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, 2007      
|------ | -------------------------------------------------------------------------------------------------------------------------------------
|       |                                                                                                                                      
|[    ] | 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 300, 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                         

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

Title of Class

Common Stock, $.01 par value

Check whether
the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange
Act.[    ]

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 there is no
disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of 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. [    ]

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

         Yes
     NoX

Issuers
revenues for its most recent fiscal year were $34,135,401.

The
aggregate market value of the common equity stock held by non-affiliates, computed by
reference to the average bid and asked prices of such stock as of February 28, 2008, was
approximately $21,153,856.

The
number of shares outstanding of the issuers common equity as of February 28, 2008
was 34,040,743.

Documents
incorporated by reference: None

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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
September, 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 segment. These assets have been integrated into the
Companys existing wound care and wound closure and specialty securement device
product lines.

In
April 2006, Derma Sciences purchased certain assets and the business of Western Medical,
Inc. (Western Medical), a manufacturer and marketer of a line of specialty
medical textile compression, support and protective dressing products. These assets have
been integrated into the Companys existing wound care product line.

In
November, 2007, Derma Sciences acquired certain assets and the business of Nutra Max
Products, Inc.s first aid division (FAD). FAD is a leading manufacturer
and marketer of branded and private label adhesive strips and related first aid products
to the medical, industrial and retail markets. The assets have been integrated into Derma
Sciences existing wound care product line.

Derma
Sciences and its subsidiaries Sunshine Products, Derma Canada and Derma First Aid
Products, Inc. are referred to collectively as the Company. The Companys
executive offices are located at 214 Carnegie Center, Suite 300, Princeton, New Jersey.

The
Company engages in the manufacture, marketing and sale of three dermatological related
product lines: wound care, wound closure and specialty securement devices and skin care.
In addition, the Company has leveraged its expanding manufacturing capabilities by
building a growing private label/original equipment manufacture (OEM)
business. The Companys customers consist of various health care agencies and
institutions such as nursing homes, hospitals, home healthcare agencies, physicians
offices and retail and closed door pharmacies. The Company sells its products principally
through distributors servicing these markets in the United States, Canada and select
international markets. The Companys principal distribution facilities are located in
St. Louis, Missouri, and Toronto, Canada. The Companys principal manufacturing
facility is located in Toronto, Canada. The Company, through Derma Canada, also maintains
a light manufacturing facility in Nantong, China producing labor intensive wound care
products. With the FAD acquisition the Company temporarily manufactures and distributes
the adhesive strips and related first aid products at a Houston, Texas location. The
manufacturing function is anticipated to be transferred to a third party by the second
quarter of 2008 while the distribution function is anticipated to be integrated with the
rest of the US distribution activities by the first quarter of 2009.

1

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Company Products and Markets

Wound Care

The
Company markets a line of wound care products to doctors, clinics, nursing homes,
hospitals and other institutions. The Wound Care line consists of basic and advanced
dressings, devices, 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.

Wound Closure and
Specialty Securement Devices

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.

Private Label/OEM

The
Company manufactures private label wound care and wound closure and specialty securement
devices for a number of U.S. and international customers.

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 has built a base business through sales of its own brand and private label brand
commodity products. Prospectively, the Company is focusing its resources on the marketing,
sale and distribution of novel higher margined advanced wound care products.

Product Pipeline

The
company currently has two development stage products. The first is GUARDIONTM Barrier
Dressings with a novel antimicrobial that the Company has licensed from QuickMed
Technologies, Inc. The patented polymer technology known as NIMBUS (novel intrinsically
micro-biocidal utility substrate) was licensed from QuickMed in April, 2007, for use in a
range of gauze and other traditional wound care dressings. The product is currently under
review by the FDA for marketing clearance. The second is DSC127, a novel angiotensin
analog, licensed from the University of Southern California in November, 2007, for use in
wound healing and scar reduction. The compound has shown activity in these areas in
pre-clinical animal model testing. The compound has successfully completed a phase I human
trial, and is expected to enter into a phase II human trial in the third quarter of 2008.

Sales Resources

United States

In
the United States, the Company employs a direct sales force 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 an executive vice president  sales, a
national director  sales, a director  corporate accounts, ten sales
representatives and one clinical resource specialist. Company sales employees receive a
base salary together with commissions based upon sales and gross profit achievement within
their area of responsibility.

2

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Canada

In
Canada, the Company employs a sales manager, one direct sales representative in Ontario,
the most densely populated province, and a manufacturers representative located in
British Colombia. Company sales employees receive a base salary together with commissions
based upon sales 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. Nursing home, home healthcare,
physician office and retail sales are for the most part made through local dealers and
government sponsored Community Care Access Centres (CCAC) agencies.

In
May 2005, the Company entered into a five year agreement with a Canadian company to serve
as the exclusive distributor of its products in Canada. The distributor maintains
strategically located distribution centers and over 40 sales representatives throughout
Canada. The Company believes the agreement provides better service to its customers
throughout Canada and greater opportunity for sales growth.

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 $1,692,130 in 2007 and
$1,225,515 in 2006.

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.

In
the United States, the Companys basic wound care products compete in a commodity
oriented marketplace with Covidien, 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 and a number of others.

In
Canada, the Companys basic wound care products compete in a commodity-oriented
marketplace with Covidien, Medicom, Medical Mart, 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.

3

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Product Sourcing

The
Company maintains manufacturing facilities in Toronto, Canada, and Nantong, China. The
Toronto and Nantong facilities manufacture the Companys line of basic and advanced
wound care and its wound closure-specialty securement device products. With the FAD
acquisition, the Company temporarily manufactures the adhesive strips and related first
aid products at a Houston, Texas, location. The adhesive strip and related first aid
products manufacturing is anticipated to be transferred to a third party by the second
quarter of 2008. The Derma line of wound and skin care 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 products 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 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
13485:2003 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

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 patented and non-patented formulations and process technologies that provide
competitive advantages in the marketplace.

The
Company believes the aforementioned patents, proprietary and non-proprietary technology
afford 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 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.

4

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Government Regulation

United States 
Scope of Regulation

Agencies

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 analagous to 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.

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

The
most restrictive controls are applied to devices placed in Class III. Class III devices
are required to have FDA approval for safety and effectiveness before they can be marketed
unless the FDA determines that pre-market approval is not necessary. Pre-market approval
necessitates the compilation of extensive safety and effectiveness data which is normally
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. ALGICELLTMAg Absorbent Gelling Dressings with
antimicrobial silver and MEDIHONEYTMWound & Burn Dressings with Active Leptospermum
Honey are unclassified.

5

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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.

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. Management believes all of the OTC products
currently marketed by the Company have been deemed to be generally recognized as safe and
effective and not misbranded.

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.

6

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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 last underwent an inspection by the
Health Products and Food Branch Inspectorate in August 2007 which occasioned the renewal
and subsequent annual 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.

Registration and Status
of Derma Canada Products Sold in United States

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

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.

U.S. 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.

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.

7

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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.

Employees

The
Company maintained 155 full-time and 33 part-time employees at December 31, 2007. Of these
employees, 74 are located in the United States, 70 in Canada and 44 in China. The Company
considers its employee relations to be satisfactory.

Item 2. Description of
Property

The
Companys headquarter offices are located in Princeton, New Jersey. In February, 2008
the Company completed an expansion and renovation of the offices increasing its square
footage to 8,024. The amended leases monthly payment is $19,726 and the lease
expires in August 2012. The Company also leases a 42,400 square foot warehouse in Fenton,
Missouri, at a rate of $20,727 per month, under a lease that expires in March 2009. The
Fenton, Missouri, facility serves as the United States distribution center for the
Companys products.

Derma
Canada leases 45,640 feet of office and manufacturing space, at a rate of $31,885 per
month, under a lease that expires in August, 2012 and leases a 20,400 square foot
distribution facility, at a rate of $11,300 per month, under a lease that expires in
August, 2009. The 20,400 square foot facility formerly served as Derma Canadas
distribution facility, a function outsourced commencing in June 2005. This facility is
being sublet under a lease that expires in June 2008. In December 2006, the Company leased
an additional 15,499 square feet of space adjacent to its Toronto office and manufacturing
space, at a rate of $10,600 per month, for additional manufacturing and warehouse space.
Simultaneously, the Company, in agreement with the landlord, was released from its lease
on 6,068 square feet of non-adjacent property. A subsidiary of Derma Canada also leases
11,400 square feet of office and manufacturing space in Nantong, China, at a rate of
$1,040 per month, under a lease that expires in June, 2008.

In
November 2007, the Company entered into a lease for $18,750 per month for approximately
50,000 square feet of manufacturing and distribution space at the former NutraMax facility
in Houston, Texas through May 2008. The Company is presently negotiating to extend the
lease or secure suitable space elsewhere in the area through the first quarter 2009.

Management
believes that the Companys facilities are adequate to meet its office, manufacturing
and distribution requirements for the foreseeable future.

Item 3. Legal Proceedings

The
Company is not a party to any material litigation.

8

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

A
special meeting of shareholders of the Company was held on December 28, 2007. At the
special meeting, the following matter was submitted to a vote of the Companys
security holders with the results indicated:

Increase
in Authorized Common Stock

Shareholders
approved an amendment of the Companys articles of incorporation to increase the
number of shares of common stock the Company is authorized to issue from 50,000,000 to
150,000,000. Details concerning the vote on the amendment are set forth below:

| |                  |            | 
| | ---------------- | ---------- | 
| | In favor         | 18,156,044 | 
| | Against          | 1,027,662  | 
| | Abstentions      | 45,397     | 
| | Broker non-votes | 0          | 

The
Company solicited proxies relative to the amendment. No proxies were solicited in
opposition to the amendment.

9

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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 listed on the Boston Stock Exchange 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 at the end of the indicated calendar quarters:

| |                    |  |       |  |       | 
| | ------------------ |  | ----- |  | ----- | 
| | Quarter Ended      |  | High  |  | Low   | 
|
| | 2007               |  |       |  |       | 
|
| | March 31, 2007     |  | $0.87 |  | $0.66 | 
| | June 30, 2007      |  | $1.10 |  | $0.59 | 
| | September 30, 2007 |  | $0.97 |  | $0.60 | 
| | December 31, 2007  |  | $1.40 |  | $0.58 | 
|
| | 2006               |  |       |  |       | 
|
| | March 31, 2006     |  | $0.84 |  | $0.45 | 
| | June 30, 2006      |  | $0.90 |  | $0.75 | 
| | September 30, 2006 |  | $0.87 |  | $0.59 | 
| | December 31, 2006  |  | $0.90 |  | $0.66 | 

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, 2008 there
were 1,264 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.

10

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Item 6.  Management's Discussion and
Analysis of Financial Condition 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 in Item 7.

Overview of Consolidated
Operating Results

The following
table highlights the year ended December 31, 2007 versus 2006 operating results:

|                                  |  |  |                         |            |   |          |            |   |   |            |   |  |    |    
|--------------------------------- |  |  | ----------------------- | ---------- | - | -------- | ---------- | - | - | ---------- | - |  | -- | ---
|                                  |  |  | Year Ended December 31, |            |  
|                                  |  |  | 2007                    | 2006       |   | Variance
|                                 
|Gross Sales                       |  |  | $                       | 42,712,304 |   | $        | 33,973,676 |   | $ | 8,738,628  |   |  | 25 | .7%
|Sales adjustments                 |  |  |                         | (8,576,903 | ) |          | (6,086,285 | ) |   | (2,490,618 | ) |  | 40 | .9%
|                                 
|Net sales                         |  |  |                         | 34,135,401 |   |          | 27,887,391 |   |   | 6,248,010  |   |  | 22 | .4%
|Cost of sales                     |  |  |                         | 22,530,986 |   |          | 18,235,003 |   |   | 4,295,983  |   |  | 23 | .6%
|                                 
|Gross profit                      |  |  |                         | 11,604,415 |   |          | 9,652,388  |   |   | 1,952,027  |   |  | 20 | .2%
|Gross profit percentage           |  |  |                         | 34.0%      |   |          | 34.6%      |  
|Operating expenses                |  |  |                         | 12,878,437 |   |          | 8,539,227  |   |   | 4,339,210  |   |  | 50 | .8%
|Interest expense                  |  |  |                         | 413,992    |   |          | 374,079    |   |   | 39,913     |   |  | 10 | .7%
|Loss on debt extinguishment       |  |  |                         | 256,628    |   |          |           |   |   | 256,628    |   |  |   |    
|Other expense/(income), net       |  |  |                         | 77,929     |   |          | (47,998    | ) |   | 125,927    |   |  |   |    
|                                 
|Total expenses                    |  |  |                         | 13,626,986 |   |          | 8,865,308  |   |   | 4,761,678  |   |  | 53 | .7%
|                                 
|(Loss) income before income taxes |  |  |                         | (2,022,571 | ) |          | 787,080    |   |   | (2,809,651 | ) |  |   |    
|                                 
|Provision for income taxes        |  |  |                         | 262,034    |   |          | 118,341    |   |   | 143,693    |   |  |   |    
|                                 
|Net (loss) income                 |  |  | $                       | (2,284,605 | ) | $        | 668,739    |   | $ | (2,953,344 | ) |  |   |    

Gross to Net Sales
Adjustments

Gross
sales are adjusted for trade rebates, distribution fees (in Canada), sales incentives,
Medicaid rebates, returns and allowances and cash discounts to derive net sales. Trade
rebates are trued-up monthly based upon an analysis of historical sales subject to rebate
and actual rebates received from distributors. The normal rebate cycle is one month.
Non-exclusive distributors generally carry one months inventory. The Companys
exclusive distributor in Canada normally carries three to four months inventory. As
distributor inventory is depleted via sales, it is replenished via purchases from the
Company. Rebates are processed and submitted for credit on a timely basis consistent with
distributor sales. If the normal rebate cycle were one-half month less than estimated at
December 31, 2007, the trade rebate reserve would be overstated by approximately $270,000.
If the normal rebate cycle were one month greater than estimated at December 31, 2007, the
trade rebate reserve would be understated by approximately $540,000. To minimize its cash
outflow invested in rebates, distributors generally strive to optimize the rebate credit
submission process.

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

11

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trends resulting, among other
causes, from distributors not submitting their rebates on a timely basis are analyzed and
factored in determining the required accrual balance.

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

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

Medicaid
rebates are accrued monthly based upon recent historical activity and reconciled quarterly
based upon receipt of rebate reports from participating state agencies. Returns and
allowances and cash discounts are accrued monthly based on recent historical activity.

Gross
to net sales adjustments comprise the following:

| |                        |   |                         |   |      |            |  
| | ---------------------- | - | ----------------------- | - | ---- | ---------- | -
| |                        |   | Year Ended December 31, |  
| |                        |   | 2007                    |   | 2006 |           
|
| | Gross Sales            | $ | 42,712,304              |   | $    | 33,973,676 |  
|
| | Trade rebates          |   | (6,629,106              | ) |      | (4,637,960 | )
| | Distribution fees      |   | (1,135,072              | ) |      | (979,776   | )
| | Sales incentives       |   | (225,386                | ) |      | (149,831   | )
| | Medicaid rebates       |   | (7,196                  | ) |      | (11,486    | )
| | Returns and allowances |   | (300,042                | ) |      | (87,101    | )
| | Cash discounts         |   | (280,101                | ) |      | (220,131   | )
|
| | Total adjustments      |   | (8,576,903              | ) |      | (6,086,285 | )
|
| | Net sales              | $ | 34,135,401              |   | $    | 27,887,391 |  

Trade rebates
increased significantly in 2007 versus 2006 due to higher rebate intensive Canadian sales
coupled with an increase in the overall rebate percentage due to renewal of buying group
contracts at lower selling prices and continuing growth of rebate intensive U.S. private
label sales. The increase in distribution fee expense is commensurate with the increase in
Canadian net sales upon which it is based. The increase in sales incentive expense
principally relates to the acquisition of the Western Medical business in April 2006,
which utilizes sales incentives to a greater degree than in the Companys other
product lines. An increased reliance on sales incentives in other areas of the
Companys business, also contributed. A continuing trend towards lower levels of
Medicaid reimbursed sales is responsible for the lower level of Medicaid rebates. Sales
returns and allowances increased in 2007 due to the higher level of sales and an overall
higher level of returns; however, the Companys returns and allowances continue to
represent less than 1% of gross sales. Cash discounts increased commensurate with the
sales increase and as a result of a slight increase in the percentage of cash discounts to
sales, as a larger portion of the sales growth continues to come from customers that have
historically taken advantage of the Companys discount terms.

12

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Rebate Reserve Roll
Forward

A
roll forward of the trade rebate accruals at December 31, 2007 and 2006 is outlined below:

|                              |  |  |   |                         |   |   |            |  
|----------------------------- |  |  | - | ----------------------- | - | - | ---------- | -
|                              |  |  |   | Year Ended December 31, |  
|                              |  |  |   | 2007                    |   |   | 2006       |  
|                             
|Beginning balance - January 1 |  |  | $ | 1,817,558               |   | $ | 1,566,590  |  
|Rebates paid                  |  |  |   | (6,041,803              | ) |   | (4,386,992 | )
|Rebates accrued               |  |  |   | 6,629,106               |   |   | 4,637,960  |  
|                             
|Ending balance - December 31  |  |  | $ | 2,404,861               |   | $ | 1,817,558  |  

The
$587,303 increase in the 2007 trade rebate reserve ending balance principally reflects an increase in the
Canadian rebate reserve due to higher sales and an increase in the exclusive
distributors inventory level commensurate with the sales and to build its safety
stock to improve customer service. An increase in the overall rebate percentage in Canada
due to renewal of buying group contracts at lower selling prices, also contributed. This
increase was partially offset by diminishing non private label U.S. rebate laden sales.
There has been no other discernable change in the nature of the Companys business as
it relates to the accrual and subsequent payment of rebates. The $250,968 increase in the
2006 trade rebate reserve principally reflects an increase in the Canadian reserve due to
higher sales, partially offset by diminishing non private label U.S. rebate laden sales
and the discontinuation of extended payment terms with a large customer.

