SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB


[X]     Annual Report under Section 13 or 15(d) of the  Securities  Exchange Act
        of 1934 for the fiscal year ended December 31, 1997

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

Commission file number:  1-31070


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

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

   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:

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

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

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

         Issuer's revenues for its most recent fiscal year were $4,010,148.

         The aggregate market value of the voting stock held by  non-affiliates,
computed by  reference  to the average bid and asked  prices of such stock as of
March 26, 1998, was approximately $9,920,988.

         The number of shares  outstanding  of each of the  issuer's  classes of
common equity, as of March 24, 1998, was 4,567,632.

         Documents Incorporated by Reference:  None


<PAGE>

                                     PART I

ITEM 1.  DESCRIPTION OF BUSINESS

Overview
--------

         Derma Sciences, Inc. (the "Company") was incorporated under the laws of
Colorado on September 10, 1984. On June 3, 1996 the Company changed its state of
domicile to  Pennsylvania.  The Company's  executive  offices are located at 214
Carnegie Center, Suite 100, Princeton, New Jersey.

         The Company engages in the development, marketing and sale of primarily
proprietary  sprays,  ointments  and  dressings  for the  management  of certain
chronic  non-healing  skin  ulcerations  such as  pressure,  diabetic and venous
ulcers,  surgical  incisions and burns.  As these wounds  primarily  afflict the
elderly, the Company markets its products mainly to healthcare providers for the
geriatric  community such as nursing homes,  similar  extended care  facilities,
hospitals and home healthcare  agencies  throughout the United States.  In 1997,
sales of wound  care  products  in the  United  States  were  estimated  at $2.6
billion. This amount is expected to increase at a rate of 5% annually.

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

         In 1997, the Company experienced a 12% decrease in annual revenue. This
decrease  is  primarily  attributable  to  changes in the  product  distribution
system.  Revenues  decreased  20% in 1996 and  increased 20% and 18% in 1994 and
1995,  respectively.  Revenues  are  principally  derived  from  the sale of the
Company's wound care products.

         The  Company's  objective  is to become a leading  provider  of chronic
wound care  products  throughout  the United  States and selected  international
markets.  The Company seeks to accomplish this objective by increased  marketing
emphasis  on  its  proprietary  zinc-nutrient  technology,  introduction  of new
products,  product  acquisitions,  product  licensing,  joint ventures and joint
marketing arrangements.

Chronic Wounds and Wound Care
-----------------------------

Wound Classification

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

         Stage III and IV pressure,  venous and  diabetic leg ulcers  constitute
three of the largest categories of chronic wounds.  Pressure ulcers,  also known
as decubitus  ulcers or  bedsores,  result from  prolonged  pressure on the skin
which impairs blood supply to the affected  area.  Lack of blood supply leads to
tissue death and ulceration of the skin and underlying tissue. Venous ulcers, or
venous stasis disease, result from poorly functioning veins, particularly in the
lower extremities,  resulting in venous insufficiency.  As a result, blood pools
in the legs causing  chronic  wounds.  Diabetic leg ulcers  result from diabetic
neuropathy.  There are  approximately  4 million  chronic  wounds in the  United
States and this number is increasing at an approximate rate of 10% annually.  Of
these wounds, 2.5 to 3.0 million were diabetic ulcers and pressure sores.


                                       1
<PAGE>

The Afflicted Population

         A  disproportionately  large  share of total U.S.  healthcare  costs is
attributable to the elderly population.  A factor of this  disproportionality is
the prevalence in elderly  patients of chronic  wounds.  It is estimated that by
the year 2000 approximately 13%, or 35 million,  of the United States population
will be over the age of 65 and that  almost 17  million  will be over the age of
75. It is also  estimated  that by the year 2030 more than 20% of all Americans,
or 60  million,  will  be  over  the  age of 65 and  that  this  segment  of the
population will account for 50% of total healthcare costs.

         Ten to twenty percent of all patients  admitted to nursing homes suffer
from chronic wounds in the nature of pressure sores or venous ulcers.  Diabetics
are  particularly  susceptible to chronic  non-healing  wounds.  Diabetics often
suffer from inadequate blood circulation and neuropathy,  a loss of sensation in
the limbs.  This  predisposes  diabetics to chronic wounds,  particularly on the
legs and feet,  and may ultimately  result in  amputation.  It is estimated that
diabetes  affects  nearly 16 million  Americans,  although  only 10.3 million of
those afflicted have been diagnosed. Approximately 15% of diabetics will develop
foot ulcerations in their lifetime.

Principles of Treatment

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

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

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

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

The Company's Products
----------------------

         The Company develops, markets and sells proprietary and non-proprietary
topical  preparations and devices primarily devoted to the management of certain
pressure and venous ulcers.  Secondary  product uses include treatment of wounds
or skin  irritations  caused by surgical  incisions,  abrasions,  burns and skin
tears.  Descriptions of the Company's products follow.  Certain of the Company's
products have  undergone,  or will soon undergo,  name changes.  These have been
noted.


                                       2
<PAGE>


Skin Care/Incontinence Protection

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

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

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

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

         NutraWash.  Formerly  Dermagran  Tri-Zinc  Incontinent Wash,  NutraWash
incorporates  the  Company's  proprietary  zinc-nutrient  technology.  It  is  a
cleanser  packaged in an eight  ounce  opaque  plastic  bottle with a pump spray
nozzle.  NutraWash  removes  dry fecal  matter,  urine and odor  resulting  from
incontinence.  Sales of this product have not been a material revenue  producing
factor.  However, the Company intends to redirect its marketing efforts relative
to NutraWash and sell the product as a companion to NutraShield.

         NutraShield  Perineal   Protectant.   NutraShield  Perineal  Protectant
incorporates the Company's proprietary zinc-nutrient technology. It is a topical
ointment packaged in tubes.  This product is a protective,  long lasting barrier
ointment for perineal care associated  with  incontinency.  NutraShield  will be
marketed  as a  companion  product  to  NutraWash.  Marketing  and sales of this
product are estimated to commence in the second quarter, 1998.

Wound Cleanser

         NutraCleanse. Formerly Dermagran Wound Cleanser with Zinc, NutraCleanse
incorporates  the  Company's  proprietary  zinc-nutrient  technology.  It  is  a
saline-based  wound  cleanser  with  moisturizing  and  lubricating   properties
packaged  in a four  ounce  translucent  plastic  bottle  with a  single  stream
dispenser  tip nozzle.  The FDA has granted a Section  510(k)  approval  for the
marketing and sale of this  cleanser.  NutraCleanse  addresses  the  traditional
wound care factors of moisture,  pH balance and nutrition.  The indicated use of
this product is to cleanse dermal wounds while  contributing  to the maintenance
of a mildly  acidic wound  environment.  Sales of  NutraCleanse  have not been a
material revenue producing factor.  The Company intends to refocus its marketing
efforts relative to this product.



                                       3
<PAGE>


Transparent Films

         DermaFilm.  DermaFilm is an intelligent film dressing,  sold in various
sizes,  with a high moisture  vapor transfer rate. The FDA has granted a Section
510(k) approval for the marketing and sale of this product.  DermaFilm addresses
the  traditional  wound care factor of  protection.  The indicated  uses of this
product are as a primary dressing on partial thickness wounds and as a secondary
dressing on full thickness wounds with moderate to heavy exudate.  Marketing and
sales of DermaFilm commenced in the first quarter, 1998.

         DermaSite.  DermaSite is a transparent film with low vapor permeability
and is sold in various sizes.  The FDA has granted a Section 510(k) approval for
the  marketing  and sale of this product.  DermaSite  addresses the  traditional
wound care  factors of  moisture  and  protection.  The  indicated  uses of this
product are as a dressing  for partial  thickness  wounds and  utilization  as a
fixation  device.  Marketing  and  sales of  DermaSite  commenced  in the  first
quarter, 1998.

Hydrocolloid Dressings

         NutraCol. NutraCol incorporates the Company's proprietary zinc-nutrient
technology.  It is an intelligent  hydrocolloid  dressing and is sold in various
sizes.  The FDA has granted a Section 510(k) approval for the marketing and sale
of this  product.  NutraCol  addresses  the  traditional  wound care  factors of
moisture,  protection and nutrition. The indicated uses of this product are as a
primary or secondary dressing for the management of moderately exudating wounds.
Marketing and sales of NutraCol commenced in the first quarter, 1998.

         DermaCol.  DermaCol is similar to NutraCol described above, but without
zinc. The FDA has granted a Section  510(k)  approval for the marketing and sale
of this  product.  DermaCol  addresses  the  traditional  wound care  factors of
moisture and protection.  The indicated uses of this product are as a primary or
secondary dressing for the management of moderately exudating wounds.  Marketing
and sales of DermaCol commenced in the first quarter, 1998.

Hydrogel/Wound Fillers

         NutraVue.    Formerly   Dermagran   Zinc-Saline   Hydrogel,    NutraVue
incorporates the Company's proprietary  zinc-nutrient  technology. It is a clear
hydrogel  packaged in tubes.  The FDA has granted a Section 510(k)  approval for
the marketing and sale of this product.  NutraVue addresses all five traditional
wound care factors. The indicated uses of this product are the management of all
stages of pressure sores, surgical incisions,  thermal burns, cuts and abrasions
and venous stasis ulcerations. Marketing and sale of NutraVue began in the third
quarter, 1996.

         NutraFil.  Formerly  Dermagran  Hydrophilic  Wound  Dressing-B  (bulk),
NutraFil incorporates the Company's proprietary  zinc-nutrient technology. It is
an advanced zinc hydrogel  formulation  packaged in tubes. The FDA has granted a
Section 510(k)  approval for the marketing and sale of this  dressing.  NutraFil
addresses  all five  traditional  wound  care  factors.  Indicated  uses are the
management  of stages II-IV  pressure  sores,  diabetic  ulcers,  venous  stasis
ulcerations, thermal burns, surgical incisions and superficial lacerations, cuts
or abrasions.

Impregnated Gauze Dressings

         NutraGauze.  Formerly Dermagran Hydrophilic Wound Dressing,  NutraGauze
incorporates  the  Company's  proprietary  zinc-nutrient  technology.  It  is an
advanced  zinc  hydrogel  formulation  impregnated  in gauze and is available in
various sizes.  The FDA has granted a Section 510(k)  approval for the marketing
and sale of this dressing.  NutraGauze addresses all five traditional wound care
factors.  Indicated  uses are the  management  of stages II-IV  pressure  sores,
diabetic ulcers,  venous stasis ulcerations,  thermal burns,  surgical incisions
and superficial lacerations, cuts or abrasions.

