SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB


[   X ] Annual Report under Section 13 or 15(d) of the Securities  Exchange Act
        of 1934 for the fiscal year ended December 31, 1996

[     ] Transition Report under Section 13 or 15(d) of the  Securities  Exchange
        Act of 1934 for the transition period from _____ to _____

Commission file number:  1-31070


                              DERMA SCIENCES, INC.
             (Exact name of Registrant as specified in its charter)

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

      121 West Grace Street, Old Forge, Pennsylvania         18518          
        (Address of principal executive offices)          (Zip code)

Registrant's telephone number:  (717) 457-1232

Securities registered under Section 12(b) of the Exchange Act:
Title of each class                    Name of each exchange on which registered

Common Stock, $.01 par value                      Boston Stock Exchange

Common Stock, $.01 par value                      Pacific Stock Exchange

Securities registered under Section 12(g) of the Exchange Act:

                          Common Stock, $.01 par value
                                (Title of Class)

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

     Check if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B is not contained in this form, and no disclosure  will be contained,  to the
best  of  the  Registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part III of this Form  10-KSB or any
amendment to this Form 10-KSB.[ X ]

     Issuer's revenues for its most recent fiscal year were $4,557,931.

     The  aggregate  market  value of the voting  stock held by  non-affiliates,
computed by  reference  to the average bid and asked  prices of such stock as of
March 3, 1997, was approximately $3,484,586.

     The number of shares  outstanding of each of the issuer's classes of common
equity, as of March 3, 1997, was 4,067,632.

     Documents Incorporated by Reference: None


<PAGE>

                                     Part I

Item 1.  Description of Business

Overview

     Derma  Sciences,  Inc. (the "Company") was  incorporated  under the laws of
Colorado on September 10, 1984. On June 3, 1996 the Company changed its state of
domicile to Pennsylvania. The Company engages in the development,  marketing and
sale of primarily proprietary sprays, ointments and dressings for the management
of certain chronic  non-healing skin ulcerations such as pressure,  diabetic and
venous ulcers,  surgical  incisions and burns. As such wounds primarily  afflict
the elderly,  the Company markets its products through independent  distributors
mainly to healthcare providers to the geriatric community such as nursing homes,
similar  extended  care  facilities,  hospitals  and  home  healthcare  agencies
throughout  the United  States.  For 1998,  sales of wound care  products in the
United  States are estimated to attain $3.0 billion.  Source:  "Wound  Dressing,
Artificial  Skin,  Cell  Therapy  &  Related  Therapeutics...Evolving  Long Term
Business  Opportunities in Wound Management," POV(R) Reports,  Executive Summary
Section, page 18, 1996.

     The Company believes that its products offer certain  advantages over those
of its competitors with respect to wound management, cost effectiveness and ease
of use.  Improved  wound  management  is achieved  by the unique  ability of the
majority  of  the  Company's   products  to   simultaneously   address  multiple
environmental  factors  affecting  the wound site  consisting  of  moisture,  pH
balance, infection control, nutrition and protection. The utilization of readily
available components and standardized manufacturing techniques contribute to the
cost effectiveness of the products. Ease of use results from the formulation and
packaging of the Company's wound care products in convenient formats.

     In 1996,  the Company  experienced a 20% decrease in annual  revenue.  This
decrease is  primarily  attributable  to  decreases  in  Medicare  reimbursement
relative to a portion of the Company's product line.  Revenues increased 20% and
18% in 1994 and 1995,  respectively.  Revenues are derived  principally from the
sale of  Dermagran  Ointment,  Dermagran  Spray,  Dermagran  Wet  Dressings  and
Dermagran Hydrophilic Wound Dressing.

     The  Company's  objective is to become a leading  provider of chronic wound
care products throughout the United States and selected  international  markets.
The Company seeks to accomplish this objective by internal product  development,
product  acquisitions,  product  licensing,  joint ventures and joint  marketing
arrangements.  The  Company  introduced  one  new  product  in  1996:  Dermagran
Zinc-Saline  Hydrogel.  Also in 1996,  the Company  entered into  licensing  and
distributorship  agreements  that extended the sale of its products into Malawi,
Mozambique, Namibia, South Africa, Zimbabwe and Israel.

Chronic Wounds and Wound Care

Wound Classification

     Wounds are  generally  classified  as acute or chronic in  accordance  with
their healing tendencies.  Acute wounds, typically those received as a result of
surgery or trauma,  heal uneventfully within an expected time frame. The healing
of chronic wounds,  however,  is protracted and subject to  complications.  Such
wounds  may  linger for  weeks,  months or years,  and may defy all  traditional
attempts at  treatment.  In many cases,  amputation  of the affected limb is the
exclusive means of effecting a cure.

     Stage III and IV pressure,  venous and diabetic leg ulcers constitute three
of the largest  categories of chronic  wounds.  Pressure  ulcers,  also known as
decubitus ulcers or bedsores,  result from prolonged  pressure on the skin which
impairs blood supply to the affected area.  Lack of blood supply leads to tissue
death and ulceration of the skin and underlying tissue. Venous ulcers, or venous
stasis disease, result from poorly functioning veins,  particularly in the lower
extremities,  resulting in venous insufficiency. As a result, blood pools in the
legs  causing  chronic   wounds.   Diabetic  leg  ulcers  result  from  diabetic
neuropathy.  As of 1989 (the latest year for which such data is available),  the
incidence  of  various  chronic  wounds  and  ulcers in the  United  States  was
estimated at not less than: (1) pressure ulcers - 2.1 million cases,  (2) venous
stasis  disease - 500,000 cases and, (3) diabetic leg ulcers - 3 million  cases.
Source:  "Chronic  Wounds,  an Overview,"  Chronic Wound Care, a Clinical Source
Book for Health Care Professionals, pages 12-18, 1989.

The Afflicted Population

     A  disproportionately  large  share  of  total  U.S.  healthcare  costs  is
attributable to the elderly population.  A factor of this  disproportionality is
the prevalence in elderly  patients of chronic  wounds.  It is estimated that by
the year 2000 12.6% (35 million) of the United  States  population  will be over
the age of 65 and that 47.6% of that  12.6% will be over the age of 75.  Source:
"Wound Dressing, Artificial Skin, Cell Therapy & Related Therapeutics...Evolving
Long  Term  Business   Opportunities   in  Wound   Management,"  POV(R) Reports,
Macroeconomic  Factors  Affecting Wound Care, page 7, 1996. It is also estimated
that by the year 2030 more than 20% of all  Americans  (60 million) will be over
the age of 65, and that this segment of the  population  will account for 50% of
total  healthcare  costs.  Source:  "Wound Care,  an Emerging  Discipline,"  New
Directions in Wound Healing, page 2, 1990.

     As of 1989 (the latest year for which such data is  available),  there were
approximately  35 million  admissions to nursing homes in the United States.  Of
these admissions,  an estimated 10 to 20 percent suffered from chronic wounds in
the  nature of  pressure  sores or venous  ulcers.  Diabetics  are  particularly
susceptible  to  chronic  non-healing   wounds.   Diabetics  often  suffer  from
inadequate blood  circulation and neuropathy,  a loss of sensation in the limbs.
This predisposes diabetics to chronic wounds, particularly on the legs and feet.
In 1989 (the latest  year for which such data is  available),  diabetes  was the
leading cause of  non-traumatic  amputations  in the United States  resulting in
approximately  50,000  limb  amputations.  As of 1989,  there  were more than 12
million  diabetics  in the  United  States of which 25%  suffered  from  chronic
non-healing  wounds and  ulcerations.  Source:  "Chronic  Wounds,  an Overview,"
Chronic Wound Care, a Clinical Source Book for Health Care Professionals,  pages
12-18, 1989.

     In 1995,  sales of wound care products in the United States were  estimated
at $2.7  billion.  This amount is expected to increase to $3.0  billion in 1998.
Source:   "Wound   Dressing,   Artificial   Skin,   Cell   Therapy   &   Related
Therapeutics...Evolving  Long Term Business  Opportunities in Wound Management,"
POV(R) Reports, Executive Summary Section, page 18, 1996.

Principles of Treatment

     Traditional techniques for the treatment of chronic wounds have principally
involved  cleansing and debriding the wound (removing infected and dead tissue),
controlling  infection with  antibiotics and protecting the wound.  For example,
topical  agents may be applied to  chemically  clean the wound and remove  wound
debris and exudate;  antibiotics  may be  administered to decrease the bacterial
count in the wound;  and  protective  dressings may be used to protect the wound
from trauma.  Each of the foregoing  treatments  is passive in nature.  That is,
these  treatments  do not  stimulate  or  accelerate  the body's  wound  healing
processes.

     It is generally recognized that several environmental factors affecting the
wound site are of critical importance in the wound healing process.  Among these
factors are: (1) adequate moisture,  (2) pH balance,  (3) infection control, (4)
nutrition,  and (5) protection.  The foregoing factors are sometimes referred to
in this filing as the "traditional wound care factors."  Virtually all currently
available wound healing  products seek to influence one or more of these factors
in order to promote an environment conducive to healing.

     Wound  care   products   are   typically   categorized   according  to  the
environmental  healing  factors  which they are  designed  to  influence.  Thus,
moisturizers  provide and maintain  moisture in the wound;  cleansers  clean the
wound;  antimicrobials  control infection;  and dressings protect the wound from
trauma and other harmful influences.

     In addition to the above described factors,  medical researchers  generally
agree that trace amounts of certain  elements are  necessary to many  biological
processes  involved in wound healing.  Among the elements so identified is zinc.
The precise role of zinc in the wound  healing  process is not well  understood.
Likewise,  there is  disagreement  among  medical  practitioners  as to the most
efficacious method of ensuring an adequate supply of zinc at the wound site.

The Company's Products

Product Descriptions

     The  Company  develops,   markets  and  sells  mostly  proprietary  topical
preparations and devices primarily devoted to the management of certain pressure
and venous ulcers.  Secondary  product uses include  treatment of wounds or skin
irritations caused by surgical incisions,  abrasions,  burns and skin tears. The
Company  believes that its products offer certain  advantages  over those of its
competitors with respect to wound  management,  cost  effectiveness  and ease of
use. Improved wound management is attributable both to the unique ability of the
majority  of  the  Company's   products  to   simultaneously   address  multiple
traditional  wound care  factors  and the  Company's  focus on zinc as a primary
wound nutrient. The utilization of readily available components and standardized
manufacturing  techniques  contribute to the cost effectiveness of the products.
Ease of use results from the  formulation  and packaging of the Company's  wound
care products in convenient formats.

     The  Company's  products,  together  with  their  features  and  uses,  are
described below:

     1.  Dermagran  Ointment.  Dermagran  Ointment is a topical  ointment with a
lanolin  odor and is  packaged  in both jars and  tubes.  The  product's  active
ingredient  is  aluminum  hydroxide  gel.  Dermagran  Ointment,   when  used  in
conjunction  with Dermagran  Spray,  addresses all five  traditional  wound care
factors.  Indicated  uses  include  stage I and II pressure  and venous  ulcers,
incisions,  burns and other skin irritations.  Dermagran Ointment is marketed in
accordance with the FDA regulatory policy on OTC drugs.

     2. Dermagran Spray. Dermagran Spray is a colorless,  odorless liquid and is
packaged in translucent  plastic bottles with pump spray nozzles.  The product's
active  ingredient is zinc acetate.  Dermagran  Spray,  when used in conjunction
with  Dermagran  Ointment,  addresses all five  traditional  wound care factors.
Indicated uses are similar to those for Dermagran  Ointment.  Dermagran Spray is
marketed in accordance with the FDA regulatory policy on OTC drugs.

     3. Dermagran II Moisturizing Spray.  Dermagran II Moisturizing Spray, which
may be used either alone or with Dermagran II Ointment, is a colorless, odorless
liquid and is packaged in translucent  plastic  bottles with pump spray nozzles.
The product's  active  ingredient is zinc  chloride.  Dermagran II  Moisturizing
Spray,  when used in conjunction with Dermagran II Ointment,  addresses all five
traditional  wound  care  factors.  Indicated  uses  include  stage I through IV
pressure and venous ulcers.  This product,  which is not sold  domestically,  is
presently  manufactured and sold in Canada.  Dermagran II Moisturizing Spray has
been approved for sale in Canada by the Canadian Health Protection Branch.  This
product,  when used in conjunction  with Dermagran II Ointment,  is indicated in
the treatment of decubitus ulcers.

     4. Dermagran II Ointment.  Dermagran II Ointment,  which may be used either
alone or with  Dermagran II  Moisturizing  Spray,  is a topical  ointment with a
lanolin  odor and is  packaged  in both jars and  tubes.  The  product's  active
ingredient  is  magnesium  hydroxide.   Dermagran  II  Ointment,  when  used  in
conjunction with Dermagran II Moisturizing Spray, addresses all five traditional
wound  care  factors.  Indicated  uses are  similar  to those for  Dermagran  II
Moisturizing Spray. This product,  which is not sold domestically,  is presently
manufactured  and sold in Canada.  Dermagran II Ointment  has been  approved for
sale in Canada by the Canadian Health Protection Branch. This product, when used
in  conjunction  with  Dermagran  II  Moisturizing  Spray,  is  indicated in the
treatment of decubitus ulcers.

     5. Dermagran Wet Dressing  (Saline).  Dermagran Wet Dressing  (Saline) is a
sterile 4" x 8", 12 ply gauze  dressing  saturated  with  sterile  solution  and
packaged in foil envelopes  with  peel-down  tabs. The FDA has granted a Section
510(k)  approval for the  marketing  and sale of this  dressing.  Dermagran  Wet
Dressing  (Saline)  addresses  the  traditional  wound care factors of moisture,
infection control and protection.  Indicated uses are the management of pressure
sores,  venous  ulcers,  incisions,  burns and skin  irritations.  Dermagran Wet
Dressing (Saline) is appropriate  whenever a saline dressing is indicated.  This
product provides a convenient, economical method of compliance with requirements
for aseptic technique in the treatment of pressure sores and similar wounds.

     6. Dermagran  Zinc-Saline Wet Dressing.  Dermagran Zinc-Saline Wet Dressing
is similar to Dermagran Wet Dressing (Saline)  described above with the addition
of trace amounts of zinc. The FDA has granted a Section 510(k)  approval for the
marketing  and  sale  of  this  dressing.  Dermagran  Zinc-Saline  Wet  Dressing
addresses all five traditional wound care factors.  The medical  indications for
Dermagran  Zinc-Saline  Wet Dressing are the same as for  Dermagran Wet Dressing
(Saline).

     7. Dermagran   Hydrophilic  Wound  Dressing.  Dermagran  Hydrophilic  Wound
Dressing  is  an  advanced  hydrogel  formulation  available  as:  (1)  a  gauze
impregnated  with a hydrophilic  compound,  and (2) a "bulk" (not impregnated in
gauze)  hydrophilic  dressing  packaged in tubes.  The FDA has granted a Section
510(k)  approval  for the  marketing  and sale of this  dressing  in both forms.
Dermagran  Hydrophilic Wound Dressing  addresses all five traditional wound care
factors.  Indicated  uses are the  management  of all stages of pressure  sores,
diabetic ulcers, first and second degree burns and surgical incisions. Marketing
and sale of Dermagran  Hydrophilic  Wound  Dressing  (gauze)  began in December,
1993.  The marketing and sale of Dermagran  Hydrophilic  Wound  Dressing  (bulk)
began in December, 1995.

     8. Dermagran Tri-Zinc Incontinent Wash. Dermagran Tri-Zinc Incontinent Wash
is a cleanser packaged in an eight ounce opaque plastic bottle with a pump spray
nozzle.  Dermagran  Tri-Zinc  Incontinent Wash removes dry fecal matter and odor
resulting from incontinence.  Sales of Dermagran Tri-Zinc  Incontinent Wash have
not been a material income producing factor, therefore, the Company is currently
phasing out the sale of this product.

     9. Dermagran  Wound Cleanser with Zinc.  Dermagran Wound Cleanser with Zinc
is a saline wound cleanser with moisturizing and lubricating properties packaged
in a four ounce  translucent  plastic bottle with a single stream  dispenser tip
nozzle. The FDA has granted a Section 510(k) approval for the marketing and sale
of this cleanser.  The indicated use of this product is to cleanse dermal wounds
while contributing to the maintenance of a mildly acidic wound environment.  The
marketing and sale of this product began in the fourth quarter,  1995.  Sales of
this product have not been a material income producing factor.

     10. Dermagran  Zinc-Saline  Hydrogel.  Dermagran  Zinc-Saline Hydrogel is a
clear  hydrogel to be packaged  in tubes.  The FDA has granted a Section  510(k)
approval for the  marketing  and sale of this  hydrogel.  Dermagran  Zinc-Saline
Hydrogel  addresses  all  five  traditional  wound  care  factors.  The  medical
indications of this hydrogel are the management of all stages of pressure sores,
first and second  degree  burns and  surgical  incisions.  Due to its ability to
conform to deep, difficult-to-reach wound beds, and the recognized importance of
zinc as an element  essential to wound healing,  the Company believes this is an
important  addition  to the  Company's  product  line.  Marketing  and  sale  of
Dermagran  Zinc-Saline  Hydrogel  began in the third  quarter,  1996 and totaled
approximately $6,600.
<PAGE>

Product Development

     The Company has incurred  expenditures for product  development in 1995 and
1996 of $688,141  and  $803,744,  respectively.  The Company  does not intend to
develop  any  product  which  would  require  it to file a New Drug  Application
("NDA"),  or its equivalent,  with the FDA or similar foreign agencies.  Rather,
the  Company  will seek to market its current  and newly  developed  or acquired
products in  accordance  with such  abbreviated  approval  procedures  as may be
available. These procedures have included in the past, and are likely to include
in the future, applications under the FDA's Tentative Final Monographs (relating
to  known  "active  ingredients")  and  Section  510(k)  (relating  to  "medical
devices"),   together  with  analogous  foreign  procedures.  See  "Governmental
Regulation."

     Products under development by the Company include the following:

     1.  Dermagran  Barrier  Cream.  Dermagran  Barrier  Cream  is a cream to be
distributed  in tubes.  The treatment  objective of this cream is to protect the
skin from external irritants associated with incontinence.

     2. Dermagran  Hydrocolloid  Dressing.  Dermagran Hydrocolloid Dressing is a
single  unit  dose  dressing.  The  treatment  objectives  of this  hydrocolloid
dressing are to remove wound exudate and provide protection for one-quarter inch
to one-eighth inch wounds and partial thickness burns. The Company believes this
dressing will be an important  addition to the  Company's  product line since it
requires less frequent changing and provides increased cost  effectiveness.  The
marketing  and sale of Dermagran  Hydrocolloid  Dressing  will  require  Section
510(k) approval from the FDA.

Product Sourcing and Quality Control

     The Company does not maintain manufacturing facilities and it contracts for
the production  and packaging of its entire  product line.  The following  table
lists the  Company's  manufacturers  as of December 31, 1996,  together with the
products manufactured by each:

       Manufacturer                             Product
       ------------                             -------

 Topiderm, Inc.                  Dermagran Ointment
 Bohemia, New York               Dermagran Hydrophilic Wound Dressing (bulk)

 Applied Labs                    Dermagran Spray
 Columbus, Indiana               Dermagran Tri-Zinc Incontinent Wash
                                 Zinc-Saline solution for Dermagran Zinc-Saline
                                     Wet Dressing

 Kendall Health Care Products    Dermagran Wet Dressing (Saline)
 Mansfield, Massachusetts        Dermagran Zinc-Saline Wet Dressing

 Technol, Inc.                   Dermagran Hydrophilic Wound Dressing (gauze)
 Fort Worth, Texas

 Ambix Laboratories              Dermagran Wound Cleanser with Zinc
 East Rutherford, New Jersey     Dermagran Zinc-Saline Hydrogel
                                 Hydrophilic compound for Dermagran
                                     Hydrophilic Wound Dressing

 Contract Pharmaceuticals Ltd.   Dermagran II Ointment
 Mississauga, Ontario            Dermagran II Moisturizing Spray


     The Company has a three year  manufacturing  contract,  expiring January 1,
1998, with Kendall Health Care Products,  the  manufacturer of the Company's Wet
Dressings.  This  contract  provides for minimum  purchases in 1997 of $189,034.
Failure  to  meet  minimum  purchase   requirements  could  result  in  contract
cancellation.

