---

U.S. SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549  FORM 10-QSB  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE
SECURITIES EXCHANGE ACT OF 1934   For Quarter Ended
     
     September 30, 2004Commission 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 100Princeton, New Jersey
08540(609) 514-4744(Address including zip code and
telephonenumber, of principal executive offices)


Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Issuer was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
   Yes [X]   No [  ]

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

|Date: September 30, 2004 | Class: Common Stock, par value $.01 per share
|------------------------ | ---------------------------------------------
|                         | Shares Outstanding: 9,524,007                

---

DERMA SCIENCES, INC.FORM
10-QSBINDEX

|Description |  | Page
|----------- |  | ----

Part I - Condensed Financial Information

|        |                                                                                                                    |   
|------- | ------------------------------------------------------------------------------------------------------------------ | --
|Item 1. | Condensed Consolidated Financial Statements                                                                        |   
|        |                                                                                                                    |   
|        | Condensed Consolidated Balance
     Sheets - September 30, 2004 and December 31, 2003                              | 3 
|        |                                                                                                                    |   
|        | Condensed Consolidated Statements of
     Operations - Three months ended September 30, 2004and September 30, 2003 | 4 
|        |                                                                                                                    |   
|        | Condensed Consolidated Statements of
     Operations - Nine months ended September 30, 2004and September 30, 2003  | 5 
|        |                                                                                                                    |   
|        | Condensed Consolidated Statements of
     Cash Flows - Nine months ended September 30, 2004and September 30, 2003  | 6 
|        |                                                                                                                    |   
|        | Notes to Consolidated Financial
     Statements                                                                    | 7 
|        |                                                                                                                    |   
|Item 2. | Management's Discussion and Analysis of
     Financial Condition and Results of Operations                         | 19
|        |                                                                                                                    |   
|Item 3. | Controls and Procedures                                                                                            | 27

Part II - Other Information

|Item 1. | Legal Proceedings | 28
|------- | ----------------- | --
|        |                   |   
|Item 6. | Exhibits          | 28
|        |                   |   

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.  CONDENSED FINANCIAL STATEMENTS

2

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DERMA SCIENCES, INC.Consolidated Balance Sheets

`=========================================================================================================
                                                                      September 30,        December 31,
                                                                          2004                2003*
                                                                      (Unaudited)
ASSETS
---------------------------------------------------------------------------------------------------------

Current Assets
Cash and cash equivalents                                             $    51,131       $     439,837
Short-term investments, restricted                                      1,004,010               -
Accounts receivable, net                                                2,425,491           2,627,092
Inventories                                                             5,041,227           4,003,258
Prepaid expenses and other current assets                                 257,148             351,962
---------------------------------------------------------------------------------------------------------
Total current assets                                                    8,779,007           7,422,149
Equipment and improvements, net                                         3,720,320           1,077,688
Goodwill                                                                1,110,967           1,110,967
Other intangible assets, net                                              429,059             158,604
Other assets, net                                                         132,561             156,765
---------------------------------------------------------------------------------------------------------

Total Assets                                                          $14,171,914        $  9,926,173
---------------------------------------------------------------------------------------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY
---------------------------------------------------------------------------------------------------------
Current Liabilities
Lines of credit                                                       $ 2,536,416        $  1,361,708
Current maturities of long-term debt                                      225,181             178,720
Note payable                                                            1,566,000               -
Accounts payable                                                        1,305,970             731,438
Accrued expenses and other current liabilities                            504,415             313,315
---------------------------------------------------------------------------------------------------------
Total current liabilities                                               6,137,982           2,585,181
---------------------------------------------------------------------------------------------------------

Long-term Liabilities
Long-term debt                                                            887,490             849,981
Other long-term liabilities                                                37,305               -
---------------------------------------------------------------------------------------------------------
Total long-term liabilities                                               924,795             849,981
---------------------------------------------------------------------------------------------------------

Total Liabilities                                                       7,062,777           3,435,162
---------------------------------------------------------------------------------------------------------

Shareholders' Equity
Common stock, $.01 par value, 30,000,000 shares authorized;
issued and outstanding: 9,524,007 shares at September 30, 2004 and
7,462,695 shares at December 31, 2003                                      95,240              74,627
Convertible preferred stock, $.01 par value; 11,750,000 shares
authorized; issued and outstanding: 2,280,407 shares at September 30,
2004 (liquidation preference of $4,210,231) and 2,284,574 shares at        22,804              22,846
December 31, 2003 (liquidation preference of $4,235,233)
Additional paid-in capital                                             18,687,917          16,746,690
Accumulated other comprehensive income                                    500,633             294,185
Accumulated deficit                                                   (12,197,457)        (10,647,337)
---------------------------------------------------------------------------------------------------------
Total Shareholders' Equity                                              7,109,137           6,491,011
---------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity                           $ 14,171,914        $  9,926,173
=========================================================================================================`

*Consolidated balance sheet at December 31, 2003 has been derived from the
audited financial statements at that date.See accompanying notes.

3

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Index

DERMA SCIENCES, INC.Consolidated Statements of Operations (Unaudited)

`=======================================================================================================
                                                                            Three months ended
                                                                               September 30,
                                                                          2004               2003
-------------------------------------------------------------------------------------------------------

Net sales                                                             $ 4,969,824        $ 4,212,619

Cost of sales                                                           3,749,380          2,812,161
-------------------------------------------------------------------------------------------------------
Gross Profit                                                            1,220,444          1,400,458
-------------------------------------------------------------------------------------------------------
Operating expenses                                                      1,412,809          1,469,362
Interest expense, net                                                      61,242             44,750
Other income, net                                                         (10,252)           (17,917)
-------------------------------------------------------------------------------------------------------
Total Expenses                                                          1,463,799          1,496,195
-------------------------------------------------------------------------------------------------------

Loss before provision for income taxes                                   (243,355)           (95,737)
Provision for income taxes                                                  -                  -
-------------------------------------------------------------------------------------------------------
Net Loss                                                              $ (243,355)        $  (95,737)
-------------------------------------------------------------------------------------------------------

Loss per common share - basic and diluted                                 $(0.03)             $(0.01)
-------------------------------------------------------------------------------------------------------
Shares used in computing loss per common share - basic and diluted      9,524,007          7,338,682
=======================================================================================================`

See accompanying notes.

4

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Index

DERMA SCIENCES, INC.Consolidated Statements of Operations (Unaudited)

`=========================================================================================================
                                                                            Nine months ended
                                                                              September 30,
                                                                          2004               2003
-------------------------------------------------------------------------------------------------------
Net sales                                                             $14,913,257        $13,065,047

Cost of sales                                                          10,830,809          8,451,050
-------------------------------------------------------------------------------------------------------
Gross Profit                                                            4,082,448          4,613,997
-------------------------------------------------------------------------------------------------------
Operating expenses                                                      5,371,942          4,470,354
Interest expense                                                          159,388            215,236
Other expense (income), net                                               101,238            (65,293)
-------------------------------------------------------------------------------------------------------
Total Expenses                                                          5,632,568          4,620,297
-------------------------------------------------------------------------------------------------------
Loss before provision for income taxes                                 (1,550,120)            (6,300)
Provision for income taxes                                                  -                  -
-------------------------------------------------------------------------------------------------------
Net Loss                                                              $(1,550,120)        $   (6,300)
-------------------------------------------------------------------------------------------------------
Loss per common share - basic and diluted                                 $(0.17)             $(0.00)
-------------------------------------------------------------------------------------------------------
Shares used in computing loss per common share - basic and diluted      9,285,722          5,656,822
=========================================================================================================`

See accompanying notes.

5

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Index

DERMA SCIENCES, INC.Consolidated Statements of Cash Flows (Unaudited)

`=========================================================================================================
                                                                            Nine months ended
                                                                                September 30,
                                                                          2004                 2003
---------------------------------------------------------------------------------------------------------
Operating Activities
    Net loss                                                          $(1,550,120)         $    (6,300)
    Adjustments to reconcile net loss to
      net cash used in operating activities:
       Depreciation                                                       213,896              115,532
       Amortization                                                       138,155              116,979
       Deferred financing costs                                             -                   15,000
       Provision for bad debts and rebates                                 38,613                6,871
       Provision for inventory obsolescence                               106,279               16,072
       Loss on disposal of equipment and improvements                     108,121                2,132
       Changes in operating assets and liabilities:
           Accounts receivable                                            243,932              (21,815)
           Inventories                                                 (1,052,987)            (576,674)
           Prepaid expenses and other current assets                       63,111              (32,916)
           Other assets                                                    11,317               10,138
           Accounts payable                                               549,250              408,370
           Accrued expenses and other current liabilities                 176,787             (212,291)
           Other long-term liabilities                                     37,305                -
---------------------------------------------------------------------------------------------------------
Net cash used in operating activities                                    (916,341)            (158,902)
---------------------------------------------------------------------------------------------------------
Investing Activities
    Cash paid for wound care business                                    (376,797)               -
    Purchases of equipment and improvements                              (961,866)             (98,885)
    Purchase of inventory and product rights                                -                 (114,691)
    Short-term investments, restricted                                 (1,004,010)               -
---------------------------------------------------------------------------------------------------------
Net cash used in investing activities                                  (2,342,673)            (213,576)
---------------------------------------------------------------------------------------------------------
Financing Activities
    Net change in lines of credit                                       1,122,704             (964,930)
    Deferred financing costs                                              (60,617)             (29,423)
    Long-term debt repayments                                            (149,946)            (150,734)
    Proceeds from issuance of stock, net of issuance costs              1,961,798            1,128,798
---------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities                     2,873,939              (16,289)
---------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash                                    (3,631)               7,290
---------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents                                (388,706)            (381,477)

Cash and cash equivalents
  Beginning of period                                                     439,837            1,496,357
---------------------------------------------------------------------------------------------------------
  End of period                                                       $    51,131          $ 1,114,880
---------------------------------------------------------------------------------------------------------
Supplemental cash flow information:
  Note payable for acquisition of wound care business                 $ 1,566,000                -
  Equipment obtained with capital leases                              $   211,973                -
=========================================================================================================`

See accompanying notes.