         Dermagran Wet Dressing  (Saline).  Dermagran Wet Dressing (Saline) is a
sterile 4" x 8", 12 ply gauze  dressing  saturated  with  sterile  solution  and
packaged in foil envelopes  with  peel-down  tabs. The FDA has granted a Section
510(k)  approval for the  marketing  and sale of this  dressing.  Dermagran  Wet
Dressing  (Saline)  addresses the  traditional wound  care factors  of moisture,


                                       4
<PAGE>

infection control and protection.  Indicated uses are the management of pressure
sores,  venous  ulcers,  incisions,  burns and skin  irritations.  Dermagran Wet
Dressing (Saline) is appropriate  whenever a saline dressing is indicated.  This
product provides a convenient, economical method of compliance with requirements
for aseptic technique in the treatment of pressure sores and similar wounds.

         NutraDress.  Formerly,  Dermagran Zinc-Saline Wet Dressing,  NutraDress
incorporates the Company's proprietary  zinc-nutrient  technology. It is similar
to  Dermagran  Wet  Dressing  (Saline)  described  above.  The FDA has granted a
Section 510(k) approval for the marketing and sale of this dressing.  NutraDress
addresses all five traditional wound care factors.  The medical  indications for
NutraDress are the same as for Dermagran Wet Dressing (Saline).

Exudate Absorptives

         NutraStat.    NutraStat    incorporates   the   Company's   proprietary
zinc-nutrient  technology.  It is a calcium alginate dressing,  containing zinc,
packaged in various sizes. The FDA has granted a Section 510(k) approval for the
marketing and sale of this product.  NutraStat  addresses the traditional  wound
care factors of moisture and nutrition.  The medical  indications  for NutraStat
are the  management of moderately to heavily  exudating  wounds such as pressure
ulcers,  venous  stasis  ulcers  and  dermal  lesions.  Marketing  and  sales of
NutraStat commenced in the first quarter, 1998.

         DermaStat.  DermaStat is a calcium  alginate  dressing,  without  zinc,
packaged in various sizes. The FDA has granted a Section 510(k) approval for the
marketing and sale of this product.  DermaStat  addresses the traditional  wound
care  factor of  moisture.  The  medical  indications  are  similar to those for
NutraStat.  Marketing  and sales of DermaStat  commenced  in the first  quarter,
1998.

         Chronicure.  Chronicure is a protein hydrolysate powder made from avian
derived collagen peptides. The FDA has granted a Section 510(k) approval for the
marketing and sale of this product.  This product addresses all five traditional
wound care  factors.  Indicated  uses are the  management of moderate to heavily
exudating wounds.

Product Development

         The Company has incurred  expenditures for product  development in 1996
and 1997 of  $803,744  and  $386,283,  respectively.  The  reduction  in product
development  expense is  attributable  to  decreases  in the  Company's  product
development  staff  together with increased  outsourcing of product  development
functions. It is the Company's current intention to work with other companies in
the development of additions to its product line. Other than as described below,
the Company has no product development agreements with other companies.

         The Company has two five-year product development and supply agreements
with  Innovative   Technologies   Limited  (London  Exchange:   ITG.L)  for  the
development and  manufacture of advanced wound care products  involving both the
Company's proprietary  zinc-nutrient technology and non-proprietary  technology.
The  Product  Development  and  Manufacturing  Agreement  (the "PDM  agreement")
provides  that  Innovative   Technologies   will  develop  and  manufacture  new
zinc-based  wound care  products for the  Company.  Product  development  costs,
estimated to aggregate  approximately  $150,000, are being borne by the Company.
The Company owns all rights to the developed  products  within the United States
and its territories. It has granted to Innovative Technologies the right to sell
and license the products  outside the United  States in return for fifty percent
of the gross  margins and fifty  percent of the fees derived from such sales and
licenses, respectively.

         NutraCol and NutraStat, discussed above under "The Company's Products,"
were  developed  and are  being  manufactured  pursuant  to the  PDM  agreement.
Marketing and sale of these products began in the first quarter, 1998.

         The  Generic  Products  Agreement  (the "GP  agreement")  appoints  the
Company as a non-exclusive United States distributor of certain  non-proprietary
wound  care  products   manufactured  by  Innovative   Technologies.   DermaCol,
DermaStat,  DermaSite  and  DermaFilm  are  products  that are  manufactured  by
Innovative  Technologies  and  distributed  by the  Company  pursuant  to the GP
agreement.  Marketing and sale of these products commenced in the first quarter,
1998.


                                       5
<PAGE>


         Management  believes that combining the Company's  zinc-based  nutrient
technology with Innovative Technologies'  biomaterial processing technology will
yield a highly effective,  differentiated  line of advanced wound care products.

Product Sourcing and Quality Assurance

         The  Company  does  not  maintain   manufacturing   facilities  and  it
outsources  contracts for the  production  and  packaging of its entire  product
line. The following table lists the Company's  manufacturers  as of December 31,
1997, together with the products manufactured by each:

   MANUFACTURER                                 PRODUCT
  --------------                               ---------
Ambix Laboratories             NutraCleanse (Dermagran Wound Cleanser with Zinc)
East Rutherford, New Jersey    NutraVue (Dermagran Zinc-Saline Hydrogel)
                               Hydrophilic compound for NutraFil and NutraGauze
                                 (Dermagran Hydrophilic Wound Dressing)

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

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

Innovative Technologies        DermaCol
 Limited                       NutraCol
Cheshire, United Kingdom       DermaStat
                               NutraStat
                               DermaSite
                               DermaFilm

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

Kimberly-Clark Tecnol          NutraGauze (Dermagran Hydrophilic Wound Dressing)
Fort Worth, Texas

Topiderm, Inc.                 Dermagran Ointment
Bohemia, New York              NutraFil (Dermagran Hydrophilic Wound Dressing-B)
                               NutraShield

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

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

Patents and Proprietary Technology
----------------------------------

         Certain of the Company's  products have received  patent  protection in
several countries under the title "Two-Step Procedure for Indolent Would Healing
and Aqueous  Medium and  Topical Ointment Used in Connection Therewith."  Patent


                                       6
<PAGE>

applications  are pending in various  other  countries.  Countries  where patent
applications have been made,  application  status and, where applicable,  patent
expiration dates are set forth below:

COUNTRY               STATUS         EXPIRATION DATE
-------               ------         ---------------

Australia             Issued         November 11, 2003

Canada                Issued         March 5, 2008

Egypt                 Pending        --

European Community*   Issued         March 20, 2007

Ireland               Issued         March 24, 2007

Japan                 Pending        --

Mexico                Issued         April 2, 2007

Philippines           Issued         July 1, 2008

Spain                 Issued         February 26, 2008

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

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

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

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

         An important part of the Company's product  development  strategy is to
acquire,  by purchase or license,  proprietary  wound care technology from other
parties.  There can be no assurance that the Company will be able to obtain such
technology  on acceptable  terms,  if at all.  Inability to license  proprietary
wound care  technology  could have a material  adverse  effect on the  Company's
business.

                                       7
<PAGE>

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

Distribution and Sales
----------------------

Domestic

         The Company has reorganized its domestic sales and distribution system.
Formerly,   the  Company   sold  the   majority  of  its   products  to  "master
distributors."  Master  distributors  typically  entered into  long-term  master
distributorship  agreements  with the  Company  providing  for large,  exclusive
territories  and  commissions  relative to all products  distributed  within the
territory.  This distribution  system frequently resulted in commission payments
to distributors who had little or no  responsibility  for the subject sale. This
would be the  case,  for  example,  when  products  were  shipped  into  several
distributors'  territories by large,  multi-state  customers of the  originating
distributor.  The practice of paying  distributors sales commissions in addition
to permitting  distributors to mark up products often resulted in excessive cost
to  the  products'  end-users,   excessive   compensation  to  distributors  and
relatively small profit margins to the Company.

         Under  its   reorganization   in  1997,   the  Company   terminated  or
renegotiated  relationships with its master distributors.  The Company currently
distributes  its  products   through  drug   wholesalers  and   medical/surgical
distributors retained on a non-territorial and non-exclusive basis. Compensation
of the Company's wholesalers and distributors is now derived from markups on the
products and various product pricing and sales growth incentives provided by the
Company. No commissions are payable under these new distribution agreements.

         The Company also seeks to improve  sales and  distribution  through the
institution  of a direct  sales  force.  To this end, the Company has retained a
senior sales executive  (Executive Vice President for Field  Operations),  three
regional  sales  managers  and five sales  representatives.  These  managers and
representatives  maintain the dual  responsibilities of supporting the Company's
expansion in the alternate  site markets as well as supporting  the  wholesalers
and distributors of the Company's products.

International

         The   Company's   wound  care   products  are   distributed   and  sold
internationally pursuant to various licensing and distribution  agreements.  The
Company has licensing  and/or  distribution  agreements with companies in Egypt,
Indonesia,  Canada,  the Philippines,  the South African region and Israel.  The
Company seeks to establish the markets in Europe, Japan, the Pacific Rim and the
Middle  East.  To date,  international  sales have not been a  material  revenue
producing factor.

Third  Party  Reimbursement
---------------------------

          The Company's  products are sold to nursing homes,  hospitals and home
healthcare agencies.  Many of these institutions seek reimbursement for the cost
of the Company's  products  from third party payors such as Medicare,  Medicaid,
health maintenance organizations and private insurers, including Blue Cross/Blue


                                       8
<PAGE>

Shield.  The  availability  of  reimbursement  from such third party payors is a
significant factor in the Company's sales of wound care products.

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

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

         Medicare is a federally  funded  program  administered  by four private
insurance  companies.  Medicare insurance  generally is available to individuals
who have  paid  social  security  taxes  and are over the age of 65  years.  The
majority of the Company's  products are eligible to receive  reimbursement  from
Medicare. However, the Company's products have been the subject of past Medicare
reimbursement cutbacks.

         Federal  and  state  governments,  as well as  private  insurers,  will
continue  their  pursuit of  programs  designed to control or reduce the cost of
health  care.   These  cost  cutting   measures   may  include   reductions   in
reimbursements  and/or  increases in rebates for wound care  products.  As such,
there is no assurance  that  reimbursements  relative to the Company's  products
will continue to be available or that the Company's rebate  obligations will not
increase.

Competition
-----------

The Wound Care Industry

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

Competing Product Descriptions

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




                                       9
<PAGE>



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

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

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

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

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

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

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

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

         The  foregoing  products  are similar in many  respects to those of the
Company in that they are  designed  to address  one or more of the  "traditional
wound care  factors."  The  Company has  products in all of the above  described
categories except antimicrobials,  antiseptics and antibiotics. See "Description
of Business-The Company's Products."

