# 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, 2003      
|------ | -------------------------------------------------------------------------------------------------------------------------------------
|       |                                                                                                                                      
|[    ] | Transition Report under Section 13 or 15(d) of the Securities
     Exchange Act of 1934 for the transition period from _____ to _____

Commission file number: 1-31070

DERMA SCIENCES, INC.(Name of small business issuer in its charter)

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

Registrant's telephone number: (800) 825-4325

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

|Title of each class               | Name of each exchange on which
     registered
|--------------------------------- | ----------------------------------------------
|                                  |                                               
|Common Stock, $.01 par
     value | Boston Stock Exchange                         
|Common Stock, $.01 par value      | Pacific Stock Exchange                        

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

Title of Class

Common Stock, $.01 par value

Check whether the Registrant:
(1) filed all reports required to be filed by Sections 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for
past 90 days.

         YesX
     No

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

Issuer's revenues for its
most recent fiscal year were $17,941,451.

The aggregate market value of
the voting stock held by non-affiliates, computed by reference to the average bid and asked prices of such stock as of February
29, 2004, was approximately $7,874,492.

The number of shares
outstanding of each of the issuer's classes of common equity, as of February 29, 2004, was 9,524,007.

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

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

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

The Companys Markets

Wound Care

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

Wound Closure 
Fasteners

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

1

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

Skin Care

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

The Companys Products

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

Wound Care Product Line

Primary Dressings - Wound CareDermagran® Ointment
     
     Topical ointment with a lanolin odor, packaged in both jars and tubes. Active ingredient:
     aluminum hydroxide gel. Used to manage stage I pressure and venous ulcers, incisions, burns and other skin irritations.Dermagran® Spray
     
     Colorless, odorless liquid, packaged in opaque plastic bottles with pump spray nozzles. Active
     ingredient: zinc acetate. Used to manage stage I pressure and venous ulcers, incisions, burns and other skin irritations.Dermagran® Hydrophilic Wound Dressing
     
     Advanced zinc hydrogel formulation impregnated in gauze pad. Used for the management of stages II
     through IV pressure sores, diabetic ulcers, venous stasis ulcerations, thermal burns, surgical incisions and superficial
     lacerations, cuts or abrasions. Also packaged in tubes and sold as Dermagran®-B Hydrophilic Wound Dressing.Primary Dressings - Hydrocolloid DressingsPrimacol Hydrocolloid Dressing
     
     Sterile, transparent, hydrocolloid dressing packaged in various sizes to accommodate different uses.
     Used to protect the wound from outside contamination such as bacteria, fecal mater, or urine. Available in the following
     configurations: Primacol Bordered Hydrocolloid Dressing, Primacol Thin Hydrocolloid Dressing, Primacol Specialty Hydrocolloid
     Dressing  Sacral and Primacol Specialty Hydrocolloid Dressing  Heel and Elbow.Primary Dressings - Calcium Alginate DressingsAlgicell Calcium Alginate Dressing
     
     Sterile dressing containing alginate ropes. Used for the absorption of moderate to large amounts of
     wound exudate and management of minor bleeding.Primary Dressings - Hydrogel DressingsAquaSite Amorphous Hydrogel Dressing
     
     Clear sterile gel packaged in bellows and tubes. Used for filling wounds, while keeping them moist,
     and absorbing small to moderate amounts of wound exudate.2
AquaSite Impregnated Dressings
     
     Sterile, gauze dressing (either non-woven or sponge) impregnated with absorbent hydrogel. Used for
     packing wounds and treating lightly exudating, partial or full thickness wounds.Primary Dressings - Foam DressingsHydroCell Foam Dressings
     
     Sterile polyurethane foam sheet with protective film. Used to protect the wound from outside
     contaminants. Available in adhesive and non-adhesive forms in the following configurations: HydroCell Adhesive Foam Dressing
     and HydroCell Thin Adhesive Foam Dressing.SorbaCell Foam Dressing
     
     Sterile foam dressing used to absorb exudate while cushioning and protecting
     the wound.Primary Dressings - SilverSilver Dressing
     
     Dressing Sterile, silver plated nylon fabric in a wide range of dressings for wound and
     burn care. Long lasting (up to 7 days) with superior anti-microbial properties.Primary Dressings - Wet DressingsWater and Saline Wet Dressings
     
     Sterile wet dressings create a moist wound environment to enhance natural wound healing and
     facilitate debridement.Primary Dressings - Gauze Dressings and SpongesDuCare® Gauze Dressings/ Sponges  Non-Sterile and Sterile
     
     Woven sponges made from 100% USP cotton. Used for general use or for debriding, covering, and
     packing wounds. Also available as non-woven sponges/dressings (DuSoft Non-Woven Dressings/Sponges  Non-Sterile and
     Sterile) and pre-slit for use with tracheotomies.Packing Strips
     
     Sterile gauze strips used to fill or pack wounds and prevent premature wound closure. Strips are
     also available impregnated with sterile Iodoform.Primary Dressings
 Hypertonic and Odor Eliminator DressingsAbsorb-a-Salt Wet Hypertonic  Dressings
     
     Sterile hypertonic saline in a gauze dressing used for packing infected or draining wounds and odor
     control.Primary Dressings - SpongesDurlix® 100% Cotton 6 Ply Fluff Sponge  Non Sterile and Sterile
     
     Gauze sponges made from 100% cotton. Used for absorbing wound exudate and packing wounds.Secondary Dressings - BandagesConforming Bandages
     
     Stretch gauze bandages used as secondary dressing for wrapping legs and arms and
     to hold dressings in place. Available in the following configurations: Dutex® 100% Cotton 2 Ply Conforming Bandage 
     Non-Sterile and Sterile, Durlex® Bandage Rolls  Non Sterile and Sterile, DuForm® Knitted Synthetic Conforming
     Bandage  Non-Sterile and Sterile, DuForm® Synthetic Conforming Bandage and DuFlex® Woven Synthetic Conforming
     Bandage  Non-Sterile and Sterile.Gazetex® Bandage Rolls  Non Sterile and Sterile
     
     Washed low-linting woven gauze rolls. Used for wrapping or packing large and deep wounds.3
Compression Bandaging Systems
     
     Latex free systems of multiple layers used for graduated compression on venous leg ulcers. The
     Companys bandaging systems are available in the following configurations: DuBoot Two-Layer Paste Compression Bandaging
     System, TresFlex Three-Layer Compression Bandaging System and DuFore Four Layer Compression Bandaging System.UnnaPress® Paste Bandage
     
     Latex free bandage (with or without calamine lotion). Used for maintaining a moist wound
     environment, resisting edema formation, and protecting the wound from external contamination and mechanical disruption during
     the healing process.ElasTive Elastic Adhesive Bandage
     
     Latex free, non-allergenic, adhesive bandage made of 100% cotton.
Used to conform to body contours without restriction.DuSor Elastic Bandage Premium and Economy
     
     Latex free, cotton-wrapped bandage with heat resistant rubber strands. Used for firm compression and
     vascular and muscle support. Available in premium and economy versions as well as with a velcro closure (PrimaCare
     Elastic Bandage with Velcro Closure).Operating Room SpongesLaparotomy Sponges  Non-sterile and Sterile, X-Ray Detectable
     
     Pre-washed or non-washed low lint, X-Ray detectable sponges used to absorb blood and other fluids
     during surgery.Surgical Gauze Packing  Plain and X-Ray Detectable
     
     A 100% USP fine mesh absorbent cotton gauze available as a roll or strip with folded or sewn ends.
     Used for drainage of sinuses or abscesses and for other delicate surgery. Available as sterile dressings as Pak-Its Plain Gauze
     Packing  Sterile, X-Ray Detectable.DuPaque Non-Sterile and Sterile X-Ray Detectable Gauze Sponges
     
     Opaque sponge made of 100% USP fine mesh absorbent cotton with folded edges. Used to absorb blood
     and other fluids during surgery. Includes an X-Ray Detectable mono-filament thread.Secondary Dressings - Abdominal PadsDuPad® Sealed-End Abdominal Pads  Non-Sterile and Sterile
     
     Sealed-end, absorbent secondary dressing used to absorb and disperse wound exudate.Secondary Dressings - Burn DressingsDuPress Sterile Burn Dressing
     
     Gauze dressing filled with cellulose. Used to absorb large amounts of fluids and minimize trauma and
     adherence to the wound.Secondary Dressings - Wound Cleansing ProductsSterile Water or Saline
     
     Sterile water or saline packaged in plastic squirt bottles for use in wound cleansing.OtherEnteral Feeding Systems
     
     Enteral feeding systems distributed by Dumex Canada and sold exclusively in Canada. Used to
     administer nutrients to patients unable to feed themselves through normal means.4
Wound Closure Fastener Product Line

Suture Strip and Strip Plus®
     
     Latex-free, flexible, moisture resistant wound closure strips made of a macroporous non-woven
     polyamide and adhesive. Used in surgical and wound closure procedures.NG Strip® Nasal Tube Fastener
     
     Latex-free, flexible, moisture resistant securement device made of a macroporous non-woven polyamide
     with adhesive. Used with any nasogastric or nasal feeding tube. Available in adult, pediatric and infant sizes.UC Strip® Catheter Tubing Fastener
     
     Latex-free, flexible, moisture resistant, one-piece catheter/tubing fastener made of a macroporous
     non-woven polyamide with adhesive. Used to secure urinary and gastrostomy catheter tubing to the patient.Cath-Strip® Recloseable Catheter Fastener
     
     Latex-free, flexible, moisture resistant multi-use recloseable catheter fastener with adhesive. Used
     with urinary catheters, gastrostomy and jejunostomy tubes, wound drainage systems, central line catheters, and multi-port IVs.Percu-Stay®
     
     Sterile, self-adhesive catheter fastener used to secure percutaneous drainage catheters. Adhesion to
     patient skin is provided by a combination moisture absorbent hydrocolloid surrounded by a breathable non-woven backing.Epi-Stay®
     
     Sterile, self-adhesive catheter fastener specially designed to secure epidural and other long
     dwelling catheters. A distinctive foam support component prevents the catheter from kinking. A transparent window made of
     polyurethane film dressing maintains visualization of the exit site and catheter position. Specially designed to minimize the
     unintended and accidental removal of the catheter.Skin Care Product Line


Skin Care and Personal Hygiene ProductsSoft Wash Bathing Sponge
     
     Latex-free, no rinse, single use bath sponge impregnated with a gentle soap and moisturizers.Optima Bath Additive
     
     Bath additive or after-bath moisturizer enhanced with acetylated lanolin alcohol. Used to lubricate
     and soften the skin.Hydro-soft Skin Conditioner
     
     Concentrated blend of skin emollients and gentle skin cleansers for moisturizing and conditioning
     the skin. Used in whirlpool and hydrotherapy units.Hair and Skin Cleansers and Washes
     
     The Company has various hair and skin cleansers/washes: Swash Conditioning Shampoo and Body Wash,
     Therabath Hair and Skin Cleanser, Hospi Bath Hair and Skin Cleanser, Bathe Away® Hair and Skin Cleanser and ApriVera®
     Hair and Skin Cleanser with AloeVera.Skin Conditioners and MoisturizersSkin Care Lotion
     
     Lotion to moisturize and soften the skin.Incontinence ProductsIn-Between® Perineal Spray Skin Cleanser
     
     An odor eliminating skin cleanser used to cleanse the entire perineal skin area.5
Dermagran® GP General Skin Protectant Ointment
     
     An ointment containing allantoin and aloe vera gel. Used as a moisture barrier on external skin
     areas where repeated exposure to body excrements and exudates may cause skin break down. May be used as skin barrier on
     friction points.Dermagran® BC Perineal Protectant Ointment
     
     An ointment consisting of a non-greasy formulation based upon the Company's proprietary
     Zinc-Nutrient and balanced pH technology. Used as a protectant against minor skin irritations due to moisture, urine, feces and
     perspiration.Skin ProtectantsDermagran® AF Antifungal Ointment
     
     An ointment containing miconazole nitrate and the Companys Zinc-Nutrient and balanced pH
     technology. Used for maintaining healthy skin and providing a long-acting barrier against moisture. Miconazole nitrate is used
     to treat jock itch, ringworm and athletes foot.ClearCell Transparent Film Dressing
     
     Non-sterile adhesive transparent film dressing used for protecting intact skin from friction, shear
     and breakdown from incontinence and drainage.Sanitizing ProductsMysotrol® No rinse Hand Sanitizer
     
     Waterless, no rinse hand sanitizer containing ethyl alcohol. Provides germicidal and virucidal
     action and meets OSHA protocol for a healthcare personnel handwash while reducing the risk of nosocomial infections.Antibacterial Soap
     
     An antibacterial soap containing chloroxylenol used to reduce nosocomial infections including both
     gram-positive and gram-negative organisms as well as yeast and fungus in institutional environments.Bacti-Guard Antibacterial Hand Soap
     
     An antibacterial hand soap containing triclosan, aloe vera and glycerin. Used to reduce nosocomial
     infections including both gram-positive and gram-negative organisms, as well as yeast and fungus in institutional environments.Whirlpool/Hard Surface Detergent/Disinfectant
     
     A detergent used specifically for cleaning hard surfaces and whirlpool units in
     nursing homes, hospitals and other institutions. Also effective as a bactericide, mildewstat, sanitizer, virucide and fungicide
     in the presence of organic soil (5% blood serum).


Distribution and Sales

United States

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

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

Canada

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

6

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

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

Other Foreign Markets

The
Companys products are sold throughout the rest of the world through various
licensing and distribution agreements. Foreign sales are made principally to Europe and
Latin America. Sales made to other foreign markets totaled approximately $773,146 in 2003
and $675,544 in 2002.

