# UNITED STATESSECURITIES 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, 2004      
|------ | -------------------------------------------------------------------------------------------------------------------------------------
|       |                                                                                                                                      
|[    ] | 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.(Name of small business issuer in its charter)

|Pennsylvania                                                        | 23-2328753                              
|------------------------------------------------------------------- | ----------------------------------------
|(State or other jurisdiction of
     incorporation or organization) | (I.R.S. EmployerIdentification
     No.)
|                                                                    |                                         
|214 Carnegie Center,
     Suite 100, Princeton, New Jersey          | 08540                                   
|(Address of principal executive
     offices)                       | (Zip code)                              

Registrant's telephone number: (609) 514-4744

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:

Title of Class

Common Stock, $.01 par value

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.

         YesX
     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. [    ]

Issuer's revenues for its
most recent fiscal year were $19,887,132

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 February
28, 2005, was approximately $3,822,770

The number of shares
outstanding of each of the issuer's classes of common equity, as of February 28, 2005, was 12,284,007

Documents Incorporated by
Reference:  None

---

Part I

Item 1. Description of
Business

Overview

Derma
Sciences, Inc. (Derma Sciences) was incorporated under the laws of Colorado on
September 10, 1984. On June 3, 1996 Derma Sciences changed its state of domicile to
Pennsylvania.

In
September, 1998 Derma Sciences acquired Genetic Laboratories Wound Care, Inc.
(Genetic Labs) by means of a tax-free reorganization whereby Genetic Labs
became a wholly-owned subsidiary of Derma Sciences. In December, 1999, pursuant to an
Agreement and Plan of Merger dated December 27, 1999, Genetic Labs was merged into Derma
Sciences by means of a tax-free reorganization whereby the separate corporate existence of
Genetic Labs ceased.

In
November, 1998 Derma Sciences purchased the stock of Sunshine Products, Inc.
(Sunshine Products) in a cash transaction. As a result of the stock purchase,
Sunshine Products became a wholly-owned subsidiary of Derma Sciences.

In
August, 2002 Derma Sciences acquired the assets of Dumex Medical Inc., a leading
manufacturer and distributor of wound care and related medical devices to the Canadian
market. The acquisition was effected by Derma Sciences wholly-owned Canadian
subsidiary, Derma Sciences Canada Inc. (Derma Canada) f/k/a Dumex Medical
Canada Inc.

In
January 2004, Derma Sciences purchased substantially all the assets of the Kimberly-Clark
Corporations wound care assets. These assets have been integrated into the
Companys existing wound care and wound closure and fastener product lines.

Derma
Sciences and its subsidiaries Sunshine Products and Derma Canada are referred to
collectively as the Company. The Companys executive offices are located
at 214 Carnegie Center, Suite 100, Princeton, New Jersey.

The
Company engages in the manufacture, marketing and sale of three dermatological related
product lines: wound care, wound closure and fasteners and skin care. The Companys
customers consist of various health care agencies and institutions such as nursing homes,
hospitals, home healthcare agencies, physicians offices and retail and closed door
pharmacies. The Company sells its products principally through distributors servicing
these markets in the United States and select international markets. In Canada, the
majority of the sales are made directly to hospitals. The Companys principal
manufacturing and distribution facilities are located in St. Louis, Missouri and Toronto,
Canada. The Company, through Derma Canada, maintains a manufacturing facility in Nantong,
China producing wound care products.

The Companys Markets

Wound Care

The
Company markets a line of wound care and surgical products to doctors, clinics, nursing
homes, hospitals and other institutions. The Wound Care line consists of basic and
advanced dressings, ointments and sprays designed to manage and treat a wide range of skin
conditions from basic burns, skin tears, abrasions and incontinence related skin
impairment to chronic non-healing skin ulcerations such as pressure, diabetic and venous
ulcers, surgical incisions and serious burns. Many of the Companys chronic wound
care products seek to provide an environment conducive to wound healing by addressing, in
addition to healing factors such as protection and infection control, additional healing
factors such as vitamins, minerals, zinc, moisture, pH balance and nutrition.

Wound Closure and
Fasteners

The
Company markets a line of wound closure strips, nasal tube fasteners and a variety of
catheter fasteners to doctors, clinics, nursing homes, hospitals and other institutions.
The Companys wound closure strips eliminate the need for sutures on the surface of
many surgical wounds, decrease the incidence of scarring and infection and promote wound
healing. In contrast to the characteristics of surgical tapes, these wound closure strips
yield to the movement of the skin thereby reducing traction blisters at the wound site. In
addition, these wound closure strips provide excellent adherence, optimum surgical wound
security and protection from irritation and skin shearing.

1

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The
Companys nasal tube and catheter fasteners facilitate attachment of suction tubes,
feeding tubes, urinary catheters, gastrostomy tubes, wound drainage systems, IVs and
chest tubes. These fasteners incorporate dynamic tape-to-skin adhesion which minimizes
irritation, blistering and skin shear. Further, the fasteners single piece
construction permits adoption of rapid and standardized attachment procedures.

Skin Care

The
Company markets general purpose and specialized skin care products to nursing homes,
hospitals, home healthcare agencies and other institutions. These products include bath
sponges, antibacterial skin cleansers, soaps, hair and body washes, lotions, body oil and
moisturizers. The Companys skin care products are designed to enable customers to
implement and maintain successful skin care/hygiene programs.

The Companys Products

Descriptions
of the Companys principle products and their intended uses are set forth below:

Wound Care Product Line

|                                      |  | Primary Dressings - Wound Care                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Dermagran® Ointment                   |  | Topical ointment with a lanolin odor, packaged in both jars
     and tubes. Active ingredient: aluminum hydroxide gel. Used to manage stage I pressure and venous ulcers, incisions, burns and
     other skin irritations.                                                                                                                                                                                                                                     
|                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Dermagran® Spray                      |  | Colorless, odorless liquid, packaged in opaque plastic
     bottles with pump spray nozzles. Active ingredient: zinc acetate. Used to manage stage I pressure and venous ulcers,
     incisions, burns and other skin irritations.                                                                                                                                                                                                                              
|                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Dermagran® Hydrophilic Wound Dressing |  | Advanced zinc hydrogel formulation impregnated in gauze pad.
     Used for the management of stages II through IV pressure sores, diabetic ulcers, venous stasis ulcerations, thermal burns,
     surgical incisions and superficial lacerations, cuts or abrasions. Also packaged in tubes and sold as Dermagran®-B
     Hydrophilic Wound Dressing.                                                                                                           
|                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                      |  | Primary Dressings - Hydrocolloid Dressings                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Primacol Hydrocolloid Dressing        |  | Sterile, transparent, hydrocolloid dressing packaged in
     various sizes to accommodate different uses. Used to protect the wound from outside contamination such as bacteria, fecal
     mater, or urine. Available in the following configurations: Primacol Bordered Hydrocolloid Dressing, Primacol Thin
     Hydrocolloid Dressing, Primacol Specialty Hydrocolloid Dressing  Sacral and Primacol Specialty Hydrocolloid Dressing
      Heel and Elbow.
|                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                      |  | Primary Dressings - Calcium Alginate Dressings                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Algicell Calcium Alginate Dressing    |  | Sterile dressing containing alginate ropes. Used for the
     absorption of moderate to large amounts of wound exudate and management of minor bleeding.                                                                                                                                                                                                                                                                                                        

2

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|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------------------------------------------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                 |  | Primary Dressings - Hydrogel Dressings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|AquaSite Amorphous Hydrogel Dressing             |  | Clear sterile gel packaged in bellows and tubes. Used for
     filling wounds, while keeping them moist, and absorbing small to moderate amounts of wound exudate.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|AquaSite Impregnated Dressing                    |  | Sterile, gauze dressing (either non-woven or sponge)
     impregnated with absorbent hydrogel. Used for packing wounds and treating lightly exudating, partial or full thickness
     wounds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                 |  | Primary Dressings - Foam Dressings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|HydroCell Foam Dressing                          |  | Sterile polyurethane foam sheet with protective film. Used to
     protect the wound from outside contaminants. Available in adhesive and non-adhesive forms in the following configurations:
     HydroCell Adhesive Foam Dressing and HydroCell Thin Adhesive Foam Dressing.                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|SorbaCell Foam Dressing                          |  | Sterile foam dressing used to absorb exudate while cushioning
     and protecting the wound.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|Petrolatum Gauze Non-Adhering Dressing           |  | Sterile, latex free petrolatum impregnated dressings are
     designed to provide non-adherent packing for full thickness wounds providing a moist environment conducive to wound healing.
     They are made of fine, soft, conformable gauze impregnated with white petrolatum. Being non-adherent, removal of these
     dressings causes minimal trauma to the wound bed and patient. Used for management of full thickness chronic wounds such as
     pressure ulcers (stages II-IV), tunneling wounds and non-infected wounds. The overwrap version of these dressings
     provides an additional layer of sterility for use in environments such as operating rooms.                                                      
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|Xeroform Petrolatum Non-Adhering Dressing        |  | Sterile, latex free Xeroform petrolatum dressing are designed
     to provide non-adherent packing for wounds, providing a moist environment conducive to wound healing. They are made of fine,
     soft, conformable gauze impregnated with 3% bismuth tribromophonate. Being non-adherent, removal of these dressings causes
     minimal trauma to the wound bed and patient. They are the impregnated dressings of choice for applications where mild
     medication or deodorizing are required, such as post-operative applications, 1st and 2nd degree burns and skin grafts. The
     overwrap version of these dressings provides an additional layer of sterility for use in environments such as
     operating rooms.
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|Shur-Conform® Oil Emulsion Non-Adhering Dressing |  | Sterile, latex free oil emulsion impregnated dressings are
     designed to provide non-adherent packing for wounds, providing a moist environment conducive to wound healing. They are made
     of a knitted cellulose acetate fabric coated with a formulated petrolatum emulsion. The knitted fabric allows wound fluid to
     move through the dressing and into a secondary absorbent dressing. Being non-adherent, removal of these dressings causes
     minimal trauma to the wound bed and patient. Used for the management of skin grafts, surgical sites, abrasions, lacerations
     dermal ulcers and cosmetic surgery sites.                                                                                         
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                 |  | Primary Dressings - Silver                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|Silver Dressing                                  |  | Dressing Sterile, silver plated nylon fabric in a wide range
     of dressings for wound and burn care. Long lasting (up to 7 days) with superior anti-microbial properties.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

3

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|                                                                      |  | Primary Dressings - Gauze Dressings and Sponges                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|DuCare® Gauze Dressings/ Sponges  Non-Sterile and
     Sterile       |  | Woven sponges made from 100% USP cotton. Used for general use
     or for debriding, covering, and packing wounds. Also available as non-woven sponges/dressings (DuSoft Non-Woven
     Dressings/Sponges  Non-Sterile and Sterile) and pre-slit for use with tracheotomies.                                                                                                                                                                                                             
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Packing Strips                                                        |  | Sterile gauze strips used to fill or pack wounds and prevent
     premature wound closure. Strips are also available impregnated with Iodoform.                                                                                                                                                                                                                                                                                                                                           
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                      |  | Primary Dressings - Sponges                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Durlix® 100% Cotton 6 Ply Fluff Sponge  Non Sterile
     and Sterile |  | Gauze sponges made from 100% cotton. Used for absorbing wound
     exudate and packing wounds.                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                      |  | Secondary Dressings - Bandages                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Conforming Bandages                                                   |  | Stretch gauze bandages used as secondary dressing for
     wrapping legs and arms and to hold dressings in place. Available in the following configurations: Dutex® 100% Cotton 2
     Ply Conforming Bandage  Non-Sterile and Sterile, Durlex® Bandage Rolls  Non Sterile and Sterile, DuForm®
     Knitted Synthetic Conforming Bandage  Non-Sterile and Sterile, DuForm® Synthetic Conforming Bandage and DuFlex®
     Woven Synthetic Conforming Bandage  Non-Sterile and Sterile.
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Gazetex® Bandage Rolls  Non Sterile and Sterile                      |  | Washed low-linting woven gauze rolls. Used for wrapping or packing large and deep wounds.                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Compression Bandaging Systems                                         |  | Latex free systems of multiple layers used for graduated
     compression on venous leg ulcers. The Companys bandaging systems are available in the following configurations: DuBoot
     Two-Layer Paste Compression Bandaging System, TresFlex Three-Layer Compression Bandaging System and DuFore Four Layer
     Compression Bandaging System.                                                                                                                                       
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|UnnaPress® Paste Bandage                                              |  | Latex free bandage (with or without calamine lotion). Used
     for maintaining a moist wound environment, resisting edema formation, and protecting the wound from external contamination
     and mechanical disruption during the healing process.                                                                                                                                                                                                                                     
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|ElasTive Elastic Adhesive Bandage                                     |  | Latex free, non-allergenic, adhesive bandage made of 100% cotton. Used to conform to body contours
     without restriction.                                                                                                                                                                                                                                                                                                                                                              
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|DuSor Elastic Bandage Premium and Economy                             |  | Latex free, cotton-wrapped bandage with heat resistant rubber
     strands. Used for firm compression and vascular and muscle support. Available in premium and economy versions as well as with
     a velcro closure (PrimaCare Elastic Bandage with Velcro Closure).                                                                                                                                                                                                                 
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                      |  | Operating Room Sponges                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Laparotomy Sponges  Non-sterile and Sterile, X-Ray
     Detectable   |  | Pre-washed or non-washed low lint, X-Ray detectable sponges
     used to absorb blood and other fluids during surgery.                                                                                                                                                                                                                                                                                                                                                                    
|                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|DuPaque Non-Sterile and Sterile X-Ray Detectable Gauze
     Sponges   |  | Opaque sponge made of 100% USP fine mesh absorbent cotton
     with folded edges. Used to absorb blood and other fluids during surgery. Includes an X-Ray detectable mono-filament thread.                                                                                                                                                                                                                                                                                                

4

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|                                                                |  |                                                                                                                                                                                  
|--------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                |  | Secondary Dressings - Abdominal Pads                                                                                                                                             
|                                                                |  |                                                                                                                                                                                  
|DuPad® Sealed-End Abdominal Pads  Non-Sterile and
     Sterile |  | Sealed-end, absorbent secondary dressing used to absorb and
     disperse wound exudate.                                                                                         
|                                                                |  |                                                                                                                                                                                  
|                                                                |  | Secondary Dressings - Burn Dressings                                                                                                                                             
|                                                                |  |                                                                                                                                                                                  
|DuPress Sterile Burn Dressing                                   |  | Gauze dressing filled with cellulose. Used to absorb large
     amounts of fluids and minimize trauma and adherence to the wound.                                                
|                                                                |  |                                                                                                                                                                                  
|                                                                |  | Secondary Dressings - Wound Cleansing Products                                                                                                                                   
|                                                                |  |                                                                                                                                                                                  
|Sterile Water or Saline                                         |  | Sterile water or saline packaged in plastic squirt bottles
     for use in wound cleansing.                                                                                      
|                                                                |  |                                                                                                                                                                                  
|                                                                |  | Other                                                                                                                                                                            
|                                                                |  |                                                                                                                                                                                  
|Enteral Feeding Systems                                         |  | Enteral feeding systems distributed by Derma Canada and sold
     exclusively in Canada. Used to administer nutrients to patients unable to feed themselves through normal means.

Wound Closure and Fastener Product Line

|Suture Strip and Strip Plus® Wound Closure
     Strips |  | Latex-free, sterile, flexible, moisture resistant wound
     closure strips made of a macroporous non-woven polyamide and adhesive. Used in surgical and wound closure procedures.                                                                                                                                                                                                      
|------------------------------------------------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                       |  |                                                                                                                                                                                                                                                                                                                                                                                         
|Shur Strip® Wound Closure Strips                       |  | Shur Strips provide an alternative to our Suture Strips that
     are more similar to the market leading brand. Shur Strips are latex free sterile skin closure strips that are made of a
     porous, non-woven backing coated with a pressure-sensitive, hypoallergenic adhesive. These strips are rigid thereby keeping
     wound edges securely together to maximize wound healing.
|                                                       |  |                                                                                                                                                                                                                                                                                                                                                                                         
|UC Strip® Catheter Tubing Fastener                     |  | Latex-free, flexible, moisture resistant, one-piece
     catheter/tubing fastener made of a macroporous non-woven polyamide with adhesive. Used to secure urinary and gastrostomy
     catheter tubing to the patient.                                                                                                                                                                  
|                                                       |  |                                                                                                                                                                                                                                                                                                                                                                                         
|Cath-Strip® Recloseable Catheter Fastener              |  | Latex-free, flexible, moisture resistant multi-use
     recloseable catheter fastener with adhesive. Used with urinary catheters, gastrostomy and jejunostomy tubes, wound drainage
     systems, central line catheters, and multi-port IVs.                                                                                                                                           
|                                                       |  |                                                                                                                                                                                                                                                                                                                                                                                         

Skin Care Product Line

|                         |  | Skin Care and Personal Hygiene Products                                                                                      
|------------------------ |  | -----------------------------------------------------------------------------------------------------------------------------
|                         |  |                                                                                                                              
|Soft Wash Bathing Sponge |  | Latex-free, no rinse, single use bath sponge impregnated with
     a gentle soap and moisturizers.                           
|                         |  |                                                                                                                              
|Optima Bath Additive     |  | Bath additive or after-bath moisturizer enhanced with
     acetylated lanolin alcohol. Used to lubricate and soften the skin.

5

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|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|----------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Hydro-soft Skin Conditioner                           |  | Concentrated blend of skin emollients and gentle skin
     cleansers for moisturizing and conditioning the skin. Used in whirlpool and hydrotherapy units.                                                                                                                                                                                                                                                  
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|Hair and Skin Cleansers and Washes                    |  | The Company has various hair and skin cleansers/washes: Swash
     Conditioning Shampoo and Body Wash, Therabath Hair and Skin Cleanser, Hospi Bath Hair and Skin Cleanser, Bathe Away® Hair
     and Skin Cleanser and ApriVera® Hair and Skin Cleanser with AloeVera, Primaderm® Anti-Dandruff Shampoo, Primaderm No
     Rinse Shampoo and Body Wash and fragrance free Primaderm Body and Hair Cleanser.
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                      |  | Skin Conditioners and Moisturizers                                                                                                                                                                                                                                                                                                                                                                          
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|Skin Care Lotion                                      |  | Lotion to moisturize and soften the skin.                                                                                                                                                                                                                                                                                                                                                                   
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|Primaderm® Skin Protectant Lotion with 3% Dimethicone |  | Greaseless and non-staining dry skin moisturizer designed to
     prevent and relieve chapped and cracked skin.                                                                                                                                                                                                                                                                                             
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                      |  | Incontinence Products                                                                                                                                                                                                                                                                                                                                                                                       
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|In-Between® Perineal Spray Skin Cleanser              |  | An odor eliminating skin cleanser used to cleanse the entire
     perineal skin area.                                                                                                                                                                                                                                                                                                                       
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|Dermagran® 3-N-1                                      |  | High foaming, pH balanced all-over body cleanser. Used as a
     no rinse perineal/skin cleanser and shampoo. Contains cleansing agents designed to dissolve fecal soils resulting from
     incontinence. Enhanced with Aloe Vera and other emollients to soothe and moisturize delicate and fragile skin. Contains zinc
     and Vitamin B6 to optimize skin integrity.                                   
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|Dermagran® GP General Skin Protectant Ointment        |  | An ointment containing allantoin and aloe vera gel. Used as a
     moisture barrier on external skin areas where repeated exposure to body excrements and exudates may cause skin break down.
     May be used as skin barrier on friction points.                                                                                                                                                          
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|Dermagran® BC Perineal Protectant Ointment            |  | An ointment consisting of a non-greasy formulation based upon
     the Company's proprietary Zinc-Nutrient and balanced pH technology. Used as a protectant against minor skin irritations due
     to moisture, urine, feces and perspiration.                                                                                                                                                             
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                      |  | Skin Protectants                                                                                                                                                                                                                                                                                                                                                                                            
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|Dermagran® AF Antifungal Ointment                     |  | An ointment containing miconazole nitrate and the
     Companys Zinc-Nutrient and balanced pH technology. Used for maintaining healthy skin and providing a long-acting
     barrier against moisture. Miconazole nitrate is used to treat jock itch, ringworm and athletes foot.                                                                                                                         
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                      |  | Sanitizing Products                                                                                                                                                                                                                                                                                                                                                                                         
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|Mysotrol® No rinse Hand Sanitizer                     |  | Waterless, no rinse hand sanitizer containing ethyl alcohol.
     Provides germicidal and virucidal action and meets OSHA protocol for a healthcare personnel handwash while reducing the risk
     of nosocomial infections.                                                                                                                                                                               
|                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                             
|Antibacterial Soap                                    |  | An antibacterial soap containing chloroxylenol used to reduce
     nosocomial infections including both gram-positive and gram-negative organisms as well as yeast and fungus in institutional
     environments.                                                                                                                                                                                           

6

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|                                              |  |                                                                                                                                                                                                                                                                            
|--------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Bacti-Guard Antibacterial Hand Soap           |  | An antibacterial hand soap containing triclosan, aloe vera
     and glycerin. Used to reduce nosocomial infections including both gram-positive and gram-negative organisms, as well as yeast
     and fungus in institutional environments.                               
|                                              |  |                                                                                                                                                                                                                                                                            
|Whirlpool/Hard Surface Detergent/Disinfectant |  | A detergent used specifically for cleaning hard surfaces and
     whirlpool units in nursing homes, hospitals and other institutions. Also effective as a bactericide, mildewstat, sanitizer,
     virucide and fungicide in the presence of organic soil (5% blood serum).
|                                              |  |                                                                                                                                                                                                                                                                            

Distribution and Sales

United States

In
the United States, the Company employs a direct sales force, manufacturers representatives
(when circumstances warrant) and a number of national, regional and local distributors
(with their own sales forces) to sell the Companys products. The majority of the
Companys sales are made to national, regional and local distributors and large
institutional customers who sell the products to end users. Direct sales to end users are
not a significant part of the Companys business.