Net Sales and Gross Margin

The
following table highlights 2007 versus 2006 product line net sales and gross profit:

|                          |  |  |   |                         |  |   |            |  |   |           |   |  |     |     
|------------------------- |  |  | - | ----------------------- |  | - | ---------- |  | - | --------- | - |  | --- | ----
|                          |  |  |   | Year Ended December 31, |  |   |           
|                          |  |  |   | 2007                    |  |   | 2006       |  |   | Variance 
|                         
|Product Line Net Sales    |  | 
|                         
|Wound care                |  |  | $ | 30,983,191              |  | $ | 24,450,557 |  | $ | 6,532,634 |   |  | 26  | .7% 
|Wound closure-specialty   |  | 
|securement devices        |  |  |   | 2,260,735               |  |   | 2,308,452  |  |   | (47,717   | ) |  | (2  | .1%)
|Skin care                 |  |  |   | 891,475                 |  |   | 1,128,382  |  |   | (236,907  | ) |  | (21 | .0%)
|                         
|Total                     |  |  | $ | 34,135,401              |  | $ | 27,887,391 |  | $ | 6,248,010 |   |  | 22  | .4% 
|                         
|Product Line Gross Profit |  | 
|                         
|Wound care                |  |  | $ | 10,043,756              |  | $ | 8,377,522  |  | $ | 1,666,234 |   |  | 19  | .9% 
|Wound closure-specialty   |  | 
|securement devices        |  |  |   | 1,318,148               |  |   | 1,111,452  |  |   | 206,696   |   |  | 18  | .6% 
|Skin care                 |  |  |   | 242,511                 |  |   | 163,414    |  |   | 79,097    |   |  | 48  | .4% 
|                         
|Total                     |  |  | $ | 11,604,415              |  | $ | 9,652,388  |  | $ | 1,952,027 |   |  | 20  | .2% 

Consolidated
net sales increased $6,248,010, or 22.4%, to $34,135,401 in 2007 from $27,887,391 in
2006. Canadian net sales increased $1,643,472, or 15.4% (9.0% excluding foreign
exchange), to $12,324,111 in 2007 from $10,680,639 in 2006. This increase was driven by
growth of $961,592 and favorable exchange of $681,880 associated with a 6.0%
strengthening of the Canadian dollar. The increase was principally attributable to higher
sales to the Companys exclusive Canadian distributor to meet demand and to
rebalance its inventory, partially offset by price erosion associated with the renewal of
bid contracts at lower overall selling prices and lower private label sales to the

13

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distributor. Real growth as measured
by sales of the Companys products reported by the distributor, unadjusted for
foreign exchange, approximated 8.4%. U.S. net sales increased $4,604,538, or 26.8%, to
$21,811,290 in 2007 from $17,206,752 in 2006. The increase was driven by the addition of
incremental FAD sales of $1,823,526 and Western Medical sales of $1,841,653, continued
private label growth and new product (Medihoney and silver alginate) sales growth of
$785,816 partially offset by continued sales decline in the skin care, specialty
securement devices and the Derma line of products. Excluding FAD and Western Medical
sales, U.S. sales increased $939,359, or 7.7%.

Consolidated
gross profit increased $1,952,027, or 20.2%, to $11,604,415 in 2007 from $9,652,388 in
2006. Company gross profit margin percentage decreased to 34.0% in 2007 from 34.6% in
2006. Canadian gross profit increased $444,051, or 12.3%, to $4,051,810 in 2007 from
$3,607,759 in 2006. Canadian gross profit margin percentage decreased to 32.9% in 2007
from 33.8% in 2006. The improvement in Canadian 2007 gross profit dollars reflects the
higher sales and favorable foreign exchange impact partially offset by margin erosion. The
margin erosion principally reflects ongoing price erosion in the Canadian traditional
wound care market, higher cost third party supplied traditional wound care products and
lower volume throughput that adversely impacted fixed overhead absorption in the
Companys Canadian manufacturing facility. U.S. gross profit increased $1,507,976, or
25.0%, to $7,552,605 in 2007 from $6,044,629 in 2006. Gross profit margin percentage
decreased to 34.6% in 2007 from 35.1% in 2006. The improvement in U.S. gross profit margin
dollars reflects the impact of higher sales. The decrease in gross profit margin
percentage is principally attributable to unfavorable product mix. The addition of the
lower margined FAD business in the fourth quarter 2007 and continued growth of the lower
margined private label business partially offset by higher margined new product sales are
the primary contributors to the decrease in gross profit margin percentage. Excluding FAD
and Western Medical, gross profit increased $400,326, or 10.1%, and the gross profit
margin percentage would have been 33.0%.

Wound
care sales consisting of traditional and advanced wound care products increased
$6,532,634, or 26.7%, in 2007 versus 2006. Traditional wound care sales increased
$4,410,535, or 26.7%. This increase was driven by an increase in Canadian basic wound care
sales of $1,643,472 together with a U.S. sales increase of $2,767,063. The Canadian sales
growth was driven principally by higher sales to the Companys exclusive Canadian
distributor due to improving demand and the distributors rebalancing of its
inventory earlier in the year, partially offset by price erosion and lower private label
sales to the distributor. The U.S. sales performance reflects incremental FAD and Western
Medical sales of approximately $2,860,000 coupled with a modest decrease for the balance
of the basic wound care line. Advanced wound care sales increased $2,122,099 or 26.7%.
This increase was principally driven by U.S. private label and new product sales growth,
partially offset by lower demand for the Derma line of products. Sales in 2007 of the
Companys new silver alginate product launched in November 2006 and Medihoney
launched in October 2007 were $666,375 and $119,441, respectively.

Wound
care gross profit increased $1,666,234, or 19.9%, in 2007 versus 2006. Gross profit margin
percentage decreased to 32.4% in 2007 from 34.3% in 2006. The gross profit margin dollar
increase reflects the sales increase and margin decrease. The margin percentage decrease
is principally attributable to unfavorable product mix.

Wound
closure-specialty securement device sales decreased $47,717, or (2.1%), in 2007 versus
2006. The decrease is principally due to the discontinuation of a private label supply
agreement partially offset by a prior year backorder fulfillment in the first quarter
2007.

Wound
closure-specialty securement device gross profit increased $206,696, or 18.6%, in 2007
versus 2006. Gross profit margin percentage increased to 58.3% in 2007 from 48.1% in 2006.
The increase in gross profit margin dollars reflects the improved gross profit margin
percentage. The gross profit margin percentage improvement is due to the flow through of
lower product costs associated with bringing the manufacture of these products in-house in
the second half of 2006.

Skin
care sales decreased $236,907, or 21.0%, in 2007 versus 2006 due to continuing competitive
pressure. Skin care gross profit improved $79,097 to $242,511 in 2007 from $163,414 in
2006. The main driver for the gross profit dollar improvement was the expiration of the
lease on the former skin care manufacturing facility.

14

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Operating Expenses

The
following table highlights 2007 versus 2006 operating expenses by type:

|                       |  |  |   |                         |  |   |           |  |   |           |   |  |     |    
|---------------------- |  |  | - | ----------------------- |  | - | --------- |  | - | --------- | - |  | --- | ---
|                       |  |  |   | Year Ended December 31, |  |   |          
|                       |  |  |   | 2007                    |  |   | 2006      |  |   | Variance 
|                      
|Distribution           |  |  | $ | 1,062,766               |  | $ | 706,012   |  | $ | 356,754   |   |  | 50  | .5%
|Marketing              |  |  |   | 1,414,264               |  |   | 640,376   |  |   | 773,888   |   |  | 120 | .9%
|Sales                  |  |  |   | 3,186,126               |  |   | 2,143,113 |  |   | 1,043,013 |   |  | 48  | .7%
|Research & development |  |  |   | 993,069                 |  |   | -         |  |   | 993,069   |   |  | -   |    
|General administrative |  |  |   | 6,222,212               |  |   | 4,849,726 |  |   | 1,372,486 |   |  | 28  | .3%
|Goodwill impairment    |  |  |   | -                       |  |   | 200,000   |  |   | (200,000  | ) |  | -   |    
|                      
|Total                  |  |  | $ | 12,878,437              |  | $ | 8,539,227 |  | $ | 4,339,210 |   |  | 50  | .8%

Operating
expense increased $4,339,210, or 50.8%, to $12,878,437 in 2007 from $8,539,227 in 2006
including an increase of $125,459 in Canadian operating expense attributable to exchange
associated with a 6.0% strengthening of the Canadian dollar.

Distribution
expense increased $356,754, or 50.5%, in 2007 versus 2006. Expenses in Canada increased
$193,357 (including $11,129 expense related to exchange) while expenses in the U.S
increased $163,397. The increase in Canada was principally attributable to higher lease,
real estate taxes, utility and maintenance expenses. In December 2006 and October 2007,
the Company leased additional space adjacent to its existing Canadian manufacturing
facility to better rationalize its operations and accommodate anticipated increased
manufacturing and warehousing requirements. The U.S. increase was principally attributable
to incremental warehouse personnel and operating costs required to support the sales
growth. Incremental resources of $77,990 required to support the FAD business acquired in
November, 2007 also contributed.

Marketing
expense increased $773,888, or 120.9%, in 2007 versus 2006. The increase was attributable
to higher compensation and benefits costs associated with the hiring of a director of
clinical affairs (new position) in February 2007. Also contributing were planned increases
in trade show attendance, promotion, product development, consulting and clinical advisory
board expense in support of the Companys growth initiatives.

Sales
expense increased $1,043,013, or 48.7%, in 2007 versus 2006. Expenses in Canada increased
$169,731 (including $34,951 expense related to exchange) while expenses in the U.S.
increased $873,282. The Canada increase was due to higher compensation and benefits,
buying group administrative fees (sales volume related), promotion and sample expenses
associated with an expanded sales effort. The U.S. increase was principally attributable
to an expansion of the sales force starting in June to one national sales director and
nine sales representatives (from two), the relocation of customer service to corporate
headquarters in June 2007, together with a higher level of operating costs associated
therewith and recruiting fees of $125,400. Incremental resources, along with broker commission
expenses totaling $240,963 required to support the FAD business acquired in November, 2007 also
contributed.

Research
& development expense increased $993,069 in 2007 versus 2006. The 2007 expense
consists of $125,000 associated with the license of certain anti-microbial technology in
March 2007 and $868,069 associated with the licensing of certain angiotensin analog
technology in November, 2007.

General
administrative expense increased $1,372,486, or 28.3%, in 2007 versus 2006. Expenses in
Canada increased $383,134 (including $79,380 expense related to exchange) while expenses
in the U.S. increased $989,352. The increase in Canada principally reflects Sarbanes
Oxley consulting (compliance program commenced in December 2006) expenses of
approximately $87,000, higher accounting, tax and audit fees of approximately $60,000,
share based compensation expense of approximately $57,000, coupled with normal
year-to-year compensation and benefit cost increases. The U.S. increase principally
reflects incremental intangible amortization expense of approximately $257,000 related to
the Western Medical and FAD acquisitions, employee and director equity based compensation

15

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expense of approximately $200,000,
Sarbanes Oxley consulting expenses of approximately $123,000, higher accounting, tax and
audit fees of approximately $60,000, higher travel expenses of approximately $66,000,
higher investor relations and public relations related expenses of approximately
$104,000, incremental directors fees of approximately $79,000, higher legal costs
of $34,000 and normal year-to-year compensation and benefit cost increases, partially
offset by lower bad debt expense of $76,000 and the non-recurrence of $32,000 worth of
one-time Western Medical transition related expense incurred in 2006.

Goodwill Impairment

In
2006, the Company wrote-off the balance of its goodwill associated with the Sunshine
Product line and recorded a charge of $200,000.

Interest Expense

Interest
expense increased $39,913, or 10.7%, to $413,992 in 2007 from $374,079 in 2006. Interest
expense in Canada decreased $21,018 while interest expense in the U.S. increased $60,931.
The decrease in Canada reflects lower outstanding term loan balances in 2007 versus 2006
partially offset by higher interest rates. All Canadian debt was paid off in and related
credit facilities extinguished in September 2007. The U.S. increase is principally due to
the financing associated with the FAD acquisition in November 2007 and a $93,821 non-cash
charge related to the issuance of common stock warrants in connection with the FAD
acquisition. Interest charges related to the common stock warrants ceased in December 2007
upon approval of an increase in authorized common shares. Up until that point, the Company
experienced lower interest expense due to lower borrowing balances in 2007 versus 2006 as
a result of the Companys improved U.S. cash flow and the payoff of the Western
Medical acquisition related term loan in December 2006. Partially offsetting these
decreases were incremental promissory note interest and deferred finance fee amortization
expense related to the Western Medical acquisition in April 2006.

Loss on Debt
Extinguishment

In
connection with the FAD acquisition in November 2007, the Company incurred a $200,000
credit facility early termination fee with its former U.S. lender. In addition, the
Company wrote-off $56,628 in un-amortized deferred financing costs associated with the
facility. The total loss on debt extinguishment of $256,628 has been recorded as a
separate line item on the consolidated statement of operations.

Other Income/Expense

Other
expense net increased $125,927 to $77,929 expense in 2007 from $47,998 income in 2006. The
main drivers for the other expense increase was an increase in foreign exchange losses and
the non-recurrence of a $64,971 gain recorded in 2006 associated with the favorable
settlement of a supplier liability.

Income Taxes

The
Company recorded a $262,034 deferred foreign income tax provision for 2007 based on the
Companys Canadian operating results. The Canadian tax expense is deferred in nature
as net operating loss carry forwards continue to be utilized to offset taxes payable. No
income tax provision was made for the Companys U.S. operations in 2007 due to a net
operating loss coupled with available net operating loss carry forwards. The Company
recorded a $118,341 provision for income taxes in 2006 consisting of a $113,841 deferred
provision associated with the Companys profitable Canadian subsidiary and a $5,000
provision in the U.S. associated with an estimated federal alternative minimum tax
payable.

Due
to uncertainties surrounding the Companys ability to use its U.S. net operating loss
carry forwards and net deferred tax assets, a full valuation allowance for the U.S. net
deferred tax assets has been provided. Effective December 31, 2006 the Companys
Canadian subsidiary, based on recent operating profitability and projected profitable
operations going forward, realized its net operating loss carry forwards and deferred tax
assets and liabilities.

16

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Net Income (Loss)

The
Company generated a net loss of $2,284,605, or ($0.09) per share (basic and diluted), in
2007 compared to net income of $668,739, or $0.03 income per share (basic and diluted), in
2006.

Liquidity and Capital
Resources

Operational Overview

Net
sales increased 22.4% (20.0% adjusted for foreign exchange) in 2007 over 2006. This growth
was driven by a sales increase in the U.S. of 26.8%, together with an increase in Canadian
sales of 15.4% (9.0% adjusted for foreign exchange). Sales growth in the U.S. was driven
by incremental sales associated with the Western Medical business (acquired April 18,
2006) of $1,841,653 and FAD business (acquired November 8, 2007) of $1,823,526 coupled
with continued growth of the private label and advanced wound care product lines. Sales of
the Companys new silver alginate product were $666,375 in 2007. The product has
exhibited steady quarter-to quarter growth since its launch in November 2006. Sales of the
Companys new honey product launched in October 2007 were $119,441in 2007. Interest
in this product and initial sales have exceeded expectations. Skin care sales continue to
deteriorate in the face of competitive pressure and a reduction of resources allocated to
support the line. Sales for the balance of the U.S. product lines were essentially flat
year-on-year. Excluding FAD and Western Medical sales, U.S. sales growth was 7.7%.
Canadian sales growth in 2007 was 8.5%, measured in local currency. Expanded marketing and
sales efforts, a continued focus on contract compliance, exploring opportunities in other
market segments (other than the Companys traditional strength in the acute care
segment) and working closely with the Companys exclusive Canadian distributor to
capitalize on sales growth opportunities are generating positive results. Real growth as
measured by sales of the Companys products reported by the Canadian distributor
approximated 8.4% in local currency in 2007.

The
Company has realized significant product cost improvement over the last several years as a
result of its manufacturing and sourcing initiatives. The savings generated by these
initiatives have helped mitigate the adverse impact of price erosion and foreign exchange
on a large portion of the Companys business and served to sustain or improve its
gross profit dollars and margin percentage. Prospectively, this trend will become
increasingly difficult to perpetuate. The significant investment in manufacturing
infrastructure over the past few years and incremental volume associated with growth of
the private label business and new products has enabled the Company to improve the
efficiency of its Canadian manufacturing operations. This trend is expected to continue.
Product cost savings associated with implementation of China and other sourcing
initiatives have been another contributor to the Companys cost reduction success.
Current market conditions in China and, to a lesser extent, in other markets portend
increasing product cost pressure. The Company will continue to seek opportunities to lower
product costs wherever possible.

At
the time of the FAD acquisition in November 2007, the seller was in the process of
transferring its domestic production to a third party supplier in China and
decommissioning most of its U.S. manufacturing infrastructure and overhead. Completion of
this initiative would allow the FAD business to significantly reduce its existing product
costs thereby allowing it to better compete in the marketplace. It was estimated that
approximately seventy percent of the initiative was complete at the time of the
acquisition. Accordingly, as part of the purchase agreement, the Company negotiated fixed
pricing for products purchased from the Chinese supplier for the twelve-month
post-acquisition period. In addition, $2,000,000 of the purchase price was placed in
escrow to be released quarterly, in $500,000 increments, to the seller or the Company
depending on whether or not certain agreed upon product cost and delivery thresholds are
met. To the extent the Company receives any of these payments, it will be recorded as a
reduction in purchase price.

Since
the FAD acquisition, the Company has had to continue manufacturing a portion of its
adhesive strip requirements in its U.S. facility at higher cost while working to complete
the transfer of products to the Chinese supplier and evaluating other cost effective
sources of supply. It is presently estimated that U.S. production will continue at a
diminishing rate through June 2008. Gross profit margins presently running at
approximately 25% are

17

---

expected to improve to approximately
35% once the transfer is complete and the U.S. manufacturing activity is for the most
part curtailed.

Operating
expenses increased 50.8% (49.4% adjusted for foreign exchange) in 2007 over 2006 in line
with expectations. The increase is attributable to incremental FAD and Western Medical
expenses (intangible asset amortization, planned sales and marketing expenses), planned
increases in distribution, marketing and sales expenses in support of the Companys
growth initiatives and higher professional service fees as a result of increasing
regulatory requirements. Excluding these expenses, growth in the balance of operating
expenses is in line with inflation and continues to be closely monitored.

In
2007, the Company made a $993,069 investment in research and development. In March 2007,
the Company paid $125,000 for certain anti-microbial technology which it plans to bring to
market as soon as the technology is approved for sale. The market potential for products
employing this technology is considered significant. In November 2007, the Company
licensed certain angiotensin analog technology for $868,069. The initial evaluation of the
market potential and probability of obtaining approval for sale of products employing this
technology was determined to be very favorable. Products employing this technology are
scheduled to enter phase II trials in early 2008. Completion of the phase II study is
expected to take several years. Presently, the Company plans to take the product through
phase II at an estimated cost of $1,450,000. Upon completion of the phase II study, the
Company will reevaluate the market potential of the product and the probability of it
ultimately being approved for sale to determine the best course of action.