Competitive Analysis

         Although  the  Company  is  considerably  smaller  than,  and lacks the
resources  of, the majority of its  competitors,  the Company  believes that its
products  compare  favorably with those of its competitors  with respect to: (1)
wound management,  (2) cost effectiveness,  and (3) convenience and ease of use.
All five  traditional  wound care factors are addressed by many of the Company's
products.  Additionally,  the  proprietary  technology  that is  employed by the
majority of these  products,  in the opinion of management,  would be difficult,
time  consuming  and  expensive to  circumvent.  For these  reasons,  management
believes  the Company  possesses  attributes  which will enable it, for the near
term, to compete  successfully in the wound care field.  The ultimate ability of
the  Company  to remain  competitive  depends  upon its  ability  to  develop or
acquire,  commercialize and market wound care technologies which are superior to
those of its competitors.

Government Regulation
---------------------

Scope of Regulation

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


                                       10
<PAGE>


Medical Devices

         The  following  products  are  registered  with  the  FDA as  "devices"
pursuant to the regulations  under Section 510(k) of the FDC Act:  Dermagran Wet
Dressing (Saline), Dermagran Zinc-Saline Wet Dressing, NutraCleanse,  DermaFilm,
DermaSite,  NutraCol,  DermaCol,  NutraFil,  NutraVue,  NutraGauze,  NutraDress,
NutraStat, DermaStat and Chronicure.

         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,  recordkeeping  requirements,  labeling  requirements and Good
Manufacturing Practice ("GMP") regulations.

         Class  II  devices  are  those  for  which  general  controls  are  not
sufficient  to  ensure  safety  and   effectiveness  and  for  which  sufficient
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.

         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
submission   of  extensive   safety  and   effectiveness   data  which  is  both
time-consuming and expensive to compile.  Consequently, the FDA approval process
relative to Class III devices may require several years.

         Devices  marketed  after May 28, 1976 belong to one of two  categories:
those  that  are  and  those  that  are  not   substantially   equivalent  to  a
Pre-amendment Device. Those that are substantially equivalent to a Pre-amendment
Device  are  given  the  same  classification  as the  equivalent  pre-amendment
product.   Those  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 place 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, the manufacturer must submit to the FDA a
Pre-market  Approval  Application ("PMA") containing evidence that the device is
safe  and  effective  prior to  publicly  marketing  the  device.  However,  the
manufacturer  may seek to convince the FDA to reclassify  the device by filing a
reclassification petition.

         All of the devices currently marketed by the Company have been found by
the FDA to be substantially equivalent to a Pre-amendment Device.

Regulation of Drugs

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

         A new drug may not be commercially marketed in the United States unless
it has been approved as safe and effective by the FDA. Such approval is based on
a New Drug Application  ("NDA")  submitted by the sponsor of the drug containing
acceptable scientific data including the results of tests to evaluate its safety
and substantial evidence of effectiveness for the conditions for  which the drug


                                       11
<PAGE>

is to be  offered.  Drugs  that are not "new" are not  subject to the "new drug"
procedure,  but  must  comply  with  all  other  drug  requirements,   including
registration, labeling and GMP regulations.

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

Prescription and Over-the-Counter Drugs

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

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

         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 depending upon whether
a drug is  considered:  (1)  generally  recognized as safe and effective and not
misbranded  (Category I), (2) not generally  recognized as safe and effective or
misbranded  (Category  II), or (3) lacking  sufficient  data for  categorization
(Category  III).  Products that do not comply with general OTC regulations or an
applicable Final Monograph are subject to a regulatory  action. Any OTC drug not
in compliance with the content and labeling requirements of a Final Monograph is
subject to a regulatory  action unless it is the subject of an approved new drug
application. The FDA has issued a Compliance Policy Guide in which it determined
not to 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.

Status of Dermagran Spray and Dermagran Ointment

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

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

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



                                       12
<PAGE>

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

Foreign Approval

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

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 current
and possible future local, state, federal and foreign regulation.

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

Employees
---------

         The Company  currently  maintains  twenty full time employees,  four of
whom serve in executive  capacities,  two of whom serve in business  development
and  regulatory  capacities,  eight of  whom  serve  in  marketing,   sales  and
distribution capacities and six  of whom serve in administrative capacities. The
Company considers its employee relations to be satisfactory.


ITEM 2.  DESCRIPTION OF PROPERTY

         Effective May 1, 1997, the Company's  executive  offices relocated from
Old Forge,  Pennsylvania  to  Princeton,  New Jersey.  The Company  leases these
offices on a month-to-month  basis at a cost of approximately  $1,600 per month.
The Company also leases a branch office in  Wilkes-Barre,  Pennsylvania  under a
lease expiring June 30, 2000, at a rate of  approximately  $3,000 per month. The
Company leases an additional branch office in Scottsdale, Arizona, under a lease
expiring  October 31, 1998, at a rate of $700 per month.  The Company also has a
month-to-month  lease for 8,200 square feet of warehouse space in Old Forge at a
rate of $1,750 per month.


ITEM 3.  LEGAL PROCEEDINGS

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

         The Company on September 6, 1995  abrogated its license  agreement with
ABS  LifeSciences,  Inc.  ("ABS")  due to the failure of ABS to produce and make
available to the Company the wound care product "Viaderm."  ABS, a subsidiary of
Integra LifeSciences  Corporation  (Nasdaq:  IART), filed a civil action against
the Company in the United States  District  Court for the District of New Jersey
in which it claims  damages  in  excess of  $50,000  for  alleged  breach by the
Company  of the  foregoing  license  agreement with  ABS.  The license agreement


                                       13
<PAGE>

generally  provided  that ABS sell to the  Company,  and  license the Company to
resell,  the wound care products  Chronicure and Viaderm.  The complaint alleges
that the Company: (1) breached its license agreement with ABS by failing to make
certain  payments and minimum  purchases  provided  therein,  and (2)  committed
business libel against ABS by publicly  announcing  that ABS had failed to honor
its obligations under the license agreement.

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

         The parties are currently engaged in the discovery process.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         The Company did not submit any matter to a vote of shareholders  during
the fourth quarter, 1997.


                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

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

           QUARTER ENDED                          HIGH             LOW
           -------------                         ------           ------
           March 31, 1996                        $4.750           $2.250

           June 30, 1996                         $4.750           $2.625

           September 30, 1996                    $3.875           $2.250

           December 31, 1996                     $3.125           $1.750

           March 31, 1997                        $2.125           $1.125

           June 30, 1997                         $2.063           $0.625

           September 30, 1997                    $1.250           $0.625

           December 31, 1997                     $1.750           $0.813

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

         As of the close of business on March 23,  1998,  there were 995 holders
of record of the Common Stock.

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


ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

Introduction
------------

         Since its formation in September of 1984,  the Company has been engaged
in the development, marketing and sale of topical preparations for the treatment
of chronic,  non-healing wounds. In 1997 and 1996, the Company experienced a 12%
and 20% decrease,  respectively,  in annual revenue.  The Company incurred a net


                                       14
<PAGE>

loss of $2,416,244 and $1,436,265 in 1997 and 1996, respectively.  The Company's
net loss for 1997 was primarily  attributable to; (1) decrease in net sales as a
result of both the  restructuring of the Company's  distribution  system and the
elimination or reduction of Medicare  reimbursement  for certain  product lines;
and (2)  increase  in  selling,  general and  administrative  expense  primarily
attributable to increases in wages and benefits expense including the incurrence
of severance  expense and an increase in bad debt expense.  At December 31, 1997
and 1996, the Company's  accumulated  deficits were  $4,080,853 and  $1,664,609,
respectively.

Results of Operations
---------------------

         The following  table presents  selected  financial  information for the
periods indicated expressed as a percentage of net sales:

                                            1997             1996
                                       -------------    -------------
Net sales ..........................       100.0%           100.0%
Cost of sales ......................        19.8             23.3
                                       -------------    -------------
     Gross profit ..................        80.2             76.7

Operating Expenses:.................
   Product development .............         9.6             17.7
   Selling, general and
    administrative .................       133.1             94.5
                                       -------------    -------------
     Total operating expenses              142.7            112.2
                                       -------------    -------------

Loss from operations ...............       (62.5)           (35.5)

Other income .......................         2.2              1.9

Income taxes - benefit .............         --               2.1
                                       -------------    -------------

Net loss                                  (60.3%)           (31.5%)
                                       =============    =============

Sales Overview
--------------

         The Company's net sales are primarily derived from Dermagran  Ointment,
Dermagran  Spray,  Dermagran  Wet  Dressings  and  Dermagran  Hydrophilic  Wound
Dressing.  Net sales decreased in 1997 compared to 1996 by 12%. This decrease is
primarily  attributable to both the restructuring of the Company's  distribution
system and the  elimination or reduction of Medicare  reimbursement  for certain
product lines.  These decreases were partially offset by a price increase during
1997.




                                       15
<PAGE>

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

                                                YEAR ENDED DECEMBER 31,
                                   ---------------------------------------------
                                            1997                    1996
                                   ---------------------   ---------------------
Product:
  Dermagran Ointment...........      $2,782,000    69%       $3,236,000    71%
  Dermagran Spray..............         273,000     7%          274,000     6%
  Wet Dressings................          77,000     2%          123,000     3%
  Hydrophilic Wound Dressing...         838,000    21%          882,000    19%
  Other Products...............          40,000     1%           43,000     1%
                                   =====================   =====================
    Total......................      $4,010,000   100%       $4,558,000   100%
                                   =====================   =====================

1997 compared to 1996
---------------------

Net Sales and Gross Profit

         Net sales  decreased in 1997 by $547,783,  or 12%, to  $4,010,148  from
$4,557,931   in  1996.   This  decrease  is  primarily   attributable   both  to
restructuring  of the  Company's  distribution  system  and the  elimination  or
reduction  of  Medicare  reimbursement  for  certain  product  lines.  Sales  of
Dermagran  Ointment  decreased  $454,000,  or 14%,  from  $3,236,000  in 1996 to
$2,782,000 in 1997.  Sales of Dermagran  Hydrophilic  Wound  Dressing  decreased
$44,000,  or 5%, from $882,000 in 1996 to $838,000 in 1997.  Dermagran Spray net
sales  decreased  $1,000 from  $274,000  in 1996 to  $273,000 in 1997.  Sales of
Dermagran  Wet  Dressing   (Saline)  and  Dermagran   Zinc-Saline  Wet  Dressing
collectively  decreased  $46,000,  or 37%,  from  $123,000 in 1996 to $77,000 in
1997.