     The Company's  products  utilize readily  available  components.  There are
numerous laboratories and production facilities with the capability of producing
the Company's products to the standards required by the FDA, the Company and the
pharmaceutical  industry. Given the availability of other suppliers, the Company
does not believe that the loss of one or more of its suppliers  would  adversely
affect its operations.

     The Company requires that all of its suppliers conform to the standards set
forth in the Good Manufacturing Practice ("GMP") regulations  promulgated by the
FDA.  See  "Government  Regulation."  No product  batch is released for shipment
until a quality  control  analysis  thereof  is  reviewed  and  approved  by the
Company.

                                      
<PAGE>
Patents and Proprietary Technology

     Certain of the  Company's  products  have  received  patent  protection  in
several countries under the title "Two-Step Procedure for Indolent Would Healing
and Aqueous Medium and Topical  Ointment Used in Connection  therewith."  Patent
applications  are pending in various  other  countries.  Countries  where patent
applications have been made,  application  status and, where applicable,  patent
expiration dates are set forth below:

      Country                    Status                 Expiration Date
      -------                    ------                 ---------------

     Australia                   Issued                 November 11, 2003

     Canada                      Issued                 March 5, 2008

     Egypt                       Pending                     ---

     European Community*         Issued                 March 20, 2007

     Ireland                     Issued                 March 24, 2007

     Japan                       Pending                     ---

     Mexico                      Issued                 April 2, 2007

     Philippines                 Issued                 July 1, 2008

     Spain                       Issued                 February 26, 2008

     United States               Issued                 July 11, 2006
__________________________                          
*    The European  Community is comprised of the following  countries:  Austria,
     Belgium,   France,  Germany,  Italy,   Luxembourg,   Netherlands,   Sweden,
     Switzerland and United Kingdom.

     The Company  believes  that the foregoing  patents and patent  applications
afford reasonable  protection to the Company against the unauthorized copying of
the technology embodied in the subject products.  However, it must be emphasized
that:  (1) the means  whereby the products may stimulate  and  accelerate  wound
healing are unknown,  and (2) the chemical and biological processes bearing upon
wound healing are highly complex and subject to a wide variety of influences and
stimuli. As such, it is possible that others will develop wound healing products
equal or superior  to those of the  Company  without  infringing  the  Company's
patents.

     The Company's policy is to seek, when appropriate, protection for candidate
products and proprietary  technology by filing patent applications in the United
States and other jurisdictions.  There can be no assurance that the Company will
file additional patent  applications or that any patent will issue on any of the
Company's  patent  applications.  Even if such  patents  issue,  there can be no
assurance that the patents will provide protection against competitive  products
or  otherwise  be  commercially  valuable.  Patent law  relating to the scope of
claims with respect to wound care pharmaceutical products is still evolving, and
the Company's patent rights are subject to this  uncertainty.  Furthermore,  the
existence  of  patent  rights  does  not  provide  absolute   assurance  against
infringement  of these rights.  The  prosecution and defense of patent claims is
both costly and time consuming, regardless of outcome.

     The  Company  has  trademark  rights in the names of each of its  products.
Dermagran  is a  registered  trademark  of  the  Company  and  may  be  used  in
conjunction  with the  names of each of the  Company's  products.  In  addition,
Tri-Zinc is a  registered  trademark  of the Company and is used in  conjunction
with  Dermagran  Tri-Zinc  Incontinent  Wash.  Dermagran II is also a registered
trademark  of  the  Company  and  is  used  in  conjunction  with  Dermagran  II
Moisturizing Spray and Dermagran II Ointment, products sold only in Canada.

     An  important  part of the  Company's  product  development  strategy is to
acquire,  by purchase or license,  proprietary  wound care technology from other
parties.  There can be no assurance that the Company will be able to obtain such
technology  on  acceptable  terms,  if at  all.  An  inability  to  obtain  such
technology  will not  interfere  with the  Company's  plans to  develop  its own
proprietary technology or to commercialize wound care products it has developed.
Such  inability  to  license  proprietary  wound  care  technology  could have a
material adverse effect on the Company's business.

     The Company  relies upon trade  secrets  and other  unpatented  proprietary
information in its product development  activities.  The Company's employees are
required  to  enter  into  agreements  providing  for  confidentiality  and  the
assignment  of  rights to  inventions  made by them  while in the  employ of the
Company.  The Company also has entered into non-disclosure  agreements which are
intended to protect its confidential  information delivered to third parties for
research and other  purposes.  There can be no assurance  that these  agreements
will provide meaningful protection of the Company's  confidential or proprietary
information.
<PAGE>
Distribution and Sales

Domestic

     Most  of the  Company's  wound  care  products  are  distributed  and  sold
domestically pursuant to the Company's "master distributor" distribution system.
Master  distributors  purchase products directly from the Company and distribute
the  products,  through  their network of  representatives  and dealers,  to end
users. Master distributors enter into master distributorship agreements with the
Company which provide for product  purchase  quotas.  While the Company provides
suggested pricing formulas or guidelines,  the master  distributor  retains sole
discretion  to  determine  the  price  at which  to sell  the  products.  Master
distributors   are   responsible   for   supervising   their  own   network   of
representatives and dealers.  Compensation to master distributors is in the form
of  markups  on   products   distributed   by  master   distributors   to  their
representatives  and dealers  and by  commissions  earned on  products  sold and
distributed, by whatever means, to national accounts or end users within a given
master distributor's territory.

     The Company's  domestic  master  distributors  and their  respective  sales
territories are set forth below:

      Distributor                            Sales Territories
      -----------                            -----------------

   D-LUX Products, Inc.              Arizona, California, Hawaii, Nevada,
   Corona, California                New Mexico     

   Dimensions Distributing, Inc.     Connecticut,  Maine,  Massachusetts,
   Norton, Massachusetts             New Hampshire, Rhode Island, Vermont

   GMI, Inc.                         New Jersey, New York, Pennsylvania
   Port Washington, New York

   InnerQuest Sales, Inc.            Illinois, Indiana, Iowa, Kansas, Michigan,
   Lamont, Illinois                  Minnesota, Missouri,Montana, Nebraska,North
                                     Dakota, South Dakota, Wisconsin

   Med Surg Systems, Inc.            Alaska, Idaho, Montana, Oregon, Washington
   Seattle, Washington



<PAGE>
     Distributor                            Sales Territories
     -----------                            -----------------

   Medical Marketing, Inc.           Utah
   Salt Lake City, Utah

   Medical Resources, Inc.           Alabama, Delaware, Florida, Georgia, 
   Richmond, Virginia                Kentucky, Maryland, Mississippi, North 
                                     Carolina, Ohio, South Carolina,  Tennessee,
                                     Virginia,  Washington DC, West Virginia

   Positive Health Products, Inc.    Arkansas, Louisiana, Oklahoma, Texas 
   Katy, Texas                       (selected areas)

   Resource Medical, Inc.            Texas (selected areas)
   Fort Worth, Texas

   Transworld Home Healthcare, Inc.  Puerto Rico, U.S. Virgin Islands
   Red Bank, New Jersey


     Two of the Company's master  distributors are responsible for a significant
portion of its product  revenues,  representing  approximately  33% of total net
sales in 1996.  GMI,  Inc. and Medical  Resources,  Inc.  were  responsible  for
approximately  21% and 12%,  respectively,  of the Company's  total net sales in
1996. The loss of one of these master distributors could have a material adverse
effect on the Company's business.

     Dealers,  representatives  and  wholesalers are subject to the authority of
master distributors and must satisfy various criteria established by the Company
as  a  prerequisite  to  distributing  the  Company's   products.   Among  these
requirements are the maintenance of reasonable product  inventories,  employment
of sales personnel knowledgeable in the marketing, sale and use of the products,
and the  conduct of  various  marketing  activities,  including  in-service  and
educational  seminars  relative to the products.  Dealers,  representatives  and
wholesalers  may market to  pharmacies  or may  distribute  directly  to nursing
homes,  hospitals  and  home  healthcare  agencies.   Compensation  of  dealers,
representatives  and  wholesalers  is  derived  from  markups  on the  Company's
products distributed by them.

     In  addition  to product  distribution  through  master  distributors,  the
Company  distributes  products through its national accounts program. A national
account  is a  customer  who  purchases  products  in one  master  distributor's
territory  and then  reships the  products to places of business in other master
distributors' territories. The Company sells its products directly to a national
account and receives a tracking list indicating the ultimate destinations of the
products.  Once the tracking list is received, the Company makes payments to the
affected  master  distributors  equivalent to the difference  between the master
distributor  price and the actual  price paid by the  national  account,  net of
discounts  and fifty percent of freight  costs.  The national  accounts  program
represented 33% of the Company's total net sales in 1996.

International

     The Company's wound care products are distributed and sold  internationally
pursuant  to various  licensing  and  distribution  agreements.  The Company has
licensing  and/or  distribution  agreements with companies in Egypt,  Indonesia,
Canada,  the  Philippines,  the South  African  region and  Israel.  The Company
currently seeks to penetrate the European and Latin American markets.

     All of the Company's  wound care products are currently sold in Egypt.  The
Company's  distributor  for  Egypt  is  Pharmaserve,  Ltd.,  Cairo.  Pharmaserve
established  a  scientific  office  in  Cairo  in  August,  1995 to  disseminate
information  about  the  Company's  products.  Sales in  Egypt  in 1996  totaled
approximately $50,000.  Presently,  the parties are operating under an exclusive
agency agreement which provides for a 12% commission  payable to Pharmaserve but
does not provide for minimum purchase quotas. The Company expects that a written
distributorship  agreement providing for minimum purchase quotas and territorial
exclusivity will be executed in the near future.

     On June 24, 1994, the Company granted an exclusive  license to manufacture,
distribute,  market and sell all of its  products in a  designated  territory to
P.T.  Tempo  Scan  Pacific  ("Tempo"),  Jakarta,  Indonesia.  Tempo's  territory
consists of Indonesia,  Malaysia, Singapore, Myanmar, Thailand, Brunei, Vietnam,
Laos,  Cambodia,  Hong Kong and Macao.  Tempo has commenced  distribution of the
Company's  products  in  Indonesia  and is  prepared  to further  introduce  the
Company's  products to other countries in its territory as the products  receive
approval by each country's health authority. Pursuant to the Agreement, Tempo is
required  to make the  following  minimum  annual  purchases:  $314,500 in 1995,
$439,325 in 1996;  $458,950 in 1997;  $505,950 in 1998; and $548,800 in 1999. In
addition,  Tempo is required to make royalty  payments of 3.5% of its sales (net
of sales taxes) to the Company.  Purchases by Tempo in 1995 and 1996 were in the
amounts of $76,191 and $45,000, respectively, and fell short of minimum purchase
requirements.  The Company has determined  that Tempo's failure to meet 1995 and
1996 minimum purchase  requirements were attributable to delays in receiving the
necessary regulatory  approvals from Indonesian  authorities.  Accordingly,  the
Company has waived Tempo's 1995 and 1996 minimum purchase requirements.

     On May 10, 1995, the Company  granted an exclusive  license to manufacture,
distribute,  market and sell Dermagran II Ointment and Dermagran II Moisturizing
Spray in Canada to Trans CanaDerm, Inc. ("TCD"), Montreal, Quebec. The Agreement
requires that TCD pay the Company a $100,000 (CDN) prepaid  royalty upon Quality
Control  verification  of the  first  batch of  product  together  with  prepaid
royalties of $85,000  (CDN),  $60,000  (CDN) and $30,000  (CDN) upon  provincial
formulary  listings  in  Ontario,  Quebec and  British  Columbia,  respectively.
Royalties,  net of the foregoing prepayments,  will be based on 15% of net sales
during the life of the Company's patent. In addition, once certain sales targets
are  achieved,  TCD will pay the  Company  milestone  payments of up to $750,000
(CDN). The Company did not receive any royalties from TCD in 1996.

     On April 8, 1995, the Company  granted an exclusive  license to distribute,
market and sell all of its products in the  Philippines  to  Inter-Health,  Inc.
("Inter-Health"),  Manila.  Inter-Health  has  filed  registration  applications
relative to the Company's  products with the appropriate  health agencies of the
Philippines.  Upon completion of product registration,  Inter-Health is required
to make the  following  minimum  annual  purchases:  $164,436 in the first year;
$193,696 in the second year;  $266,396 in the third year; $294,818 in the fourth
year; $325,186 in the fifth year; and $350,947 in the sixth year. Sales have not
yet commenced in the Philippines.

     On  January  29,  1996,  the  Company  granted  an  exclusive   license  to
distribute, market and sell all of its products in Malawi, Mozambique,  Namibia,
South Africa and Zimbabwe to Manta Medical ("Manta"),  Bryanston,  South Africa.
Product  registration  applications  are being  processed.  Upon  completion  of
product  registration,  Manta is required to make the following  minimum  annual
purchases:  $115,000 in the first year; $138,000 in the second year; $165,000 in
the third year;  $198,000 in the fourth  year;  and  $237,600 in the fifth year.
Sales have not yet commenced in Manta's territory.

     On  October  31,  1996,  the  Company  granted  an  exclusive   license  to
distribute,  market and sell seven of its products in Israel to Gamida-MedEquip,
Ltd. ("Gamida"),  Givat Savyon,  Israel. Minimum purchase requirements are to be
established after December 31, 1997. Sales have not yet commenced in Israel.

Third Party Reimbursement

     The Company sells its wound care products to nursing  homes,  hospitals and
home healthcare  agencies.  Several of the Company's dealers seek  reimbursement
from  third  party  payors  such  as  Medicare,   Medicaid,  health  maintenance
organizations  and private  insurers,  including  Blue  Cross/Blue  Shield.  The
availability  of  reimbursement  from such third party  payors is a  significant
factor in the Company's sales of wound care products.

     Medicaid is a federally funded program administered by the states. Medicaid
insurance  is available to  individuals  who have no Medicare or private  health
insurance or to individuals who have exhausted their Medicare benefits. Included
in the  Medicaid  insurance  coverage  are  in-patient  stays in long  term care
facilities, hospitalization and drugs.

     Medicaid  reimbursement of the Company's products is dependent upon Company
paid rebates to state Medicaid agencies.  Effective January 1, 1991, the Omnibus
Budget  Reconciliation  Act of  1990  requires  pharmaceutical  companies,  as a
condition of the  eligibility  of its products  for Medicaid  reimbursement,  to
enter into a rebate  agreement  with the federal  government.  Only drugs of the
pharmaceutical  companies  having  such rebate  agreements  are covered by state
Medicaid programs. Pharmaceutical companies participating in the Medicaid rebate
program  must remit to state  Medicaid  agencies a  formula-based  rebate  which
varies from quarter to quarter in accordance  with the  Company's  quarterly net
sales  and  the  average   manufacturer   price  of  the  individual   products.
Historically,  Medicaid  rebates have ranged  between 3% and 5% of the Company's
net sales.

     Medicare  is a  federally  funded  program  administered  by  four  private
insurance  companies.  Medicare insurance  generally is available to individuals
who have  paid  social  security  taxes  and are over the age of 65  years.  The
majority of the Company's  products are eligible to receive  reimbursement  from
Medicare.  However,  certain  of these  products  have been the  subject of past
Medicare   reimbursement   cutbacks.   In  1991  the   Health   Care   Financing
Administration  ("HCFA")  implemented a 73.3%  reduction in  reimbursements  for
wound care kits.  These  cutbacks were  applicable  to all claims  submitted for
Medicare reimbursement and were sought to be applied  retroactively.  Wound care
kit reimbursements by Medicare were temporarily  suspended pending determination
of the legality of the retroactive aspect of the cutbacks.  Reimbursements  were
resumed in the first quarter, 1992.

     Since 1991, Medicare  reimbursement relative to wound care kits was limited
to wound  dressings  necessitated  by, and used  within  two weeks of,  surgery.
Non-dressing components of the kits were ineligible for reimbursement. Dressings
used in non-surgical  applications  or outside of the two-week period  following
surgery were,  likewise,  ineligible for  reimbursement.  On June 1, 1994,  HCFA
adopted  amendments  liberalizing  the  Medicare  Carrier's  Manual  relative to
reimbursement  of wound care  products.  Effective  with the  adoption  of these
amendments,  all dressings utilized after debridement of a wound became eligible
for Medicare reimbursement.  In addition to dressings,  components of wound care
kits utilized to secure dressings,  such as tape and gauze, also became eligible
for  reimbursement.  The HCFA amendments  restructured the manner in which wound
care products were classified.  Such  restructuring  served to place products in
separate categories thereby allowing for reimbursement pricing by category.  All
of  the  Company's  products  except  Dermagran  Spray  and  Dermagran  Tri-Zinc
Incontinent Wash were listed as eligible for reimbursement.

     Recently HCFA amended its policies to exclude Wound Care Kits from Medicare
reimbursement.  However,  sold  separately,  the  Company's  products,  with the
exception of Dermagran  Spray,  Dermagran Wound Cleanser with Zinc and Dermagran
Tri-Zinc  Incontinent Wash, continue to be eligible for Medicare  reimbursement.
For this reason, the Company phased out the sale of Wound Care Kits in the first
quarter, 1996.

     Federal and state governments,  as well as private insurers,  will continue
their pursuit of programs designed to control or reduce the cost of health care.
These cost cutting  measures may include  reductions  in  reimbursements  and/or
increases in rebates for wound care products. As such, there can be no assurance
as to whether  reimbursements  for the  Company's  products  will continue to be
available or as to the future extent of the Company's rebate obligations.

Competition

The Wound Care Industry

     The wound care sector of the  pharmaceutical  industry is  characterized by
rapidly evolving technology and intense competition.  The Company's  competitors
include major pharmaceutical, chemical and specialized pharmaceutical companies,
many of which have financial,  technical and marketing  resources  significantly
greater than those of the Company. In addition, many specialized  pharmaceutical
companies  have formed  collaborations  with  large,  established  companies  to
support research, development and commercialization of wound care products which
may be competitive with those of the Company. Academic institutions,  government
agencies and other public and private research organizations are also conducting
research  activities and may  commercialize  wound care products on their own or
through joint ventures.  The existence of competing  products or treatments,  or
products or treatments that may be developed in the future, may adversely affect
the marketability of products developed by the Company.

Competing Product Descriptions

     The Company's  competitors  market several varieties of wound care products
which compete with those of the Company.  The following table sets forth generic
descriptions of these products:

      Product                                  Description
      -------                                  -----------

Skin protectants ............Creams,  gels,  pastes or foams  used to  protect
                             the skin from friction, abrasions and moisture.

Wound cleansers .............Cleansing  solutions used to remove wound debris,
                             exudate and bacteria.

Gauze dressings .............Impregnated  and  dry  dressings used to protect
                             and/or deliver substances to the wound site.

Antimicrobials, antiseptics, 
antibiotics..................Drugs, often in topical application format, used
                             to prevent and control infection.

Transparent films ...........Clear, plastic-like wound coverings used to provide
                             protection and maintain moisture in the wound site.

Hydrocolloids ...............Fluid-absorbing dressings which  maintain  a  moist
                             wound environment and provide infection control and
                             pH balance.

Gels/hydrogels ..............Water based preparations used to provide  moisture,
                             protection and drainage absorption to the wound.

Calcium alginates ...........Highly  absorbent dressings used  to  remove  wound
                             exudate.

     The foregoing products are similar in many respects to those of the Company
in that they are designed to address one or more of the "traditional  wound care
factors."