The
Companys direct sales force consists of a Vice President  Sales and Marketing,
a Vice President  Corporate Accounts and three Regional Sales Managers together with
varying numbers of manufacturers representatives as market opportunities require. Company
sales employees receive a base salary together with commissions based upon sales and gross
profit achievement within their area of responsibility. Manufacturers representatives
receive commissions based upon sales in their territory and market segment.

Canada

In
Canada, the Company employs a Sales Manager, two direct sales representatives, one each in
Ontario and Quebec, the two most densely populated provinces, and a manufacturers
representative located in British Colombia.

Company sales employees receive a base salary
together with commissions based upon sales and gross profit achievement within their areas
of responsibility. The majority of the Companys Canadian sales are to hospitals
pursuant to tender contracts with national, provincial and local buying groups. These
institutional contracts are generally exclusive in nature and are awarded for a term of 1
to 5 years. Sales in the provinces of Saskatchewan and Newfoundland are made through
dealers. Nursing home, home healthcare, physician office and retail sales are for the most
part made through local dealers and government sponsored Community Care Access Centres
(CCAC) agencies. The Company also conducts business through a number of distributors.

The
majority of the Companys Canadian products are distributed directly to end users
through the Companys distribution facility servicing Ontario, Quebec, the Maritime
Provinces and a network of public warehouses strategically located throughout Western
Canada. Distribution of products in Saskatchewan and Newfoundland are made to the dealers
servicing those provinces.

Other Foreign Markets

The
Companys products are sold throughout the rest of the world through various
licensing and distribution agreements. Foreign sales are made principally to Europe and
Latin America. Sales made to other foreign markets totaled approximately $963,000 in 2004
and $773,000 in 2003.

Competition

The
wound and skin care sectors of the medical products industry are characterized by rapidly
evolving technology and intense competition. Many suppliers of competing products are
considerably larger and have much greater resources than the Company. In addition, many
specialized products companies have formed collaborations with large, established
companies to support research, development and commercialization of wound and skin 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 and skin care products on their
own or through joint ventures.

7

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In
the United States, the Companys basic wound care products compete in a very
competitive commodity oriented marketplace with Kendall Tyco, Medical Action and a number
of others. In the advanced wound care products marketplace, the Company competes
principally with Bristol-Myers Squibb  Convatec, Smith & Nephew and Johnson
& Johnson. The market for wound closure strips and catheter fasteners is characterized
by a wide range of generic competition. The most dominant competitor in the suture strip
market is 3M. The Companys skin care products compete in a commodity oriented
marketplace with Provon, Chester Laboratories, Calgon Vestal  Steris and a number of
others.

In
Canada, the Companys basic wound care products compete in a very competitive
commodity-oriented marketplace with Kendall Tyco, Medicom, Medical Mart, Johnson &
Johnson, Source Medical and a number of others. In the advanced wound care products
marketplace, the Company competes principally with the same competitors as it competes
with in the United States together with a number of domestic generic companies.

The
ability of the Company to remain competitive is based on its ability to provide its
customers with a broad range of quality products, at a competitive price with superior
customer service. The prospective ability to cost effectively develop and or acquire and
commercialize new products that provide superior value is an integral component of the
Companys ability to stay competitive. The Company believes that the breadth and
quality of its existing product lines, the infrastructure in place to cost effectively
source and market its products and the skill and dedication of its employees will allow
the Company to successfully compete.

Product Sourcing

The
Company maintains manufacturing facilities in St. Louis, Missouri, Toronto, Canada and
Nantong, China. The St. Louis facility manufactures the Companys line of skin care
products with the exception of the patient bathing sponge. The Toronto and Nantong
facilities manufacture the Companys line of basic and advanced wound care products.
The Derma line of wound care, wound closure-fastener products and the patient bathing
sponge are outsourced. A number of basic and advanced wound care products are sourced in
semi-finished and finished form directly from suppliers. Derma Canada also serves in a
distributor capacity (sourcing finished product directly from suppliers) for a number of
medical device products in Canada.

The
Company maintains a long-standing network of suppliers for its outsourced products. The
majority of the Companys outsourced products utilize readily available components.
Accordingly, there are numerous companies capable of manufacturing these products to
applicable regulatory standards. Given the ready availability of other suppliers, as well
as the Companys policy regarding maintenance of adequate safety stock levels, the
Company does not believe that a temporary interruption in supply or loss of one or more of
its suppliers would have a long-term detrimental impact on its operations.

The
Nantong facility is ISO 9002 certified. The Toronto facility is ISO 9001 2000/ISO 13485/EN
46001 certified. The Company requires that all of its suppliers conform to the standards
set forth in the Good Manufacturing Practice (GMP) regulations promulgated by
the United States FDA and local health agencies.

Patents, Proprietary and
Non-Proprietary Technology

Under
the title Two-Step Procedure for Indolent Wound Healing and Aqueous Medium and
Topical Ointment Used in Connection therewith, the Companys Dermagran Ointment
and Dermagran Spray incorporating a unique Zinc Nutrient formulation and balanced pH
technology have received patent protection in the United States and a number of foreign
countries.

Under
the title Topical Barrier Composition Containing Silicone and Bentonite, the
Companys Dermagran BC (barrier cream) has received patent protection in the United
States for its non-greasy formulation offering a long lasting barrier effect. This patent
will expire in the year 2017.

8

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The
Company also has patents on its line of wound closure Suture Strips and line of catheter
and tube fasteners comprised of NG Strips, UC Strip and Cath-Strip in the United States
and United Kingdom incorporating an exclusive non woven material and skin friendly
adhesive designed to provide the superior performance of dynamic adherence. These patents
begin to expire in the year 2005.

The
Company has a trademark on the name Derma Sciences in the United States and
Dumex in the United States and Canada. A significant number of the
Companys products in the United States are trademarked. The Company possesses a
number of non-patented formulations and process technologies that provide competitive
advantages in the marketplace.

The
Company believes the aforementioned patents, proprietary and non-proprietary technology
affords reasonable protection to the Company against the unauthorized copying of the
technology embodied in the subject products. However, the specific means whereby these
products promote wound healing and skin care are unknown and the chemical and biological
processes bearing upon wound healing and skin care are highly complex and subject to a
wide variety of influences and stimuli. As such, it is possible that competitors will
develop products equal to or superior to those of the Company without infringing upon the
Companys intellectual property.

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 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 the outcome.

An
important component of the Companys growth strategy is to acquire, by purchase or
license, both proprietary and non-proprietary wound and skin care technology. There can be
no assurance that the Company will be able to obtain such technology on acceptable terms,
if at all. Future inability to acquire or license wound and skin care technology could
have a material adverse effect on the Companys business.

Government Regulation

United States 
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. The
United States Food and Drug Administration (FDA) is responsible for
enforcement of the Federal Food, Drug and Cosmetic Act, as amended, (FDC Act)
which regulates drugs and devices manufactured and distributed in interstate commerce.
Many of the Companys products are classified either as over-the-counter 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 over-the-counter drugs and devices. All states have
individual laws that resemble the FDC Act and the FTC Act.

Medical
Devices

The
FDC Act requires that all devices for human use marketed in the United States prior to May
28, 1976 (Pre-amendment 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, record-keeping
requirements, labeling requirements, and Good Manufacturing Practice (GMP)
regulations.

The
following products are registered with the FDA as Class I devices pursuant to
the regulations under Section 510(k) of the FDC Act: Dermagran Zinc-Saline Dressing,
Dermagran Hydrogel Wound Dressing, Dermagran Hydrophilic Wound Dressing, Dermagran-B
Hydrophilic Wound Dressing, Dermagran Wound Cleanser, Suture Strip, NG Strip, Cath-Strip
and UC Strip.

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.

9

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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. Approval of Class III devices may require several years.

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 Pre-amendment Device. Those that are
substantially equivalent to a Pre-amendment Device are given the same classification as
the equivalent Pre-amendment Device. New devices which are not substantially equivalent to
Pre-amendment Devices are automatically placed in Class III thereby 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 Pre-amendment Device. If the FDA
determines that the device is not substantially equivalent to a Pre-amendment Device, it
is automatically placed 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. However, the manufacturer may request that the FDA reclassify the device by filing
a reclassification petition. All of the devices currently marketed by the Company, with
the exceptions of Sterile Water and Sterile Saline, have been found by the FDA to be
substantially equivalent to a Pre-amendment Device and are, therefore, classified in Class
I. Sterile Water and Sterile Saline are classified in Class II.

Over-the-Counter
Drugs

Prescription
drugs may be dispensed only 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.
Those of the Companys products which are classified as over-the-counter drugs
pursuant to the FDC Act are: Dermagran Spray, Dermagran Ointment, Mysotrol, Antibacterial
Soap, Dermagran AF, Dermagran BC, Dermagran GP, Primaderm Anti-Dandruff Shampoo and
Primaderm Skin Protectant Lotion with 3% Dimethicone.

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 regulatory action. Any OTC
drug not in compliance with the content and labeling requirements of a Final Monograph is
subject to 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, Dermagran Ointment, Dermagran AF, Dermagran BC, Dermagran GP, Primaderm
Anti-Dandruff Shampoo and Primaderm Skin Protectant Lotion with 3% Dimethicone 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 has
resulted in the issuance of a final monograph specifying those active ingredients which
are permitted in, and defining labeling requirements for, such products. The FDA has
released its final monograph for skin protectant drug products for OTC human use which
became effective June 4, 2004.

10

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Canada  Scope of
Regulation

Medical
Devices

The
Medical Devices Regulations have been established under the authority of the Food and
Drugs Act and apply to all medical devices imported and sold in Canada. The Medical
Devices Bureau of the Therapeutic Products Directorate is the national authority that
monitors and evaluates the safety, effectiveness and quality of diagnostic and therapeutic
medical devices in Canada.

On
July 1, 1998 the Medical Devices Regulations set forth the requirements governing the
sale, importation and advertisement of medical devices in Canada. Regulatory scrutiny is
applied in these areas based on risk management principles that classify medical devices
into four classes, with Class I representing the lowest risk and Class IV the highest.

Every
medical device imported or sold in Canada, with the exception of Class I medical devices,
is required to be licensed prior to being imported or sold. A device license will be
issued to the manufacturer of a device if it is determined that the device meets
applicable safety and effectiveness requirements. Although Class I devices do not require
a license, they are monitored through Establishment Licenses. An Establishment License
permits importers, distributors and manufacturers of Class I devices to operate in Canada
without using a licensed importer.

As
of January 1, 2003, manufacturers of Class II, III and IV devices are required to have a
quality system registered to ISO 13485 or ISO 13488 by a registrar recognized by Health
Canada. Proof of registration must be submitted with any new license application after
January 1, 2003 and with the renewal of existing licenses after November 1, 2003.

The
following Company products have been licensed as Class II products with the Therapeutic
Products Directorate: Cotton Gauze Packing  X Ray detectable, Packing strips 
Cotton, Dupaque X Ray Detectable Sponges, Bulb Syringe for irrigation, Tonsil Sponges, Eye
Spear, Hydrogel Wound Dressing, Surgical Sponges, Calcium Alginate Dressing, Sterile
Gastrostomy Tube, Foam Dressing, Composite Dressing, Laparotomy Sponges, Tracheostomy
Sponges, Hydrocolloid Dressing Sterile, Petrolatum Gauze Non-Adhering Dressing, Xeroform
Petrolatum Non-Adhering Dressing and Shur-Conform Oil Emulsion Non-Adhering Dressing.

Drugs

The
Health Products and Food Branch Inspectorate of Health Canada is mandated to regulate
drugs and the processes used to manufacture drugs. A Drug Establishment License is
required for activities such as fabrication, packaging/labeling, importation,
distribution, wholesale and testing. Derma Canada underwent an inspection by Health
Products and Food Branch Inspectorate on September 28, 2004 which successfully resulted in
the renewal of its Drug Establishment License.

Once
a drug has been approved, the Therapeutic Products Directorate issues a DIN (Drug
Identification Number) which permits the manufacturer to market the drug in Canada. A DIN
lets the user know that the product has undergone and passed a review of its formulation,
labeling and instructions for use. A drug product sold in Canada without a DIN is not in
compliance with Canadian Law. The Companys product, Iodoform Packing Strip 5% W/W,
has been assigned a DIN number by Health Canada.

Registration and Status
of Derma Canada Products Sold in United States

All
products manufactured at Derma Canada are Class I devices with the exception of Sterile
Water and Sterile Saline which are classified as Class II devices.

Derma
Canada has passed inspection by the United States Food and Drug Administration.

11

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Other Foreign Regulatory
Authorities

Whether
or not FDA approval has been obtained, approval of medical drugs and devices by regulatory
authorities in foreign countries must be obtained prior to marketing drugs and devices 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.

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 future local, state, federal and foreign
regulation.

The
Company is also 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.

Third Party Reimbursement

In
the United States, the Company sells its wound care products to nursing homes, hospitals,
home healthcare agencies, retail and closed door pharmacies and similar
institutions. The patients at these institutions for whose care the Companys
products are purchased often are covered by medical insurance. Accordingly, the
Companys customers routinely seek reimbursement for the cost of the Companys
wound care products from third party payors such as Medicare, Medicaid, health maintenance
organizations and private insurers. The availability of reimbursement from such third
party payors is a 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. 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. In 2004, Medicaid sales were 2% of total Company sales and 34%
of sales for products subject to Medicaid rebates. Medicaid rebates represent less than 1%
of net sales.

Medicare
is a federally funded program administered by private insurance companies. Medicare
insurance generally is available to individuals who have paid social security taxes and
are over the age of 65 years. Several of the Companys wound care and fixation
products are eligible for Medicare reimbursement.

The
Prospective Payment Systems (PPS) enacted by Congress as part of the Balanced Budget Act
of 1997 places per capita (per patient) limits on the amount of Medicare
payments for goods and services provided by skilled nursing facilities. PPS has generally
had a negative impact on the long-term care industry as well as suppliers to this
industry, including the Company.

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 mandatory rebates
for wound care products. As such, there is uncertainty as to whether, and to what extent,
reimbursements for the Companys products will continue to be available. Likewise,
there is uncertainty as to the future extent of the Companys rebate obligations.

12

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Product Development

The
Company conducts limited product development activities. The Companys development
resources are directed towards line extensions and coordinating and implementing changes
to product and packaging specifications. The Company relies heavily on purchasing and
licensing of products to expand its product lines.

Employees

The
Company maintained 145 full-time and 3 part-time employees at December 31, 2004. Of these
employees, 35 are located in the United States, 68 in Canada and 45 in China. The Company
considers its employee relations to be satisfactory.

Item 2. Description of
Property

The
Companys executive offices are located in Princeton, New Jersey. The Company has a
lease for its executive office space, at a rate of $10,421 per month, that expires in
August, 2007. The Company has a three year lease for 24,000 square feet of office, light
manufacturing and warehouse space in St. Louis, Missouri expiring in January 2007 at a
rate of $7,663 per month and a month-to-month lease for 2,000 additional adjacent square
feet of warehouse space in St. Louis at a rate of $1,000 per month. In March 2004, the
Company leased a 42,400 square foot warehouse in Fenton, Missouri at a rate of $11,951 per
month that expires in March 2009. The Fenton, Missouri facility serves as the United
States distribution center for the Companys products while the St. Louis, Missouri
facility is used primarily for light manufacturing.

Derma
Canada maintains a lease for 51,700 feet of executive office and manufacturing space, at a
rate of $18,820 per month, that expires in August, 2012 and a lease for a 20,400 square
foot distribution facility, at a rate of $7,135 per month, that expires in August, 2009,
both located in Toronto, Canada. A subsidiary of Derma Canada also leases a 11,400 square
foot manufacturing facility in Nantong, China, at a rate of $1,010 per month, that expires
in June, 2008. Derma Canadas facilities are adequate to meet its manufacturing and
distribution requirements for the foreseeable future.

Item 3. Legal Proceedings

The
Company is not a party to any material litigation.

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, 2004.

13

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Part II

Item 5. Market for Common Equity, Related Shareholder Matters
and Small Business Issuer Purchases of Equity Securities

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

`Quarter Ended                         High        Low
                    -------------                         ----        ---
                          2003
                          ----
                    March 31, 2003                        $0.60      $0.35
                    June 30, 2003                         $2.10      $0.36
                    September 30, 2003                    $2.30      $0.75
                    December 31, 2003                     $1.45      $0.90

                          2004
                          ----
                    March 31, 2004                        $1.90      $1.08
                    June 30, 2004                         $1.32      $0.56
                    September 30, 2004                    $0.75      $0.43
                    December 31, 2004                     $0.90      $0.47`

The
stock prices reflect inter-dealer prices without retail mark-up, mark-down or commission
and may not necessarily represent actual transactions. There is no public market for the
Companys preferred stock. As of the close of business on February 28, 2005, there
were 1,193 holders of record of the Common Stock. The Company has paid no cash dividends
in respect of its Common Stock and does not intend to pay cash dividends in the near
future.

Item 6. Management's Discussion and Analysis or Plan of
Operations

Reference to Consolidated
Financial Statements

Managements
Discussion and Analysis or Plan of Operations should be read in conjunction with the
Companys consolidated financial statements and notes to consolidated financial
statements set forth below under Item 7.

Results of Operations

Overview

The
2004 and 2003 operating results include Derma Sciences, Inc. and its subsidiaries.
Operating results for the assets purchased from Kimberly-Clark Corporation are included in
the 2004 operating results from January 9, 2004, the date of purchase. Unless otherwise
indicated by the context, the term Canadian operations is used throughout this discussion
in reference to the operations of Derma Sciences Canada Inc. and the term U.S. operations
is used throughout this discussion in reference to the Companys U.S. operations.

The
Company engages in the manufacture, marketing and sale of three dermatological product
lines consisting of wound care, wound closure and fasteners and skin care. The wound care
line is composed of basic and advanced wound care products. Basic wound care consists of
gauze dressings, abdominal pads, laparotomy sponges, burn dressings and bandages. Advanced
wound care products consist of ointments, packing strips, hydrogel dressings, hydrocolloid
dressings, foam dressings and impregnated gauze dressings. The wound closure and fastener
line consists of wound closure strips and a variety of catheter fasteners. The skin care
line consists of bath sponges, skin cleansers, soaps, hair and body washes and
moisturizers.

14

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The
following table highlights 2004 versus 2003 operating results:

`Year Ended December 31
                                       ----------------------
                                        2004               2003                      Variance
                                        ----               ----                      --------

Net sales                            $19,887,132         $17,941,451        $ 1,945,681        10.8%
Cost of sales                         14,623,223          11,803,902          2,819,321        23.9%
                                      ----------          ----------          ---------

Gross profit                           5,263,909           6,137,549           (873,640)      (14.2%)
Gross profit percentage                   26.5%               34.2%
Operating expenses                     7,087,513           6,059,516          1,027,997        17.0%
Interest expense                         227,305             263,253            (35,948)      (13.7%)
Other expense (income), net              287,784            (207,461)           495,245        --
                                        --------           ----------           -------

Total expenses                         7,602,602           6,115,308          1,487,294        24.3%
                                       ---------           ---------          ---------
(Loss) income before income taxes     (2,338,693)             22,241         (2,360,934)
Provision for income taxes                  --                  --                 --            --
                                      -----------          ---------         -----------

Net (loss) income                    $(2,338,693)        $    22,241        $(2,360,934)
                                      ===========         ==========         ===========`

Sales and Gross Profit

The following
table highlights 2004 versus 2003 product line net sales and gross profit:

`Year Ended December 31
                                       ----------------------
                                        2004               2003                      Variance
                                        ----               ----                      --------
Product Line Net Sales
----------------------
Wound care                           $14,609,033         $12,873,602         $1,735,431        13.5%
Wound closure and fasteners            3,339,432           3,005,517            333,915        11.1%
Skin care                              1,938,667           2,062,332           (123,665)       (6.0%)
                                       ---------           ---------           ---------

    Totals                           $19,887,132         $17,941,451         $1,945,681        10.8%
                                      ==========          ==========          =========

Product Line Gross Profit
-------------------------

Wound care                            $3,201,239          $4,150,237          $(948,998)      (22.9%)
Wound closure and fasteners            1,690,466           1,467,747            222,719        15.2%
Skin care                                372,204             519,565           (147,361)      (28.4%)
                                        --------           ---------           ---------

    Totals                            $5,263,909         $ 6,137,549          $(873,640)      (14.2%)
                                       =========          ==========           =========`

Wound
care sales increased $1,735,431, or 13.5%, to $14,609,033 in 2004 from $12,873,602 in
2003. The increase was partially attributable to an increase in basic wound care product
sales of $885,352, or 9.1%. This increase was driven by continued strong growth in the
U.S. of $558,023, or 43.5%, growth of $911,357, or 11.5%, in the core Canadian business
(comprised of 3.6% real growth and 7.9% related to a 7.4% strengthening of the Canadian
dollar) partially offset by a $553,371 decrease in Canadian sales associated with the sale
of the narcotics business and loss of contract manufacturing business in 2003. The
increase in wound care sales was also attributable to an increase in advanced wound care
sales of $850,079, or 27.5%. This increase was driven by new private label business of
approximately $560,000 with U. S. distributors, $393,767 related to growth of new silver
products launched in late 2003 and incremental sales of $1,130,000 associated with the
acquisition the Kimberly-Clark Corporation wound care business in January 2004, partially
offset by a $1,237,475, or 40.3%, reduction in Dermagran sales due to a successful 2003
year end promotion and increasing competitive pressure.