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

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

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

Product Sourcing

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

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

The
Nantong facility is ISO 9002 certified. The Toronto facility is ISO 9001 2000/ISO 13485/EN
46001 certified. Action has been initiated to prepare the Companys St. Louis
facility for ISO certification in 2005. The Company requires that all of its suppliers
conform to the standards set forth in the Good Manufacturing Practice (GMP)
regulations promulgated by the United States FDA and local health agencies.

Patents, Proprietary and
Non-Proprietary Technology

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

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

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

The
Company has submitted patent applications relative to: the suspension of particles in a
cosmetic composition, the dispensing of gauze packing and a vitamin formulation for
chronic wounds.

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

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

Patent
law relating to the scope of claims with respect to wound care pharmaceutical products is
still evolving and the Companys patent rights are subject to uncertainty.
Furthermore, the existence of patent rights does not provide absolute assurance against
infringement of these rights. The prosecution and defense of patent claims is both costly
and time consuming, regardless of the outcome.

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

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Government Regulation

United States 
Scope of Regulation

The
manufacture, distribution and advertising of the Company and its products are subject to
regulation by numerous federal and state governmental agencies in the United States. The
United States Food and Drug Administration (FDA) is responsible for
enforcement of the Federal Food, Drug and Cosmetic Act, as amended, (FDC Act)
which regulates drugs and devices manufactured and distributed in interstate commerce.
Many of the Companys products are classified either as over-the-counter drugs or
medical devices pursuant to the FDC Act. The Federal Trade Commission (FTC)
administers the Federal Trade Commission Act (FTC Act) which regulates the
advertising of products including over-the-counter drugs and devices. All states have
individual laws that resemble the FDC Act and the FTC Act.

Medical
Devices

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

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

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

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

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

All
manufacturers are required to give the FDA ninety days notice before they can introduce a
device on the market. During the ninety-day period, the FDA will determine whether the
device is or is not substantially equivalent to a Pre-amendment Device. If the FDA
determines that the device is not substantially equivalent to a Pre-amendment Device, it
is automatically placed in Class III and the manufacturer will have to provide the FDA
with a Premarket Approval Application (PMA) containing evidence that the
device is safe and effective before the device may be commercially distributed to the
public. However, the manufacturer may request that the FDA reclassify the device by filing
a reclassification petition. All of the devices currently marketed by the Company, with
the exceptions of Sterile Water and Sterile Saline, have been found by the FDA to be
substantially equivalent to a Pre-amendment Device and are, therefore, classified in Class
I. Sterile Water and Sterile Saline are classified in Class II.

9

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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.
Those of the Companys products which are classified as over-the-counter drugs
pursuant to the FDC Act are: Dermagran Spray, Dermagran Ointment, Mysotrol, Antibacterial
Soap, Dermagran AF, Dermagran BC and Dermagran GP.

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

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

Dermagran
Spray, Dermagran Ointment, Dermagran AF, Dermagran BC and Dermagran GP are currently being
marketed as over-the-counter skin protectant drug products. Skin protectant products are
the subject of an ongoing FDA rule making procedure which has resulted in the issuance of
a final monograph specifying those active ingredients which are permitted in, and defining
labeling requirements for, such products. The FDA has released its final monograph for
skin protectant drug products for OTC human use to be effective June 4, 2004.

Dermagran
Spray and Dermagran Ointment have been formulated and labeled in accordance with the
proposals outlined in the Preliminary Monograph. It is the Companys intention to
manufacture Dermagran Spray and Dermagran Ointment pursuant to the FDAs Final
Monograph relative to skin protectants and to make whatever formulation and
labeling changes are necessary to fully comply with the final regulation.

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.

10

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

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

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. Dumex Canada underwent an inspection by Health
Products and Food Branch Inspectorate on October 24, 2001 which successfully resulted in
the issuance of the Drug Establishment License.

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

Registration and Status
of Dumex Products Sold in United States

All
products manufactured at Dumex Canada are Class I devices with the exception of Sterile
Water and Sterile Saline which are classified as Class II devices. Dumex Canada also
manufactures over-the-counter drugs such as skin care products, wound cleanser and
UnnaPress Paste Bandages.

Dumex
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.

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Third Party Reimbursement

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

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

Medicaid
reimbursement of the Companys products is dependent upon Company paid rebates to
state Medicaid agencies. Effective January 1, 1991, the Omnibus Budget Reconciliation Act
of 1990 requires pharmaceutical companies, as a condition of the eligibility of its
products for Medicaid reimbursement, to enter into a rebate agreement with the federal
government. Only drugs of the pharmaceutical companies having such rebate agreements are
covered by state Medicaid programs. Pharmaceutical companies participating in the Medicaid
rebate program must remit to state Medicaid agencies a formula-based rebate which varies
from quarter to quarter in accordance with the Companys quarterly net sales and the
average manufacturer price of the individual products. In 2003, Medicaid sales were 3% of
total Company sales and 23% of sales for products subject to Medicaid rebates. Medicaid
rebates represent approximately 1% of net sales.

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

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

Federal
and state governments, as well as private insurers, will continue their pursuit of
programs designed to control or reduce the cost of health care. These cost cutting
measures may include reductions in reimbursements and/or increases in mandatory rebates
for wound care products. As such, there is uncertainty as to whether, and to what extent,
reimbursements for the Companys products will continue to be available. Likewise,
there is uncertainty as to the future extent of the Companys rebate obligations.

Product Development

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

Employees

The
Company maintained 130 full-time and 7 part-time employees at December 31, 2003. Of these
employees, 41 are located in the United States, 62 in Canada and 34 in China. The Company
considers its employee relations to be satisfactory.

12

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Item 2. Description of
Property

The
Companys executive offices are located in Princeton, New Jersey. The Company has a
lease for its executive office space, at a rate of $10,246 per month, that expires in
August, 2007. The Company has a month-to-month lease for 8,200 square feet of warehouse
space in Old Forge, Pennsylvania at a rate of $1,925 per month. The Company has a three
year lease for 24,000 square feet of office, light manufacturing and warehouse space in
St. Louis, Missouri expiring in January 2007 at a rate of $7,440 per month and a
month-to-month lease for 2,000 additional adjacent square feet of warehouse space in St.
Louis at a rate of $1,000 per month. In March 2004, the Company will commence leasing a
42,400 square foot warehouse in Fenton, Missouri at a rate of $11,951 per month that
expires in October 2008. This facility will serve as the major United States distribution
center for the Companys products, while the St Louis, Missouri facility will be used
primarily for light manufacturing.

Dumex
Canada operates from a 51,700 square foot leased manufacturing facility, at a rate of
$16,900 per month, that expires in August, 2007 and a 20,400 square foot distribution
facility, at a rate of $6,900 per month, that expires in August, 2004 both located in
Toronto, Canada. A subsidiary of Dumex Canada also leases a 11,400 square foot
manufacturing facility in Nantong, China at a rate of $1,030 per month that expires in
June, 2008. Dumex Canadas facilities are adequate to meet its manufacturing and
distribution requirements.

Item 3. Legal Proceedings

The
Company is not a party to any material litigation.

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

The Company
did not submit any matter to a vote of shareholders during the fourth quarter, 2003.

13

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Part II

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

The
Common Stock of the Company is traded on the OTC Bulletin Board under the symbol
DSCI.OB. The Common Stock is also traded on the Boston and Pacific Stock
Exchanges under the symbol DMS. The Companys Common Stock commenced
trading on May 13, 1994. The following table sets forth the high and low bid prices for
the Companys Common Stock:

| | Quarter Ended      |  | High  |  | Low  
| | ------------------ |  | ----- |  | -----
| | 2002               |  |       |  |      
| | March 31, 2002     |  | $0.80 |  | $0.53
| | June 30, 2002      |  | $0.72 |  | $0.35
| | September 30, 2002 |  | $0.85 |  | $0.35
| | December 31, 2002  |  | $0.85 |  | $0.35
| | 2003               |  |       |  |      
| | March 31, 2003     |  | $0.60 |  | $0.35
| | June 30, 2003      |  | $2.10 |  | $0.36
| | September 30, 2003 |  | $2.30 |  | $0.75
| | December 31, 2003  |  | $1.45 |  | $0.90

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 27, 2004, there
were 1,199 holders of record of the Common Stock. The Company has paid no cash dividends
in respect of its Common Stock and does not intend to pay cash dividends in the near
future.

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

Reference to Consolidated
Financial Statements

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

Results of Operations

The 2003 operating results
include the financial results of Dumex Medical Canada Inc. for all of 2003 and for 2002 from the August 26, 2002 acquisition date.
Unless otherwise indicated by the context, the term Dumex is used throughout this discussion in reference to the operations of
Dumex Medical Canada Inc. and the term Derma is used throughout this discussion in reference to the operations of the Company
excluding Dumex.

The
following table highlights the 2003 and 2002 operating results.

| |                             |  |                        |            |      |  |          |            |  |  |   |           |   |  |      |  
| | --------------------------- |  | ---------------------- | ---------- | ---- |  | -------- | ---------- |  |  | - | --------- | - |  | ---- | -
| |                             |  | Year Ended December 31 |            |      |  |          |            |  | 
| |                             |  | 2003                   |            | 2002 |  | Variance |            |  |  |   |           |  
| |                             |  |                        |            |      |  |          |            |  |  |   |           |   |  |      |  
| | Net sales                   |  | $                      | 17,941,451 |      |  | $        | 11,749,472 |  |  | $ | 6,191,979 |   |  | 53%  |  
| | Gross profit                |  |                        | 6,137,549  |      |  |          | 5,260,202  |  |  |   | 877,347   |   |  | 17%  |  
| | Operating expenses          |  |                        | 6,059,516  |      |  |          | 4,891,019  |  |  |   | 1,168,497 |   |  | 24%  |  
| | Interest expense, net       |  |                        | 263,253    |      |  |          | 239,079    |  |  |   | 24,174    |   |  | 10%  |  
| | Other (income) expense, net |  |                        | (207,461   | )    |  |          | 68,736     |  |  |   | 276,197   |   |  | --   |  
| | Total expenses              |  |                        | 6,115,308  |      |  |          | 5,198,834  |  |  |   | 916,474   |   |  | 18%  |  
| | Income before income taxes  |  |                        | 22,241     |      |  |          | 61,368     |  |  |   | (39,127   | ) |  | (64% | )
| | Provision for income taxes  |  |                        | --         |      |  |          | --         |  |  |   | --        |   |  | --   |  
| |                             |  |                        |            |      |  |          |            |  |  |   |           |  
| | Net income                  |  | $                      | 22,241     |      |  | $        | 61,368     |  |  | $ | (39,127   | ) |  | (64% | )
| |                             |  |                        |            |      |  |          |            |  |  |   |           |  

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Net sales
increased $6,191,979, or 53%, to $17,941,451 in 2003 from $11,749,472 in 2002. The
increase is due to the inclusion of the Dumex business in the Companys operating
results for the entire 2003 year versus the August 26, 2002 acquisition date in 2002. The
Derma product line sales declined 6% in 2003 compared with 2002. Derma wound care sales
increased 4% in 2003, primarily as a result of an aggressive sales and marketing effort at
the end of 2003 to sell, at a discount, selected Derma wound care products. The sales of
Derma wound closure fasteners and skin care businesses declined 5% and 20%, respectively,
primarily due to competitive pressures across these product lines, along with the
Companys decision to focus a significant portion of its sales and marketing
resources on expanding the U.S. Dumex business.

Dumex
2003 hospital sales grew in line with expectations on a local currency basis and benefited
from a stronger Canadian dollar and two major contracts that provided significant volumes
albeit at approximately 20% lower pricing than 2002 due to the competitive nature of basic
wound care products in Canada. Private label sales declined significantly in 2003 due to
the loss of several customers and are expected to remain at minimal levels in 2004.

Gross
profit increased $877,347, or 17%, in 2003 to $6,137,549 from $5,260,202 in 2002 due
principally to the inclusion of the incremental Dumex sales. Overall, gross profit
percentages have decreased to 34% from 45% in 2002. This decrease is attributable to the
increasingly higher percentage of lower margin Dumex sales as a percentage of total sales
coupled with pricing and product cost pressures in certain segments of the business.
Overall, Dumex margins improved approximately 1.5% in 2003 versus 2002. Dumex margins in
2003 were negatively impacted by higher China sourced raw material cotton and freight
costs, competitive sales pricing and lower fixed overhead absorption as a result of
outsourcing products to China versus in-house manufacture. These negative gross profit
impacts were offset by the strengthening of the Canadian dollar versus the U.S. dollar
resulting in significant cost savings on U.S. dollar denominated inventory purchases.

With
respect to the Derma product lines, 2003 versus 2002 gross profit percentages declined 2%
in the wound care line due to pricing pressures, were flat in the wound closure fasteners
business and declined 8% in the skin care line. The skin care line margins declined due to
the adverse impact of lower sales volumes on operational efficiency and fixed overhead
absorption.