6

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Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

1. Organization and
Summary of Significant Accounting Policies

Derma
Sciences, Inc. and its subsidiaries (the Company) are full line providers of
wound care, wound closure-fasteners 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 principal manufacturing and distribution facilities are
located in St. Louis, Missouri and Toronto, Canada. The Company also has a manufacturing
facility in 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-QSB and Item 310(b)
of Regulation S-B. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of America for
complete financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation have been
included. Operating results for the three and nine month periods ended September 30, 2004,
are not necessarily indicative of the results that may be expected for the year ending
December 31, 2004. For further information, refer to the consolidated financial statements
and footnotes thereto for the year ended December 31, 2003, included in Form 10-KSB
previously filed with the Securities and Exchange Commission.

Summary
of Significant Accounting Policies:

Principles
of Consolidation  The consolidated financial statements include the accounts of
Derma Sciences, Inc. and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.

Use
of Estimates  In conformity with accounting principles generally accepted in the
United States of America, the preparation of financial statements requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Although these estimates are based on knowledge of
current events and actions which may be undertaken in the future, actual results may
ultimately differ from these estimates.

Foreign
Currency Translation  Assets and liabilities are translated using the exchange rates
in effect at the balance sheet date, while income and expenses are translated using
average rates. Translation adjustments are reported as a component of shareholders
equity in accumulated other comprehensive income (loss).

Cash and Cash
Equivalents  The Company considers unrestricted cash and cash equivalents as amounts on hand, on deposit in financial
institutions and highly liquid investments purchased with an original maturity of three months or less.

Short-term
Investments, Restricted  Short-term investments, restricted represents funds
deposited with the U.S. Lender in connection with a stand-by letter of credit (Note 8) and
are invested in money market funds and certificates of deposit with maturities of less
than 6 months.

Concentration
of Credit Risk  Financial instruments that subject the Company to a concentration of
credit risk consist principally of cash and cash equivalents and accounts receivable. The
Company maintains cash and cash equivalents with various financial institutions. The
Company performs periodic evaluations of the relative credit standing of those financial
institutions, and the Companys policy is designed to limit exposure to any one
institution. The Companys accounts receivable is net of an allowance for doubtful
accounts. The Company does not require collateral or other security to support credit
sales, but provides an allowance for doubtful accounts based on historical experience and
specifically identified risks. Accounts receivable are charged off against the allowance
for doubtful accounts when management determines that recovery is unlikely and the Company
ceases collection efforts.

7

---

Inventories
 Inventories consist primarily of raw materials, packaging materials, work in
process and finished goods valued at the lower of cost or market. Cost is determined on
the basis of the first-in, first-out method.

Equipment and
Improvements  Equipment and improvements are stated at cost and are depreciated principally by the straight-line method
over the estimated useful lives of the assets ranging from three to ten years. Leasehold improvements are depreciated over the
lesser of their useful lives or the remaining lease term.

Fair
Value of Financial Instruments  The carrying value of cash and cash equivalents,
accounts receivable, prepaid expenses and other current assets, accounts payable and
accrued expenses reported in the consolidated balance sheets equal or approximate fair
value due to their short maturities. The fair value of the Companys long-term debt
approximates book value as such notes are at market rates currently available to the
Company.

Other Intangible
Assets  Patents and trademarks and other intangible assets with definite lives are stated on the basis of cost. Patents
and trademarks are amortized over 12 to 17 years on a straight-line basis. Other intangible assets are amortized over 5 years on a
straight line basis.

Goodwill
 Goodwill of $1,110,967 represents the excess of the purchase price over the fair
value of identifiable net assets acquired in the 1998 acquisition of Sunshine Products.
This business combination was accounted for as a purchase. The Company adopted Statement
of Financial Accounting Standards No. 142 (SFAS No. 142), Goodwill and
Other Intangible Assets on January 1, 2002. Goodwill and certain other intangible
assets having indefinite lives are no longer amortized to earnings, but instead are
subject to periodic (annual) testing for impairment. The Company tests goodwill for
impairment using the two-step process prescribed by SFAS No. 142. The first step tests for
potential impairment, while the second step measures the amount of impairment, if any. The
Company uses a discounted cash flow analysis to complete the first step in this process.
The Company conducted the required annual impairment review in the fourth quarter of 2003
and determined that the goodwill carrying value was not impaired. A similar review will be
performed in the fourth quarter of 2004.

Long Lived Assets
 In accordance with SFAS 144, Accounting for Impairment or Disposal of Long Lived Assets the Company reviews its
long-lived assets with definite lives whenever events or changes in circumstances indicate that the carrying amount of such assets
may not be recoverable. If the carrying amount of the asset or group of assets exceeds its net realizable value, the asset will be
written down to its fair value.

Stock
Based Compensation  SFAS No.123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation-Transition and Disclosure, provides companies with a choice to follow the
accounting provisions of SFAS No. 123 in determination of stock-based compensation expense or to continue with the provisions of
APB No. 25, Accounting for Stock Issued to Employees and related interpretations in accounting for stock-compensation
plans. The Company has elected to follow the intrinsic value method of accounting under the accounting provisions of APB 25. Under
APB 25, if the exercise price of the Companys stock options equals or exceeds the market price of the underlying Common
Stock on the date of grant, generally no compensation expense is recognized. The Company has issued common stock options to
certain executives with vesting contingent upon the achievement of performance targets. These options could result in a
compensation charge in the future based on the difference between the exercise price of the options and the market price of the
Companys common stock at a future date if the performance targets are met and the options vest.

Pro
forma information regarding net income (loss) and earnings (loss) per share is required by
SFAS No. 123, which also requires that the information be determined as if the Company has
accounted for its stock options granted under the fair value method of that Statement. The
fair value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 2004 and 2003:
risk-free interest rate of 4.25% in the third and second quarters 2004 and 4.0% in the
first quarter 2004 and 2003; dividend yield of 0%; a volatility factor of the expected
market price of the Companys common stock of 1.448 in the third and second quarters
2004, 1.463 in the first quarter 2004 and 1.663 in 2003; and an expected option life of 5
years.

8

---

The
Black-Scholes option valuation model was developed for use in estimating the fair value of
traded options which have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions including the
expected stock price volatility. The Companys stock options have characteristics
significantly different from those of traded options. Further, changes in the subjective
input assumptions related to the options can materially affect the fair value estimate.
Therefore, in managements opinion the existing models do not necessarily provide a
reliable single measure of the fair value of the Companys stock options.

For
purposes of pro forma disclosures, the estimated fair value of stock options is amortized
to expense over the options vesting period. Therefore, future pro forma compensation
expense may be greater as additional options are granted. The Companys pro forma
information follows:

`Three Months Ended                Nine Months Ended
                                                           September 30,                    September 30,
                                                     2004             2003              2004             2003
                                                  ----------       ----------      ------------       ----------
Net loss - as reported                            $(243,355)       $ (95,737)      $(1,550,120)       $  (6,300)
Pro forma compensation expense                     (173,736)        (185,879)         (708,084)        (587,461)
                                                  ----------       ----------      ------------       ----------

Pro forma net loss                                $(417,091)       $(281,616)      $(2,258,204)       $(593,761)
                                                  ==========       ==========      ============       ==========

Loss per common share - basic and diluted
    As reported                                      $(0.03)          $(0.01)           $(0.17)          $(0.00)
    Pro forma                                        $(0.04)          $(0.04)           $(0.24)          $(0.10)`

Income
Taxes  The Company accounts for income taxes using an asset and liability approach. The
asset and liability approach requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of temporary differences between the
financial reporting and tax basis of assets and liabilities.