In
November 2007, in connection with the FAD acquisition, the Company entered into a new
five-year credit and security agreement comprised of an $8,000,000 revolver and a
$6,000,000 term loan. At closing, the Company applied the entirety of the term loan and
$3,000,000 of the revolver in satisfaction of the Companys obligations under the
purchase agreement and related obligations. The balance of the revolver, subject to
availability and covenant constraints, will be used to fund the Companys growth
initiatives. Given the significant increase in debt, interest expense will become a more
significant component of the Companys overall cost structure going forward.

The
Company reported a loss of $2,284,605 for 2007. Components of the loss include significant
investment in incremental sales and marketing resources, together with product development
and licensing costs. Not unexpectedly, but also contributing, has been a significant
increase in mandated Sarbanes-Oxley and audit related costs to remain compliant with
increasingly stringent regulatory and external reporting requirements. The Company
anticipates it will continue to operate at a loss in the near term as it attempts to
leverage its growth initiatives with incremental investment, continues to support the
angiotensin analog phase II study, completes the transfer of the FAD products to China and
decommissions the U.S. manufacturing operation.

Cash Flow and Working
Capital

At
December 31, 2007 and December 31, 2006, the Company had cash and cash equivalents on hand
of $577,096 and $1,285,943, respectively. The $708,847 decrease in cash reflects net cash
provided by operating activities of $1,368,117, net cash used in investing activities of
$14,226,606, net cash provided by financing activities of $11,896,372 and cash provided as
a result of exchange rate changes of $253,270.

Net
cash provided in operating activities of $1,368,117 stems from $812,185 cash provided
from operations (net loss plus non-cash items), together with $555,932 cash provided from
the net change in operating assets and liabilities. The increase in cash provided from
operations is associated with significant capital expenditures over the last couple of
years (resulting in higher levels of depreciation expense), a significant increase in
amortizable intangibles in connection with the FAD and Western Medical acquisitions,
higher rebate reserves in Canada due to increases in rebate intensive sales and the
commencement of expensing of share based compensation beginning in 2006 thereby
increasing the magnitude of non-cash charges. Higher receivables, accounts payable and
accrued expenses and other current liabilities, partially offset by higher inventory and
timing related prepaid and other current assets, were the main drivers behind the net
change in ongoing operating assets and liabilities. The changes in receivables, prepaid
and other current assets and accounts payable are for the most part timing related. The
significant increase in inventory reflects an increase and rebalancing of the U.S.
finished goods inventory to improve customer

18

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service and replenish inventory
levels. These levels were lower than normal due to unexpected production delays caused by
the equipment and facility improvements activities that took place at the Companys
manufacturing operation in Canada in the second half of 2006. Also contributing was an
OEM customer component and finished goods inventory build in Canada to meet agreed upon
safety stock requirements and new product inventory builds. The increase in accrued
expenses and other current liabilities principally reflects unpaid license fees of
$840,000 at year end.

Net
cash used in investing activities of $14,226,606 reflects cash used for the acquisition of
FAD of $13,000,000 together with capitalized transaction related expenses of $737,665. In
addition, $491,212 was used principally for purchases of equipment at the Companys
manufacturing operation in Canada to expand manufacturing capability in response to growth
and/or efficiency opportunities and a new trade show booth to support the Companys
growing sales and marketing activities, leasehold improvements and furniture at corporate
headquarters and new computer equipment .

Net
cash provided in financing activities of $11,896,372 reflects cash received of $5,610,915,
net of offering expenses of $389,079, from the private sale of common stock and warrants
together with term loan proceeds of $6,000,000 and line of credit proceeds of $1,219,197,
less $434,190 of deferred financing fees associated with the transaction and regularly
scheduled debt payments of $499,950. This latter includes the final payment of the Canadian term loan
in September 2007.

Working
capital decreased $399,011, or 6.9%, at December 31, 2007 to $5,369,038 from $5,768,049 at
December 31, 2006. Working capital of this magnitude is considered sufficient to support
ongoing operations.

Financing Arrangements

In
November 2007, the Company entered into a new five-year revolving credit and security
agreement comprised of an $8,000,000 revolver and a $6,000,000 term loan with its new U.S.
lender. The revolver provides for maximum borrowings of $8,000,000. Advances under the
revolver may be drawn, from time to time, up to the amount of 85% of eligible receivables
(as defined) and 60% of eligible inventory (as defined). Interest on outstanding advances
is payable at the LIBOR monthly rate, plus 2.75%. In addition, the Company will pay a
monthly unused line fee of 0.5% per annum on the difference between the daily average
amount of advances outstanding and $8,000,000, together with a monthly collateral
management fee of $2,000. At December 31, 2007 maximum advances under the agreement were
$6,831,552. Advances outstanding against the revolver were $1,219,197 at December 31,
2007, leaving as additional $5,612,355 available for borrowing. Interest on the term loan
is payable at the LIBOR monthly rate, plus 4.25%. Monthly payments of principal in the
amount of $100,000 together with interest are due under the agreement.

The
Company terminated its revolving credit facility agreement with its former U.S. lender in
November 2007 in connection with securing new financing for the FAD acquisition. In
connection with the termination, the Company paid an early termination fee of $200,000 and
wrote-off $56,628 of un-amortized deferred financing costs associated with the facility

The
Company terminated its revolving credit facility agreement with its Canadian lender in
October 2007 in connection with securing new financing for the FAD acquisition.

Prospective Assessment

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

19

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Beginning
in 2005, the Company expanded its product in-licensing and development efforts. As a
result of these efforts, the Company launched its silver alginate product in November
2006. Sales of this product have increased each quarter since its launch. The Company
launched its first honey product in October 2007. This product represents the first of its
kind and interest in the product has been high. Sales have increased steadily and current
indications are that the planned honey based line of products could result in significant
incremental sales. In addition, the Company has several other promising products in its
pipeline that it expects to launch over the next twelve to eighteen months. The Company
anticipates its core business sales will remain relatively stable over the near term.

Consistent
with its strategic objectives, the Company took the following actions in the second half
of 2007:

|1. |  | The Company expanded its direct sales force from three to ten personnel
               principally to sell the Companys new advanced wound care products with the
               launch of Medihoney in October 2007 as the anchor product. Depending on
               Medihoneys early results, the plan is to gradually add an additional ten
               to fifteen sales personnel in 2008 to leverage this opportunity.
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2. |  | The Company invested in new product development with the first product being DSC
               127. While the launch of DSC 127 is several years away, the initial evaluation
               of the market potential for this product was determined to be significant. The
               product recently began the phase II trial (to achieve proof of principle in a
               human model) which is expected to be completed by mid-2010. The projected cost
               to complete the phase II trial is approximately $1,450,000. The results of the
               phase II trial will determine the efficacy and safety of the product and further
               refine its market potential. The cost of the phase III trial and bringing the
               product to market are expected to be significant. Should the decision be made to
               proceed with the DSC 127 development plan after completion of phase II, the
               Company plans to fund the additional development costs out of available cash
               flow or the sale of equity, as needed, or sublicense or sell the rights to the
               compound.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. |  | In November 2007, the Company purchased the assets of the FAD for approximately
               $13,700,000. The FAD is a leading manufacturer and marketer of adhesive strips
               and related first aid products. The integration of existing FAD business will
               serve to expand the Companys existing basic and advanced wound care lines
               to new customers and markets, especially the retail market where the Company
               does not have a presence. In addition, the Company expects to be able to reduce
               existing FAD product costs by completing the transfer of production of certain
               FAD products to lower cost suppliers.
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Based
upon the action taken in 2007 and the desire to leverage its growth opportunities in 2008
and beyond, the Company determined that it would need additional financing in order to
implement its strategic objectives. Accordingly, on March 31, 2008, the Company received
executed stock purchase agreements (SPAs) totaling $5,680,000, (net of
$420,000 in estimated commission and other offering expenses) from the sale of common
stock and warrants. The Company expects to close on the SPAs and receive the funds on
April 2, 2008. In addition, the Company negotiated an amendment to its debt covenants
included in its credit facility. The new covenants are consistent with the Companys
implementing its growth strategy for 2008.

With
the equity infusion and the new debt covenants, the Company anticipates having sufficient
liquidity in place to meet its operating needs through the next twelve months.

The
Common Stock of the Company is traded on the OTC Bulletin Board under the symbol
DSCI.OB. The Common stock is listed on the Boston Stock Exchange 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.

20

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Factors Affecting Future
Prospects

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

Up
to 18,991,646 shares of the Companys common stock are potentially issuable upon the
conversion, exercise or vesting of outstanding convertible preferred stock, warrants,
options and restricted stock awards (dilutive securities). The shares of
common stock potentially issuable upon conversion, exercise or vesting of dilutive
securities are substantial compared to the 34,040,743 shares of common stock currently
outstanding.

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

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

The
Company earned net income of $668,739 in 2006, $22,241 in 2003, $61,368 in 2002 and
$192,398 in 2001 and incurred losses of $2,284,605 in 2007, $1,099,990 in 2005, $2,338,693
in 2004, $2,581,337 in 2000 and $2,998,919 in 1999. At December 31, 2007, the Company had
an accumulated deficit of $15,701,886. Although the Company achieved profitability in
2006, 2003, 2002 and 2001, the Company cannot offer any assurance that it will be able to
generate sustained or significant earnings.

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

Historically,
the market price of the Companys common stock has been volatile. The high and low
prices for the years 2003 through 2007 are set forth in the table below:

| |                                                           |  |       |  |       | 
| | --------------------------------------------------------- |  | ----- |  | ----- | 
| | Derma Sciences, Inc.
        Trading Range  Common Stock | 
|
| | Year                                                      |  | Low   |  | High  | 
|
| | 2003                                                      |  | $0.35 |  | $2.30 | 
| | 2004                                                      |  | $0.43 |  | $1.90 | 
| | 2005                                                      |  | $0.42 |  | $0.78 | 
| | 2006                                                      |  | $0.45 |  | $0.90 | 
| | 2007                                                      |  | $0.58 |  | $1.40 | 

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

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

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

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

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

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

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

21

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

The Company has not paid, and is
unlikely to pay in the near future, cash dividends on its securities.

The
Company has never paid any cash dividends on its common or preferred stock and does not
anticipate paying cash dividends in the foreseeable future. The payment of dividends by
the Company will depend on its future earnings, financial condition and such other
business and economic factors as the Companys management may consider relevant.

The Companys foreign operations
are essential to its economic success and are subject to various unique risks.

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 maintain a continuous supply of basic wound
care products from its operations and suppliers in China. While the Company does not
envision any adverse change to operations in Canada and China, adverse changes to these
operations, as a result of political, governmental, regulatory, economic, exchange rates,
labor, logistical or other factors, could have an adverse effect on the Companys
future operating results.

The rate of reimbursement for the
purchase of the Companys products by government and private insurance is subject to
change.

Sales
of several of the Companys wound care products depend partly on the ability of its
customers to obtain reimbursement for the cost of its products from government health
administration agencies such as Medicare and Medicaid. Both government health
administration agencies and private insurance firms continuously seek to reduce healthcare
costs. These cost reduction efforts may adversely affect both the eligibility of the
Companys products for reimbursement and the rate of reimbursement. Although
management believes that reimbursement policies relative to the Companys products
will remain stable for the foreseeable future, it can offer no assurance that the
Companys products will continue to be eligible for reimbursement indefinitely or
that the rate of reimbursement will not be reduced.

The Companys success may depend
upon its ability to protect its patents and proprietary technology.

The
Company owns patents, both in the United States and abroad, for several of its products,
and relies upon the protection afforded by its patents and trade secrets to protect its
technology. The Companys success may depend upon its ability to protect its
intellectual property. However, the enforcement of intellectual property rights can be
both expensive and time consuming. Therefore, the Company may not be able to devote the
resources necessary to prevent infringement of its intellectual property. Also, the
Companys competitors may develop or acquire substantially similar technologies
without infringing the Companys patents or trade secrets. For these reasons, the
Company cannot be certain that its patents and proprietary technology will provide it with
a competitive advantage.

If members of the Companys
management and their affiliates were to exercise all warrants and options held by them,
and if substantially all of the restricted stock awards were granted to members of
management and were to vest, members of management and their affiliates could acquire a
majority of the voting stock of the Company.

The
executive officers and directors of the Company, together with institutions with which
they are affiliated, own substantial amounts of the Companys common stock, together
with outstanding options and warrants to purchase

22

---

the Companys common stock. In
addition, the Company has adopted, and its shareholders have approved, a restricted stock
plan pursuant to which the Companys outside directors and executive officers may be
awarded up to 2,500,000 shares of restricted stock. Outside directors have been awarded
to date 175,000 shares of restricted common stock that have not yet vested. Depending
upon the warrants and options exercised by outside investors, if directors and affiliates
were to exercise their options and warrants, and if additional shares of restricted stock
are awarded to the Companys directors and executive officers and such awards vest,
members of management and their affiliates could obtain a majority of the Companys
voting stock. As a result, these officers, directors and affiliates of the Company would
be in a position to significantly influence the strategic direction of the Company, the
composition of its board of directors and the outcome of fundamental transactions
requiring shareholder approval.

Government regulation plays a
significant role in the Companys ability to acquire and market products.

Government
regulation by the United States Food and Drug Administration and similar agencies in other
countries is a significant factor in the development, manufacturing and marketing of many
of the Companys products and in the Companys acquisition or licensing of new
products. Complying with government regulations is often time consuming and expensive and
may involve delays or actions adversely impacting the marketing and sale of the
Companys current or future products.

Approximately half of the
Companys products are manufactured by third party manufacturers.

Approximately
one half of the Companys products are manufactured by third party manufacturers. One
manufacturer produces advanced wound care products which account for about ten percent of
the Companys sales. Each of the Companys other manufacturers produces products
that individually account for less than ten percent of the Companys sales.

Management
considers the Companys relationships with its third party manufacturers to be
excellent. Although there are several manufacturers potentially available for each of the
Companys products, if a current manufacturer were unable or unwilling to continue to
manufacture the Companys products, distribution and sales of the affected products
could be delayed for the period necessary to secure a replacement.

Competitors could invent products
superior to those of the Company and cause its products and technology to become obsolete.

The
Company operates in an industry where technological developments occur at a rapid pace.
The Company competes with a large number of established companies and institutions many of
which have more capital, larger staffs and greater expertise than the Company. The
companies with which the Company competes include Bristol Myers Squibb-Convatec, Smith
& Nephew, Johnson & Johnson, 3M, Kendall, Hermitage, Medical Action, Cyprus,
DeRoyal, Provon, Calgon Vestal-Steris, Chester Laboratories, Medicom and Medical Mart,
together with a number of smaller companies. The Companys competitors currently
manufacture and distribute a variety of products that are in many respects comparable to
those of the Company. While management has no specific knowledge of products under
development by the Companys competitors, it is possible that these competitors may
develop technologies and products that are more effective than any the Company currently
has. If this occurs, any of the Companys products and technology affected by these
developments could become obsolete.

23

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Although the Company is insured, any
material product liability claims could adversely affect its business.

The
Company sells over-the-counter products and medical devices and is exposed to the risk of
lawsuits claiming alleged injury caused by its products. Among the grounds for potential
claims against the Company are injuries due to alleged product inefficacy and injuries
resulting from infection due to allegedly non-sterile products. Although the Company
carries product liability insurance with limits of $1.0 million per occurrence and $2.0
million aggregate with $10.0 million in umbrella coverage, this insurance may not be
adequate to reimburse the Company for all damages that it could suffer as a result of
successful product liability claims. No material product liability claim has ever been
made against the Company and management is not aware of any pending product liability
claims. However, a successful material product liability suit could adversely affect the
Companys business.

Additional Financial
Information

Forward Looking Statements

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

Critical Accounting
Policies

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

Revenue Recognition and
Adjustments to Revenue

Revenue
is recognized when product is shipped and title passes to the customer and collectability
is reasonably assured. When the Company recognizes revenue from the sale of its products,
it simultaneously adjusts revenue for estimated trade rebates and distribution fees (in
Canada). A trade rebate represents the difference between the invoice price to the
wholesaler and the indirect customers contract price. These rebates are estimated
based on historical experience, estimated future trends, estimated customer inventory
levels, current contract sales terms with wholesale and indirect customers and other
competitive factors. The Company pays its exclusive Canadian distributor a fixed fee based
on sales subject to the fee (as defined) for distribution services in Canada. The
distribution fee is accrued monthly based on the estimated percentage of distribution fee
expense to net sales. If the assumptions used to calculate these rebates and fees do not
appropriately reflect future activity, the Companys financial position, results of
operations and cash flows could be impacted. The Company continually monitors the factors
that influence these rebates and fees and makes adjustments as necessary.

Goodwill

At
December 31, 2007, the Company had $9,524,305 of goodwill consisting of $7,084,263
(preliminary) relating to the FAD acquisition in November 2007 and $2,440,042 relating to
the Western Medical acquisition in April

24

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2006. The goodwill is included in
the wound care segment for reporting purposes. The Company tests goodwill for impairment
in the fourth quarter of each year or when impairment indicators are present. The process
of evaluating the potential impairment of goodwill is highly subjective and requires
significant judgments and assumptions in estimating future cash flows to determine the
fair value of each reporting unit. These assumptions include future growth rates,
discount factors, future tax rates and other factors. The Companys cash flow
forecasts are based on assumptions that are consistent with the plans and estimates used
to manage the underlying business. In addition, the Company makes certain judgments about
allocating shared assets to the balance sheet for this segment. If the expected cash
flows are not realized, impairment losses may be recorded in the future.

Inventory

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

Stock-Based Compensation

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

25

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Item 7. Consolidated
Financial Statements

Index

|                                                                                                  |     
|------------------------------------------------------------------------------------------------- | ----
|Description                                                                                       | Page
|                                                                                                  |     
|Report of Independent Registered Public Accounting
   Firm                                        | 26  
|                                                                                                  |     
|Consolidated Balance Sheets as of December 31, 2007
   and 2006                                   | 27  
|                                                                                                  |     
|Consolidated Statements of Operations for the
   Years Ended December 31, 2007 and 2006           | 28  
|                                                                                                  |     
|Consolidated Statements of Shareholders
   Equity for the Years Ended December 31, 2007 and 2006 | 29  
|                                                                                                  |     
|Consolidated Statements of Cash
   Flows for the Years Ended December 31, 2007 and 2006           | 30  
|                                                                                                  |     
|Notes to Consolidated Financial
   Statements                                                     | 31  
|                                                                                                  |     

26

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Report of Independent
Registered Public Accounting Firm

To the Shareholders and
Board of Directorsof Derma Sciences, Inc.