Operating
expenses increased $1,168,497, or 24%, to $6,059,516 in 2003 from $4,891,019 in 2002. The
increase is attributable to the inclusion of Dumex operating expenses for all of 2003
versus the August 26, 2002 acquisition date in 2002. Derma total operating expenses were
flat in 2003 compared to 2002. Derma warehouse expenses increased 30% in 2003 which was
primarily attributable to additional resources required to distribute the Dumex product
line to U.S. customers commencing July 1, 2003. Derma 2003 versus 2002 marketing expenses
decreased by 52% as a result of lower printing, promotion and consulting activities, while
management devoted additional resources to the reorganization, expansion and upgrade of
the sales force. Derma 2003 versus 2002 sales expenses increased 3%. Excluding a 2002
severance expense relating to a former sales executive, sales expenses increased 20% in
2003. Derma 2003 versus 2002 general and administrative expenses increased 2% as a result
of higher employee compensation, accounting, insurance and public relations fees,
partially offset by integration savings in the regulatory area, along with lower bad debt,
bank charge and depreciation expenses.

Dumex
2003 operating expenses met expectations on a local currency basis but were adversely
impacted by the strengthening Canadian dollar versus the U.S. dollar. The Canadian dollar
appreciated approximately 11% versus the U.S. dollar when comparing the 12 month 2003
versus the last four months of 2002 Canadian dollar versus U.S. dollar average exchange
rate. In 2003, Dumex realized approximately $100,000 in warehouse and customer service
costs savings resulting from the mid-year closure of the Atlanta distribution center and
the transfer of Dumexs U.S. customer service functions to the Companys St.
Louis facility. These 2003 versus 2002 cost savings were offset by increased resources
devoted to the sales function to more aggressively promote the Dumex product line in
Canada, and increased utility, travel, insurance and accounting costs.

Interest
expense, net increased $24,174 to $263,253 in 2003 versus $239,079 in 2002. The increase
in 2003 is primarily due to the inclusion of Dumex interest expense for the entire year
2003 of $104,959 and the write off of deferred financing costs related to the February 28,
2003 termination of the Companys former U.S. line of credit in the amount of
$66,342, partially offset by the decrease attributable to the non-recurrence of an imputed
non-cash interest charge of $135,200 associated with the conversion of the Companys
series C and D bonds and accrued interest outstanding in January 2002.

15

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Other
income, net increased $276,197 in 2003 to $207,461 of income from $68,736 of expense in
2002. The following table highlights the major other (income) expense items for the years
ended December 31, 2003 and 2002:

| |                                                         |  |           |   |  |         | 
| | ------------------------------------------------------- |  | --------- | - |  | ------- | 
| |                                                         |  | 2003      |   |  | 2002    | 
| |                                                         |  |           |   |  |         | 
| | Gain on sale and/or conversion of slow moving inventory |  | $(202,087 | ) |  | -       | 
| | Settlement of payroll tax liability                     |  | (88,712   | ) |  | -       | 
| | Other                                                   |  | 83,338    |   |  | 68,736  | 
| |                                                         |  |           |   | 
| | Total                                                   |  | $(207,461 | ) |  | $68,736 | 
| |                                                         |  |           |   | 

The Company did not record
any tax expense in 2003 or 2002 as net operating loss carryforwards have been available to offset taxable income. At December 31,
2003 the Company has net operating loss carryforwards of approximately $6,750,000 for federal and state income tax purposes. The
federal net operating loss carryforwards begin to expire in 2012-2020 and the state net operating loss carryforwards begin to
expire in 2004-2010. The Company also has foreign net operating loss carryforwards of $157,000 that begin to expire in 2009.

The
Company generated net income of $22,241, or $0.00 per share (basic) and $0.00 per share
(diluted), in 2003 compared to net income of $61,368, or $0.02 per share (basic) and $0.01
share (diluted), in 2002.

Liquidity and Capital
Resources

In
June 2003, the Company closed a private offering of 4,000,000 shares of its common stock
at a price of $0.50 per share. Offering proceeds were used to fund strategic initiatives
and for general working capital purposes. From January 2002 through December 31, 2003,
4,000,000 shares of common stock were issued pursuant to the offering and offering
proceeds of $1,879,810, net of $120,190 in offering expenses, were received of which
$1,126,490 was received in 2003.

As
of November 23, 1999 the Company entered into a 4 year agreement to serve as the exclusive
distributor in the United States for certain catheter fasteners. The manufacturer of the
fasteners has given the Company the required nine months notice of its intention not to
renew the agreement in its present form. Accordingly, the Companys rights under the
current agreement will terminate on August 23, 2004. The parties are presently engaged in
negotiations with a view to executing a new agreement. However, no assurance can be given
that these negotiations will prove successful. Annual sales of catheter fasteners under
the current agreement aggregate approximately $750,000.

At
December 31, 2003 and December 31, 2002, the Company had cash and cash equivalents of
$439,837 and $1,496,357, respectively. The $1,056,520 decrease in cash primarily arose
from the investment of $915,305 in operating activities, principally related to
receivables arising from a year-end sales increase and an increase in inventory to take
advantage of anticipated market opportunities, together with investing activities of
$200,325 consisting of the purchase of product rights in the amount of $114,691 and
capital expenditures of $85,634. Funds provided by financing activities were $77,780
principally relating to proceeds from issuance of stock, net of offering costs, of
$1,126,490, an increase in the Canadian line of credit of $176,523, partially offset by
debt repayments of $195,810, payoff of the U.S. line of credit of $1,000,000 and deferred
financing costs of $29,423. Working capital increased $1,481,967 to $4,836,968 at December
31, 2003 due principally to increases in accounts receivable arising from strong December
2003 sales and an increase in inventory to support anticipated 2004 business
opportunities.

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The
Company renewed its revolving credit facility agreement to fund Dumexs day-to-day
operations on December 31, 2003. Maximum potential advances under the agreement at
December 31, 2003 were $1,429,000. Advances outstanding against the credit facility were
$1,361,708 at December 31, 2003, leaving an additional $67,292 available for borrowing.

The
Company has a line of credit agreement with a U.S. lender for a maximum principal amount
of $3,000,000. No funds have been drawn against the line to date. Estimated maximum
potential advances under the line at December 31, 2003 were $1,630,000. Advances will be
utilized to fund strategic initiatives and for general working capital purposes.

On
January 9, 2004, the Company purchased certain wound care assets and product rights from
the Kimberly-Clark Corporation for total consideration of approximately $2.0 million. The
consideration consisted of cash of $434,000 and a seller financed, non interest bearing
promissory note due on or before December 31, 2004 of $1,566,000. The cash outlay consists
of $300,100 paid at closing and $133,900 for estimated acquisition related costs to be
paid as incurred. The equipment purchased will be transferred and installed in the
Companys manufacturing facility in Toronto, Canada in the second quarter 2004.
Estimated costs, the majority of which will be capitalized, to complete the transfer,
installation and validation of the equipment are $300,000.

In
accordance with the purchase agreement, the Company began to record sales effective
January 1, 2004. Kimberly-Clark will manufacture wound care products, for the account of
the Company, at its facility through March 31, 2004 to meet current customer demand and to
build sufficient inventory to cover the period during which production at the
Kimberly-Clark facility is discontinued and the equipment is transferred to the
Companys facility in Toronto, Canada. Upon cessation of manufacturing at
Kimberly-Clarks facility, the Company will purchase, in accordance with a
pre-determined formula, inventory consisting of raw materials and a three to four months
supply of finished goods. The price of this inventory is estimated to be $750,000.

In
January and February, 2004, the Company entered into capital and operating lease
obligations totaling $296,200 for distribution equipment for the Companys Fenton,
Missouri distribution facility, expected to come on-line in March 2004, and upgrades to
Company-wide telephone and information technology equipment.

On
January 30, 2004 the Company entered into a new one year line of credit agreement with its
U.S. lender. The maximum principal amount of the line increased to $4,000,000 from
$3,000,000. Estimated maximum potential advances under the agreement are equal to the
lesser of (A) $4,000,000 or (B) the sum of (i) 80% of eligible receivables (as defined),
(ii) 50% of eligible inventory (as defined), (iii) an amount equal to the immediate
liquidation value of funds deposited with the U.S. lender in a restricted account as
security for any letters of credit extended by the lender on the Companys behalf up
to $1,000,000, less the aggregate of any outstanding letters of credit issued by the
lender. All other terms and conditions of the agreement remained unchanged. In connection
with entering into the new line of credit agreement, the Company deposited $1,000,000 of
cash in a restricted account with the U.S. lender and the lender issued an irrevocable
standby letter of credit on the Companys behalf for the benefit of Kimberly-Clark
Corporation in the amount of $1,566,000.

Estimated
maximum potential advances under the new line of credit agreement on the date of signing
were $1,130,000. No funds have been drawn against the line to date. Advances will be
utilized for general working capital purposes. The restricted cash of $1,000,000 together
with available cash on hand or available line borrowing capacity will be utilized to pay
the $1,566,000 Kimberly-Clark promissory note due December 31, 2004.

On
February 25, 2004, the Company closed a private offering of 2,057,145 shares of its common
stock at a price of $1.05 per share. Offering proceeds will be used to fund strategic
initiatives and for general working capital purposes. Offering proceeds of $1,975,000, net
of estimated offering expenses of $185,000, have been received.

On
March 9, 2004 the Company terminated the employment of William M. Goodwin, its Executive
Vice President and President of its Dumex Medical Canada Inc. subsidiary. Mr.
Goodwins duties will be assumed by the Company President and Chief Executive
Officer, Edward J. Quilty. The Company does not expect that the departure of Mr. Goodwin
will have an adverse effect upon its operations or those of its Dumex Medical Canada
subsidiary. The Company anticipates taking a charge of approximately $250,000 in the first
quarter, 2004 relative to severance and other costs related to Mr. Goodwins
termination.

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Prospectively,
the Company seeks to increase sales and profits by, among other initiatives, integration
of the Kimberly-Clark Corporation wound care assets into the Companys operations,
increased private label activity with certain major distributors, increased in-house
manufacturing of selected products currently purchased from outside manufacturers,
increased Dumex product line sales in the U.S. and organic growth of its core product
lines in the U.S. and Canada. In 2004, the Company anticipates higher costs arising from
the larger, stand-alone Fenton, Missouri distribution center facility, additional
resources devoted to sales and marketing to enable the Company to more aggressively
promote its products, integration costs related to the Kimberly-Clark Corporation wound
care assets acquisition and higher expenses related to upgrading the Companys
information technology computer systems and network. The Company will increase inventory
levels, as necessary, during the first quarter 2004 in order to support anticipated 2004
business opportunities.

During
the remainder of 2004, an additional $200,000 to $300,000 is expected to be incurred to
upgrade the Companys manufacturing capability.

Among the potential sources
of capital the Company expects to utilize to finance its growth plans are anticipated improved profitability, prudent utilization
of available lines of credit, leasing arrangements and the proceeds of its most recently completed common stock private offering.
Strategically, the Companys plan is to stay focused on its base business while considering external opportunities to
leverage its core capabilities for growth. The Company believes that its available funds from operations, the U.S. and Canadian
lines of credit and the capital raised from the private offerings in 2003 and the first quarter of 2004 will be sufficient to meet
the Company's capital requirements for the foreseeable future.

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

Additional Financial
Information

Forward Looking Statements

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

Critical Accounting
Policies

Estimates
and assumptions are required in the determination of sales deductions for trade rebates,
discounts and allowances. Significant estimates and assumptions are also required in
determining the appropriateness of amortization periods for identifiable intangible
assets, the potential impairment of goodwill and the valuation of inventory. Some of these
judgments can be subjective and complex, and, consequently, actual results may differ from
these estimates. For any individual estimate or assumption made by us, there may also be
other reasonable estimates or assumptions. We believe, however, that given current facts
and circumstances, it is unlikely that applying any such other reasonable judgment would
cause a material adverse effect on our consolidated results of operations, financial
position or cash flows for the periods represented in this section. Our 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. When we recognize
revenue from the sale of our products, we simultaneously adjust revenue for estimated
trade rebates. A trade rebate represents the difference between our 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 our wholesale and indirect customers and other
competitive factors. If the assumptions we used to calculate these rebates do not
appropriately reflect future activity, our financial position, results of operations and
cash flows could be impacted. We continually monitor the factors that influence these
rebates and make adjustments as necessary.

18

---

Goodwill

At
December 31, 2003, the Companys skin care segment had $1,110,967 of goodwill. The
Company tests goodwill for impairment in the fourth quarter of each year or when
impairment indicators are present. The process of evaluating the potential impairment of
goodwill is highly subjective and requires significant judgments and assumptions in
estimating future cash flows to determine the fair value of the reporting unit. These
assumptions include future growth rates, discount factors, future tax rates and other
factors. The Companys cash flow forecasts are based on assumptions that are
consistent with the plans and estimates used to manage the underlying business. In
addition, the Company makes certain judgments about allocating shared assets to the
balance sheet for this segment. If the expected cash flows are not realized, impairment
losses may be recorded in the future.