Revenue
Recognition  The Company operates in three segments: wound care, wound
closure-fasteners and skin care. Sales are recorded when product is shipped and title
passes to customers and collectability is assured. Gross sales are adjusted for cash
discounts, Medicaid rebates and trade rebates to derive net sales. Freight costs billed to
and reimbursed by customers are recorded as a component of revenue. Freight costs to ship
product to customers are recorded as a component of cost of sales.

Net Income (Loss) per
Share  Net income (loss) per common share - basic is computed by dividing net income (loss) by the weighted average
number of common shares outstanding for the period. Net income (loss) per common share - diluted reflects the potential dilution
of earnings by including potentially issuable shares of common stock, including those attributable to stock options, warrants and
convertible preferred stock in the weighted average number of common shares outstanding for a period, if dilutive. Potential
common stock has not been included in the computation of diluted loss per share as the effect would be anti-dilutive. The number
of potential common stock equivalents for the three and nine months ended September 30, 2004 and 2003 are outlined below.

`September 30,
                                                           2004               2003
                                                           ----               ----
                  Three months ended                     2,677,212          6,140,791
                  Nine months ended                      3,979,452          4,612,694`

9

---

Reclassifications
 Certain reclassifications have been made to prior year amounts reported to conform
with the 2004 presentation.

2. Acquisition of
Kimberly-Clark Corporations Wound Care Assets

On January 9, 2004, the
Company purchased certain wound care assets from Kimberly-Clark Corporation. The assets acquired consist of manufacturing
equipment, product rights and other intangibles. The purchase price for the assets was $1,942,797 and was paid as follows: (1)
$300,100 at closing; (2) $1,566,000 via a seller financed promissory note due December 31, 2004, without interest (Note 8); and
(3) $76,697 incurred for transaction costs. The acquisition has been accounted for as a purchase of a business and the purchase
price has been preliminarily allocated to equipment in the amount of $1,600,000 and intangible assets (Note 6) in the amount of
$342,797 based upon the estimated fair values of the assets acquired.

During
the three and nine months ended September 30, 2004, the Kimberly-Clark wound care products
generated $178,832 and $1,241,785 in net sales, respectively. Kimberly-Clark manufactured
wound care products, for the account of the Company, at its facility through April 9, 2004
to meet current customer demand and to build sufficient inventory to cover the period
during which production at the Kimberly-Clark facility was discontinued and the equipment
was transferred to the Companys facility in Toronto, Canada. Upon cessation of
manufacturing at Kimberly-Clarks facility, the Company purchased, in accordance with
a pre-determined formula, inventory consisting of raw and packaging materials and up to
four months supply of finished goods. The purchase price of this inventory was
approximately $550,000. Cash on hand and borrowings against available credit lines were
used to pay for this inventory.

The
Company completed the transfer, installation and validation of the equipment and commenced
manufacturing in Toronto, Canada in August 2004. Through September 30, 2004, the Company
expended $837,000 on equipment and manufacturing facility upgrades at its Toronto, Canada
location.

The
unaudited pro forma information below presents results of operations as if the acquisition of the business
had occurred on January 1, 2003. The pro forma information is based on historical results
and is not necessarily indicative of the operations of the combined entity had the
acquisition occurred on January 1, 2003 , nor is it necessarily indicative of future
results. Pro forma results for 2004 have not been presented as the acquisition occurred on
January 9, 2004 and the recorded results would not have been materially different had the
acquisition occurred on January 1, 2004.

`Three Months Ended                  Nine Months Ended
                                                       September 30, 2003                 September 30, 2003
                                                       ------------------                 ------------------
Net sales                                                $4,735,000                         $14,650,000
Net loss                                                  $(415,000)                          $(970,000)
Loss per common share-basic and diluted                      $(0.06)                             $(0.17)`

3. Accounts Receivable

Accounts
receivable include the following:

`September 30, 2004       December 31, 2003
                                                           ------------------       -----------------
        Trade accounts receivable                               $2,614,321               $2,802,985
        Less:  Allowance for doubtful accounts                     (47,442)                 (35,785)
               Allowance for trade rebates                        (196,356)                (212,000)
                                                                -----------              -----------
             Net trade receivables                               2,370,523                2,555,200
        Other receivables                                           54,968                   71,892
                                                                -----------              -----------

             Total receivables                                  $2,425,491               $2,627,092
                                                                ===========              ===========`

10

---

The
allowance for trade rebates reflects estimated rebates embedded in outstanding trade
receivables.

4. Inventories

Inventories include the
following:

`September 30, 2004       December 31, 2003
                                                           ------------------       -----------------
        Finished goods                                          $3,526,482               $2,814,651
        Work in process                                             99,333                  172,536
        Packaging materials                                        538,672                  307,635
        Raw materials                                              876,740                  708,436
                                                                -----------              -----------

             Total inventory                                    $5,041,227               $4,003,258
                                                                ===========              ===========`

5. Equipment and
Improvements

Equipment and improvements
include the following:

`September 30, 2004       December 31, 2003
                                                           ------------------       -----------------
        Machinery and equipment                                 $3,442,118               $1,277,352
        Furniture and fixtures                                     193,107                  183,967
        Leasehold improvements                                     680,092                   49,541
                                                                -----------              -----------
             Gross equipment and improvements                    4,315,317                1,510,860
        Less:  accumulated depreciation                           (594,997)                (433,172)
                                                                -----------              -----------

             Net equipment and improvements                     $3,720,320               $1,077,688
                                                                ===========              ===========`

Machinery
and equipment and leasehold improvements increased in the nine months ended September 30,
2004 principally due to the acquisition of, and infrastructure upgrades to, the
Companys Canadian manufacturing operation to integrate the Kimberly-Clark
Corporation wound care assets. The Company incurred a charge of $108,121 for the nine
months ended September 30, 2004 related to the disposal of obsolete equipment.

6. Other Intangible
Assets, net

`September 30, 2004       December 31, 2003
                                                           ------------------       -----------------

        Patents and trademarks                                    $444,067                 $444,067
        Other intangible assets                                    383,364                   40,567
                                                                -----------              -----------

             Gross other intangible assets                         827,431                  484,634
             Less: accumulated amortization                       (398,372)                (326,030)
                                                                -----------              -----------

             Other intangible assets, net                         $429,059                 $158,604
                                                                ===========              ===========`

Intangible
assets increased in the nine months ended September 30, 2004 due to the acquisition of
Kimberly-Clark Corporations wound care assets.

11

---

7. Other Assets, net

Other assets, net include the
following:

`September 30, 2004       December 31, 2003
                                                           ------------------       -----------------
        Deferred financing costs, net                            $  63,283                $  77,415
        Deposits                                                    69,278                   69,834
        Other                                                        -                        9,516
                                                                -----------              -----------

             Total other assets, net                              $132,561                 $156,765
                                                                ===========              ===========`

8. Short-Term Borrowings

Short-term borrowings include
the following:

`September 30, 2004       December 31, 2003
                                                           ------------------       -----------------
        U.S. line of credit                                    $   832,310                   -
        Canadian line of credit                                  1,704,106               $1,361,708
                                                                -----------              -----------
             Subtotal - lines of credit borrowings               2,536,416                1,361,708
        Note payable - Kimberly-Clark Corporation                1,566,000                   -
                                                                -----------              -----------

             Total short-term borrowings                        $4,102,416               $1,361,708
                                                                ===========              ===========`

U.S. Line of Credit

In
March 2003 the Company entered into a one year line of credit agreement (subject to annual
renewal) with a U.S. lender (the Agreement) for a maximum principal amount of
$2,000,000. On December 24, 2003, the Company entered into a new one year line of credit
agreement with its U.S. lender for a maximum principal amount of $3,000,000. The Company
terminated its prior U.S. line of credit on February 28, 2003 by repaying the $1,000,000
outstanding indebtedness and paying a $50,000 early termination fee. In addition, the
Company charged $66,342 to interest expense during 2003 for deferred financing costs
associated with the prior U.S. line of credit.

On
January 30, 2004 the Company entered into a modified one year line of credit agreement
with its U.S. lender. The maximum principal amount of the line increased to $4,000,000
from $3,000,000. Funds of $832,310 were outstanding against the line at September 30,
2004. Advances were used to fund strategic initiatives and for general working capital
purposes. Estimated maximum potential advances under the agreement are equal to the lesser
of (A) $4,000,000 or (B) the sum of (i) 80% of eligible receivables (as defined), (ii) 50%
of eligible inventory (as defined), (iii) an amount equal to the immediate liquidation
value of funds deposited with the U.S. lender in a restricted account as security for any
letters of credit extended by the lender on the Companys behalf up to $1,000,000,
less the aggregate of any outstanding letters of credit issued by the lender. Interest on
outstanding advances is payable monthly in arrears at the one month LIBOR rate (as
published in The Wall Street Journal), plus 5.0%, or 6.84% at September 30,
2004. In addition, the Company paid an annual line fee of $40,000. This line fee and any
one-time lender or legal costs associated with securing the line of credit were deferred
and will be amortized to interest expense over the term of the line of credit.