15

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Wound
care gross profit declined $948,998, or 22.9%, to $3,201,239 in 2004 from $4,150,237 in
2003. Gross profit margins declined to 21.9% in 2004 from 32.2% in 2003. Gross profit and
margin erosion occurred in both the basic and advanced wound care segments of the line.
The main drivers of the decrease were the sales decline in the high margined Dermagran
products coupled with sales growth in the lower margined products. In addition, costs for
a large percentage of the products included in this line that are manufactured in Toronto
were adversely impacted by higher transition related one-time costs and manufacturing
inefficiencies associated with the installation of the equipment purchased from
Kimberly-Clark Corporation. Also contributing were the initial manufacture of a number of
new advanced wound care products in 2004 and the ongoing pressure on overhead absorption
associated with discontinuation of select basic wound care product manufacturing in
Toronto in favor of lower cost sourcing alternatives in China. One-time costs of $91,400
related to obsolete inventory write-offs and severance were additional factors.

Wound
closure and fastener sales increased $333,915, or 11.1%, to $3,339,432 in 2004 from
$3,005,517 in 2003. Incremental wound closure strip sales associated with the products
purchased from Kimberly-Clark Corporation in January 2004 is responsible for the increase.
Wound closure and fastener gross profit margin increased $222,719, or 15.2%, to $1,690,466
in 2004 from $1,467,747 in 2003 and margins improved slightly, increasing to 50.6% in 2004
from 48.8% in 2003. The increase in gross profit and margin percentage reflects the
increase in higher margined wound closure strip sales.

Skin
care sales decreased $123,665, or 6.0%, to $1,938,667 in 2004 from $2,062,332 in 2003 due
to competitive pressure and several customer-distributors establishing their own brand of
product and deemphasizing other brands. Skin care gross profit declined $147,361, or
28.4%, to $372,204 in 2004 from $519,565 in 2003. The decrease was driven by lower pricing
to retain or secure new business in a highly competitive marketplace, the adverse impact
of lower production volume on overhead absorption and higher material and freight costs
associated with increasing oil prices.

Operating Expense

The
following table highlights 2004 versus 2003 operating expenses by type:

`Year Ended December 31
                              ----------------------
                                2004                2003                    Variance
                                ----                ----                    --------

Distribution                $1,043,288         $   720,421           $322,867        44.8%
Marketing                      369,446             181,769            187,677       103.3%
Sales                        1,833,200           1,797,002             36,198         2.0%
General administrative       3,841,579           3,360,324            481,255        14.3%
                             ---------           ---------           --------

    Total                   $7,087,513          $6,059,516         $1,027,997        17.0%
                             =========           =========          =========`

Operating
expenses increased $1,027,997, or 17.0%, to $7,087,513 in 2004 from $6,059,516 in 2003. Of
this increase, $164,555, or 2.7%, related to the impact of a 7.4% strengthening of the
Canadian dollar on the Canadian operations.

Distribution
expense increased $322,867, or 44.8%, in 2004 versus 2003. The increase was due
principally to higher U.S. operations costs of $265,599 associated with the Companys
new U.S. distribution center opened in March 2004, together with one-time costs of $61,400
to close an older distribution facility. Canadian distribution costs increased $57,268 in
2004 versus 2003 due to unfavorable foreign exchange of $25,679 and a higher overall level
of activity associated with U.S. private label and Kimberly-Clark product growth
initiatives.

Marketing
expense increased $187,677, or 103.3%, in 2004 versus 2003 as a result of hiring a
marketing director in February 2004, together with higher trade show, literature and
promotional spending in support of the Companys growth initiatives.

Sales
expense increased $36,198, or 2.0%, in 2004 versus 2003. U.S. operations expense increased
$63,833 due to higher sampling and buying group related fees, partially offset by lower
manufacturing representative commissions. These latter reductions resulted from the
Companys efforts in the U.S. to focus on using direct representatives to solicit
distributors and large buying groups, together with private label growth initiatives.
Canadian operations expense decreased $27,635 in 2004 versus 2003 due principally to the
closure of the operations U.S. sales facility in July 2003. Year on year savings
associated with the closure of this facility were partially offset by higher costs
associated with upgrading sales resources in the provinces of Ontario and Quebec and
unfavorable foreign exchange of $31,172.

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General
administrative expense increased $481,255, or 14.3%, in 2004 versus 2003. U.S. operations
increased $297,751, or 13.0%. The main drivers of the increase were $140,000 of
incremental information technology (IT) costs associated with upgrades to the
Companys IT infrastructure, higher intangible asset amortization costs associated
with the Kimberly-Clark Corporation wound care asset purchase in January 2004 and
write-off of the remaining Gericare product rights in December 2004 of approximately
$95,000, write-off of the Medi-Health promissory note to bad debts in March 2004 of
$42,600, together with higher accounting, legal, insurance and compensation and benefit
costs, partially offset by lower regulatory costs reflecting a 2003 cost reduction
initiative. Canadian operations expense increased $183,504, or 16.4%. Of this increase,
$107,704, or 9.6%, related to unfavorable foreign exchange and the balance of the increase
was driven by employee termination costs of approximately $50,000 and higher compensation
and benefit and insurance costs.

Interest Expense

Interest
expense decreased $35,948 to $227,305 in 2004 from $263,253 in 2003. Excluding 2003
one-time expense items of approximately $70,000 related principally to the write-off of
deferred financing fees and bond conversion imputed interest charges, the approximate
$34,000 increase in 2004 versus 2003 relates to higher outstanding debt balances and
higher loan related bank fees.

Other Income/Expense

Other
expense increased $495,245 to $287,784 expense in 2004 from $207,461 income in 2003. The
increase is primarily attributable to the write-off of obsolete equipment in 2004
principally at the Companys Toronto manufacturing facility of $273,263 coupled with
the non recurrence in 2004 of one-time 2003 income items related to the sale by Derma
Sciences Canada Inc. of obsolete inventory of approximately $197,000 and its narcotics
business of approximately $44,000.

Income Taxes

The
Company did not record any tax expense for 2004 or 2003 given its net operating loss in
2004 and available net operating loss carry forwards.

Net Income/Loss

The
Company incurred a $2,338,693 loss, or $0.25 loss per share (basic and diluted), in 2004
compared to net income of $22,241, or $0.00 per share (basic and diluted), in 2003.

Liquidity and Capital
Resources

2004 Operational Overview

The
Companys 2004 operating results have had an adverse impact on its liquidity. While
sales increased $1,945,681, the Company experienced a margin erosion of $873,640 in 2004
versus 2003. Sales related to the Companys key growth initiatives did not meet
expectations as the implementation and ramp-up stages have taken longer than expected.
Much of the 2004 sales growth came from lower margined products while sales of the
Companys highest margined Dermagran product line declined due to competitive
pressure. The skin care product line continues to face competitive pressure from larger
and more cost effective manufacturers and the Company has lost skin care business as a
number of its larger customers expand or implement their own private label skin care lines
through lower cost manufacturers. Further, lower skin care sales volumes have had an
adverse impact on the cost effectiveness of the Companys skin care manufacturing
facility. During 2004, the Companys agreement for the exclusive distribution of
certain catheter fasteners in the U.S. was not renewed. Sales and gross profit for these
products in 2004 where approximately $845,000 and $383,000, respectively. Replacement of
these lost sales and margins is a primary objective for the Company in 2005. Growth of the
Companys private label initiatives are expected to help offset the catheter fastener
loss.

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The
Company has been successful in its effort to reduce its basic wound care costs and remain
competitive in this product area by discontinuing the manufacture of these products in
Toronto and either out sourcing their manufacture or manufacturing the products in the
Companys China facility. Significant cost savings have been negotiated or
implemented and the Company started to realize these savings in the fourth quarter of
2004. The Company expects to realize the full benefit of these savings in 2005. To
compensate for the loss of basic wound care production in Toronto, the Company is
retrofitting the facility on an as needed basis to establish the capability to manufacture
higher value added products that can be cost effectively manufactured there. The start-up
and launch of a private label line of advanced wound care products for a major U.S.
distributor and the installation of the equipment purchased from Kimberly-Clark
Corporation in the Companys Toronto manufacturing facility during 2004 represented
the initial phase of this plan. However, these projects resulted in one-time
implementation costs during the transition period that adversely impacted 2004
performance. Both projects were essentially complete by year-end and the Company does not
expect to incur similar costs going forward. The Company also experienced one-time costs
of $91,400 related to inventory write-offs and severance that adversely impacted gross
profit.

Operating
expense increased $863,442, excluding the unfavorable impact of foreign exchange in the
amount of $164,555, in 2004. The Company has been upgrading its infrastructure over the
past two years in the areas of distribution, marketing, sales and information technology
in light of recent acquisitions and in anticipation of planned sales growth. These
initiatives are principally responsible for $457,842 of the increase. Also contributing
were total one-time costs of $405,600 consisting of $61,400 related to the closure of a
U.S. distribution center, $301,600 related to employee termination costs and $42,600
related to the write-off a supplier promissory note.

In
2004, the Company incurred $273,200 of one-time costs recorded in other expense primarily
related to the write-off of obsolete equipment at the Companys Toronto and China
facilities.

Margin
erosion, higher operating expenses and one-time costs of $770,400 were the principal
drivers behind the Companys 2004 net loss of $2,338,693. In response, the Company is
taking steps to accelerate sales growth and properly align operating expenses with
expected revenues in 2005.

On
January 9, 2004, the Company purchased the Kimberly-Clark Corporation wound care business
for total consideration of $1,942,797. The consideration consisted of cash of $376,797 and
a seller financed, non-interest bearing promissory note due on or before December 31, 2004
of $1,566,000. The cash outlay consisted of $300,100 paid at closing and $76,697 for
acquisition related costs. The equipment purchased was installed in a newly renovated area
in the Companys manufacturing facility in Toronto, Canada that was completed in
August 2004. The cost to transfer, install and validate the equipment was approximately
$680,000. The promissory note was paid in full on December 30, 2004 using restricted cash
on deposit with the U.S. lender and available line capacity.

On
February 25, 2004, the Company closed a private offering of 2,057,145 shares of its common
stock at a price of $1.05 per share. Offering proceeds were used to fund the acquisition
of the Kimberly-Clark Corporation wound care business and for general working capital
purposes. Offering proceeds of $1,961,797 , net of offering expenses of $198,203, were
received.

On
September 24, 2004, the Company settled litigation brought against it and its wholly owned
Canadian subsidiary by a former executive relative to the executives termination of
employment. Pursuant to the settlement, the Company will pay the sum of $269,500 over a
period of seven months and extend the expiration date of previously granted options to
purchase 500,000 shares of the Companys common stock at $0.50 per share from May 9,
2004 to September 30, 2006. The settlement costs, together with estimated other costs
associated with the termination aggregating $301,600, were charged against the reserve
established in March 2004 to cover the estimated cost of the litigation. The balance of
$91,490 due the former employee at year-end is payable monthly at $24,950 per month
through March with the final payment of $16,640 due in April 2005.

In
2004, the Company entered into operating and capital leases totaling approximately
$4,222,000 in commitments through 2012, with terms ranging from three to five
years, relative to the following: extension of the Canada manufacturing facility lease in
the amount of $1,902,000, lease for the new U.S. distribution center in the amount of
$1,118,000, Canada distribution and U.S. manufacturing facility extensions in the amount
of $903,000 and U.S. distribution center equipment and upgrades to the Company-wide
telecommunications and information technology equipment in the amount of $299,000.

18

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On
February 8, 2005, the Company closed a private offering of 2,760,000 units at $0.50 per
unit, each unit consisting of one share of the Companys common stock and one
four-year series G warrant to purchase one share of common stock at a price of $1.05.
Total offering proceeds of $1,230,000, net of $150,000 in estimated offering expenses,
will be used for working capital. The offering was initiated in December 2004. In 2004,
the Company sold 1,555,000 units and received offering proceeds of $681,359, net of
$78,641 in estimated offering expenses. In 2005, the Company sold 1,205,000 units and
received offering proceeds of $548,641, net of $71,359 in estimated offering expenses.

In
2004, the Companys exclusive distribution agreement for certain catheter fasteners
expired and was not renewed by the manufacturer. In accordance with the Companys
distribution agreement with a major customer for the fasteners, if the customer
subsequently enters into an agreement with the manufacturer to distribute these products,
then the customer shall pay the company an upset fee of $200,000 in forty-eight monthly
installments of $4,167.

As
of January 2005, the customer advised the Company that it had entered into an agreement
with the manufacturer to distribute the catheter fasteners and that it was liable for
payment of the upset fee. In January 2005, the Company discounted the future cash flow
stream associated with the payment of the upset fee and recognized a gain of $164,300.

Cash Flow

At
December 31, 2004 and 2003, the Company had cash and cash equivalents of $46,508 and
$439,837, respectively. The $393,329 decrease in cash and cash equivalents resulted from
net cash used in operating activities of $1,106,883 and net cash used in investing
activities of $2,973,385, partially offset by net cash provided by financing activities of
$3,690,901.

Net
cash used in operating activities stems from the net loss experienced for the year in the
amount of $1,273,706 (net loss less non cash items) partially offset by cash generated
from the net change of $166,823 in operating assets and liabilities. A $910,904 increase
in inventory to support planned growth initiatives and as a result of the Kimberly-Clark
Corporation acquisition in January 2004, offset by a reduction in receivables and
increases in accounts payable and accrued liabilities, were the primary factors behind the
net positive change in operating assets and liabilities. The decrease in receivables is
due principally to a higher than normal year-end 2003 balance associated with a successful
year-end promotion program. The underlying composition of receivables in terms of
collectability and aging has remained relatively consistent. Payables and accrued
liabilities are up due to efforts to improve the use of alternative financing
opportunities.

Net
cash used in investing activities relates to $1,942,797 cash paid to acquire the
Kimberly-Clark Corporation wound care business in 2004 and capital expenditures of
$1,030,588. The majority of the capital expenditures relate to equipment and leasehold
improvements associated with the transfer and installation of the equipment purchased from
Kimberly-Clark Corporation in the Companys Toronto manufacturing facility. The
balance relates to equipment upgrades and purchases to improve efficiency at the
Companys St. Louis manufacturing facility and expenditures associated with opening
the new U.S. distribution center in St. Louis.

Net
cash provided by financing activities consisted of net proceeds of $2,643,156 from the
sale of common stock in two private placements, one in the first quarter 2004 and the
second in the fourth quarter 2004, coupled with increased line of credit borrowings of
$1,348,780, partially offset by deferred financing costs related to annual bank fees
associated with the Companys line of credit agreements and outstanding letters of
credit and normally scheduled long term debt repayments.

Working Capital

Working
capital decreased $1,987,372 at December 31, 2004 to $2,849,596 from $4,836,968 at
December 31, 2003. The decrease in cash and increased accounts payable, accrued
liabilities and line of credit borrowings are principally attributable to funding the
Companys net operating loss for the year and increases in inventory, together with
cash paid for the Kimberly-Clark Corporation wound care business and capital expenditures
related to the transfer and installation of the equipment in the Companys Toronto
facility.

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Financing Arrangements
 United States

On
January 30, 2004 the Company entered into a modified one year line of credit agreement
with its previous U.S. lender (the prior agreement). The maximum principal
amount of the line increased to $4,000,000 from $3,000,000. In connection with entering
into this line of credit agreement, the Company deposited $1,000,000 of cash in a
restricted account with the U.S. lender and the U.S. lender issued an irrevocable standby
letter of credit on the Companys behalf for the benefit of Kimberly-Clark
Corporation in the amount of $1,566,000. Advances were used to fund strategic initiatives
and for general working capital purposes. Estimated maximum potential advances under the
prior agreement were equal to the lesser of (A) $4,000,000 or (B) the sum of (i) 80% of
eligible receivables (as defined), (ii) 50% of eligible inventory (as defined), (iii) an
amount equal to the immediate liquidation value of funds deposited with the U.S. lender in
a restricted account as security for any letters of credit extended by the lender on the
Companys behalf up to $1,000,000, less the aggregate amount of any outstanding
letters of credit issued by the U.S. lender.

Ongoing
operating losses resulted in the Company being out of compliance with certain of its U.S.
line of credit covenants at March 31, June 30 and September 30, 2004. In return for a
commitment to secure alternative financing for its U.S. obligations prior to the January
31, 2005 maturity date of the prior agreement, the U.S. lender agreed to waive the
Companys prior covenant violations and to maintain the line of credit until maturity
thereof. The Company has incurred waiver fees of $7,500 and agreed to an increase in the
rate of interest payable under the line. All other terms of the prior agreement were
maintained in full force and effect.

On
December 30, 2004, the Company paid off the promissory note due Kimberly-Clark Corporation
in the amount of $1,566,000 using the restricted cash on deposit with the U.S. lender of
$1,000,000 and available line capacity. In addition, the irrevocable standby letter of
credit issued on behalf of the Kimberly-Clark Corporation in the amount of $1,566,000 was
cancelled. In connection with this transaction, the maximum principal amount of the line
was reduced from $4,000,000 to $2,000,000. All other terms of the prior agreement remained
in full force and effect.

Maximum
potential advances (after deducting $200,000 for irrevocable letters of credit
outstanding) under the prior agreement at December 31, 2004 were $1,692,649. Advances
outstanding against the prior agreement were $1,312,756 at December 31, 2004, leaving an
additional $379,893 available for borrowing.

On
January 13, 2005, in connection with the refinancing of the U.S. line of credit, the
Company paid off and cancelled the outstanding irrevocable standby letter of credit issued
by the U.S. lender in the amount of $200,000 held by the Companys Canadian lender as
additional security for its credit facility. The $200,000 paid to the Canadian lender was
applied as a permanent principal reduction against the principal amount due in 2007
associated with the Companys outstanding term loan with the Canadian lender.
Subsequently, on January 31, 2005 the Canadian lender agreed as part of refinancing of the
U.S. line of credit to retain its second lien security interest and guarantee position
against the Companys U.S. assets and not to exercise its rights under its second
lien security interest and guarantee against the U.S. assets without the new U.S.
lenders approval.

On
January 31, 2005 the Company entered into a three year revolving credit facility agreement
(the new agreement) with a new U.S. lender for a maximum principal amount of
$2,000,000. The new agreement replaces a $2,000,000 revolving credit facility that expired
on January 31, 2005 with the previous U.S. lender. At January 31, 2005 maximum potential
advances under the new agreement were approximately $1,700,000. On January 31, 2005, the
Company applied advances of approximately $1,300,000 under the new agreement in
satisfaction of the prior U.S. lenders outstanding obligations. Future advances will
be utilized to fund strategic initiatives and general working capital requirements. The
Company incurred loan origination and legal fees of approximately $135,200 in connection
with the implementation of the new agreement. These fees have been deferred and are being
amortized to interest expense over the three year term of the new agreement.

20

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The
Company may request advances under the new agreement up to the value of 85% of eligible
receivables (as defined) and 55% of eligible inventory (as defined). Interest on
outstanding advances is payable monthly in arrears at the prime rate (as defined) plus
2.5%, but not less than 7.5% per annum. At January 31, 2005 the effective interest rate
was 7.75%. In addition, the Company pays a monthly collateral management fee at the rate
of 1.5% per annum upon the daily average amount of advances outstanding and a monthly
unused line fee of 0.5% per annum upon the difference between the daily average amount of
advances outstanding and $2,000,000. Outstanding advances are secured by all of the
Companys existing and after-acquired tangible and intangible U.S. assets. In
addition, the Company has accorded the new U.S. lender its guarantee of payment together
with a second lien security interest in the assets of the Companys wholly owned
Canadian subsidiary. The new U.S. lender has agreed not to exercise its rights under its
second lien security interest and guarantee against the Canadian assets without the
Canadian lenders approval.

Over
the term of the new agreement, the Company has agreed to comply with the following
covenants as measured at the end of each month for the average of the three most recent
calendar months based upon its consolidated operating results: a) maintain EBITDA
(earnings before interest, taxes, depreciation and amortization) in the range of negative
$300,000 (as of January 31, 2005) transitioning to positive $600,000 (post December 31,
2005) and (b) maintain its fixed charge ratio (EBITDA divided by the sum of debt service,
capital expenditures, income taxes and dividends) in the range of 1.0 to 1.0 (as of
January 31, 2005) to 1.25 to 1.0 (post December 31, 2005). In addition, as it pertains to
the Companys U.S. operations, cash collections may not be less than $800,000 for
each calendar month through June 30, 2005 and $900,000 for each calendar month thereafter,
and at all times the Companys cash on hand (including unused borrowing capacity
under the new agreement) must not be less than $200,000. Additional covenants governing
permitted indebtedness, liens, payments of dividends and protection of collateral are
included in the new agreement.

Based
upon consolidated operating results for February 2005, the Company was out of compliance
with its EBITDA and fixed charge ratio covenant under the new agreement at February 28,
2005. The U.S. lender agreed to waive these covenant violations. The Company expects to,
but cannot assure that it will, maintain compliance with all applicable loan covenants in
the future.