Inventory

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

Item 7. Consolidated
Financial Statements

Index

|                                                     |     
|---------------------------------------------------- | ----
|Description                                          | Page
|                                                     |     
|Report of Independent Auditors                       | 20  
|                                                     |     
|Consolidated Balance Sheets                          | 21  
|                                                     |     
|Consolidated Statements of Operations                | 22  
|                                                     |     
|Consolidated Statements of Cash
     Flows           | 23  
|                                                     |     
|Consolidated Statements of Shareholders'
     Equity | 24  
|                                                     |     
|Notes to Consolidated Financial
     Statements      | 25  
|                                                     |     

19

---

Financial Index

Report of Independent
Auditors

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

We
have audited the accompanying consolidated balance sheets of Derma Sciences, Inc. as of
December 31, 2003 and 2002, and the related consolidated statements of operations, cash
flows and shareholders equity for each of the two years in the period ended December
31, 2003. 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 auditing standards generally accepted in the
United States. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In
our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Derma Sciences, Inc. at December 31, 2003
and 2002, and the consolidated results of its operations and its cash flows for each of
the two years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States.

| | /s/  ERNST & YOUNG LLP
| | ----------------------

Philadelphia, Pennsylvania
February 20, 2004,except for Note 21, as to which thedate is March 9, 2004

20

---

Financial Index

DERMA SCIENCES, INC.Consolidated Balance Sheets

`===================================================================================================
                                                                               December 31,
ASSETS                                                                    2003             2002
---------------------------------------------------------------------------------------------------

Current Assets
  Cash and cash equivalents                                          $    439,837     $  1,496,357
  Accounts receivable, net                                              2,627,092        1,975,993
  Inventories                                                           4,003,258        2,875,755
  Prepaid expenses and other current assets                               351,962          281,066
---------------------------------------------------------------------------------------------------
Total current assets                                                    7,422,149        6,629,171
Property and equipment, net                                             1,077,688          987,891
Goodwill                                                                1,110,967        1,110,967
Patents and trademarks, net                                               123,671          140,378
Other assets, net                                                         191,698          220,177
---------------------------------------------------------------------------------------------------
Total Assets                                                         $  9,926,173     $  9,088,584
---------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
---------------------------------------------------------------------------------------------------
Current Liabilities
  Line of credit                                                     $  1,361,708     $  1,962,627
  Current maturities of long-term debt                                    178,720          173,493
  Accounts payable                                                        731,438          692,259
  Accrued expenses and other current liabilities                          313,315          445,791
---------------------------------------------------------------------------------------------------
Total current liabilities                                               2,585,181        3,274,170
---------------------------------------------------------------------------------------------------
Long-term debt                                                            849,981          845,455
---------------------------------------------------------------------------------------------------
Total Liabilities                                                       3,435,162        4,119,625
---------------------------------------------------------------------------------------------------
Shareholders' Equity
Common stock, $.01 par value, 30,000,000 shares authorized;
  issued and outstanding: 7,462,695 shares in 2003; 4,631,276 shares
  in 2002                                                                  74,627           46,313
Convertible preferred stock, $.01 par value; 11,750,000 shares
  authorized; issued and outstanding: 2,284,574 shares in 2003;
  2,526,242 shares in 2002 (liquidation preference of $4,235,233
  at December 31, 2003)                                                    22,846           25,262
Additional paid-in capital                                             16,746,690       15,588,698
Accumulated other comprehensive income (loss)                             294,185          (21,736)
Accumulated deficit                                                   (10,647,337)     (10,669,578)
---------------------------------------------------------------------------------------------------
Total Shareholders' Equity                                              6,491,011        4,968,959
---------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity                           $  9,926,173     $  9,088,584
===================================================================================================`

See accompanying notes.

21

---

Financial Index

DERMA SCIENCES, INC.Consolidated Statements of Operations

`===================================================================================================
                                                                     Year ended December 31
                                                                     2003            2002
---------------------------------------------------------------------------------------------------

Net Sales                                                            $ 17,941,451     $ 11,749,472

Cost of sales                                                          11,803,902        6,489,270
---------------------------------------------------------------------------------------------------
Gross Profit                                                            6,137,549        5,260,202
---------------------------------------------------------------------------------------------------
Operating expenses                                                      6,059,516        4,891,019
Interest expense, net                                                     263,253          239,079
Other (income) expense, net                                              (207,461)          68,736
---------------------------------------------------------------------------------------------------
Total Expenses                                                          6,115,308        5,198,834
---------------------------------------------------------------------------------------------------
Income before provision for income taxes                                   22,241           61,368
Provision for income taxes                                                  -                -
---------------------------------------------------------------------------------------------------
Net Income                                                           $     22,241     $     61,368
---------------------------------------------------------------------------------------------------
Income per common share - basic                                      $       0.00     $       0.02
---------------------------------------------------------------------------------------------------
Income per common share - diluted                                    $       0.00     $       0.01
---------------------------------------------------------------------------------------------------
Shares used in computing income per common share - basic                6,108,290        3,740,307
---------------------------------------------------------------------------------------------------
Shares used in computing income per common share - diluted             10,795,026        6,886,113
===================================================================================================`

See accompanying notes.

22

---

Financial Index

DERMA SCIENCES, INC.Consolidated Statements of Cash Flows

`===================================================================================================
                                                                          Year Ended December 31
                                                                          2003              2002
----------------------------------------------------------------------------------------------------
Operating Activities
  Net income                                                          $    22,241     $     61,368
  Adjustments to reconcile net income to net cash (used in)
  provided by operating activities:
    Depreciation                                                          156,771           97,081
    Amortization                                                           88,232           72,248
    Deferred financing costs                                               66,342          120,200
    Provision for bad debts and rebates                                   111,785           25,248
    Provision for inventory obsolescence                                   50,453           55,297
    Loss on disposal of property and equipment                              2,132            -
    Employee stock option expense                                          57,400            -
    Changes in operating assets and liabilities:
       Accounts receivable                                               (507,346)         164,379
       Inventories                                                       (732,986)         566,788
       Prepaid expenses and other current assets                          (46,784)        (122,579)
       Other assets                                                         1,529          (32,905)
       Accounts payable                                                    (7,308)        (287,135)
       Accrued expenses and other current liabilities                    (177,766)         116,829
---------------------------------------------------------------------------------------------------
Net cash (used in) provided by operating activities                      (915,305)         836,819
---------------------------------------------------------------------------------------------------
Investing Activities
  Purchase of product rights                                             (114,691)           -
  Purchases of property and equipment                                     (85,634)         (84,746)
  Acquisition of business assets, net of cash acquired                      -           (1,047,762)
---------------------------------------------------------------------------------------------------
Net cash used in investing activities                                    (200,325)      (1,132,508)
---------------------------------------------------------------------------------------------------
Financing Activities
  Net change in bank line of credit                                      (823,477)         662,950
  Deferred financing costs                                                (29,423)         (97,797)
  Long-term debt repayments                                              (195,810)         (51,445)
  Proceeds from issuance of stock, net of offering costs                1,126,490          753,320
---------------------------------------------------------------------------------------------------
Net cash provided by financing activities                                  77,780        1,267,028
---------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash                                   (18,670)             235
---------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents                   (1,056,520)         971,574

Cash and cash equivalents
  Beginning of year                                                     1,496,357          524,783
---------------------------------------------------------------------------------------------------
  End of year                                                        $    439,837     $  1,496,357
---------------------------------------------------------------------------------------------------

Supplemental cash flow information
  Bond conversion reset provision charged to paid-in capital                -              $45,000
  Conversion of bonds payable and accrued interest to preferred stock       -             $595,200
  Common stock and warrants issued for debt conversion/extension            -             $120,200
  Stock options granted in connection with acquisition                      -             $115,000
===================================================================================================`

See accompanying notes.

23

---

Financial Index

DERMA SCIENCES,
INC.Consolidated Statements of Shareholders'
Equity

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

Balance, December 31, 2001      2,407,109   1,960,009    $24,071     $19,600    $13,987,882          -      $(10,730,946)   $3,300,607
-----------------------------------------------------------------------------------------------------------------------------------------

Net income                           -           -          -           -              -             -            61,368        61,368
Foreign currency translation
  adjustment                         -           -          -           -              -          (21,736)          -          (21,736)
                                                                                                                               --------
Comprehensive income - total         -           -          -           -              -             -              -           39,632
Issuance of common stock in
  private placement, net of
  offering costs of $46,680     1,600,000        -        16,000        -           737,320          -              -          753,320
Conversion of convertible bonds      -      1,190,400       -         11,904        748,496          -              -          760,400
Conversion of preferred shares    624,167    (624,167)     6,242      (6,242)          -             -              -             -
Stock options granted in
  connection with acquisition
  and related financing              -           -          -           -           115,000          -              -          115,000
-----------------------------------------------------------------------------------------------------------------------------------------

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

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

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


See accompanying notes.

24

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

1.     Organization and
Summary of Significant Accounting Policies

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

Summary
of Significant Accounting Policies:

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

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

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

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

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

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.

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

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

Patents
and Trademarks  Patents and trademarks are stated on the basis of cost and are
amortized over 12 to 17 years on a straight-line basis.

25

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

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

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 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.

Cash
Flow Information  Interest paid during 2003 and 2002 amounted to $170,233 and
$88,567, respectively.

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

Pro
forma information regarding net income (loss) and earnings (loss) per share is required by
SFAS No. 123, which also requires that the information be determined as if the Company has
accounted for its stock options granted under the fair value method of that Statement. The
fair value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 2003 and 2002:
risk-free interest rate of 4.0%, dividend yield of 0%; a volatility factor of the expected
market price of the Companys Common Stock of 1.663 and 0.753, respectively; and an
expected option life of 5 years.

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

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

26

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

| |                                          |  |      |          |   |      |   |          |  
| | ---------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
| |                                          |  | 2003 |          |   | 2002
| |                                          |  |      |          |   |      |   |          |  
| | Net income - as reported                 |  | $    | 22,241   |   |      | $ | 61,368   |  
| | APB 25 compensation expense              |  |      | 57,400   |   |      |   | -        |  
| | Pro forma compensation expense           |  |      | (646,007 | ) |      |   | (199,380 | )
| |                                          |  |      |          |  
| | Pro forma net loss                       |  | $    | (566,366 | ) |      | $ | (138,012 | )
| |                                          |  |      |          |  
| | Income (loss) per common share - basic   |  |      |          |   |      |   |          |  
| | As reported                              |  |      | $0.00    |   |      |   | $0.02    |  
| | Pro forma                                |  |      | $(0.09   | ) |      |   | $(0.04   | )
| |                                          |  |      |          |   |      |   |          |  
| | Income (loss) per common share - diluted |  |      |          |   |      |   |          |  
| | As reported                              |  |      | $0.00    |   |      |   | $0.01    |  
| | Pro forma                                |  |      | $(0.09   | ) |      |   | $(0.04   | )

The
weighted average fair value per share of options granted during 2003 and 2002 was $0.96
and $0.39, respectively.

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

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

Advertising
and Promotion Costs  Advertising and promotion costs are expensed in the year
incurred and were $234,919 and $260,631 in 2003 and 2002, respectively.

Net
Income per Share  Net income per common share  basic is computed by dividing
net income by the weighted average number of common shares outstanding for the period. Net
income per common share  diluted reflects the potential dilution of earnings by
including other common stock equivalents, including stock options, warrants, convertible
preferred stock and convertible bonds in the weighted average number of common shares
outstanding for a period, if dilutive.

Reclassifications
 Certain reclassifications have been made to prior year amounts reported to conform
with the 2003 presentation.

2.     Dumex Medical Inc.
Acquisition

On
August 26, 2002, the Company acquired substantially all 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 the Companys wholly owned Canadian
subsidiary, Dumex Medical Canada Inc. The results of operations of Dumex Medical Canada
Inc. have been included in the Companys consolidated financial statements since the
acquisition date.

The
acquisition was accounted for as a purchase and the acquisition cost of $3,976,425 was
allocated to assets and liabilities based upon estimates of their fair values. Assets
acquired totaled $3,976,425 and liabilities were $2,888,882. Cash payments of $1,060,543
and stock options valued at $27,000 were also issued as part of the purchase
consideration. The following table summarizes the estimated fair values of the assets and
liabilities at the date of acquisition:

27

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

`Assets Acquired
                                        ---------------

     Cash                                      $     12,781
     Receivables                                  1,268,983
     Inventory                                    1,732,853
     Property and equipment                         842,296
     Other assets                                   119,512

       Total assets acquired                                         $3,976,425



                                      Consideration Paid
                                      ------------------

     Senior debt                                 $2,397,893
     Other liabilities                              490,989

       Total liabilities and debt                                    $2,888,882

     Cash payments                                                    1,060,543
     Stock options granted                                               27,000

       Total consideration paid                                      $3,976,425`

The
unaudited pro forma information below presents results of operations as if the acquisition
had occurred on January 1, 2002. The pro forma information is based on historical results
and is not necessarily indicative of the operations of the combined entity had the
acquisition occurred on January 1, 2002, nor is it necessarily indicative of future
results.

`Year Ended December 31, 2002
                                                   ----------------------------

    Net sales                                                $17,480,000

    Net loss                                                 $(1,100,000)

    Loss per common share - basic and diluted                   $(0.29)`

The Dumex Medical Inc.
operating results included in the foregoing condensed operating results for the year ended December 31, 2002 have been translated
at the average exchange rate of 1.5706 Canadian dollars to 1 U.S. dollar.

28

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

3.     Accounts Receivable

Accounts
receivable include the following:

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----

    Trade accounts receivable                        $2,802,985      $1,943,674
    Less:  Allowance for doubtful accounts              (35,785)        (40,000)
           Allowance for trade rebates                 (212,000)        (96,000)
                                                      ----------      ----------
         Net trade receivables                        2,555,200       1,807,674
    Other receivables                                    71,892         168,319
                                                      ----------      ----------

         Total receivables                           $2,627,092      $1,975,993
                                                      ==========      ==========`

The
allowance for trade rebates reflects estimated rebates embedded in outstanding trade
receivables. Other receivables at December 31, 2003 include $34,709 related to the sale of
the Dumex Medical Canada Inc. narcotics product line that was sold in December 2003. Other
receivables at December 31, 2002 include $133,065 related to a contract settlement fee
recorded in connection with the Dumex Medical Inc. acquisition that was received in
January 2003.