In
connection with entering into this line of credit agreement in January 2004, the Company
deposited $1,000,000 of cash in a restricted account with the U.S. lender and the U.S.
lender issued an irrevocable standby letter of credit on the Companys behalf for the
benefit of Kimberly-Clark Corporation in the amount of $1,566,000.

Outstanding
advances are secured by all tangible and intangible assets of the Companys U.S.
operations. Over the term of the Agreement, the Company has agreed to maintain its fixed
charge ratio (as defined) at not less than 1.25:1.0 as measured quarterly on a twelve
month trailing basis. Additional covenants governing permitted

12

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indebtedness, changes in
entity status, purchase of securities and protection of collateral are included in the
Agreement. Outstanding standby letters of credit, less the restricted cash, serve to
reduce the Companys potential borrowing capacity under the Agreement by $766,000.

Year to date operating losses
resulted in the Company being out of compliance with certain of its U.S. line of credit covenants at March 31, June 30 and
September 30, 2004. The Company intends to secure alternative financing for its U.S. obligations prior to the January 31, 2005
maturity of its current U.S. line of credit. The U.S. lender has agreed to waive the Company's prior and current covenant
violations and to maintain the line of credit until maturity thereof. The Company has incurred waiver fees of $7,500 and agreed to
an increase in the rate of interest payable under the line. All other terms of the line of credit agreement remain in full force
and effect. If the Company is unsuccessful in obtaining acceptable financing prior to January 31, 2005, it will attempt to
negotiate an extension with its current lender or accept financing on unfavorable terms.

Canadian
Line of Credit

On
December 30, 2003, the Company renewed its revolving credit facility agreement (the
Derma Canada Agreement) for a maximum principal amount of $1,743,800 with a
Canadian bank. The renewed credit facility expires on December 31, 2004. The
Companys wholly owned Canadian subsidiary, Derma Sciences Canada Inc., may request
advances under the Derma Canada Agreement up to the value of seventy-five percent (75%) of
its eligible receivables (as defined) plus the lesser of $872,000 or forty percent (40%)
of eligible inventory (as defined) less priority claims. Interest on outstanding advances
is payable monthly at the prime rate (as defined) plus 1.0%, or 5.00% for advances
outstanding at September 30, 2004. Outstanding advances are secured by all tangible and
intangible assets of Derma Sciences Canada Inc. In addition, the Canadian bank has a
second lien security interest in the assets of the Companys U.S. operations. The
Company has also guaranteed payment of amounts due under the Derma Canada Agreement.

Over
the term of the Derma Canada Agreement, the Company has agreed to comply with a number of
financial covenants governing minimum working capital, current ratios, tangible net worth,
interest coverage, total indebtedness to tangible net worth and total indebtedness to
adjusted pre-tax earnings. Certain of these covenants are measured monthly while others
are measured annually. Additional covenants governing permitted indebtedness, liens,
payments of dividends and protection of collateral are included in the Derma Canada
Agreement. In the event of a margin deficiency (as defined) or covenant violation, the
Company is required to advance up to an additional $396,000 of working capital to Derma
Sciences Canada Inc. in order to correct the deficiency. This additional working capital
may be repaid to the Company 45 days after the margin deficiency or covenant violation has
been cured upon the condition that such repayment not result in a margin deficiency,
covenant violation or any other event of default. The Company was in compliance with these
covenants at September 30, 2004.

As
security for indebtedness of the Companys subsidiary, Derma Sciences Canada Inc.,
the Company has accorded a Canadian bank its guarantee of payment together with a second
lien security interest in the Companys assets located in the U.S. In connection with
the Derma Canada Agreement and in return for a standby letter of credit in the amount of
$200,000 against the Companys U.S. line of credit, the Canadian bank has agreed not
to exercise its rights under its second lien security interest and guarantee against the
Companys U.S. assets without the U.S. lenders approval.

Note
Payable  Kimberly-Clark Corporation

The
Kimberly-Clark Corporation and the Company amended the January 9, 2004 purchase agreement
on January 30, 2004. This amended agreement provides for payment of the $1,566,000 balance
due in accordance with an amended promissory note, secured by an irrevocable letter of
credit issued by the Companys lender, requiring a single payment of $1,566,000,
without interest, on or before December 31, 2004.

13

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9. Long-Term Debt

Long-term
debt includes the following:

`September 30, 2004       December 31, 2003
                                                              ------------------       -----------------
        Canadian term loan                                         $  918,675              $1,025,839
        Capital lease obligations                                     193,996                   2,862
                                                                   ----------              ----------

             Total debt                                             1,112,671               1,028,701
        Less:  current maturities                                     225,181                 178,720
                                                                   ----------              ----------

             Long-term debt                                        $  887,490              $  849,981
                                                                   ==========              ==========`

In
connection with the acquisition of substantially all the assets of Dumex Medical Inc. in
2002, the Company entered into a five-year term loan agreement with a Canadian Bank. The
loan is repayable in monthly payments consisting of principal of $15,060 and interest.
Interest on the outstanding principal balance is payable monthly at the banks prime
rate (as defined) plus 1.25% or 5.25% at September 30, 2004. The term loan is secured by
all tangible and intangible assets of Derma Sciences Canada Inc. and subject to the same
financial covenants applicable to the operating line of credit (Note 8).

The
Company has two capital lease obligations for certain distribution equipment totaling
$150,080 and computer equipment totaling $43,916. The distribution and computer equipment
capital leases bear interest at annual rates of 7.63% and 3.93%, respectively, and expire
in March 2009 and April 2007, respectively.

10. Shareholders
Equity

Preferred
Stock

There
are 150,003 shares of series A convertible preferred stock outstanding. 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. 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. During the nine months ended
September 30, 2004, 4,167 series B preferred shares were converted into common stock.

There
are 619,055 shares of series C convertible preferred stock outstanding. 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. 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.

14

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Stock
Purchase Warrants

At
September 30, 2004, the Company had warrants outstanding to purchase the Companys
common stock as outlined below:

`Series       Number of Warrants      Exercise Price    Expiration Date
                  ------       ------------------      --------------    ---------------
                     E                  1,870,007            $0.85       July 18, 2005
                     F                  1,309,441            $0.57       January 6, 2007`

Other
Equity Transactions

On
February 25, 2004, the Company closed a private offering of 2,057,145 shares of its common
stock at a price of $1.05 per share. Offering proceeds of $1,961,798, net of $198,202 in
offering expenses, were used to fund strategic initiatives and for general working capital
purposes.

In
June 2003, the Company closed a private offering of 4,000,000 shares of its common stock
at a price of $0.50 per share. Total offering proceeds of $1,879,810, net of $120,190 in
offering expenses, were used to fund strategic initiatives and for general working capital
purposes.

In
March 2004, 4,167 shares of series B preferred stock were converted into 4,167 shares of
common stock. In July 2003, a total of 241,668 shares of series B, C and D preferred stock
were converted into 241,668 shares of common stock.

11. Comprehensive (Loss)
Income

The
Companys comprehensive (loss) income was as follows:

`Three Months Ended               Nine Months Ended
                                                           September 30,                    September 30,
                                                       2004           2003               2004           2003
                                                    ----------      ---------       ------------    -----------

Net loss - as reported                              $(243,355)      $(95,737)       $(1,550,120)    $   (6,300)
Other comprehensive income (loss):
    Foreign currency translation adjustment           227,270         (1,768)           206,448        245,742
                                                    ----------      ---------       ------------    -----------

Comprehensive (loss) income                         $ (16,085)      $(97,505)       $(1,343,672)    $  239,442
                                                    ==========      =========       ============    ===========`

12. Operating Segments

The Company
consists of three operating segments: wound care, wound closure-fasteners and skin care.
Products in the wound care segment consist of basic and advanced dressings, ointments and
sprays designed to treat wounds. Wound closure-fasteners products include wound closure
strips, nasal tube fasteners, a variety of catheter fasteners and net dressings. The skin
care segment consists of bath sponges, antibacterial skin cleansers, hair and body soaps,
lotions and moisturizers designed to enable customers to implement and maintain successful
skin care / hygiene programs.

Products
in all three operating segments are marketed to long-term care facilities, hospitals,
physicians, clinics, home health care agencies and other healthcare institutions. The
manufacture of advanced wound care and wound closure-fastener products is primarily
outsourced. Basic wound care and skin care products are manufactured in-house with the
exception of the bath sponge line. Internally, the segments are managed at the gross
profit level. The aggregation or allocation of other costs by segment is not practical.

