core
product demand and the realization of new business opportunities. Sales for the
traditional wound care line were adversely impacted by the non-recurrence of a spot sale
realized in 2008 and softening demand. Core traditional wound care sales are expected to
remain stable going forward and the Company has the opportunity to increase sales based on
its recent signing of a GPO agreement. Sales for the specialty fixation and closure device
line, while experiencing some fluctuation over the past several quarters, are expected to
be relatively stable going forward. Skin care and bathing sales are expected to continue
to deteriorate in the face of competitive pressure and a reduction of the resources
allocated to support the line. Adjusted for exchange, Canada sales to the exclusive
distributor were down 12.8% in 2009. Measured in local currency, sales of the
Companys products reported by the Canadian distributor continued to grow, albeit
modestly. The Companys exclusive Canadian distributor initiated a program to reduce
its inventory beginning in the first quarter. This program is expected to last through the
second quarter and is primarily responsible for the lower

18

---



Index

Canadian sales. Expanded marketing
and sales efforts, a continued focus on contract compliance, exploring opportunities in
other market segments (other than the Companys traditional strength in the acute
care segment) and working closely with the Companys exclusive Canadian distributor
to capitalize on sales growth opportunities are expected to generate positive results
going forward. The Company is actively pursuing distributors in numerous countries to
increase its international sales. A number of the Companys advanced wound care
products have recently earned CE mark status and the Company anticipates that during 2009
it will establish agreements with distributors in Europe and the Middle East.

The
Company has realized significant product cost improvement over the last several years as a
result of its manufacturing and sourcing initiatives. The savings generated by these
initiatives have helped partially mitigate the adverse impact of price erosion and foreign
exchange on a large portion of the Companys business and served to sustain or
improve its gross profit dollars. Product cost savings associated with implementation of
China and other sourcing initiatives have been another contributor to the Companys
cost reduction success. Current market conditions in China and other markets portend
increasing product and transportation costs that will put pressure on the Companys
margins. The Company will continue to seek opportunities both internally and externally to
lower its transportation and product costs and raise selling prices wherever possible in
an effort to offset the adverse impact of these higher costs.

Operating
expenses decreased 10.6% in 2009 over 2008 in line with expectations. This reduction
reflects the Companys plan to scale back its sales and marketing efforts to more
affordable levels in line with actual revenue and to implement general and administrative
cost reduction initiatives. The Company will continue to closely monitor its operating
expenses.

In
November 2007, the Company made a significant investment in research and development via
the licensing of certain angiotensin analog technology including lead candidate DSC127.
The initial evaluation of the market potential and probability of obtaining approval for
sale of products employing this technology was determined to be favorable. DSC127 entered
the phase II portion of product development trials in the first quarter 2008. Completion
of the phase II study is expected by the second quarter of 2010. Presently, the Company
plans to take DSC127 through phase II at an estimated cost of $1,600,000, including the
$783,672 spent on research and development to date. Upon completion of the phase II study
in 2010, the Company will reevaluate the market potential of DSC127 and the probability of
its ultimately being approved for sale to determine the best future course of action.

In
November 2007, in connection with the FAD acquisition, the Company entered into a new
five-year credit and security agreement comprised of an $8,000,000 revolver and a
$6,000,000 term loan. Outstanding borrowings on the line of credit and term loan were
$3,534,113 and $4,400,000, respectively at March 31, 2009. Given the significant increase
in debt, interest expense has become a larger component of the Companys overall cost
structure. The Company has benefited over the past several quarters from lower market
interest rates. In connection with the amendment to its credit and security agreement
effective March 31, 2009, the Companys interest rate was raised approximately 200
basis points. Going forward, the Companys cost of debt will increase.

The
Company reported a loss of $758,080 in the first quarter 2009 consistent with
expectations. While sales declined, gross profit dollars increased due to a favorable
sales mix, the elimination of higher cost FAD domestic manufacturing in the fourth quarter
2008, lower transportation costs and improved manufacturing performance in Canada. As
expected, operating expenses were reduced. The Company continued to fund its investment in
R&D as planned. The Company anticipates it will continue to operate at a loss in the
near term, but expects to significantly improve upon its 2008 performance.

Cash Flow and Working
Capital

At
March 31, 2009 and December 31, 2008, the Company had cash and cash equivalents on hand of
$288,605 and $391,038, respectively. The $102,433 decrease in cash reflects net cash used
in financing activities of $249,854 and cash used as a result of exchange rate changes of
$48,601, less cash provided by operating activities of $154,677 and net cash provided in
investing activities of $41,345.