We have audited the accompanying
consolidated balance sheets of Derma Sciences, Inc. and Subsidiaries as of December 31,
2007 and 2006, and the related consolidated statements of operations, shareholders
equity and cash flows for each of the two years in the period ended December 31, 2007.
These financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audits to obtain reasonable assurance about
whether the financial statements are free of material misstatement. We were not engaged to
perform an audit of the Companys internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the Companys internal
control over financial reporting. Accordingly we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and significant
estimates made by management, and 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,
2007 and 2006, and the consolidated results of their operations and their cash flows for
each of the two years in the period ended December 31, 2007, in conformity with U.S.
generally accepted accounting principles.

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

Philadelphia, PennsylvaniaMarch
31, 2008

27

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Financial Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                                     |  |                |   |               |  
|-------------------------------------------------------------------- |  | -------------- | - | ------------- | -
|Consolidated Balance Sheets                                         
|                                                                    
|                                                                     |  | December 31,   |  
|ASSETS                                                               |  | 2007           |   | 2006          |  
|                                                                    
|Current Assets                                                       |  |                |   |               |  
|Cash and cash equivalents                                            |  | $      577,096 |   | $   1,285,943 |  
|Accounts receivable, net                                             |  | 3,667,119      |   | 2,090,073     |  
|Inventories                                                          |  | 9,935,977      |   | 4,678,107     |  
|Prepaid expenses and other current assets                            |  | 1,210,135      |   | 460,343       |  
|                                                                    
|Total current assets                                                 |  | 15,390,327     |   | 8,514,466     |  
|Equipment and improvements, net                                      |  | 4,909,049      |   | 4,133,595     |  
|Goodwill                                                             |  | 9,524,305      |   | 2,441,542     |  
|Other intangible assets, net                                         |  | 5,537,653      |   | 3,197,365     |  
|Other assets, net                                                    |  | 509,507        |   | 218,953       |  
|                                                                    
|Total Assets                                                         |  | $ 35,870,841   |   | $ 18,505,921  |  
|                                                                    
|LIABILITIES AND SHAREHOLDERS' EQUITY                                 | 
|                                                                    
|Current Liabilities                                                  | 
|Line of credit borrowings                                            |  | 1,219,197      |   |              |  
|Current maturities of long-term debt                                 |  | 1,288,532      |   | 338,155       |  
|Accounts payable                                                     |  | 4,092,278      |   | 1,645,575     |  
|Accrued expenses and other current liabilities                       |  | 3,421,282      |   | 762,687       |  
|                                                                    
|Total current liabilities                                            |  | 10,021,289     |   | 2,746,417     |  
|Long-term debt                                                       |  | 5,292,136      |   | 546,268       |  
|Other long-term liabilities                                          |  | 82,402         |   | 106,900       |  
|Deferred tax liability                                               |  | 420,059        |   | 128,324       |  
|                                                                    
|Total Liabilities                                                    |  | 15,815,886     |   | 3,527,909     |  
|                                                                    
|Shareholders' Equity                                                 | 
|Convertible preferred stock, $.01 par value; 11,750,000 shares       | 
|authorized; issued and outstanding: 2,280,407 at December 31, 2007   | 
|and 2006 (liquidation preference of $4,210,231 at December 31, 2007) |  | 22,804         |   | 22,804        |  
|Common stock, $.01 par value, 150,000,000 and 50,000,000 shares      | 
|authorized at December 31, 2007 and December 31, 2006, respectively; | 
|issued and outstanding: 33,829,755 shares at December 31, 2007 and   | 
|24,906,160 shares at December 31, 2006                               |  | 338,298        |   | 249,062       |  
|Additional paid-in capital                                           |  | 33,540,952     |   | 27,272,440    |  
|Accumulated other comprehensive income                              | 
|cumulative translation adjustments                                   |  | 1,854,787      |   | 850,987       |  
|Accumulated deficit                                                  |  | (15,701,886    | ) | (13,417,281   | )
|                                                                    
|Total Shareholders' Equity                                           |  | 20,054,955     |   | 14,978,012    |  
|                                                                    
|Total Liabilities and Shareholders' Equity                           |  | $ 35,870,841   |   | $ 18,505,921  |  
|                                                                    

See accompanying consolidated notes.

28

---



Financial Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                                  |  |                         |   |                   |  
|----------------------------------------------------------------- |  | ----------------------- | - | ----------------- | -
|Consolidated Statements of Operations                            
|                                                                 
|                                                                  |  | Year Ended December 31,
|                                                                  |  | 2007                    |   | 2006              |  
|                                                                 
|Net Sales                                                         |  | $ 34,135,401            |   | $ 27,887,391      |  
|Cost of sales                                                     |  | 22,530,986              |   | 18,235,003        |  
|                                                                 
|Gross Profit                                                      |  | 11,604,415              |   | 9,652,388         |  
|                                                                 
|Operating expenses                                                | 
|Selling, general and administrative                               |  | 11,885,368              |   | 8,339,227         |  
|Research and development                                          |  | 993,069                 |   | -                 |  
|Goodwill impairment                                               |  | -                       |   | 200,000           |  
|                                                                 
|Total operating expenses                                          |  | 12,878,437              |   | 8,539,227         |  
|                                                                 
|Operating (loss) income                                           |  | (1,274,022              | ) | 1,113,161         |  
|                                                                 
|Other expense (income):                                           | 
|Interest expense                                                  |  | 413,992                 |   | 374,079           |  
|Loss on debt extinguishment                                       |  | 256,628                 |   | -                 |  
|Other expense (income)                                            |  | 77,929                  |   | (47,998           | )
|                                                                 
|Total other expense                                               |  | 748,549                 |   | 326,081           |  
|                                                                 
|(Loss) income before provision for income taxes                   |  | (2,022,571              | ) | 787,080           |  
|Provision for income taxes                                        |  | 262,034                 |   | 118,341           |  
|                                                                 
|Net (Loss) Income                                                 |  | $(2,284,605             | ) | $      668,739    |  
|                                                                 
|(Loss) income per common share - basic and diluted                |  | $         (0.09         | ) | $            0.03 |  
|                                                                 
|Shares used in computing (loss) income per common share - basic   |  | 26,523,541              |   | 20,591,085        |  
|                                                                 
|Shares used in computing (loss) income per common share - diluted |  | 26,523,541              |   | 24,409,760        |  
|                                                                 

See accompanying consolidated notes.

29

---



Financial Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                |  |                       |   |                    |   |                           |   |             |  |                          |   |                                            |  |                    |   |                          | 
|----------------------------------------------- |  | --------------------- | - | ------------------ | - | ------------------------- | - | ----------- |  | ------------------------ | - | ------------------------------------------ |  | ------------------ | - | ------------------------ | 
|Consolidated Statements of Shareholders Equity
|                                               
|                                                |  | PreferredSharesIssued |   | CommonSharesIssued |   | ConvertiblePreferredStock |   | CommonStock |  | AdditionalPaid-InCapital |   | AccumulatedOtherComprehensiveIncome (Loss) |  | AccumulatedDeficit |   | TotalShareholdersEquity | 
|                                               
|Balance, December 31, 2005 (Restated)           |  | 2,280,407             |   | 12,285,768         |   | $      22,804             |   | $   122,858 |  | $19,905,059              |   | $   884,099                                |  | $(14,086,020       | ) | $  6,848,800             | 
|Net income                                      |  | 668,739               |   | 668,739            |  
|Foreign currency translation adjustment         |  | (33,112               | ) |                    |   | (33,112                   | )
|Comprehensive income  total                    |  | 635,627               |  
|Issuance of common stock in                     | 
|private placement, net of issuance              | 
|costs of $590,407                               |  |                       |   | 12,620,392         |   |                           |   | 126,204     |  | 7,155,625                |   |                                            |  |                    |   | 7,281,829                | 
|Employee stock option expense                   |  | 211,756               |   |                    |   |                           |   | 211,756     | 
|                                               
|Balance, December 31, 2006                      |  | 2,280,407             |   | 24,906,160         |   | $      22,804             |   | $   249,062 |  | $27,272,440              |   | $   850,987                                |  | $(13,417,281       | ) | $14,978,012              | 
|Net loss                                        |  | (2,284,605            | ) | (2,284,605         | )
|Foreign currency translation adjustment         |  | 1,003,800             |   |                    |   | 1,003,800                 |  
|Comprehensive loss  total                      |  | (1,280,805            | )
|Issuance of common stock in                     | 
|private placement net of issuance               | 
|costs of $389,079                               |  |                       |   | 8,571,420          |   |                           |   | 85,714      |  | 5,525,201                |   |                                            |  |                    |   | 5,610,915                | 
|Cashless exercise of warrants                   |  |                       |   | 352,175            |   |                           |   | 3,522       |  | (3,522                   | ) |                                            |  |                    |   | -                        | 
|Common stock warrants                           |  | 93,821                |   |                    |   |                           |   | 93,821      | 
|Employee stock option expense                   |  | 653,012               |   |                    |   |                           |   | 653,012     | 
|                                               
|Balance, December 31, 2007                      |  | 2,280,407             |   | 33,829,755         |   | $      22,804             |   | $   338,298 |  | $33,540,952              |   | $1,854,787                                 |  | $(15,701,886       | ) | $20,054,955              | 
|                                               

See accompanying consolidated notes.

30

---



Financial Index

DERMA SCIENCES, INC. AND
SUBSIDIARIES

|                                                                    |  |                         |   |                |  
|------------------------------------------------------------------- |  | ----------------------- | - | -------------- | -
|Consolidated Statements of Cash Flows                              
|                                                                   
|                                                                    |  | Year Ended December 31, |  
|                                                                    |  | 2007                    |   | 2006           |  
|                                                                   
|Operating Activities                                                |  |                         |   |                |  
|Net income (loss)                                                   |  | $(2,284,605             | ) | $    668,739   |  
|Adjustments to reconcile net income (loss) to net                   | 
|cash provided by operating activities:                              | 
|Depreciation of equipment and improvements                          |  | 773,280                 |   | 611,229        |  
|Amortization of intangible assets                                   |  | 659,712                 |   | 402,411        |  
|Amortization of deferred financing costs                            |  | 119,807                 |   | 86,234         |  
|Provision for bad debts                                             |  | 15,971                  |   | 1,584          |  
|Allowance for sales adjustments                                     |  | 413,029                 |   | 332,837        |  
|Provision for inventory obsolescence                                |  | 131,151                 |   | 73,497         |  
|Goodwill impairment                                                 |  |                        |   | 200,000        |  
|Loss on disposal of equipment                                       |  | 3,164                   |   | 19,624         |  
|Deferred rent expense                                               |  | (28,191                 | ) | 6,934          |  
|Compensation charge for employee stock options                      |  | 604,592                 |   | 181,494        |  
|Compensation charge for restricted stock                            |  | 48,420                  |   | 30,262         |  
|Non cash interest expense                                           |  | 93,821                  |   |               |  
|Gain on settlement of accounts payable                              |  |                        |   | (64,971        | )
|Deferred tax provision                                              |  | 262,034                 |   | 113,341        |  
|Changes in operating assets and liabilities:                        | 
|Accounts receivable                                                 |  | 1,557,072               |   | (1,016,750     | )
|Inventories                                                         |  | (2,519,367              | ) | 252,488        |  
|Prepaid expenses and other current assets                           |  | (742,647                | ) | (264,476       | )
|Other assets                                                        |  | 33,929                  |   | 43,245         |  
|Accounts payable                                                    |  | 1,301,925               |   | 65,125         |  
|Accrued expenses and other current liabilities                      |  | 925,020                 |   | 256,332        |  
|                                                                   
|Net cash provided by operating activities                           |  | 1,368,117               |   | 1,999,179      |  
|                                                                   
|Investing Activities                                                | 
|Acquisition of businesses                                           |  | (13,000,000             | ) | (6,000,000     | )
|Costs of acquiring businesses                                       |  | (737,665                | ) | (769,675       | )
|Purchase of equipment and improvements                              |  | (491,212                | ) | (931,968       | )
|Proceeds from sale of equipment                                     |  | 2,271                   |   | 14,952         |  
|                                                                   
|Net cash used in investing activities                               |  | (14,226,606             | ) | (7,686,691     | )
|                                                                   
|Financing Activities                                                | 
|U.S. term loan proceeds                                             |  | 6,000,000               |   | 1,000,000      |  
|Net change in bank line of credit                                   |  | 1,219,197               |   | (1,080,561     | )
|Deferred financing costs                                            |  | (434,190                | ) | (48,722        | )
|Long-term debt repayments                                           |  | (499,550                | ) | (1,296,310     | )
|Proceeds from issuance of stock, net of issuance costs              |  | 5,610,915               |   | 7,281,829      |  
|                                                                   
|Net cash provided by financing activities                           |  | 11,896,372              |   | 5,856,236      |  
|                                                                   
|Effect of exchange rate changes on cash                             |  | 253,270                 |   | 11,889         |  
|                                                                   
|Net (decrease) increase in cash and cash equivalents                |  | (708,847                | ) | 180,613        |  
|Cash and cash equivalents                                           | 
|Beginning of year                                                   |  | 1,285,943               |   | 1,105,330      |  
|                                                                   
|End of year                                                         |  | $      577,096          |   | $ 1,285,943    |  
|                                                                   
|Supplemental disclosures of cash flow information:                  | 
|Issuance of promissory note in connection with business acquisition |  | $                      |   | $    500,000   |  
|Equipment obtained with capital leases                              |  | $      163,745          |   |               |  
|Cash paid during the year for:                                      |  |                         |  
|Interest                                                            |  | $      344,709          |   | $      297,720 |  
|                                                                   

See accompanying consolidated notes.

31

---



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) is a full line provider of
wound care, wound closure and specialty securement devices and skin care products. The
Company markets its products principally through independent distributors servicing the
long-term care, home health and acute care markets in the United States, Canada and other
select international markets. The Companys U.S. distribution facility is located in
St. Louis, Missouri, while the Companys Canadian distribution facility is located in
Toronto. The Company has manufacturing facilities in Toronto, Canada and Nantong, China.
With the FAD acquisition, the Company temporarily manufactures and distributes the
adhesive strips and related first aid products at a Houston, Texas location.

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). For the Companys Canadian
subsidiary, whose functional currency is the Canadian dollar, exchange rate fluctuations
on foreign currency denominated assets and liabilities other than the functional currency
resulted in $161,244 and $60,055 of expense for the years ended December 31, 2007 and
2006, respectively.

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. 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,

32

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

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.

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 amortized 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 term nature. 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 or fair value as determined as of the date of
acquisition. 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 non-compete agreements are
amortized over 5 to 10 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 The Company tests goodwill for impairment using the two-step process prescribed by
Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangible
Assets (SFAS 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. If the first step indicates
an impairment, i.e. when the carrying value exceeds the fair value, then the second step
is required to determine the implied fair value of goodwill. The implied fair value of
goodwill is calculated in the same manner that goodwill is calculated in a business
combination. The allocation is to be performed as if the reporting unit had just been
acquired and the fair value of the unit was the purchase price. The goodwill impairment
equals the carrying value of goodwill less the implied fair value of goodwill. The Company
performs its goodwill impairment test as of December 31 of each year, or more frequently
if impairment indicators are present.

In
connection with the acquisitions of certain assets of NutraMax Products, Inc. in 2007 and
Western Medical, Inc. in 2006 (see Note 2), the Company recorded goodwill of $7,084,263
and $2,440,042, respectively, representing the excess of the purchase price over the fair
value of identifiable assets acquired and liabilities assumed. For tax purposes, the
goodwill is deductible and is being amortized over fifteen years.

The
Company recorded a goodwill impairment charge of $200,000 in 2006 related to its Sunshine
Products (Sunshine) product line which it acquired in 1998. There is no
remaining goodwill related to Sunshine after the impairment charge.

Stock-Based
Compensation  Effective January 1, 2006 the Company adopted SFAS 123R which
revises SFAS 123 Accounting for Stock-Based Compensation (SFAS 123)
and supersedes Accounting Principles Board Opinion 25 Accounting for Stock Issued
to Employees. SFAS 123R requires that new, modified and unvested share-based
payment transactions with employees, such as grants of stock options and restricted
stock, be

33

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

recognized in the financial
statements based on their fair value at the grant date and recognized as compensation
expense over their vesting periods. The Company estimates the fair value of stock options
as of the date of grant using the Black-Scholes or binomial/lattice pricing model (as
applicable) and restricted stock based on the quoted market price.

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
specialty securement devices and skin care. Sales are recorded when product is shipped or
title passes to customers and collectability is reasonably assured. Gross sales are
adjusted for cash discounts, returns and allowances, trade rebates, distribution fees (in
Canada) and other sales deductions 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 $469,041 and $353,583 in 2007 and 2006, respectively.

Royalties The Company recognizes royalty expenses associated with the products sold at the
time the related sale occurs and records them as a component of selling expense. Royalty
expense for the years ended December 31, 2007 and 2006 was $48,157 and $0, respectively.

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 the effects of the assumed exercise, conversion or
issuance of potentially issuable shares of common stock (potentially dilutive
securities), including those attributable to stock options, warrants, convertible
preferred stock and restricted common stock in the weighted average number of common
shares outstanding for a period, if dilutive. The effects of the assumed exercise of
warrants and stock options are determined using the treasury stock method. Potentially
dilutive securities have not been included in the computation of diluted loss per share
for the year ended December 31, 2007 as the effect would be anti-dilutive.