Competitive Analysis

     Although the Company is considerably  smaller than, and lacks the resources
of, the  majority of its  competitors,  the Company  believes  that its products
compare  favorably  with those of its  competitors  with  respect  to: (1) wound
management,  (2) cost  effectiveness,  and (3)  convenience and ease of use. All
five  traditional  wound care  factors  are  addressed  by the  majority  of the
Company's products. Additionally, the proprietary technology that is employed by
the  majority  of  these  products,  in the  opinion  of  management,  would  be
difficult,  time  consuming  and  expensive to  circumvent.  For these  reasons,

<PAGE>

management  believes the Company possesses  attributes which will enable it, for
the near term,  to compete  successfully  in the wound care field.  The ultimate
ability of the Company to remain competitive depends upon its ability to develop
or acquire,  and  commercialize,  wound care technologies  which are superior to
those of its competitors.

     The following table lists the Company's major competitors,  their competing
products and the Company's competitive products:

Competitor         Competitor's Product     Company's Competitive Product
----------         --------------------     -----------------------------

Sween Corporation  Sween Cream              Dermagran Ointment/Dermagran Spray
                   Peri-Wash(R)Incontinent  Dermagran Tri-Zinc Incontinent Wash
                   Cleanser-Deodorizer

Carrington Labs    Cara-Klenz TM            Dermagran Wound Cleanser with Zinc
                   Carra Foam TM Skin 
                   Perineal Cleanser        Dermagran Tri-Zinc Incontinent Wash
                   Carrington Dermal  
                   Wound Gel TM             Dermagran Hydrophilic Wound Dressing
                                            Dermagran Zinc-Saline Hydrogel
                   Carrasyn TM              Dermagran Hydrophilic Wound Dressing
                                            Dermagran Zinc-Saline Hydrogel

C.R. Bard          Biolex Wound Gel         Dermagran Hydrophilic Wound Dressing
                                            Dermagran Zinc-Saline Hydrogel
                   Biolex Wound Cleanser    Dermagran Wound Cleanser with Zinc
                   Hygiene1(R)              Dermagran Tri-Zinc Incontinent Wash

Calgon Vestal      Aloe Vesta(R) Perineal   Dermagran Tri-Zinc Incontinent Wash
                   Solution
 
Dow B.             Granulex TM              Dermagran Ointment/Dermagran Spray
 Hickman/steriseal

Smith & Nephew     Intrasite Gel TM         Dermagran Hydrophilic Wound Dressing
 United                                     Dermagran Zinc-Saline Hydrogel

Southwest          Elastogel TM             Dermagran Hydrophilic Wound Dressing
 Technologies                               Dermagran Zinc-Saline Hydrogel

Kendall Health     Curity Wet Dressings(R)  Dermagran Wet Dressing (Saline)
 Care Products                              Dermagran Zinc-Saline Wet Dressing
                                            Dermagran Hydrophilic Wound Dressing
                                            Dermagran Zinc-Saline Hydrogel

Government Regulation

Scope of Regulation

     The  manufacture,  distribution  and  advertising  of the  Company  and its
products are subject to  regulation by numerous  federal and state  governmental
agencies in the United States and by similar agencies in foreign countries.  The
United  States  Food  and  Drug   Administration   ("FDA")  is  responsible  for
enforcement  of the  Federal  Food,  Drug and  Cosmetic  Act ("FDC  Act")  which
regulates drugs and devices manufactured and distributed in interstate commerce.
The Company's  products are either drugs or medical devices  pursuant to the FDC
Act.  The  Federal  Trade  Commission  ("FTC")  administers  the  Federal  Trade
Commission Act ("FTC Act") which regulates the advertising of products including
drugs and devices.  All states have  individual  laws which resemble the FDC Act
and the FTC Act.




                                       
<PAGE>

Medical Devices

     The  following  products  are  devices  within the  meaning of the FDC Act:
Dermagran Wet Dressing (Saline),  Dermagran Zinc-Saline Wet Dressing,  Dermagran
Hydrophilic  Wound  Dressing,  Dermagran  Wound Cleanser with Zinc and Dermagran
Zinc-Saline Hydrogel.  Dermagran Hydrocolloid Dressing, which is currently under
development by the Company, is also a device within the meaning of the FDC Act.

     The FDC Act requires  that all devices for human use marketed in the United
States prior to May 28, 1976 ("Preamendment  Devices") be classified by the FDA,
based on recommendations of expert panels, into one of three regulatory classes.
Class I products  are subject  only to the general  controls  which apply to all
devices,  irrespective of class.  General  controls  include the registration of
manufacturers,  recordkeeping  requirements,  labeling  requirements,  and  Good
Manufacturing Practice ("GMP") regulations.

     Class II devices are those for which general controls are not sufficient to
ensure  safety and  effectiveness,  and for which enough  information  exists to
develop a standard.  These  devices are required to meet  performance  standards
established   by  the  FDA.   Performance   standards  may  specify   materials,
construction  components,  ingredients,  labeling  and other  properties  of the
device.  A standard  may also  provide for the testing of devices to ensure that
different lots of individual products conform to the requirements.

     The most  restrictive  controls are applied to devices placed in Class III.
Class III devices are required to have FDA approval for safety and effectiveness
before they can be marketed unless the FDA determines  that pre-market  approval
is not necessary.  Pre-market approval necessitates the compilation of extensive
safety and  effectiveness  data which is  extremely  expensive to compile and it
would take years to achieve approval.

     Devices  marketed after May 28, 1976 are considered to be one of two kinds:
those that are and those that are not  substantially  the same as a Preamendment
Device.  Those that are  substantially  equivalent to a Preamendment  Device are
classified the same as the equivalent  pre-amendment  product. Those new devices
which are not substantially equivalent to Preamendment Devices are automatically
in Class III, requiring pre-market approval.

     All  manufacturers  are required to give the FDA ninety days notice  before
they can introduce a device on the market. During the ninety-day period, the FDA
will  determine  whether the device is or is not  substantially  equivalent to a
Preamendment  Device. If the FDA determines that the device is not substantially
equivalent to a Preamendment  Device,  it is  automatically in Class III and the
manufacturer will have to provide the FDA with a Premarket Approval  Application
("PMA")  containing  evidence that the device is safe and  effective  before the
device may be  commercially  distributed to the public.  The  manufacturer  may,
however,  try  to  convince  the  FDA to  reclassify  the  device  by  filing  a
reclassification petition.

     All of the devices currently marketed by the Company have been found by the
FDA to be substantially  equivalent to a Preamendment  Device.  Also, it appears
that the devices under development by the Company are substantially identical to
Preamendment Devices and will not require the submission and approval of a PMA.

Drugs

     The Company's  products  which are  classified as drugs pursuant to the FDC
Act are Dermagran  Spray and Dermagran  Ointment.  Pursuant to the provisions of
the FDC Act  the  FDA  has  been  given  extensive  authority  to  regulate  the
manufacture and distribution of drugs.

     "New" drugs are very  closely  regulated by the FDA. A drug is a "new drug"
if it is not generally recognized among scientifically qualified experts as safe
and  effective  for use under  the  conditions  indicated  in its  labeling.  In
addition,  a drug is a new drug if it has not been used to a material  extent or
for a material time under the indicated conditions, apart from use in safety and
effectiveness  investigations,  even if the drug has become generally recognized
as safe and effective as a result of such investigation.  The definition applies
not only to active ingredients but to finished drug products as well.

     A new drug may not be commercially  marketed in the United States unless it
has been  approved as safe and effective by the FDA. Such approval is based on a
New Drug  Application  ("NDA")  submitted by the sponsor of the drug  containing
acceptable scientific data including the results of tests to evaluate its safety
and substantial  evidence of effectiveness for the conditions for which the drug
is to be  offered.  Drugs  that are not "new" are not  subject to the "new drug"
procedure,  but  must  comply  with  all  other  drug  requirements,   including
registration, labeling, and GMP regulations.

     Prior to the commencement of clinical studies to compile the data necessary
for approval of a NDA, the sponsor  must obtain  approval of an  Investigational
New Drug  Application  to  commence  investigations  regarding  the  safety  and
effectiveness of drugs.
<PAGE>

Over-the-Counter Drugs

     Prescription  drugs may be dispensed  only by or on the  prescription  of a
licensed  practitioner  and must be labeled:  "Caution:  Federal  law  prohibits
dispensing  without  prescription."  In  general,  a drug is  restricted  to the
prescription  class  if it  is  not  safe  for  use  except  under  professional
supervision.  All drugs having  characteristics that do not require prescription
dispensing are considered to be  over-the-counter  ("OTC") drugs.  The Company's
drug products are classified as OTC drugs.

     In 1972, the FDA began a comprehensive review of the safety,  efficacy, and
labeling of all OTC drugs for the purpose of establishing  the conditions  under
which such drugs  could be  generally  recognized  as safe,  effective,  and not
misbranded.  To  facilitate  the review,  these drug  products were grouped into
therapeutic  classes, and advisory panels were established to review each class.
The  panels  completed  their  review  in 1983,  and it  remains  for the FDA to
complete the rulemaking process.

     On the basis of the recommendations submitted by the panels, the FDA issues
monographs  setting forth the conditions under which OTC drugs in each class are
deemed  to be  generally  recognized  as safe,  effective,  and not  misbranded.
Generally,   the   administrative   process   includes  the   publication  of  a
"Preliminary,"  "Tentative  Final," and "Final Monograph." During the rulemaking
process,  products are placed into one of three categories  describing whether a
drug is  deemed  to be  generally  recognized  as  safe  and  effective  and not
misbranded (Category I), to be not generally recognized as safe and effective or
misbranded  (Category  II),  or  to  lack  sufficient  data  for  categorization
(Category  III).  Products that do not comply with general OTC regulations or an
applicable Final Monograph are subject to a regulatory  action. Any OTC drug not
in compliance with the content and labeling requirements of a Final Monograph is
subject to a regulatory  action unless it is the subject of an approved new drug
application. The FDA has issued a Compliance Policy Guide in which it determined
that it would not  pursue  regulatory  action  against  OTC  drugs  prior to the
adoption  of a final  regulation  unless  failure to do so  presents a potential
public health hazard.

     Dermagran  Spray and  Dermagran  Ointment are currently  being  marketed as
over-the-counter skin protectant drug products. Skin protectant products are the
subject  of an  ongoing  FDA rule  making  procedure  which  will  result in the
issuance of a final  regulation  specifying those active  ingredients  which are
permitted  in,  and  designating  labeling   requirements  for,  such  products.
Preliminary  Monographs and Tentative Final  Monographs  applicable to Dermagran
Spray  and  Dermagran  Ointment  have  been  issued by the FDA in 1978 and 1984,
respectively.

     Dermagran Spray and Dermagran  Ointment have been formulated and labeled in
accordance  with  the  proposals  outlined  in the  Preliminary  Monograph.  The
Dermagran Spray and Dermagran  Ointment  labels carry  treatment  indications of
"For  symptoms of oozing and weeping  due to rubbing or  friction"  and "For the
temporary   protection  and  lubrication  of  minor  skin  irritations  such  as
intertrigo, chafing, galling, rubbing or friction," respectively.

     Under the Tentative Final Monograph,  products formulated and identified in
the manner of Dermagran Spray and Dermagran  Ointment would be required to carry
treatment indications of "Dries the oozing and weeping of poison ivy, poison oak
and poison  sumac."  Thus,  if the  proposals  outlined in the  Tentative  Final
Monograph are adopted  without  modification  in a final  regulation,  and if no
modifications  were made to the  formulations  of Dermagran  Spray and Dermagran
Ointment,  the treatment  indications  on the current Spray and Ointment  labels
would have to be revised.

     It is currently  impossible to predict when the FDA will promulgate a final
regulation,  what the final  regulation  will provide or how a final  regulation
(monograph)  will affect either of these  products or their labels.  Pursuant to
the  FDA's  Compliance  Policy  Guide,  discussed  above,  Dermagran  Spray  and
Dermagran Ointment may be marketed under their current monographs until one year
following the issuance of a Final  Monograph.  It is the Company's  intention to
manufacture  Dermagran Spray and Dermagran  Ointment pursuant to the FDA's Final
Monograph  relative to "skin  protectants" and to make whatever  formulation and
labeling changes are necessary to fully comply with the final regulation.

Foreign Approval

     Whether or not FDA  approval  has been  obtained,  approval of a product by
regulatory  authorities  in  foreign  countries  must be  obtained  prior to the
commencement  of marketing of the product in such  countries.  The  requirements
governing the conduct of clinical  trials and product  approval vary widely from
country to country,  and the time required for approval may be longer or shorter
than that required for FDA approval.  Although  there are procedures for unified
filings for certain European countries,  most countries currently maintain their
own product approval procedures and requirements.
<PAGE>

Other Regulatory Requirements

     In addition to the regulatory framework for product approvals,  the Company
is subject to  regulation  under state and federal law,  including  requirements
regarding occupational safety,  laboratory practices,  environmental  protection
and  hazardous  substance  control,  and may be  subject  to other  present  and
possible future local, state, federal and foreign regulation.

     The Company is subject to federal,  state and foreign laws and  regulations
adopted  for the  protection  of the  environment  and the  health and safety of
employees.  Management  believes that the Company is in compliance with all such
laws,  regulations  and  standards  currently  in  effect  and  that the cost of
compliance  with such laws,  regulations  and standards will not have a material
adverse effect on the Company.

Employees

     Prior  to  the  restructuring  of  its  operations,  the  Company  employed
twenty-two full time employees.  The Company  currently  maintains  sixteen full
time employees, two of whom serve in executive capacities, nine of whom serve in
marketing,   sales  and   distribution   capacities,   two  of  whom   serve  in
administrative  capacities  and  three  of whom  serve  in  product  development
capacities.  The Company also  employs  three part time  employees.  The Company
considers its employee relations to be satisfactory.

Item 2.  Description of Property

     The Company's executive offices,  occupying approximately 4,440 square feet
of leased  space in Old Forge,  Pennsylvania,  are leased from Amos M. Clark,  a
shareholder  and former Vice  President and director of the Company.  This lease
has a five-year  term  expiring  December  31,  1999,  at the rate of $3,600 per
month,  subject  to  cancellation  upon six  months  notice at the option of the
Company.  The Company also has a lease for 8,200 square feet of warehouse  space
in Old Forge with a three-year  term  expiring  December 31, 1997,  at a rate of
$1,750 per month.



                                       
<PAGE>

Item 3.  Legal Proceedings

Morgan Paris, Inc. v. Derma Sciences, Inc.

     On September 21, 1994, the Company  terminated  its master  distributorship
agreement  with Morgan Paris,  Inc.  ("Morgan  Paris") "for cause." Morgan Paris
filed a civil action against the Company in the United States District Court for
the Southern District of Ohio on September 7, 1994, with amendments on September
19, 1994,  and January 17, 1995. The complaint,  as amended,  generally  alleges
that the Company  violated the Sherman  Antitrust Act and the Ohio Valentine Act
and that it breached the Master  Distributorship  Agreement between Morgan Paris
and the  Company.  The  Complaint  sought  compensatory  damages of $9  million,
trebled to $27 million, relative to alleged anti-trust violations, together with
a temporary  restraining order and preliminary  injunction enjoining the Company
from  the  "unlawful   practices"  alleged  in  the  complaint.   Morgan  Paris'
application for a temporary restraining order was denied on September 23, 1994.

     The  Company,  in its response to the Morgan  Paris  complaint,  denied the
factual basis and legal  sufficiency  of the  anti-trust  and breach of contract
claims.  In addition,  the Company filed  counterclaims  against Morgan Paris in
which it alleges that Morgan Paris breached the master distributor  contract by:
(1) failing to pay invoices  within thirty days after written  notice and demand
for payment,  and (2) publishing  and  distributing  information  defamatory and
harmful to the  reputation  and business  interests of the Company by publishing
and distributing defamatory statements concerning the Company to the news media.
In  addition,  the  Company's  counterclaims  alleged that Morgan Paris had: (1)
willfully and intentionally infringed on the Company's tradename and trademarks,
and (2) engaged in deceptive trade  practices.  The Company sought  compensatory
damages in the amount of the  outstanding  invoices,  $60,154.61  plus interest,
$60,000 for its breach of contract  claim and  reasonable  costs and  attorneys'
fees and a permanent  injunction enjoining Morgan Paris from using the Company's
tradename and/or trademarks and from representing  itself as an authorized agent
or representative of the Company or its products.

     This litigation was settled in the second  quarter,  1996 at no loss to the
Company.

Derma Sciences, Inc. v. Geritrex Corporation

     The Company  filed a  complaint  on January 5, 1995,  in the United  States
District  Court  for  the  Southern   District  of  New  York  against  Geritrex
Corporation  ("Geritrex").  The complaint  seeks  injunctive  relief and damages
under several counts,  including  false  advertising of goods sold in interstate
commerce under the Lanham Act, false  advertising and deceptive  practices under
various New York  statutes  and unfair  competition  under the common law of the
State of New York. The complaint alleges that Geritrex Corporation, the producer
of Dermadrox Ointment and Dermadrox  Moisturizing Spray, falsely advertised that
its products were  "equivalent" to Dermagran  products  manufactured and sold by
the Company.

     The Company has  ascertained  that Geritrex  ceased  claiming that Geritrex
products are  equivalent to the Company's  products.  Accordingly,  the Geritrex
litigation has been terminated.

ABS LifeSciences, Inc. v. Derma Sciences, Inc.

     The Company on September 6, 1995  abrogated its license  agreement with ABS
LifeSciences,  Inc.  ("ABS")  due to the  failure  of ABS to  produce  and  make
available to the Company the wound care product  "Viaderm".  The Company  ceased
sales of Chronicure on that date.

     ABS, a subsidiary of Integra LifeSciences Corporation (Nasdaq: IART), filed
a civil action  against the Company in the United States  District Court for the
District  of New  Jersey in which it claims  damages  in excess of  $50,000  for
alleged  breach by the  Company of a license  agreement  with ABS.  The  license
agreement generally provided that ABS will sell to the Company,  and license the
Company to  resell,  the wound  care products Chronicure(R) and  Viaderm(R). The
complaint alleges that the Company:  (1) breached its license agreement with ABS
by failing to make certain payments and minimum purchases provided therein,  and
(2) committed  business  libel against ABS by publicly  announcing  that ABS had
failed to honor its obligations under the license agreement.

     The Company, in its response to the ABS complaint, denied the claims of ABS
and asserted counterclaims of fraudulent  misrepresentation,  breach of contract
and  fraud in the  inducement.  In its  counterclaims,  the  Company  seeks  the
following  remedies and damages:  (1)  recission of the license  agreement,  (2)
compensatory  damages in excess of  $700,000  representing  unearned  royalties,
unsold and unsalable product,  production  expenses,  general and administrative
expenses, injury to business interests and reputation, and (3) punitive damages.
<PAGE>

     The parties are currently engaged in the discovery process.

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

     The Company did not submit any matter to a vote of shareholders  during the
fourth quarter, 1996.




                                       
<PAGE>

                                     Part II

Item 5.  Market for Common Equity and Related Shareholder Matters

     The  Common  Stock of the  Company  is traded on  Nasdaq  under the  symbol
"DSCI."  The  Common  Stock is also  traded  on the  Boston  and  Pacific  Stock
Exchanges under the symbol "DMS." The Company's  Common Stock commenced  trading
on May 13, 1994. The following  table sets forth the high and low bid prices for
the Company's Common Stock as reported by Nasdaq:

              Quarter Ended                      High         Low
              ------------------                ------       ----- 

              March 31, 1995                     5 1/4       4 3/4

              June 30, 1995                      5 1/4       2 1/2

              September 30, 1995                 3 1/4       1 7/8

              December 31, 1995                  3 1/4         2

              March 31, 1996                     4 3/4       2 1/4

              June 30, 1996                      4 3/4       2 5/8

              September 30, 1996                 3 7/8       2 1/4

              December 31, 1996                  3 1/8       1 3/4


     The stock  prices  reflect  inter-dealer  prices  without  retail  mark-up,
mark-down or commission and may not necessarily represent actual transactions.