4.     Inventories

Inventories
include the following:

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----

        Finished goods                               $2,814,651      $2,111,546
        Work in process                                 172,536          91,788
        Packaging materials                             307,635         287,903
        Raw materials                                   708,436         384,518
                                                      ----------      ----------

             Total inventory                         $4,003,258      $2,875,755
                                                      ==========      ==========`

5.     Property and Equipment

Property and equipment
include the following:

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----

        Machinery and equipment                      $1,277,352      $1,043,383
        Furniture and fixtures                          183,967         165,858
        Leasehold improvements                           49,541          40,714
                                                      ----------      ----------
             Gross property and equipment             1,510,860       1,249,955
        Less:  accumulated depreciation                (433,172)       (262,064)
                                                      ----------      ----------

             Net property and equipment              $1,077,688      $  987,891
                                                      ==========      ==========`

29

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Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

6.     Patents and Trademarks

Patents
and trademarks include the following:

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----

        Patents and trademarks                       $  444,067      $  444,067
        Less:    accumulated amortization              (320,396)       (303,689)
                                                      ----------      ----------

                 Patents and trademarks, net         $ 123,671       $  140,378
                                                      ==========      ==========`

At
December 31,2003, the expected amortization of patents and trademarks is $16,707 per year
in 2004 through 2008. The weighted average remaining useful life of these intangibles is
7.4 years.

7.     Other Assets

Other assets include the
following:

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----

        Deferred financing costs, net                $   77,415      $  162,314
        Deposits                                         69,834          57,863
        Other                                            44,449            -
                                                      ----------      ----------

             Total other assets                      $  191,698      $  220,177
                                                      ==========      ==========`

8.     Short-Term Borrowings

Short-term
borrowings include the following:

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----

        U.S. line of credit                                -         $1,000,000
        Canadian line of credit                      $1,361,708         962,627
                                                      ----------      ----------

             Total short-term borrowings             $1,361,708      $1,962,627
                                                      ==========      ==========`

U.S.
Line of Credit

In
March, 2003 the Company entered into a one year line of credit agreement (subject to
annual renewal) with a U.S. lender (the Agreement) for a maximum principal
amount of $2,000,000. On December 24, 2003, the Company entered into a new one year line
of credit agreement with its U.S. lender for a maximum principal amount of $3,000,000. No
funds have been drawn against the line to date. Advances will be utilized to fund
strategic initiatives and for general working capital purposes. The Company terminated its
prior U.S. line of credit on February 28, 2003 by repaying the $1,000,000 outstanding
indebtedness and paying a $50,000 early termination fee. In addition, the Company charged
$66,342 to interest expense for deferred financing costs associated with the prior U.S.
line of credit.

The
Company may request advances under the Agreement up to the value of 80% of eligible U.S.
receivables (as defined) and 50% of eligible U.S. inventory (as defined), excluding
work-in-process inventory. Interest on outstanding advances is payable monthly in arrears
at the one month LIBOR rate (as published in The Wall Street Journal), plus
3.0%, or 4.1% on December 31, 2003. In addition, the Company will pay an annual line fee
of $30,000. This line fee and any one-time lender or legal costs associated with securing
the line of credit will be deferred and amortized to interest expense over the line term
of one year.

30

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

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

Canadian
Line of Credit

On December 30, 2003, the
Company renewed its revolving credit facility agreement (the Dumex Agreement) for a maximum principal amount of
$1,700,000 with a Canadian bank. The renewed credit facility expires on December 31, 2004. The Companys wholly owned
Canadian subsidiary, Dumex Medical Canada Inc., may request advances under the Dumex Agreement up to the value of seventy-five
percent (75%) of its eligible receivables (as defined) and fifty percent (50%) of eligible inventory (as defined) up to a maximum
of $730,000. Interest on outstanding advances is payable monthly at the prime rate (as defined) plus 1.0%, or 5.5% for advances
outstanding at December 31, 2003. Outstanding advances are secured by all tangible and intangible assets of Dumex Medical Canada
Inc. In addition, the Canadian bank has a second lien security interest in the assets of the Companys U.S. operations. The
Company has also guaranteed payment of amounts due under the Dumex Agreement.

Over
the term of the Dumex Agreement, the Company has agreed to comply with a number of
financial covenants governing minimum working capital, current ratios, tangible net worth,
interest coverage, total indebtedness to tangible net worth and total indebtedness to
adjusted pre-tax earnings. These covenants are measured at the end of each month.
Additional covenants governing permitted indebtedness, liens, payments of dividends and
protection of collateral are included in the Dumex Agreement. In the event of a margin
deficiency (as defined) or covenant violation, the Company is required to advance up to an
additional $385,000 of working capital to Dumex Medical Canada Inc. in order to correct
the deficiency. This additional working capital may be repaid to the Company 45 days after
the margin deficiency or covenant violation has been cured upon the condition that such
repayment not result in a margin deficiency, covenant violation or any other event of
default.

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

9.     Convertible Bonds

Effective
January 7, 2002, bondholders of all the Companys issued and outstanding series C and
D convertible bonds converted the entirety of the $475,000 principal and $120,200 accrued
interest into units at a rate of one unit for each $0.50 of principal and interest
converted. Each unit consists of one share of series C or series D preferred stock and one
and one tenth warrants to purchase one share of common stock at a per share exercise price
of $0.57 (Series F Warrants). Each share of preferred stock is convertible
into common stock on a one-for-one basis. Principal and accrued interest under the bonds
totaling $595,200 were converted into 1,190,400 shares of convertible preferred stock and
1,309,441 series F warrants.

In
connection with the conversion, the Company recognized an imputed non-cash interest charge
of $165,200. A charge of $45,000 was taken to account for the value of the reset
concession granted to the bondholders. This charge was amortized over the eighteen-month
term of a reset concession. A charge of $120,200 was taken immediately in 2002 to account
for the conversion terms associated with the accrued interest.

31

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Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

10.   Accrued Expenses and
Other Current Liabilities

Accrued
expenses and other current liabilities include the following:

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----

     Accrued compensation and related taxes          $  105,783      $  233,093
     Accrued sales, goods and services taxes            154,974          59,217
     Other                                               52,558         153,481
                                                      ----------      ----------

       Total accrued expenses and other current
         liabilities                                 $  313,315      $  445,791
                                                      ==========      ==========`

11.   Long-Term Debt

Long-term debt includes the
following:

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----

     Canadian term loan                              $1,025,839      $  987,576
     Capital lease obligations                            2,862          31,372
                                                      ----------      ----------

          Total debt                                  1,028,701       1,018,948
     Less:  current maturities                          178,720         173,493
                                                      ----------      ----------

          Long-term debt                             $  849,981      $  845,455
                                                      ==========      ==========`

In
connection with the acquisition of substantially all the assets of Dumex Medical Inc., the
Company entered into a five-year term loan agreement with a Canadian Bank. The loan is
repayable in monthly payments consisting of principal and interest. Interest on the
outstanding principal balance is payable monthly at the banks prime rate (as
defined) plus 1.25%, or 5.75% at December 31, 2003. The term loan is secured by all
tangible and intangible assets of Dumex Medical Canada Inc. and subject to the same
financial covenants applicable to the operating line of credit (See Note 8).

The
Company has commitments under a capital lease for certain manufacturing equipment.
Payments consisting of principal and accrued interest at an annual rate of 10.75% are made
monthly. The lease expires in August 2004.

The
following are the term loan and capital lease maturities for the next 4 years:

`Term Loan            Capital Lease           Total
                      ---------            -------------           -----

     2004            $  175,858                $2,862           $  178,720
     2005               188,199                  -                 188,199
     2006               212,881                  -                 212,881
     2007               448,901                  -                 448,901
                      ---------                 -----            ---------

                     $1,025,839                $2,862           $1,028,701
                      =========                 =====            =========`

32

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

During the period January 1,
2004 through February 20, 2004, the Company entered into two capital leases with total lease commitments of $215,600. The Company
entered into a 36 month computer equipment and a 60 month distribution center related equipment lease with lease commitments of
$50,600 and $165,000, respectively. The Company also entered into two operating leases with total lease commitments of $80,600 for
telephone system, computer networking and office equipment.

12.   Shareholders
Equity

Preferred
Stock

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

There
are 444,170 shares of series B convertible preferred stock outstanding. The series B
preferred stock is convertible into common stock on a one-for-one basis, bears no
dividend, maintains a liquidation preference of $6.00 per share, votes as a class on
matters affecting the series B preferred stock and maintains voting rights identical to
the common stock on all other matters.

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

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

Stock
Purchase Warrants

At
December 31, 2003, the Company had warrants outstanding to purchase the Companys
common stock as outlined below:

`Series       Number of Warrants      Exercise Price    Expiration Date
    ------       ------------------      --------------    ---------------

      E                1,870,007              $0.85        July 18, 2005
      F                1,309,441              $0.57        January 6, 2007`

The
Companys 666,673 series B warrants with an exercise price of $6.75 per share expired
on June 15, 2002. In connection with the conversion of the Company series C and D
convertible bonds on January 2, 2002, 1,309,441 series F warrants were issued. In July
2003 there was a cashless exercise of 330,002 series E warrants into 189,751 shares of
common stock.

Other
Equity Transactions

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

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

33

---

In
May 2002, a total of 624,167 shares of series A, B and C preferred stock were converted
into 624,167 shares of common stock.

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

Shares
Reserved for Future Issuance

At
December 31, 2003, the Company has reserved the following shares of common stock for
future issuance:

`Convertible preferred shares (series A - D)           2,284,574
    Common stock options outstanding                      3,676,155
    Common stock options available for grant                604,500
    Common stock warrants (series E - F)                  3,179,448
                                                          ---------

    Total common stock shares reserved                    9,744,677
                                                          =========`

13.   Operating Segments

The
Company consists of three operating segments: wound care, wound closure-fasteners and skin
care. Products in the wound care segment consist of basic and advanced dressings,
ointments and sprays designed to treat wounds. Wound closure-fasteners products include
wound closure strips, nasal tube fasteners, a variety of catheter fasteners and net
dressings. The skin care segment consists of bath sponges, antibacterial skin cleansers,
hair and body soaps, lotions and moisturizers designed to enable customers to implement
and maintain successful skin care / hygiene programs. Dumex Medical Canada Inc.s
operating results have been included in the wound care segment for all of 2003 and in 2002
since the acquisition date of August 26, 2002.

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

Segment sales and gross
profit for 2003 and 2002 are as follows:

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

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

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

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

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

Net long-lived assets    $   992,628            -         $1,328,507    $     26,123   $ 2,347,258
                          ==========                       =========     ============   ===========`

34

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

`Year Ended December 31, 2002
                                        ----------------------------

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

Net sales                $  6,007,456      $3,157,218     $2,584,798           -       $11,749,472
                          ----------        ---------      ---------     -----------    -----------

Gross profit                2,815,534       1,579,807        864,861           -         5,260,202
Total expenses                   -               -              -       $(5,198,834)    (5,198,834)
                                                                                        -----------

Net income                                                                             $    61,368
                                                                                        ===========

Net long-lived assets    $    946,321            -         $1,250,536   $    42,379    $ 2,239,236
                          ==========                       =========     ============   ===========`

Long-lived
assets consist of property and equipment, patents and trademarks and goodwill. Wound care
long-lived assets consist principally of Dumex Medical Canada Inc. property and equipment
and patents and trademarks. Wound closure and fastener products are for the most part
outsourced and accordingly are not supported internally by long-lived assets. Skin care
long-lived assets consist of goodwill associated with the acquisition of Sunshine
Products, Inc. and property and equipment associated therewith.

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

`United States      Canada        Other        Total
                         -------------      ------        -----        -----
2003
----

Net sales                  $9,163,379     $8,004,926    $773,146    $17,941,451
                            ---------      ---------     -------     ----------
Gross profit               $4,340,601     $1,526,348    $270,600    $ 6,137,549
                            ---------      ---------     -------     ----------
Net long-lived assets      $1,531,415     $  757,321    $ 58,522    $ 2,347,258
                            ---------      ---------     -------     ----------

2002
----

Net sales                  $8,799,412     $2,274,516    $675,544    $11,749,472
                            ---------      ---------     -------     ----------
Gross profit               $4,615,202     $  410,000    $235,000    $ 5,260,202
                            ---------      ---------     -------     ----------
Net long-lived assets      $1,439,254     $  757,159    $ 42,823    $ 2,239,236
                            ---------      ---------     -------     ----------`

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

14.   Income Taxes

Income
before income taxes consists of the following components:

`2003            2002
                                                        ----            ----
    Domestic                                         $ (3,620)      $ 243,582
    Foreign                                            25,861        (182,214)
                                                       -------       ---------

    Total income before income taxes                 $ 22,241       $  61,368
                                                       =======       =========`

35

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

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

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----
    Deferred tax liabilities:
       Prepaid insurance                             $  (12,326)     $  (10,531)
       Patent amortization                              (44,755)        (51,537)
       Deferred financing costs                          (5,267)        (26,930)
                                                      ----------      ----------
         Total deferred tax liabilities                 (62,348)        (88,998)
    Deferred tax assets:
       Net operating loss carryforwards - U.S.        2,741,346       2,849,013
       Net operating loss foreign                        53,296          61,953
       Depreciation                                      60,418          80,481
       Amortization of intangibles                       85,881          94,759
       Accrued expenses                                 159,007         148,931
       Allowance for doubtful accounts                   12,178          16,237
       Other                                             23,301          16,814
                                                      ----------      ----------
         Gross deferred tax assets                    3,135,427       3,268,188
       Valuation allowance                           (3,073,079)     (3,179,190)
                                                      ----------      ----------
         Total deferred tax assets                       62,348          88,998
                                                      ----------      ----------

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

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

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

`December 31,
                                                       ----------------------
                                                        2003            2002
                                                        ----            ----

    Tax expense at U.S. statutory rates              $    7,562      $   21,596
    Differential in foreign taxes                        (8,793)         61,953
    Use of net operating loss carryforwards             (67,529)        (93,715)
    Nondeductible expenses                               68,760          10,166
                                                      ----------      ----------

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

At December 31, 2003, the
Company has net operating loss carryforwards of approximately $6,750,000 for federal income tax purposes that begin to expire in
years 2012 through 2020. For state income tax purposes, the Company has net operating loss carryforwards of approximately
$6,750,000 that expire in years 2004 through 2010. As of December 31, 2003, the Company has foreign net operating loss
carryforwards of approximately $157,000 which begin to expire in 2009. The timing in which the Company can utilize its net
operating loss carryforwards in any year or in total may be limited under the Internal Revenue Code section 382 regarding changes
in ownership of corporations.