The
Company may terminate the new agreement at any time after January 31, 2006 by paying all
outstanding indebtedness and any other payments due the U.S. lender and paying the U.S.
lender a yield maintenance based early termination fee equal to the product of: (a) the
effective yield on the facility for the six months prior to termination (expressed as an
annual percentage rate), (b) $2,000,000, and (c) the quotient of the months remaining in
the original term of the new agreement divided by 12.

Financing Arrangements
 Canada

In
September 2004, the Company finalized the annual renewal of its revolving credit facility
(the Canadian agreement) for a maximum principal amount of $1,830,000
($2,200,000 Canadian) with its Canadian lender. The next annual renew is expected to be
completed by May 1, 2005. In return for an irrevocable standby letter of credit in the
amount of $200,000 against the Companys U.S. line of credit, the Canadian lender
agreed not to exercise its rights under its first lien security interest and loan
guarantees against the Companys U.S. assets without the U.S. lenders approval.
Maximum potential advances under the Canadian agreement at December 31, 2004 were
$1,741,861. Advances outstanding against the Canadian agreement were $1,507,528 at
December 31, 2004 leaving an additional $234,333 available for borrowing.

Losses principally associated
with the write-off of obsolete equipment, employee termination costs and a revamping of manufacturing operations in Toronto
resulted in Derma Sciences Canada being out of compliance with certain of its income based loan covenants that are measured
annually at December 31, 2004. The Canadian lender agreed to waive the covenant violations at December 31, 2004. The Company has
incurred fees of $12,000 associated with the granting of waivers in 2004. The Company expects to, but cannot assure that it will,
maintain compliance with all applicable loan covenants in the future.

On
January 13, 2005 the company paid off the $200,000 outstanding irrevocable standby letter
of credit issued by the U.S. lender to the Canadian lender against the U.S. line of
credit. The $200,000 paid to the Canadian lender was applied as a permanent principal
reduction against the principal amount due in 2007 under the term loan with the Canadian
lender.

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Prospective Assessment

The
Company seeks to increase sales and gross margins and return to profitability by
increasing sales of contracted private label products, continued growth of the basic wound
care product line in the U.S., a reversal of the Dermagran product line sales erosion
experienced in 2004 and a renewed focus on organic growth of core product lines in the
U.S. and Canada. The Company expects to fully realize the benefit of lower product costs
in 2005 associated with lower basic wound care costs negotiated in mid-2004 as lower cost
inventory moves fully into the supply chain. Additional cost savings will be fully
realized in 2005 resulting from commencement in late 2004 of in-house manufacture of a
wide range of products using the equipment purchased from Kimberly-Clark Corporation as
well as the non-recurrence of the one-time costs incurred in 2004 associated with bringing
the manufacture of these products on line. Operating expenses, which have gradually
increased since early 2003 in anticipation of planned sales growth, will be closely
monitored. Steps will be taken to reduce operating expenses if planned sales and margin
growth are not realized.

Going
forward, capital expenditure requirements will decrease significantly given that the
installation of the Kimberly-Clark Corporation equipment in Toronto has been completed.
Prospective capital investment will be limited to that necessary to maintain current
operations. Growth oriented capital investment will be delayed until the Companys
financial position improves. The Company plans to continue to closely monitor inventory
levels with the objective to reduce its investment in inventory wherever possible.

The
Company believes that available funds from expected improving operations, available lines
of credit and the recently completed common stock private offering will be sufficient to
satisfy the Companys liquidity requirements for the foreseeable future. If need be,
the Company expects that it can secure additional equity funding to improve liquidity.

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

Additional Financial
Information

Forward Looking Statements

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

Critical Accounting
Policies

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

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Revenue Recognition and
Adjustments to Revenue

Revenue
is recognized when product is shipped and title passes to the customer and collectability
is reasonably assured. When the Company recognizes revenue from the sale of products, the Company
simultaneously adjusts revenue for estimated trade rebates. A trade rebate represents the
difference between invoice price to the wholesaler and the indirect customers
contract price. These rebates are estimated based on historical experience, estimated
future trends, estimated customer inventory levels, current contract sales terms with
customers and other competitive factors. If the assumptions used to calculate these
rebates do not appropriately reflect future activity, the Companys financial
position, results of operations and cash flows could be impacted. The Company continually
monitors the factors that influence these rebates and makes adjustments as necessary.

Goodwill

At
December 31, 2004, the Companys skin care segment had $1,110,967 of goodwill. The
Company tests goodwill for impairment in the fourth quarter of each year or when
impairment indicators are present. The process of evaluating the potential impairment of
goodwill is highly subjective and requires significant judgments and assumptions in
estimating future cash flows to determine the fair value of the reporting unit. These
assumptions include future growth rates, discount factors, future tax rates and other
factors. The Companys cash flow forecasts are based on assumptions that are
consistent with the plans and estimates used to manage the underlying business. In
addition, the Company makes certain judgments about allocating shared assets to the
balance sheet for this segment. If the expected cash flows are not realized, impairment
losses may be recorded in the future.

Inventory

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

Recent Accounting
Pronouncements

In
December 2004, the FASB issued SFAS No. 123(R) (revised 2004), Share-Based
Payment, which amends FASB Statement No. 123 and will be effective for public
companies for interim or annual periods beginning after June 15, 2005. The new standard
will require the Company to expense employee stock options and other share-based payments
beginning in fiscal 2006. The FASB believes the use of a binomial lattice model for option
valuation is capable of more fully reflecting certain characteristics of employee share
options compared to the Black-Scholes options pricing model. The new standard may be
adopted in one of three ways  the modified prospective transition method, a
variation of the modified prospective transition method or the modified retrospective
transition method. The Company is currently evaluating how it will adopt the standard and
the effect that the adoption of SFAS 123(R) will have on its financial position and
results of operations.

In
November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment
of ARB No. 43, Chapter 4". This statement amends the guidance in ARB
No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for
abnormal amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage). Paragraph 5 of ARB No. 43, Chapter 4, previously stated that
...under some circumstances, items such as idle facility expense, excessive
spoilage, double freight, and rehandling costs may be so abnormal as to require treatment
as current period charges... SFAS No. 151 requires that those items be recognized as
current-period charges regardless of whether they meet the criterion of so
abnormal. In addition, this statement requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the production
facilities. The provisions of SFAS 151 shall be applied prospectively and are effective
for inventory costs incurred during fiscal years beginning after June 15, 2005, with
earlier application permitted for inventory costs incurred during fiscal years beginning
after the date this Statement was issued. The Company is currently evaluating how it will
adopt the standard and the effect that the adoption of SFAS No. 151 will have on its
financial position and results of operations.

23

---

Item 7. Consolidated
Financial Statements

Index

|                                                                                                    |     
|--------------------------------------------------------------------------------------------------- | ----
|Description                                                                                         | Page
|                                                                                                    |     
|Report of Independent Registered Public Accounting
     Firm                                        | 25  
|                                                                                                    |     
|Report of Independent Registered Public Accounting
     Firm                                        | 26  
|                                                                                                    |     
|Consolidated Balance Sheets as of December 31, 2004
     and 2003                                   | 27  
|                                                                                                    |     
|Consolidated Statements of Operations for the
     Years Ended December 31, 2004 and 2003           | 28  
|                                                                                                    |     
|Consolidated Statements of Shareholders'
     Equity for the Years Ended December 31, 2004 and 2003 | 29  
|                                                                                                    |     
|Consolidated Statements of Cash
     Flows for the Years Ended December 31, 2004 and 2003           | 30  
|                                                                                                    |     
|Notes to Consolidated Financial
     Statements                                                     | 31  
|                                                                                                    |     

24

---

Financial Index

Report of Independent
Registered Public Accounting Firm

To the Shareholders and
Board of DirectorsDerma Sciences, Inc.

We have audited the accompanying
consolidated balance sheet of Derma Sciences, Inc. and Subsidiaries as of December 31,
2004, and the related consolidated statements of operation, shareholders equity and
cash flows for the year then ended. 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 audit.

We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States). 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 consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of Derma Sciences, Inc. and Subsidiaries at December 31,
2004, and their consolidated results of operations and cash flows for the year then ended,
in conformity with U.S. generally accepted accounting principles.

| | /s/ J.H. Cohn LLP
| | -----------------

Roseland, New JerseyMarch 23, 2005

25

---

Report of Independent
Registered Public Accounting Firm

To the Shareholders and
Board of DirectorsDerma Sciences, Inc.

We have audited the accompanying
consolidated balance sheet of Derma Sciences, Inc. and Subsidiaries as of December 31,
2003, and the related consolidated statements of operations, cash flows and
shareholders equity for the year then ended. 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 audit.

We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States). 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 audit provides a reasonable basis for our
opinion.

In our opinion, the financial
statements referred to above present fairly, in all material respects, the consolidated
financial position of Derma Sciences, Inc. and Subsidiaries at December 31, 2003, and the
consolidated results of its operations and its cash flows for the year then ended, in
conformity with U.S. generally accepted accounting principles.

| | /s/ Ernst & Young LLP
| | ---------------------

Philadelphia, PennsylvaniaFebruary 20, 2004

26

---

Financial Index

DERMA SCIENCES, INC.Consolidated Balance Sheets

`December 31,
ASSETS                                                                  2004            2003
-----------------------------------------------------------------------------------------------

Current Assets
Cash and cash equivalents                                         $     46,508    $    439,837
Accounts receivable, net                                             2,601,092       2,627,092
Inventories                                                          4,932,232       4,003,258
Prepaid expenses and other current assets                              181,201         351,962
-----------------------------------------------------------------------------------------------
Total current assets                                                 7,761,033       7,422,149
Equipment and improvements, net                                      3,662,557       1,077,688
Goodwill                                                             1,110,967       1,110,967
Other intangible assets, net                                           383,911         158,604
Other assets, net                                                      132,464         156,765
-----------------------------------------------------------------------------------------------
Total Assets                                                      $ 13,050,932    $  9,926,173
-----------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
-----------------------------------------------------------------------------------------------
Current Liabilities
Line of credit                                                    $  2,820,284    $  1,361,708
Current maturities of long-term debt                                   247,306         178,720
Accounts payable                                                     1,249,409         731,438
Accrued expenses and other current liabilities                         594,438         313,315
-----------------------------------------------------------------------------------------------
Total current liabilities                                            4,911,437       2,585,181
Long-term debt                                                         867,539         849,981
Other long-term liabilities                                             53,207           -
-----------------------------------------------------------------------------------------------
Total Liabilities                                                    5,832,183       3,435,162
-----------------------------------------------------------------------------------------------
Commitments
Shareholders' Equity
Convertible preferred stock, $.01 par value; 11,750,000 shares
authorized; issued and outstanding: 2,280,407 shares in 2004;
(liquidation preference of $4,210,231) and 2,284,574 shares at
December 31, 2003 (liquidation preference of $4,235,233)                22,804          22,846
Common stock, $.01 par value, 30,000,000 shares authorized;
issued and outstanding: 11,079,007 shares at December 31, 2004
and 7,462,695 shares at December 31, 2003                              110,790          74,627
Additional paid-in capital                                          19,371,225      16,746,690
Accumulated other comprehensive income -
cumulative translation adjustments                                     699,960         294,185
Accumulated deficit                                                (12,986,030)    (10,647,337)
-----------------------------------------------------------------------------------------------
Total Shareholders' Equity                                           7,218,749       6,491,011
-----------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity                        $ 13,050,932    $  9,926,173
-----------------------------------------------------------------------------------------------`

See accompanying consolidated notes.

27

---

Financial Index

DERMA SCIENCES, INC.Consolidated Statements of Operations

`Year ended December 31
                                                                         2004            2003
-------------------------------------------------------------------------------------------------

Net Sales                                                            $19,887,132     $17,941,451

Cost of sales                                                         14,623,223      11,803,902
-------------------------------------------------------------------------------------------------
Gross Profit                                                           5,263,909       6,137,549
-------------------------------------------------------------------------------------------------
Operating expenses                                                     7,087,513       6,059,516
Interest expense                                                         227,305         263,253
Other expense (income), net                                              287,784        (207,461)
-------------------------------------------------------------------------------------------------
Total Expenses                                                         7,602,602       6,115,308
-------------------------------------------------------------------------------------------------
(Loss) income before provision for income taxes                       (2,338,693)         22,241
Provision for income taxes                                                  -               -
-------------------------------------------------------------------------------------------------
Net (Loss) Income                                                    $(2,338,693)    $    22,241
-------------------------------------------------------------------------------------------------
(Loss) income per common share - basic                               $     (0.25)    $      0.00
-------------------------------------------------------------------------------------------------
(Loss) income per common share - diluted                             $    ( 0.25)    $      0.00
-------------------------------------------------------------------------------------------------
Shares used in computing (loss) income per common share - basic        9,424,191       6,108,290
-------------------------------------------------------------------------------------------------
Shares used in computing (loss) income per common share - diluted      9,424,191      10,795,026
-------------------------------------------------------------------------------------------------`

See accompanying consolidated notes.

28

---

Financial Index

DERMA SCIENCES,
INC.Consolidated Statements of Shareholders'
Equity

Accumulated
                                         Preferred     Common   Convertible            Additional      Other                        Total
                                           Shares       Shares   Preferred   Common    Paid-In    Comprehensive   Accumulated   Shareholders'
                                           Issued       Issued     Stock      Stock     Capital    Income (Loss)     Deficit        Equity
---------------------------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 2002                2,526,242   4,631,276   $25,262    $46,313  $15,588,698    $(21,736)    $(10,669,578)  $4,968,959

Net income                                     -           -         -          -            -              -           22,241       22,241
Foreign currency translation adjustment        -           -         -          -            -        315,921             -         315,921
                                                                                                                                    -------
Comprehensive income - total                   -           -         -          -            -           -                -         338,162
Issuance of common stock in
   private placement, net of
   issuance costs of $73,510                   -      2,400,000      -        24,000    1,102,490           -                -    1,126,490
Conversion of series B, C and D
   preferred shares                        (241,668)    241,668    (2,416)    2,416         -            -                -            -
Cashless exercise of common stock
   warrants                                    -        189,751      -         1,898       (1,898)          -                -         -
Employee stock option expense                  -           -         -          -          57,400           -                -       57,400
---------------------------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 2003                2,284,574   7,462,695   $22,846    $74,627  $16,746,690    $294,185     $(10,647,337)  $6,491,011

Net loss                                       -           -         -          -            -              -       (2,338,693)  (2,338,693)
Foreign currency translation adjustment        -           -         -          -            -        405,775             -         405,775
                                                                                                                                    -------
Comprehensive loss - total                     -           -         -          -            -           -                -      (1,932,918)
Issuance of common stock in
   private placement, net of issuance
   costs of $276,844                           -      3,612,145      -        36,121    2,624,535           -                -    2,660,656
Conversion of series B preferred stock       (4,167)      4,167       (42)       42         -            -                -            -
---------------------------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 2004                2,280,407  11,079,007   $22,804   $110,790  $19,371,225    $699,960     $(12,986,030)  $7,218,749
---------------------------------------------------------------------------------------------------------------------------------------------


See accompanying consolidated notes.

29

---

Financial Index

DERMA SCIENCES, INC.Consolidated Statements of Cash Flows

`Year Ended December 31
                                                                          2004              2003
-----------------------------------------------------------------------------------------------------
Operating Activities
    Net (loss) income                                                $(2,338,693)        $    22,241
    Adjustments to reconcile net (loss) income to net
    cash used in operating activities:
      Depreciation of equipment and improvements                         320,474             156,771
      Amortization of intangible assets                                  117,490              22,341
      Amortization of deferred financing costs                            88,483             132,233
      Provision for bad debts and rebates                                 15,233             111,785
      Provision for inventory obsolescence                               196,837              50,453
      Loss on disposal of equipment and improvements                     273,263               2,132
      Deferred rent expense                                               53,207               -
      Employee stock option expense                                        -                  57,400
      Changes in operating assets and liabilities:
          Accounts receivable                                            181,001            (507,346)
          Inventories                                                   (910,904)           (732,986)
          Prepaid expenses and other current assets                      157,692             (46,784)
          Other assets                                                    11,276               1,529
          Accounts payable                                               470,184              (7,308)
          Accrued expenses and other current liabilities                 257,574            (177,766)

-----------------------------------------------------------------------------------------------------
Net cash used in operating activities                                 (1,106,883)           (915,305)
-----------------------------------------------------------------------------------------------------
Investing Activities
    Cash paid for wound care business                                 (1,942,797)              -
    Purchase of equipment and improvements                            (1,030,588)            (85,634)
    Purchase of inventory and product rights                               -                (114,691)
-----------------------------------------------------------------------------------------------------
Net cash used in investing activities                                 (2,973,385)           (200,325)
-----------------------------------------------------------------------------------------------------
Financing Activities
    Net change in bank line of credit                                  1,348,780            (823,477)
    Deferred financing costs                                             (91,409)            (29,423)
    Long-term debt repayments                                           (209,626)           (195,810)
    Proceeds from issuance of stock, net of issuance costs             2,643,156           1,126,490
-----------------------------------------------------------------------------------------------------
Net cash provided by financing activities                              3,690,901              77,780
-----------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash                                   (3,962)            (18,670)
-----------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents                               (393,329)         (1,056,520)

Cash and cash equivalents
  Beginning of year                                                      439,837           1,496,357
-----------------------------------------------------------------------------------------------------
  End of year                                                        $    46,508         $   439,837
-----------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
    Interest                                                            $172,663            $170,233
Supplemental schedule of non cash investing and financing activities:
    Equipment obtained with capital leases                              $228,518                -
-----------------------------------------------------------------------------------------------------`

See accompanying consolidated notes.

30

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

1.     Organization and
Summary of Significant Accounting Policies

Derma
Sciences, Inc. and its subsidiaries (the Company) are full line providers of
wound care, wound closure-fasteners and skin care products. The Company markets its
products principally through independent distributors servicing the long-term care, home
health and acute care markets in the United States, Canada and other select international
markets. The Companys principal manufacturing and distribution facilities are
located in St. Louis, Missouri and Toronto, Canada. The Company also has a manufacturing
facility in Nantong, China.

Summary
of Significant Accounting Policies:

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

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

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

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

Concentration
of Credit Risk  Financial instruments that subject the Company to a concentration of
credit risk consist principally of cash and cash equivalents and accounts receivable. The
Company maintains cash and cash equivalents with various financial institutions in amounts
which at times may exceed federally insured limits. Accounts are guaranteed by the Federal
Deposit Insurance Corporation (FDIC) up to $100,000. At December 31, 2003, the Company had
approximately $314,000 on deposit in excess of FDIC limits. The Company has not
experienced any losses in such accounts. The Companys accounts receivable balance is
net of an allowance for doubtful accounts. The Company does not require collateral or
other security to support credit sales, but provides an allowance for doubtful accounts
based on historical experience and specifically identified risks. Accounts receivable are
charged off against the allowance for doubtful accounts when management determines that
recovery is unlikely and the Company ceases collection efforts.

Foreign
Operations Risk  The Companys future operations and earnings will depend to a
large extent on the results of its operations in Canada and its ability to continue to
maintain a continuous supply of basic wound care products from its own operation and/or
its suppliers in China. While the Company does not envision any adverse change to the
manner in which operations in Canada and China are presently being conducted, there can be
no assurance that the Company will be able to successfully conduct such operations in the
future, and a failure to do so may have a material adverse effect on the Companys
consolidated financial position, results of operations and cash flows. Also, the success
of the Companys operations will be subject to numerous contingencies, some of which
are beyond managements control. These contingencies include general and regional
economic conditions, prices for the Companys products, prices for materials and
products purchased from suppliers, competition and changes in regulations.

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

31

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

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

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

Other
Intangible Assets  Patents and trademarks and other intangible assets with definite
lives are stated on the basis of cost. Patent and trademarks are amortized over 12 to 17
years on a straight-line basis. Other intangible assets consisting of product rights,
formulations and specifications, regulatory approvals, customer lists and a non-compete
agreement are amortized over 5 years on a straight-line basis.

Long
Lived Assets  In accordance with Statement of Financial Accounting Standards No. 144
(SFAS 144), Accounting for Impairment or Disposal of Long Lived
Assets the Company reviews its long-lived assets with definitive lives whenever
events or changes in circumstances indicate that the carrying amount of such assets may
not be recoverable. If the carrying amount of the asset or group of assets exceeds its net
realizable value, the asset will be written down to its fair value.

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

Stock
Based Compensation  SFAS No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, provides companies with a choice to follow
the provisions of SFAS No. 123 in the determination of stock-based employee compensation
expense based on the fair values of the options or to continue to use the intrinsic value
method pursuant to the provisions of Accounting for Stock Issued to Employees
APB 25 and related interpretations in accounting for stock-compensation plans. The Company
has elected to follow the provisions of APB 25. Under APB 25, if the exercise price of the
Companys stock options granted to employees equals or exceeds the market price of
the underlying common stock on the date of grant, generally no compensation expense is
recognized. During 2003, certain executives received common stock options with vesting
based on the achievement of certain performance targets. The Company recognized
compensation expense of $57,400 in 2003 related to these options. As of December 31, 2004,
there were no unvested performance-based options outstanding.

Pro
forma information regarding net income (loss) and earnings (loss) per share is required by
SFAS No. 123, which also requires that the information be determined as if the Company has
accounted for its stock options granted to employees under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average assumptions for
2004 and 2003: risk-free interest rate of 4.25% in the second through fourth quarters 2004
and 4.0% in the first quarter 2004 and 2003; dividend yield of 0%; a volatility factor of
the expected market price of the Companys Common Stock of 1.409 in the fourth
quarter of 2004, 1.448 in the third and second quarters of 2004, 1.463 in the first
quarter 2004 and 1.663 in 2003; and an expected option life of 5 years.