     As of the close of business on March 3, 1997,  there were 1,033  holders of
record of the Common Stock.

     The Company has paid no cash  dividends  in respect of its Common Stock and
the Company has no intention to pay cash dividends in the near future.

Item 6. Management's  Discussion and Analysis of Financial Condition and Results
        of Operations

Introduction

     Since its  formation in September of 1984,  the Company has been engaged in
the development, marketing and sale of topical preparations for the treatment of
chronic,  non-healing  wounds.  Revenues increased 20% and 18% in 1994 and 1995,
respectively. In 1996, the Company experienced a 20% decrease in annual revenue.
The  Company  earned  net  income  of  $88,728  and  $75,347  in 1994 and  1995,
respectively,  and incurred a net loss of $1,436,265 in 1996.  The Company's net
loss for 1996 was  primarily  attributable  to: (1) the  decrease in sales;  (2)
legal costs  incurred in connection  with the  settlement  of litigation  with a
master  distributor;  (3) restructuring of the Company's  operations;  (4) write
down of obsolete inventory; (5) increase in sales and marketing expense; and (6)
the  write  off  of  capitalized   costs  relative  to  construction  of  a  new
headquarters  facility.  At December  31,  1994,  1995 and 1996,  the  Company's
retained deficits were $303,691, $228,344 and $1,664,609, respectively.




                                       
<PAGE>

Results of Operations

     The following table presents selected financial information for the periods
indicated expressed as a percentage of net sales:
                                      
                                               Year Ended December 31,
                                     ------------------------------------
                                        1994         1995          1996
                                    ----------    ---------    ----------
Net sales ..........................   100.0%        100.0%       100.0%
Cost of sales ......................    30.2          22.7         23.3
                                    -------------------------------------
   Gross profit ....................    69.8         77.3          76.7

Operating Expenses:

   Product development .............     8.2         12.0          17.7
   Selling, general and
    administrative .................    58.5         61.0          94.5
                                    -------------------------------------
     Total operating expenses           66.7         73.0         112.2
                                    -------------------------------------

Income (loss) from operations ......     3.1          4.3         (35.5)

Other income (expense)..............     0.7         (2.4)          1.9

Income taxes .......................    (2.0)        (0.6)          2.1
                                    -------------------------------------

Net income (loss)...................     1.8%         1.3%        (31.5%)
                                    =====================================

Sales Overview

     The  Company's  net sales are primarily  derived from  Dermagran  Ointment,
Dermagran  Spray,  Dermagran  Wet  Dressings  and  Dermagran  Hydrophilic  Wound
Dressing.  Net sales decreased in 1996 compared to 1995 by 20%. This decrease is
primarily  attributable  to  decreases in Medicare  reimbursement  relative to a
portion of the Company's product line. Net sales increased in 1994 and 1995 over
prior years by 20% and 18%, respectively.  In 1994, the Company implemented a 5%
price increase relative to Dermagran Spray and Dermagran  Ointment.  In 1995 and
1996,  the  Company  implemented  a 5% price  increase  relative to all of their
products.  Apart from these price  increases,  sales increases for 1994 and 1995
resulted from increased sales volume.

     The following table presents sales, by product, expressed in dollars and as
a percentage of net sales:

                                        Year Ended December 31,
                           -----------------------------------------------------
                               1994                 1995             1996
                           ------------------  ----------------- ---------------
Product:
Dermagran Ointment........ $2,634,000   55%   $3,407,000   60%  $3,236,000  71%
Dermagran Spray...........    389,000    8%      434,000    8%     274,000   6%
Wound Care Kits (1).......    338,000    7%       67,000    1%       ---    ---
Wet Dressings.............    501,000   10%      303,000    5%     123,000   3%
Hydrophilic Wound Dressing    779,000   16%    1,345,000   24%     882,000  19%
Chronicure (2)............    154,000    3%       85,000    1%       ---    ---
Other Products............     51,000    1%       84,000    1%      43,000   1%
                          ------------------ ----------------- -----------------
  Total................... $4,846,000  100%   $5,725,000  100%  $4,558,000 100%
                          ================== ================= =================
                         
(1)  The Company phased out sales of Wound Care Kits in the first quarter, 1996.
     See "Item 1. Description of Business - Third Party Reimbursement."
(2)  The Company  ceased sales of Chronicure in  September,  1995.  See "Item 3.
     Legal Proceedings."


<PAGE>

1996 compared to 1995

Net Sales and Gross Profit

     Net sales  decreased  in 1996 by  $1,166,647,  or 20%, to  $4,557,931  from
$5,724,578  in 1995.  This  decrease is primarily  attributable  to decreases in
Medicare  reimbursement  relative to a portion of the  Company's  product  line.
Sales of Dermagran Ointment decreased  $171,000,  or 5%, from $3,407,000 in 1995
to $3,236,000 in 1996. Sales of Dermagran  Hydrophilic Wound Dressing  decreased
$463,000,  or 34%, from $1,345,000 in 1995 to $882,000 in 1996.  Dermagran Spray
net sales decreased $160,000, or 37%, from $434,000 in 1995 to $274,000 in 1996.
Sales of Dermagran Wet Dressing (Saline) and Dermagran  Zinc-Saline Wet Dressing
collectively  decreased  $180,000,  or 59%, from $303,000 in 1995 to $123,000 in
1996.

     Cost of sales and gross  profit,  expressed as a  percentage  of net sales,
remained  relatively  constant  at 23% and 77%,  respectively,  in both 1996 and
1995. Aggregate cost of sales decreased $235,716,  or 18%, to $1,062,392 in 1996
from $1,298,108 in 1995.  Aggregate gross profit decreased $930,931,  or 21%, to
$3,495,539  in 1996  from  $4,426,470  in 1995.  These  decreases  are  directly
attributable to the decrease in sales.

Operating Expenses

     Operating expenses increased  $936,045,  or 22%, from $4,176,670 in 1995 to
$5,112,715 in 1996. Product development expense increased $115,603, or 17%, from
$688,141 in 1995 to $803,744 in 1996,  and  increased as a  percentage  of sales
from 12% in 1995 to 18% in 1996. The increase in product  development expense is
primarily  attributable to: (1) research  incident to expansion of the Company's
product line into the dermatology market; (2) submission of a patent application
and  the  commencement  of  clinical  trials  relative  to a  new  product;  (3)
submission of a FDA 510(k) application  relative to extended claims with respect
to one of the Company's  products;  and (4) hiring of a Director of Research and
Medical Communications in July, 1995.

     Selling, general and administrative expense for 1996 increased $820,442, or
24%, to $4,308,971  from  $3,488,529  in 1995,  and increased as a percentage of
sales from 61% in 1995 to 95% in 1996.  The  increase  in  selling,  general and
administrative  expense is primarily  attributable  to: (1) increased  sales and
marketing  expense;  (2)  severance  expense  due  to the  restructuring  of the
Company's  operations;  (3)  increased  legal  expense;  and  (4)  write  off of
capitalized costs relative to construction of a new headquarters facility.

     Sales  and  marketing  expense  for 1996  increased  $291,306,  or 61%,  to
$771,455 from $480,149 in 1995. This increase is attributable to the development
of the Company's interactive wound care brochure, development and continuance of
the Company's disease management  program and increased  advertising and product
promotional  expenses.  Severance  expense  totaled  $227,327  for  1996  and is
attributable to the elimination of the positions of Vice President for Sales and
Marketing,  Director of  Purchasing  and Director of  International  Development
together with several support  positions as part of the Company's  restructuring
of operations.

     Legal  expense  for 1996  increased  $107,830,  or 84%,  to  $235,806  from
$127,976 in 1995. This increase is primarily  attributable  to costs  associated
with the Company's  litigation  defense and  settlement  negotiations  in Morgan
Paris,  Inc.  v.  Derma  Sciences,  Inc.  and ABS  LifeSciences,  Inc.  v. Derma
Sciences,  Inc. The Morgan Paris  litigation  has been settled at no loss to the
Company. The Company has deferred indefinitely plans to build a new headquarters
facility.  Accordingly,  the Company  expensed $82,589  representing  previously
capitalized design and site selection costs.

Loss from Operations

     The Company incurred a loss from operations for 1996 of $1,617,176 compared
to income from  operations  of $249,800 in 1995.  This loss is  attributable  to
lower sales and higher operating expenses as discussed above.



<PAGE>

Other Income (Expense)

     During  1995,  the Company  recognized  a loss on the write off of deferred
merger and  acquisition  costs  relative to the  termination  of a  contemplated
merger with Scherer Healthcare,  Inc. and (potentially) ProCyte Corporation.  No
such expenses were recognized in 1996.

Net Loss

     The Company incurred a net loss in 1996 of $1,436,265,  or $0.35 per share,
as compared to net income of $75,347, or $0.02 per share, in 1995.

1995 compared to 1994

Net Sales and Gross Profit

     Net  sales  increased  in 1995 by  $878,674,  or 18%,  to  $5,724,578  from
$4,845,904 in 1994.  This increase is primarily  attributable to increased sales
of Dermagran Hydrophilic Wound Dressing (gauze) and Dermagran Ointment. Sales of
Dermagran  Hydrophilic  Wound  Dressing  (gauze)  rose  $558,000,  or 72%,  from
$779,000  in 1994 to  $1,337,000  in 1995.  Sales  of  Dermagran  Ointment  rose
$773,000, or 29%, from $2,634,000 in 1994 to $3,407,000 in 1995. Dermagran Spray
sales  increased  $45,000,  or 12%,  from  $389,000 in 1994 to $434,000 in 1995.
Sales of  Dermagran  Hydrophilic  Wound  Dressing  (bulk)  and  Dermagran  Wound
Cleanser with Zinc  commenced in December,  1995 and totaled  $8,300 and $2,000,
respectively. Sales of Dermagran Wet Dressing (Saline) and Dermagran Zinc-Saline
Wet Dressing  decreased  collectively  $198,000.  Wound Care Kit sales decreased
$271,000,  or 80%,  from  $338,000  in 1994 to  $67,000 in 1995.  The  foregoing
decreases  are  primarily  attributable  to certain  changes in the Health  Care
Financing  Administration's  policies the effect of which was to reduce, and, in
the case of Wound Care Kits, eliminate Medicare reimbursements relative to these
products.

     The Company has  increased  sales  internationally  from $64,000 in 1994 to
$206,963 in 1995. This increase is  attributable to initiating  product sales in
Indonesia, Canada and Puerto Rico. Product sales in various other countries will
commence  once  product  approvals  are  received  from  appropriate  regulatory
authorities.  See "Item 1.  Description of Business -  Distribution  and Sales -
International."

     During the third quarter, 1995, the Company ceased all sales of Chronicure,
a product licensed from ABS LifeSciences, Inc. See "Item 3. Legal Proceedings."

     Cost of sales,  expressed as a percentage of net sales,  decreased from 30%
in 1994 to 23% in 1995.  Aggregate cost of sales decreased $166,545,  or 11%, to
$1,298,108  in 1995 from  $1,464,653  in 1994.  These  decreases are a result of
shifts in the product  mix toward  relatively  higher  margin  products  and the
renegotiation   (lowering)  of  prices  by  several  of  the  Company's  product
manufacturers.

     Expressed as a percentage of net sales,  gross profit increased from 70% in
1994 to 77% in 1995. Aggregate gross profit increased in 1995 by $1,045,219,  or
31%, to $4,426,470 from $3,381,251 in 1994 as a result of the factors  discussed
in the preceding paragraph.

Operating Expenses

     Operating expenses increased  $943,673,  or 29%, from $3,232,997 in 1994 to
$4,176,670 in 1995. Product development expense increased $288,940, or 72%, from
$399,201 in 1994 to $688,141 in 1995,  and  increased as a  percentage  of sales
from 8.2% in 1994 to 12% in 1995. The increase in product development expense is
primarily attributable to the preparation of several applications to the FDA for
Section  510(k)  product  approval  and the hiring of a Director of Research and
Medical Communications in July, 1995.

     Selling, general and administrative expense for 1995 increased $654,733, or
23%, to $3,488,529  from  $2,833,796  in 1994,  and increased as a percentage of
sales from 58.5% in 1994 to 61% in 1995.  The  increase in selling,  general and
administrative  expense is  attributable  to increases in  commissions  expense,
general  administrative  expense,   nonrecurring  severance  expense  and  legal
expense.

     Commissions  expense for 1995 increased  $317,702 to $995,349 from $677,647
in 1994. This increase is attributable to the increase in national account sales
and the increase in sales of Dermagran Ointment and Dermagran  Hydrophilic Wound
Dressing (gauze), which products generate relatively higher commissions. General
administrative  expense for 1995 increased  $172,473 to $269,112 from $96,639 in
1994.  General  administrative  expense includes  expenses  incurred relative to
public  relations  and  participation  in  various   brokerage/investor   shows,
directors' and officers' liability  insurance,  territory license fees and board
of  directors'  compensation.  Severance  expense in the amount of $131,292  was
incurred  relative to the  elimination  of the  position of Vice  President  for
Marketing as a result of the  consolidation of the Company's sales and marketing
departments. Legal expense for 1995 increased $103,445 to $350,911 from $247,466
in 1994. This increase is primarily  attributable  to costs  associated with the
Company's  litigation defense in Morgan Paris, Inc. v. Derma Sciences,  Inc. and
ABS LifeSciences, Inc. v. Derma Sciences, Inc. See "Item 3. Legal Proceedings."
<PAGE>

Income from Operations

     The Company's income from operations for 1995 increased  $101,546,  or 68%,
to  $249,800  from  $148,254  in 1994.  This  increase  in income  is  primarily
attributable to the increase in gross profit.

Deferred Merger and Acquisition Costs

     The  Company  incurred  investment  banking  and  legal  expenses  totaling
$294,268 in connection with  negotiations and document  preparation  relative to
the  contemplated  merger of the  Company  with  Scherer  Healthcare,  Inc.  and
(potentially)  ProCyte  Corporation.  Discussions  relative  to this merger were
terminated during the second quarter, 1995. For further information please refer
to the Company's Form 10-KSB filed on March 31, 1995.

Net Income

     The Company's net income in 1995 decreased $13,381, or 15%, to $75,347 from
$88,728 in 1994.  This decrease is primarily  attributable  to the  nonrecurring
merger and acquisition costs discussed above.

Financial Ratios

     The following  table  presents  selected  financial  ratios for the periods
indicated:
             
                                                         December 31,
                                                 ------ -- ------- -- -------
                                                 1994       1995       1996
                                                 ------    -------    -------
 Current Ratio.................................   3.69       3.64       2.04
 Quick Ratio...................................   2.87       2.75       1.55
 Liabilities-to-Assets Ratio...................    .23        .25        .43
 Liabilities-to-Equity Ratio...................    .30        .34        .76
 Inventory Turnover............................   2.45       1.35       1.11

     The 1996 decreases in the Company's  current and quick ratios are primarily
attributable to the use of the Company's proceeds of its initial public offering
for the purchase of certain assets of Morgan Paris, Inc. and for working capital
together with increased  accounts payable and accrued  expenses.  See "Liquidity
and Capital  Resources" and "Notes to Financial  Statements." The 1996 increases
in the  Company's  liabilities-to-assets  and  liabilities-to-equity  ratios are
primarily  attributable to increased accounts payable and accrued expenses.  See
"Notes to Financial Statements."
 
     The   1995   increases   in   the   Company's   liabilities-to-assets   and
liabilities-to-equity  ratios are primarily attributable to the increased use of
its  line  of  credit.  The  decrease  in the  rate  of  inventory  turnover  is
attributable to increased  inventory  levels  necessary to support the Company's
expanding  product  line and  decreased  sales  of Wet  Dressings  coupled  with
contractual minimum purchase requirements of these products.  See "Liquidity and
Capital Resources."

Liquidity and Capital Resources

     At December 31,  1994,  1995 and 1996,  the Company had working  capital of
$3,398,096,  $3,788,582  and  $2,280,348,  respectively.  The 1996  decrease  is
primarily  attributable to the use of a portion of the proceeds of the Company's
public offering as discussed below, together with increased accounts payable and
accrued expenses. See "Notes to Financial Statements."

     The Company  publicly sold 900,000  shares of its common stock at $5.00 per
share  (exclusive of  commissions,  discounts and offering  expenses) on May 13,
1994. On May 23, 1994, the Company used $470,000 of the proceeds of its offering
to repay the  outstanding  balance  on its bank  line of  credit.  In 1995,  the
Company  used  approximately  $300,000  of  the  proceeds  of its  offering  for
investment  banking  and legal  expenses  relative to the  contemplated  ProCyte
Corporation/Scherer  Healthcare, Inc. merger. In 1996, the Company used $160,000
of the proceeds for the purchase of Morgan  Paris,  Inc.'s assets (see "Notes to
Financial  Statements")  and  $439,000 for working  capital.  The balance of the
proceeds are invested in U.S. Treasury Bills having an aggregate market value of
$1,887,171 on December 31, 1996.

     The Company's President,  John T. Borthwick, Vice President for Finance and
Operations, Gary L. Borthwick and former Vice President for Sales and Marketing,
Donald F. McHale, RN received draws against incentive  compensation  during 1994
in the amounts of $99,530, $84,436 and $77,893,  respectively.  The Compensation
Committee of the Board of Directors  subsequently  determined  that no incentive
compensation was payable relative to 1994. Accordingly, the foregoing executives
executed   promissory  notes  requiring   repayment  of  the  subject  incentive
compensation  over a period  of ten years  with  interest  of 8.01%  per  annum.
Pursuant to its recent  restructuring,  the Company  terminated  the services of
Donald F. McHale.  Mr. McHale repaid his  promissory  note in January,  1997. In
January,  1997, John T. Borthwick and Gary L. Borthwick tendered common stock of
the Company at the stock's  closing price quoted by Nasdaq on the date of tender
($2.00 per share) in  satisfaction  of payments  due during 1996 with respect to
the foregoing promissory notes.
<PAGE>

     The Company has a short-term line of credit for $1,000,000 at a fluctuating
rate per annum equal to the bank's prime rate (8.25% at December 31, 1996). This
line of credit is secured by accounts  receivable,  inventory  and the Company's
United States patent and trademarks.  In 1996, the Company  utilized its line of
credit  primarily as working  capital.  Although the Company believes that funds
generated  from  operations  and  available  from  its  line of  credit  will be
sufficient  to  serve  its  working  capital  requirements  for the  near  term,
increased  sales  volume may  require  that the credit  line be  increased.  The
Company believes that it has the ability to secure appropriate  increases in its
credit line if required.

     The Company is currently defending a civil action brought against it by ABS
LifeSciences, Inc. See "Item 3. Legal Proceedings." As of December 31, 1996, the
Company had expended  approximately  $188,000 attributable to the lawsuit in the
form of legal expense, travel expense and other administrative expenses.

     The Company has a three year  manufacturing  contract,  expiring January 1,
1998, with Kendall Health Care Products,  the  manufacturer of the Company's Wet
Dressings.  This  contract  provides for minimum  purchases in 1997 of $189,034.
Failure  to  meet  minimum  purchase   requirements  could  result  in  contract
cancellation.

     Statements that are not historical  facts,  including  statements about the
Company's  confidence  and  strategies,   expectations  about  new  or  existing
products, technologies and opportunities, and 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 risks,  impact of competitive  products and prices,
product  development,  commercialization or technological delay or difficulties,
and trade, legal, social and economic risks.


<PAGE>

Item 7.  Financial Statements

                                       Index
                                       -----
Description                                                               Page
-----------                                                              ------
Report of Independent Auditors.....................................         25

Balance Sheets.....................................................         26

Statements of Operations...........................................         27

Statements of Shareholders' Equity.................................         28

Statements of Cash Flows...........................................         29

Notes to Financial Statements......................................         30



<PAGE>

Report of Independent Auditors

Board of Directors
Derma Sciences, Inc.