15.   Operating Leases

The
Company has operating lease agreements for its facilities and equipment expiring in
various years through 2009. Expense under these agreements amounted to $636,298 and
$399,941 in 2003 and 2002, respectively. Minimum future rental payments under
non-cancelable operating leases as of December 31, 2003 are:

36

---

Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

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

            2004                                   $  623,949
            2005                                      633,593
            2006                                      672,313
            2007                                      496,730
            2008                                      278,066
            Thereafter                                 45,118
                                                    ---------

         Total minimum future rental payments      $2,749,769
                                                    =========`

16.   Stock Options

The
Company has a stock option plan under which options to purchase a maximum of 1,300,000
shares of common stock may be issued. The plan permits the granting of both incentive
stock options and nonqualified stock options to employees and directors of the Company and
certain outside consultants and advisors to the Company. The option exercise price may not
be less than the fair market value of the stock on the date of the grant of the option.
The duration of each option may not exceed 10 years from the date of grant. Options under
the plan to purchase 671,000 shares of common stock were granted to officers, directors,
agents and employees in 2003 with exercise prices ranging from $0.90 to $1.70 per share.
As of December 31, 2003, options to purchase 695,500 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). Non-plan
options to purchase 221,740 and 1,698,000 shares of common stock were granted to officers,
directors, agents and employees in 2003 and 2002, respectively, with exercise prices
ranging from $0.37 to $1.70 per share. All non-plan options were granted at the fair
market value at the date of grant. As of December 31, 2003, non-plan options to purchase
2,980,655 shares of the Companys common stock were issued and outstanding.

A
summary of the Companys stock option activity and related information for the years
ended December 31, 2003 and 2002 follows:

`2003                               2002

                                                   Weighted                       Weighted
                                                   Average                        Average
                                     Options    Exercise Price      Options    Exercise Price
                                     -------    --------------      -------    --------------

Outstanding - beginning of year    2,787,915        $1.11         1,273,435        $1.97
  Granted                            946,000        $1.01         1,698,000        $0.55
  Forfeited                          (57,760)       $0.57          (183,520)       $2.06
                                   ----------                     ----------

Outstanding - end of year          3,676,155        $1.09         2,787,915        $1.11
                                   =========                      =========

Exercisable at end of year         2,501,705        $1.22         1,352,415        $1.71
                                   =========         ====         =========         ====`

Exercise
prices for options outstanding December 31, 2003 ranged from $0.37 to $12.50. The weighted
average remaining contractual life of options outstanding at December 31, 2003 was 7.6
years.

37

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Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

---

17.   Related Party
Transactions

The
Company has a consulting agreement with its founder, former president and former director.
In 2003 and 2002 compensation and reimbursed expenses under this agreement were $34,167
and $56,742, respectively.

The
Company purchases marketing services from a firm owned by the son of a director. Total
expenses for services rendered in 2003 and 2002 were $16,832 and $54,371, respectively.

A
director of the Company is a general partner in the firm that owned $475,000 of
convertible bonds which were converted into common stock in January 2002. This firm also
holds a significant equity ownership in the Company.

18.   Retirement Benefits

The
Company maintains a profit sharing/401(k) plan for eligible full-time U.S. employees.
Participants may contribute up to 12% of their salary to the plan, subject to IRS
limitations. The Company makes a matching contribution of 50% on the first 6% of each
participants annual earnings contributed to the plan. Company contributions to the
plan for the years ended December 31, 2003 and 2002 were $31,437 and $35,723,
respectively.

19.   Distribution Agreement

As
of November 23, 1999 the Company entered into a 4 year agreement to serve as the exclusive
distributor in the United States for certain catheter fasteners. The manufacturer of the
fasteners has given the Company the required nine months notice of its intention not to
renew the agreement in its present form. Accordingly, the Companys rights under the
current agreement will terminate on August 23, 2004. The parties are presently engaged in
negotiations with a view to executing a new agreement. However, no assurance can be given
that these negotiations will prove successful. Annual sales of catheter fasteners under
the current agreement aggregate approximately $750,000.

20.   Acquisition of Kimberly-Clark Corporation's
Wound Care Assets and Related Increase in U.S. Line of Credit

On
January 9, 2004, the Company purchased substantially all of Kimberly-Clark
Corporations wound care product line. Kimberly-Clark Corporations annual sales
relative to this product line approximated $2.0 million. The assets acquired consist of
manufacturing equipment, product rights and other intangibles. The purchase price for the
assets was approximately $2.0 million. The purchase price was (or will be) paid as
follows: (1) $ 300,100 paid at closing; (2) $1,566,000 via a seller financed promissory
note due December 31, 2004, without interest; and (3) $133,900 cash to be paid as incurred
for estimated transaction costs. The purchase price has been preliminarily allocated to
equipment in the amount of $1,600,000 and intangible assets in the amount of $400,000
based upon these assets estimated fair market values.

In
accordance with the purchase agreement, the Company began to record sales effective
January 9, 2004. Kimberly-Clark will manufacture wound care products, for the account of
the Company, at its facility through March 31, 2004 to meet current customer demand and to
build sufficient inventory to cover the period during which production at the
Kimberly-Clark facility is discontinued and the equipment is transferred to the
Companys facility in Toronto, Canada. Upon cessation of manufacturing at
Kimberly-Clarks facility, the Company will purchase, in accordance with a
pre-determined formula, inventory consisting of raw materials and a three to four months
supply of finished goods. The price of this inventory is estimated to be $750,000. Cash on
hand or draws against available credit lines will be used to pay for this inventory.

38

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Financial Index

DERMA SCIENCES, INC.
Notes To Consolidated Financial Statements

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The
Company expects that it will take three months from the date of cessation of manufacturing
at Kimberly-Clark to transfer, install and validate the equipment and commence
manufacturing in Toronto, Canada. The cost to complete the transfer is estimated at
$300,000. The majority of this cost is expected to be capitalized.

On
January 30, 2004 the Company entered into a new one year line of credit agreement with its
U.S. lender. The maximum principal amount of the line increased to $4,000,000 from
$3,000,000. Estimated maximum potential advances under the agreement are equal to the
lesser of (A) $4,000,000 or (B) the sum of (i) 80% of eligible receivables (as defined),
(ii) 50% of eligible inventory (as defined), (iii) an amount equal to the immediate
liquidation value of funds deposited with the U.S. lender in a restricted account as
security for any letters of credit extended by the lender on the Companys behalf up
to $1,000,000, less the aggregate of any outstanding letters of credit issued by the
lender. All other terms and conditions of the agreement remained unchanged. In connection
with entering into the new line of credit agreement, the Company deposited $1,000,000 of
cash in a restricted account with the U.S. lender and the lender issued an irrevocable
standby letter of credit on the Companys behalf for the benefit of Kimberly-Clark
Corporation in the amount of $1,566,000.

21.   Subsequent Events

Common Stock Private
Offering

On February 25, 2004, the
Company closed a private offering of 2,057,145 shares of its common stock at a price of $1.05 per share. Offering proceeds of
$1,975,000, net of $185,000 in estimated offering expenses, will be used to fund strategic initiatives and for general working
capital purposes.

Termination of William M.
Goodwin Employment

On
March 9, 2004 the Company terminated the employment of William M. Goodwin, its Executive
Vice President and President of its Dumex Medical Canada Inc. subsidiary. Mr.
Goodwins duties will be assumed by the Company President and Chief Executive
Officer, Edward J. Quilty. The Company does not expect that the departure of Mr. Goodwin
will have an adverse effect upon its operations or those of its Dumex Medical Canada
subsidiary. The Company anticipates taking a charge of approximately $250,000 in the first
quarter, 2004 relative to severance and other costs related to Mr. Goodwins
termination.

Item 8A.   Controls and
Procedures

Evaluation of Disclosure
Controls and Procedures

The
Company maintains controls and procedures designed to ensure that information required to
be disclosed in the reports that the Company files or submits under the Securities
Exchange Act of 1934 are recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the SEC. Based upon an evaluation of these
controls and procedures performed within 90 days of the filing date of this report, the
Chief Executive Officer and Chief Financial Officer of the Company concluded that the
Companys disclosure controls and procedures were adequate.

Changes in Internal
Controls

The
Company made no significant changes in its internal controls or in other factors that
could significantly affect these controls subsequent to the date of the evaluation of
these controls by the Chief Executive Officer and Chief Financial Officer.

39

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Part III

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

Directors and Executive
Officers

The
directors and executive officers of the Company are:

| | Name                                  | Age |  | Position held with the Company                                     
| | ------------------------------------- | --- |  | -------------------------------------------------------------------
| |                                       |     |  |                                                                    
| | Edward J. Quilty (1)                  | 53  |  | Chairman, President and Chief Executive Officer                    
| | John E. Yetter, CPA                   | 51  |  | Vice President and Chief Financial Officer                         
| | Robert C. Cole                        | 51  |  | Vice President - Sales & Marketing                                 
| | Srini Conjeevaram (1)(2)(3)           | 45  |  | Director                                                           
| | Stephen T. Wills, CPA, MST  (1)(2)(3) | 47  |  | Director                                                           
| | James T. O'Brien (2)                  | 65  |  | Director                                                           
| | C. Richard Stafford, Esq. (2)(3)      | 68  |  | Director                                                           
| | Richard J. Keim (2)(3)                | 68  |  | Director                                                           
| | William Goodwin (4)                   | 44  |  | Executive Vice President - President Dumex Medical Canada
     Inc.

_______________ 
(1)   Member of the Nominating Committee. (2)   Member of the Compensation Committee. (3)  
Member of the Audit Committee. (4)   Effective March 9, 2004, Mr. Goodwin's employment with the Company and its
Canadian subsidiary was terminated.

Information Relative to Directors and Executive Officers

Edward J. Quilty has
served as Chief Executive Officer of the Company since November, 1996, Chairman of the Board since May, 1996 and as a director of
the Company since March, 1996. Mr. Quilty was the Chairman of the Board of Palatin Technologies, Inc., a publicly traded
biopharmaceutical company specializing in peptide drug design for diagnostic and therapeutic agents from November, 1995 until May,
2000. During the period November, 1996 through May, 2000 Mr. Quilty held the Chief Executive Officer positions at both the Company
and Palatin Technologies, Inc. From July, 1994 through November, 1995, he was President and Chief Executive Officer of MedChem
Products, Inc., a publicly traded developer and manufacturer of specialty medical products which was acquired by C. R. Bard in
November, 1995. From March, 1992 through July, 1994 Mr. Quilty served as President and Chief Executive Officer of Life Medical
Sciences, Inc., a publicly traded developer and manufacturer of specialty medical products including wound healing agents. The
assets of Life Medical Sciences were purchased by MedChem Products, Inc. During the period January, 1987 through September, 1991
Mr. Quilty served as Vice President - Sales and Marketing and later as Executive Vice President with McGaw Laboratories, a
pharmaceutical and medical device company. Previously, he served from 1974 in a variety of sales, marketing and management
positions with Baxter/American Hospital Supply Corporation. Mr. Quilty has over 25 years of experience in the healthcare industry
primarily in strategic planning, management and sales and marketing. Mr. Quilty is director of the MedTech Group, a privately held
medical products company. He earned a Bachelor of Science degree from Southwest Missouri State University, Springfield, Missouri
in 1973 and a Master of Business Administration degree from Ohio University, Athens, Ohio in 1987.

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

40

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William M. Goodwin has
served as Executive Vice President of the Company and President of the Company's subsidiary, Dumex Medical Canada Inc., since
August, 2002. Effective March 9, 2004, Mr. Goodwin's employment with the Company and its Canadian subsidiary was terminated. Mr.
Goodwin is the founder and former President of Dumex Medical Inc. In 1998, Mr. Goodwin, as a member of the Team Canada Mission,
accompanied the Canadian Prime Minister and Provincial Premiers on trade missions to Mexico and South America. He served two years
on the Executive Committee, a worldwide association of corporate Presidents organized to develop and promote business excellence.
Mr. Goodwin has over 25 years experience in the medical products industry. He received a certificate in marketing from Ryerson
University, Toronto, Ontario.

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

Srini Conjeevaram has
served as director of the Company since May, 1998. Mr. Conjeevaram has been the General Partner and Chief Financial Officer of
Galen Associates, a healthcare venture capital firm, since January, 1991. Prior to his affiliation with Galen Associates, he was
an Associate in Corporate Finance at Smith Barney from July, 1989 to December, 1990 and a Senior Project Engineer for General
Motors Corporation from April, 1982 to July, 1987. Mr. Conjeevaram serves as a director of Halsey Drug Company, Inc., a publicly
traded company, and ONI Incorporated. He earned a Bachelor of Science degree in Mechanical Engineering from Madras University,
Madras, India, a Master of Science degree in Mechanical Engineering from Stanford University, Stanford, California, and a Master
of Business Administration in Finance from Indiana University, Bloomington, Indiana.