15

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Segment
net sales to external customers and gross profit for the three months and nine months
ended September 30, 2004 and 2003 are as follows:

`Three Months Ended September 30, 2004
                                       -------------------------------------
                                                 Wound Closure-                                           Total
                               Wound Care          Fasteners        Skin Care       Other Costs          Company
                               ----------          ----------      ----------       ------------       -----------

Net sales                      $3,733,166          $  725,930      $  510,728              -           $4,969,824
                               ----------          ----------      ----------       ------------       -----------
Gross profit                      720,295             372,212         127,937              -            1,220,444
Total expenses                      -                   -                -          $(1,463,799)       (1,463,799)

Net loss                                                                                               $ (243,355)
                                                                                                       ===========

Net long-lived assets          $3,644,730               -          $1,344,394       $    271,222       $5,260,346
                               ==========                          ==========       ============       ===========



                                       Three Months Ended September 30, 2003
                                       -------------------------------------
                                                 Wound Closure-                                           Total
                               Wound Care          Fasteners        Skin Care       Other Costs          Company
                               ----------          ----------      ----------       ------------       -----------

Net sales                      $3,059,851            $651,924      $  500,844              -          $ 4,212,619
                               ----------          ----------      ----------       ------------       -----------

Gross profit                      941,038             326,826         132,594              -            1,400,458
Total expenses                       -                  -                -          $(1,496,195)       (1,496,195)

Net loss                                                                                            $     (95,737)
                                                                                                       ===========

Net long-lived assets          $1,017,710               -          $1,327,829      $      30,726      $ 2,376,265
                               ==========                          ==========       ============       ===========



                                        Nine Months Ended September 30, 2004
                                       -------------------------------------
                                                 Wound Closure-                                           Total
                               Wound Care          Fasteners        Skin Care       Other Costs          Company
                               ----------          ----------      ----------       ------------       -----------

Net sales                     $10,798,118          $2,624,198      $1,490,941              -          $14,913,257
                              -----------          ----------      ----------       ------------       -----------

Gross profit                    2,443,510           1,313,593         325,345              -            4,082,448
Total expenses                    -                     -                -          $(5,632,568)       (5,632,568)

Net loss                                                                                              $(1,550,120)
                                                                                                      ============

Net long-lived assets         $ 3,644,730               -          $1,344,394       $   271,222       $ 5,260,346
                               ==========                          ==========       ============      ============`

16

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`Nine Months Ended September 30, 2003
                                       -------------------------------------
                                                 Wound Closure-                                           Total
                               Wound Care          Fasteners        Skin Care       Other Costs          Company
                               ----------          ----------      ----------       ------------       -----------

Net sales                      $9,266,229          $2,220,288      $1,578,530              -          $13,065,047
                               ----------          ----------      ----------       ------------       -----------

Gross profit                    3,093,372           1,075,701         444,924              -            4,613,997
Total expenses                       -                  -                -          $(4,620,297)       (4,620,297)

Net loss                                                                                              $    (6,300)
                                                                                                      ============

Net long-lived assets          $1,017,710               -          $1,327,829       $    30,726       $ 2,376,265
                               ==========                          ==========       ============       ===========`

Long-lived
assets consist of property and equipment, patents and trademarks, other intangible assets
and goodwill. Wound care long-lived assets consist principally of Derma Sciences Canada
Inc., property and equipment and other intangible assets acquired in the Kimberly-Clark
wound care asset acquisition and patents and trademarks. Wound closure-fasteners are for
the most part outsourced and accordingly are not supported by long-lived assets. Skin care
long-lived assets consist of goodwill associated with the acquisition of Sunshine
Products, Inc. and property and equipment associated therewith. Corporate headquarters and
the Companys U.S. distribution center property and equipment are included in the
other costs column since they service all three business segments.

The
following table presents net sales by geographic region.

`Nine Months Ended
                                 Three Months Ended September 30,           September 30,
                                 --------------------------------           -------------
                                      2004             2003             2004             2003
                                      ----             ----             ----             ----
         United States                 51%              49%              53%              44%
         Canada                        46%              48%              43%              52%
         Rest of world                  3%               3%               4%               4%`

The following
table presents net long lived assets by geographic region.

`September 30, 2004            September 30, 2003
                                              ------------------            ------------------
         United States                             $2,046,933                    $1,528,617
         Canada                                     3,175,680                       808,210
         Rest of world                                 37,733                        39,438
                                                   ----------                    ----------
         Total                                     $5,260,346                    $2,376,265
                                                   ==========                    ==========`

13. Income Taxes

No
provision for income taxes has been made in either the three or nine months ended
September 30, 2004 and 2003 given the Companys loss in 2004 and the available net
operating loss carryforwards. A benefit has not been recorded as the realization of the
net operating losses is not assured and the timing in which the Company can utilize its
net operating loss carryforwards in any year or in total may be limited under the Internal
Revenue Code section 382 regarding changes in ownership of corporations.

At
December 31, 2003, the Company has net operating loss carryforwards of approximately
$6,819,000 for federal income tax purposes that begin to expire in years 2012 through
2020. For state income tax purposes, the

17

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Company has net operating loss carryforwards of
approximately $6,819,000 that expire in years 2004 through 2010. As of December 31, 2003,
the Company has foreign net operating loss carryforwards of approximately $191,000 which
begin to expire in 2009.

14. Distribution
Agreement for Certain Catheter Fasteners

As
of November 23, 1999 the Company entered into a 4 year agreement to serve as the exclusive
distributor in the United States for certain catheter fasteners. The agreement expired by
its terms on August 23, 2004. The parties are presently engaged in negotiations with a
view to executing a new agreement. However, no assurance can be given that these
negotiations will prove successful. Year 2004 sales of catheter fasteners under the
current agreement were approximately $725,000 through the nine months ended September 30,
2004. In the absence of a new agreement, prospective sales will be limited to the sell off
of inventory on hand and are not expected to be significant.

15. Distribution
Agreement for Silver Plated Wound Dressings

On
October 1, 2003 the Company entered into a 5 year agreement to serve as the exclusive
distributor to the U.S. military (excluding the Veterans Administration) and Canada for
certain silver plated wound dressings. During each year of the agreement, the Company is
required to purchase a minimum dollar quantity of product from the manufacturer. In the
event the Company fails to meet the annual minimum dollar quantity requirement, the
manufacturer, at its option, may cancel or amend the agreement. The manufacturer has given
the Company notice that, due to its failure to meet its minimum dollar quantity for the
contract year ended September 30, 2004 for the U.S. military market, it intends to
amend the agreement. The parties are presently engaged in negotiations with a view to
executing a new agreement that preserves the Companys exclusivity in the U.S.
military and Canadian markets and provides opportunities for the Company to open new
markets for silver plated dressings. While no assurance can be given as to the ultimate
results of these negotiations, the Company anticipates that its present rights to the U.S.
military and Canadian markets will continue for the indefinite future.

16. Employee Termination
Costs

On
September 24, 2004 the Company settled litigation brought against it and its wholly owned
Canadian subsidiary by its former Executive Vice President and President of Derma Sciences
Canada, Inc. relative to the executives termination of employment. Pursuant to the
settlement, the Company will pay to, or on behalf of, the executive the sum of $269,500
over a period of seven months and will extend the expiration date of previously granted
options to purchase 500,000 shares of the Companys common stock at $0.50 per share
from May 9, 2004 to September 30, 2006. The settlement costs together with estimated other
costs associated with the termination aggregating $326,400 were charged against the
reserve established in March 2004 to cover the estimated cost of the settlement in the
amount of $450,000 resulting in a gain on the settlement of $123,600. This gain was
recorded against general administrative expense in the statement of operations consistent
with the recording of the original charge.

18

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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Quarter Ended September 30, 2004 Compared to Quarter Ended
September 30, 2003

Results of Operations

The
third quarter 2004 and 2003 operating results include the financial results of Derma
Sciences, Inc. and its subsidiaries. Unless otherwise indicated by the context, the term
Derma Canada is used throughout this discussion in reference to the operations of Derma
Sciences Canada Inc. and the term Derma U.S. is used throughout this discussion in
reference to the operations of the Company excluding Derma Canada.

The
Company engages in the manufacture, marketing and sale of dermatological related product
lines consisting of wound care, wound closure-fasteners and skin care. The wound care line
is composed of basic and advanced wound care products. Basic wound care products consists
primarily of gauze dressings, abdominal pads, burn dressings and bandages. Advanced wound
care products consists of ointments, packing strips, hydrogel dressings, hydrocolloid
dressings, foam dressings and impregnated gauze dressings. Ointments are sold under the
Companys Dermagran® name and various other advanced wound care products are sold
under the Dumex name as well as other private labels. The wound closure fasteners line
consists of wound closure strips, nasal tube fasteners and a variety of catheter
fasteners. The skin care line, sold under the Companys Sunshine Products label,
consists of bath sponges, skin cleansers, soaps, hair and body washes and moisturizers.