         Cost of sales expressed as a percentage of net sales decreased from 23%
in 1996 to 20% in 1997. This decrease is  attributable  primarily to an increase
in net sales  resulting  from a price  increase  during 1997.  Aggregate cost of
sales decreased  $269,180,  or 25%, to $793,212 in 1997 from $1,062,392 in 1996.
The decrease in  aggregate  cost of sales is  attributable  to a decrease in net
sales discussed above.

         Gross profit  expressed as a percentage of net sales increased from 77%
in 1996 to 80% in 1997.  Aggregate gross profit  decreased  $278,603,  or 8%, to
$3,216,936  in 1997 from  $3,495,539  in 1996.  The increase in the gross profit
percentage is attributable to the price increase  discussed  above. The decrease
in the aggregate  gross profit is primarily  attributable to the sales decreases
discussed above.

Operating Expenses

         Operating expenses increased $609,035,  or 12%, from $5,112,715 in 1996
to $5,721,750 in 1997. Product development  expense decreased $417,461,  or 52%,
from $803,744 in 1996 to $386,283 in 1997 and decreased as a percentage of sales
from 18% in 1996 to 10% in 1997. The decrease in product  development expense is
primarily  attributable to a decrease in product  development  staffing together
with increased outsourcing of product development functions.

         Selling,   general  and  administrative   expense  for  1997  increased
$1,026,496,  or 24%, to  $5,335,467  from  $4,308,971 in 1996 and increased as a
percentage  of sales from 95% in 1996 to 133% in 1997.  The increase in selling,
general and  administrative  expense is primarily  attributable  to increases in
wages and benefits expense  including the incurrence of severance expense and an
increase in bad debt expense.

         Wages and  benefits  expense  expressed  as a  percentage  of net sales
increased in 1997 to 45% from 30% in 1996.  Aggregate wages and benefits expense
increased  $429,754  to  $1,817,961  in 1997  from  $1,388,207  in  1996.  These
increases  are  attributable  to an increase in  severance  costs of $159,665 to
$386,992  and  compensation  incident  to the  hiring  of  marketing  and  sales
personnel of $554,015.

         Bad debt expense for 1997 expressed as a percentage of sales  increased
in 1997 to 14% from 3% in 1996. Aggregate bad debt expense increased $436,924 to
$558,530  in  1997  from  $121,606  in  1996.   These  increases  are  primarily


                                       16
<PAGE>

attributable to the reserve and write off of uncollectible  accounts relating to
the restructuring of the Company's distribution system.

         Recruiting fees of $97,000 were incurred in 1997 in connection with the
hiring of marketing and sales  personnel.  No comparable  costs were incurred in
1996.

Loss from Operations

         The  Company  incurred  a loss  from  operations  for  1997 and 1996 of
$2,504,814 and  $1,617,176,  respectively.  This loss is  attributable  to lower
sales and higher operating expenses as discussed above.

Net Loss

         The  Company  incurred  a net loss in 1997 and 1996 of  $2,416,244  and
$1,436,265, or $0.58 and $0.35 per share, respectively.

Financial Ratios
----------------

         The following table presents selected  financial ratios for the periods
indicated:

                                                          DECEMBER 31,
                                                       -----------------
                                                        1997       1996
                                                       ------     ------
            Current Ratio.........................      1.65       2.04
            Quick Ratio...........................      1.20       1.55
            Liabilities-to-Assets Ratio...........       .51        .43
            Liabilities-to-Equity Ratio...........      1.03        .76
            Inventory Turnover....................       .98       1.11

         The 1997  decreases  in the  Company's  current  and quick  ratios  are
primarily  attributable  to the use of the  Company's  proceeds  of its  initial
public offering for working capital together with increased accounts payable and
accrued expenses.  See "Liquidity and Capital Resources" and "Notes to Financial
Statements."  The 1997  increases  in the  Company's  liabilities-to-assets  and
liabilities-to-equity  ratios are primarily  attributable to increased  accounts
payable and accrued expenses. See "Notes to Financial Statements."

Liquidity and Capital Resources
-------------------------------

         At  December  31,  1997 and 1996 the  Company  had  working  capital of
$1,451,239  and  $2,280,348,   respectively.  The  1997  decrease  is  primarily
attributable  to the use of a portion of the  proceeds of the  Company's  public
offering as  discussed  below,  together  with  increased  accounts  payable and
accrued expenses. See "Notes to Financial Statements."

         The Company  publicly sold 900,000  shares of its common stock at $5.00
per share  (exclusive of commissions  and related  expenses) on May 13, 1994. On
May 23, 1994, the Company used $470,000 of the proceeds of its offering to repay
the  outstanding  balance on its bank line of credit.  In 1995, the Company used
approximately  $300,000 of the proceeds of its offering for  investment  banking
and legal  expenses  relative to the  contemplated  ProCyte  Corporation/Scherer
Healthcare,  Inc. merger. In 1996, the Company used $160,000 of the proceeds for
the  purchase  of  Morgan   Paris,   Inc.'s  assets  (see  "Notes  to  Financial
Statements") and $439,000 for working capital.  The balance of the proceeds were
invested in U.S.  Treasury Bills having an aggregate  market value of $1,887,171
on December 31, 1996.  These amounts were utilized in operations  during 1997 to
fund the Company's losses.


                                       17
<PAGE>

         On November 19, 1997, the Company successfully closed on its $1,800,000
securities offering (exclusive of commissions and related expenses). On November
24, 1997,  $400,000 of such securities were converted directly into common stock
and warrants.  The  remaining  $1,400,000 of the  securities  were  converted to
preferred stock and warrants, effective as of December 31, 1997. The proceeds of
the  convertible  securities  are  invested  in  short  term,  investment  grade
commercial  paper having an aggregate market value of $1,808,000 on December 31,
1997.

         The  Company  has  a  short-term  line  of  credit  for  $800,000  at a
fluctuating  rate per annum equal to the bank's base rate (8.50% at December 31,
1997). This line of credit is secured by accounts receivable,  inventory and the
company's United States patent and trademarks.  In 1997 the Company utilized its
line of credit primarily as working capital.  Although the Company believes that
funds  generated  from  operations and available from its line of credit will be
sufficient  to  serve  its  working  capital  requirements  for the  near  term,
increased  sales  volume may  require  that the credit  line be  increased.  The
Company believes that it has the ability to secure appropriate  increases in its
credit line if required, based on increased accounts receivable.

         The Company is currently defending a civil action brought against it by
ABS  LifeSciences,  Inc.  As of December  31,  1997,  the  Company had  expended
approximately $279,000 attributable to the lawsuit in the form of legal expense,
travel expense and other administrative expenses.

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



ITEM 7.  FINANCIAL STATEMENTS

                                      INDEX

           Description                                                     Page
           -----------                                                     ----
           Report of Independent Auditors........................           19

           Balance Sheets........................................           20

           Statements of Operations..............................           21

           Statements of Shareholders' Equity....................           22

           Statements of Cash Flows..............................           23

           Notes to Financial Statements.........................           24









                                       18
<PAGE>



REPORT OF INDEPENDENT AUDITORS

Board of Directors
Derma Sciences, Inc.

         We have  audited the  accompanying  balance  sheets of Derma  Sciences,
Inc., as of December 31, 1997 and 1996 and the related statements of operations,
shareholders'  equity,  and cash flows for the years then ended. These financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

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

         In our opinion,  the  financial  statements  referred to above  present
fairly,  in all material  respects,  the financial  position of Derma  Sciences,
Inc., at December 31, 1997 and 1996,  and the results of its  operations and its
cash flows for the years then  ended,  in  conformity  with  generally  accepted
accounting principles.



                                                    ERNST & YOUNG LLP


Philadelphia, Pennsylvania
February 18, 1998








                                       19
<PAGE>


                              DERMA SCIENCES, INC.
                                 BALANCE SHEETS


                                     ASSETS
<TABLE>
<CAPTION>
                                                                                        December 31,
                                                                                ----------------------------
                                                                                    1996            1997
                                                                                ------------    ------------
<S>                                                                              <C>            <C>
CURRENT ASSETS:
Cash and cash equivalents                                                        $    60,208    $ 2,173,893
Short-term investments                                                             1,887,171              0
Accounts receivable, net of allowance for doubtful accounts of $86,000 in 1996
and $50,000 in 1997                                                                1,319,853        487,407
Current portion of officers' notes receivable                                        150,177         19,330
Inventory                                                                            837,659        774,672
Prepaid expenses and other current assets                                            224,774        215,204
                                                                                 ------------   ------------
Total Current Assets                                                               4,479,842      3,670,506
                                                                                 ------------   ------------

PROPERTY AND EQUIPMENT, NET                                                          112,510        144,591
                                                                                 ------------   ------------

OTHER ASSETS:
Officers notes receivable                                                            155,554         90,979
Intangibles, net                                                                     514,439        410,779
Other assets                                                                          52,957         54,985
                                                                                 ------------   ------------
Total Assets                                                                     $ 5,315,302    $ 4,371,840
                                                                                 ============   ============

                      LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
Bank line of credit                                                              $   800,000    $   549,633
Accounts payable                                                                     745,542        920,753
Accrued expenses                                                                     653,952        748,881
                                                                                 ------------   ------------
Total Current Liabilities                                                          2,199,494      2,219,267
                                                                                 ------------   ------------

OTHER LIABILITIES                                                                     95,000              0
                                                                                 ------------   ------------
Total Liabilities                                                                  2,294,494      2,219,267
                                                                                 ------------   ------------

SHAREHOLDERS' EQUITY:
Common stock, $.01 par value, authorized 15,000,000 shares, issued and
outstanding 4,079,233 shares in 1996, 4,567,632 shares in 1997                        40,792         45,676
Convertible preferred stock, $0.01 par value, authorized 1,750,000 shares,
issued and outstanding 1,750,000 shares                                                    0         17,500
Additional paid-in capital                                                         4,644,625      6,170,250
Accumulated deficit                                                               (1,664,609)    (4,080,853)
                                                                                 ------------   ------------
Total Shareholders' Equity                                                         3,020,808      2,152,573
                                                                                 ------------   ------------
Total Liabilities and Shareholders' Equity                                       $ 5,315,302    $ 4,371,840
                                                                                 ============   ============
</TABLE>

See accompanying notes.