32

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

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

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

`2004              2003
                                                                                   ----              ----

         Net (loss) income - as reported                                      $(2,338,693)        $  22,241
         Add:     Stock-based employee compensation expense included
                  in reported net (loss) income                                     -                57,400
         Deduct:  Total stock-based employee compensation expense
                  determined under fair value method for all awards              (871,212)         (646,007)
                                                                                ----------          -------

         Pro forma net loss                                                   $(3,209,905)        $(566,366)
                                                                                =========           =======

         (Loss) income per common share - basic and diluted
             As reported                                                          $(0.25)            $0.00
             Pro forma                                                            $(0.34)           $(0.09)`

The
weighted average fair value per share of options granted during 2004 and 2003 was $1.13
and $0.96, respectively.

As
a result of amendments to SFAS No. 123, the Company will be required to expense the fair
value of employee stock options beginning with its fiscal quarter ending March 31, 2006.

Income
Taxes  Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets, including tax loss and credit carryforwards, and liabilities are
measured using enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date. Deferred income tax expense represents the
change during the period in the deferred tax assets and deferred tax liabilities. The
components of the deferred tax assets and liabilities are individually classified as
current and non-current based on their characteristics. Deferred tax assets are reduced by
a valuation allowance when, in the opinion of management, it is more likely than not that
some portion or all of the deferred tax assets will not be realized.

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

Advertising
and Promotion Costs  Advertising and promotion costs are expensed as incurred and
were $297,716 and $234,919 in 2004 and 2003, respectively.

33

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

Net
Income (Loss) per Share  Net income (loss) per common share  basic is computed
by dividing net income (loss) by the weighted average number of common shares outstanding
for the period. Net income (loss) per common share  diluted reflects the potential
dilution of earnings by including potentially issuable shares of common stock
(potentially dilutive securities), including those attributable to stock
options, warrants and convertible preferred stock in the weighted average number of common
shares outstanding for a period, if dilutive. Potential common stock has not been included
in the computation of diluted loss per share as the effect would be anti-dilutive.

Shares
used to compute income per common share on a fully diluted basis for the years ended
December 31, 2004 (assuming profitability) and 2003 are outlined below:

`December 31,
                                                           ------------
                                                       2004               2003
                                                       ----               ----

        Common shares                               9,424,191          6,108,290
                                                    ---------          ---------

        Dilutive shares:
           Preferred stock                          2,281,346          2,420,943
           Warrants                                   544,664          1,004,034
           Stock options                              901,463          1,261,759
                                                    ---------          ---------

               Sub-total dilutive shares            3,727,473          4,686,736
                                                    ---------          ---------

               Total dilutive shares               13,151,664         10,795,026
                                                   ==========         ==========`

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

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

On
January 9, 2004, the Company purchased certain wound care assets from Kimberly-Clark
Corporation. The primary purpose of the acquisition was to obtain equipment to expand the
Companys in-house manufacturing capabilities and to broaden its product line. The
assets acquired consist of manufacturing equipment, product rights and other intangibles.
The purchase price for the assets was $1,942,797 and was paid as follows: (1) $300,100 at
closing; (2) $1,566,000 via a seller financed promissory note due December 31, 2004,
without interest (see Note 8); and (3) $76,697 incurred for transaction costs. The
acquisition has been accounted for as a purchase of a business and the purchase price has
been allocated to equipment in the amount of $1,600,000 and intangible assets (see Note 6)
in the amount of $342,797 based upon the estimated fair values of the assets acquired. The
promissory note was paid in full on December 30, 2004.

During
the year ended December 31, 2004, the Kimberly-Clark wound care products generated
$1,391,491 in net sales. Kimberly-Clark manufactured wound care products, for the account
of the Company, at its facility through April 9, 2004 to meet current customer demand and
to build sufficient inventory to cover the period during which production at the
Kimberly-Clark facility was discontinued and the equipment was transferred to the
Companys facility in Toronto, Canada. Upon cessation of manufacturing at
Kimberly-Clarks facility, the Company purchased, in accordance with a pre-determined
formula, inventory consisting of raw and packaging materials and up to four months supply
of finished goods. The purchase price of this inventory was approximately $550,000. Cash
on hand and borrowings against available credit lines were used to pay for this
inventory.

34

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

The
Company completed the transfer, installation and validation of the equipment and commenced
manufacturing in Toronto, Canada in August 2004. Through December 31, 2004, the Company
expended approximately $680,000 on equipment and manufacturing facility upgrades at its
Toronto, Canada location.

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

`Year Ended December 31, 2003
                                                              ----------------------------
         Net sales                                                 $20,242,000
         Net loss                                                  $(1,426,000)
         Loss per common share-basic and diluted                        $(0.23)`

3.     Accounts Receivable

Accounts
receivable include the following:

`December 31,
                                                               -----------------------
                                                               2004               2003
                                                               ----               ----

        Trade accounts receivable                          $2,774,293         $2,802,985
        Less:  Allowance for doubtful accounts                (57,090)           (35,785)
               Allowance for trade rebates                   (164,000)          (212,000)
                                                            ----------         ----------
             Net trade receivables                          2,553,203          2,555,200
        Other receivables                                      47,889             71,892
                                                            ---------          ----------
             Total receivables                             $2,601,092         $2,627,092
                                                            =========          =========`

4.     Inventories

Inventories
include the following:

`December 31,
                                                               -----------------------
                                                               2004               2003
                                                               ----               ----

        Finished goods                                     $3,531,095          $2,814,651
        Work in process                                        71,423             172,536
        Packaging materials                                   461,052             307,635
        Raw materials                                         868,662             708,436
                                                            ---------           ---------
             Total inventory                               $4,932,232          $4,003,258
                                                            =========           =========`

35

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

5.     Equipment and
Improvements, net

Equipment
and improvements include the following:

`December 31,
                                                               -----------------------
                                                               2004               2003
                                                               ----               ----

        Machinery and equipment                            $3,407,073          $1,277,352
        Furniture and fixtures                                196,506             183,967
        Leasehold improvements                                714,992              49,541
                                                            ---------           ---------
             Gross equipment and improvements               4,318,571           1,510,860
        Less:  accumulated depreciation                      (656,014)           (433,172)
                                                             ---------           ---------

             Total equipment and improvements, net         $3,662,557          $1,077,688
                                                            =========           =========`

Machinery and
equipment and leasehold improvements increased in the year ended December 31, 2004
principally due to the acquisition of the Kimberly-Clark Corporation wound care assets and
infrastructure improvements to the Companys Canadian manufacturing facilities
necessitated thereby. The Company incurred a charge of $273,263 for the year ended
December 31, 2004 related to the disposal of obsolete equipment.

Included
in equipment and improvements at December 31, 2004 was machinery and equipment with a cost
of $228,518 and accumulated amortization of $22,989 attributable to leased equipment.
Amortization of assets under capital leases is included in depreciation expense.

6.     Other Intangible
Assets, net

Other
intangible assets, net include the following:

`December 31,
                                                               -----------------------
                                                               2004               2003
                                                               ----               ----
        Patents and trademarks                             $ 444,067          $ 444,067
        Other intangible assets                              342,797             40,567
                                                             -------            -------

             Gross other intangible assets                   786,864            484,634
             Less accumulated amortization                  (402,953)          (326,030)
                                                            ---------          ---------

             Other intangible assets, net                   $383,911           $158,604
                                                             =======            =======`

At
December 31, 2004, the Company recorded a $21,410 one-time charge to write-off the balance
of other intangible assets related to the Genesis ointment product rights. In connection
with the acquisition of the Kimberly-Clark Corporation wound care assets in January 2004,
the Company allocated $342,797 of the purchase price to intangible assets consisting of
product rights, formulations and specifications, regulatory approvals, customer lists and
a non-compete agreement.

36

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

The
weighted average useful life of patent and trademarks and other intangibles is 6.9 years
and 4.0 years, respectively. Actual amortization expense for 2004 and 2003 and
estimated thereafter by year is outlined below:

`Patents and        Other
                                                      Trademarks      Intangibles       Total
                                                      ----------      -----------       -----

Actual amortization expense for year ended 12/31/04    $ 15,696        $101,794        $117,490
                                                        -------         -------         -------
Actual amortization expense for year ended 12/31/03    $ 16,707          $5,634        $ 22,341
                                                        -------         -------         -------

Estimated amortization expense for year ending:

         12/31/05                                      $ 15,696        $ 68,511        $ 84,207
         12/31/06                                        15,696          68,511          84,207
         12/31/07                                        15,696          68,511          84,207
         12/31/08                                        15,696          68,511          84,207
         12/31/09                                        15,696           1,892          17,588
         Thereafter                                      29,495             -            29,495
                                                        -------         -------         -------

              Total                                    $107,975        $275,936         $383,911
                                                        =======         =======          =======`

7.     Other Assets, net

Other
assets, net include the following:

`December 31,
                                                               -----------------------
                                                               2004               2003
                                                               ----               ----

        Deferred financing costs, net                       $ 60,728            $ 77,415
        Deposits                                              71,736              69,834
        Other                                                   -                  9,516
                                                             -------             -------
             Total other assets, net                        $132,464            $156,765
                                                             =======             =======`

Deferred
financing costs related to the U.S. credit facility are being amortized over one year.
Deferred financing costs related to the Canadian credit facility are being amortized over
five years.

8.     Line of Credit
Borrowings

Short-term
borrowings include the following:

`December 31,
                                                               -----------------------
                                                               2004               2003
                                                               ----               ----

        U.S. line of credit                                $1,312,756               -
        Canadian line of credit                            $1,507,528          $1,361,708
                                                            ---------           ---------
             Total line of credit borrowings               $2,820,284          $1,361,708
                                                            =========           =========`

37

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

U.S.
Line of Credit

In
March 2003, the Company entered into a one year line of credit agreement (subject to
annual renewal) with a U.S. lender (the Agreement) for a maximum principal
amount of $2,000,000. In connection with entering into the Agreement, the U.S. lender
issued an irrevocable standby letter of credit on the Companys behalf for the
benefit of the Companys Canadian lender in the amount of $200,000. The standby
letter of credit served to reduce the Companys potential borrowing capacity under
the Agreement by the outstanding balance of the letter of credit. On December 24, 2003,
the Company entered into a new one year line of credit agreement with its U.S. lender for
a maximum principal amount of $3,000,000. The Company terminated its prior U.S. line of
credit on February 28, 2003 with another lender by repaying its outstanding indebtedness
and paying a $50,000 early termination fee. In addition, the Company charged $66,342 to
interest expense during 2003 for deferred financing costs associated with the prior U.S.
line of credit.

On
January 30, 2004, the Company entered into a modified one year line of credit agreement
with its U.S. lender. The maximum principal amount of the line increased to $4,000,000
from $3,000,000. In connection with entering into this line of credit agreement, the
Company deposited $1,000,000 of cash in a restricted account with the U.S. lender and the
U.S. lender issued an irrevocable standby letter of credit on the Companys behalf
for the benefit of Kimberly-Clark Corporation in the amount of $1,566,000 (see Note 2).
Advances were used to fund strategic initiatives and for general working capital purposes.
Estimated maximum potential advances under the Agreement are equal to the lesser of (A)
$4,000,000 or (B) the sum of (i) 80% of eligible receivables (as defined), (ii) 50% of
eligible inventory (as defined), (iii) an amount equal to the immediate liquidation value
of funds deposited with the U.S. lender in a restricted account as security for any
letters of credit extended by the lender on the Companys behalf up to $1,000,000,
less the aggregate amount of any outstanding letters of credit issued by the U.S. lender.
Interest on outstanding advances is payable monthly in arrears at the one month LIBOR rate
(as published in The Wall Street Journal) plus 7.0%, or 9.39% at December 31,
2004. In addition, the Company paid an annual line fee of $40,000. This line fee and any
one-time lender or legal costs associated with securing the line of credit were deferred
and are being amortized to interest expense over the term of the line of credit.

Outstanding
advances are secured by all tangible and intangible assets of the Companys U.S.
operations. Over the term if the Agreement, the Company has agreed to maintain its fixed
charge ratio (as defined) at not less than 1.25:1.0 as measured quarterly on a twelve
month trailing basis. Additional covenants governing permitted indebtedness, changes in
entity status, purchases of securities and protection of collateral are included in the
Agreement. Ongoing operating losses resulted in the Company being out of compliance with
certain of its U.S. line of credit covenants at March 31, June 30 and September 30, 2004.
In return for a commitment to secure alternative financing for its U.S. obligations prior
to the January 31, 2005 maturity date of the Agreement (see Note 20), the U.S. lender
agreed to waive the Companys prior covenant violations and to maintain the line of
credit until maturity thereof. The Company has incurred waiver fees of $7,500 and agreed
to an increase in the rate of interest payable under the line. All other terms of the
Agreement remain in full force and effect.

On
December 30, 2004, the Company paid off the promissory note due Kimberly-Clark Corporation
in the amount $1,566,000 using the restricted cash on deposit with the U.S. lender of
$1,000,000 and available line capacity. In addition, the irrevocable standby letter of
credit issued on behalf of the Kimberly-Clark Corporation in the amount of $1,566,000 was
cancelled. In connection with this transaction, the maximum principal amount of the line
was reduced from $4,000,000 to $2,000,000. All other terms of the Agreement remain in full
force and effect. The remaining outstanding irrevocable standby letter of credit issued on
behalf of the Companys Canadian lender serves to reduce the Companys potential
borrowing capacity under the Agreement by $200,000.

Canadian
Line of Credit

In
September 2004, the Company finalized the annual renewal of its revolving credit facility
(the Canadian Agreement) for a maximum principal amount of $1,830,000
($2,200,000 Canadian) with its Canadian lender. The next annual review is expected to be
completed by May 1, 2005. The Companys wholly owned Canadian subsidiary, Derma
Sciences Canada Inc., may request advances under the Canadian Agreement up to the value of
75% of eligible receivables (as defined) plus the lesser of $915,000 ($1,100,000 Canadian)
or 40% of eligible inventory (as defined), less priority claims. Interest on outstanding
advances is payable monthly in arrears at prime rate (as defined) plus 1.0%, or 5.25% for
Canadian dollar advances and 6.75% for U.S. dollar denominated advances at December 31,
2004. Outstanding advances are secured by all tangible and intangible assets of Derma
Sciences Canada Inc. In addition, the Company has accorded the Canadian lender its
guarantee of payment together with a second lien security interest in the Companys
assets located in the U.S. In return for an irrevocable standby letter of credit in the
amount of $200,000 against the Companys U.S. line of credit, the Canadian lender has
agreed not to exercise its rights under its second lien security interest and guarantee
against the Companys U.S. assets without the U.S. lenders approval.

38

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

Over
the term of the Canadian Agreement, the Company has agreed to comply with a number of
financial covenants governing minimum working capital, current ratios, tangible net worth,
interest coverage, total indebtedness to tangible net worth and total indebtedness to
adjusted pre-tax earnings. Additional covenants governing permitted indebtedness, liens,
payments of dividends and protection of collateral are included in the Canadian Agreement.
In the event of a margin deficiency (as defined) or covenant violation, the Company is
required to advance up to an additional $416,000 ($500,000 Canadian) of working capital to
Derma Sciences Canada Inc. in order to correct the deficiency. This additional working
capital may be repaid to the Company 45 days after the margin deficiency or covenant
violation has been cured upon the condition that such repayment not result in a margin
deficiency, covenant violation or any other event of default.

Losses principally associated
with the write-off of obsolete equipment, employee termination costs and a revamping of manufacturing operations in Toronto
resulted in Derma Sciences Canada being out of compliance with certain of its income based loan covenants that are measured
annually at December 31, 2004. The Canadian lender agreed to waive the covenant violations at December 31, 2004. The Company has
incurred fees of $12,000 associated with the granting of the waivers in 2004. The Company expects to, but cannot assure that it
will, maintain compliance with all applicable loan covenants in the future.

9.     Accrued Expenses and
Other Current Liabilities

Accrued
expenses and other current liabilities include the following:

`December 31,
                                                               -----------------------
                                                               2004               2003
                                                               ----               ----

        Accrued compensation and related taxes               $218,037           $105,783
        Accrued sales, goods and services taxes               197,984            154,974
        Accrued administrative fees                           107,916             20,200
        Other                                                  70,501             32,358
                                                              -------            -------
             Total accrued expenses and other current
               liabilities                                   $594,438           $313,315
                                                              =======            =======`

10.   Long-Term Debt

Long-term
debt includes the following:

`December 31,
                                                               -----------------------
                                                               2004               2003
                                                               ----               ----

        Canadian term loan                                 $  916,805         $1,025,839
        Capital lease obligations                             198,040              2,862
                                                              -------          ---------

             Total debt                                     1,114,845          1,028,701
        Less:  current maturities                             247,306            178,720
                                                            ---------          ---------
             Long-term debt                                $  867,539         $  849,981
                                                             ========          =========`

39

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

The following are the term
loan maturities for the next 3 years:

`Year Ending
                      December 31                                Term Loan
                      -----------                                ---------

                      2005                                        $196,339
                      2006                                         229,617
                      2007                                         490,849
                                                                   -------

                      Total term loan obligations                  916,805
                      Less:  current maturities                    196,339
                                                                   -------

                      Long-term loan obligations                  $720,466
                                                                   =======`

In
connection with the acquisition of substantially all the assets of Dumex Medical Inc., the
Company entered into a five-year term loan agreement with a Canadian Bank. The loan is
repayable in monthly payments consisting of principal and interest. Interest on the
outstanding principal balance is payable monthly at the banks prime rate (as
defined) plus 1.25%, or 5.5% at December 31, 2004. The term loan is secured by all
tangible and intangible assets of Derma Canada and is subject to the same financial
covenants applicable to the operating line of credit (see Note 8).

The
Company has four capital lease obligations for certain distribution equipment and computer
equipment totaling $198,040. The capital leases bear interest at annual rates ranging from
3.9% to 10.2% with the longest lease term expiring in April 2009.

The
future minimum lease payments required under the capital leases and the present value of
the minimum lease payments as of December 31, 2004 are as follows:

`Year Ending                                              Capital Lease
              December 31                                               Obligations
              -----------                                               -----------

                    2005                                                   $ 62,898
                    2006                                                     63,131
                    2007                                                     49,623
                    2008                                                     38,925
                    2009                                                     12,975
                                                                            -------

              Total minimum lease payments                                  227,552
              Less:  Amount representing interest                            29,512
                                                                            -------

              Present value of capital lease obligations                    198,040
              Less:  Current maturities of capital lease obligations         50,967
                                                                            -------

              Long-term capital lease obligations                          $147,073
                                                                            =======`

11.   Shareholders
Equity

Preferred
Stock

There
are 150,003 shares of series A convertible preferred stock outstanding at December 31,
2004. The series A preferred stock is convertible into common stock on a one-for-one
basis, bears no dividend, maintains a liquidation preference of $4.00 per share, votes as
a class on matters affecting the series A preferred stock and maintains voting rights
identical to the common stock on all other matters.

40

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

There
are 440,003 shares of series B convertible preferred stock outstanding at December 31,
2004. The series B preferred stock is convertible into common stock on a one-for-one
basis, bears no dividend, maintains a liquidation preference of $6.00 per share, votes as
a class on matters affecting the series B preferred stock and maintains voting rights
identical to the common stock on all other matters. During the year ended December 31,
2004, 4,167 series B preferred shares were converted into common stock. In 2003, 8,334
shares of series B preferred shares were converted into common stock.

There
are 619,055 shares of series C convertible preferred stock outstanding at December 31,
2004. The series C preferred stock is convertible into common stock on a one-for-one
basis, bears no dividend, maintains a liquidation preference averaging $0.70 per share,
votes as a class on matters affecting the series C preferred stock and maintains voting
rights identical to the common stock on all other matters. In 2003, 100,000 shares of
series C preferred stock were converted into common stock.

There
are 1,071,346 shares of series D convertible preferred stock outstanding at December 31,
2004. The series D preferred stock is convertible into common stock on a one-for-one
basis, bears no dividend, maintains a liquidation preference averaging $0.50 per share,
votes as a class on matters affecting the series D preferred stock and maintains voting
rights identical to the common stock on all other matters. In 2003, 133,334 shares of
series D preferred stock were converted into common stock.

Common
Stock

During
2004, the Company conducted two private common stock offerings. In February 2004, the
Company closed a private offering of 2,057,145 shares of its common stock at a price of
$1.05 per share. Total offering proceeds of $1,961,797, net of $198,203 in offering
expenses, were used to fund strategic initiatives and for general working capital
purposes. As of December 31, 2004, the Company sold 1,555,000 units at $0.50 per unit,
each unit consisting of one share of the Companys common stock and one four-year
series G warrant to purchase one share of common stock at the price of $1.05 as part of a
new continuing offering. Total offering proceeds of $681,359, net of offering expenses of
$78,641, were received. In March 2004, 4,167 shares of series B preferred stock were
converted into 4,167 shares of common stock.

In
June 2003, the Company closed a private offering of 4,000,000 shares of its common stock
at a price of $0.50 per share initiated in January 2002. Total offering proceeds of
$1,879,810, net of $120,190 in offering expenses, were used to fund strategic initiatives
and for general working capital purposes. In 2003, the Company sold 2,400,000 shares of
common stock and received total offering proceeds of $1,126,490, net of $73,510 in
offering expenses.