The
following table highlights the 2004 and 2003 operating results:

`Quarter Ended September 30,
                                               ---------------------------
                                                2004              2003                 Variance
                                                ----              ----                 --------

Net sales                                    $4,969,824       $4,212,619          $ 757,205      18%
Cost of sales                                 3,749,380        2,812,161            937,219      33%
                                             -----------      -----------         ----------
Gross profit                                  1,220,444        1,400,458           (180,014)    (13%)
Gross profit percentage                            25%              33%
Operating expenses                            1,412,809        1,469,362            (56,553)     (4%)
Interest expense, net                            61,242           44,750             16,492      37%
Other (income) expense, net                     (10,252)         (17,917)             7,665     (43%)
                                             -----------      -----------         ----------
Total expenses                                1,463,799        1,496,195            (32,396)     (2%)
Loss before income taxes                       (243,355)         (95,737)          (147,618)      -
Provision for income taxes                         -                -                  -          -
                                             -----------      -----------         ----------

Net loss                                     $ (243,355)      $  (95,737)         $(147,618)      -
                                             ===========      ===========         ==========`

Net sales
increased $757,205, or 18%, to $4,969,824 in the third quarter 2004 from $4,212,619 in the
third quarter 2003. The increase is attributable to increased sales of all major product
lines (wound care, wound closure fasteners and skin care) except for the Dermagran
component of the advanced wound care product line.

Wound
care sales increased $673,315, or 22%, to $3,733,166 in the third quarter 2004 from
$3,059,851 in the third quarter 2003. In the third quarter 2004 versus 2003, advanced
wound care sales increased 34% to $961,661 from $717,128. Sales of all major product lines
except for the Dermagran advanced wound care products increased. The components of the
sales increases include the Kimberly-Clark Corporation (KCC) advanced wound care products,
Silverlon advanced wound care products and U.S. private label advanced wound care
products. The aforementioned sales increases were partially offset by a $282,475, or 39%,
decrease in sales of Dermagran advanced wound care products attributable to lower sales
volumes and pricing pressures.

Basic
wound care sales increased $428,782, or 18%, to $2,771,505 in the third quarter 2004 from
$2,342,723 in the third quarter 2003. The increase is attributable to a 49% and 14%
increase in United States and Canada market sales, respectively. The increase in United
States sales is attributable to a concerted sales and marketing effort to grow this
product line. The Canada market basic wound care sales increase is attributable to

19

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higher
dealer sales, higher contract compliance and a 6% stronger Canadian versus U.S. dollar
exchange rate. Excluding the effects of exchange rates, Canada market third quarter 2004
basic wound care sales versus 2003 increased 7%.

Wound
closure fastener sales increased $74,006, or 11%, to $725,930 in the third quarter 2004
from $651,924 in the third quarter 2003. The third quarter 2004 sales increase is
primarily the result of higher suture strip sales and the addition of the Shur Strips line
of suture strips acquired from KCC in January, 2004.

Third
quarter 2004 and 2003 skin care sales were $510,728 and $500,844, respectively,
representing an increase of 2%. This increase is primarily attributable to the addition of
several new customers in the second quarter of 2004.

Gross profit in the third
quarter 2004 versus 2003 decreased $180,014, or 13%, to $1,220,444 from $1,400,458. Overall gross profit percentages were 25% and
33% in the third quarter 2004 and 2003, respectively. The decrease in gross profit dollars and percentage is primarily
attributable to the sales volume decline of the higher profit margin Dermagran advanced wound care products line, along with an
increase in the percentage of sales represented by lower margin basic wound care, KCC and U.S. private label advanced wound care
products. Higher than anticipated in-house manufacturing costs, one-time production start-up costs and manufacturing
inefficiencies related to the startup of the in-house production of the KCC and U.S. private label product lines also contributed
to the gross profit decrease.

Wound
care gross profit in the third quarter 2004 versus 2003 decreased $220,743, or 23%, to
$720,295 from $941,038. The wound care line experienced gross profit decreases in both the
basic and advanced wound care products lines. The decrease in the wound care gross profit
is primarily attributable to the 39% sales decline of the Companys highest margin
Dermagran product line. In addition, the Company incurred higher than anticipated
manufacturing costs and competitive pressure on selling prices. During the third quarter
2004, the Company incurred higher than anticipated manufacturing costs including one-time
start up costs (validation, training and equipment installation), labor and material
inefficiencies, and unfavorable overhead absorption related to some of the KCC and U.S.
private label advanced wound care products. Gross profits in the third quarter of 2004
versus 2003 were also adversely impacted by competitive selling price pressure in the
United States and Canada basic wound care markets.

Wound
closure fasteners line gross profit in the third quarter 2004 versus 2003 increased
$45,386, or 14%, to $372,212 from $326,826. This increase is attributable to increased
sales of suture strips and the addition of the Shur Strip line of suture strips acquired
from KCC in January 2004.

Skin care line gross profit
in the third quarter 2004 versus 2003 decreased $4,657, or 4%, to $127,937 from $132,594. The decrease is attributable to
increases in fixed overhead expenses resulting from the relocation to the new U.S. distribution center of the customer service and
distribution functions (which functions previously absorbed a portion of the manufacturing facility's overhead) and higher freight
expense to customers, partially offset by revaluation of finished goods inventory to more accurately reflect labor and overhead in
product costs and a claim for business interruption damages incurred while the roof of the Company's leased manufacturing facility
was being replaced which served to offset the cost of manufacturing inefficiencies incurred as a result thereof.

Operating
expenses decreased $56,553, or 4%, to $1,412,809 in the third quarter 2004 from $1,469,362
in the third quarter 2003. Warehousing expenses increased $56,198, or 30%, primarily
associated with the new U.S. distribution facility that opened in March 2004 and higher
Canadian operating expenses associated with the increased level of activity related to the
KCC and U.S. private label growth initiatives and increased rent and utility costs. In
addition, marketing expenses increased $24,950, or 76%, in the third quarter 2004 versus
2003 as a result of compensation expense related to the hiring of a marketing director in
the first quarter 2004. Sales expenses decreased $26,861, or 6%, in the third quarter 2004
versus 2003. This decrease is primarily attributable to lower commission and travel
expenses and the elimination in June 2003 of the remaining Derma Canada U.S. sales
operation. General and administrative expenses decreased $110,840, or 14%, in the third
quarter 2004 versus 2003 principally related to the reversal of $123,600 in employee
termination costs accrued in the first quarter 2004 related to the settlement of this
matter, partially offset by the hiring of an information technology director and spending
associated with upgrading the Companys computer infrastructure.

20

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Interest
expense, net increased $16,492 to $61,242 in the third quarter 2004 from $44,750 in the
third quarter 2003. This increase is primarily attributable to the amortization of higher
U.S. line of credit fees, incremental interest incurred on U.S. line of credit borrowings
and capital leases initiated in 2004, partially offset by lower interest expense incurred
by the Companys Canadian subsidiary as a result of lower 2004 interest rates on its
line of credit.

Other
income, net decreased $7,665 to $10,252 in the third quarter 2004 from $17,917 in the
third quarter 2003. This decrease is primarily attributable to the non-recurrence in 2004
of sales of slow-moving inventory and lower royalty income, partially offset by higher
exchange gains and lower temporary storage and demurrage container costs.

Given
available net operating loss carryforwards, no provision for income taxes was made in the
third quarter 2004 and 2003. A benefit has not been recorded as the realization of the net
operating losses is not assured.

The
Company incurred a $243,355 loss, or $0.03 loss per share (basic and diluted), in the
third quarter 2004 compared to net loss of $95,737, or $0.01 loss per share (basic and
diluted), in the third quarter 2003.

Nine months Ended September 30, 2004 Compared to Nine Months Ended September
30, 2003

Results of Operations

The
following table highlights the 2004 and 2003 operating results:

`Quarter Ended September 30,
                                               ---------------------------
                                                2004              2003                 Variance
                                                ----              ----                 --------

Net sales                                   $14,913,257      $13,065,047        $ 1,848,210      14%
Cost of sales                                10,830,809        8,451,050          2,379,759      28%
                                            ------------     ------------       ------------
Gross profit                                  4,082,448        4,613,997           (531,549)    (12%)
Gross profit percentage                            27%              35%
Operating expenses                            5,371,942        4,470,354            901,588      20%
Interest expense, net                           159,388          215,236            (55,848)    (26%)
Other expense (income), net                     101,238          (65,293)           166,531       -
                                            ------------     ------------       ------------
Total expenses                                5,632,568        4,620,297          1,012,271      22%
Loss before income taxes                     (1,550,120)          (6,300)        (1,543,820)      -
Provision for income taxes                         -                -                  -          -
                                            ------------     ------------       ------------

Net loss                                    $(1,550,120)     $    (6,300)       $(1,543,820)      -
                                            ============     ============       ============`

Net sales
increased $1,848,210, or 14%, to $14,913,257 for the nine months ended September 30, 2004
from $13,065,047 for the nine months ended September 30, 2003. The increase is
attributable to a 17% and 18% increase in wound care and wound closure fasteners sales,
respectively, partially offset by a 6% decrease in skin care sales. Favorable exchange
associated with a 7% strengthening of the Canadian dollar also contributed.