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

James T. O'Brien has
served as a director of the Company since May, 2001. He currently serves as the President and Chief Executive Officer of O'Brien
Marketing & Communications. Previously, Mr. O'Brien served from 1989 to 1991 as President and Chief Operating Officer for Elan
Corporation (NYSE: ELN), a multi-national medical products and pharmaceutical company. In 1986, Mr. O'Brien founded O'Brien
Pharmaceuticals and served as its President and Chief Executive Officer until the acquisition of this company by Elan Corporation.
During the period 1980 to 1986, Mr. O'Brien held several division presidencies with the Revlon Health Care Group. Prior to his
association with Revlon, he served for seventeen years with Sandoz Pharmaceuticals, Inc., most recently as Vice President of U.S.
Marketing and Sales. Mr. O'Brien serves on the boards of directors of CyDex, Inc. and Benedictine College. He earned a Bachelor of
Science in Business Administration from Benedictine College, Atchison, Kansas, in 1960 and attended the Harvard University
Advanced Management Program in 1974.

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

41

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Richard J. Keim has
served as a director of the Company since May, 2002. He is the founder and Managing Director of Kensington Management Group, LLC,
a portfolio manager with assets in excess of $70 million. Prior to organizing Kensington in 1986, Mr. Keim founded and served as
Executive Vice President of the Buckingham Research Group Incorporated, a registered broker-dealer, from 1982 through 1993 and
Executive Vice President and Chief Investment Officer of Buckingham Capital Management from 1985 until 1993. Mr. Keim received his
Bachelor of Arts in Business Administration from the University of Wisconsin and his Master of Business Administration from the
University of Chicago. He is a Senior Security Analyst, a Chartered Financial Analyst, and a member of the New York Society of
Security Analysts and the Financial Analyst Federation.

Compliance with Section 16(a) of the Exchange Act

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

To the Company's knowledge,
based solely on a review of the copies of such reports furnished to the Company, all reports under Section 16(a) required to be
filed by its officers, directors and greater than ten-percent beneficial owners were timely filed with the exception of Form 4 -
Statement of Changes in Beneficial Ownership of Securities by Srini Conjeevaram, James T. O'Brien, C. Richard Stafford, Esq. and
Richard J. Keim the filing of which was untimely.

Item 10.  Executive Compensation

Compensation of Outside Directors

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

Compensation of Executive Officers

Summary Compensation Table

The following table shows all
compensation paid by the Company for the years 2001, 2002 and 2003 to: its Chief Executive Officer, four individuals who served as
the Company's officers or directors on December 31, 2003 whose compensation exceeded $100,000 for their services (in all
capacities) and up to two individuals who would have been disclosed herein under the foregoing criteria if they had been officers
on December 31, 2003:

42

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

Edward J. Quilty                 2003   $250,000          --         75,000       $10,745
Chairman, President and          2002   $247,167      $30,000        30,000       $10,245
Chief Executive Officer          2001   $187,583          --        225,000        $5,745

John E. Yetter, CPA              2003   $182,500      $25,000        40,000        $6,000
Vice President and               2002   $174,458      $20,000        20,000        $5,500
Chief Financial Officer          2001   $152,020          --        100,000          $803

William M. Goodwin               2003   $172,216          --            --         $15,341
Executive Vice President         2002    $56,644 (1)  $63,686       500,000         $4,356 (1)

Robert C. Cole                   2003   $155,000          --            --          $7,200
Vice President - Sales and       2002        --           --        175,000            --
Marketing

Martha A. Crimmins               2003   $100,000       $5,215        30,000        $3,156
Vice President - Operations      2002    $92,645       $9,282           --         $3,058
                                 2001    $90,000       $8,100        50,000        $1,062`

_________________

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

Option Grants Table

The
following table sets forth information regarding grants of stock options to the following
named executive officers and directors during the year ended December 31, 2003:

`Percent of Total
                                           Options Granted to    Exercise
                            # of Options     Employees and        Price
              Name             Granted      Directors in 2003    ($/Share)   Expiration Date
              ----          ------------   ------------------    ---------   ---------------

C. Richard Stafford, Esq.      70,000 (1)        7.40%            $0.90      May 22, 2013
Srini Conjeevaram              70,000 (1)        7.40%            $0.90      May 22, 2013
Richard J. Keim                70,000 (1)        7.40%            $0.90      May 22, 2013
James T. O'Brien               70,000 (1)        7.40%            $0.90      May 22, 2013
Edward J. Quilty               75,000 (2)        7.93%            $0.37      March 25, 2013
Stephen T. Wills, CPA, MST     70,000 (1)        7.40%            $0.90      May 22, 2013
John E. Yetter, CPA            40,000 (3)        4.23%            $0.37      March 25, 2013`

_________________

(1)    
          These options vest at the rate of 55,000 on the date of grant and 5,000 per year
          thereafter.

(2)    
          These options vest at the rate of 6,250 on the date of grant, 50,000 at December
          31, 2003 and 6,250 per year thereafter.

(3)     These options vest at the rate of
          5,000 on the date of grant, 20,000 at December 31, 2003 and 5,000 per year
          thereafter.

Aggregate Year End Option
Value Table

The
following table sets forth information regarding the aggregate number and value of options
to purchase Common Stock held by the named executive officers as of December 31, 2003. No
options have been exercised:

43

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`Number of Shares              $ Value of Unexercised
                                Underlying Unexercised            In-The-Money Options
                             Options at December 31, 2003         At December 31, 2003 (1)
                             ----------------------------      ----------------------------
   Name                      Exercisable    Unexercisable      Exercisable    Unexercisable
   ----                      -----------    -------------      -----------    -------------

   Edward J. Quilty            345,305         120,750           $85,793         $50,258
   John E. Yetter, CPA         157,000          63,000           $85,570         $26,430
   William M. Goodwin          500,000               0          $250,000              $0
   Martha A. Crimmins           36,000          44,000           $12,000          $8,000
   Robert C. Cole               70,000         105,000           $35,000         $52,500`

_________________

(1)    
          Determined based on the fair market value for the Companys Common Stock at
          December 31, 2003 of $1.19 per share.

Employment Arrangements

Edward J. Quilty

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

John E. Yetter, CPA

The
Company employs John E. Yetter, CPA, its Vice President and Chief Financial Officer,
pursuant to a one-year employment agreement, effective March 1, 2004, providing for base
compensation in the amount of $195,000 per year and incentive compensation in the
discretion of the Companys board of directors. The agreement further provides for
the payment of severance compensation in the amount of one-years base salary upon
failure of the Company to renew the agreement for successive one-year terms or for
termination of Mr. Yetters employment other than for cause. In addition,
upon a change in control of the Company, Mr. Yetter may, within six-months of the change
in control, tender his resignation and receive one-years severance compensation.

Robert C. Cole

The
Company employs Robert C. Cole, its Vice President for Sales and Marketing, pursuant to a
one-year employment agreement, effective March 1, 2004, providing for base compensation in
the amount of $170,000 per year and incentive compensation in the discretion of the
Companys board of directors. The agreement further provides for the payment of
severance compensation in the amount of one-years base salary upon failure of the
Company to renew the agreement for successive one-year terms or for termination of Mr.
Coles employment other than for cause. In addition, upon a change in
control of the Company, Mr. Cole may, within six-months of the change in control, tender
his resignation and receive one-years severance compensation.

Martha A. Crimmins

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

44

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William M. Goodwin

The
Company employed William M. Goodwin, its Executive Vice President and President of the
Companys Dumex Medical Canada subsidiary, pursuant to an agreement dated August 26,
2002. Effective March 9, 2004, Mr. Goodwins employment with the Company and its
Canadian subsidiary was terminated. Mr. Goodwins employment agreement provides for
the payment of severance compensation in the amount of two-years salary upon
termination of the agreement by the Company other than for cause. At the time
of his termination, Mr. Goodwins base compensation was at the annual rate of
$250,000 (Canadian). Pursuant to his employment agreement, Mr. Goodwin was granted the
option to purchase 500,000 shares of the Companys common stock at a price $0.50 per
share. These options are fully vested and may be exercised until the close of business
June 7, 2004.

Stock Option Plan

The
Company adopted the Stock Option Plan (the Plan) July 18, 1991 and amended the
Plan January 14, 1994, May 22, 1996, July 14, 1998 and February 6, 2003. The number of
shares of Common Stock reserved for issuance pursuant to the Plan is 1,300,000 shares. The
Plan authorizes the Company to grant two types of equity incentives: (i) options intended
to qualify as incentive stock options (ISOs) as defined in Section
422 of the Internal Revenue Code of 1986, as amended, and (ii) nonqualified stock options
(NQSOs). The Plan authorizes options to be granted to directors, officers, key
employees and consultants of the Company, except that ISOs may be granted only to
employees. The Plan is administered by a committee of disinterested directors designated
by the Board of Directors (the Compensation Committee). Subject to the
provisions of the Plan, the Compensation Committee determines who is eligible to receive
stock options, together with the nature, amount, timing, exercise price, vesting schedule
and all other terms and conditions of the options to be granted.

Under
the Plan, ISOs and NQSOs may have a term of up to ten years. Stock options are not
assignable or transferable except by will or the laws of descent and distribution. Stock
options granted under the Plan which have lapsed or terminated revert to the status of
unissued and become available for reissuance.

At
December 31, 2003, options to purchase 695,500 shares of the Companys Common Stock
at prices in the range of $0.90 to $5.00 per share were issued and outstanding under the
Plan.

Equity Compensation Plan
Information

The
following table provides information concerning the Companys equity compensation
plans or individual arrangements that were approved by shareholders and those that were
not approved by shareholders as of December 31, 2003:

`Number of Securities
                                                                                Remaining Available
                              Number of Securities                              for Future Issuance
                               to be Issued Upon       Weighted-Average            Under Equity
                                  Exercise of          Exercise Price of        Compensation Plans
                              Outstanding Options,    Outstanding Options,    (Excluding Securities
Plan Category                 Warrants and Rights     Warrants and Rights     Reflected in Column 1)
-------------                 -------------------     -------------------     ----------------------
Equity Compensation Plans
Approved by Shareholders
                                   695,500 (1)              $1.35                    604,500
Equity Compensation Plans
Not Approved by
Shareholders                     2,980,655 (2)              $1.03                          0
                                 ---------                   ----                    -------

Total                            3,676,155                  $1.09                    604,500
                                 =========                   ====                    =======`

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_________________

|(1) | The securities consist of Incentive Stock Options and Nonqualified Stock Options
          granted to officers, directors, employees and consultants in 1997, 1998 and 2003
          pursuant to the Companys Stock Option Plan. The per share exercise price
          of the options is in the range of $0.90 to $5.00. The shares of Common Stock
          underlying the options have not been registered under the Securities Act of
          1933.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The securities consist of Nonqualified Stock Options granted to officers,
          directors, employees and consultants of the Company during the period 1995
          through 2003. These options were effected pursuant to employment agreements or
          stock option agreements recommended by the Compensation Committee of the
          Companys Board of Directors and approved by its Board of Directors. The
          per share exercise price of the options is in the range of $0.37 to $12.50. The
          shares of Common Stock underlying the options have not been registered under the
          Securities Act of 1933.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Code of Ethics

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

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

The
following table sets forth as of February 29, 2004 certain information regarding the
current beneficial ownership of shares of the Companys Common Stock by: (i) each
person known by the Company to own beneficially more than 5% of the outstanding shares of
Common Stock, (ii) each director of the Company, (iii) each officer of the Company, and
(iv) all directors and officers of the Company as a group:

`Number of Shares         Percent
Name and Address of Beneficial Owner (1)              Beneficially Owned (15)  Beneficially Owned (15)
----------------------------------------              -----------------------  -----------------------

Srini Conjeevaram (2).................................        6,050,516            53.52%
Richard J. Keim (3)...................................        1,740,500            21.68%
Hambrecht & Quist California (4)......................        1,064,167            13.47%
Edward J. Quilty (5)..................................          913,240            11.35%
William M. Goodwin (6)................................          500,000             6.28%
Dolphin Offshore Partners (7).........................          480,002             6.31%
Guerrilla Partners (8)................................          450,000             6.03%
Stephen T. Wills, CPA, MST (9)........................          415,336             5.35%
John E. Yetter, CPA (10)..............................          206,000             2.70%
James T. O'Brien (11).................................          192,100             2.52%
C. Richard Stafford, Esq. (12)........................          125,000             1.65%
Robert C. Cole (13)...................................           80,000             1.06%
All directors and officers as a group (9 persons) (14)        10,222,692               (*)`

_________________

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

|(2) | Srini Conjeevaram is a General Partner of the Galen III Partnerships. The Galen
          III Partnerships can be reached at: 610 Fifth Avenue, Fifth Floor, New York, New
          York 10020. Includes shares owned by Galen Partners III, L.P., Galen Partners
          International III, L.P. and Galen Employee Fund III, L.P. Ownership consists of:
          1,762,000 shares of Common Stock; 125,003 shares of Class A Convertible
          Preferred Stock (Class A Preferred); 416,668 shares of Class B
          Convertible Preferred Stock (Class B Preferred); 619,055 shares of
          Class C Convertible Preferred Stock (Class C Preferred); 1,071,346
          shares of Class D Convertible Preferred Stock (Class D Preferred);
          550,003 warrants to purchase Common Stock exercisable at $0.75 per share
          (Class E Warrants); 1,309,441 warrants to purchase common stock
          exercisable at $0.50 per share (Class F Warrants); and exercisable
          options to purchase 197,000 shares of Common Stock. No additional options to
          purchase Common Stock will become exercisable within 60 days of February 29,
          2004.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