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

Stock
Purchase Warrants

At
December 31, 2004, the Company had warrants outstanding to purchase 4,734,448 shares of
the Companys common stock as outlined below:

`Series       Number of Warrants      Exercise Price    Expiration Date
                  ------       ------------------      --------------    ---------------
                     E                  1,870,007            $0.85       July 18, 2005
                     F                  1,309,441            $0.57       January 6, 2007
                     G                  1,555,000            $1.05       December 31, 2008`

41

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

As
of December 31, 2004, the Company sold 1,555,000 units at $0.50 per unit, each unit
consisting of one share of common stock and one four-year series G warrant to purchase one
share of common stock at the price of $1.05. In July 2003 there was a cashless exercise of
330,002 series E warrants into 189,751 shares of common stock. There were no other changes
in outstanding warrants during 2004 and 2003.

Stock
Options

The
Company has a stock option plan under which options to purchase a maximum of 3,500,000
shares of common stock may be issued. The plan permits the granting of both incentive
stock options and nonqualified stock options to employees and directors of the Company and
certain outside consultants and advisors to the Company. The option exercise price may not
be less than the fair market value of the stock on the date of the grant of the option.
The duration of each option may not exceed 10 years from the date of grant. Options under
the plan to purchase 1,452,000 shares of common stock were granted to officers, directors,
agents and employees in 2004 with exercise prices ranging from $0.625 to $1.55 per share.
As of December 31, 2004, options to purchase 2,228,000 shares of the Companys common
stock were issued and outstanding under the plan. No options granted under the plan have
been exercised.

The
Company has previously granted nonqualified stock options to officers, directors, agents
and employees outside of the stock option plan (non-plan options). All
non-plan options were granted at the fair market value at the date of grant. As of
December 31, 2004, non-plan options to purchase 2,236,655 shares of the Companys
common stock were issued and outstanding.

A
summary of the Companys stock option activity and related information for the years
ended December 31, 2004 and 2003 follows:

`2004                                 2003
                                               -------------------------------      -------------------------------
                                                                   Weighted                             Weighted
                                                                   Average                              Average
                                                 Options        Exercise Price        Options        Exercise Price
                                                 -------        --------------        -------        --------------

Outstanding - beginning of year                3,676,155            $1.09           2,787,915            $1.11
    Granted                                    1,452,000            $1.20             946,000            $1.01
    Forfeited                                   (663,500)           $1.55             (57,760)           $0.57
                                               ----------                            ---------

Outstanding - end of year                      4,464,655            $1.06           3,676,155            $1.09
                                               =========                            =========

Exercisable at end of year                     3,645,955            $1.08           2,501,705            $1.22
                                               =========                            =========`

The
following table summarizes information about fixed stock options outstanding at December
31, 2004:

`Options Outstanding                              Options Exercisable
                       --------------------------------------------------------     -------------------------------
                          Number         Weighted-Average                             Number
Range of Exercise      Outstanding          Remaining          Weighted-Average     Exercisable    Weighted-Average
      Prices           at 12/31/04       Contractual Life       Exercise Price      at 12/31/04     Exercise Price
-----------------      -----------       ----------------       --------------      -----------     --------------

$0.35 - $1.00           3,668,000               6.5                  $0.60            3,163,000           $0.60
$1.01 - $2.00             517,000               8.8                  $1.55              203,300           $1.56
$2.01 - $12.50            279,655               3.5                  $6.20              279,655           $6.20
                        ---------                                                     ---------

                        4,464,655               6.6                                   3,645,955
                        =========                                                     =========`

42

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

Shares Reserved for Future
Issuance

At
December 31, 2004, the Company has reserved the following shares of common stock for
future issuance:

`Convertible preferred shares (series A - D)        2,280,407
         Common stock options outstanding                   4,464,655
         Common stock options available for grant           1,272,000
         Common stock warrants (series E - G)               4,734,448
                                                            ---------

         Total common stock shares reserved                12,751,510
                                                           ==========`

12.   Operating Segments

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

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

Segment
sales and gross profit for 2004 and 2003 are as follows:

`Year Ended December 31, 2004
                                            ----------------------------
                                                Wound Closure-                                           Total
                               Wound Care         Fasteners         Skin Care          Other            Company
                               ----------         ---------         ---------          -----            -------

Net sales                     $14,609,033          $3,339,432      $1,938,667              -          $19,887,132
                               ----------           ---------       ---------         --------         ----------

Gross profit                    3,206,470           1,685,235         372,204              -            5,263,909
Total expenses                    -                     -                -          $(7,602,602)       (7,602,602)
                                                                                                       -----------

Net loss                                                                                              $(2,338,693)
                                                                                                       ===========

Net long-lived assets         $ 3,535,611               -          $1,352,059      $    269,765       $ 5,157,435
                                =========                            =========       ===========       ==========`

43

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

`Year Ended December 31, 2003
                                            ----------------------------

                                                Wound Closure-                                           Total
                              Wound Care          Fasteners         Skin Care          Other            Company
                              ----------          ---------         ---------          -----            -------

Net sales                     $12,873,602          $3,005,517      $2,062,332              -          $17,941,451
                               ----------           ---------       ---------         --------         ----------

Gross profit                    4,150,237           1,467,747         519,565              -            6,137,549
Total expenses                    -                     -                -          $(6,115,308)       (6,115,308)
                                                                                                       -----------

Net income                                                                                            $    22,241
                                                                                                       ===========

Net long-lived assets         $   992,628               -          $1,328,507      $     26,124       $ 2,347,259
                                =========                           =========        ===========       ==========`

Long-lived
assets consist of equipment and improvements, other intangible assets and goodwill. Wound
care long-lived assets consist principally of Derma Sciences Canada Inc. equipment and
improvements and other intangible assets. Wound closure and fastener products are for the
most part outsourced and accordingly are not supported internally by long-lived assets.
Skin care long-lived assets consist of goodwill associated with the acquisition of
Sunshine Products, Inc. and equipment and improvements associated therewith. Corporate
headquarters and the Companys U.S. distribution center equipment and improvements
are included in the Other column since they service all three business segments.

A
geographical breakdown of the Companys sales, gross profit and long-lived assets is
outlined below:

`United States        Canada             Other            Total
                          -------------        ------             -----            -----
2004
----

Net sales                  $10,096,492       $8,827,210       $   963,430       $19,887,132
                            ----------        ---------        ----------        ----------
Gross profit               $ 3,593,663       $1,333,045       $   337,201       $ 5,263,909
                            ----------        ---------        ----------        ----------
Net long-lived assets      $ 2,020,946       $3,115,293       $    21,196       $ 5,157,435
                            ----------        ---------        ----------        ----------

2003
----

Net sales                  $ 9,163,379       $8,004,926       $   773,146       $17,941,451
                            ----------        ---------        ----------        ----------
Gross profit               $ 4,340,601       $1,526,348       $   270,600       $ 6,137,549
                            ----------        ---------        ----------        ----------
Net long-lived assets      $ 1,531,415       $  757,321       $    58,523       $ 2,347,259
                            ----------        ---------        ----------        ----------`

Other
sales and gross profit relate principally to wound closure and fastener sales in Europe.
Other long-lived assets relate to the Companys manufacturing facility in China.

13.   Income Taxes

(Loss) income before income
taxes consists of the following components:

`2004            2003
                                                            ----            ----

        Domestic                                       $(1,431,001)        $(3,620)
        Foreign                                           (907,692)         25,861
                                                        -----------         -------
        Total (loss) income before income taxes        $(2,338,693)        $22,241
                                                         =========          ======`

44

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Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

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

`December 31,
                                                                       ------------
                                                                 2004               2003
                                                                 ----               ----
        Deferred tax liabilities:
           Prepaid insurance                               $   (10,215)       $   (12,326)
           Patent amortization                                 (51,127)           (44,755)
           Deferred financing costs                            (14,033)            (5,267)
                                                             ----------         ----------

             Total deferred tax liabilities                    (75,375)           (62,348)
                                                             ----------         ----------

        Deferred tax assets:
           Net operating loss carryforwards - U.S.           3,300,395          2,741,346
           Net operating loss foreign                          361,911             53,296
           Depreciation                                         24,442             60,418
           Amortization of intangibles                          86,702             85,881
           Accrued expenses                                     51,277             20,178
           Inventory obsolescence reserve                       93,365             52,771
           Allowance for trade rebates                          66,573             86,058
           Allowance for doubtful accounts                      18,886             12,178
           Other                                                23,301             23,301
                                                             ----------         ----------
             Gross deferred tax assets                       4,026,852          3,135,427
           Valuation allowance                              (3,951,477)        (3,073,079)
                                                             ----------         ----------
             Total deferred tax assets                          75,375             62,348
                                                             ----------         ----------

        Net deferred tax assets                            $    -             $    -
                                                             ==========         ==========`

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

The
reconciliation of income tax computed at the U.S. federal statutory tax rates to income
tax expense is:

`December 31,
                                                            -----------------------
                                                             2004             2003
                                                             ----             ----

        Tax expense at federal statutory rate              $(795,156)      $   7,562
        State tax, net of federal benefit                   (154,120)          -
        Differential in foreign taxes                         54,461          (8,793)
        Use of net operating loss carryforwards                -             (67,529)
        Nondeductible expenses                                16,417          68,760
                                                             -------          ------
             Total                                          (878,398)          -
        Valuation allowance                                  878,398           -
                                                             -------          ------

        Provision for income taxes                         $    -          $   -
                                                             =======         =======`

At
December 31, 2004, the Company has net operating loss carryforwards of approximately
$8,130,000 for federal income tax purposes that begin to expire in years 2012 through
2024. For state income tax purposes, the Company has net operating loss carryforwards in a
number of jurisdictions in varying amounts and with varying expiration dates. The most
significant net operating loss is in New Jersey, site of the Companys domicile. This
state presently has a moratorium on the use of net operating losses. As of December 31,
2004, the Company has foreign net operating loss carryforwards of approximately $1,065,000
which begin to expire in 2009. The timing in which the Company can utilize its net
operating loss carryforwards in any year or in total may be limited under the Internal
Revenue Code section 382 regarding changes in ownership of corporations. Due to
uncertainties surrounding the Companys ability to use its net operating loss
carryforwards, a valuation allowance has been provided as of December 31, 2004.

45

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Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

14.   Distribution
Agreement for Silver Plated Wound Dressings

On
October 1, 2003 the Company entered into a 5 year agreement to serve as the exclusive
distributor to the U.S. military (excluding the Veterans Administration) and Canada for
certain silver plated wound dressings. During each year of the agreement, the Company is
required to purchase a minimum dollar quantity of product from the manufacturer. In the
event the Company fails to meet the annual minimum dollar quantity requirement, the
manufacturer, at its option, may cancel or amend the agreement. The manufacturer has given
the Company notice that, due to its failure to meet its minimum dollar quantity for the
contract year ended September 30, 2004 for the U.S. military market, it intends to amend
the agreement. While no formal agreement has been signed, the parties have reached a basis
of understanding whereby the Company retains exclusivity on its current military customers
and in Canada. Exclusive rights may be added prospectively for additional customers with
the manufacturers approval. The Company anticipates that its present rights as
outlined in the basis of understanding between the two parties will permit it to continue
to open new markets for silver plated dressings.

15.   Distribution
Agreement for Certain Catheter Fasteners

As
of November 23, 1999 the Company entered into an agreement to serve as the exclusive
distributor in the United States for certain catheter fasteners. The agreement expired by
it terms on August 23, 2004 and was not renewed. Sales and gross margin of these catheter
fasteners in 2004 and 2003 were approximately $845,000 and $907,000, and $383,000 and
$376,000, respectively.

16.   Employee Termination
Costs

On
September 24, 2004 the Company settled litigation brought against it and its wholly owned
Canadian subsidiary by its former Executive Vice President and President of Derma Sciences
Canada, Inc. relative to the executives termination of employment. Pursuant to the
settlement, the Company will pay to, or on behalf of, the executive the sum of $269,500
over a period of seven months and will extend the expiration date of previously granted
options to purchase 500,000 shares of the Companys common stock at $0.50 per share
from May 9, 2004 to September 30, 2006. The settlement costs together with estimated other
costs associated with the termination aggregating $301,600 were recorded in general and
administrative expense in the 2004 consolidated statement of operations.

17.   Operating Leases

The
Company has operating lease agreements for its facilities and equipment expiring in
various years through 2012. Expense under these agreements amounted to $997,060 and
$636,298 in 2004 and 2003, respectively. During 2004, the Company entered into a five year
lease in March 2004 for its new U.S. distribution center in St. Louis, extended the lease
on its Toronto manufacturing facility five years through 2012 in connection with the
installation of the Kimberly-Clark Corporation equipment there, renewed its Canadian
distribution center lease for an additional five years through 2009 and renewed its St.
Louis manufacturing facility lease for three years through 2007. The leases provide for
increases in future minimum annual rental payments based on agreed upon terms over the
life of the lease and/or annual inflationary increases tied to a published price index.
The leases provide for renewal options consistent with the terms of the current lease. It
is expected that these leases will be renewed or replaced by leases in other properties.

46

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Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

Minimum
future rental payments under non-cancelable operating leases as of December 31, 2004 are:

`Year Ending                            Minimum Future
                  December 31,                              Payments
                  -----------                               --------

                      2005                                 $1,002,953
                      2006                                  1,016,000
                      2007                                    893,872
                      2008                                    787,363
                      2009                                    509,569
                      Thereafter                              591,700
                                                            ---------

                  Total minimum future rental payments     $4,801,457
                                                            =========`

Minimum rental
payments associated with the U.S. distribution lease range from $11,000 per month in year
one to $21,600 in year five of the lease term. The Company is recording lease expense
monthly at $16,300, the weighted average monthly lease expense over the life of the lease.
The difference between the monthly lease expense being recorded and the amount paid is
being recorded as deferred rent expense on the balance sheet. At December 31, 2004,
$53,207 of deferred rent expense was recorded

18.   Related Party
Transactions

The
Company has a consulting agreement with its founder, former president and former director.
In 2004 and 2003 compensation and reimbursed expenses under this agreement were $28,643
and $34,167, respectively.

A
director of the Company is a general partner in the firm that holds a significant equity
ownership in the Company. In 2004, the firm was paid a $45,000 private equity fund raising
commission.

19.   Retirement Benefits

The
Company maintains a profit sharing/401(k) plan for eligible full-time U.S. employees.
Participants may contribute up to 12% of their salary to the plan, subject to IRS
limitations. The Company makes a matching contribution of 50% on the first 6% of each
participants annual earnings contributed to the plan. Company contributions to the
plan for the years ended December 31, 2004 and 2003 were $39,945 and $31,437,
respectively.

20.   Subsequent Events

Payoff of Letter of Credit

On
January 13, 2005 in connection with the refinancing of the U.S. line of credit, the
Company paid off and cancelled the outstanding irrevocable standby letter of credit issued
by the U.S. lender in the amount of $200,000 held by the Companys Canadian lender as
additional security for its credit facility. The $200,000 paid to the Canadian lender was
applied as a permanent principal reduction against the principal amount due in 2007
associated with the Companys outstanding term loan with the Canadian lender (see
Note 10). Subsequently, on January 31, 2005 the Canadian lender agreed as part of
refinancing of the U.S. line of credit to retain its second lien security interest and
guarantee position against the Companys U.S. assets and not to exercise its rights
under its second lien security interest and guarantee against the U.S. assets without the
U.S. lenders approval.

47

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

U.S. Line of Credit
Refinancing

On
January 31, 2005, the Company entered into a three year revolving credit facility
agreement (the New Agreement) with a new U.S. lender for a maximum principal
amount of $2,000,000. The New Agreement replaces a $2,000,000 revolving credit facility
that expired on January 31, 2005 (see Note 8). At January 31, 2005 maximum potential
advances under the New Agreement were approximately $1,700,000. On January 31, 2005, the
Company applied advances of approximately $1,300,000 under the New Agreement in
satisfaction of the prior U.S. lenders outstanding obligations. Future advances will
be utilized to fund strategic initiatives and general working capital requirements. The
Company incurred loan origination and legal fees of approximately $135,200 in connection
with the implementation of the New Agreement. These fees have been deferred and are being
amortized to interest expense over the three year term of the New Agreement.

The
Company may request advances under the New Agreement up to the value of 85% of eligible
receivables (as defined) and 55% of eligible inventory (as defined). Interest on
outstanding advances is payable monthly in arrears at the prime rate (as defined) plus
2.5%, but not less than 7.5% per annum. At January 31, 2005 the effective interest rate
was 7.75%. In addition, the Company pays a monthly collateral management fee at the rate
of 1.5% per annum upon the daily average amount of advances outstanding and a monthly
unused line fee of 0.5% per annum upon the difference between the daily average amount of
advances outstanding and $2,000,000. Outstanding advances are secured by all of the
Companys existing and after-acquired tangible and intangible U.S. assets. In
addition, the Company has accorded the new U.S. lender its guarantee of payment together
with a second lien security interest in the assets of the Companys wholly owned
Canadian subsidiary. The new U.S. lender has agreed not to exercise its rights under its
second lien security interest and guarantee against the Canadian assets without the
Canadian lenders approval.

Over
the term of the New Agreement, the Company has agreed to comply with the following
covenants as measured at the end of each month for the average of the three most recent
calendar months based upon its consolidated operating results: a) maintain EBITDA
(earnings before interest, taxes, depreciation and amortization) in the range of negative
$300,000 (as of January 31, 2005) transitioning to positive $600,000 (post December 31,
2005) and (b) maintain its fixed charge ratio (EBITDA divided by the sum of debt service,
capital expenditures, income taxes and dividends) in the range of 1.0 to 1.0 (as of
January 31, 2005) to 1.25 to 1.0 (post December 31, 2005). In addition, as it pertains to
the Companys U.S. operations, cash collections may not be less than $800,000 for
each calendar month through June 30, 2005 and $900,000 for each calendar month thereafter,
and at all times the Companys cash on hand (including unused borrowing capacity
under the New Agreement) must not be less than $200,000. Additional covenants governing
permitted indebtedness, liens, payments of dividends and protection of collateral are
included in the New Agreement.

Based
upon consolidated operating results for February 2005, the Company was out of compliance
with its EBITDA and fixed charge ratio covenant under the New Agreement at February 28,
2005. The U.S. lender agreed to waive these covenant violations. The Company expects to,
but cannot ensure that it will, maintain compliance with all applicable loan covenants in
the future.

The
Company may terminate the New Agreement at any time after January 31, 2006 by paying all
outstanding indebtedness and any other payments due the new U.S. lender and paying the new
U.S. lender a yield maintenance based early termination fee equal to the product of: (a)
the effective yield on the facility for the six months prior to termination (expressed as
an annual percentage rate), (b) $2,000,000, and (c) the quotient of the months remaining
in the original term of the New Agreement divided by 12.

Common Stock Private
Offering

On
February 8, 2005, the Company closed a private offering of 2,760,000 units at $0.50 per
unit, each unit consisting of one share of the Companys common stock and one
four-year series G warrant to purchase one share of common stock at a price of $1.05.
Total offering proceeds of $1,230,000, net of $150,000 in estimated offering expenses,
will be used for working capital. During 2005, the Company sold 1,205,000 units at $0.50
per unit and received total offering proceeds of $548,641, net of $71,359 in estimated
offering expenses.

48

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Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

Distribution Agreement
Upset Fee

In
2004, the Companys exclusive distribution agreement for certain catheter fasteners
expired and was not renewed by the manufacturer (see Note 15). In accordance with the
Companys distribution agreement with a major customer for these catheter fasteners,
if the customer subsequently enters into an agreement with the manufacturer to distribute
these products, then the customer shall pay the Company an upset fee of $200,000 payable
in forty-eight monthly installments of $4,167.

As
of January 2005, the customer advised the Company that it had entered into an agreement
with the manufacturer to distribute the catheter fasteners and that it was liable for
payment of the upset fee. In January 2005, the Company discounted the future cash flow
stream associated with the payment of the upset fee and recognized a gain of $164,300.

49

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Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

Item 8A. Controls and
Procedures

The
Companys management, with the participation of the Companys Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys
disclosure controls and procedures as of December 31, 2004. Based on this evaluation, the
Companys Chief Executive Officer and Chief Financial Officer concluded that the
Companys disclosure controls and procedures are effective for gathering, analyzing
and disclosing the information the Company is required to disclose in the reports it files
under the Securities Exchange Act of 1934, within the time periods specified in the
SECs rules and forms.

During
the three months ended December 31, 2004, there was no change in the Companys
internal controls over financial reporting that materially affected, or is reasonably
likely to materially affect, the Companys internal controls over financial
reporting.

50

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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)(2)             | 54  |  | Chairman, President and Chief Executive Officer
| | John E. Yetter, CPA                 | 52  |  | Vice President and Chief Financial Officer     
| | Robert C. Cole                      | 52  |  | Vice President - Sales & Marketing             
| | Frederic Eigner                     | 55  |  | Executive Vice President - Operations          
| | Srini Conjeevaram (1)(2)(3)         | 46  |  | Director                                       
| | Stephen T. Wills, CPA, MST (2)(3)   | 48  |  | Director                                       
| | James T. O'Brien (2)(3)             | 66  |  | Director                                       
| | C. Richard Stafford, Esq. (1)(2)(3) | 69  |  | Director                                       
| | Richard J. Keim (2)(3)              | 69  |  | Director                                       

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

All members of the board of
directors are "independent directors" as defined in Nasdaq Marketplace Rule 4200 with the exception of Edward J. Quilty.