                                       20
<PAGE>

                              DERMA SCIENCES, INC.
                            STATEMENTS OF OPERATIONS


                                                  Year ended December 31,
                                                ---------------------------
                                                    1996           1997
                                                ------------   ------------

NET SALES                                       $ 4,557,931    $ 4,010,148

COST OF SALES                                     1,062,392        793,212
                                                ------------   ------------

GROSS PROFIT                                      3,495,539      3,216,936
                                                ------------   ------------

OPERATING EXPENSES:
   Product development                              803,744        386,283
   Selling, general and administrative            4,308,971      5,335,467
                                                ------------   ------------
       Total Operating Expenses                   5,112,715      5,721,750
                                                ------------   ------------

LOSS FROM OPERATIONS                             (1,617,176)    (2,504,814)
                                                ------------   ------------

OTHER INCOME (EXPENSE):
   Interest and miscellaneous income                151,854        154,155
   Interest expense                                 (63,919)       (65,585)
                                                ------------   ------------
       Total Other Income                            87,935         88,570
                                                ------------   ------------

LOSS BEFORE INCOME TAXES:                        (1,529,241)    (2,416,244)
   Income taxes (benefit)                           (92,976)             0
                                                ------------   ------------

NET LOSS                                        ($1,436,265)   ($2,416,244)
                                                ============   ============

NET LOSS PER COMMON SHARE - BASIC AND DILUTED   ($     0.35)   ($     0.58)
                                                ============   ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
      OUTSTANDING                                 4,079,233      4,150,965
                                                ============   ============

See accompanying notes.

                                       21
<PAGE>

                              DERMA SCIENCES, INC.
                       STATEMENTS OF SHAREHOLDERS' EQUITY



<TABLE>
<CAPTION>
                                                                                                                         Total
                                       Convertible                              Additional         Accumulated      Shareholders'
                                     Preferred Stock       Common Stock       Paid-In Capital        Deficit            Equity
                                    -----------------------------------------------------------------------------------------------
<S>                                       <C>                    <C>              <C>              <C>                 <C>
Balance, December 31, 1995                 $        0             $40,542          $4,584,719       ($  228,344)        $4,396,917
Issuance of 25,000
   common shares                                    0                 250              59,906                 0             60,156
Net loss                                            0                   0                   0        (1,436,265)        (1,436,265)
                                    -----------------------------------------------------------------------------------------------

Balance, December 31, 1996                          0              40,792           4,644,625        (1,664,609)         3,020,808
Tender of common shares
   by officers for payment
   of notes receivable in
   January, 1997                                    0                (116)            (23,086)                0            (23,202)
Issuance of 2,250,000
   convertible securities in
   November, 1997, net of
   issuance costs                              22,500                   0           1,548,711                 0          1,571,211
Conversion of convertible
   securities into 500,000
   common shares in
   November, 1997                              (5,000)              5,000                   0                 0                  0
Net loss                                            0                   0                   0        (2,416,244)        (2,416,244)
                                    -----------------------------------------------------------------------------------------------

Balance, December 31, 1997                    $17,500             $45,676          $6,170,250       ($4,080,853)        $2,152,573
                                    ===============================================================================================
</TABLE>

See accompanying notes.


                                       22
<PAGE>

                              DERMA SCIENCES, INC.
                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                  Year ended December 31,
                                                               ---------------------------
                                                                   1996           1997
                                                               ------------   ------------
<S>                                                            <C>            <C>
OPERATING ACTIVITIES:
   Net Loss                                                    ($1,436,265)   ($2,416,244)

   Adjustments to Reconcile Net Loss to Net Cash
     Used in Operating Activities:
       Depreciation and amortization                               113,049        205,393
       Provision for bad debts                                     121,606        558,530
       Deferred taxes, net                                         (46,672)             0
       Loss on abandonment                                          82,589              0
       Charge related to issuance of common shares                  60,156              0
       Changes in operating assets and liabilities:
          Accounts receivable                                      (95,446)       273,916
          Inventory                                                232,026         62,987
          Prepaid expenses and other current assets                (11,660)         9,570
          Other assets                                              (7,836)        (2,028)
          Accounts payable                                         363,909        175,211
          Accrued expenses and other liabilities                   206,859            (71)
                                                               ------------   ------------
             Net Cash Used in Operating Activities                (417,685)    (1,132,736)
                                                               ------------   ------------

INVESTING ACTIVITIES:
       Decrease in short-term investments                          492,304      1,887,171
       Purchases of property and equipment, net                    (65,464)       (85,969)
       Acquisition of contract rights                             (160,000)             0
       Increase in patents and trademarks                          (44,384)       (47,855)
                                                               ------------   ------------
             Net Cash Provided by Investing Activities             222,456      1,753,347
                                                               ------------   ------------

FINANCING ACTIVITIES:
      Net change in bank line of credit                            100,000       (250,367)
      (Advances to) collection of officers' notes receivable       (40,089)       172,230
      Proceeds from issuance of convertible securities,
          net of issuance costs                                          0      1,571,211
      Principal payments on long-term debt and capitalized
          lease obligations                                           (247)             0
                                                               ------------   ------------
             Net Cash Provided by Financing Activities              59,664      1,493,074
                                                               ------------   ------------

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS              (135,565)     2,113,685
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                     195,773         60,208
                                                               ------------   ------------

CASH AND CASH EQUIVALENTS AT END OF YEAR                       $    60,208    $ 2,173,893
                                                               ============   ============
</TABLE>

See accompanying notes.


                                       23
<PAGE>

                         NOTES TO FINANCIAL STATEMENTS

                               DECEMBER 31, 1997

1.       THE COMPANY

         Derma  Sciences,  Inc. (the  "Company") is engaged in the  development,
marketing and sale of primarily proprietary sprays,  ointments and dressings for
the management of certain chronic  non-healing skin ulcerations such as pressure
and venous  ulcers,  surgical  incisions  and burns.  The  Company  markets  its
products  principally  through  independent  distributors,  mainly to healthcare
agencies  throughout the United States. In addition,  the Company's products are
available in selected markets  throughout the world through strategic  alliances
with local companies.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

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

Inventory

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

Property and Equipment

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

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

Intangible Assets

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

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

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

Asset Impairment

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

                                       24
<PAGE>

Cash Equivalents

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

Short-term Investments

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

Cash Flow Information

         Interest  paid  during 1997 and 1996  amounted to $63,035 and  $63,919,
respectively.  Income  taxes  paid  during  1997 and 1996  amounted  to $-0- and
$14,185, respectively.

         Non-cash  transactions  in 1997  included  receipts of 11,601 shares of
common stock in repayment of officers' note receivable.

Stock Based Compensation

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

Net Loss Per Common Share

         Net loss per common share is calculated based upon the weighted average
number of  shares of common  stock,  on an as if  converted  basis,  outstanding
during each period. All options and warrants were excluded in the calculation of
weighted average shares outstanding since their inclusion would have had, in the
aggregate, an anti-dilutive effect.

         In February  1997,  the  Financial  Accounting  Standards  Board issued
Statement of Financial  Accounting  Standard No. 128,  "Earnings per Share." The
statement  is  effective  for  financial  statements  for periods  ending  after
December  15,  1997,  and  changes  the method in which  earnings  per share are
determined.  Adoption of this statement by the Company did not have an impact on
earnings per share as the Company incurred losses in both 1997 and 1996.

Impact of Recent Accounting Pronouncements

         In  June  1997,  the  Financial   Accounting   Standards  Board  issued
Statements  No.  130, "Reporting  Comprehensive  Income" and Statement  No. 131,
"Disclosures about Segments of an Enterprise and Related  Information,"  both of
which are  required  to be adopted on January 1, 1998.  Statement  130  requires
financial statement reporting of all non-owner related changes in equity for the
periods being presented.  Statement 131 requires disclosure of revenue, earnings
and other  financial  information  pertaining  to  business  segments by which a
company is managed, as well as factors used by management to determine segments.
The  Company  believes  adoption  of  Statement  130 will  have no effect on its
financial  reporting and is currently  evaluating the  requirements of Statement
131 to determine the impact it will have on financial statement disclosures.


                                       25
<PAGE>

Income Taxes

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

Revenue Recognition

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

3.       PROPERTY AND EQUIPMENT

         Property and equipment comprise the following:

                                               DECEMBER 31,
                                           -------------------
                                             1997       1996
                                           --------   --------

          Furniture and equipment          $318,734   $232,775
          Leasehold improvements             14,543     14,543
                                           --------   --------
                                            333,277    247,318
          Less: Accumulated depreciation    188,686    134,808
                                           --------   --------
                                           $144,591   $112,510
                                           ========   ========

4.       INTANGIBLES

         Intangibles comprise the following:

                                               DECEMBER 31,
                                           -------------------
                                             1997       1996
                                           --------   --------

          Goodwill                         $ 50,731   $ 50,731
          Patents and trademarks            406,859    359,004
          Contract rights                   350,000    350,000
                                           --------   --------
                                            807,590    759,735
          Less: Accumulated amortization    396,811    245,296
                                           --------   --------
                                           $410,779   $514,439
                                           ========   ========

5.       CONCENTRATION OF CREDIT RISK

         The  Company  sells  almost  all  of its  products  to  medical  supply
companies,  pharmacies and healthcare providers.  At December 31, 1997 and 1996,
primarily all of the Company's  accounts  receivable  are from  companies in the
healthcare industry. Credit is extended based on an evaluation of the customer's
financial condition and collateral is not required.

         The Company  currently  has  manufacturing  arrangements  in place with
contract manufacturers with respect to all of its products. The Company believes
that the raw  materials  used in  manufacturing  its products  are  available in
adequate quantities from multiple sources.

         Although the Company  typically has a  manufacturing  agreement  with a
single source for each product,  multiple sources are generally  available.  The
Company has never experienced a material  interruption of supply from any of its
manufacturers.  However, in those instances in which it has only a single source
of  supply,  any  material  delay  or cessation  of production  by the Company's



                                       26
<PAGE>

contract  manufacturers  could have a material  adverse  impact on the Company's
results  of  operations.  The  Company  does  not  believe  that  the  level  of
manufacturing over-capacity in the industry is likely to change significantly in
the near  future  and,  accordingly,  does not believe  that its  reliance  upon
contract  manufacturers  will have a material  adverse  effect on the  Company's
operations.

         The Company is dependent  on two  distributors  who  purchase  products
directly from the Company.  These two distributors  accounted for 18% and 33% of
net sales in 1997 and 1996,  respectively.  Included in accounts  receivable are
amounts  representing 39% of the total receivables for these two distributors at
December 31, 1997.