34

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

Total
dilutive shares that have or would have been used to compute diluted income per common
share for the year ended December 31, 2007 and 2006 are outlined below:

| |                                  |                         |            |  |            | 
| | -------------------------------- | ----------------------- | ---------- |  | ---------- | 
| |                                  | Year Ended December 31, |           
| |                                  | 2007                    | 2006       | 
|
| | Weighted average common shares   |                         |            |  |            | 
| | outstanding - basic              |                         | 26,523,541 |  | 20,591,085 | 
| | Dilutive shares attributable to: |                        
| | Convertible preferred stock      |                         | -          |  | 2,280,407  | 
| | Restricted common stock          |                         | -          |  | 112,192    | 
| | Warrants                         |                         | -          |  | 299,329    | 
| | Stock options                    |                         | -          |  | 1,126,747  | 
|
| | Sub-total dilutive shares        |                         | -          |  | 3,818,675  | 
|
| | Weighted average common          |                        
| | shares outstanding - diluted     |                         | 26,523,541 |  | 24,409,760 | 

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

| |                           |                         |            |  |           | 
| | ------------------------- | ----------------------- | ---------- |  | --------- | 
| |                           | Year Ended December 31, |           
| |                           | 2007                    | 2006       | 
|
| | Excluded dilutive shares: |                         |            |  |           | 
| | Preferred stock           |                         | 2,280,407  |  | -         | 
| | Restricted common stock   |                         | 175,000    |  | -         | 
| | Stock options             |                         | 8,223,480  |  | 2,161,155 | 
| | Warrants                  |                         | 8,312,759  |  | 5,415,098 | 
|
| | Total dilutive shares     |                         | 18,991,646 |  | 7,576,253 | 

Recently
Issued Accounting Pronouncements In June 2006, the Financial Accounting
Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes  an Interpretation of SFAS No. 109 (FIN
48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in
financial statements in accordance with Statement of Financial Accounting Standards
(SFAS) No. 109, Accounting for Income Taxes. FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement recognition
and measurement of a tax position taken or expected to be taken in a tax return. FIN 48
also provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition. The Company adopted the
provisions of FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material
effect on the Companys financial condition or results of operations for the year
ended December 31, 2007.

As
of January 1, 2007 and December 31, 2007, the Company had no unrecognized tax benefits,
and no adjustment to its financial position, results of operations or cash flows was
required. The Company does not expect that unrecognized tax benefits will increase within
the next twelve months. The Company records interest and penalties related to tax matters
within other expense on the accompanying Consolidated Statements of Operations. These
amounts are not material to the consolidated financial statements for the periods
presented. The Companys U.S. tax returns are subject to examination by federal and
state taxing authorities. Tax years prior to 2002 are no longer subject to federal or
state examination. The Companys State of New Jersey tax returns for the tax years
2002 through 2005 have been examined and there were no assessments. The Companys
2003 and 2002 Canadian tax returns were subject to examination and adjustment by the
Canada Customs and Revenue Agency. These

35

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

adjustments did not have a material
impact on the Companys financial position, results of operations or cash flows. Tax
years prior to 2004 are no longer subject to examination in Canada.

In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS 157), which defines fair value, establishes a framework for measuring
fair value, and expands disclosures about fair value measurements. SFAS 157 applies under
other accounting pronouncements that require or permit fair value measurements, but does
not require any new fair value measurements. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. The Company will adopt SFAS 157 as of January 1, 2008, as
required. The Company does not expect SFAS 157 to have a material impact on its
consolidated financial statements.

In
December 2007, the FASB issued SFAS No. 141 (revised), Business
Combinations (SFAS 141(R)), which is intended to improve reporting by
creating greater consistency in the accounting and financial reporting of business
combinations. SFAS 141(R) requires that the acquiring entity in a business combination
recognize all (and only) the assets and liabilities assumed in the transaction,
establishes the acquisition-date fair value as the measurement objective for all assets
acquired and liabilities assumed, and requires the acquirer to disclose to investors and
other users all of the information that they need to evaluate and understand the nature
and financial effect of the business combination. In addition, SFAS 141(R) impacts the
accounting for transaction and restructuring costs. SFAS 141(R) is effective for business
combinations for which the acquisition date is on or after the beginning of the first
annual reporting period beginning on or after December 15, 2008. The Company is
currently determining the impact of SFAS 141(R) on its consolidated financial statements.

Reclassifications Certain reclassifications have been made to prior year reported amounts to conform
with the 2007 presentation.

2.     Acquisitions

NutraMax
Acquisition

On
November 8, 2007, the Company acquired certain assets and assumed the trade payables of
the NutraMax Products, Inc., (NutraMax) first aid division (FAD)
for $13,000,000 cash and a $500,000 potential earn out bonus. The cash purchase price
consisted of $10,250,000 paid to NutraMax, $2,000,000 deposited in a supply agreement
escrow account and $750,000 deposited in an indemnification escrow account. The supply
agreement escrow funds are payable to NutraMax quarterly, in the amount of $500,000 plus
interest at 6% from the closing date, upon achievement of certain agreed-upon third party
supplier product cost and delivery performance objectives. The indemnification escrow
funds are being held for one year from the date of closing against any intervening
adjustments to the purchase price. If certain agreed-upon third party supplier product
cost and delivery performance objectives are met during the twelve month post closing
period, the Company will pay to NutraMax an additional $500,000 which will be recorded as
an addition to the purchase price. In addition, the Company incurred $737,665 of
capitalized transaction costs, $434,190 of deferred financing costs and $256,628 of debt
extinguishment expense related to the acquisition. The purchased assets consist of
receivables, inventory, equipment, other amortizable intangibles and goodwill. To fund the
acquisition, the Company raised $5,610,915 (net of $389,079 in commission and other
offering expenses) from the private sale of 8,571,420 shares of common stock at a price of
$0.70 per share, together with 2,142,855 five-year warrants to purchase one share of
common stock at a price of $0.77 per share. In addition, the Company entered into a new
five-year credit and security agreement comprised of an $8,000,000 revolver and a
$6,000,000 term loan. At closing, the Company applied the entirety of the $6,000,000 term
loan and approximately $3,000,000 of the revolver in satisfaction of the Companys
obligations under the purchase agreement and related obligations.

The
FAD is a leading manufacturer and marketer of branded and private label adhesive strips
and related first aid products to the medical, industrial and retail markets. For its
latest fiscal year ended September 29, 2007, FAD reported audited sales of $16,688,000,
gross profit of $1,232,000 and a net loss of $880,000. The FADs

36

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

product line will serve to expand
the Companys existing basic wound care line to new customers and markets,
especially the retail market where the Company does not have a presence. The Company
anticipates being able to leverage cross selling opportunities presented by the purchase
to grow sales. In addition, the Company expects to be able to significantly reduce FAD
product costs by completing the transfer of production of FAD products, initiated by
NutraMax, to lower cost suppliers.

The
acquisition has been accounted for as a purchase. Accordingly, the results of operations
of FAD have been included in the consolidated financial statements commencing November 8,
2007. A preliminary allocation of the purchase price is outlined below:

| |                                                  |  |               |  
| | ------------------------------------------------ |  | ------------- | -
| | Purchase Price:                                  |  |               |  
|
| | Cash paid                                        |  | $ 13,000,000  |  
| | Transaction costs                                |  | 737,665       |  
|
| | Total                                            |  | $ 13,737,665  |  
|
| | Allocation of Purchase Price:                    | 
|
| | Trade receivables                                |  | $   2,075,636 |  
| | Inventory                                        |  | 2,361,597     |  
| | Equipment                                        |  | 300,000       |  
| | Goodwill                                         |  | 7,084,263     |  
| | Identifiable intangibles subject to amortization |  | 3,000,000     |  
| | Liabilities Assumed                              |  | (1,083,831    | )
|
| | Total                                            |  | $ 13,737,665  |  

The
allocation of the preliminary purchase price to the estimated fair values of the assets
acquired and liabilities assumed as reflected in the consolidated financial statements is
preliminary and subject to change based on finalization of the Companys valuation.
The Company is currently assessing the fair value of the identifiable tangible and
intangible assets acquired and liabilities assumed. It is expected that the current assets
and liabilities assumed will approximate the values assigned as of the date of the
acquisition. A valuation study is presently being conducted to establish the fair market
value of the equipment and the identifiable intangibles acquired. The intangible assets
acquired consist primarily of customer lists, trademarks, a supply agreement and a
non-compete agreement. Since the date of the acquisition, the estimated identifiable
intangibles have been amortized to general administrative expense assuming a useful life
of five years. The final purchase price allocation to reflect the fair values of the
assets acquired and liabilities assumed will be based on the final results of the
agreed-upon third party supplier, product cost and delivery performance objectives and the
outcome of the Companys valuation study. The final valuation is expected to be
completed in the second quarter of 2008.

The
Company has retained certain NutraMax personnel to perform sales and marketing,
manufacturing and distribution activities on a permanent and transitional basis.
Manufacturing activities are expected to continue in Houston on an as needed basis through
the second quarter 2008 to meet customer demand and build safety stock. Distribution
activities are expected to continue through the first quarter 2009, at which time the
Company will have determined how best to rationalize its U.S. distribution network. The
Company has entered into a six month lease for NutraMaxs former facility in Houston,
Texas. Under the terms of the lease, the Company will pay the landlord $18,750 per month
and will be responsible for utilities and ongoing normal repair and maintenance costs.
Under an agreement between the Company and NutraMax, NutraMax has agreed to reimburse the
Company for one-half of the utilities expense during the lease term and to pay for the
clean up and removal of any of its assets remaining in the facility at the end of the
Companys lease. The Company is presently looking for equivalent warehouse space in
Houston to be utilized through the first quarter 2009.

37

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

Western
Medical Acquisition

On
April 18, 2006, the Company acquired certain assets and assumed the trade payables and the
business of Western Medical, Inc. (Western Medical) for $6,500,000 of which
$6,000,000 was paid in cash and $500,000 was paid via a three-year promissory note issued
to Western Medical by the Company. In addition, the Company incurred a total of $819,052
of transaction costs related to the acquisition. The purchased assets consist of trade
receivables, inventories, equipment and certain identifiable intangibles.

The
acquisition has been accounted for under the purchase method. Accordingly, the results of
operations of Western Medical have been included in the consolidated financial statements
commencing April 18, 2006. The purchase price and allocation of the purchase price are
outlined below:

| |                                                  |  |              |  
| | ------------------------------------------------ |  | ------------ | -
| | Purchase Price:                                  |  |              |  
|
| | Cash paid                                        |  | $ 6,000,000  |  
| | Promissory note bearing interest at 12%          |  | 500,000      |  
| | Transaction costs                                |  | 819,052      |  
|
| | Total                                            |  | $ 7,319,052  |  
|
| | Allocation of Purchase Price:                    | 
|
| | Trade receivables                                |  | $    484,965 |  
| | Inventory                                        |  | 1,179,233    |  
| | Equipment                                        |  | 483,932      |  
| | Goodwill                                         |  | 2,440,042    |  
| | Identifiable intangibles subject to amortization |  | 3,300,000    |  
| | Liabilities assumed                              |  | (569,120     | )
|
| | Total                                            |  | $ 7,319,052  |  

The
allocation of the purchase price to the assets acquired and liabilities assumed as
reflected in the consolidated financial statements is based on finalization of the
Companys valuation study to establish the fair market value of the assets,
liabilities and the identifiable intangible assets and goodwill acquired. The identifiable
intangible assets acquired consist of customer lists, trademarks and a non-compete
agreement. See Note 7 for additional information concerning other identifiable intangible
assets.

The
unaudited pro forma information below presents combined results of operations as if the
FAD and Western Medical acquisitions had occurred at January 1, 2006 instead of November
8, 2007 and April 18, 2006, respectively. The pro forma information is based on historical
results and is not necessarily indicative of the results of operations of the combined
entity had the acquisition occurred at the beginning of the periods presented, nor is it
necessarily indicative of future results.

38

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

| |                                      |                         |                  |   |                   | 
| | ------------------------------------ | ----------------------- | ---------------- | - | ----------------- | 
| |                                      | Year Ended December 31, |                 
| |                                      | 2007                    | 2006             |  
| |                                      | (Unaudited)             | (Unaudited)      |  
|
| | Revenues                             |                         | $     48,548,377 |   | $     48,879,390  | 
|
| | Net (loss) income                    |                         | $     (3,131,722 | ) | $       1,440,343 | 
| | Net (loss) income  per common share: |                        
|
| | Basic                                |                         | $(0.12)          |   | $0.07             | 
| | Diluted                              |                         | $(0.12)          |   | $0.06             | 

3.     Accounts Receivable

Accounts
receivable include the following:

| |                                          |      |              |   |             |  
| | ---------------------------------------- | ---- | ------------ | - | ----------- | -
| |                                          |      | December 31, |  
| |                                          | 2007 | 2006         |  
|
| | Accounts receivable                      |      | $ 4,070,658  |   | $ 4,223,995 |  
| | Less:  Allowance for doubtful accounts   |      | (123,000     | ) | (81,425     | )
| | Allowance for trade rebates              |      | (213,550     | ) | (1,727,559  | )
| | Allowance for distribution fee           |      | -            |   | (300,438    | )
| | Allowance for cash discounts and returns |      | (66,989      | ) | (24,500     | )
|
| | Accounts receivable, net                 |      | $ 3,667,119  |   | $ 2,090,073 |  

At
December 31, 2007 Derma Canadas net accounts receivable balance was a credit of
$1,650,528. The credit balance was primarily attributable to the trade rebate allowance
from its largest customer exceeding the underlying trade accounts receivables outstanding.
The credit balance has been reclassed to accrued expenses and other current liabilities
for financial statement presentation purposes (see Note 9).

4.     Inventories

Inventories
include the following:

| |                     |      |              |  |            | 
| | ------------------- | ---- | ------------ |  | ---------- | 
| |                     |      | December 31, | 
| |                     | 2007 | 2006         | 
|
| | Finished goods      |      | $6,660,454   |  | $2,784,612 | 
| | Work in process     |      | 180,823      |  | 92,780     | 
| | Packaging materials |      | 1,152,268    |  | 777,046    | 
| | Raw materials       |      | 1,942,432    |  | 1,023,669  | 
|
| | Total inventory     |      | $9,935,977   |  | $4,678,107 | 

39

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

5.     Equipment and
Improvements, net

Equipment
and improvements include the following:

| |                                       |      |              |   |             |  
| | ------------------------------------- | ---- | ------------ | - | ----------- | -
| |                                       |      | December 31, |  
| |                                       | 2007 | 2006         |  
|
| | Machinery and equipment               |      | $ 5,527,923  |   | $ 4,408,244 |  
| | Furniture and fixtures                |      | 455,737      |   | 274,299     |  
| | Leasehold improvements                |      | 1,462,690    |   | 1,112,897   |  
| |                                       |      | 7,446,350    |   | 5,795,440   |  
| | Less:  accumulated depreciation       |      | (2,537,301   | ) | (1,661,845  | )
|
| | Total equipment and improvements, net |      | $ 4,909,049  |   | $ 4,133,595 |  

Included
in equipment and improvements at December 31, 2007 was machinery and equipment with a cost
of $161,381 and accumulated amortization of $60,518 and furniture and fixtures with a cost
of $163,745 and accumulated amortization of $19,104 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, |  
| |                               | 2007 | 2006         |  
|
| | Patents and trademarks        |      | $    444,067 |   | $   444,067 |  
| | Other intangible assets       |      | 6,642,797    |   | 3,642,797   |  
|
| | Gross other intangible assets |      | 7,086,864    |   | 4,086,864   |  
| | Less accumulated amortization |      | (1,549,211   | ) | (889,499    | )
|
| | Other intangible assets, net  |      | $ 5,537,653  |   | $3,197,365  |  

The
Company is presently conducting a valuation analysis of the FAD purchased net assets to
determine the allocation of the final purchase price to the underlying assets acquired.
The preliminary identifiable intangibles subject to amortization in the amount of
$3,000,000 are being amortized over five years. In 2007, the amortization expense related
to these assets was $100,000.

In
connection with the April 18, 2006 acquisition of certain assets and assumption of trade
payables and the business of Western Medical, the Company allocated $3,300,000 of the
purchase price to identifiable intangible assets as outlined below:

| |                       |  |             |  |                     |  |                     | 
| | --------------------- |  | ----------- |  | ------------------- |  | ------------------- | 
| |                       |  | Fair Value  |  | Annual Amortization |  | Amortization Period | 
|
| | Trademarks            |  | $   600,000 |  | $  60,000           |  | 10 years            | 
| | Customer list         |  | 1,500,000   |  | 150,000             |  | 10 years            | 
| | Non-compete agreement |  | 1,200,000   |  | 240,000             |  | 5 years             | 
|
| | Total                 |  | $3,300,000  |  | $450,000            | 

40

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

The
weighted average useful life of patent and trademarks and other intangibles as of December
31, 2007 and 2006 is 4.9 years. Actual amortization expense for 2007 and 2006 and
estimated thereafter by year is outlined below:

|                                                             |                       |         |                      |             |       |             |  |            | 
|------------------------------------------------------------ | --------------------- | ------- | -------------------- | ----------- | ----- | ----------- |  | ---------- | 
|                                                             | Patents andTrademarks |         | Other    Intangibles |             | Total |            
|                                                            
|Actual amortization expense for year ended December 31, 2007 |                       | $41,201 |                      | $   618,511 |       | $   659,712 | 
|                                                            
|Actual amortization expense for year ended December 31, 2006 |                       | $15,148 |                      | $   387,263 |       | $   402,411 | 
|                                                            
|Estimated amortization expense                              
|                                                            
|                                                             | 2008                  |         |                      | $36,012     |       | $1,118,513  |  | $1,154,525 | 
|                                                             | 2009                  |         |                      | -           |       | 1,051,878   |  | 1,051,878  | 
|                                                             | 2010                  |         |                      | -           |       | 1,050,000   |  | 1,050,000  | 
|                                                             | 2011                  |         |                      | -           |       | 1,050,000   |  | 1,050,000  | 
|                                                             | 2012                  |         |                      | -           |       | 950,000     |  | 950,000    | 
|                                                             | Thereafter            |         |                      | -           |       | 281,250     |  | 281,250    | 
|                                                            
|                                                             | Total                 |         |                      | $36,012     |       | $5,501,641  |  | $5,537,653 | 

7.     Other Assets, net

Other
assets, net include the following:

| |                               |      |              |  |          | 
| | ----------------------------- | ---- | ------------ |  | -------- | 
| |                               |      | December 31, | 
| |                               | 2007 | 2006         | 
|
| | Deferred financing costs, net |      | $419,496     |  | $104,198 | 
| | Deposits                      |      | 90,011       |  | 67,360   | 
| | Long-term receivable          |      | -            |  | 47,395   | 
|
| | Total other assets, net       |      | $509,507     |  | $218,953 | 

Deferred
financing costs related to the U.S. credit facility are being amortized over the five-year
term of the related facility. Unamortized deferred financing costs in the amount of
$56,628 associated with the $3,500,000 revolving line of credit agreement which was paid
off in November, 2007 were written-off and included in Loss on Debt Extinguishment in the
Consolidated Statement of Operations.