     We have audited the accompanying balance sheets of Derma Sciences,  Inc. as
of  December  31,  1995 and 1996,  and the  related  statements  of  operations,
shareholders'  equity,  and cash flows for each of the three years in the period
ended December 31, 1996. These financial  statements are the  responsibility  of
the Company's  management.  Our responsibility is to express an opinion on these
financial statements based on our audits.

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

     In our opinion,  the financial statements referred to above present fairly,
in all material  respects,  the financial  position of Derma  Sciences,  Inc. at
December 31, 1995 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.




                                         ERNST & YOUNG LLP





Philadelphia, Pennsylvania
January 17, 1997


<PAGE>

                              DERMA SCIENCES, INC.
                                 BALANCE SHEETS


                                     ASSETS
                                                              December 31,
                                                      --------------------------
                                                          1995            1996
                                                      -------------  -----------
CURRENT ASSETS:
Cash and cash equivalents                            $   195,773    $    60,208
Short-term investments                                 2,379,475      1,887,171
Accounts receivable, net of allowance                   
 for doubtful accounts of 1995-$66,00;1996-$86,000     1,346,013      1,319,853
Current portion of officers' notes receivable             18,248        150,177
Inventory                                              1,069,685        837,659
Prepaid expenses and other current assets                213,114        224,774
                                                     -------------  ------------
   Total Current Assets                                5,222,308      4,479,842

PROPERTY AND EQUIPMENT, NET                              171,566        112,510

OTHER ASSETS:
Officers' notes receivable                               247,394        155,554
Intangibles, net                                         191,173        514,439
Other assets                                              45,121         52,957
                                                     -------------  ------------
   Total Other Assets                                    483,688        722,950
                                                     -------------  ------------
        Total Assets                                 $ 5,877,562   $  5,315,302
                                                     =============  ============

                      LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
Demand note payable                                  $   700,000   $    800,000
Accounts payable                                         381,633        745,542
Accrued expenses                                         352,093        653,952
                                                     -------------  ------------
   Total Current Liabilities                           1,433,726      2,199,494

DEFERRED TAXES                                            46,672              0
                                                                    
OTHER LIABILITIES                                            247         95,000

SHAREHOLDERS' EQUITY:
Common stock, $.01 par value, authorized 15,000,000  
 shares, issued and outstanding 1995-4,054,233;              
 1996--4,079,233 shares                                   40,542         40,792
Additional paid-in capital                             4,584,719      4,644,625
Retained deficit                                        (228,344)    (1,664,609)
                                                     -------------  ------------
   Total Shareholders' Equity                          4,396,917      3,020,808
                                                     -------------  ------------
        Total Liabilities and Shareholders' Equity   $ 5,877,562    $ 5,315,302
                                                     =============  ============

See accompanying notes.

<PAGE>

                              DERMA SCIENCES, INC.
                            STATEMENTS OF OPERATIONS



                                                 Year ended December 31,
                                       -----------------------------------------
                                           1994          1995           1996
                                       ------------  ------------  -------------
 
NET SALES                              $ 4,845,904   $ 5,724,578    $ 4,557,931

COST OF SALES                            1,464,653     1,298,108      1,062,392
                                       ------------  ------------  -------------

GROSS PROFIT                             3,381,251     4,426,470      3,495,539

OPERATING EXPENSES:
Product development                        399,201       688,141        803,744
Selling, general and administrative      2,833,796     3,488,529      4,308,971
                                       ------------  ------------  -------------
    Total Operating Expenses             3,232,997     4,176,670      5,112,715
                                       ------------  ------------  -------------

INCOME (LOSS) FROM OPERATIONS              148,254       249,800     (1,617,176)

OTHER INCOME (EXPENSE):
Interest income                             70,913       209,333        151,854
Interest expense                           (32,697)      (54,672)       (63,919)
Deferred merger and acquisition costs            0      (294,268)             0
                                        ------------  ------------  ------------
    Total Other Income (Expense)            38,216      (139,607)        87,935
                                        ------------  ------------  ------------

INCOME (LOSS) BEFORE INCOME TAXES:         186,470       110,193     (1,529,241)
   Income taxes (benefit)                   97,742        34,846        (92,976)
                                       ------------  ------------  -------------

NET INCOME (LOSS)                      $   88,728    $   75,347    ($ 1,436,265)
                                       ============  ============  =============

NET INCOME (LOSS) PER COMMON SHARE     $     0.02    $     0.02    ($      0.35)
                                       ============  ============  =============
WEIGHTED AVERAGE NUMBER OF COMMON        
 SHARES OUTSTANDING                     3,722,808     4,054,233       4,079,233
                                       ============  ============  =============

See accompanying notes.





<PAGE>


                              DERMA SCIENCES, INC.
                       STATEMENTS OF SHAREHOLDERS' EQUITY


                                             Additional            Total
                                   Common    Paid-In     Retained  Shareholders'
                                   Stock     Capital     Deficit   Equity
                                 ----------------------------------------------
Balance, January 1, 1994          $31,542  $1,373,622  ($  392,419) $1,012,745

Net proceeds from the Company's           
    initial public offering         9,000   3,211,097            0   3,220,097

Net Income                                                  88,728      88,728
                                 ---------------------------------------------

Balance, December 31, 1994        $40,542  $4,584,719  ($  303,691) $4,321,570

Net Income                                                  75,347      75,347
                                 ---------------------------------------------

Balance, December 31, 1995        $40,542  $4,584,719  ($  228,344) $4,396,917

Issuance of 25,000 common shares      250      59,906            0      60,156

Net Loss                                0           0   (1,436,265) (1,436,265)
                                 ----------------------------------------------

Balance, December 31, 1996        $40,792  $4,644,625  ($1,664,609) $3,020,808
                                 ----------------------------------------------


See accompanying notes.


<PAGE>
                              DERMA SCIENCES, INC.
                            STATEMENTS OF CASH FLOWS


                                                     Year ended December 31,
                                                 -------------------------------
                                                   1994       1995       1996
                                                 --------- --------- -----------
OPERATING ACTIVITIES:
Net Income (Loss)                                $ 88,728  $ 75,347 ($1,436,265)

Adjustments to Reconcile Net Income (Loss) to Net
 Cash Provided by (Used in) Operating Activities:
  Depreciation and amortization                    44,143     46,116    113,049
  Provision for bad debts                          83,999    (17,999)   121,606
  Write off of deferred merger & acquisition costs      0    300,000          0
  Deferred taxes, net                              30,217     16,455     46,672)
  Loss on abandonment                                   0          0     82,589
  Charge related to issuance of common shares           0          0     60,156
  Changes in operating assets and liabilities:                        
   Accounts receivable                           (454,625)  (281,622)   (95,446)
   Inventory                                     (520,728)  (212,177)   232,026
   Prepaid expenses and other current assets      (58,963)   (73,457)   (11,660)
   Other assets                                     7,711     22,072     (7,836)
   Accounts payable                               230,656    (63,770)   363,909
   Accrued expenses                                53,569    117,145    206,859
   Income taxes payable                            24,491    (54,671)         0
                                                 ---------  ---------  ---------
    Net Cash Used in Operating Activities        (470,802)  (126,561)  (417,685)

INVESTING ACTIVITIES:
  (Increase) decrease in short-term
   investments                                (2,392,423)   201,778    492,304
  Deferred merger & acquisition costs           (300,000)         0          0
  Purchases of property and equipment, net       (19,342)   (55,452)   (65,464)
  Acquisition of contract rights                       0          0   (160,000)
  Increase in patents and trademarks             (41,420)   (26,739)   (44,384)
                                               ------------ --------- ----------
    Net Cash (Used in) Provided by
     Investing Activities                     (2,753,185)   119,587    222,456

FINANCING ACTIVITIES:
  Net change in revolving line of credit          80,000    170,000    100,000
  Principal payments on long-term debt and                  
  capitalized lease obligations                  (15,682)    (6,460)      (247)
  Officers' notes receivable                    (296,156)    30,514    (40,089)
  Decrease in deferred offering costs            134,878          0          0
  Net proceeds from initial public offering    3,220,097          0          0
                                               -----------   --------  --------
    Net Cash Provided by Financing Activities  3,123,137    194,054     59,664
 
NET (DECREASE) INCREASE IN CASH AND
  CASH EQUIVALENTS                              (100,850)   187,080   (135,565)
CASH AND CASH EQUIVALENTS AT
  BEGINNING OF YEAR                              109,543      8,693    195,773
                                               -----------  --------- ---------

CASH AND CASH EQUIVALENTS AT END OF YEAR       $   8,693  $ 195,773   $ 60,208
                                               =========== ========== =========

See accompanying notes.




<PAGE>

Notes to Financial Statements

December 31, 1996

1.   The Company

     Derma  Sciences,  Inc. (the "Company") was  incorporated  under the laws of
Colorado on  September  10, 1984 for the purpose of  marketing  various  medical
products developed under a U.S. Patent. On June 3, 1996, the Company changed its
state of domicile to  Pennsylvania.  The Company is engaged in the  development,
marketing and sale of primarily proprietary sprays,  ointments and dressings for
the management of certain chronic  non-healing skin ulcerations such as pressure
and venous  ulcers,  surgical  incisions  and burns.  The  Company  markets  its
products  through  independent  distributors,   mainly  to  healthcare  agencies
throughout the United States. In addition,  the Company's products are available
in selected markets throughout the world through strategic  alliances with local
companies.

2.   Summary of Significant Accounting Policies

Use of Estimates

     The  preparation  of financial  statements  in  conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that affect the amounts  reported in the financial  statements  and
accompanying notes. Actual results could differ from those estimates.

Inventory

     Inventory  is stated at the lower of cost  (using the  first-in,  first-out
method),  or market.  The  Company's  inventory  consists  primarily of finished
goods.

Property and Equipment

     Property and equipment is recorded at cost.  Depreciation is recorded using
accelerated methods over the estimated useful lives of the assets.  Depreciation
expense includes the amortization of equipment recorded under capital leases.

     The  Company  had  engaged an  architectural  firm to design new  corporate
headquarters for the anticipated  relocation of the Company's offices. All costs
incurred were capitalized as construction in progress.  As of December 31, 1995,
costs incurred  totaled $82,589.  All costs previously  capitalized were written
off during 1996 when the Company deferred indefinitely plans for construction.

Intangible Assets

     Goodwill  represents the excess of estimated fair market value over cost of
net  tangible  assets at the time of  acquisition  of  product  lines  acquired.
Goodwill is being amortized using the straight-line method over forty years.

     The patent rights,  which were assigned to the Company, are being amortized
using the straight-line  method over the remaining life of the patent,  which is
ten (10) years.  Patents and  trademarks  acquired  are recorded at cost and are
amortized using the straight-line method over the remaining legal lives.

     Contract  rights,  which were acquired by the Company,  are being amortized
using the  straight-line  method  over the  remaining  thirty  month term of the
master distributorship agreement expiring December 31, 1998.


<PAGE>

2.   Summary of Significant Accounting Policies (continued)

Asset Impairment

     The carrying value of long-lived assets including identifiable  intangibles
and goodwill related to those assets are reviewed if the facts and circumstances
suggest that an item may be impaired. If this review indicates that a long-lived
asset will not be recoverable,  as determined  based on the future  undiscounted
cash flows of the asset, the Company's carrying value of the long-lived asset is
reduced to fair value.

Cash Equivalents

     The Company  considers  all highly  liquid  investments  with a maturity of
three months or less when purchased to be cash  equivalents.  The carrying value
of these investments approximates fair value.

Short-term Investments

     Short-term investments at December 31, 1995 and December 31, 1996 represent
primarily  U.S.  Treasury  Bills  that  are  carried  at  amortized  cost  which
approximates  fair value.  All  investments  are  available  for sale and mature
within 12 months of year end.  Realized gains and losses,  based on the specific
identification method, were not material.

Deferred Merger Costs

     Expenses deferred in 1994 relative to the possible combination of companies
were written off in 1995 when those merger discussions ceased.

Cash Flow Information

     Interest paid during 1994,  1995 and 1996 amounted to $32,697,  $54,672 and
$63,919, respectively.  Income taxes paid during 1994, 1995 and 1996 amounted to
$22,818, $53,922 and $14,185, respectively.

Stock Based Compensation

     The Company  grants stock options for a fixed number of shares to employees
with an  exercise  price  equal to the fair  value of the  shares at the date of
grant.  The Company  accounts for stock  option  grants in  accordance  with APB
Opinion No. 25,  Accounting  for Stock Issued to  Employees,  and,  accordingly,
recognizes no compensation expense for the stock option grants.

Net Income (Loss) Per Common Share

     Net income  (loss) per share of common  stock is computed  by dividing  net
income  (loss)  by the  weighted  average  number  of  shares  of  common  stock
outstanding  during each period presented.  Stock options were not considered in
the  calculation  of net  income  (loss)  per  share in 1996  because  they were
anti-dilutive.

Income Taxes

     The Company  accounts for income taxes under the  liability  method.  Under
this  method,  deferred  tax  assets and  liabilities  are  determined  based on
differences  between financial reporting and tax bases of assets and liabilities
and are  measured  using the  enacted  tax rates and laws that will be in effect
when the differences are expected to reverse.


<PAGE>

2.   Summary of Significant Accounting Policies (continued)

Revenue Recognition

     The Company's  products are  primarily  sold to  independent  distributors.
Sales are recorded when product is shipped.

Reclassifications

     Certain  amounts  in the  balance  sheet  and  statement  of cash  flows at
December 31, 1995 have been reclassified to conform to the 1996 presentation.

3.    Property and Equipment

      Property and equipment comprise the following:

                                                          December 31,
                                                    ---------------------------
                                                       1995           1996
                                                    -----------     ----------

               Furniture and equipment                $169,844       $232,775
               Leasehold improvements                   12,009         14,543
               Construction in progress                 82,589              0
                                                    -----------     ----------
                                                       264,442        247,318
               Less: Accumulated depreciation           92,876        134,808
                                                    -----------     ----------
                                                      $171,566       $112,510
                                                    ===========     ==========
                                    
4.    Intangibles

      Intangibles comprise the following:

                                                          December 31,
                                                    ---------------------------
                                                       1995           1996
                                                    -----------     ----------

               Goodwill                              $  50,731      $  50,731
               Patents and trademarks                  314,620        359,004
               Contract rights                               0        350,000
                                                    -----------     ----------
                                                       365,351        759,735
               Less: Accumulated amortization          174,178        245,296
                                                    -----------     ----------
                                                      $191,173       $514,439
                                                    ===========     ==========

5.   Concentration of Credit Risk

     The Company sells almost all of its products to medical  supply  companies,
pharmacies and healthcare  providers.  At December 31, 1995 and 1996,  primarily
all of the Company's  accounts  receivable  are from companies in the healthcare
industry.  Credit is extended based on an evaluation of the customer's financial
condition and collateral is not required.

     The Company is dependent on two distributors who purchase products directly
from the Company.  These two distributors  accounted for 42%, 34% and 33% of net
sales in 1994, 1995 and 1996, respectively.


<PAGE>

6.    Accrued Expenses

      Accrued expenses comprise the following:

                                                           December 31,
                                                    ----------------------------
                                                       1995            1996
                                                    -----------     ------------

               Commissions payable                    $224,275         $235,681
               Accrued severance                             0          191,521
               Medicaid rebates payable                 42,418           58,669
               Other                                    85,400          168,081
                                                    ----------     -------------
                                                      $352,093         $653,952
                                                    ===========     ============

7.   Medicaid Rebates Payable

     Medicaid reimbursement for the Company's products is dependent upon Company
paid  rebates to state  Medicaid  agencies.  The Company is required to remit to
Medicaid agencies a formula-based  rebate on quarterly net product sales and the
average  price  per  product  of the  Company's  products  subject  to  Medicaid
reimbursement.

8.   Demand Note Payable

     The Company has a  $1,000,000  revolving  line of credit with a bank,  with
$700,000 and $800,000  outstanding at December 31, 1995 and 1996,  respectively,
which amounts  approximate fair value. The maturity date of the line is June 30,
1997. The line of credit agreement  requires  monthly  interest  payments at the
bank's base rate, as defined,  (8.25% at December 31, 1996).  The line of credit
is secured by a general lien on accounts receivable, inventory and the Company's
United States patents and trademarks.

9.   Operating Leases

     The Company has  noncancellable  operating lease agreements for a warehouse
and two automobiles.  Rent expense under these  agreements  amounted to $35,141,
$35,653 and $35,689 in 1994,  1995 and 1996,  respectively.  As of December  31,
1996, the 1997 minimum lease payments under these agreements total $30,435.
<PAGE>

10.  Income Taxes

     At December 31, 1996, the Company has net operating loss  carryforwards  of
approximately $1,140,000 for state income tax purposes that expire in years 1997
through 1999. These  carryforwards  are the result of the reenactment of the net
operating loss provisions, effective for tax years beginning on January 1, 1995,
by the state in which the Company files its  corporate tax returns.  For Federal
tax purposes, the Company has a net operating loss carryforward of $923,000.

     Significant components of the Company's deferred tax assets and liabilities
are as follows:

                                                       December 31,
                                            --------------------------------
                                                   1995               1996
                                            -------------      -------------
Deferred tax liabilities:

Depreciation                                     ($12,876)        $        0
Prepaid insurance                                 (19,253)           (12,864)
Patent amortization                               (55,600)           (66,493)
                                            -------------      -------------
     Total deferred liabilities                   (87,729)           (79,357)

Deferred tax assets:

Net operating loss carryforwards                     520            413,103
Inventory                                              0             35,424
Depreciation                                           0             17,067
Capital loss                                       2,622              2,622
Trademark amortization                             6,963              7,501
Research and development credit                        0             21,249
Foreign tax credit                                 4,160              3,310
Allowance for bad debts                           26,792             34,911
Other                                                  0             33,546
                                            -------------      -------------
                                                  41,057            568,733
Valuation allowance                                    0           (489,376)
                                            -------------      -------------
     Total deferred tax assets                    41,057             79,357

                                            -------------      -------------
Net deferred tax (liabilities) assets           ($46,672)        $        0
                                            =============      =============

     The  majority  of the  current  year  valuation  allowance  relates  to net
operating loss  carryforwards for which realization is not assured. 

     Significant components of the provision for income taxes are as follows:

                                          Year ended December 31,
                           -------------------------------------------------
                                 1994              1995              1996
                           -------------     -------------     -------------
Current:

Federal                         $35,771           $18,391         ($46,304)
State                            31,754                 0                0
                           -------------     -------------     ------------
     Total current               67,525            18,391          (46,304)

Deferred:

Federal                          37,617            (3,063)         (12,118)
State                           (7,400 )           19,518          (34,554)
                           -------------    -------------     -------------
     Total deferred              30,217            16,455          (46,672)

                           -------------    -------------     -------------
                                $97,742           $34,846         ($92,976)
                           =============     =============    =============



<PAGE>

10.  Income Taxes (continued)

     The  reconciliation  of income tax  attributable  to continuing  operations
computed at the U.S. federal statutory tax rates to income tax  expense(benefit)
is:

                                                     Year ended December 31,
                                             -----------------------------------
                                                1994        1995         1996
                                             ----------- ----------  -----------

Tax at U.S. statutory rates                     $63,399    $37,507    ($521,655)

State income taxes, net of federal benefit       16,074      7,273      (78,491)

(Reduction) increase in valuation allowance     (16,586)         0      489,376

Research and development credits                       0    (7,648)           0

Nondeductible expenses                           42,282     11,663       (8,372)

Effect of graduated tax rates                    (7,427)   (11,750)      20,082

Other                                                 0     (2,199)       6,084
                                             ----------- ----------  -----------
                                                $97,742    $34,846    ($ 92,976)
                                             =========== ==========  ===========

11.  Morgan Paris Acquisition

     During May, 1996, the Company acquired the contract rights under the Morgan
Paris,  Inc.  Master  Distributorship  Agreement for $350,000.  The Company paid
$160,000 at the date of closing.  The remaining  purchase  price will be paid in
two equal  non-interest  installments  of $95,000 on or before December 31, 1997
and 1998,  respectively.  The note payable  relating to the  remaining  purchase
price  represents  a non-cash  transaction  which has not been  reflected in the
statement of cash flows.