6.       ACCRUED EXPENSES

         Accrued expenses comprise the following:

                                         DECEMBER 31,
                                     -------------------
                                       1997       1996
                                     --------   --------

          Commissions payable        $ 19,433   $235,681
          Accrued severance           195,000    191,521
          Medicaid rebates payable    163,787     58,669
          Other                       370,661    168,081
                                     --------   --------
                                     $748,881   $653,952
                                     ========   ========

7.       MEDICAID REBATES PAYABLE

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

8.       BANK LINE OF CREDIT

         The Company has a $800,000  revolving line of credit with a bank,  with
$549,633 and $800,000  outstanding at December 31, 1997 and 1996,  respectively,
which amounts  approximate  fair value. The maturity date of the line is May 31,
1998. The line of credit agreement  requires  monthly  interest  payments at the
bank's base rate, as defined, (8.5% at December 31, 1997). The line of credit is
secured by a general lien on accounts  receivable,  inventory  and the Company's
United States patents and trademarks.

9.       OPERATING LEASES

         The Company has noncancellable operating lease agreements for an office
and one automobile.  Rent expense under these agreements amounted to $27,612 and
$35,689  in 1997 and 1996,  respectively.  As of  December  31,  1997,  the 1998
minimum lease payments under these agreements total $46,080.

10.      INCOME TAXES

         At December 31, 1997, the Company has  Pennsylvania  and New Jersey net
operating  loss   carryforwards  of   approximately   $3,100,000  and  $463,000,
respectively  for state  income tax  purposes  that expire in years 1998 through
2000.  For  Federal  tax  purposes,   the  Company  has  a  net  operating  loss
carryforward of approximately $3,240,000 expiring in years 2011 and 2016.



                                       27
<PAGE>


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

                                                              DECEMBER 31,
                                                      --------------------------
                                                          1997          1996
                                                      -----------   ------------
     Deferred tax liabilities:
     Prepaid insurance                                ($   9,233)    ($  12,864)
     Patent amortization                                 (82,748)       (66,493)
                                                      -----------    -----------
     Total deferred tax liabilities                      (91,981)       (79,357)

     Deferred tax assets:
     Net operating loss carryforwards                  1,332,878        413,103
     Depreciation                                         26,760         17,067
     Amortization of intangibles                          55,513          7,501
     Foreign tax, research and development credits        24,559         24,559
     Allowance for bad debts                              20,297         34,911
     Other                                                70,610         71,592
                                                      -----------    -----------
                                                       1,530,617        568,733

     Valuation allowance                              (1,438,636)      (489,376)
                                                      -----------    -----------
     Total deferred tax assets                            91,981         79,357
                                                      -----------    -----------
     Net deferred tax assets                           $       0      $       0
                                                      ===========    ===========

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

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

                                                     1997               1996
                                                  ---------          ---------
                      Current:
                        Federal                       --             ($46,304)
                        State                         --                 --
                          Total current               --              (46,304)

                      Deferred:
                        Federal                       --              (12,118)
                        State                         --              (34,554)
                          Total deferred              --              (46,672)
                                                  --------           ---------
                      Total provision for
                        Income taxes                  --             ($92,976)
                                                  ========           =========

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

                                                     1997         1996
                                                  ----------   ----------

     Tax at U.S. statutory rates                  ($821,523)   ($521,655)
     State income taxes, net of federal benefit    (148,589)     (78,491)
     Increase in valuation allowance                949,260      489,376
     Nondeductible expenses                          11,686       (8,372)
     Effect of graduated tax rates                   11,750       20,082
     Other                                           (2,584)       6,084
                                                  ==========   ==========
     Total provisions for income taxes            $       0    ($ 92,976)
                                                  ==========   ==========


                                       28
<PAGE>

11.      MORGAN PARIS ACQUISITION

         During May 1996,  the Company  acquired the  contract  rights under the
Morgan Paris, Inc., Master  Distributorship  Agreement for $350,000. The Company
paid  $160,000 at the date of closing.  The remaining  purchase  price was to be
paid in two equal non-interest installments of $95,000 on or before December 31,
1997 and 1998, respectively.

         Subsequent  to the initial  compromise,  the Company  renegotiated  the
arrangement to provide for a $125,000  remittance which  represented  payment in
full of the remaining purchase price of $190,000.

12.      SHAREHOLDERS' EQUITY

Convertible Securities Offering

         On  November  19,  1997,  the  Company  successfully  closed a  private
placement of Convertible Securities ("Securities") in which an aggregate of $1.8
million was raised (net proceeds were $1,571,211 after related costs).  Terms of
the Securities  required that upon approval by the Company's  shareholders  of a
new class of Series A Convertible  Shares  ("Preferred  Stock"),  the Securities
automatically  convert  into  Units at the rate of $0.80  per  Unit.  Each  Unit
consists of one share of Preferred  Stock  convertible  into one share of Common
Stock and one warrant to purchase one share of Common Stock exercisable at $0.90
per  share.  As the  Securities  were  not  payable  in  cash,  the  unconverted
Securities at year end have been classified as Preferred Stock.  Warrants issued
in connection with this offering totaled 2,250,000.

Conversion to Common Stock

         On November  24,  1997,  the Company  accepted  the offer of  investors
owning $400,000 of Securities to convert these  Securities  directly into Common
Stock and Warrants in like manner as if: (1) these Securities had been converted
into Units and (2) the Preferred  Stock  comprising the Units had been converted
into Common Stock.

Preferred Stock

         The Company's  shareholders,  at a special meeting of shareholders held
on  January  7,  1998,  authorized  creation  of  1,750,000  shares  of Series A
convertible  preferred stock. Upon the shareholders'  authorization of preferred
stock,  the $1,400,000 of outstanding  Securities were  automatically  converted
into 1,750,000  Units  (effective as of December 31, 1997).  The preferred stock
bears no  dividend  and there are no  conversion  price  reset or  anti-dilution
provisions. It has a liquidation preference of $1,225,000 at December 31, 1997.

Stock Purchase Warrants

         At December 31, 1997, the Company had 2,390,000 warrants outstanding to
purchase the Company's common stock,  all of which are currently  exercisable at
prices ranging from $.90 to $6.25 expiring 1998 through 2001.

13.      STOCK OPTIONS

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

         The Company has a stock  option plan under which  options to purchase a
maximum of 450,000  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,  excluding members of the Compensation

                                       29
<PAGE>

Committee,  and certain  outside  consultants  and advisors to the Company.  The
option  exercise  price may not be less than 100%  (110% for owners of more than
10% of common  stock of the  Company  on the date of  grant) of the fair  market
value of the stock on the date of the grant of the option.  The duration of each
option may not exceed 10 years from the date of grant  (five years for owners of
more than 10% of the common stock of the Company).  No options granted under the
plan have been exercised.

         In addition to the options granted under the stock option plan,  during
1996 options to purchase 375,000 shares of common stock were granted to officers
and directors with exercise prices ranging from $2.31 to $2.50 per share. During
1997,  options  to  purchase  856,000  shares of common  stock  were  granted to
officers and  directors  with  exercise  prices  ranging from $.80 to $1.125 per
share. No options have been exercised.

         Pro forma  information  regarding  net income and earnings per share is
required  by  Statement  123,  which  also  requires  that  the  information  be
determined  as if the  Company  has  accounted  for its  stock  options  granted
subsequent  to December 31, 1994 under the fair value method of that  Statement.
The fair value for these  options  was  estimated  at the date of grant  using a
Black-Scholes   option   pricing  model  with  the  following   weighted-average
assumptions  for 1997 and  1996:  risk-free  interest  rate of 6.25%  and  6.0%,
respectively;  dividend yield of 0%; a volatility  factor of the expected market
price of the  Company's  common  stock of 0.830 and 0.511,  respectively;  and a
weighted average life of the option of 4 years.

         The  Black-Scholes  option  valuation  model was  developed  for use in
estimating the fair value of traded  options which have no vesting  restrictions
and are fully  transferable.  In addition,  option  valuation models require the
input of highly  subjective  assumptions  including  the  expected  stock  price
volatility.  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
traded  options is amortized to expense over the options'  vesting  period.  The
Company's pro forma information follows:

                                                     1997            1996
                                                ------------     ------------
           Pro forma net loss                   ($2,813,852)     ($1,529,232)
           Pro forma loss per common share           ($0.68)          ($0.37)

         Statement  123 is  applicable  only to options  granted  subsequent  to
December 31, 1994.  As such, the pro forma  effect is not fully reflected  until
1997.

         A  summary  of  the  Company's   stock  option   activity  and  related
information for the years ended December 31 follows:

<TABLE>
<CAPTION>
                                                         1997                                1996
                                            ------------------------------        ----------------------------
                                                            Weighted                            Weighted
                                                            Average                             Average
                                               Options      Exercise Price         Options      Exercise Price
           -----------------------------    ------------------------------        ----------------------------
<S>                                             <C>            <C>                  <C>            <C>
           Outstanding-beginning of year         420,125        $2.46                270,125        $2.44
             Granted                             906,000         1.12                150,000         2.50
             Exercised                                 0          --                       0          --
             Forfeited                          (155,125)        2.46                      0          --

                                            ----------------------------           ------------------------
           Outstanding-end of year             1,171,000        $1.57                420,125        $2.46
                                            =============    ===========           ========================
           Exercisable at end of year            674,833                             142,500
</TABLE>

         Exercise  prices for options  outstanding  under the stock option plan,
non-statutory  option agreements and employment  agreements at December 31, 1997
ranged from $0.80 to $3.60.

                                       30
<PAGE>

14.      COMMITMENTS AND CONTINGENCIES

         ABS LifeSciences,  Inc. ("ABS"),  a subsidiary of Integra  LifeSciences
Corporation,  filed a civil  action  against  the  Company in the United  States
District  Court for the  District  of New Jersey in which it claims  damages for
alleged  breach by the Company of a license  agreement with ABS. The Company has
been  advised by counsel that its  defenses to this action are  meritorious.  No
provision  has  been  made  for  this  action  in  the  accompanying   financial
statements.

15.      RELATED PARTY TRANSACTIONS

         The Company leased office space from a shareholder of the Company under
an operating  lease which was  terminated  January 31, 1998.  Rent expense under
this lease was $43,200 for the years ended December 1997 and 1996.

         In 1994, the Company entered into a five-year consulting agreement with
a director and  shareholder.  The agreement  provides that this  individual will
provide consulting  services to the Company in return for annual compensation of
$70,000,  to be adjusted from time to time by the Company's  President and Chief
Executive Officer. In 1997 and 1996, such compensation was $99,000.

         In 1995, the Company loaned an officer $28,000 on demand at an interest
rate of 9.0%.  This loan was  guaranteed by an individual  who is a director and
shareholder. In 1997 the officer repaid the promissory note.