Wound
care sales for the nine months ended September 30, 2004 versus 2003 increased $1,531,889,
or 17%, to $10,798,118 from $9,266,229. For the nine months ended September 30, 2004
versus 2003, basic wound care sales increased 8% to $7,699,707 from $7,141,486 while
advanced wound care sales increased 46% to $3,098,411 from $2,124,743. The basic wound
care sales increase is attributable to a 43% increase in United States basic wound care
product sales along with a 3% increase in Canadian market basic wound care sales. The
Canadian market basic wound care increase is attributable to a 7% stronger Canadian versus
U.S. dollar exchange rate. Excluding the effects of foreign exchange, Canadian market
sales decreased 5%. The decrease in Canadian market basic wound care sales on a local
currency basis for the nine months ended September 30, 2004 versus 2003 is attributable to
the non-recurrence in 2004 of the one-time SARS epidemic related sales of face masks and
the almost complete loss of the Canadian private label business in 2004, partially offset
by a 4% sales growth to hospitals and dealers in 2004. The 46% increase in sales of the
advanced wound care products is attributable to the January 2004

21

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acquisition of KCCs
advanced wound care products, sales growth of both the U.S. private label and Silverlon
advanced wound care products. During the nine months ended September 30, 2004 versus 2003,
advanced wound care sales growth was partially offset by a $772,076, or 36%, sales decline
for Dermagran advanced wound care products attributable to a successful 2003 year-end
sales promotion incentive and 2004 lower sales volume and pricing pressures.

Wound
closure fasteners product line sales for the nine months ended September 30, 2004 versus
2003 increased $403,910, or 18%, to $2,624,198 from $2,220,288 as a result of increased
sales of Percu Stay catheter fasteners to one customer in anticipation of the expiration
of the Companys sourcing agreement for this product and the addition of the Shur
Strip line of suture strips acquired from KCC in January 2004.

Skin
care product line sales decreased $87,589, or 6%, to $1,490,941 for the nine months ended
September 30, 2004 from $1,578,530 for the nine months ended September 30, 2003 due to
competitive pressures. While 2004 sales were lower versus the first nine months of 2003,
skin care sales in both the second and third quarters of 2004 exceeded the comparable 2003
quarter as a result of the addition of several new customers.

Gross profit for the nine
months ended September 30, 2004 versus 2003 decreased $531,549, or 12%, to $4,082,448 from $4,613,997. Overall gross profit
percentages were 27% and 35% in the first nine months of 2004 and 2003, respectively. The decrease in 2004 versus 2003 gross
profit dollars and percentage principally reflects the significantly lower sales of the high margin Dermagran products coupled
with an unfavorable sales mix shift to growth of the Company's lower margin products. One-time start-up related costs associated
with bringing the manufacture of the U.S. private label growth initiative products and products purchased from KCC on line in the
Company's Toronto, Canada facility also contributed.

Wound
care product line gross profit for the nine months ended September 30, 2004 versus 2003
decreased $649,862, or 21%, to $2,443,510 from $3,093,372. For the first nine months of
2004 versus 2003, the basic and advanced wound care product lines both experienced
declines in gross profit. The decline in the wound care product line gross profit is
primarily attributable to the 36% sales decline of the Companys highest margin
Dermagran product line incident to the above discussed work down of the higher customer
inventory levels at year-end 2003, together with continuing 2004 decreases in sales volume
and pricing pressures and a $60,000 write-off of obsolete inventory in the first quarter
2004. In addition, the Company incurred higher than anticipated manufacturing costs at its
Canada manufacturing facility which adversely impacted 2004 gross profits. These higher
manufacturing costs were attributable to labor and material inefficiencies, one-time start
up costs and unfavorable overhead absorption principally related to startup of the KCC and
U.S. private label product growth initiatives. In addition, manufacturing overhead
absorption was adversely impacted by the offloading of products that were previously
packaged in the Companys Canadian facility to China. Gross profits in the first nine
months of 2004 versus 2003 were also adversely impacted by selling price pressure in the
United States and Canada basic wound care markets.

Wound
closure fasteners product line gross profit for the nine months ended September 30, 2004
versus 2003 increased $237,892, or 22%, to $1,313,593 from $1,075,701. This increase is
primarily attributable to higher sales of catheter fasteners and the addition of the Shur
Strip line of suture strips acquired from KCC in January 2004.

Skin
care product line gross profit for the nine months ended September 30, 2004 versus 2003
decreased $119,579, or 27%, to $325,345 from $444,924. The decrease is attributable to
increases in overhead expenses resulting from relocation to the new U.S. distribution
center of the customer service and distribution functions (which functions previously
absorbed a portion of the manufacturing facilitys overhead), lower production volume
and higher freight costs.

Operating
expenses increased $901,588, or 20%, to $5,371,942 in the first nine months of 2004 from
$4,470,354 in the first nine months of 2003. Warehouse expenses increased $291,094, or
56%, in 2004 versus 2003 as a result of a one-time $61,334 expense to close the Old Forge,
Pennsylvania distribution center effective March 31, 2004 and higher operating costs at
the new U.S. Distribution Center. Canadian distribution expenses were higher in 2004
versus 2003 due to unfavorable exchange and a higher level of activity related to the KCC
and U.S. private label growth initiatives necessitating additional warehouse personnel and
higher operating costs. Marketing expenses increased $128,639, or 93%, in 2004 versus 2003
as a result of hiring a marketing director along with

22

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higher trade show, promotional
activities and spending associated with the U.S. private label wound care product line.
Sales expenses increased $13,267, or 1%, in 2004 versus 2003 primarily resulting from
higher sampling and U.S. private label administrative fees, largely offset by lower
commissions and savings from the closure of the Derma Canada U.S. sales facility in 2003.
General and administrative expenses increased $468,588, or 19%, in the first nine months
of 2004 versus 2003. This increase is primarily attributable to the settlement costs
associated with the termination of an executive, hiring of an information technology
director, upgrades to the Companys computer equipment and infrastructure, higher bad
debt expenses and higher expenses associated with amortization of the KCC intangible
asset, professional services, insurance, travel and compensation, partially offset by
lower regulatory costs. Comparing 2004 versus 2003, net of settlement and avoidance, the
Company incurred a $95,000 expense related to the terminated executive.

Interest
expense, net decreased $55,848 to $159,388 in the first nine months ended September 30,
2004 from $215,236 in the first nine months ended September 30, 2003. This decrease is
primarily attributable to the February 2003 termination of the Companys existing
United States line of credit facility resulting in the write-off of $66,342 of deferred
financing costs.

Other
expense increased $166,531 to $101,238 expense for the first nine months ended September
30, 2004 from $65,293 income for the nine months ended September 30, 2003. The increase is
primarily attributable to the incurrence in 2004 of a loss on disposal of property and
equipment and the non-recurrence in 2004 of one-time net income items experienced in 2003.

Given
available net operating loss carryforwards, no provision for income taxes has been made in
the first nine months ended September 30, 2004 and 2003. A benefit has not been recorded
as the realization of the net operating losses is not assured.

The
Company incurred a $1,550,120 loss, or $0.17 loss per share (basic and diluted), in the
first nine months ended September 30, 2004 compared to a net loss of $6,300, or $0.00 per
share (basic and diluted), in the first nine months ended September 30, 2003.

Liquidity and Capital
Resources

At September 30, 2004 and
December 31, 2003 the Company had cash and cash equivalents of $51,131 and $439,837, respectively. The $388,706 decrease in cash
and cash equivalents resulted from net cash used in operating activities of $916,341 and net cash used in investing activities of
$2,342,673, partially offset by net cash provided by financing activities of $2,873,939.

Net cash used in operating
activities was $916,341. The net use of cash stems from the net loss experienced in the first nine months of the year, offset by
non-cash charges and cash generated from the net change in operating assets and liabilities. A $1,052,987 increase in inventory to
support planned growth initiatives, offset by a reduction in accounts receivable and increases in accounts payable and accrued
liabilities, were the primary factors behind the net positive change in operating assets and liabilities.

Net cash used in investing
activities relates to $376,797 cash paid to acquire the Kimberly-Clark Corporation wound care business in January 2004, restricted
short-term investments set aside to collateralize the Kimberly-Clark note payable and $961,866 for purchases of equipment and
leasehold improvements. The majority of the equipment and leasehold improvement expenditure relates to the subsequent transfer and
installation of the Kimberly-Clark equipment in the Company's manufacturing facility in Toronto, Canada. The balance principally
relates to equipment purchases to improve manufacturing efficiency and expenditures associated with opening the new U.S.
Distribution Center.

Net
cash provided by financing activities consisted of net proceeds of $1,961,798 from the
sale of common stock in the first quarter, coupled with increased line of credit
borrowings of $1,122,704, partially offset by deferred financing costs related to annual
bank fees associated with the Companys line of credit agreements and outstanding
letters of credit and normally scheduled debt repayment.