     The cost of the  acquisition  has been  capitalized  and is being amortized
over the  remaining  thirty month term of the master  distributorship  agreement
expiring December 31, 1998.

12.  Stock Options

     The Company has elected to follow  Accounting  Principles Board Opinion No.
25,   "Accounting   for  Stock  Issued  to  Employees"   (APB  25)  and  related
Interpretations in accounting for its stock options because, as discussed below,
the alternative fair value accounting provided for under FASB Statement No. 123,
"Accounting  for  Stock-Based  Compensation,"  requires use of option  valuation
models that were not developed for use in valuing stock  options.  Under APB 25,
because the exercise  price of the  Company's  stock  options  equals the market
price of the underlying  stock on the date of grant, no compensation  expense is
recognized.

     The Company has a stock option plan under which there have been  authorized
a maximum of 450,000  shares.  The plan permits the  granting of both  incentive
stock options and  nonqualified  stock options to key employees and directors of
the  Company,  excluding  members of the  Compensation  Committee,  and  certain
outside consultants and advisors to the Company.  The purchase price will not be
less than 100% (110% for owners of more than 10% of common  stock of the Company
on the date of grant) of the fair  market  value of the stock on the date of the
grant of such option.  The duration of each option will not exceed 10 years from
the date of grant (five years for owners of more than 10% of the common stock of
the Company). Options vest at a rate of 20% per year. There have been no options
exercised under the plan.


<PAGE>

12.  Stock Options (continued)

     In addition to the options  granted under the stock option plan at December
31, 1996,  there were also 375,000 shares subject to options granted to officers
and directors  pursuant to agreements with exercise prices ranging from $2.31 to
$2.50.  Options  vest at a rate of 20% per  year.  There  have  been no  options
exercised.

     Pro forma  information  regarding  net  income  and  earnings  per share is
required  by  Statement  123,  which  also  requires  that  the  information  be
determined  as if the  Company  has  accounted  for its  stock  options  granted
subsequent  to December 31, 1994 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 1995 and 1996:  risk-free interest rate of 6.0%;  dividend yield
of 0%; a volatility  factor of the expected market price of the Company's common
stock of 0.511; and a weighted average life of the option of 4 years.

     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.   Because  the   Company's   stock   options  have   characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially  affect the fair value estimate,  in
management's  opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options.

     For purposes of pro forma  disclosures,  the estimated fair value of traded
options is amortized to expense over the options' vesting period.  The Company's
pro forma information follows:

                                                         1995           1996
                                                       -------      -----------
    Pro forma net income (loss)                        $72,193      ($1,529,232)
    Pro forma earnings (loss) per common share         $  0.02      ($     0.37)

     Because  Statement 123 is applicable only to options granted  subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1997.

     A summary of the Company's  stock option  activity and related  information
for the years ended December 31 follows:
  
                                 1994             1995               1996
                            ---------------- ----------------- -----------------
                                    Weighted-        Weighted-         Weighted-
                                    Average          Average           Average
                                    Exercise         Exercise          Exercise
                            Option  Price    Option  Price     Option  Price
                           -------- ------ -------- -------- --------- ---------
Outstanding-beginning         
of year                      11,125   $3.60  35,125   $2.85    270,125   $2.44
  Granted                    24,000    2.50 235,000    2.38    150,000    2.50
  Exercised                       0               0                  0
  Forfeited                       0               0                  0

                          ---------  ------ -------- -------- ---------- ------
Outstanding-end of year      35,125   $2.85 270,125   $2.44    420,125   $2.46
                          ========== ====== ======== ======== ========== ======
Exercisable at end of year    4,450          58,475            142,500

Weighted-average fair value  
of options granted during
the year                                     $1.08              $1.16

<PAGE>

12.  Stock Options (continued)

     Exercise  prices for options  outstanding  under the stock  option plan and
other  agreements  at December  31,  1996  ranged  from $2.31 to $3.60.  Options
granted during 1994 had an original exercise price of $5.00.  These options were
repriced by the Board of Directors during 1995 at $2.50.

13.  Commitments and Contingencies

     ABS  LifeSciences,  Inc.  ("ABS"),  a  subsidiary  of Integra  LifeSciences
Corporation,  filed a civil  action  against  the  Company in the United  States
District  Court for the  District  of New  Jersey in which it claims  damages in
excess of $50,000 for alleged breach by the Company of a license  agreement with
ABS.  Management  believes  it will  prevail in this  action and  therefore,  no
provision  has  been  made  for  this  action  in  the  accompanying   financial
statements.

     The Company has entered  into an  agreement  to purchase  inventory  from a
supplier which specifies the quantities to be purchased. The minimum commitments
for inventory purchases for 1997 are $189,034.

14.  Related Party Transactions

     The Company  leases office space from a shareholder of the Company under an
operating  lease that expires in December,  1999.  The Company can terminate the
lease at any time upon giving 180 days written notification. Annual rent expense
under this lease was $43,200 for the years ended December, 1995 and 1996.

     In 1994, the Company entered into a five-year  consulting  agreement with a
director and  shareholder.  The  agreement  provides that this  individual  will
provide consulting  services to the Company in return for annual compensation of
$70,000,  to be adjusted from time to time by the Company's  President and Chief
Executive Officer. In 1996, such compensation was $99,000.

     In 1995,  the  Company  loaned an officer  $28,000 on demand at an interest
rate of 9.0%.  This loan was  guaranteed by an individual  who is a director and
shareholder.  Subsequent to December 31, 1996, the officer repaid the promissory
note.

15.  Officers' Notes Receivable

     Various   officers  of  the  Company   received  draws  against   incentive
compensation  during 1994  totaling  approximately  $296,156.  The  Compensation
Committee of the Board of Directors  subsequently  determined  that no incentive
compensation was payable relative to 1994.  Accordingly,  the officers  executed
promissory notes requiring repayment of the incentive compensation over a period
of ten years  with  interest  of 8.01% per  annum.  The Board of  Directors  has
determined  that the officers may tender  either  common stock of the Company or
cash in payment of the promissory notes.

     In 1995, the Compensation  Committee approved  forgiveness of one officer's
promissory  note in the  amount of $34,292  as part of the  officer's  severance
package.  Subsequent to December 31, 1996, another officer repaid his promissory
note of $77,893 inclusive of principal and interest.
<PAGE>
Item  8.  Changes  in and  Disagreements  with  Accountants  on  Accounting  and
          Financial Disclosure

     There were no changes in or  disagreements  with  accountants on accounting
and  financial  disclosure  matters  during any period  covered by the financial
statements filed herein or any period subsequent thereto.

                                    Part III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
        with Section 16(a) of the Exchange Act

Directors and Executive Officers
   
     The directors and executive officers of the Company are:

 Name                       Age  Position held with the Company
--------------------------- --- -----------------------------------------
Edward J.Quilty (1) ....... 46 Chairman of the Board
John T.Borthwick (1)(4) ... 43 President,Chief Executive Officer and Director
Mary G.Clark, RN (1)....... 64 Vice Chairman of the Board and Special Consultant
Gary L.Borthwick .......... 38 Vice President for Finance and Operations, 
                               Chief Financial Officer, Treasurer and Director
Robert P.DiGiovine, RPh ... 40 Director of Regulatory Affairs and Product
                               Development, Secretary and Director
Margaret R. Spencer (4) ... 70 Director
Joseph V. Villasin, MD (2)  56 Director
Dr. Hsia-Fu Chao .......... 60 Director
Robert W. Naismith, Ph.D. . 51 Director
Herbert Grossman,RPh (2)(3) 66 Director
Laurence F. Lane (3)(4).... 51 Director

_______________
(1)  Member of the Executive Committee.
(2)  Member of the Audit Committee.
(3)  Member of the Compensation Committee.
(4)  Member of the Nominating Committee.

Information Relative to Directors and Executive Officers

     Edward J. Quilty has served as Chairman of the Board since May,  1996 and a
director of the Company since March,  1996.  Mr. Quilty has been the Chairman of
the Board of RhoMed,  Inc., a biopharmaceutical  company specializing in peptide
drug design for diagnostic and therapeutic  agents,  since November,  1995. From
July, 1994 through November,  1995, he was President and Chief Executive Officer
of MedChem  Products,  Inc., a publicly  traded  developer and  manufacturer  of
specialty medical products acquired by C.R. Bard in November,  1995. From March,
1992 through July,  1994,  Mr.  Quilty  served as President and Chief  Executive
Officer  of Life  Medical  Sciences,  Inc.,  a  developer  and  manufacturer  of
specialty  medical products  including wound healing agents.  The assets of Life
Medical  Sciences were purchased by MedChem Products Inc. Mr. Quilty has over 25
years of experience in the healthcare  industry primarily in strategic planning,
management  and sales and  marketing.  Mr. Quilty is a member of the  Healthcare
Manufacturing  Marketing Council. He earned a Bachelor of Science from Southwest
Missouri State University, Springfield, Missouri in 1972 and his M.B.A from Ohio
University, Athens, Ohio in 1987.

     John T.  Borthwick has served as President and Chief  Executive  Officer of
the Company  since  February,  1991.  He has served as a director of the Company
since  November,  1984 and served as Vice Chairman of the Board from  September,
1994 to June, 1995. Previously, he was Vice President for Marketing and National
Sales Manager of the Company from 1984 through 1990. Mr. Borthwick serves on the
board of directors  of Plansoft  Corporation,  a  developmental  stage  employee
benefit  plan  administration  software  company.  During  1988  and  1989,  Mr.
Borthwick  also served as President  of Wound  Management  Services,  a Medicare
billing service  specializing in wound care. In 1993, Mr.  Borthwick served as a
member of the board of directors of the National  Association for the Support of
Long Term Care, an organization  which represents the legislative and regulatory
interests of the long term care  industry.  Mr.  Borthwick  earned a Bachelor of
Arts in Biology from Temple University in 1975.

     Mary G.  Clark,  RN,  founded  the  Company  and has  served  as a  Special
Consultant for Scientific  Affairs to the Company and Vice Chairman of the Board
since March,  1994 and June, 1995,  respectively.  She served as Chairman of the
Board of the Company from February,  1991 through March, 1994. Mrs. Clark served
as the  Company's  President  from 1984 to 1990,  and as director of the Company
from  November,  1984 to March,  1994.  She is the inventor and original  patent
holder  of the  Company's  flagship  products,  Dermagran  Spray  and  Dermagran
Ointment. She is also the founder, owner and operator of the Primary Medical and
Nutritional  Clinic, Old Forge,  Pennsylvania,  a clinic specializing in medical
and  nutritional  preventative  therapies.  She has over 32  years  of  clinical
medical  experience of which 18 years are in the  nutritional  biochemistry  and
ortho-molecular  medicine  fields.  Mrs. Clark earned a Registered  Nurse degree
from Scranton  State  General  Hospital in 1954 and a Clinical  Nurse  Therapist
degree in Intensive Cardiovascular Care from Mechanicsburg Rehabilitation Center
in 1972. She was appointed by former  Pennsylvania  Governor  Robert P. Casey to
membership  on the  Entrepreneurial  Advisory  Board  for  the  Commonwealth  of
Pennsylvania.
<PAGE>

     Gary L.  Borthwick was appointed  Vice President for Finance and Operations
in March,  1995 and has served as Vice President for Finance and Chief Financial
Officer of the Company since February,  1991. He has served as a director of the
Company since July,  1988.  He joined the Company in 1985 as Operations  Manager
and served as  Comptroller  from 1987  through  1990.  Mr.  Borthwick  owned and
operated K&G Health Foods, a health food store in Old Forge, Pennsylvania,  from
1979   through   1992.   In   addition,   he   served   from  1988  to  1989  as
Secretary/Treasurer  of Wound Management Services,  Dunmore,  Pennsylvania.  Mr.
Borthwick earned an Associate  Degree in Accounting and Business  Administration
from Keystone Junior College in 1979.

     Robert P.  DiGiovine,  RPh,  serves as Director of  Regulatory  Affairs and
Product Development of the Company.  Formerly, Mr. DiGiovine served as Assistant
Director of Scientific Affairs of the Company from December, 1993. He has served
as Assistant  Secretary since July, 1994, and as a director of the Company since
July,  1988.  Mr.  DiGiovine is a registered  pharmacist  and formerly owned and
operated  DiGiovine  Drug Store, a retail  pharmacy in Old Forge,  Pennsylvania,
from 1985 to 1993. He attended  Bloomsburg  State College and the  University of
Scranton  and  earned  his  Bachelor  of Science  in  Pharmacology  from  Temple
University, Philadelphia, Pennsylvania, in 1980.

     Margaret R. Spencer has served as a director of the Company since November,
1984.  She served as Vice  Chairman of the Board of the Company  from  February,
1991  through  September,  1994 and  Chairman of the Board from  December,  1985
through   February,   1991.  She  is  a  Pennsylvania   licensed   Nursing  Home
Administrator  and served from 1977 until her  retirement  in October,  1992, as
Executive  Director and Chief  Executive  Officer of Heritage House, a continuum
care  community  for persons 62 years of age and older  located in Wilkes Barre,
Pennsylvania.  Mrs.  Spencer  earned a Bachelor  of Arts in  Economics  from the
University of Pennsylvania in 1948.

     Joseph V. Villasin, MD, has served as a director of the Company since July,
1985. He has been a staff physician and Medical  Director at Clarks Summit State
Hospital Long Term Care Facility in Clarks Summit, Pennsylvania,  since 1980 and
1990, respectively.  Previously,  Dr. Villasin served as the President,  Medical
Staff, at Clarks Summit State Hospital. He has also maintained a general medical
practice  clinic in Scranton,  Pennsylvania,  since 1980 and  performs  clinical
studies   relative  to  the  Company's   products.   Dr.   Villasin  earned  his
undergraduate  degree from the University of the  Philippines  College of Arts &
Sciences in 1962 and graduated from the University of the Philippines College of
Medicine in 1967.  He completed  his  post-graduate  training at the  Philippine
General Hospital, St. Michael Hospital,  Milwaukee,  Wisconsin,  Mercy Hospital,
Pittsburgh,  Pennsylvania, and Wilson Memorial Hospital, Johnson City, New York,
during 1967 through 1978.  He has  instructed  anatomy at the  University of the
Philippines and pathology at the University of Pittsburgh College of Medicine.

     Dr. Hsia-Fu Chao has served as a director of the Company since July,  1994.
Dr. Chao also serves on the board of  directors  of  Hymedix,  Inc.,  a publicly
traded  developer and distributor of  pharmaceutical  products.  He has been the
Chairman of First Taiwan Investment Holding, Inc. and a director of First Taiwan
Investment Banking Group since 1986. Dr. Chao previously served as Chairman, and
presently serves as a Consultant Physician and a director,  of the China Medical
Center,  Taipei,  Taiwan R.O.C.  He graduated from the National  Defense Medical
Center  (Taiwan) in 1961 and was a Fellow in medicine at Washington  University.
Dr. Chao completed his residency and  ultimately  served as Chief of Division of
Gastroenterological  Oncology at the Veterans General Hospital,  Taipei,  Taiwan
R.O.C. He has held  professorships at the National Yang Ming Medical  University
and the National Defense Medical Center.

     Robert W.  Naismith,  Ph.D.,  has served as a director of the Company since
March, 1994 and served as Chairman of the Board from January,  1995 through May,
1996.  He currently  serves as the Managing  Director of Healthcare at BlueStone
Capital Partners, L.P. and Chairman of William Naismith Associates,  a strategic
business  consulting  firm.  He is also a  Senior  Fellow  at the  Institute  of
Molecular   Biology  &  Medicine  at  the  University  of  Scranton,   Scranton,
Pennsylvania.  Dr.  Naismith  co-founded,  and  served as the  President,  Chief
Executive Officer and a director of Biofor,  Inc., a biopharmaceutical  research
and discovery company specializing in rational drug design via computer assisted
molecular analysis,  from 1986 to 1995. In addition, he served as Vice President
of  Scherer  Healthcare,   Inc.,  an  Atlanta  based  healthcare  company  whose
subsidiaries  address  various  medical service and product markets from 1986 to
1995. Dr. Naismith has served as Chairman of the  Compensation  Committee of the
Board of Directors of Penn Security Bank & Trust Company, Scranton, Pennsylvania
since 1988, as a director and Chairman of the Joint Conference  Committee of the
Community  Medical  Center,  Scranton,  Pennsylvania  from  1980 to 1992  and as
Chairman and  director of a publicly  traded  bridge  fund.  He holds an adjunct
associate  professorship  in the  School of  Medicine  at Case  Western  Reserve
University  and  adjunct   professorships   in  the  Department  of  Biology  at
Pennsylvania State University and the Department of Biology at the University of
Scranton.  Dr.  Naismith also serves as a Trustee of the William  Harvey Medical
Foundation, London, U.K. He is a member of the Editorial Board of the Journal of
Applied  Toxicology and the Journal of Hazardous Waste and is the author of over
30 publications.  Dr. Naismith  received his Bachelor of Science in Biology from
East Stroudsburg  University in 1966 and his Ph.D. in Genetics from Pennsylvania
State  University in 1971. He was awarded a tenured  Associate  Professorship at
Pennsylvania State University in Biology in 1977.
<PAGE>

     Herbert Grossman,  RPh, has served as a director of the Company since June,
1995. Mr. Grossman has been President, Chief Executive Officer and a director of
Beacon  Laboratories LLC, a development  stage research company  specializing in
the development of technology for the treatment of cancer,  since July, 1995. He
has over forty  years  experience  in general  management,  corporate  planning,
marketing,  advertising and publishing in the domestic and worldwide  healthcare
industry.  From  1992  to 1995  Mr.  Grossman  served  as a  strategic  business
consultant to the Ortho Diagnostic Systems division of Johnson & Johnson. He was
Chairman  of the Board and a  director  of the  Zambon  Corporation,  the United
States  subsidiary  of the Zambon Group,  an Italian  based  research-intensive,
multinational  healthcare  manufacturer of  pharmaceuticals,  fine chemicals and
hospital products,  from 1990 through 1992 and 1988 through 1992,  respectively.
Mr.  Grossman  previously  served as the founding  President and Chief Executive
Officer of the Zambon  Corporation.  He serves on the boards of directors of the
following corporations:  Biofor, Inc., Opticare Centers, Inc., Strategic Medical
Communications,  Inc., Jenner  Technologies and REMBIS Associates.  Mr. Grossman
has served on numerous  government  and business  committees,  most  recently on
Deloitte  Haskins  &  Sells'  National   Emerging  Business  Advisory  Board  in
conjunction  with the White  House  Conference  on Small  Business.  He earned a
Bachelor of Science in Pharmacy from Long Island University, Brooklyn College of
Pharmacy,  New York, in 1951. Mr. Grossman also attended the University of Miami
Graduate Business School and New York University Graduate Business School.

     Laurence F. Lane has served as a director of the Company since June,  1995.
Mr. Lane has been the Senior Vice  President of Regulatory  Affairs of NovaCare,
Inc., a publicly  traded medical  rehabilitation  corporation,  since  November,
1986.  He has over twenty years of government  relations and policy  experience.
Mr. Lane has served as the Director for Special  Programs of the American Health
Care Association, Director for Policy Development of the American Association of
Homes for the Aging and legislative  representative of the American  Association
of Retired Persons. He managed the 1980 White House Mini-Conference on Long Term
Care and served as a  credentialed  resource  person  for the 1981  White  House
Conference  on  Aging.  Mr.  Lane is a member  of the  following  organizations:
National Association for the Support of Long Term Care,  International  Subacute
Healthcare  Association,   National  Association  for  Rehabilitation  Agencies,
National  Health  Lawyers  Association,   and  Healthcare  Financial  Management
Association. He earned a Bachelor of Arts and M.A. from the School of Public and
International Affairs of George Washington University, Washington, D.C. Mr. Lane
has pursued doctoral studies at the Washington Public Affairs Center, University
of  Southern  California  and  received a  Gerontology  certificate  from Andrus
Gerontology Center, University of Southern California in 1974.