46

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|(3) | Richard J. Keim is a Managing Director of Kensington Management Group, LLC.
          Kensington Management Group, LLC can be reached at: 200 Park Avenue, New York,
          New York 10016. Includes shares owned by Kensington Partners L.P., Kensington
          Partners II L.P., Bald Eagle Fund Ltd., Peter Orthwein Managed Account and Peter
          Orthwein Family Trust. Ownership consists of: 1,175,500 shares of Common Stock,
          440,000 Class E Warrants and exercisable options to purchase 125,000 shares of
          Common Stock. No additional options to purchase Common Stock will become
          exercisable within 60 days of February 29, 2004.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Hambrecht & Quist California can be reached at: One Bush Street, San
          Francisco, California 94104. Ownership consists of: 624,167 shares of Common
          Stock and 440,000 Class E Warrants.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Ownership consists of: 335,684 shares of Common Stock; 220,001 Class E Warrants;
          and exercisable options to purchase 357,555 shares of Common Stock. No
          additional options to purchase Common Stock will become exercisable within 60
          days of February 29, 2004.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Ownership consists of: exercisable options to purchase 500,000 shares of Common
          Stock. No additional options to purchase Common Stock will become exercisable
          within 60 days of February 29, 2004.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Dolphin Offshore Partners can be reached at: 129 East 17th Street, New York, New
          York 10003. Ownership consists of: 333,334 shares of Common Stock and 146,668
          Class E Warrants.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Guerrilla Partners can be reached at: 237 Park Avenue, New York, New York 10017.
          Includes shares owned by Guerrilla Partners and Guerrilla IRA Partners.
          Ownership consists of: 450,000 shares of Common Stock.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) | Ownership consists of: 119,668 shares of Common Stock; 58,668 Class E Warrants;
          and exercisable options to purchase 237,000 shares of Common Stock. No
          additional options to purchase Common Stock will become exercisable within 60
          days of February 29, 2004.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) | Ownership consists of: 40,000 shares of Common Stock; and exercisable options to
          purchase 166,000 shares of Common Stock. No additional options to purchase
          Common Stock will become exercisable within 60 days of February 29, 2004.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(11) | Ownership consists of: 41,600 shares of Common Stock; and exercisable options to
          purchase 150,500 shares of Common Stock. No additional options to purchase
          Common Stock will become exercisable within 60 days of February 29, 2004.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(12) | Ownership consists of exercisable options to purchase 125,000 shares of Common
          Stock. No additional options to purchase Common Stock will become exercisable
          within 60 days of February 29, 2004.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(13) | Ownership consists of: 10,000 shares of Common Stock; and exercisable options to
          purchase 70,000 shares of Common Stock. No additional options to purchase Common
          Stock will become exercisable within 60 days of February 29, 2004.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(14) | Ownership consists of: an aggregate of 8,228,523 shares of Common Stock, Class A
          Preferred, Class B Preferred, Class C Preferred, Class D Preferred, Class E
          Warrants, Class F Warrants and options currently exercisable and exercisable
          within 60 days of February 29, 2004 to purchase shares of Common Stock.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(15) | The number of shares beneficially owned and the percent beneficially owned by
          each entity or individual assume the exercise of all exercisable options
          (including those that would be exercisable within 60 days of February 29, 2004),
          the exercise of all warrants and the conversion into Common Stock of all
          Convertible Preferred Stock owned by such entity or individual. The percent
          beneficially owned is a fraction the numerator of which is the number of shares
          of Common Stock beneficially owned by each entity or individual and the
          denominator of which is the number of outstanding shares of Common Stock plus
          the number of shares of Common Stock which would be issued upon exercise by the
          subject entity or individual of its/his/her own options and warrants and the
          conversion into Common Stock of its/his/her own Convertible Preferred Stock.
          This method of computing the percent beneficially owned results in the aggregate
          ownership percentages exceeding 100%.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(*) | In excess of 100 percent. See note 15.
|--- | --------------------------------------

Item 12. Certain
Relationships and Related Transactions

The
Company has a consulting agreement with its founder, former president and former director.
In 2003 and 2002 compensation and reimbursed expenses under this agreement were $34,167
and $56,742, respectively.

The
Company purchases marketing services from a firm owned by the son of a director. Total
expenses for services rendered in 2003 and 2002 were $16,832 and $54,371, respectively.

47

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A director of the Company is
a general partner in the firm that owns $475,000 of convertible bonds which were converted into common stock in January 2002. The
firm also holds a significant equity ownership of the Company.

Item 13.  Exhibits and Reports on Form 8-K

(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 | Certificate of Designations, Voting Powers, Preferences and Rights of the Series of
Preferred Stock of Derma Sciences, Inc. to be 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).
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.07 | Certificate of Designations, Voting Powers, Preferences and Rights of the Series of
Preferred Stock of Derma Sciences, Inc. to be 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).
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|10.02* | Senior Management Stock Option Agreement, dated April 30, 1997, between the Company and
Edward J. Quilty (previously filed as Exhibit 10.05 to the Companys Form 8-K filed
on May 6, 1997 and incorporated herein by reference).
|------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.03* | Stock Option Agreement, dated August 24, 2001, between the Company
and Edward J. Quilty.
|------ | ----------------------------------------------------------------------------------------

|10.04* | Stock Option Agreement, dated February 26, 2002, between the Company
and Edward J. Quilty.
|------ | ------------------------------------------------------------------------------------------

|10.05* | Stock Option Agreement, dated March 25, 2003, between the Company
and Edward J. Quilty.
|------ | ---------------------------------------------------------------------------------------

48

---

|10.06* | Employment Agreement, dated March 1, 2004, between the Company
and John E. Yetter, CPA.
|------ | ---------------------------------------------------------------------------------------

|10.07* | Stock Option Agreement, dated August 28, 2000, between the
Company and John E. Yetter, CPA (previously filed as Exhibit 10.31 to the Company's Form 10-KSB/A-1 filed on August 10, 2001 and
incorporated herein by reference).
|------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.08* | Stock Option Agreement, dated August 24, 2001, between the
Company and John E. Yetter , CPA.
|------ | --------------------------------------------------------------------------------------------

|10.09* | Stock Option Agreement, dated February 26, 2002, between the
Company and John E. Yetter , CPA.
|------ | ----------------------------------------------------------------------------------------------

|10.10* | Stock Option Agreement, dated March 25, 2003, between the
Company and John E. Yetter , CPA.
|------ | -------------------------------------------------------------------------------------------

|10.11* | Employment Agreement, dated March 1, 2004, between the Company
and Robert C. Cole.
|------ | ----------------------------------------------------------------------------------

|10.12* | Stock Option Agreement, dated November 26, 2003, between the
Company and Robert C. Cole.
|------ | ----------------------------------------------------------------------------------------

|10.13* | Employment Agreement, dated December 28, 2001, between the
Company and Martha A. Crimmins.
|------ | ------------------------------------------------------------------------------------------

|10.14* | Stock Option Agreement, dated August 24, 2001, between the
Company and Martha A. Crimmins.
|------ | ------------------------------------------------------------------------------------------

|10.15* | Stock Option Agreement, dated July 7, 2003, between the Company
and Martha A. Crimmins.
|------ | ---------------------------------------------------------------------------------------

|10.16* | Employment Agreement, dated July 23, 2002, between the Company and
William M. Goodwin (previously filed as Exhibit 10.05 to the Company's Form 10-KSB filed on March 31, 2003 and incorporated herein
by reference).
|------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

|10.19 | Manufacturers Agreement, dated August 25, 1992, between the Company and TapeMark Company
(previously filed as Exhibit 10.50 to the Companys Form 10-KSB filed on March 31,
1999 and incorporated herein by reference).
|----- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.20 | The Derma Sciences, Inc. 401(k) Plan, as amended February 6, 2003 (previously filed as Appendix C to the Company's Proxy Statement
filed March 31, 2003).
|----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|10.21 | Distribution Agreement, dated July 13, 2000, between
the Company and Merit Medical Systems, Inc. (previously filed as Exhibit 10.01 to the Company's Form 8-K filed August 1, 2000 and
incorporated by reference).
|----- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.22 |  | Bond Amendment Agreement, dated January 5, 2001 between the Company and Galen Partners III, L.P., Galen Partners International
III, L.P. and Galen Employee Fund III, L.P. (previously filed as Exhibit 10.01 to the Company's Form 8-K filed March 19, 2001 and
incorporated herein by reference).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.23 |  | Purchase Agreement, dated February 28, 2002 relative to the private placement of
securities (previously filed as Exhibit 10.01 to the Companys Form 8-K filed on
March 6, 2002 and incorporated herein by reference).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.24 |  | Registration Rights Agreement, dated February 28, 2002 relative to the private placement
of securities (previously filed as Exhibit 10.02 to the Companys Form 8-K filed on
March 6, 2002 and incorporated herein by reference).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.25 |  | Offer of Finance dated July 23, 2002 relative to financing by the Company of the purchase
of the assets of Dumex Medical Inc. through the Laurentian Bank of Canada (previously
filed as Exhibit 10.01 to the Companys Form 8-K filed on September 10, 2002 and
incorporated herein by reference).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

49

---

|10.26 |  | Guarantee of the Company dated on or about August 26, 2002 of indebtedness of Dumex
Medical Canada Inc. to the Laurentian Bank of Canada (previously filed as Exhibit 10.03 to
the Companys Form 8-K filed on September 10, 2002 and incorporated herein by
reference).
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.27 |  | Guarantee of the subsidiary of the Company, Sunshine Products, Inc., dated on or about
August 26, 2002 of indebtedness of Dumex Medical Canada Inc. to the Laurentian Bank of
Canada (previously filed as Exhibit 10.04 to the Companys Form 8-K filed on
September 10, 2002 and incorporated herein by reference).
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.28 |  | Security Agreement of the Company dated on or about August 26, 2002 pledging collateral to
secure its guarantee of indebtedness of Dumex Medical Canada Inc. to the Laurentian Bank
of Canada (previously filed as Exhibit 10.05 to the Companys Form 8-K filed on
September 10, 2002 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.29 |  | Security Agreement of the subsidiary of the Company, Sunshine Products, Inc., dated on or
about August 26, 2002 pledging collateral to secure its guarantee of indebtedness of Dumex
Medical Canada Inc. to the Laurentian Bank of Canada (previously filed as Exhibit 10.06 to
the Companys Form 8-K filed on September 10, 2002 and incorporated herein by
reference).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.30 |  | 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).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.31 |  | 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).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.32 |  | Revolving Credit, Loan and Security Agreement, dated March 27, 2003, between the Company
and Merrill Lynch Business Financial Services, Inc. (previously filed as Exhibit 10.01 to
the Companys Form 8-K filed on May 2, 2003 and incorporated herein by reference).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.33 |  | Form of Purchase Agreement relative to private placement of securities (previously filed
as Exhibit 10.01 to the Companys Form 8-K filed on June 12, 2003 and incorporated
herein by reference).
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.34 |  | Form of Registration Rights Agreement relative to private placement of securities
(previously filed as Exhibit 10.02 to the Companys Form 8-K filed on June 12, 2003
and incorporated herein by reference).
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.35 |  | Asset Purchase Agreement, dated August 6, 2003, between the Company and GeriCare
Providers, Inc. (previously filed as Exhibit 10.01 to the Companys Form 8-K filed on
August 29, 2003 and incorporated herein by reference).
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.36 |  | Distribution Agreement, dated October 1, 2003, between the Company and Argentum Medical,
LLC (previously filed as Exhibit 10.01 to the Companys Form 8-K filed on November
13, 2003 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.

50

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(b)  Reports on Form 8-K

Form
8-K was filed on November 13, 2003 relative to the execution by the Registrant of a
distribution agreement with Argentum Medical, LLC. Form 8-K was filed on November 13, 2003
relative to the Registrants third quarter, 2003 financial results. Form 8-K was
filed on December 16, 2003 relative to the execution by the Registrant of a product supply
agreement with McKesson Medical-Surgical Inc.

Item 14. Principal
Accountant Fees and Services

Independent Auditor Fees

Fees
for professional services provided by the Companys independent auditors, Ernst &
Young LLP, for the years ended December 31, 2003 and 2002 are as follows:

`2003                 2002
                                          ----                 ----

    Audit fees                         $138,500             $116,500
    Audit-related fees                    8,700               62,000
    Tax fees                             37,700               15,500
    All other fees                          --                   --
                                        -------              -------

    Totals                             $184,900             $194,000
                                        =======              =======`

Audit Fees

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

Audit-Related Fees

Audit related fees
principally include accounting consultations and an audit in connection with the acquisition of substantially all of the assets of
Dumex Medical Inc. in 2002.

51

---

Tax Fees

Tax fees consist of fees
relative to analysis of the Company's net operating loss carryforwards in 2003 and preparation of the Company's consolidated
United States federal, state and local and Canadian tax returns in 2003 and 2002.

Audit Committee
Pre-Approval Policy

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

52

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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 30, 2004 | By: /s/ Edward J. Quilty                            
|               | Edward J.
     Quilty                               
|               | Chairman,
     President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated on March 30, 2004.

| | 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            |                                                             

53

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