         In 1997, the Company entered into a consulting  arrangement with a firm
with  which the  Company's  Chief  Financial  Officer is  affiliated  to provide
financial  and  accounting  services.  Total  expenses for these  services  were
$85,000 in 1997.

16.      OFFICERS' NOTES RECEIVABLE

         Various  officers  of the  Company  received  draws  against  incentive
compensation  during 1994  totaling  approximately  $296,165.  The  Compensation
Committee of the Board of Directors  subsequently  determined  that no incentive
compensation was payable relative to 1994.  Accordingly,  the officers  executed
promissory notes requiring repayment of the incentive compensation over a period
of ten (10) years with  interest of 8.01% per annum.  The Board of Directors has
determined  that the officers may tender  either  common stock of the Company or
cash in payment of the promissory notes.

         During 1997, the  Compensation  Committee  approved  forgiveness of one
officer's  promissory  note in the amount of  $74,248  as part of the  officer's
severance  package.  Repayments of other officers' notes receivable  during 1997
totaled $134,031 inclusive of principal and interest.


ITEM 8.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
         FINANCIAL DISCLOSURE

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


                                       31
<PAGE>


                                    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 (2)         47   Chairman of the Board
     Mary G. Clark, RN            64   Special Consultant and Director
     Richard S. Mink              45   Chief Operating Officer
     Charles F. Caudell, III      45   Executive Vice President
     Stephen T. Wills, CPA        41   Chief Financial Officer
     John T. Borthwick (3)        44   Director of Business Development and
                                        Director
     Laurence F. Lane (1)(2)(3)   52   Director
     Timothy J. Patrick           39   Director
----------------------
(1)  Member of the Audit Committee.
(2)  Member of the Compensation Committee.
(3)  Member of the Nominating Committee.

Information Relative to Directors and Executive Officers
--------------------------------------------------------

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

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

         RICHARD S. MINK, has served as Chief  Operating  Officer of the Company
since November, 1997, having previously served the Company as Vice President for
Marketing since April,  1997. Prior to joining the Company,  Mr. Mink was Senior
Vice President/General  Manager,  Marketing Information Services Division of Bio
Imaging  Technologies,  Inc., a medical  image data and  information  management
company,  from November, 1996 to April,  1997.  He was a self-employed marketing


                                       32
<PAGE>

consultant from May, 1995 to October,  1996,  Executive Vice President for Sales
and Marketing for MedChem,  Inc. from August,  1994 to May, 1995, Vice President
for Sales and  Marketing for Life Medical  Sciences  from July,  1993 to August,
1994,  and had  risen to the  position  of  Director  of  Marketing  for  Becton
Dickinson  Company  during his tenure  there from  August,  1977 to July,  1993.
During May, 1996 through  April,  1997,  Mr. Mink was a member of the New Jersey
Technology  Council  Healthcare  Advisory Board. He earned a Bachelor of Science
degree in Biology/Chemistry and a Master of Business  Administration degree from
Rutgers University, Newark, New Jersey in 1975 and 1977, respectively.

         CHARLES F.  CAUDELL III, has served as  Executive  Vice  President  for
Field Operations of the Company since November,  1997 having  previously  served
the Company as Vice President for Sales since April,  1997. Prior to joining the
Company, Mr. Caudell was Division Director of CalgonVestal, a former Merck & Co.
wound care subsidiary, and later Division Director of ConvaTec upon the purchase
of this company by Bristol  Myers-Squibb,  from January, 1984 to April, 1997. He
has thirteen  years  experience in management  and sales.  Mr.  Caudell earned a
Bachelor  of  Arts  degree  in  Communications   from  Wake  Forest  University,
Winston-Salem,  North  Carolina in 1974 and a Master of Business  Administration
from Ohio University, Athens, Ohio in 1993.

         STEPHEN T. WILLS, CPA, MST has served as Chief Financial Officer of the
Company since July, 1997 and Vice President since November, 1997. Mr. Wills also
serves as President and Chief Operating Officer of Golomb,  Wills & Company, PC,
a public  accounting firm, and as Vice President and Chief Financial  Officer of
Palatin Technologies,  Inc., a publicly traded biopharmaceutical company. He has
eighteen years  experience in financial and corporate  accounting  matters.  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.

         JOHN T. BORTHWICK has served as Director of Business Development of the
Company since November, 1997 and served as President and Chief Executive Officer
of the Company from February,  1991 to November, 1997 and February, 1991 to May,
1997,  respectively.  He has served as a director of the Company since November,
1984 and  served as Vice  Chairman  of the Board from  September,  1994 to June,
1995. Previously, he was Vice President for Marketing and National Sales Manager
of the Company  from 1984 through  1990.  Mr.  Borthwick  serves on the board of
directors of Plansoft  Corporation,  a developmental stage employee benefit plan
administration software company. During 1988 and 1989, Mr. Borthwick also served
as  President  of  Wound  Management   Services,   a  Medicare  billing  service
specializing  in wound care. In 1993,  Mr.  Borthwick  served as a member of the
board of  directors  of the  National  Association  for the Support of Long Term
Care, an organization which represents the legislative and regulatory  interests
of the long term care  industry.  Mr.  Borthwick  earned a  Bachelor  of Arts in
Biology from Temple University in 1975.

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


                                       33
<PAGE>

         TIMOTHY  J.  PATRICK  has  served  as  director  of the  Company  since
February,  1998. Mr. Patrick has been the President and Chief Executive  Officer
of Proxima Therapeutics,  Inc., a medical device company developing  proprietary
site-specific  delivery systems for the treatment of solid tumors,  since April,
1996. He previously served as President of Gesco International,  a subsidiary of
MedChem Products that  manufactured and marketed PICC vascular access catheters,
from July, 1994 to January, 1996. Mr. Patrick served McGaw, Inc. for 13 years in
various  sales  executive  positions  the last of which was President of Central
Admixture  Pharmacy  Services,  a business  unit of McGaw,  Inc.  that  provided
patient-specific  intravenous  solution  products  to  hospitals  and home  care
companies.  Mr.  Patrick  earned a Bachelor of Arts degree in Biology from Miami
University, Oxford, Ohio in 1981.

Family Relationships
--------------------

         Mary G. Clark is the mother of John T. Borthwick.

Compliance with Section 16(a) of the Exchange Act
-------------------------------------------------

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

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


ITEM 12.  EXECUTIVE COMPENSATION

Summary Compensation Table

         The following table shows all  compensation  paid by the Company to its
Chairman,  Chief Financial Officer and each of the Company's  executive officers
whose compensation exceeded $100,000 for their services in all capacities during
the years 1995, 1996 and 1997:
<TABLE>
<CAPTION>
                                                        ANNUAL COMPENSATION
                                                        -------------------                            ALL OTHER
NAME AND PRINCIPAL POSITION                YEAR        SALARY         BONUS       OPTIONS (#)        COMPENSATION
                                           ----       --------       -------      ------------       ------------
<S>                                        <C>       <C>           <C>             <C>             <C>
Edward J. Quilty(1)                        1997      $ 149,986          --           300,000(2)           --
Chairman                                   1996      $  59,615          --           150,000

Richard S. Mink                            1997       $100,961      $25,000(3)       200,000              --
Chief Operating Officer

Charles F. Caudell, III                    1997       $100,961          --           200,000              --
Executive Vice President
for Field Operations

Stephen T. Wills, CPA(4)                   1997      $  85,000          --            75,000              --
Vice President and
Chief Financial Officer
</TABLE>

                                       34
<PAGE>

<TABLE>
<CAPTION>
                                                        ANNUAL COMPENSATION
                                                        -------------------                            ALL OTHER
NAME AND PRINCIPAL POSITION                YEAR        SALARY         BONUS       OPTIONS (#)        COMPENSATION
                                           ----       --------       -------      ------------       ------------
<S>                                        <C>       <C>           <C>             <C>             <C>
John T. Borthwick(5)                       1997       $180,000          --           50,000        $ 9,962       (6)
Director of Business Development           1996       $180,000          --              --         $ 10,861   (6)(7)
                                           1995       $150,000      $40,000         100,000        $ 10,712   (6)(7)

Gary L. Borthwick(8)                       1997       $ 67,500          --           59,000(9)     $216,762 (10)(11)
Vice President for Finance & Operations    1996       $135,000          --              --         $  7,514     (11)
and Chief Financial Officer                1995       $119,000      $20,000          50,000        $  7,514     (11)
</TABLE>
----------------------------------
(1)   Mr. Edward J. Quilty is the Principal Executive Officer of the Company.
(2)   Includes 100,000 options granted in November, 1997, 50,000 options granted
      to members of senior management and 150,000 options  originally granted in
      1996 and repriced by the Executive  Committee of the Board of Directors on
      April 8, 1997.
(3)   Sign-on bonus.
(4)   Represents  compensation  earned during the period July through  December,
      1997.
(5)   Mr. John T. Borthwick resigned as Chief Executive Officer and President in
      May, 1997 and November, 1997, respectively.
(6)   The Company  enrolled John T. Borthwick in a  split-dollar  life insurance
      program on July 1, 1993.  The monthly  premiums  are $830.18 for  $500,000
      coverage.
(7)   Matching contributions made pursuant to the Company's 401(k) plan.
(8)    Mr. Gary L. Borthwick resigned as of July 1, 1997.
(9)    Options to purchase  59,000  shares of Common  Stock were  granted to Mr.
       Borthwick  during 1997.  However only 19,000 of these  options had vested
       prior to his resignation.
(10)  This  amount  consists  of  $135,000  consulting  fees and $74,248 in debt
      forgiveness.  For  additional  information  relative  to  Mr.  Borthwick's
      severance,  please  refer  to  the  Company's  Form  8-K  filed  with  the
      Securities and Exchange Commission on July 1, 1997.
(11)  The Company  enrolled Gary L. Borthwick in a  split-dollar  life insurance
      program on  February  1, 1993.  The  monthly  premiums  were  $626.15  for
      $500,000 coverage.