Family Relationships

     Mary G. Clark is the  mother of John T.  Borthwick  and Gary L.  Borthwick.
Margaret R. Spencer is the mother-in-law of John T. Borthwick.

Compliance with Section 16(a) of the Exchange Act

     Section 16(a) of the Securities  Exchange Act of 1934 (the "Exchange  Act")
requires the Company's  directors and  executive  officers,  and persons who own
more than ten percent of a registered class of the Company's equity  securities,
to file with the Securities and Exchange  Commission (the "Commission")  initial
reports of  ownership  and reports of changes in  ownership  of common stock and
other equity securities of the Company. Officers, directors and greater than ten
percent  shareholders  are  required  by  Commission  regulation  to furnish the
Company with copies of all Section 16(a) forms they file.

     To the Company's knowledge,  based solely on a review of the copies of such
reports furnished to the Company, all reports under Section 16(a) required to be
filed by its officers,  directors and greater than ten-percent beneficial owners
were timely filed.


<PAGE>

Item 12.  Executive Compensation

Summary Compensation Table

     The following table shows all compensation paid by the Company to its Chief
Executive  Officer  and to each of its  executive  officers  whose  compensation
exceeded  $100,000 for their services in all  capacities  during the years 1994,
1995 and 1996:

                                   Annual Compensation             
                                   -------------------  Options     All Other
Name and Principal Position   Year    Salary    Bonus     (#)      Compensation
----------------------------- ----   -------   -------  -------   --------------
John T. Borthwick             1996  $180,000      ---      ---    $10,861 (1)(2)
President and Chief           1995   150,000   $40,000   100,000   10,712 (1)(2)
Executive Officer             1994    93,500      ---      ---      9,962 (1)


Gary L. Borthwick             1996   135,000      ---      ---       7,514 (3)
Vice President for            1995   119,000    20,000    50,000     7,514 (3)
Finance & Operations and      1994    72,800      ---      ---       7,514 (3)
Chief Financial Officer


Donald F. McHale, RN          1996   150,000      ---      ---       2,289 (4)
Vice President for Sales      1995   129,000    13,800     ---         645 (2)
& Marketing                   1994    65,000      ---     50,000       ---


____________________________                           
(1)  The Company  enrolled John T.  Borthwick in a  split-dollar  life insurance
     program on July 1, 1993.  The monthly  premiums  are  $830.18 for  $500,000
     coverage.
(2)  Matching contributions made pursuant to the Company's 401(k) plan.
(3)  The Company  enrolled Gary L.  Borthwick in a  split-dollar  life insurance
     program on February 1, 1993. The monthly  premiums are $626.15 for $500,000
     coverage.
(4)  This amount consists solely of matching  contributions made pursuant to the
     Company's 401(k) plan. Mr. McHale's  employment  terminated on December 31,
     1996.  His severance  payment,  in the amount of $189,000,  was accrued for
     accounting  purposes  in 1996 but was not paid  until  January,  1997.  For
     information  relative to Mr.  McHale's  severance,  please refer to Exhibit
     10.54.

Option Grants Table

     The  following  table  sets  forth  information  regarding  grants of stock
options made for the year ended December 31, 1996:

                                  Percent of Total    Exercise                 
                    Options       Options Granted to  Price
 Name               Granted (#)   Employees in 1996  ($/Share)  Expiration Date
 ----------------  ------------   ------------------ ---------- ----------------
 Edward J. Quilty   150,000(1)           100%           2.50     May 22, 2007

__________________
(1)   These options began vesting at a rate of 20% per year on May 22, 1996.


<PAGE>

Aggregate Year End Option Value Table

     The following table sets forth  information  regarding the aggregate number
and value of options  held by the above  executive  officers as of December  31,
1996. No options have been exercised:

                                                            Value of Unexercised
                                 Number of Shares           In-The-Money Options
                              Underlying Unexercised        at December 31, 1996
                           Options at December 31, 1996           ($)(1)
                         -----------------------------    ---------------------
  Name                     Exercisable  Unexercisable  Exercisable Unexercisable
  -----------------------  -----------  -------------  ----------- -------------
  John T. Borthwick........ 20,000(2)      80,000         0            0
  Gary L. Borthwick........ 10,000(2)      40,000         0            0
  Donald F. McHale, RN ....  4,000(3)           0         0            0
                            20,000(4)           0         0            0
___________________________
(1)  Determined  based on a fair market value for the Company's  common stock at
     December 31, 1996 of $2.00 per share.
(2)  These  options  began  vesting at a rate of 20% per year on January 1, 1996
     and are exercisable at $2.31 per share.
(3)  These options are  exercisable  at $3.60 per share and will expire on March
     31, 1997 if not exercised.
(4)  These  options were granted in 1994 in the  following  amounts and exercise
     prices:  10,000 at $4.50 per share; 20,000 at $5.00 per share and 20,000 at
     $6.50  per  share.  All of these  options  were  repriced  by the  Board of
     Directors and are  exercisable at $2.50 per share.  If unexercised by March
     31, 1997, these options will expire.

Compensation of Directors

     All directors are reimbursed for expenses  incurred in connection with each
board and committee  meeting  attended.  Each outside director receives $500 for
every board meeting and for each separately held committee meeting attended.  In
addition,  each outside director  receives an annual retainer of $5,000.  Inside
directors receive no compensation for their services as directors.

     The  following  table sets forth  certain  information  with respect to the
grant of all  options  under  the  Stock  Option  Plan to the  directors  of the
Company:

                                  Exercisable
                         Options  Options at         Exercise  
                         Granted  December 31, 1996  Price
Name                     (#)           (#)           ($/Share) Expiration Date
------------------------ -------- ------------------ --------- ---------------
Dr. Hsia-Fu Chao......... 10,000(1)   4,000           2.50    November 21, 2006
Robert P. DiGiovine, RPh   1,500(2)   1,200           3.60    August 14, 1997
Robert W. Naismith, Ph.D. 10,000(1)   4,000           2.50    November 21, 2006
Margaret R. Spencer .....  3,125(2)   2,500           3.60    August 14, 1997
                          10,000(1)   4,000           2.50    November 21, 2006
Joseph V. Villasin, MD ..  1,500(2)   1,200           3.60    August 14, 1997
                          10,000(1)   4,000           2.50    November 21, 2006

________________________                           
(1) These options began vesting at a rate of 20% per year on November 21, 1995.
(2) These options began vesting at a rate of 20% per year on August 14, 1993.



<PAGE>

     The  following  table sets forth  certain  information  with respect to the
grant of options to directors of the Company exclusive of the Stock Option Plan:

                                  Exercisable
                         Options  Options at         Exercise  
                         Granted  December 31, 1996  Price
Name                     (#)           (#)           ($/Share) Expiration Date
------------------------ -------- ------------------ --------- ---------------
  Herbert Grossman, RPh. 10,000(1)  4,000               2.50   November 21, 2006
  Laurence F. Lane...... 10,000(1)  4,000               2.50   November 21, 2006

________________________                           
(1) These options began vesting at a rate of 20% per year on November 21, 1995.

Employment Arrangements

     The Company entered into a five-year employment agreement (the "Agreement")
with John T. Borthwick,  its President and Chief Executive Officer,  on December
29,  1995,  and  amended  on March 5,  1997.  The  Agreement  provides  that Mr.
Borthwick will receive base  compensation  of $180,000 during the calendar years
1996, 1997 and 1998 and base  compensation  for the calendar years 1999 and 2000
to be  determined  by the  Board of  Directors  upon the  recommendation  of the
Compensation  Committee,  together with such incentive and/or bonus compensation
as may be awarded upon the  recommendation of the Compensation  Committee of the
Board of Directors;  provided, however, incentive and/or bonus compensation,  if
any,  will be  predicated  upon the  extent to which  the  Company  attains  its
earnings  goals and the  extent of Mr.  Borthwick's  contributions  thereto.  As
additional   compensation,   the   Agreement   grants  Mr.   Borthwick   100,000
non-qualified stock options, exercisable at a price of $2.31 per share, of which
20,000 are vested as of January 1, 1996 and the remaining  80,000 vest at a rate
of 20% per year. If the Company sells additional common stock during the term of
the Agreement in a transaction, or related series of transactions, the result of
which is to increase  the number of shares of common stock  outstanding  by 40%,
then Mr. Borthwick will be granted such additional stock options, exercisable at
$2.31  per  share,  as may be  necessary  to  enable  him to  purchase  the same
percentage of  outstanding  common stock as he maintained  prior to such sale or
issuance.  In addition, in the event of a sale of substantially all of the stock
or assets of the Company,  or a merger or  consolidation of the Company in which
the Company is not the surviving  entity,  or upon the written  agreement of the
Company to effect such sale,  merger or  consolidation,  Mr. Borthwick will have
the  option  of  completing  the  remaining  term of his  employment  under  the
Agreement or receiving  severance  compensation  equal to his total compensation
accrued during the twelve-month  period immediately  preceding such sale, merger
or consolidation.  Further,  in the event of such sale, merger or consolidation:
(1) the stock options granted pursuant to the Agreement will become  exercisable
in their  entirety  and will  remain  exercisable  for a period of not less than
thirty (30) days;  and (2) the  promissory  note between Mr.  Borthwick  and the
Company  dated January 17, 1995 in the original  principal  amount of $99,530.34
will be forgiven. The Agreement further provides that Mr. Borthwick will receive
a  severance  payment  of 100% of his  total  compensation  accrued  during  the
twelve-month period immediately preceding the expiration of the Agreement if the
Company  does not  renew or extend  the term of the  Agreement  upon  expiration
thereof.  The Agreement  also provides that Mr.  Borthwick  will receive:  (i) a
vehicle  for use  primarily  (but not  exclusively)  in the  conduct  of Company
business,  (ii) split-dollar life insurance in the face amount of $500,000,  and
(iii) disability income insurance providing for payments of 50% of compensation.
Mr.  Borthwick  may not disclose  any  confidential  information  of the Company
during or after the term of the Agreement,  and may not compete with the Company
during the term of the Agreement and for a period of one year thereafter.

     The Company entered into a five-year employment agreement (the "Agreement")
with Gary L. Borthwick,  its Vice President for Finance and Operations and Chief
Financial  Officer,  on December  29,  1995,  and amended on March 5, 1997.  The
Agreement provides that Mr. Borthwick will receive base compensation of $135,000
during the  calendar  years 1996,  1997 and 1998 and base  compensation  for the
calendar years 1999 and 2000 to be determined by the Board of Directors upon the
recommendation  of the  Compensation  Committee,  together  with such  incentive
and/or  bonus  compensation  as may be awarded  upon the  recommendation  of the
Compensation Committee of the Board of Directors;  provided,  however, incentive
and/or bonus compensation,  if any, shall be predicated upon the extent to which
the  Company  attains  its  earnings  goals and the  extent  of Mr.  Borthwick's
contributions  thereto.  As additional  compensation,  the Agreement  grants Mr.
Borthwick 50,000  non-qualified  stock options,  exercisable at a price of $2.31
per share,  of which  10,000 are vested as of January 1, 1996 and the  remaining
40,000 vest at a rate of 20% per year.  If the Company sells  additional  common
stock during the term of the Agreement in a  transaction,  or related  series of
transactions,  the result of which is to increase the number of shares of common
stock  outstanding by 40%, then Mr.  Borthwick  will be granted such  additional
stock options, exercisable at $2.31 per share, as may be necessary to enable him
to purchase the same  percentage  of  outstanding  common stock as he maintained
prior  to  such  sale  or  issuance.  In  addition,  in the  event  of a sale of
substantially  all of the  stock  or  assets  of the  Company,  or a  merger  or
consolidation  of the Company in which the Company is not the surviving  entity,
or upon the written  agreement  of the  Company to effect  such sale,  merger or
consolidation,  Mr.  Borthwick  will have the option of completing the remaining
term of his employment under the Agreement or receiving  severance  compensation
equal  to  his  total  compensation   accrued  during  the  twelve-month  period
immediately preceding such sale, merger or consolidation.  Further, in the event
of such sale, merger or consolidation: (1) the stock options granted pursuant to
the  Agreement  will  become  exercisable  in their  entirety  and  will  remain
exercisable  for a  period  of not  less  than  thirty  (30)  days;  and (2) the
promissory note between Mr.  Borthwick and the Company dated January 17, 1995 in
the original  principal  amount of  $84,436.11  will be forgiven.  The Agreement
further provides that Mr. Borthwick will receive a severance  payment of 100% of
his total  compensation  accrued  during  the  twelve-month  period  immediately
preceding  the  expiration  of the  Agreement  if the Company  does not renew or
extend the term of the Agreement  upon  expiration  thereof.  The Agreement also
provides that Mr. Borthwick will receive: (i) split-dollar life insurance in the
face amount of $500,000,  and (ii)  disability  income  insurance  providing for
payments of 80% of compensation. Mr. Borthwick may not disclose any confidential
information of the Company  during or after the term of the  Agreement,  and may
not compete with the Company  during the term of the  Agreement and for a period
of one year thereafter.

     The  Company   entered  into  a  three-year   employment   agreement   (the
"Agreement")  with  Robert  P.  DiGiovine,   RPh,  its  Director  of  Regulatory
Compliance and Product Development, on December 29, 1995. The Agreement provides
that Mr.  DiGiovine  will  receive  base  compensation  of $75,000,  $80,000 and
$85,000 for the calendar years 1996, 1997 and 1998, respectively,  together with
such  incentive   and/or  bonus   compensation   as  may  be  awarded  upon  the
recommendation  of  the  Compensation  Committee  of  the  Board  of  Directors;
provided,  however,  incentive  and/or  bonus  compensation,  if any,  shall  be
predicated  upon the extent to which the Company  attains its earnings goals and
the extent of Mr. DiGiovine's  contributions  thereto;  provided,  further, that
such incentive and/or bonus compensation shall not exceed 35% of Mr. DiGiovine's
base compensation for that year. In addition,  as further compensation under the
Agreement,  the Company has granted Mr.  DiGiovine  15,000  non-qualified  stock
options  which vest in three  installments  during  the  period  January 1, 1996
through January 1, 1998 at an exercise price of $2.50 per share. In the event of
the sale of substantially all of the stock or assets of the Company, or upon the
merger or consolidation of the Company in which the Company is not the surviving
entity, or upon the written agreement of the Company to effect such sale, merger
or consolidation, Mr. DiGiovine will have the option of completing the remaining
term of his employment under the Agreement or receiving  severance  compensation
equal  to  his  total  compensation   accrued  during  the  twelve-month  period
immediately preceding such sale, merger or consolidation.  Further, in the event
of such sale,  merger or consolidation the stock options granted pursuant to the
Agreement will become exercisable in their entirety and shall remain exercisable
for a period of not less than thirty (30) days. The Agreement  further  provides
that Mr.  DiGiovine  will  receive  a  severance  payment  of 100% of his  total
compensation  accrued during the twelve-month  period immediately  preceding the
expiration  of the Agreement if the Company does not renew or extend the term of
the Agreement  upon  expiration  thereof.  The Agreement  also provides that Mr.
DiGiovine will receive disability income insurance providing for payments of 50%
of compensation.  Mr. DiGiovine may not disclose any confidential information of
the Company during or after the term of the Agreement,  and may not compete with
the  Company  during  the term of the  Agreement  and for a  period  of one year
thereafter.

     The  Company   entered  into  a  three-year   employment   agreement   (the
"Agreement")  with Edward J.  Quilty,  its  Chairman of the Board,  on August 1,
1996. The Agreement provides that Mr. Quilty will receive base salary of $75,000
per year,  together with a $25,000  annual bonus and such  additional  incentive
compensation  as may be  awarded  upon the  recommendation  of the  Compensation
Committee of the Board of Directors;  provided,  however,  additional  incentive
compensation,  if any, shall be predicated  upon the extent to which the Company
attains its earnings goals and the extent of Mr. Quilty's contributions thereto.
As   additional   compensation,   the  Agreement   grants  Mr.  Quilty   150,000
non-qualified stock options, exercisable at a price of $2.50 per share, of which
30,000 are vested as of May 22, 1996 and the remaining 120,000 vest at a rate of
20% per year.  These  options  become 100%  exercisable  if Mr.  Quilty  becomes
disabled, the Agreement is terminated by the Company other than "for cause," the
Agreement is terminated by Mr. Quilty for the Company's  breach, or in the event
of the sale of substantially all of the stock or assets of the Company,  or upon
the  merger or  consolidation  of the  Company  in which the  Company is not the
surviving  entity.  If the Company sells additional common stock during the term
of the Agreement in a transaction, or related series of transactions, the result
of which is to increase the number of shares of common stock outstanding by 40%,
then Mr. Quilty will be granted such  additional  stock options,  exercisable at
$2.50  per  share,  as may be  necessary  to  enable  him to  purchase  the same
percentage of  outstanding  common stock as he maintained  prior to such sale or
issuance.  In  addition,  in the event of the sale of  substantially  all of the
stock or assets of the  Company,  or upon the  merger  or  consolidation  of the
Company in which the Company is not the surviving entity,  the Company shall pay
Mr.  Quilty a  severance  payment  equal to the  greater  of his  salary for the
remaining  term of the  Agreement or $100,000.  Mr.  Quilty may not disclose any
confidential  information  of the  Company  during  or  after  the  term  of the
Agreement, and may not compete with the Company during the term of the Agreement
and for a period of one year thereafter.
<PAGE>

Stock Option Plan

     The Company  adopted the Stock Option Plan,  (the "Plan") in July 1991, and
amended the Plan in January, 1994 and November 21, 1995. The number of shares of
common stock  ("Common  Stock")  reserved  for issuance  pursuant to the Plan is
450,000  shares.  The Plan  authorizes  the Company to grant two types of equity
incentives:  (i)  options  intended  to qualify  as  "incentive  stock  options"
("ISOs")  as defined in Section 422 of the  Internal  Revenue  Code of 1986,  as
amended,  and (ii) non-qualified  stock options  ("NQSOs").  The Plan authorizes
options to be granted to directors,  officers,  key employees and consultants of
the  Company,  except that ISOs may be granted  only to  employees.  The Plan is
administered by a committee of disinterested  directors  designated by the Board
of Directors (the "Compensation Committee").  Subject to the restrictions of the
Plan,  the  Compensation  Committee  determines who is eligible to receive stock
options,  the nature,  amount and timing of options  granted under the Plan, the
exercise price and vesting schedule of any options granted,  and all other terms
and conditions of the options to be granted.

     Under the Plan,  ISOs and  NQSOs may have a term of up to ten  years.  Many
options which have been granted  under the Plan vest over the  five-year  period
following the date of grant.  Stock options are not  assignable or  transferable
except by will or the laws of  descent  and  distributi  on.  Shares  subject to
options  granted under the Plan which have lapsed or terminated may again become
available for options granted under the Plan.

     At December 31, 1996,  there were 66,125 shares subject to options  granted
under the Plan,  with  exercise  prices  ranging  from $2.50 to $3.60 per share.
Options to purchase 6,125 shares began vesting in August,  1993 at a rate of 20%
per year. In October,  1994,  options to purchase  20,000 shares were granted to
Donald F. McHale  under the Plan at an exercise  price of $5.00.  These  options
were  repriced by the Board of Directors at $2.50 and began  vesting in October,
1995 at a rate of 20% per  year.  On  March  31,  1997,  Mr.  McHale's  right to
exercise his options will terminate.  Options to purchase an aggregate of 40,000
shares were  granted and began  vesting in  November,  1995 at a rate of 20% per
year.