23

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Working
capital decreased $2,195,943 at September 30, 2004 to $2,641,025 from $4,836,968 at
December 31, 2003. The decrease in cash and increased line of credit borrowings associated
with the Companys year-to-date net operating loss, together with cash paid for the
Kimberly-Clark Corporation wound care business and capital expenditures related to the
Kimberly-Clark Corporation equipment transfer, are the primary reasons for the decline.
The $1,566,000 seller financed Kimberly-Clark Corporation note payable due on or before
December 31, 2004, offset by the increase in restricted short-term investments of
$1,004,010 which has be set aside to pay this note, also contributed.

The
Company renewed its revolving credit facility agreement with its Canadian lender to fund
its day-to-day Canadian operations on December 31, 2003. Maximum potential advances under
the agreement at September 30, 2004 were $1,743,800. Advances outstanding against the
credit facility were $1,704,106 at September 30, 2004, leaving an additional $39,694
available for borrowing.

A first quarter charge of
$450,000 related to an employee termination resulted in the Canadian operation being out of compliance with certain of its loan
covenants. The Canadian bank agreed to waive the covenant violations at March 31, 2004 and adjust the monthly covenants
prospectively in anticipation of the above described equity investment the Company is making in its Canadian operation relative to
the Kimberly-Clark Corporation equipment transfer. The covenants have been reset and the Company anticipates that it will be able
to comply with the adjusted covenants until year-end. Certain of the bank's income based covenants are measured for compliance
annually. Given its year-to-date net operating loss, the Company expects to be out of compliance with these covenants at year-end.
The Canadian lender is aware of this situation and both parties are working to amend the covenants by year-end with a view to
maintaining the Company's compliance with same.

On January 30, 2004, the
Company entered into a modified one-year line of credit agreement with its U.S. lender. The maximum principal amount of the line
is $4,000,000. Estimated maximum potential advances under the agreement are equal to the lesser of (a) $4,000,000, or (b) the sum
of (i) 80% of eligible receivables (as defined), (ii) 50% of eligible inventory (as defined), (iii) an amount equal to the
immediate liquidation value of funds deposited with the U.S. lender in a restricted account as security for any letters of credit
extended by the lender on the Company's behalf up to $1,000,000, less the aggregate of any outstanding letters of credits issued
by the lender. All other items and conditions of the agreement remained unchanged. In connection with entering into the modified
line of credit agreement, the Company deposited cash in the amount of $1,000,000 in a restricted account with the U.S. lender and
the U.S. lender issued an irrevocable standby letter of credit on the Company's behalf for the benefit of Kimberly-Clark
Corporation in the amount of $1,566,000 expiring January 31, 2005. Total letters of credit outstanding at September 30, 2004 were
$1,766,000 for both the U.S. and Canada.

Maximum potential advances
(after deducting $766,000 representing the difference between the letters of credit outstanding and the restricted short-term
investments on deposit with the lender) under the U.S. line of credit agreement at September 30, 2004 were $1,102,100. Advances
outstanding against the credit facility were $832,310 at September 30, 2004, leaving an additional $269,790 available for
borrowing. Advances are utilized to fund the U.S. operations' day-to-day working capital requirements and the Company's strategic
growth initiatives in the U.S and Canada. The restricted short-term investments of $1,004,010, together with cash on hand or
available line borrowing capacity, will be utilized to pay the $1,566,000 Kimberly-Clark Corporation promissory note due December
31, 2004.

Year to date operating
losses resulted in the Company being out of compliance with certain of its U.S. line of credit covenants at March 31, June 30 and
September 30, 2004. The Company intends to secure alternative financing for its U.S. obligations prior to the January 31, 2005
maturity of the U.S. line of credit. The U.S. lender has agreed to waive the Company's prior and current covenant violations and
to maintain the line of credit until maturity thereof. The Company has incurred waiver fees of $7,500 and has agreed to an
increase in the rate of interest payable under the line. All other terms of the line of credit agreement remain in full force and
effect. The Company anticipates that it will be able to comply with the U.S. lender's interim requirements and maintain its
existing borrowing capacity until such time as it secures alternative financing. If the Company is unsuccessful in obtaining
acceptable financing prior to January 31, 2005, it will attempt to negotiate an extension with its current lender or accept
financing on unfavorable terms.

24

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On January 9, 2004, the
Company purchased the Kimberly-Clark Corporation wound care business for total consideration of $1,942,797. The consideration
consisted of cash of $376,797 and a seller financed, non-interest bearing promissory note due on or before December 31, 2004 of
$1,566,000. The cash outlay consisted of $300,100 paid at closing and $76,697 for acquisition related costs. The equipment
purchased was installed in a newly renovated area in the Company's manufacturing facility in Toronto, Canada that was completed in
August 2004. The cost to transfer, install and validate the equipment was $837,000.

On
February 25, 2004, the Company closed a private offering of 2,057,145 shares of its common
stock at a price of $1.05 per share. Offering proceeds were used to fund the acquisition
of the Kimberly-Clark Corporation wound care business and for general working capital
purposes. Offering proceeds of $1,961,798, net of offering expenses of $198,202, have been
received.

On
September 24, 2004 the Company settled litigation brought against it and its wholly owned
Canadian subsidiary by a former executive relative to the executives termination of
employment. Pursuant to the settlement, the Company will pay the sum of $269,500 over a
period of seven months and extend the expiration date of previously granted options to
purchase 500,000 shares of the Companys common stock at $0.50 per share from May 9,
2004 to September 30, 2006. The settlement costs together with estimated other costs
associated with the termination aggregating $326,400 were charged against the termination
reserve of $450,000 established in March 2004, resulting in a gain of $123,600. The
initial payment against the cash settlement of $115,400 was made on September 24, 2004.
The balance of $154,100 is payable monthly beginning in October 2004 at $23,100 per month
for six months with the final payment of $15,500 due April 2005.

In
the first nine months of 2004, the Company entered into capital and operating leases of
$292,000 with terms ranging from three to five years for equipment at the new U.S.
distribution center that opened in March 2004 and upgrades to the Company-wide
telecommunications and information technology equipment.

Prospectively,
the Company seeks to increase sales and gross margin contribution and return to
profitability by increasing the sale of contracted private label products to distributors,
fully integrating the Kimberly-Clark Corporation wound care products into the
Companys product offering, continuing growth of the basic wound care product line in
the U.S. and a renewed focus on organic growth of its core product lines in the U.S. and
Canada. Product cost savings started to be realized in the third quarter as a result of
recently negotiated lower basic wound care costs. These savings are expected to increase
significantly in the fourth quarter 2004 and beyond as lower cost inventory moves into the
distribution chain. Additional product cost savings will begin to be realized in the
fourth quarter 2004 resulting from the in-house manufacture of a wide range of products
using the equipment purchased from the Kimberly-Clark Corporation as well as the
non-recurrence of one-time costs associated with bringing the manufacture of these
products on line. Operating expenses, which have gradually increased since early 2003 in
anticipation of planned sales growth, will be closely monitored. Steps will be taken to
reduce operating expenses if the anticipated sales and margin growth are not realized.

Going
forward, capital expenditure requirements will decrease given that the installation of the
Kimberly-Clark Corporation equipment in Toronto, Canada has largely been completed. Plans
are in place to prospectively reduce the level of inventory on hand as higher initial
inventory levels associated with the Kimberly-Clark Corporation wound care business
purchase and U.S. private label growth initiatives reach equilibrium and steps are taken
to reduce the investment in inventory in other areas.

The
Company believes that available funds from operations coupled with its available lines of
credit will be sufficient to satisfy the Companys capital requirements for the
foreseeable future. If need be, the Company expects that it can secure additional equity
funding to improve liquidity.

The
Common Stock of the Company is traded on the OTC Bulletin Board under the symbol
DSCI.OB. The Common Stock is also traded on the Boston and Pacific Stock
Exchanges under the symbol DMS. 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.

25

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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,
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 represented in this section.
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 assured. When the Company recognizes revenue from the sale of products, the Company
simultaneously adjusts revenue for estimated trade rebates. A trade rebate represents the
difference between 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
customers and other competitive factors. If the assumptions used to calculate these
rebates 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 makes adjustments as necessary.

Goodwill

At
September 30, 2004, the Companys skin care segment had $1,110,967 of goodwill. 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 the 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.

26

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Item 3.  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 September 30, 2004. 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 fiscal three
months ended September 30, 2004, there was no change in the Company's internal control over financial reporting that materially
affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

27

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Part II  Other
Information

Item 1. Legal Proceedings

None

Item 6. Exhibits

Exhibits. All exhibits required by Item 601 of Regulation S-B and required
          hereunder, as filed with the Securities and Exchange Commission in Form 10-KSB
          on March 31, 2004, 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 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 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 caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.

|                         |  | DERMA SCIENCES, INC.                                                                         
|------------------------ |  | ---------------------------------------------------------------------------------------------
|                         |  |                                                                                              
|                         |  |                                                                                              
|                         |  |                                                                                              
|Dated: November 12, 2004 |  | By:/s/ John E.
     Yetter
         John E. Yetter, CPA
         Chief Financial
     Officer