Information Relative to Directors and Executive Officers

Edward
J. Quilty has served as Chief Executive Officer of the Company since November, 1996,
Chairman of the Board since May, 1996 and as a director of the Company since March, 1996.
Mr. Quilty was the Chairman of the Board of Palatin Technologies, Inc., a publicly traded
biopharmaceutical company specializing in peptide drug design for diagnostic and
therapeutic agents from November, 1995 until May, 2000. During the period November, 1996
through May, 2000 Mr. Quilty held the Chief Executive Officer positions at both the
Company and Palatin Technologies, Inc. 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 which was 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 publicly traded developer and
manufacturer of specialty medical products including wound healing agents. The assets of
Life Medical Sciences were purchased by MedChem Products, Inc. During the period January,
1987 through September, 1991 Mr. Quilty served as Vice President  Sales and
Marketing and later as Executive Vice President with McGaw Laboratories, a pharmaceutical
and medical device company. Previously, he served from 1974 in a variety of sales,
marketing and management positions with Baxter/American Hospital Supply Corporation. Mr.
Quilty has over 30 years of experience in the healthcare industry primarily in strategic
planning, management and sales and marketing. Mr. Quilty is director of the MedTech Group,
a privately held medical products company. He earned a Bachelor of Science degree from
Southwest Missouri State University, Springfield, Missouri in 1973 and a Master of
Business Administration degree from Ohio University, Athens, Ohio in 1987.

John
E. Yetter, CPA has served as Vice President and Chief Financial Officer of the Company
since August, 2000. Prior to joining the Company, Mr. Yetter held a variety of senior
financial positions with Bristol-Myers Squibb. Before his association with Bristol-Myers,
he held several supervisory financial positions with Cooper Industries, Inc., Price
Waterhouse and Hulse Manufacturing Company. Mr. Yetter is a member of the American
Institute of Certified Public Accountants and the New York Society of Certified Public
Accountants. He earned a Bachelor of Science in Accounting, magna cum laude, from Boston
College School of Management, Boston, Massachusetts in 1975.

51

---

Robert
C. Cole has served as the Companys Vice President  Sales and Marketing since
January, 2003. Prior to joining the Company, Mr. Cole held a variety of executive sales
positions with B. Braun Medical and predecessor firms beginning in 1974, most recently as
Vice President, Sales, Eastern Zone. Mr. Cole earned his Bachelor of Science degree in
Biology, cum laude, from St. Vincents College, Latrobe, Pennsylvania, in 1974.

Frederic
Eigner has served as Executive Vice President for Operations of the Company and General
Manager of the Companys Canadian subsidiary, Derma Sciences Canada Inc., since
March, 2005. Previously he served as Vice President for Operations of Derma Sciences
Canada Inc. since August, 2002. Prior to its acquisition by the Company, he held several
positions with Dumex Medical Inc. during the period 1992 until August of 2002, most
recently as Executive Vice President. Prior to his association with Dumex Medical, Mr.
Eigner held a variety of executive manufacturing positions with The Kendall Company during
the period 1980 through 1992, most recently as Director of Manufacturing. He earned a
Bachelor of Science degree in Industrial Engineering from the High Technical school of
Kranj, Slovenia, in 1975, a Master of Science in Chemical Engineering from the University
of Maribor, Slovenia, in 1980, and a Master of Business Administration from the University
of Toronto, Ontario, Canada, in 2000.

Srini
Conjeevaram has served as director of the Company since May, 1998. Mr. Conjeevaram is a
General Partner of Galen Associates, a healthcare venture capital firm, and has been with
Galen Associates since 1991. Prior to his affiliation with Galen Associates, he was an
Associate in Corporate Finance at Smith Barney from 1989 to 1990 and a Senior Project
Engineer for General Motors Corporation from 1982 to 1987. Mr. Conjeevaram serves as a
director of ONI Incorporated and Integrated Diagnostic Centers, Inc. and as an observer on
the board of directors of Acura Pharmaceutical, Inc. He earned a Bachelor of Science
degree in Mechanical Engineering from Madras University, Madras, India, a Master of
Science degree in Mechanical Engineering from Stanford University, Stanford, California,
and a Master of Business Administration in Finance from Indiana University, Bloomington,
Indiana.

Stephen
T. Wills, CPA, MST has served as a director of the Company since May, 2000. He also served
as Chief Financial Officer of the Company from July, 1997 and Vice President from
November, 1997 until his resignation from these positions in July, 2000. Mr. Wills
currently serves as Executive Vice President  Operations and Chief Financial Officer
of Palatin Technologies, Inc., a publicly traded biopharmaceutical company. Mr. Wills is a
member of the American Institute of Certified Public Accountants, New Jersey Society of
Certified Public Accountants and Pennsylvania Institute of Certified Public Accountants.
He earned a Bachelor of Science degree in Accounting from West Chester University, West
Chester, Pennsylvania in 1979 and a Master of Science in Taxation from Temple University,
Philadelphia, Pennsylvania in 1994.

James
T. OBrien has served as a director of the Company since May, 2001. He currently
serves as a consultant to the pharmaceutical and healthcare industries. Most recently, he
served as President of OBrien Marketing & Communications. Previously, Mr.
OBrien served from 1989 to 1991 as President and Chief Operating Officer for Elan
Corporation (NYSE: ELN), a multi-national medical products and pharmaceutical company. In
1986, Mr. OBrien founded OBrien Pharmaceuticals and served as its President
and Chief Executive Officer until the acquisition of this company by Elan Corporation.
During the period 1980 to 1986, Mr. OBrien held several division presidencies with
the Revlon Health Care Group. Prior to his association with Revlon, he served for
seventeen years with Sandoz Pharmaceuticals, Inc., most recently as Vice President of U.S.
Marketing and Sales. Mr. OBrien serves on the board of directors of Pharmaquest,
Inc. and serves as chairman of the board of directors of Benedictine College. He earned a
Bachelor of Science in Business Administration from Benedictine College, Atchison, Kansas,
in 1960 and attended the Harvard University Advanced Management Program in 1974.

C. Richard Stafford,
Esq. has served as a director of the Company since May, 2002. Mr. Stafford is a consultant to the pharmaceutical industry.
Previously, he was Vice President for Corporate Development and a member of the operating committee of Carter-Wallace, Inc., a
multinational manufacturer of pharmaceutical, toiletry and diagnostic products. Prior to joining Carter-Wallace, Inc. in 1977, Mr.
Stafford was President of Caithness Corporation, a natural resources development firm, and an adjunct professor of law at New York
Law School. Mr. Stafford earned his Bachelor of Arts, cum laude, from Harvard College, his Bachelor of Laws from Harvard Law
School and his Master of Laws from New York University Law School.

52

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Richard
J. Keim has served as a director of the Company since May, 2002. He is the founder and
Managing Director of Kensington Management Group, LLC, a portfolio manager with assets in
excess of $75 million. Prior to organizing Kensington in 1986, Mr. Keim founded and served
as Executive Vice President of the Buckingham Research Group Incorporated, a registered
broker-dealer, from 1982 through 1993 and Executive Vice President and Chief Investment
Officer of Buckingham Capital Management from 1985 until 1993. Mr. Keim received his
Bachelor of Arts in Business Administration from the University of Wisconsin and his
Master of Business Administration from the University of Chicago. He is a Senior Security
Analyst, a Chartered Financial Analyst, and a member of the New York Society of Security
Analysts and the Financial Analyst Federation.

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 with
the exception of Form 3  Initial Statement of Beneficial Ownership of Securities by
Voyager Partners and Frederic Eigner and Form 4  Statement of Changes in Beneficial
Ownership of Securities by Robert C. Cole the filing of which were untimely.

Information Relative to
Audit Committee

The
Company has established an audit committee in accordance with section 3(a)(58)(A) of the
Securities Exchange Act of 1934. Members of the audit committee are designated in the
table under the heading Directors and Executive Officers above. Stephen T. Wills, CPA,
MST, chairman of the audit committee, is the audit committee financial expert and is
independent as that term is used in Nasdaq Marketplace Rule 4200.

Item 10. Executive
Compensation

Compensation of Outside
Directors

Upon
election or appointment, outside directors receive options to purchase 20,000 shares of
the Companys Common Stock at a price per share equal to the fair market value of the
Common Stock on the date of the option grant. These options vest at the rate of 5,000 on
the date of grant and 5,000 per year thereafter. For each year of service, outside
directors receive options to purchase 70,000 shares of the Companys Common Stock at
a price per share equal to the fair market value of the Common Stock on the date of the
option grant. These options vest at the rate of 55,000 on the date of grant and 5,000 per
year thereafter. Effective January 1, 2005 each outside Director will receive a $12,000
cash payment, payable quarterly, for each year of service on the board of directors. All
directors are reimbursed for expenses incurred in connection with each board and committee
meeting attended. Inside directors receive no compensation for their services as
directors.

Compensation of Executive
Officers

Summary Compensation Table

The
following table shows all compensation paid by the Company in the years 2002, 2003 and
2004 to its Chief Executive Officer, four individuals who served as the Companys
officers or directors on December 31, 2004 whose compensation exceeded $100,000 for their
services (in all capacities) and up to two individuals who would have been disclosed
herein under the foregoing criteria if they had been officers on December 31, 2004:

53

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`Annual Compensation
                                                      -------------------      # of Options      All Other
Name and Principal Position                Year       Salary         Bonus        Granted      Compensation
---------------------------                ----       ------         -----        -------      ------------

Edward J. Quilty                           2004      $287,499       $40,000       300,000        $11,245
Chairman, President and                    2003      $250,000          --          75,000        $10,745
Chief Executive Officer                    2002      $247,167       $30,000        30,000        $10,245

John E. Yetter, CPA                        2004      $193,333       $30,000       175,000         $6,500
Vice President and                         2003      $182,500       $25,000        40,000         $6,000
Chief Financial Officer                    2002      $174,458       $20,000        20,000         $5,500
                                                                       --
Robert C. Cole                             2004      $167,500       $25,000       175,000        $11,100
Vice President - Sales and Marketing       2003      $155,000          --            --           $7,200
                                           2002          --                       175,000           --

Frederic Eigner                            2004      $108,280       $19,215       100,000           $303
Executive Vice President - Operations      2003       $96,181          --                           $282
and General Manager, Derma Sciences        2002       $29,908 (1)      --                            $94
Canada Inc.

Martha A. Crimmins                         2004      $107,500          --          50,000         $3,225
Vice President - Operations                2003      $100,000        $5,215        30,000         $3,156
                                           2002       $92,645        $9,282          --           $3,058`

_____________________________

(1)     Represents compensation earned during the period
August through December, 2002.

Option Grants Table

The
following table sets forth information regarding grants of stock options to the following
named executive officers and directors during the year ended December 31, 2004:

`Percent of Total
                                                         Options Granted to        Exercise
                                     # of Options          Employees and            Price
              Name                      Granted          Directors in 2004        ($/Share)    Expiration Date
              ----                   -------------       -----------------        ---------    ---------------

Edward J. Quilty                       300,000 (1)            23.81%                $1.55      February 23, 2014
John E. Yetter, CPA                    175,000 (2)            13.89%                $1.55      February 23, 2014
Robert C. Cole                         175,000 (2)            13.89%                $1.55      February 23, 2014
Frederic Eigner                        100,000 (3)             7.94%                $1.55      February 23, 2014
Martha A. Crimmins                      50,000 (4)             3.97%                $1.55      February 23, 2014
Stephen T. Wills, CPA, MST              70,000 (5)             5.56%                $0.70      May 26, 2014
Srini Conjeevaram                       70,000 (5)             5.56%                $0.70      May 26, 2014
James T. O'Brien                        70,000 (5)             5.56%                $0.70      May 26, 2014
Richard J. Keim                         70,000 (5)             5.56%                $0.70      May 26, 2014
C. Richard Stafford, Esq.               70,000 (5)             5.56%                $0.70      May 26, 2014`

_________________

|(1) | These options vest as follows: (i) to the extent of 50,000 thereof, at the rate
          of 12,500 upon grant and 12,500 annually; and (ii) to the extent of 250,000
          thereof, upon the attainment of certain performance objectives. These latter
          options lapsed effective December 31, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | These options vest as follows: (i) to the extent of 25,000 thereof, at the rate
          of 6,250 upon grant and 6,250 annually; and (ii) to the extent of 150,000
          thereof, upon the attainment of certain performance objectives. These latter
          options lapsed effective December 31, 2004.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

54

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|(3) | These options vest as follows: (i) to the extent of 30,000 thereof, at the rate
          of 7,500 upon grant and 7,500 annually; and (ii) to the extent of 70,000
          thereof, upon the attainment of certain performance objectives. These latter
          options lapsed effective December 31, 2004.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | These options vest as follows: (i) to the extent of 20,000 thereof, at the rate
          of 5,000 upon grant and 5,000 annually; and (ii) to the extent of 30,000
          thereof, upon the attainment of certain performance objectives. These latter
          options lapsed effective December 31, 2004.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | These options vest at the rate of 55,000 on the date of grant and 5,000 per year
          thereafter.
|--- | ------------------------------------------------------------------------------------------------------

Aggregate Year End Option
Value Table

The
following table sets forth information regarding the aggregate number and value of options
to purchase Common Stock held by the named executive officers as of December 31, 2004. No
options have been exercised:

`Number of Shares                  $ Value of Unexercised
                                             Underlying Unexercised                In-The-Money Options
                                          Options at December 31, 2004           At December 31, 2004 (1)
                                        -------------------------------       ------------------------------
   Name                                 Exercisable       Unexercisable       Exercisable      Unexercisable
   ----                                 -----------       -------------       -----------      -------------
   Edward J. Quilty                        415,055          101,000              $35,825             $8,425
   John E. Yetter, CPA                     192,250           52,750              $16,300             $4,500
   Robert C. Cole                          111,250           88,750               $4,200             $2,800
   Frederic Eigner                          45,500           54,500                    0                  0
   Martha A. Crimmins                       57,000           43,000               $5,600             $1,400`

_________________

(1)    
          Determined based on the fair market value for the Companys Common Stock at
          December 31, 2004 of $0.54 per share.

Employment Arrangements

Edward J. Quilty

The
Company employs Edward J. Quilty, its Chairman, President and Chief Executive Officer,
pursuant to a two-year employment agreement, effective March 1, 2004, providing for base
compensation in the amount of $295,000 per year and incentive compensation in the
discretion of the Companys board of directors. The agreement further provides for
the payment of severance compensation in the amount of two-years base salary upon
failure of the Company to renew the agreement for successive two-year terms or for
termination of Mr. Quiltys employment other than for cause. In addition,
upon a change in control of the Company, Mr. Quilty may, within six-months of the change
in control, tender his resignation and receive two-years severance compensation.

John E. Yetter, CPA

The
Company employs John E. Yetter, CPA, its Vice President and Chief Financial Officer,
pursuant to a one-year employment agreement, renewed effective March 1, 2005, providing
for base compensation in the amount of $195,000 per year and incentive compensation in the
discretion of the Companys board of directors. The agreement further provides for
the payment of severance compensation in the amount of one-years base salary upon
failure of the Company to renew the agreement for successive one-year terms or for
termination of Mr. Yetters employment other than for cause. In addition,
upon a change in control of the Company, Mr. Yetter may, within six-months of the change
in control, tender his resignation and receive one-years severance compensation.

Robert C. Cole

The
Company employs Robert C. Cole, its Vice President for Sales and Marketing, pursuant to a
one-year employment agreement, renewed effective March 1, 2005, providing for base
compensation in the amount of $170,000 per year and incentive compensation in the
discretion of the Companys board of directors. The agreement further provides for
the payment of severance compensation in the amount of one-years base salary upon
failure of the Company to renew the agreement for successive one-year terms or for
termination of Mr. Coles employment other than for cause. In addition,
upon a change in control of the Company, Mr. Cole may, within six-months of the change in
control, tender his resignation and receive one-years severance compensation.

55

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Frederic Eigner

The
Company employs Frederic Eigner, its Vice President and Executive Vice President 
Operations and General Manager of Derma Sciences Canada Inc., pursuant to a one-year
employment agreement, effective March 1, 2005, providing for base compensation in the
amount of $114,500 ($142,000 Canadian) per year and incentive compensation in the
discretion of the Companys board of directors. The agreement further provides for
the payment of severance compensation in the amount of one-years base salary upon
failure of the Company to renew the agreement for successive one-year terms or for
termination of Mr. Eigners employment other than for cause. In addition,
upon a change in control of the Company, Mr. Eigner may, within six-months of the change
in control, tender his resignation and receive one-years severance compensation.

Martha A. Crimmins

The
Company employs Martha A. Crimmins, its Vice President  Operations, pursuant to an
employment agreement dated December 28, 2001. The agreement, as amended, provides for base
compensation of $110,000 per year together with performance-based bonuses. The agreement
also provides for the payment of severance compensation in the amount of six months
salary upon termination of the agreement by the Company other than for cause.
In addition, upon a change in control of the Company, Ms. Crimmins may, within six-months
of the change in control, tender her resignation and receive six months severance
compensation.

Stock Option Plan

The
Company adopted the Stock Option Plan (the Plan) July 18, 1991 and amended the
Plan January 14, 1994, May 22, 1996, July 14, 1998, February 6, 2003 and February 24,
2004. The number of shares of Common Stock reserved for issuance pursuant to the Plan is
3,500,000 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)
nonqualified 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 provisions of the Plan, the Compensation Committee determines who is
eligible to receive stock options, together with the nature, amount, timing, exercise
price, vesting schedule 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. Stock options are not
assignable or transferable except by will or the laws of descent and distribution. Stock
options granted under the Plan which have lapsed or terminated revert to the status of
unissued and become available for reissuance.

At
December 31, 2004, options to purchase 2,228,000 shares of the Companys Common Stock
at prices in the range of $0.37 to $5.00 per share were issued and outstanding under the
Plan.

Equity Compensation Plan
Information

The
following table provides information concerning the Companys equity compensation
plans or individual arrangements that were approved by shareholders and those that were
not approved by shareholders as of December 31, 2004:

56

---

`Number of Securities
                                                                                 Remaining Available for
                                                                                  Future Issuance Under
                               Number of Securities to     Weighted-Average       Equity Compensation
                               be Issued Upon Exercise     Exercise Price of       Plans (Excluding
                               of Outstanding Options,    Outstanding Options,        Securities
Plan Category                    Warrants and Rights      Warrants and Rights     Reflected in Column 1)
-------------                    -------------------      -------------------     ----------------------

Equity Compensation Plans
Approved by Shareholders
                                   2,228,000 (1)                  $0.91                  1,272,000
Equity Compensation Plans
Not Approved by
Shareholders                       2,236,655 (2)                  $1.21                          0
                                   ---------                      -----                  ---------

Total                              4,464,655                      $1.06                  1,272,000
                                   =========                       ====                  =========`

_________________

|(1) | The securities consist of Incentive Stock Options and Nonqualified Stock Options
          granted to officers, directors, employees and consultants in 1997, 1998, 2003
          and 2004 pursuant to the Companys Stock Option Plan. The per share
          exercise price of the options is in the range of $0.37 to $5.00. The shares of
          Common Stock underlying the options have not been registered under the
          Securities Act of 1933.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The securities consist of Nonqualified Stock Options granted to officers,
          directors, employees and consultants of the Company during the period 1995
          through 2002. These options were effected pursuant to employment agreements or
          stock option agreements recommended by the Compensation Committee of the
          Companys Board of Directors and approved by its Board of Directors. The
          per share exercise price of the options is in the range of $0.40 to $12.50. The
          shares of Common Stock underlying the options have not been registered under the
          Securities Act of 1933.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Code of Ethics

The
Company has adopted a code of ethics that applies to its principal executive officer,
principal financial officer, principal accounting officer (controller) and persons
performing similar functions. The Company has filed a copy of its code of ethics as
Exhibit 10.42 to its Form 10-KSB filed on March 31, 2003.