Special Consultant to the Company

     The Company  entered into a five-year  consulting  agreement  ("Agreement")
with Mary G. Clark,  on March 14, 1994.  The Agreement  provides that Mrs. Clark
will receive annual  compensation  of $70,000 with  compensation  to be adjusted
from time to time by the President and Chief  Executive  Officer of the Company.
In addition,  in the event of a sale of substantially all of the stock or assets
of the Company, or a merger or consolidation of the Company in which the Company
is not the surviving  entity,  Mrs. Clark will have the option of completing the
remaining term of the Agreement or receiving severance compensation equal to her
annual compensation. The Agreement further provides that Mrs. Clark will receive
a severance  payment  equal to her annual  compensation  if the Company does not
renew or extend the term of the Agreement upon expiration thereof and disability
income insurance providing for payments of 50% of her annual compensation.  Mrs.
Clark may not disclose any  confidential  information  of the Company  during or
after the term of the Agreement, and may not compete with the Company during the
term of the Agreement and for a period of one year thereafter.

     Mrs. Clark serves as the Company's  acting Director of Scientific  Affairs.
In this capacity,  she maintains  primary  responsibility  for quality  control,
product  formulations,  clinical  studies  and  liaison  with  the Food and Drug
Administration.
<PAGE>

Item 11.  Security Ownership of Certain Beneficial Owners and Management

     The  following  table sets forth as of March 3, 1997,  certain  information
regarding the current  beneficial  ownership of shares of the  Company's  Common
Stock by (i) each person known by the Company to own  beneficially  more than 5%
of the  outstanding  shares of Common Stock,  (ii) each director of the Company,
(iii) each officer of the Company,  and (iv) all  directors  and officers of the
Company as a group:
                                                                        Percent
                                              Number of Shares      Beneficially
 Name and Address of Beneficial Owner (1)     Beneficially Owned        Owned  
--------------------------------------------- -------------------- ------------
Mary G. Clark, RN...............................     1,025,474           25.14%
John T. Borthwick (2)...........................       299,414            7.30%
Dr. Hsia-Fu Chao (3)............................       252,000            6.18%
Gary L. Borthwick (4)...........................       187,788            4.60%
Edward J. Quilty (5)............................        50,500            1.24%
Joseph V. Villasin, MD (6)......................        27,825             *
Robert P. DiGiovine, RPh (7)....................        15,075             *
Laurence F. Lane (8)............................        12,000             *
Margaret R. Spencer (9).........................         7,000             *
Robert W. Naismith, Ph.D. (8)...................         4,000             *
Herbert Grossman, RPh (8).......................         4,000             *
All directors and officers as a group
(11 persons) (10)...............................     1,885,076           46.21%
___________________________                           
 *    Less than one percent
(1)  Except as otherwise noted, the address of each of the persons listed is 121
     West Grace Street, Old Forge, Pennsylvania 18518.
(2)  Includes  40,000  shares  subject  to  options  currently  exercisable.  No
     additional  shares  subject to options  will become  exercisable  within 60
     days.
(3)  First Taiwan Investment  Holding,  Inc., 15/F, 563, Chung Hsiao, East Road,
     Section 4 Taipei,  Taiwan R.O.C.,  beneficially  owns 248,000 shares of the
     Company's Common Stock.  These shares are also beneficially  owned by First
     Taiwan  Investment & Development,  Inc.,  First Taiwan  Investment  Banking
     Group and Dr. Chao by virtue of his  position  as Chairman of First  Taiwan
     Investment Holding, Inc. Includes 4,000 shares subject to options currently
     exercisable.   No  additional   shares   subject  to  options  will  become
     exercisable within 60 days.
(4)  Includes  20,000  shares  subject  to  options  currently  exercisable.  No
     additional  shares  subject to options  will become  exercisable  within 60
     days.
(5)  Includes 30,000 shares subject to options currently exercisable. On May 22,
     1997, 30,000 additional shares subject to options will become exercisable.
(6)  Includes  5,200  shares  subject  to  options  currently  exercisable.   No
     additional  shares  subject to options  will become  exercisable  within 60
     days.
(7)  Includes  11,200  shares  subject  to  options  currently  exercisable.  No
     additional  shares  subject to options  will become  exercisable  within 60
     days.
(8)  Includes  4,000  shares  subject  to  options  currently  exercisable.   No
     additional  shares  subject to options  will become  exercisable  within 60
     days.
(9)  Includes  6,500  shares  subject  to  options  currently  exercisable.   No
     additional  shares  subject to options  will become  exercisable  within 60
     days.
(10) Includes 128,900 shares subject to options currently exercisable.

Item 12.  Certain Relationships and Related Transactions

     The Company has entered into a five-year consulting agreement with its Vice
Chairman  of the  Board,  founder  and  former  President,  Mary G.  Clark.  The
agreement  provides that Mrs. Clark will provide  services to the Company as its
Special Consultant for Scientific  Affairs with annual  compensation of $70,000,
to be adjusted from time to time by the Company's  President and Chief Executive
Officer. Mrs. Clark's annual compensation for 1996 was $99,000.

     The  Company  has  entered  into  a  five-year   lease   agreement  with  a
shareholder,  Amos M. Clark, for the lease of its executive offices. The Company
can  terminate the lease at any time upon giving six months  notice.  The annual
rental  payment for 1996 was $43,200.  Amos M. Clark is a former Vice  President
and director of the Company and is the husband of Mary G. Clark.
<PAGE>

Item 13.  Exhibits and Reports on Form 8-K

(a)  Exhibits


Exhibit                                     
Number                           Description                                Page
                                 -----------                                ----

3.1    Articles of Incorporation  effective June 3, 1996 (Previously filed    --
         as Exhibit B to the Company's  Proxy Statement filed on April 23,
         1996 and incorporated herein by reference.)
3.2    Bylaws effective June 3, 1996  (Previously  filed as Exhibit C to      --
         the Company's Proxy Statement filed on April 23, 1996 and
         incorporated herein by reference.)
10.01* Stock Option  Plan,  dated  July  18,  1991  (Previously  filed as     --
         Exhibit 10.01 to the Company's  Registration Statement filed
         on Form SB-2, No. 33-52246-NY, declared effective on May 13,
         1994  ["Registration  Statement"] and incorporated herein by
         reference.)
10.02* Stock Option Plan  Amendment,  dated January 14, 1994  (Previously     --
         filed  as  Exhibit  10.02 to  the  Company's  Registration
         Statement and incorporated herein by reference.)
10.03* Stock Option Plan Amendment,  dated November 21, 1995  (Previously     --
         filed as Exhibit 10.03 to the Company's Form 10-KSB on March
         29, 1996 ["1996 Form  10-KSB"]  and  incorporated  herein by
         reference.).
10.04  Master Distributorship Agreement, dated November 4, 1994, between      --
         the Company and Dimensions  Distributing,  Inc.  (Previously
         filed as Exhibit 10.03 to the Company's Form 10-KSB on March
         31, 1995 ["1995 Form  10-KSB"]  and  incorporated  herein by
         reference.)
10.05  Master Distributorship Agreement, dated December 5, 1994, between      --
         the Company and GMI, Inc. (Previously filed as Exhibit 10.04
         to the Company's 1995 Form 10-KSB and incorporated herein by
         reference.)
10.06  Master  Distributorship   Agreement,  dated  November  16,  1994,      --
         between  the Company and D-LUX  Products,  Inc.  (Previously
         filed as Exhibit 10.05 to the Company's 1995 Form 10-KSB and
         incorporated herein by reference.)
10.07  Master  Distributorship   Agreement,  dated  December  14,  1994,      --
         between the  Company  and  Positive  Health  Products,  Inc.
         (Previously  filed as Exhibit  10.06 to the  Company's  1995
         Form 10-KSB and incorporated herein by reference.)
10.08  Master Distributorship  Agreement, dated October 1, 1994, between      --
         the Company and Resource Medical,  Inc. (Previously filed as
         Exhibit  10.07  to  the  Company's   1995  Form  10-KSB  and
         incorporated herein by reference.)
10.09  Master Distributorship Agreement, dated July 1, 1993, between the      --
         Company and Medical  Resources,  Inc.  (Previously  filed as
         Exhibit  10.07 to the Company's  Registration  Statement and
         incorporated herein by reference.)
10.10  Master  Distributorship   Agreement,  dated  November  21,  1994       --
         between the Company and Med Surg Systems,  Inc.  (Previously
         filed as Exhibit 10.10 to the Company's 1995 Form 10-KSB and
         incorporated herein by reference.)
10.11  Master Distributorship  Agreement,  dated July 12, 1993,  between      --
          the Company and Medical Marketing, Inc. (Previously filed as
          Exhibit  10.11  to  the  Company's   1995  Form  10-KSB  and
          incorporated herein by reference.)
10.12  Master Distributorship  Agreement,  dated August 3, 1994, between      --
         the Company and Med Net, Inc.  (Previously  filed as Exhibit
         10.12 to the  Company's  1995 Form  10-KSB and  incorporated
         herein by reference.)
10.13  Master Distributorship Agreement, dated January 23, 1996, between     
         the Company and InnerQuest Sales, Inc.
10.14  Manufacturer Purchase Agreement, dated December 22, 1994, between      --
         the  Company  and  Kendall   Healthcare   Products   Company
         (Previously  filed as Exhibit  10.20 to the  Company's  1995
         Form 10-KSB and incorporated herein by reference. )
10.15  Loan Agreement,  dated July 15, 1993, between the Company and PNC      --
         Bank  (Previously  filed as Exhibit  10.40 to the  Company's
         Registration    Statement   and   incorporated   herein   by
         reference.)
10.16  Commitment Letter,  dated June 17, 1993, to the Company from           --
         PNC Bank relative to line of credit  (Previously  filed
         as  Exhibit   10.41  to  the   Company's   Registration
         statement and incorporated herein by reference.)
10.17  Promissory Note,  dated July 15,  1993,  from the Company to           --
         PNC  Bank  (Previously  filed as  Exhibit  10.42 to the
         Company's   Registration   Statement  and  incorporated
         herein by reference.)
<PAGE>
10.18  Commercial Security Agreement,  dated July 15, 1993, between           --
         the Company and PNC Bank  (Previously  filed as Exhibit
         10.43  to  the  Company's  Registration  Statement  and
         incorporated herein by reference.)
10.19  Assignment of Trademarks from the Company in connection with           --
         the PNC Bank  financing  (Previously  filed as  Exhibit
         10.44  to  the  Company's  Registration  Statement  and
         incorporated herein by reference.)
10.20  Trademark  Security  Agreement  between  the Company and PNC           --
         Bank   (Previously   filed  as  Exhibit  10.45  to  the
         Company's   Registration   Statement  and  incorporated
         herein by reference.)
10.21  Assignment of Patents  from the Company in  connection  with           --
         the PNC Bank  financing  (Previously  filed as  Exhibit
         10.46  to  the  Company's  Registration  Statement  and
         incorporated herein by reference.)
10.22  Patent Security  Agreement  between the Company and PNC Bank           --
         (Previously  filed as  Exhibit  10.47 to the  Company's
         Registration   Statement  and  incorporated  herein  by
         reference.)
10.23  Financing  Statement  executed  July 15,  1993  between  the           --
         Company and PNC Bank (Previously filed as Exhibit 10.48
         to   the   Company's    Registration    Statement   and
         incorporated herein by reference.)
10.24  Agreement to Provide Insurance, dated July 15, 1993, between           --
         the Company and PNC Bank  (Previously  filed as Exhibit
         10.49  to  the  Company's  Registration  Statement  and
         incorporated herein by reference.)
10.25  Patent  Assignment,  dated April 22, 1994,  from PNC Bank to           --
         the Company  (Previously  filed as Exhibit 10.91 to the
         Company's   Registration   Statement  and  incorporated
         herein by reference.)
10.26  Riderto the  Security  Agreement - Patents,  dated April 27,           --
         1994,  between  the  Company  and PNC Bank  (Previously
         filed as Exhibit  10.92 to the  Company's  Registration
         Statement and incorporated herein by reference.)
10.27  Changes in Terms Agreement, dated June 27, 1994, between the           --
         Company  and PNC  Bank.  (Previously  filed as  Exhibit
         10.52 to the  Company's  1995 Form 10-KSB  incorporated
         herein by reference.)
10.28  Changes in Terms Agreement,  dated July 7, 1995, between the           --
         Company and PNC Bank (Previously filed as Exhibit 10.28
         to the Company's 1996 Form 10-KSB  incorporated  herein
         by reference.)
10.29  Lease Agreement,  dated January 14, 1994, between the Company          --
         and Amos M. Clark (Previously filed as Exhibit 10.50
         to   the   Company's    Registration    Statement   and
         incorporated herein by reference.)
10.30  Lease Agreement,   dated  September  1, 1993,   between  the           --
         Company  and  Mariotti  Building  Products  (Previously
         filed as Exhibit  10.51 to the  Company's  Registration
         Statement and incorporated herein by reference.)
10.31  License Agreement,  dated June 24, 1994, between the Company           --
         and  P.T.  Tempo  Scan  Pacific  (Previously  filed  as
         Exhibit 1 to the Company's Form 8-K dated June 24, 1994
         and incorporated herein by reference.)
10.32  License Agreement,  dated May 10, 1995,  between the Company           --
         and Trans  CanaDerm,  Inc.(Previously  filed as Exhibit
         10.03 to the  Company's  Form 10-QSB  filed on June 30,
         1995 and incorporated herein by reference.)
10.33  License  Agreement,  dated  October  31,  1996,  between the           
         Company and Gamida- MedEquip Ltd.
10.34  License  Agreement,  dated May 1, 1995,  between the Company           --
         and Canadian Medical Supply, Inc.  (Previously filed as
         Exhibit  10.04 to the  Company's  Form 10-QSB  filed on
         June 30, 1995 and incorporated herein by reference.)
10.35  Distribution  Agreement,  dated  April 8, 1995,  between the           --
         Company and  Inter-Health,  Inc.  (Previously  filed as
         Exhibit  10.02 to the  Company's  Form 10-QSB  filed on
         June 30, 1995 and incorporated herein by reference.)
10.36  Distribution Agreement,  dated January 29, 1996, between the           --
         Company and Manta Medical  (Previously filed as Exhibit
         10.36  to  the   Company's   1996   Form   10-KSB   and
         incorporated herein by reference.)
10.37* Employment Agreement,  dated December 29, 1995,  between the           --
         Company and John T. Borthwick (Previously  filed as
         Exhibit  10.37 to the  Company's  1996 Form  10-KSB and
         incorporated herein by reference.)
10.38* Addendum to Employment  Agreement,  dated March 5, 1997,  between      
         the Company and John T. Borthwick.
10.39* Employment  Agreement,  dated  December  29,  1995,  between  the      --
         Company and Gary L. Borthwick  (Previously  filed as Exhibit
         10.38 to the  Company's  1996 Form  10-KSB and  incorporated
         herein by reference.)
10.40* Addendum to Employment  Agreement,  dated March 5, 1997,  between      
        the Company and Gary L. Borthwick.
10.41* Employment Agreement,  dated August 1, 1996,  between the Company     
         and Edward J. Quilty.
10.42* Employment  Agreement,  dated  December  29,  1995,  between  the      --
         Company and Robert P. DiGiovine (Previously filed as Exhibit
         10.41 to the  Company's  1996 Form  10-KSB and  incorporated
         herein by reference.)
10.43* Promissory Note, dated January 17, 1995,  between the Company and      --
         John T. Borthwick  (Previously filed as Exhibit 10.73 to the
         Company's   1995   Form   10-KSB   incorporated   herein  by
         reference.)
10.44* Promissory Note, dated January 17, 1995,  between the Company and      --
         Gary L. Borthwick  (Previously filed as Exhibit 10.74 to the
         Company's   1995   Form   10-KSB   incorporated   herein  by
         reference.)
10.45* Stock Option  Agreement,  dated  November  21,  1995,  between the     --
         Company and Margaret R. Spencer (Previously filed as Exhibit
         10.48 to the  Company's  1996 Form  10-KSB and  incorporated
         herein by reference.)
10.46* Stock Option  Agreement, dated  November  21,  1995,  between the      --
         Company and Robert W. Naismith,  Ph.D.  (Previously filed as
         Exhibit  10.50  to  the  Company's   1996  Form  10-KSB  and
         incorporated herein by reference.)
10.47* Stock Option  Agreement, dated  November  21,  1995,  between the      --
         Company and  Laurence F. Lane  (Previously  filed as Exhibit
         10.51 to the  Company's  1996 Form 10- KSB and  incorporated
         herein by reference.)
10.48* Stock Option  Agreement, dated  November  21,  1995,  between the      --
         Company and Herbert  Grossman  (Previously  filed as Exhibit
         10.52 to the  Company's  1996 Form  10-KSB and  incorporated
         herein by reference.)
10.49* Stock Option  Agreement, dated  November  21,  1995,  between the      --
         Company and Joseph V. Villasin  (Previously filed as Exhibit
         10.53 to the  Company's  1996 Form  10-KSB and  incorporated
         herein by reference.)
10.50  Asset Purchase  Agreement,  dated  June  21,  1996,  between  the      --
         Company and Morgan Paris, Inc.  (Previously filed as Exhibit
         10.01 to the Company's Form 8-K filed on June 27, 1996.)
10.51  Settlement  Agreement  and Mutual  Release,  dated June 21, 1996,      --
         between the Company and Morgan Paris, Inc. (Previously filed
         as Exhibit 10.02 to the Company's Form 8-K filed on June 27,
         1996.)
10.52  Network  Services  Agreement,  dated  May 8,  1996,  between  the      --
         Company and CompuServe,  Inc.  (Previously  filed as Exhibit
         10.01 to the  Company's  Form  10-QSB  filed on  August  13,
         1996.)
10.53  Consulting Agreement,  dated March 14, 1994,  between the Company      --
         and Mary G. Clark  (Previously filed as Exhibit 10.80 to the
         Company's  Registration Statement and incorporated herein by
         reference.)
10.54  Agreement and  Release,  dated  December  23,  1996,  between the      --
         Company and Donald F. McHale. (Previously  filed as Exhibit
         10.01  to the  Company's  Form  8-K filed on January 6, 1997)
10.60* The  Company's 401(k) Plan, dated June 30, 1995 (Previously filed      --
         as  Exhibit  10.56 to the  Company's  1996 Form  10-KSB  and
         incorporated herein by reference.)
27     Financial  Data  Schedule                                              

  ____________________
*  Management  contract or compensatory plan.

(b)  Reports on Form 8-K

     No report on Form 8-K was filed by the Company  during the fourth  quarter,
1996.


<PAGE>

                            SIGNATURES

     In accordance  with Section 13 or 15(d) of the  Securities  Exchange Act of
1934,  the  Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

March 21, 1997
                             DERMA SCIENCES, INC.



                             By:   /s/  John T. Borthwick                
                                        -----------------
                                        John T. Borthwick
                                        President and Chief Executive Officer


     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
report  has  been  signed  below  by the  following  persons  on  behalf  of the
Registrant and in the capacities indicated on March 21, 1997.


         Signatures:                         Title:


    /s/  Edward J. Quilty          Chairman of the Board
         ----------------
         Edward J. Quilty

    /s/  Mary G. Clark             Vice Chairman of the Board
         -------------
         Mary G. Clark

    /s/  John T. Borthwick         President, Chief Executive Officer
         -----------------         and Director
         John T. Borthwick        

    /s/  Gary L. Borthwick         Vice  President for Finance and  Operations,
         -----------------         Chief Financial Officer and Director
         Gary L. Borthwick         

    /s/  Joseph V. Villasin        Director
         ------------------
         Joseph V. Villasin, MD

    /s/  Margaret R. Spencer       Director
         -------------------
         Margaret R. Spencer

    /s/  Robert W. Naismith        Director
         ------------------
         Robert W. Naismith, Ph.D.

    /s/  Robert P. DiGiovine       Director
         -------------------
         Robert P. DiGiovine, RPh