8.     Line of Credit
Borrowings

Short-term
borrowings include the following:

| |                                 |      |              |  |             | 
| | ------------------------------- | ---- | ------------ |  | ----------- | 
| |                                 |      | December 31, | 
| |                                 | 2007 | 2006         | 
|
| | U.S. line of credit             |      | $1,219,197   |  | $         - | 
| | Canadian line of credit         |      | -            |  | -           | 
|
| | Total line of credit borrowings |      | $1,219,197   |  | $         - | 

41

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

U.S.
Line of Credit

In
November, 2007, the Company entered into a new five-year revolving credit agreement
providing for maximum borrowings of $8,000,000 with its new U.S. lender. Advances under
the revolving credit agreement may be drawn, from time to time, up to the amount of 85% of
eligible receivables (as defined) and 60% of eligible inventory (as defined). Interest on
outstanding advances under the revolving credit agreement is payable at the LIBOR monthly
rate, plus 2.75%, (7.595% at December 31, 2007). In addition, the Company will pay a
monthly unused line fee of 0.5% per annum on the difference between the daily average
amount of advances outstanding under the agreement and $8,000,000 together with a monthly
collateral management fee of $2,000. Outstanding balances under the agreement are secured
by all of the Companys and its subsidiaries existing and after-acquired
tangible and intangible assets located in the United States and Canada.

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

The
revolving credit agreement replaced the Companys then existing $3,500,000 revolver
with its previous U.S. lender. The Company terminated its $3,500,000 revolving credit
agreement and paid off all outstanding indebtedness with this U.S. lender in November,
2007 incurring a $200,000 early termination fee. The early termination fee is included in
Loss on Debt Extinguishment in the Consolidated Statement of Operations.

Canadian
Line of Credit

In
December 2006, the Company renewed its revolving credit facility with its Canadian lender
(the Canadian Agreement) which had a maximum borrowing capacity of $529,000
($500,000 Canadian) at the time the agreement was terminated by the Company in October, 2007.

9.     Accrued Expenses and
Other Current Liabilities

Accrued
expenses and other current liabilities include the following:

| |                                                         |      |              |  |           | 
| | ------------------------------------------------------- | ---- | ------------ |  | --------- | 
| |                                                         |      | December 31, | 
| |                                                         | 2007 | 2006         | 
|
| | Accrued Canadian sales rebate, net (see notes 3 and 15) |      | $1,650,528   |  | $       - | 
| | USC License Fee (see note 15)                           |      | 839,348      |  | -         | 
| | Accrued compensation and related taxes                  |      | 520,185      |  | 472,156   | 
| | Accrued sales incentives and administrative fees        |      | 249,262      |  | 197,090   | 
| | Other                                                   |      | 161,959      |  | 93,441    | 
|
| | Total accrued expenses and other current liabilities    |      | $3,421,282   |  | $762,687  | 

At
December 31, 2007, the value of the Canadian accrued sales rebate and other reserves
exceeded the value of the underlying trade receivables outstanding. The net credit balance
in trade receivables was reclassified for financial reporting purposes to accrued expense
to recognize it as a net liability.

42

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

10.   Long-Term Debt

Long-term
debt includes the following:

| |                           |      |              |  |           | 
| | ------------------------- | ---- | ------------ |  | --------- | 
| |                           |      | December 31, | 
| |                           | 2007 | 2006         | 
|
| | U.S. term loan            |      | $5,900,000   |  | $       - | 
| | Canadian term loan        |      | -            |  | 295,881   | 
| | Promissory note           |      | 500,000      |  | 500,000   | 
| | Capital lease obligations |      | 180,668      |  | 88,542    | 
|
| | Total debt                |      | 6,580,668    |  | 884,423   | 
|
| | Less:  current maturities |      | 1,288,532    |  | 338,155   | 
|
| | Long-term debt            |      | $5,292,136   |  | $546,268  | 

The
following are term loan and promissory note maturities over the next five years:

| |                             |                              |            | 
| | --------------------------- | ---------------------------- | ---------- | 
| | Year EndingDecember 31,     | Term Loan andPromissory Note |           
|
| | 2008                        |                              | $1,200,000 | 
| | 2009                        |                              | 1,700,000  | 
| | 2010                        |                              | 1,200,000  | 
| | 2011                        |                              | 1,200,000  | 
| | 2012                        |                              | 1,100,000  | 
|
| | Total term loan obligations |                              | 6,400,000  | 
| | Less: current maturities    |                              | 1,200,000  | 
|
| | Long-term loan obligations  |                              | $5,200,000 | 

U.S.
Term Loan

In
November, 2007, the Company entered into a five-year $6,000,000 term loan agreement with
its new U.S. lender. Interest on the term loan is payable at the LIBOR monthly rate plus
4.25%, (9.095% at December 31, 2007). Monthly payments of principal in the amount of
$100,000 together with interest are due under the agreement. The agreement is secured by
all of the Companys and its subsidiaries existing and after-acquired tangible
and intangible assets located in the United States and Canada.

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

43

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

Canadian
Term Loan

In
August 2002, the Company entered into a five-year term loan agreement with its Canadian
lender. The loan was repayable in monthly payments consisting of principal and interest.
Interest on the outstanding principal balance was payable monthly at the banks prime
rate (as defined) plus 1.25%. The Canadian term loan was paid off in September, 2007.

Promissory
Note

In
connection with the acquisition of Western Medical in April 2006, a portion of the
purchase price was paid via a three-year unsecured promissory note issued to the seller.
The principal amount of the promissory note, together with simple interest of 12%, is
payable in 11 quarterly installments of interest only in the amount of $15,000 and a final
payment of accrued interest of $15,000 and the principal balance of $500,000 on April 18,
2009. The promissory note may be prepaid in part or in full at any time without penalty.

Capital
Lease Obligations

The
Company has two capital lease obligations for certain office furniture and distribution
equipment totaling $180,668 as of December 31, 2007. The capital lease obligations bear
interest at annual rates ranging from 7.6% to 9.6% with the longest lease term expiring in
May 2010.

The
future minimum lease payments required under the capital leases and the present value of
the minimum lease payments as of December 31, 2007 are as follows:

| |                                                        |  |                          | 
| | ------------------------------------------------------ |  | ------------------------ | 
| | Year EndingDecember 31,                                |  | Capital LeaseObligations | 
|
| | 2008                                                   |  | $101,466                 | 
| | 2009                                                   |  | 72,272                   | 
| | 2010                                                   |  | 26,059                   | 
|
| | Total minimum lease payments                           |  | 199,797                  | 
| | Less:  Amount representing interest                    |  | 19,129                   | 
|
| | Present value of capital lease obligations             |  | 180,668                  | 
| | Less:  Current maturities of capital lease obligations |  | 88,532                   | 
|
| | Long-term capital lease obligations                    |  | $  92,136                | 

11.   Shareholders
Equity

Preferred
Stock

There
are 150,003 shares of series A convertible preferred stock outstanding at December 31,
2007. The series A preferred stock is convertible into common stock on a one-for-one
basis, bears no dividend, maintains a liquidation preference of $4.00 per share, votes as
a class on matters affecting the series A preferred stock and maintains voting rights
identical to the common stock on all other matters.

There
are 440,003 shares of series B convertible preferred stock outstanding at December 31,
2007. 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.

44

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

There
are 619,055 shares of series C convertible preferred stock outstanding at December 31,
2007. The series C preferred stock is convertible into common stock on a one-for-one
basis, bears no dividend, maintains a liquidation preference averaging $0.70 per share,
votes as a class on matters affecting the series C preferred stock and maintains voting
rights identical to the common stock on all other matters.

There
are 1,071,346 shares of series D convertible preferred stock outstanding at December 31,
2007. The series D preferred stock is convertible into common stock on a one-for-one
basis, bears no dividend, maintains a liquidation preference averaging $0.50 per share,
votes as a class on matters affecting the series D preferred stock and maintains voting
rights identical to the common stock on all other matters.

Common
Stock

On
December 28, 2007 the Company increased the number of authorized shares of common stock
from 50,000,000 to 150,000,000.

In
November, 2007 the Company raised $5,610,915 (net of $389,079 in commission and other
offering expenses) from the private sale to two institutional investors of 8,571,420
shares of the Companys common stock at the price of $0.70 per share, together with
2,142,855 five-year warrants to purchase one share of common stock at the price of $0.77.
The funds were used for the acquisition of FAD.

In
accordance with the series F warrant agreement, effective January 4, 2007, the owners
effected a cashless exercise of all issued and outstanding series F warrants comprising
1,309,441 warrants with an exercise price of $0.57 per warrant. Based on the thirty day
trailing average closing price of $0.78 per share, the warrants had a calculated value of
$0.21 each ($0.78  $0.57), or $274,983 in the aggregate, and were exchanged for
352,175 shares of common stock.

On
August 3, 2006, the Company entered into an agreement to sell 2,000,000 shares of its
common stock at $0.75 per share for a total sales price of $1,500,000 to an existing
shareholder. The shareholder paid $500,000 on August 3, 2006 and paid the balance due of
$1,000,000, together with interest thereon at the annual rate of 2.5%, or $8,500, on
December 5, 2006. The Company raised $1,478,525 (net of $21,475 in offering expenses)
related to this offering which was used to pay down debt and for general working capital
purposes.

On
May 11, 2006, the Company increased the number of authorized shares of common stock from
30,000,000 to 50,000,000.

In
April 2006, the Company raised $5,803,304 (net of $568,932 in commission and other
offering expenses) from a private offering of 2,655,098 units (10,620,392 shares in total)
at $2.40 per unit, each unit consisting of four shares of the Companys common stock
and one five-year Series H warrant (2,655,098 warrants in total) to purchase one share of
common stock at the price of $1.00. In addition, the placement agent received 754,806
five-year Series I warrants to purchase one share of common stock at $0.72. The funds were
used in the acquisition of certain assets of Western Medical.

45

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

Stock
Purchase Warrants

At
December 31, 2007, the Company had warrants outstanding to purchase 8,312,759 shares of
the Companys common stock as outlined below:

| |        |                    |                |                   | 
| | ------ | ------------------ | -------------- | ----------------- | 
| | Series | Number of Warrants | Exercise Price | Expiration Date   | 
|
| | G      | 2,760,000          | $1.05          | December 31, 2008 | 
| | H      | 2,655,098          | $1.00          | April 30, 2011    | 
| | I      | 754,806            | $0.72          | April 30, 2011    | 
| | J      | 2,142,855          | $0.77          | May 31, 2013      | 
|
| | Total  | 8,312,759          |                |                   | 

Stock
Options

The
Company has a stock option plan under which options to purchase a maximum of 10,000,000
shares of common stock may be issued. The plan permits the granting of both incentive
stock options and nonqualified stock options to employees and directors of the Company and
certain outside consultants and advisors to the Company. The option exercise price may not
be less than the fair market value of the stock on the date of the grant of the option.
The duration of each option may not exceed 10 years from the date of grant. Under the
plan, service based options to purchase 1,880,000 and 585,000 shares of common stock were
granted to officers, directors, agents and employees in 2007 and 2006, respectively, with
exercise prices ranging from $0.60 to $0.81 per share. Market based options to purchase
700,000 shares of common stock were granted to officers in 2007. In 2007, 29,000 plan
options were forfeited. As of December 31, 2007, options to purchase 6,152,625 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, 2007, non-plan options to purchase 2,070,855 shares of the Companys
common stock were issued and outstanding. In 2007 and 2006 165,800 and 500,000 non-plan
options, respectively, expired.

For
the years ended December 31, 2007 and 2006 the fair value of each service based option
award was estimated at the date of grant using the Black-Scholes option pricing model. The
weighted-average assumptions for the years ended December 31, 2007 and 2006 were as
follows:

| |                              |  |       |  |       | 
| | ---------------------------- |  | ----- |  | ----- | 
| |                              |  | 2007  |  | 2006  | 
|
| | Risk-free interest rate      |  | 4.28% |  | 4.56% | 
| | Volatility factor            |  | 118%  |  | 127%  | 
| | Dividend yield               |  | 0%    |  | 0%    | 
| | Expected option life (years) |  | 6.25  |  | 6.25  | 
| | Contractual life (years)     |  | 10    |  | 10    | 

In
both 2007 and 2006, the risk-free rate utilized represents the U.S. Treasury yield curve
rate which approximates the risk-free rate for the expected option life at the time of
grant. In 2007 and 2006, the volatility factor was calculated based on the seventy-five
month-end closing prices of the Companys common stock preceding the month of stock
option grant, respectively. Effective January 1, 2006, the Company adopted, based on
guidance from Staff Accounting Bulletin 107, a stock option life of 6.25 years. As a
result, the Company also adopted on January 1, 2006, a seventy-five month volatility
period to coincide with the expected stock option life. The dividend yield is 0% since
the Company does not anticipate paying dividends in the near future. Based on the

46

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

Companys historical experience
of options that cancel before becoming fully vested, the Company effective January 1,
2006 has assumed an annualized forfeiture rate of 1.0% for all options. Under the true-up
provision of SFAS 123R, the Company will record additional expense if the actual
forfeiture rate is lower than estimated, and will record a recovery of prior expense if
the actual forfeiture rate is higher than estimated.

For
the year ended December 31, 2007 the fair value of each market based option award was
estimated at the date of grant using the binomial/lattice option pricing model. The
weighted-average assumptions for the year ended December 31, 2007 was as follows:

| |                              |  |       | 
| | ---------------------------- |  | ----- | 
| |                              |  | 2007  | 
|
| | Risk-free interest rate      |  | 3.97% | 
| | Volatility factor            |  | 99.3% | 
| | Dividend yield               |  | 0%    | 
| | Expected option life (years) |  | 8.5   | 
| | Contractual life (years)     |  | 10    | 

The
risk-free rate utilized represents the U.S. Treasury yield curve rate which approximates
the risk-free rate for the expected option life at the time of grant. The volatility
factor was calculated based on the seventy-five month-end closing prices of the
Companys common stock preceding the month of stock option grant, respectively. A one
hundred and twenty month volatility period to coincide with the contractual stock option
life was utilized. The dividend yield is 0% since the Company does not anticipate paying
dividends in the near future. Based on the Companys historical experience of options
that cancel before becoming fully vested, the Company has assumed an annualized forfeiture
rate of 0% for all options. Under the true-up provision of SFAS 123R, the Company will
record additional expense if the actual forfeiture rate is lower than estimated, and will
record a recovery of prior expense if the actual forfeiture rate is higher than estimated.

A
summary of the Companys stock option activity and related information for the years
ended December 31, 2007 and 2006 follows:

|                                |  |           |   |                               |  |           |   |                               | 
|------------------------------- |  | --------- | - | ----------------------------- |  | --------- | - | ----------------------------- | 
|                                |  | 2007      |   | 2006                          | 
|                               
|                                |  | Options   |   | WeightedAverageExercise Price |  | Options   |   | WeightedAverageExercise Price | 
|                               
|Outstanding - beginning of year |  | 5,838,280 |   | $0.94                         |  | 5,773,280 |   | $0.92                         | 
|Granted                         |  | 2,580,000 |   | $0.68                         |  | 585,000   |   | $0.74                         | 
|Forfeited/Expired               |  | (194,800  | ) | $4.08                         |  | (520,000  | ) | $0.51                         | 
|                               
|Outstanding - end of year       |  | 8,223,480 |   | $0.78                         |  | 5,838,280 |   | $0.94                         | 
|                               
|Exercisable at end of year      |  | 5,885,980 |   | $0.82                         |  | 5,533,280 |   | $0.95                         | 

The
weighted average fair value per share of options granted during 2007 and 2006 was $0.72
and $0.67, respectively. The fair value of options vested during 2007 and 2006 was
$461,606 and $113,737, respectively.

47

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

The
following table summarizes information related to stock options outstanding and
exercisable at December 31, 2007:

|                        |  |                                  |  |                                           |  |                                |  |                                  |  |                                | 
|----------------------- |  | -------------------------------- |  | ----------------------------------------- |  | ------------------------------ |  | -------------------------------- |  | ------------------------------ | 
|Range ofExercise Prices |  | Number    Outstanding at12/31/06 |  | Weighted-AverageRemainingContractual Life |  | Weighted-AverageExercise Price |  | Number    Exercisable at12/31/06 |  | Weighted-AverageExercise Price | 
|                       
|$0.37 - $0.50           |  | 2,186,125                        |  | 5.9                                       |  | $0.45                          |  | 2,186,125                        |  | $0.45                          | 
|$0.51 - $0.75           |  | 3,806,000                        |  | 7.4                                       |  | $0.63                          |  | 2,122,250                        |  | $0.63                          | 
|$0.80 - $1.20           |  | 1,695,000                        |  | 6.9                                       |  | $0.86                          |  | 1,041,250                        |  | $0.89                          | 
|$1.55 - $1.70           |  | 366,500                          |  | 5.8                                       |  | $1.64                          |  | 366,500                          |  | $1.64                          | 
|$1.71 - $12.50          |  | 169,855                          |  | 1.3                                       |  | $5.83                          |  | 169,855                          |  | $5.83                          | 
|                       
|                        |  | 8,223,480                        |  | 6.7                                       |  |                                |  | 5,885,980                        |  |                                | 

For
the years ended December 31, 2007 and 2006, no income tax benefit was recognized related
to stock option activity.

During
the year ended December 31, 2007 and 2006, stock option compensation expense was recorded
using the fair value method under SFAS 123R as follows:

| |                                         |  |           |  |           | 
| | --------------------------------------- |  | --------- |  | --------- | 
| |                                         |  | 2007      |  | 2006      | 
|
| | Cost of sales                           |  | $  23,825 |  | $  16,030 | 
| | Operating expenses                      |  | 580,767   |  | 165,464   | 
|
| | Total stock option compensation expense |  | $604,592  |  | $181,494  | 

As
of December 31, 2007, there was $1,011,570 of unrecognized compensation cost related to
nonvested service based awards and $423,500 related to nonvested market based awards
granted under the plan. That cost is expected to be recognized over the options
remaining weighted average vesting period of 2.26 years for service based options and 2.00
years for market based options.

Restricted
Common Stock

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

On
May 12, 2006, 175,000 shares of restricted common stock were granted to non-employee
members of the Companys board of directors and will vest three years from the date
of the grant. The fair market value at the date of grant, determined by the quoted market
price, was $145,250 or $0.83 per share. The fair market value of the grant is being
recognized to compensation expense over the three-year service period. For the years ended
December 31, 2007 and 2006, $48,420 and $30,262 respectively was recorded in operating
expenses for these grants.