Item 11. Security Ownership of Certain Beneficial Owners and Management
and Related Shareholder Matters

The
following table sets forth as of March 31, 2005 certain information regarding the
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:

57

---

`Percent
                                                           Number of Shares       Beneficially
Name and Address of Beneficial Owner (1)               Beneficially Owned (17)     Owned (17)
----------------------------------------               -----------------------     ----------

Srini Conjeevaram (2)..................................        6,140,516            36.85%
Richard J. Keim (3)....................................        1,830,500            14.15%
Voyager Partners (4)...................................        1,428,572            11.63%
Edward J. Quilty (5)...................................        1,105,115             8.50%
Hambrecht & Quist California (6).......................        1,064,167             8.36%
Norman H. Pessin (7)...................................        1,003,000             7.91%
Bushido Capital Master Fund (8)........................        1,000,000             7.82%
William R. Grant (9)...................................          900,000             7.21%
Endeavor Asset Management (10).........................          800,000             6.31%
Stephen T. Wills, CPA, MST (11)........................          505,336             3.99%
James T. O'Brien (12)..................................          361,600             2.88%
C. Richard Stafford, Esq. (13).........................          285,000             2.27%
John E. Yetter, CPA (14)...............................          252,875             2.02%
Robert C. Cole (15)....................................          166,875             1.34%
All directors and officers as a group (8 persons) (16)        10,647,817            72.00%`

_________________

|(1) | Except as otherwise noted, the address of each of the persons listed is: 214
          Carnegie Center, Suite 100, Princeton, New Jersey 08540.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Srini Conjeevaram is a General Partner of the Galen III Partnerships. The Galen
          III Partnerships can be reached at: 610 Fifth Avenue, Fifth Floor, New York, New
          York 10020. Includes shares owned by Galen Partners III, L.P., Galen Partners
          International III, L.P. and Galen Employee Fund III, L.P. Ownership consists of:
          1,762,000 shares of Common Stock, 125,003 shares of Class A Convertible
          Preferred Stock (Class A Preferred), 416,668 shares of Class B
          Convertible Preferred Stock (Class B Preferred), 619,055 shares of
          Class C Convertible Preferred Stock (Class C Preferred), 1,071,346
          shares of Class D Convertible Preferred Stock (Class D Preferred),
          550,003 warrants to purchase Common Stock exercisable at $0.75 per share
          (Class E Warrants), 1,309,441 warrants to purchase common stock
          exercisable at $0.50 per share (Class F Warrants) and exercisable
          options to purchase 287,000 shares of Common Stock. No additional options to
          purchase Common Stock will become exercisable within 60 days of March 31, 2005.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Richard J. Keim is a Managing Director of Kensington Management Group, LLC.
          Kensington Management Group, LLC can be reached at: 200 Park Avenue, New York,
          New York 10016. Includes shares owned by Kensington Partners L.P., Kensington
          Partners II L.P., Bald Eagle Fund Ltd., Peter Orthwein Managed Account and Peter
          Orthwein Family Trust. Ownership consists of: 1,175,500 shares of Common Stock,
          440,000 Class E Warrants and exercisable options to purchase 215,000 shares of
          Common Stock. No additional options to purchase Common Stock will become
          exercisable within 60 days of March 31, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Voyager Partners can be reached at: Oakmont Corporation, 865 South Figueroa
          Street, Suite 700, Los Angles, California 90017. Ownership consists of:
          1,428,572 shares of Common Stock.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Edward J. Quiltys ownership consists of: 385,684 shares of Common Stock,
          220,001 Class E Warrants, 50,000 Class G Warrants and exercisable options to
          purchase 449,430 shares of Common Stock. No additional options to purchase
          Common Stock will become exercisable within 60 days of March 31, 2005.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Hambrecht & Quist California can be reached at: One Bush Street, San
          Francisco, California 94104. Ownership consists of: 624,167 shares of Common
          Stock and 440,000 Class E Warrants.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Norman H. Pessin can be reached at 455 East 57th Street, New York, New York. Ownership consists of 603,000 shares of
          Common Stock and 400,000 Class G Warrants.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Bushido Capital Master Fund can be reached at 275 Seventh Avenue, Suite 2000,
          New York, New York 10001. Ownership consists of 500,000 shares of Common Stock
          and 500,000 warrants to purchase Common Stock at $1.05 per share (Class G
          Warrants).
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) | William R. Grant can be reached at 30 Sutton Place # 7B, New York, New York
          10022. Ownership consists of: 700,000 shares of Common Stock and 200,000 Class G
          Warrants.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) | Endeavor Asset Management can be reached at 29 Broadway, Room 1125, New York,
          New York 10006. Ownership consists of: 400,000 shares of Common Stock and
          400,000 Class G Warrants.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

58

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|(11) | Stephen T. Wills ownership consists of: 119,668 shares of Common Stock,
          58,668 Class E Warrants and exercisable options to purchase 327,000 shares of
          Common Stock. No additional options to purchase Common Stock will become
          exercisable within 60 days of March 31, 2005.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(12) | James T. OBriens ownership consists of: 81,600 shares of Common
          Stock and exercisable options to purchase 240,000 shares of Common Stock. No
          additional options to purchase Common Stock will become exercisable within 60
          days of March 31, 2005.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(13) | C. Richard Staffords ownership consists of: 35,000 shares of Common Stock,
          35,000 Class G Warrants and exercisable options to purchase 215,000 shares of
          Common Stock. No additional options to purchase Common Stock will become
          exercisable within 60 days of March 31, 2005.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(14) | John E. Yetters ownership consists of: 40,000 shares of Common Stock and
          exercisable options to purchase 212,875 shares of Common Stock. No additional
          options to purchase Common Stock will become exercisable within 60 days of March
          31, 2005.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(15) | Robert C. Coles ownership consists of: 25,000 shares of Common Stock and
          exercisable options to purchase 126,875 shares of Common Stock. No additional
          options to purchase Common Stock will become exercisable within 60 days of March
          31, 2005.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(16) | Ownership consists of: Common Stock, Class A Preferred, Class B Preferred, Class
          C Preferred, Class D Preferred, Class E Warrants, Class F Warrants, Class G
          Warrants and options currently exercisable and exercisable within 60 days of
          March 31, 2005 to purchase shares of Common Stock.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(17) | The number of shares beneficially owned and the percent beneficially owned by
          each entity or individual assume the exercise of all exercisable options
          (including those that would be exercisable within 60 days of March 31, 2005),
          the exercise of all warrants and the conversion into Common Stock of all
          Convertible Preferred Stock owned by such entity or individual. The percent
          beneficially owned is a fraction the numerator of which is the number of shares
          of Common Stock beneficially owned by each entity or individual and the
          denominator of which is the number of outstanding shares of Common Stock plus
          the number of shares of Common Stock which would be issued upon exercise by the
          subject entity or individual of its/his/her own options and warrants and the
          conversion into Common Stock of its/his/her own Convertible Preferred Stock.
          This method of computing the percent beneficially owned results in the aggregate
          ownership percentages of all owners exceeding 100%.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Item 12. Certain
Relationships and Related Transactions

The
Company has a consulting agreement with its founder, former president and former director.
In 2004 and 2003 compensation and reimbursed expenses under this agreement were $28,643
and $34,167, respectively.

A
director of the Company is a general partner in the firm that holds a significant equity
ownership of the Company. In 2004, the firm was paid a $45,000 private equity fund raising
commission.

Item 13. Exhibits

(a) Exhibits

`Exhibit
Number                                                   Description
------                                                   -----------

3.01        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).
3.02        Amendment to the Articles of Incorporation effective February 10, 1998 (previously
               filed as Exhibit A to the Company's Proxy Statement filed on December 22, 1997 and
               incorporated herein by reference).
3.03        Amendment to the Articles of Incorporation effective October 20, 1998 (previously filed
               as Exhibit A to the Company's Proxy Statement filed on August 14, 1998 and
               incorporated herein by reference).
3.04        Amendment to the Articles of Incorporation effective May 26, 1999 (previously filed as
               Exhibit A to the Company's Proxy Statement filed on April 13, 1999 and incorporated
               herein by reference).`

59

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`3.05        Amendment to the Articles of Incorporation effective August 2, 1999 (previously filed
               as Exhibit 3 to the Company's Form 8-K filed on August 6, 1999 and incorporated
               herein by reference).
3.06        Certificate of Designations, Voting Powers, Preferences and Rights of the Series of
               Preferred Stock of Derma Sciences, Inc. Designated Series A Convertible Preferred
               Stock (previously filed as Exhibit 10.03 to the Company's Form 8-K filed on November
               24, 1997 and incorporated herein by reference).
3.07        Certificate of Designations, Voting Powers, Preferences and Rights of the Series of
               Preferred Stock of Derma Sciences, Inc. Designated Series B Convertible Preferred
               Stock (previously filed as Exhibit 10.05 to the Company's Form 8-K filed on July 9,
               1998 and incorporated herein by reference).
3.08        Certificate of Designations, Voting Powers, Preferences and Rights of the Series of
               Preferred Stock of Derma Sciences, Inc. Designated Series C Convertible Preferred
               Stock (previously filed as Exhibit 10.05 to the Company's Form 8-K filed on August
               20, 1999 and incorporated herein by reference).
3.09        Certificate of Designations, Voting Powers, Preferences and Rights of the Series of
               Preferred Stock of Derma Sciences, Inc. Designated Series D Convertible Preferred
               Stock (previously filed as Exhibit 10.05 to the Company's Form 8-K filed on January
               10, 2000 and incorporated herein by reference).
3.10        Bylaws effective May 14, 1997 (previously filed as Exhibit 3.1 to the Company's Form
               10-QSB filed on August 15, 1997 and incorporated herein by reference).
10.01*      Employment Agreement, dated March 1, 2004, between the Company and Edward J. Quilty
               (previously filed as Exhibit 10.01 to the Company's Form 10-KSB filed on March 30,
               2004 and incorporated herein by reference).
10.02*      Senior Management Stock Option Agreement, dated April 30, 1997, between the Company and
               Edward J. Quilty (previously filed as Exhibit 10.05 to the Company's Form 8-K filed
               on May 6, 1997 and incorporated herein by reference).
10.03*      Stock Option Agreement, dated August 24, 2001, between the Company and Edward J. Quilty
               (previously filed as Exhibit 10.03 to the Company's Form 10-KSB filed on March 30,
               2004 and incorporated herein by reference).
10.04*      Stock Option Agreement, dated February 26, 2002, between the Company and Edward J.
               Quilty (previously filed as Exhibit 10.04 to the Company's Form 10-KSB filed on
               March 30, 2004 and incorporated herein by reference).
10.05*      Employment Agreement, dated March 1, 2004, between the Company and John E.
               Yetter, CPA (previously filed as Exhibit 10.06 to the Company's Form 10-KSB filed on
               March 30, 2004 and incorporated herein by reference).
10.06*      Stock Option Agreement, dated August 28, 2000, between the Company and John E. Yetter,
               CPA (previously filed as Exhibit 10.31 to the Company's Form 10-KSB/A-1 filed on
               August 10, 2001 and incorporated herein by reference).
10.07*      Stock Option Agreement, dated August 24, 2001, between the Company and John E. Yetter ,
               CPA. (previously filed as Exhibit 10.08 to the Company's Form 10-KSB filed on March
               30, 2004 and incorporated herein by reference).
10.08*      Stock Option Agreement, dated February 26, 2002, between the Company and John E. Yetter
               , CPA. (previously filed as Exhibit 10.09 to the Company's Form 10-KSB filed on
               March 30, 2004 and incorporated herein by reference).
10.09*      Employment Agreement, dated March 1, 2004, between the Company and Robert C. Cole
               (previously filed as Exhibit 10.11 to the Company's Form 10-KSB filed on March 30,
               2004 and incorporated herein by reference).
10.10*      Stock Option Agreement, dated November 26, 2002, between the Company and Robert C. Cole
               (previously filed as Exhibit 10.12 to the Company's Form 10-KSB filed on March 30,
               2004 and incorporated herein by reference).
10.11*      Employment Agreement, dated December 28, 2001, between the Company and Martha A.
               Crimmins (previously filed as Exhibit 10.13 to the Company's Form 10-KSB filed on
               March 30, 2004 and incorporated herein by reference).`

60

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`10.12*      Stock Option Agreement, dated August 24, 2001, between the Company and Martha A.
               Crimmins (previously filed as Exhibit 10.14 to the Company's Form 10-KSB filed on
               March 30, 2004 and incorporated herein by reference).
10.13       Agreement and Plan of Merger dated December 27, 1999 by and among Derma Sciences, Inc.
               and Genetic Laboratories Wound Care, Inc. (previously filed as Exhibit 10.01 to the
               Company's Form 8-K filed on January 10, 2000 and incorporated herein by reference).
10.14       Asset Purchase Agreement and amendments thereto, dated June 28, 2002, July 12, 2002 and
               July 18, 2002, by and between Derma Sciences, Inc. and Dumex Medical, Inc.
               (previously filed as Exhibits 2.01, 2.02 and 2.03 to the Company's Form 8-K filed on
               September 10, 2002 and incorporated herein by reference).
10.15       Manufacturers Agreement, dated August 25, 1992, between the Company and TapeMark
               Company (previously filed as Exhibit 10.50 to the Company's Form 10-KSB filed on
               March 31, 1999 and incorporated herein by reference).
10.16       The Derma Sciences, Inc. 401(k) Plan, as amended February 24, 2004 (previously filed as
               Appendix C to the Company's Proxy Statement filed April 5, 2004 and incorporated
               herein by reference).
10.17       Bond Amendment Agreement, dated January 5, 2001 between the Company and Galen Partners
               III, L.P., Galen Partners International III, L.P. and Galen Employee Fund III, L.P.
               (previously filed as Exhibit 10.01 to the Company's Form 8-K filed March 19, 2001
               and incorporated herein by reference).
10.18       Purchase Agreement, dated February 28, 2002 relative to the private placement of
               securities (previously filed as Exhibit 10.01 to the Company's Form 8-K filed on
               March 6, 2002 and incorporated herein by reference).
10.19       Registration Rights Agreement, dated February 28, 2002 relative to the private
               placement of securities (previously filed as Exhibit 10.02 to the Company's Form 8-K
               filed on March 6, 2002 and incorporated herein by reference).
10.20       Offer of Finance dated July 23, 2002 relative to financing by the Company of the
               purchase of the assets of Dumex Medical Inc. through the Laurentian Bank of Canada
               (previously filed as Exhibit 10.01 to the Company's Form 8-K filed on September 10,
               2002 and incorporated herein by reference).
10.21       Guarantee of the Company dated on or about August 26, 2002 of indebtedness of Dumex
               Medical Canada Inc. to the Laurentian Bank of Canada (previously filed as Exhibit
               10.03 to the Company's Form 8-K filed on September 10, 2002 and incorporated herein
               by reference).
10.22       Guarantee of the subsidiary of the Company, Sunshine Products, Inc., dated on or about
               August 26, 2002 of indebtedness of Dumex Medical Canada Inc. to the Laurentian Bank
               of Canada (previously filed as Exhibit 10.04 to the Company's Form 8-K filed on
               September 10, 2002 and incorporated herein by reference).
10.23       Security Agreement of the Company dated on or about August 26, 2002 pledging collateral
               to secure its guarantee of indebtedness of Dumex Medical Canada Inc. to the
               Laurentian Bank of Canada (previously filed as Exhibit 10.05 to the Company's Form
               8-K filed on September 10, 2002 and incorporated herein by reference).
10.24       Security Agreement of the subsidiary of the Company, Sunshine Products, Inc., dated on
               or about August 26, 2002 pledging collateral to secure its guarantee of indebtedness
               of Dumex Medical Canada Inc. to the Laurentian Bank of Canada (previously filed as
               Exhibit 10.06 to the Company's Form 8-K filed on September 10, 2002 and incorporated
               herein by reference).
10.25       Bond Conversion Agreement, dated January 7, 2002, between the Company and Galen
               Partners III, Galen Partners International III, Galen Employee Fund III (previously
               filed as Exhibit 10.01 to the Company's Form 8-K filed on March 7, 2002 and
               incorporated herein by reference).
10.26       Code of ethics applicable to the Company's principal executive officer, principal
               financial officer and principal accounting officer (previously filed as Exhibit
               10.42 to the Company's Form 10-KSB filed on March 31, 2003 and incorporated herein
               by reference).`

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`10.27       Revolving Credit, Loan and Security Agreement, dated March 27, 2003, between the
               Company and Merrill Lynch Business Financial Services, Inc. (previously filed as
               Exhibit 10.01 to the Company's Form 8-K filed on May 2, 2003 and incorporated herein
               by reference).
10.28       Form of Purchase Agreement relative to private placement of securities (previously
               filed as Exhibit 10.01 to the Company's Form 8-K filed on June 12, 2003 and
               incorporated herein by reference).
10.29       Form of Registration Rights Agreement relative to private placement of securities
               (previously filed as Exhibit 10.02 to the Company's Form 8-K filed on June 12, 2003
               and incorporated herein by reference).
10.30       Asset Purchase Agreement, dated August 6, 2003, between the Company and GeriCare
               Providers, Inc. (previously filed as Exhibit 10.01 to the Company's Form 8-K filed
               on August 29, 2003 and incorporated herein by reference).
10.31       Purchase Agreement, dated January 9, 2004 between the Company and Kimberly-Clark
               Corporation (previously filed as Exhibit 2.01 to the Company's Form 8-K filed on
               January 23, 2004 and incorporated herein by reference).
10.32       Security Agreement dated January 9, 2004 between the Company and Kimberly-Clark
               Corporation (previously filed as Exhibit 10.01 to the Company's Form 8-K filed on
               January 23, 2004 and incorporated herein by reference).
10.33       Lease Agreement, dated January 9, 2003 between the Company and Kimberly-Clark
               Corporation (previously filed as Exhibit 10.02 to the Company's Form 8-K filed on
               January 23, 2004 and incorporated herein by reference).
10.34       Supply Agreement dated January , 2004 between the Company and Kimberly-Clark
               Corporation (previously filed as Exhibit 10.03 to the Company's Form 8-K filed on
               January 23, 2004 and incorporated herein by reference).
10.35       Trademark License Agreement dated January , 2004 between the Company and Kimberly-Clark
               Corporation (previously filed as Exhibit 10.04 to the Company's Form 8-K filed on
               January 23, 2004 and incorporated herein by reference).
10.36       Trademark Assignment dated January , 2004 between the Company and Kimberly-Clark
               Corporation (previously filed as Exhibit 10.05 to the Company's Form 8-K filed on
               January 23, 2004 and incorporated herein by reference).
10.37       Amendment to Purchase Agreement, dated as of January 9, 2004 between the Company and
               Kimberly-Clark Corporation (previously filed as Exhibit 2.01 to the Company's Form
               8-K/A-2 filed on February 6, 2004 and incorporated herein by reference).
10.38       Form of Purchase Agreement relative to private placement of common stock (previously
               filed as Exhibit 10.01 to the Company's Form 8-K filed on March 8, 2004 and
               incorporated herein by reference).
10.39       Form of Registration Rights Agreement relative to private placement of common stock
               (previously filed as Exhibit 10.02 to the Company's Form 8-K filed on March 8, 2004
               and incorporated herein by reference).
10.40       Form of Purchase Agreement relative to private placement of common stock and series G
               warrants.
10.41       Form of Registration Rights Agreement relative to private placement of common stock and
               series G warrants.
10.42       Employment Agreement, dated March 1, 2005, between the Company and Frederic Eigner.
16.1        Letter from previous certifying accountants concurring with the Company's statements
               relative to this firm in the Company's report concerning its change of certifying
               accountants (previously filed as Exhibit 16.1 to the Company's Form 8-K filed
               October 4, 2004 and incorporated herein by reference).
21          Information relative to subsidiaries.
23.1        Consent of J.H. Cohn LLP.
23.2        Consent of Ernst & Young LLP.
31.1        Certification of the Principal Executive Officer pursuant to Section 302 of the
               Sarbanes-Oxley act of 2002.
31.2        Certification of the Principal Financial Officer pursuant to Section 302 of the
               Sarbanes-Oxley act of 2002.
32.1        Certification of the Principal Executive Officer pursuant to U.S.C. Section 1350 as
               adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.`

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`32.2        Certification of the Principal Financial Officer pursuant to U.S.C. Section 1350 as
               adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1        Risk factors affecting future prospects.`

_________________

* Management contract or compensatory
plan.

Item 14. Principal
Accountant Fees and Services

Independent Registered
Public Accounting Firm Fees

Fees
for professional services provided by the Companys Independent Registered Public Accounting
Firms, J.H. Cohn LLP (effective September 29, 2004) and Ernst & Young LLP for the year
ended December 31, 2004 and Ernst & Young LLP for the year ended December 31, 2003,
are as follows:

`2004                 2003
                                             ----                 ----

               Audit fees                  $182,645             $138,500
               Audit related fees            22,985                8,700
               Tax fees                      26,265               37,700
                                            -------              -------

               Totals                      $231,895             $184,900
                                            =======              =======`

Audit Fees

Audit
fees consist of fees relative to the audit of the Companys year-end financial
statements and review of the Companys quarterly reports on Form 10-QSB.

Audit Related Fees

Audit
related fees principally include fees relative to the Form 8-K in connection with the
Kimberly-Clark Corporation wound care asset acquisition in 2004, along with accounting
consultations in 2004 and 2003.

Tax Fees

Tax
fees consist of fees relative to analysis of the Companys net operating loss
carryforwards in 2003 and preparation of the Companys consolidated United States
federal, state and local and Canadian tax returns in 2004 and 2003.

Audit Committee
Pre-Approval Policy

It
is the policy of the Companys audit committee to approve all engagements of the
Companys independent auditors to render audit or non-audit services prior to the
initiation of such services.

63

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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.

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.

|               | DERMA SCIENCES, INC.                                
|-------------- | ----------------------------------------------------
|               |                                                     
|               |                                                     
|March 30, 2005 | By: /s/ Edward J. Quilty                            
|               | Edward J.
     Quilty                               
|               | Chairman,
     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 30, 2005.

| | Signatures: |  |  | Title: | 
| | ----------- |  |  | ------ | 

|/s/ Edward J. Quilty       | President, Chief Executive Officer and Chairman of the Board
|-------------------------- | ------------------------------------------------------------
|Edward J. Quilty           | of Directors (Principal Executive
     Officer)             
|                           |                                                             
|/s/ John E. Yetter         | Vice President and Chief Financial Officer                  
|John E. Yetter, CPA        | (Principal Financial and Accounting
     Officer)           
|                           |                                                             
|/s/ Srini Conjeevaram      | Director                                                    
|Srini Conjeevaram          |                                                             
|                           |                                                             
|/s/ Stephen T. Wills       | Director                                                    
|Stephen T. Wills, CPA, MST |                                                             
|                           |                                                             
|/s/ James T. O'Brien       | Director                                                    
|James T. O'Brien           |                                                             
|                           |                                                             
|/s/ C. Richard Stafford    | Director                                                    
|C. Richard Stafford, Esq.  |                                                             
|                           |                                                             
|/s/ Richard J. Keim        | Director                                                    
|Richard J. Keim            |                                                             

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