Net
cash provided by operating activities of $154,677 stems from $230,709 cash provided from
operations (net loss plus non-cash items), together with $76,032 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

19

---



Index

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 ongoing operating assets and liabilities. The
change in receivables reflects lower sales and improved collections. The reduced
investment in inventory reflects the beginning of a focused plan to reduce inventory
levels while maintaining customer service requirements. The decrease in accounts payable
reflects a significant reduction in payables related to inventory in-transit (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 in Canadian reserves.

Net
cash provided by investing activities of $41,345 reflects receipt of $61,000 cash from the
sale of assets associated with the discontinuation of FAD domestic manufacturing,
partially offset by $19,655 in capital expenditures.

Net
cash used in financing activities of $249,854 reflects regularly scheduled debt payments
of $331,050 and an increase in restricted cash of $6,312, partially offset by increased
line of credit borrowings of $87,508.

Working
capital decreased $418,668, or 6.2%, at March 31, 2009 to $6,320,983 from $6,739,651 at
December 31, 2008. 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 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 March 31, 2009, together with available revolver capacity of $924,057,
the Company has $1,212,662 of available liquidity at March 31, 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.

Beginning
in 2005, the Company expanded its product in-licensing and development efforts. As a
result of these efforts, the Company launched its silver alginate product 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
three new products, the MedEfficiency line of Total Contact Cast systems (October 2008),
XTRASORB (November 2008) and MOBILITY 1 (January 2009). All three products have received
interest in the marketplace and complement the Companys existing products. In
addition, the Company received clearance in February 2009 for BIOGUARD, its novel

20

---



Index

antimicrobial infection control
product which it expects to launch in June 2009. 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 significant 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 significant opportunities for sales growth. The Company began to realize the
significant savings associated with discontinuing its higher cost U.S. production in the
fourth quarter. In addition, the FAD is working to firm up a cost effective supply chain
for its adhesive bandages and first aid related products. The new supply chain is
expected to be in place by mid-2009, at which time the Company expects to be able to
further reduce its product costs and improve liquidity by significantly reducing the
level of inventory required to support the ongoing business.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 budget.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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
mid-2010. The projected cost to complete the phase II trials are approximately
$1,600,000, including the $783,672 incurred in 2008. The Company plans to continue with
this investment and anticipates spending approximately $816,328 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 March 31, 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.

21

---



Index

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 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
March 31, 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.

22

---



Index

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 March 31, 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 $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 March 31, 2009,
the Company had an accumulated deficit of $20,683,020 (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.

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 19,926,291 shares of the Companys common stock are potentially issuable upon the
conversion, exercise or vesting of outstanding convertible preferred stock, warrants,
options and restricted stock awards (dilutive securities). The shares of
common stock potentially issuable upon conversion, exercise or vesting of dilutive
securities are substantial compared to the 40,140,743 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 quarter of 2009 are set forth in the
table below:

23

---



Index

| |                                                           |  |       |  |       | 
| | --------------------------------------------------------- |  | ----- |  | ----- | 
| | 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(*)                                                   |  | $0.35 |  | $0.70 | 
| |                                                           |  |       |  |       | 
| | (*) January 1 through March 31.                           | 

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.

24

---



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 March 31, 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 three months ended March 31, 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.

25

---



Index

Part II  Other
Information

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 the Sarbanes-Oxley Act of 2002                                           
| | 31.2    | Certification of the Principal Financial Officer pursuant to Section
     302 of the Sarbanes-Oxley Act of 2002                                           
| | 32.1    | Certification of the Principal Executive Officer pursuant to U.S.C.
     Section 1350 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.
     Section 1350 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 duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.

|                     |                      |                                            | 
|-------------------- | -------------------- | ------------------------------------------ | 
|                     | DERMA SCIENCES, INC. |                                           
|Dated:  May 15, 2009 | By:                  | /s/ John E. Yetter                         | 
|                     |                      | John E. Yetter, CPAChief Financial Officer | 

26

---



Index

EXHIBIT INDEX

| |         |                                                                                                                                                           
| | ------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | Exhibit | Description                                                                                                                                               
| | 31.1    | Certification of the Principal Executive Officer pursuant to Section
     302 of the Sarbanes-Oxley Act of 2002                                           
| | 31.2    | Certification of the Principal Financial Officer pursuant to Section
     302 of the Sarbanes-Oxley Act of 2002                                           
| | 32.1    | Certification of the Principal Executive Officer pursuant to U.S.C.
     Section 1350 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.
     Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002