48

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

Shares
Reserved for Future Issuance

At
December 31, 2007, the Company had reserved the following shares of common stock for
future issuance:

| |                                                  |            | 
| | ------------------------------------------------ | ---------- | 
| | Convertible preferred shares (series A - D)      | 2,280,407  | 
| | Common stock options available for grant         | 3,847,375  | 
| | Common stock options outstanding                 | 8,223,480  | 
| | Common stock warrants outstanding (series G - J) | 8,312,759  | 
| | Restricted common stock available for grant      | 2,325,000  | 
| | Restricted common stock grants                   | 175,000    | 
|
| | Total common stock shares reserved               | 25,164,021 | 

Securities
Registration Obligations

During
the period April, 2005 through November, 2007, the Company privately issued securities in
a total of four syndications. In connection with each such syndication, the Company agreed
with purchasers both to register the securities for public sale and to use its best
efforts to maintain the effectiveness of such registration statements. The Company has
satisfied its obligations to register the securities issued in each of the four
syndications for public sale and has maintained the effectiveness of such registrations
through the date hereof.

The
securities registration provisions applicable to the earlier three syndications do not
specify liquidated damages for failure to maintain the effectiveness of the subject
registrations. The Companys securities registration obligations relative to these
syndications expire on June 14, 2008, October 20, 2009 and November 27, 2009.

The
securities registration provisions applicable to the November, 2007 syndication require
that if the Securities and Exchange Commission suspends the effectiveness of the subject
registration, an event not now anticipated, the Company must pay purchasers one thirtieth
of one percent of the purchase price of the securities for each day the registration is
not effective up to a maximum of ten percent of the purchase price. The Companys
maximum potential liability under the foregoing provision would be $600,000. The
Companys securities registration obligations relative to the November, 2007
syndication expire on January 2, 2011.

12.   Operating Segments

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

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

49

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

Segment
sales, gross profit and other related information for 2007 and 2006 are as follows:

|                             |  |                |   |                                                   |  |             |  |                |   |                  |  
|---------------------------- |  | -------------- | - | ------------------------------------------------- |  | ----------- |  | -------------- | - | ---------------- | -
|Year Ended December 31, 2007
|                            
|                             |  | Wound Care     |   | Wound Closure-Specialty        Securement Devices |  | Skin Care   |  | Other          |   | Total    Company |  
|                            
|Net sales                    |  | $ 30,983,191   |   | $2,260,735                                        |  | $   891,475 |  | -              |   | $ 34,135,401     |  
|                            
|Gross profit                 |  | 10,043,756     |   | 1,318,148                                         |  | 242,511     |  | -              |   | 11,604,415       |  
|Total expenses               |  | -              |   | -                                                 |  | -           |  | $(13,889,020   | ) | (13,889,020      | )
|                            
|Net loss                     |  | $(2,284,605    | )
|                            
|Net long-lived assets        |  | $ 19,345,496   |   | $   146,768                                       |  | $        -  |  | $      478,743 |   | $ 19,971,007     |  
|                            
|Year Ended December 31, 2006
|                            
|                             |  | Wound Care     |   | Wound Closure-Specialty        Securement Devices |  | Skin Care   |  | Other          |   | Total    Company |  
|                            
|Net sales                    |  | $ 24,450,557   |   | $2,308,452                                        |  | $1,128,382  |  | -              |   | $ 27,887,391     |  
|                            
|Gross profit                 |  | 8,377,523      |   | 1,111,452                                         |  | 163,413     |  | -              |   | 9,652,388        |  
|Total expenses               |  | -              |   | -                                                 |  | -           |  | $(8,983,649    | ) | (8,983,649       | )
|                            
|Net income                   |  | $      668,739 |  
|                            
|Net long-lived assets        |  | $   9,341,294  |   | $   163,076                                       |  | $       -   |  | $      268,132 |   | $   9,772,502    |  

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, other identifiable intangible assets and goodwill. The significant increase
in wound care net long-lived assets in 2007 relates to other identifiable intangible
assets and goodwill acquired in connection with the FAD acquisition (see Note 2).
Corporate headquarters and the Companys U.S. distribution center equipment and
improvements are included in the Other column since they service all three operating
segments.

50

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

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

|                      |  |               |  |             |  |            |  |             | 
|--------------------- |  | ------------- |  | ----------- |  | ---------- |  | ----------- | 
|2007                  |  | United States |  | Canada      |  | Other      |  | Total       | 
|                     
|Net sales             |  | $20,119,160   |  | $12,324,111 |  | $1,692,130 |  | $34,135,401 | 
|Gross profit          |  | $7,560,253    |  | $3,451,907  |  | $592,246   |  | $11,604,415 | 
|Net long-lived assets |  | $15,835,701   |  | $3,775,581  |  | $359,725   |  | $19,971,007 | 
|                     
|2006                  | 
|                     
|Net sales             |  | $15,981,237   |  | $10,680,639 |  | $1,225,515 |  | $27,887,391 | 
|Gross profit          |  | $6,047,105    |  | $3,176,353  |  | $428,930   |  | $9,652,388  | 
|Net long-lived assets |  | $5,907,039    |  | $3,461,824  |  | $403,639   |  | $9,772,502  | 

Other
sales and gross profit relate principally to wound closure and specialty securement
devices sales in Europe and are invoiced by the United States operation.

For
the year ended December 31, 2007, the Company has a major U.S. customer comprising 16% of
U.S. sales and 19% of U.S. operations trade accounts receivable at December 31, 2007. The
Companys wholly owned Canadian subsidiary sells to one customer who serves as its
exclusive third party distributor and comprises 100% of Canada operations trade accounts
receivable at December 31, 2007.

13.   Income Taxes

Income
(loss) before income taxes consists of the following components:

| |                                         |      |             |   |           |  
| | --------------------------------------- | ---- | ----------- | - | --------- | -
| |                                         | 2007 | 2006        |  
|
| | Domestic                                |      | $(2,588,667 | ) | $(37,518  | )
| | Foreign                                 |      | 566,096     |   | 824,598   |  
|
| | Total (loss) income before income taxes |      | $(2,022,571 | ) | $ 787,080 |  

51

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

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

| |                                  |      |            |  |            | 
| | -------------------------------- | ---- | ---------- |  | ---------- | 
| |                                  | 2007 | 2006       | 
|
| | Current:                         |      |            |  |            | 
| | Federal                          |      | $        - |  | $    5,000 | 
| | State                            |      | -          | 
| | Foreign                          |      | -          |  | -          | 
|
| | Total current                    |      | -          |  | 5,000      | 
|
| | Deferred:                        |     
| | Federal                          |      | -          |  | -          | 
| | State                            |      | -          |  | -          | 
| | Foreign                          |      | 262,034    |  | 113,341    | 
|
| | Total deferred                   |      | 262,034    |  | 113,341    | 
|
| | Total provision for income taxes |      | $262,034   |  | $118,341   | 

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

| |                                            |              |             |   |             |  
| | ------------------------------------------ | ------------ | ----------- | - | ----------- | -
| |                                            | December 31, |            
| |                                            | 2007         | 2006        |  
|
| | Deferred tax liabilities:                  |              |             |   |             |  
| | Prepaids                                   |              | $   (32,444 | ) | $   (70,518 | )
| | Intangible amortization                    |              | (127,402    | ) | (70,364     | )
| | Deductible acquisition costs               |              | (113,345    | ) | (113,936    | )
| | Depreciation                               |              | (435,394    | ) | (365,368    | )
|
| | Total deferred tax liabilities             |              | (708,585    | ) | (620,186    | )
|
| | Deferred tax assets:                       |             
| | Net operating loss carryforwards  U.S.    |              | 3,900,236   |   | 3,698,253   |  
| | Net operating loss carryforwards  foreign |              | 22,145      |   | 193,614     |  
| | Equity based compensation                  |              | 111,468     |   | 113,064     |  
| | Allowance for sales deductions             |              | 149,063     |   | 153,825     |  
| | Amortization of intangibles                |              | 649,882     |   | 166,466     |  
| | Inventory adjustments                      |              | 197,481     |   | 106,047     |  
| | Other                                      |              | 27,931      |   | 61,933      |  
|
| | Gross deferred tax assets                  |              | 5,058,206   |   | 4,493,202   |  
| | Valuation allowance                        |              | (4,765,541  | ) | (3,986,357  | )
|
| | Total deferred tax assets                  |              | 292,665     |   | 506,845     |  
|
| | Net deferred tax liabilities               |              | $  (415,920 | ) | $  (113,341 | )

The
net deferred tax liability relates to the Companys Canadian operation and consists
of a deferred tax asset  current of $4,139 and a net deferred tax liability long
term of $420,059 as of December 31, 2007. The deferred tax asset  current is
included in prepaid expenses and other current assets in the consolidated balance

52

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

sheet. The remaining valuation
allowance relates to the U.S. The timing in which the Company can utilize its U.S.
federal 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 U.S. net operating loss
carryforwards and net deferred tax assets, a full valuation allowance has been provided
as of December 31, 2007 and 2006.

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

---

| |                                       |      |              |   |           |  
| | ------------------------------------- | ---- | ------------ | - | --------- | -
| |                                       |      | December 31, |  
| |                                       | 2007 | 2006         |  
|
| | Tax expense at federal statutory rate |      | $(687,674    | ) | $ 267,607 |  
| | State tax, net of federal benefit     |      | (110,442     | ) | (16,658   | )
| | Goodwill impairment loss              |      | -            |   | 68,000    |  
| | Nondeductible expenses                |      | 187,713      |   | 12,633    |  
| | Other                                 |      | 93,253       |   | 31,591    |  
|
| | Total                                 |      | (517,150     | ) | 363,173   |  
|
| | Change in valuation allowance         |      | 779,184      |   | (244,832  | )
|
| | Provision for income taxes            |      | $ 262,034    |   | $ 118,341 |  

At
December 31, 2007, the Company has net operating loss carryforwards of approximately
$9,100,000 for federal income tax purposes that begin to expire in years 2017 through
2027. 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 state net operating loss carryforward is approximately $5,300,000 in New
Jersey, the site of the Companys headquarters. New Jersey currently allows the
deduction of net operating losses up to 100% of net income. The state has a seven year
carryforward period but such period is extended where an otherwise deductible net
operating loss was disallowed in full or in part because of previous limitations. The New
Jersey carryforwards begin to expire in years 2008 through 2014.

14.   Retirement Benefits

The
Company maintains a profit sharing/401(k) plan for eligible full-time U.S. employees.
Participants may contribute a fixed percentage 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, 2007 and 2006 were $50,347 and $51,111,
respectively.

The
Companys Canadian subsidiary maintains a group retirement savings plan (Registered
Retirement Savings Plan) for eligible full time Canadian employees. The Canadian
subsidiary makes a matching contribution of 50% of an employees contribution to a
maximum of 3% of annual gross earnings. Employee contribution limits to the group
retirement savings plan are set by the Canada Customs and Revenue Agency. The
Companys Canadian subsidiarys contributions to the plan for the year ended
December 31, 2007 and 2006 were $54,939 and $48,692, respectively.

15.   Commitments

Operating
Leases

The
Company has operating lease agreements for its facilities and equipment expiring in
various years through 2012. Rent expense under non-cancelable operating agreements
amounted to $1,280,654 and $1,067,965 in

53

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Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

2007 and 2006, respectively. The
leases provide for increases in future minimum annual rental payments based on specified
conditions 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 on other properties.

Net
minimum future rental payments under these operating leases as of December 31, 2007 are:

| |                                      |  |             |  
| | ------------------------------------ |  | ----------- | -
| | Minimum Future Rental Payments       | 
| | Year Ending December 31,             |  | Amount      |  
|
| | 2008                                 |  | $ 1,515,498 |  
| | 2009                                 |  | 1,193,103   |  
| | 2010                                 |  | 1,056,180   |  
| | 2011                                 |  | 1,052,210   |  
| | 2012                                 |  | 585,802     |  
| | Thereafter                           |  | -           |  
|
| | Total minimum future rental payments |  | $ 5,402,793 |  
| | Sublease income                      |  | (136,010    | )
|
| | Net minimum future rental payments   |  | $ 5,266,783 |  

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,
2007, $70,987 of deferred rent expense was recorded.

Comvita
Licensing, Manufacturing and Sales Agreement

On
February 13, 2006 the Company entered into an exclusive five year licensing, manufacturing
and sales agreement (the Agreement) with Comvita New Zealand Limited, whereby
the Company will manufacture and sell a line of Manuka Honey based wound care products
developed by Comvita. These products are supported by proprietary intellectual property
that will serve to provide a competitive advantage in the market place. Access to this
technology and these products represents a significant milestone in the Companys
strategy to build a larger presence in the advanced wound care market segment. Under the
Agreement, the Company receives exclusive rights to manufacture and sell its branded
products throughout North and South America within the professional medical-surgical
marketplace (i.e. extended care, acute care, home care, etc). Comvita retains the right to
these products in the consumer marketplace and has the option to purchase its branded
consumer product requirements from the Company at agreed upon pricing.

In
accordance with the Agreement, the Company will purchase its requirements for active honey
from Comvita at agreed upon pricing. As consideration for the grant of the license, the
Company will pay Comvita a royalty based on sales. The Agreement calls for the Company to
spend a minimum of either $200,000 or 8% of sales per year on Advertising and Promotion in
support of these products. Further, the Agreement calls for minimum sales achievement
targets beginning in the second year of the Agreement and each year thereafter to maintain
exclusivity. The agreement commenced upon the receipt of regulatory approval of the first
product which occurred during the fourth quarter of 2007. In 2007 the Company purchased
$109,956 of active honey and incurred $8,472 of royalties under the agreement.

54

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

Quick-Med
Technologies, Inc.  License Agreement

On
March 23, 2007, the Company entered into a patent and technology license agreement (the
Agreement) with Quick-Med Technologies, Inc. (QMT) relating to
QMTs proprietary anti-microbial technology (the Technology). The Company
anticipates utilizing the Technology in a series of wound care products, including
conforming gauze, gauze sponges, gauze bandage rolls, gauze packing strips, oil emulsion
acetate and Unna boot dressings. Initiation of the marketing and sale of products
incorporating the Technology is dependent upon the grant by the FDA of approval for use of
the Technology in primary and secondary wound dressings. The fact and timing of such
approval are uncertain.

The
initial term of the Agreement extends from March 23, 2007 (the Effective Date)
for a period equal to the shorter of five years from the first commercial sale of products
under the Agreement or seven years from the Effective Date. Under the Agreement, QMT
granted to the Company an exclusive, royalty-bearing right and license to make, use and
sell products incorporating the Technology in the United States and Canada (with the
exception of sales to the United States government and agencies thereof in which case the
license will be non-exclusive).

In
consideration for the license to the Technology, the Company paid QMT a license fee in the
amount of $125,000. The total non-refundable license and advance royalty payments of
$125,000 was charged to research and development expense in 2007 in the consolidated
statement of operations. The foregoing advance royalty payments are creditable against
future royalties that become due under the Agreement.

Royalties
are payable upon the Companys net sales of products utilizing the Technology at the
rate of 20% for sales within exclusive territories and 10% for sales within non-exclusive
territories. The Agreement provides for escalating minimum royalty payments for each
contract year. In the event for a given contract year the Company fails to make the
required minimum royalty payments, but makes at least 50% of the required minimum royalty
payments, QMTs exclusive remedy would be the termination of the Companys
exclusive rights to the Technology. In the event for a given contract year the Company
fails to make at least 50% of the required minimum royalty payments, or if the Company
fails to make the required minimum royalty payments for three contract years, QMTs
exclusive remedies would be the termination of the Companys exclusive rights to the
Technology or termination of the Agreement.

USC
License Agreement

On
November 2, 2007, the Company entered into a license agreement (the License
Agreement) with the University of Southern California (USC) pursuant to
which the Company acquired exclusive rights to 49 United States and foreign patents and
non-exclusive rights to one patent, together with trade secrets and know-how, related to
an angiotensin analog (the patents, trade secrets and know-how, collectively, the
Angiotensin Analog Technology). The Angiotensin Analog Technology relates to a
topical application for the treatment of chronic wounds such as diabetic ulcers, leg
ulcers associated with venous insufficiency, pressure ulcers (bed sores), burns and
surgical scars.

The
Company paid to or on behalf of USC an initial license fee of $839,348 during the first
quarter of 2008. The initial license fee was charged to research and development expense
in 2007, in the consolidated statement of operations. Additionally, the Company will pay
USC royalties relative to sales of products employing the Angiotensin Analog Technology at
the rates of 6.5% and 8.5% in respect of revenues less than $100 Million and revenues
equal to or greater than $100 Million, respectively. In addition, the Company will make
milestone payments to USC of up to $9,625,000 predicated upon obtaining approval of the
FDA of various indications for the Angiotensin Analog Products as well as the attainment
of various sales objectives. Further, the Company is obligated to spend at least
$1,250,000 on direct marketing of the initial Angiotensin Analog Product within twelve
months of the FDAs approval thereof.

55

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

The
compound employing the Angiotensin Analog Technology is classified as a drug
the sale of which is conditioned upon FDA approval. The process of obtaining FDA approval
for the compound consists of subjecting the compound to a series of pre-clinical and
clinical studies, these latter known as phase I, phase II and phase III studies.

The
compound has successfully undergone pre-clinical and phase I clinical studies. The phase
II clinical studies commenced in 2008 and are expected to be concluded by the end of 2009.
If the phase II clinical studies are successful, phase III clinical studies are expected
to begin in January, 2010 and, barring unforeseen events, are expected to be completed by
the end of 2012. In the event the phase III clinical studies are successful, evaluation of
the clinical studies by the FDA is expected to be completed by the end of 2013.

The
Companys costs incident to conducting phase II and phase III clinical studies
relative to the compound are expected to aggregate approximately $1.3 Million and $10.0
Million, respectively. The Company is under no obligation to undertake or complete phase
II or phase III studies. Should it elect not to do so, the Company may either sublicense
the Angiotensin Analog Technology to one or more pharmaceutical concerns or release the
Technology to USC. In this latter event, USC would reimburse the Company for certain of
its costs incident to clinical studies that have theretofore been performed.

Canadian
Distribution Agreement

The
Company has a five-year agreement expiring May 1, 2010 with a Canadian company to serve as
the exclusive distributor of its products in Canada. The agreement also appoints the
distributor as the Companys servicing agent to fulfill supply contracts held
directly by the Company. The Company recognizes revenue under the agreement when title and
risk of loss pass to the distributor and collectability is reasonably assured which is at
the time product is shipped to the distributor. Payment terms from the distributor are 30
days. The agreement automatically renews after five-years for consecutive periods of one
year each on the same terms and conditions unless either party gives notice of its intent
not to renew 180 days prior to expiry. Either party has the right to terminate the
agreement when an event of default (as defined) has occurred with respect to the other
party. The distributor is entitled to continue to sell or otherwise dispose of all
inventory owned by it from and after the date of contract expiration or termination. If
termination of the agreement is not occasioned by breach by the distributor, the
distributor will be entitled on notice to the Company to return saleable inventory (as
defined) to the Company. In the event sales returns are expected, they will be reserved
for at the time of sale. Since the inception of the agreement, sales returns have been
minimal.

The
distributor assumes responsibility for customer service, product delivery and maintenance
and warehousing of sufficient inventory to meet agreed upon order fulfillment
requirements. On an ongoing basis, the distributor will place inventory replenishment
orders with the Company at agreed upon prices, 120 days in advance of scheduled delivery.
Unless amended, each order becomes non-cancelable 90 days in advance of scheduled
delivery.

With
respect to sales made by the distributor, the Company will pay the distributor an agreed
upon distribution fee and a specified incentive for growth (as achieved). The Company will
reimburse the distributor for the difference between the price paid by the distributor and
the Companys contract price with the end customer upon submission by the distributor
of an agreed upon rebate report. Further, the agreement requires the distributor to meet
specified minimum regular sales growth targets in the first four years and achieve a
minimum annual private label product purchase target. Failure of the distributor to meet
the annual purchase requirements shall not be considered an event of default. In this
situation, the Company, at its discretion, may cancel the agreement. In the fiscal year of
the agreement ending May 31, 2007 the distributor did not meet its growth targets and no
additional growth incentives were earned. The Company opted not to exercise its option to
cancel the agreement as a result of the distributors failure to meet its growth
targets.

56

---

Financial Index

|DERMA SCIENCES, INC.                      
|------------------------------------------
|Notes To Consolidated Financial Statements

16.   Subsequent Events

Clinical
Services Agreement

In
January 2008, the Company entered into an agreement with a clinical services company to
provide phase II clinical studies for the angiotensin analog technology compound licensed
from USC in November 2007.

Costs
under the agreement include services fees of approximately $23,000 per month from January
2008 to January 2010 and reimbursement of sterile manufacturing, toxicology and
statistician support services estimated in the amount of $470,000. The foregoing costs
represent an estimate of the Companys costs under the agreement; however, actual
costs could exceed these estimates. In addition, the clinical services company is the
recipient of a grant issued by the National Institute of Health and will use the proceeds
of the grant of approximately $1,575,000 to cover certain other clinical testing costs
(including patient care, toxicology studies and certain other costs). The Company is
responsible for these other costs to the extent that they exceed the amount of the grant.
If the amount under the grant is reduced by more than 10%, Derma Sciences may terminate
the agreement. In addition, the agreement may be terminated upon termination of the USC
license agreement.

Amendment
to Bank Covenants

Effective
March 28, 2008, the Companys U.S. lender agreed to waive all prior financial and
reporting covenant defaults and amend the existing minimum EBITDA, fixed charge coverage,
senior debt coverage and total debt coverage covenants, to be measured on a quarterly
basis, to allow the Company to implement its growth strategy. Amendment of the covenants
was predicated upon the Companys commitment to raise a minimum of $3,000,000 by
May 1, 2008 from the sale of equity and agreement to limit its maximum revolver
borrowing to the lesser of (a) the revolver loan commitment ($8,000,000) or (b) the
borrowing base (as defined), less $1,500,000. The $3,000,000 equity infusion will be used
to pay down the existing revolver balance and the funds will be credited as a component of
EBITDA for covenant compliance purposes. The Company incurred fees of $250,000 associated
with the granting of the covenant amendment, together with estimated related expenses of
$40,000.

Sale
of Equity

As
of March 31, 2008, the Company received executed stock purchase agreements (SPAs)
totaling $5,680,000 (net of $420,000 in estimated commission and other offering expenses)
from the private sale of 6,100,000 shares of common stock at a price of $1.00 per share,
together with 3,050,000 five-year warrants to purchase one share of common stock at a
price of $1.20 per share. In addition, the placement agent for the shares sold received
142,500 five-year warrants to purchase one share of common stock at $1.10 per share.  The
Company expects to close on the SPAs and receive the funds on April 2, 2008.  The
proceeds will be used to meet the minimum equity infusion requirements associated with
the Companys amended bank covenants and in support of the Companys strategic
growth initiatives.

57

---

Item 8. Changes In and
Disagreements With Accountants on Accounting and Financial Disclosure

Not
applicable.

Item 8A. Controls and Procedures

The
Companys management, including the Companys Chief Executive Officer and Chief
Financial Officer, is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the Company. Internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States. Management conducted an
assessment of the effectiveness of the Companys internal control over financial
reporting as of December 31, 2007 based on criteria established in Internal
Control  Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.

On
November 8, 2007 the Company completed the acquisition of FAD. Due to the close proximity
of the completion date of the acquisition to the date of managements assessment,
management  has  not  evaluated  the  effectiveness 
of  internal  control  over financial  reporting at FAD. FAD
represents approximately $15,755,000 of consolidated total
assets and $1,824,000 of consolidated net revenue in
the consolidated financial statements as of and for the year ended December 31,
2007.  Accordingly, managements assessment as of December 31, 2007 does not
include the internal control over financial reporting of FAD.

Based
on this assessment, management believes that, as of December 31, 2007, the
Companys internal control over financial reporting was designed and operating
effectively.

This
annual report does not include an audit report of the companys registered public
accounting firm regarding internal control over financial reporting. Managements
report was not subject to audit by the companys registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that permit the
company to provide only managements report in this annual report.

Part III

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

Information
in response to this Item is incorporated herein by reference to our definitive proxy
statement for our 2008 annual meeting of shareholders to be filed with the Securities and
Exchange Commission not later than April 30, 2008.

|Item 10. |  | Executive Compensation
|-------- |  | ----------------------

Information
in response to this Item is incorporated herein by reference to our definitive proxy
statement for our 2008 annual meeting of shareholders to be filed with the Securities and
Exchange Commission not later than April 30, 2008.

|Item 11. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
|-------- |  | ----------------------------------------------------------------------------------------------

Information
in response to this Item is incorporated herein by reference to our definitive proxy
statement for our 2008 annual meeting of shareholders to be filed with the Securities and
Exchange Commission not later than April 30, 2008.

58

---

|Item 12. |  | Certain Relationships and Related Transactions
|-------- |  | ----------------------------------------------

Information
in response to this Item is incorporated herein by reference to our definitive proxy
statement for our 2008 annual meeting of shareholders to be filed with the Securities and
Exchange Commission not later than April 30, 2008.

|Item 13. |  | Exhibits
|-------- |  | --------

(a) Exhibits

|ExhibitNumber |  | 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).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 |  | Amendment to the Articles of Incorporation effective December 28, 2007 (previously filed
as Appendix A to the Companys Proxy Statement filed November 21, 2007 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 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).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.08 |  | 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).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.09 |  | 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).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.10 |  | 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).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.11 |  | 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* |  | 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).
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

59

---

|10.03* |  | 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).
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.04* |  | Employment Agreement, dated March 1, 2005, between the Company and Frederic Eigner
(previously filed as Exhibit 10.42 to the Companys Form 10-KSB filed on March 31,
2005 and incorporated herein by reference).
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.05* |  | Employment Agreement, dated March 1, 2006, between the Company and Barry J. Wolfenson
(previously filed as Exhibit 10.06 to the Companys Form 10-KSB filed on March 30,
2006 and incorporated herein by reference).
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.06 |  | 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).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.07 |  | 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).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.08 |  | The Derma Sciences, Inc. Stock Option Plan, as amended November 29, 2007, filed with this report.
|----- |  | -------------------------------------------------------------------------------------------------

|10.09 |  | 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).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.10 |  | 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).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.11 |  | 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).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.12 |  | 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).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.13 |  | 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).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.14 |  | 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).
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.15 |  | 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).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.16 |  | 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).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.17 |  | 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).
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

60

---

|10.18 |  | 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).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.19 |  | 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).
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.20 |  | Form of Purchase Agreement relative to private placement of common stock and series G
warrants (previously filed as Exhibit 10.40 to the Companys Form 10-KSB filed on
March 31, 2005 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.21 |  | Form of Registration Rights Agreement relative to private placement of common stock and
series G warrants (previously filed as Exhibit 10.41 to the Companys Form 10-KSB
filed on March 31, 2005 and incorporated herein by reference).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.22 |  | Private Placement Memorandum with Amendments relative to the private placement of
securities effected on April 18, 2006 (previously filed as Exhibit 10.01 to the
Companys Form 8-K filed on April 24, 2006 and incorporated herein by reference).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.23 |  | Form of Purchase Agreement relative to the private placement of securities effected on
April 18, 2006 (previously filed as Exhibit 10.02 to the Companys Form 8-K filed on
April 24, 2006 and incorporated herein by reference).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.24 |  | Form of Registration Rights Agreement relative to the private placement of securities
effected on April 18, 2006 (previously filed as Exhibit 10.03 to the Companys Form
8-K filed on April 24, 2006 and incorporated herein by reference).
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.25 |  | Warrant Agreement between the Company and StockTrans, Inc. relative to the private
placement of securities effected on April 18, 2006 (previously filed as Exhibit 10.04 to
the Companys Form 8-K filed on April 24, 2006 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.26 |  | Placement Agreement between the Company and Taglich Brothers, Inc. relative to the private
placement of securities effected on April 18, 2006 (previously filed as Exhibit 10.05 to
the Companys Form 8-K filed on April 24, 2006 and incorporated herein by reference).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.27 |  | Asset Purchase Agreement, dated January 26, 2006, relative to the Companys purchase
on April 18, 2006 of the assets of Western Medical, Inc. (previously filed as Exhibit
10.01 to the Companys Form 8-K filed on April 24, 2006 and incorporated herein by
reference).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.28 |  | Purchase Agreement, dated August 3, 2006, between the Company and Comvita New Zealand
Limited relative to the private sale of securities (previously filed as Exhibit 10.01 to
the Companys Form 8-K filed on August 7, 2006 and incorporated herein by reference).
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.29 |  | Registration Rights Agreement, dated August 3, 2006, between the Company and Comvita New
Zealand Limited relative to the private sale of securities (previously filed as Exhibit
10.03 to the Companys Form 8-K filed on August 7, 2006 and incorporated herein by
reference).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.30 |  | Patent and Technology License Agreement, dated March 23, 2007, between the Company and
Quick-Med Technologies, Inc. (previously filed as Exhibit 10.01 to the Companys Form
8-K filed on March 29, 2007 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.31 |  | Asset Purchase Agreement, dated November 8, 2007, between the Company and NutraMax
Products, Inc. relative to the purchase by the Companys subsidiary, Derma First Aid
Products, Inc, of substantially all of the assets of the First Aid division of NutraMax
(previously filed as Exhibit 2.01 to the Companys Form 8-K filed on November 15,
2007 and amended on January 15, 2008 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

61

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|10.32 |  | Form of Purchase Agreement relative to the private placement of common stock and series H
and I warrants effected on November 8, 2007 (previously filed as Exhibit 10.01 and 10.02
to the Companys Form 8-K filed on November 15, 2007 and incorporated herein by
reference).
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.33 |  | License Agreement, dated November 2, 2007, between the Company and the University of
Southern California (previously filed as Exhibit 10.01 to the Companys Form 8-K
filed on November 8, 2007 and incorporated herein by reference).
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.34 |  | Patent and Technology License Agreement, dated March 23, 2007, between the Company and
Quick-Med Technologies, Inc. (previously filed as Exhibit 10.01 to the Companys Form
8-K filed on March 29, 2007 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.35 |  | Credit and Security Agreement, dated November 8, 2007, between the Company and Merrill
Lynch Capital (previously filed as Exhibit 10.01 to the Companys Form 8-K filed on
November 15, 2007 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.36 |  | Clinical Services Agreement, dated January 22, 2008, between the Company and U.S. Biotest,
Inc. (previously filed as Exhibit 10.01 to the companys Form 8-K filed on January
28, 2008 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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
December 8, 2006 and incorporated herein by reference).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|21 |  | Information
relative to subsidiaries.
|-- |  | -------------------------------------

|23.1 |  | 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.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

_________________

* Management contract or compensatory
plan.

Item 14. Principal
Accountant Fees and Services

Information
in response to this Item is incorporated herein by reference to our definitive proxy
statement for our 2008 annual meeting of shareholders to be filed with the Securities and
Exchange Commission not later than April 30, 2008.

62

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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.

|               | DERMA SCIENCES, INC.                                
|-------------- | ----------------------------------------------------
|               |                                                     
|               |                                                     
|March 31, 2008 | 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 31, 2008.

| | 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            |                                                             
|                           |                                                             
|/s/ Robert G. Moussa       | Director                                                    
|Robert G. Moussa           |                                                             

63

---

EXHIBIT INDEX

|ExhibitNumber |  | 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).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 |  | Amendment to the Articles of Incorporation effective December 28, 2007 (previously filed
as Appendix A to the Companys Proxy Statement filed November 21, 2007 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 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).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.08 |  | 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).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.09 |  | 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).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.10 |  | 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).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.11 |  | 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* |  | 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).
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.03* |  | 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).
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.04* |  | Employment Agreement, dated March 1, 2005, between the Company and Frederic Eigner
(previously filed as Exhibit 10.42 to the Companys Form 10-KSB filed on March 31,
2005 and incorporated herein by reference).
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.05* |  | Employment Agreement, dated March 1, 2006, between the Company and Barry J. Wolfenson
(previously filed as Exhibit 10.06 to the Companys Form 10-KSB filed on March 30,
2006 and incorporated herein by reference).
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.06 |  | 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).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.07 |  | 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).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.08 |  | The Derma Sciences, Inc. Stock Option Plan, as amended November 29, 2007, filed with this report.
|----- |  | -------------------------------------------------------------------------------------------------

|10.09 |  | 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).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.10 |  | 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).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.11 |  | 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).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.12 |  | 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).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.13 |  | 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).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.14 |  | 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).
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.15 |  | 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).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.16 |  | 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).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.17 |  | 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).
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.18 |  | 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).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.19 |  | 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).
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.20 |  | Form of Purchase Agreement relative to private placement of common stock and series G
warrants (previously filed as Exhibit 10.40 to the Companys Form 10-KSB filed on
March 31, 2005 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.21 |  | Form of Registration Rights Agreement relative to private placement of common stock and
series G warrants (previously filed as Exhibit 10.41 to the Companys Form 10-KSB
filed on March 31, 2005 and incorporated herein by reference).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.22 |  | Private Placement Memorandum with Amendments relative to the private placement of
securities effected on April 18, 2006 (previously filed as Exhibit 10.01 to the
Companys Form 8-K filed on April 24, 2006 and incorporated herein by reference).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.23 |  | Form of Purchase Agreement relative to the private placement of securities effected on
April 18, 2006 (previously filed as Exhibit 10.02 to the Companys Form 8-K filed on
April 24, 2006 and incorporated herein by reference).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.24 |  | Form of Registration Rights Agreement relative to the private placement of securities
effected on April 18, 2006 (previously filed as Exhibit 10.03 to the Companys Form
8-K filed on April 24, 2006 and incorporated herein by reference).
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.25 |  | Warrant Agreement between the Company and StockTrans, Inc. relative to the private
placement of securities effected on April 18, 2006 (previously filed as Exhibit 10.04 to
the Companys Form 8-K filed on April 24, 2006 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.26 |  | Placement Agreement between the Company and Taglich Brothers, Inc. relative to the private
placement of securities effected on April 18, 2006 (previously filed as Exhibit 10.05 to
the Companys Form 8-K filed on April 24, 2006 and incorporated herein by reference).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.27 |  | Asset Purchase Agreement, dated January 26, 2006, relative to the Companys purchase
on April 18, 2006 of the assets of Western Medical, Inc. (previously filed as Exhibit
10.01 to the Companys Form 8-K filed on April 24, 2006 and incorporated herein by
reference).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.28 |  | Purchase Agreement, dated August 3, 2006, between the Company and Comvita New Zealand
Limited relative to the private sale of securities (previously filed as Exhibit 10.01 to
the Companys Form 8-K filed on August 7, 2006 and incorporated herein by reference).
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.29 |  | Registration Rights Agreement, dated August 3, 2006, between the Company and Comvita New
Zealand Limited relative to the private sale of securities (previously filed as Exhibit
10.03 to the Companys Form 8-K filed on August 7, 2006 and incorporated herein by
reference).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.30 |  | Patent and Technology License Agreement, dated March 23, 2007, between the Company and
Quick-Med Technologies, Inc. (previously filed as Exhibit 10.01 to the Companys Form
8-K filed on March 29, 2007 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.31 |  | Asset Purchase Agreement, dated November 8, 2007, between the Company and NutraMax
Products, Inc. relative to the purchase by the Companys subsidiary, Derma First Aid
Products, Inc, of substantially all of the assets of the First Aid division of NutraMax
(previously filed as Exhibit 2.01 to the Companys Form 8-K filed on November 15,
2007 and amended on January 15, 2008 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.32 |  | Form of Purchase Agreement relative to the private placement of common stock and series H
and I warrants effected on November 8, 2007 (previously filed as Exhibit 10.01 and 10.02
to the Companys Form 8-K filed on November 15, 2007 and incorporated herein by
reference).
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.33 |  | License Agreement, dated November 2, 2007, between the Company and the University of
Southern California (previously filed as Exhibit 10.01 to the Companys Form 8-K
filed on November 8, 2007 and incorporated herein by reference).
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.34 |  | Patent and Technology License Agreement, dated March 23, 2007, between the Company and
Quick-Med Technologies, Inc. (previously filed as Exhibit 10.01 to the Companys Form
8-K filed on March 29, 2007 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.35 |  | Credit and Security Agreement, dated November 8, 2007, between the Company and Merrill
Lynch Capital (previously filed as Exhibit 10.01 to the Companys Form 8-K filed on
November 15, 2007 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.36 |  | Clinical Services Agreement, dated January 22, 2008, between the Company and U.S. Biotest,
Inc. (previously filed as Exhibit 10.01 to the companys Form 8-K filed on January
28, 2008 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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
December 8, 2006 and incorporated herein by reference).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|21 |  | Information
relative to subsidiaries.
|-- |  | -------------------------------------

|23.1 |  | 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.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

_________________

* Management contract or compensatory
plan.