Option Grants Table

         The following table sets forth  information  regarding  grants of stock
options to the named  executive  officers  made for the year ended  December 31,
1997:
<TABLE>
<CAPTION>
                                                    PERCENT OF TOTAL       EXERCISE
                                    OPTIONS        OPTIONS GRANTED TO        PRICE
     NAME                         GRANTED (#)       EMPLOYEES IN 1997      ($/SHARE)       EXPIRATION DATE
     -------                     -------------     ------------------     ----------      -----------------
<S>                               <C>                   <C>             <C>              <C>
     Edward J. Quilty             50,000    (1)           6.4%            $1.125             April 8, 2007
                                 100,000    (2)          12.8%             $0.80          January 29, 2008
                                 150,000    (3)         N/A(3)            $1.125              May 22, 2007

     Richard S. Mink              50,000    (1)           6.4%            $1.125             April 8, 2007
                                 118,000    (4)          15.1%            $1.125            April 14, 2007
                                  32,000    (5)           4.1%            $1.125            April 14, 2007

     Charles F. Caudell, III      50,000    (1)           6.4%            $1.125             April 8, 2007
                                 118,000    (6)          15.1%            $1.125            April 21, 2007
                                  32,000    (7)           4.1%            $1.125            April 21, 2007

     Stephen T. Wills, CPA        45,000    (8)           5.7%             $1.00             July 22, 2007
                                  30,000    (9)           3.8%             $1.00             July 22, 2007

</TABLE>

                                       35
<PAGE>
<TABLE>
<CAPTION>
                                                    PERCENT OF TOTAL       EXERCISE
                                    OPTIONS        OPTIONS GRANTED TO        PRICE
     NAME                         GRANTED (#)       EMPLOYEES IN 1997      ($/SHARE)       EXPIRATION DATE
     -------                     -------------     ------------------     ----------      -----------------
<S>                               <C>                   <C>             <C>              <C>

     John T. Borthwick            50,000    (1)           6.4%            $1.125            April 8, 2007

     Gary L. Borthwick            50,000(1)(10)           6.4%            $1.125             July 1, 2002
</TABLE>
-------------------
(1)   These  non-qualified  options to  purchase  Common  Stock were  granted to
      members of the Company's  Senior  Management on April 8, 1997.  Options to
      purchase 10,000 shares were vested upon the grant and the remainder of the
      options vest in 10,000 increments on April 8 of each year through April 8,
      2001  at  which  time  the  options  will be  fully  vested.  Vesting  may
      accelerate  as follows:  (a) 25,000 of the options will vest if either net
      sales exceed  $6,000,000 in a 12 consecutive month period or the Company's
      Common Stock price for 180 consecutive  days exceeds $3.00 per share;  and
      (b) all  50,000  of the  options  will vest if  either  net  sales  exceed
      $8,000,000 in a 12 consecutive  month period or the Company's Common Stock
      price for 180  consecutive  days  exceeds  $5.00 per  share.  For  further
      information relative to these options,  please refer to the Company's Form
      8-K filed with the Securities and Exchange Commission on May 6, 1997.
(2)   These  incentive  stock  options to purchase  Common Stock were granted in
      November, 1997 and are vested.
(3)   These non-qualified  options to purchase Common Stock were granted in 1996
      pursuant  to Mr.  Quilty's  Employment  Agreement  at a price of $2.50 per
      share. These options were repriced by the Executive Committee of the Board
      of Directors on April 8, 1997.
(4)   These  options to  purchase  Common  Stock were part of an April 14,  1997
      grant of 150,000  non-qualified  options pursuant to Mr. Mink's Employment
      Agreement.  Of the original  grant,  118,000  options were  converted from
      non-qualified  to incentive stock options on November 5, 1997.  Options to
      purchase  59,000 shares  vested on November 14, 1997.  Options to purchase
      two additional  increments of 29,500 shares each will vest on November 14,
      1998 and April, 14, 1999,  respectively.  For further information relative
      to these options, please refer to "Employment Arrangements" below.
(5)   These  options to  purchase  Common  Stock  constitute  the  non-qualified
      options  component  of the 150,000  options  grant  discussed  in note (3)
      above.  Options to purchase  16,000  shares  vested on November  14, 1997.
      Options to purchase two  additional  increments  of 8,000 shares each will
      vest on November 14, 1998 and April, 14, 1999,  respectively.  For further
      information relative to these options,  please refer to the Company's Form
      8-K filed with the Securities and Exchange Commission on May 6, 1997.
(6)   These  options to  purchase  Common  Stock were part of an April 21,  1997
      grant  of  150,000   non-qualified   options  pursuant  to  Mr.  Caudell's
      employment  Agreement.   Of  the  original  grant,  118,000  options  were
      converted  from  non-qualified  to incentive  stock options on November 5,
      1997.  Options to purchase  59,000  shares  vested on November  21,  1997.
      Options to purchase two  additional  increments of 29,500 shares each will
      vest on November 21, 1998 and April, 21, 1999,  respectively.  For further
      information  relative  to  these  options,  please  refer  to  "Employment
      Arrangements" below.
(7)   These  options to  purchase  Common  Stock  constitute  the  non-qualified
      options  component  of the 150,000  options  grant  discussed  in note (5)
      above.  Options to purchase  16,000  shares  vested on November  21, 1997.
      Options to purchase two  additional  increments  of 8,000 shares each will
      vest on November 21, 1998 and April, 21, 1999,  respectively.  For further
      information relative to these options,  please refer to the Company's Form
      8-K filed with the Securities and Exchange Commission on May 6, 1997.
(8)   These options to purchase  Common Stock were part of a July 23, 1997 grant
      of 75,000  non-qualified  options  pursuant  to Mr.  Wills'  Stock  Option
      Agreement.  Of the original  grant,  45,000  options were  converted  from
      non-qualified  to  incentive  stock  options on  November  5, 1997.  These
      options vest over the period March 22, 1998 through January 22, 1999 at an
      average rate of 4,090 shares per month.
(9)   These  options to  purchase  Common  Stock  constitute  the  non-qualified
      options component of the 75,000 options grant discussed in note (7) above.
      Options to  purchase  20,833  shares were  vested on  December  22,  1997.
      Options to purchase an  additional  9,167  shares were vested on March 22,
      1998.
(10)  Pursuant to Mr.  Borthwick's  severance  agreement,  these options  ceased
      vesting  at  10,000  shares.  For  further  information  relative  to this
      agreement,  please  refer  to  the  Company's  Form  8-K  filed  with  the
      Securities and Exchange Commission on July 1, 1997.


                                       36
<PAGE>

Aggregate Year End Option Value Table

         The  following  table sets forth  information  regarding the number and
value of options to purchase Common Stock held by the named  executive  officers
as of December 31, 1997. No options have been exercised:
<TABLE>
<CAPTION>
                                               NUMBER OF SHARES                    VALUE OF UNEXERCISED
                                            UNDERLYING UNEXERCISED                IN-THE-MONEY OPTIONS
                                       OPTIONS AT DECEMBER 31, 1997 (#)         AT DECEMBER 31, 1997 ($)(1)
                                       --------------------------------       -----------------------------
     NAME                               EXERCISABLE      UNEXERCISABLE        EXERCISABLE     UNEXERCISABLE
     ----                               -----------      -------------        -----------     -------------
<S>                                        <C>               <C>                <C>              <C>
     Edward J. Quilty ...................  112,500           37,500                   0                0
                                            10,000           40,000                   0                0
                                           100,000                0             $32,500                0

     Richard S. Mink ....................   10,000           40,000                   0                0
                                            59,000           59,000                   0                0
                                            16,000           16,000                   0                0

     Charles F. Caudell, III ............   10,000           40,000                   0                0
                                            59,000           59,000                   0                0
                                            16,000           16,000                   0                0

     Stephen T. Wills, CPA...............        0           45,000                   0           $5,625
                                            20,833            9,167             $ 2,604           $1,146

     John T. Borthwick ..................   60,000           40,000                   0                0
                                            10,000           40,000                   0                0

     Gary L. Borthwick ..................   10,000                0                   0                0
                                            20,000                0                   0                0
                                             9,000                0                   0                0
</TABLE>
-------------------
(1)   Determined  based on a fair market value for the Company's Common Stock at
      December 31, 1997 of $1.125 per share.

COMPENSATION OF DIRECTORS

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

         Certain  directors of the Company  resigned and were granted options to
purchase a total of 61,000 shares of Common Stock in April,  1997. The following
table sets forth  information with respect to the grant of  non-qualified  stock
options to Laurence F. Lane, a current director of the Company, exclusive of the
Stock Option Plan:
<TABLE> <CAPTION>
                                        OPTIONS       EXERCISABLE OPTIONS AT   EXERCISE PRICE
     NAME                              GRANTED (#)     DECEMBER 31, 1997 (#)      ($/SHARE)        EXPIRATION DATE
     ----                              -----------     ---------------------      ---------        ---------------
<S>                                    <C>                       <C>               <C>          <C>
     Laurence F. Lane                  10,000(1)                 6,000             $1.125       November 21, 2006
                                       10,000(2)                10,000             $1.125           April 7, 2007
</TABLE>
------------------
(1)   These options began vesting at a rate of 20% per year on November 21, 1995
      and were repriced by the Executive Committee on April 8, 1997.
(2)   These options were granted on April 8, 1997.


                                       37
<PAGE>

EMPLOYMENT ARRANGEMENTS

         The Company entered into a three-year employment agreement on August 1,
1996, as amended on May 2, 1997, (the  "Agreement")  with Edward J. Quilty,  its
Chairman of the Board. The Agreement  provides that Mr. Quilty will receive base
salary  of  $150,000  per  year,   together  with  such   additional   incentive
compensation  as may be  awarded  upon the  recommendation  of the  Compensation
Committee of the Board of Directors;  provided,  however,  additional  incentive
compensation,  if any, shall be predicated  upon the extent to which the Company
attains its earnings goals and the extent of Mr. Quilty's contributions thereto.
As   additional   compensation,   the  Agreement   grants  Mr.  Quilty   150,000
non-qualified  stock  options,  exercisable  at a price of $1.125 per share,  of
which  112,500 were vested as of October 8, 1997 and the  remaining  37,500 will
vest on April 8, 1998.  These  options  become 100%  exercisable  if Mr.  Quilty
becomes  disabled,  the  Agreement is  terminated by the Company other than "for
cause," the Agreement is terminated by Mr. Quilty for the Company's  breach,  or
in the  event of the sale of  substantially  all of the  stock or  assets of the
Company, or upon the merger or consolidation of the Company in which the Company
is not the surviving entity. If the Company sells additional Common Stock during
the term of the Agreement in a transaction,  or related series of  transactions,
the  result of which is to  increase  the  number  of  shares  of  Common  Stock
outstanding  by 40%,  then Mr.  Quilty  will be granted  such  additional  stock
options,  exercisable at $1.125 per share,  as may be necessary to enable him to
purchase the same percentage of outstanding  Common Stock as he maintained prior
to such sale or issuance. In addition, in the event of the sale of substantially
all of the stock or assets of the Company,  or upon the merger or  consolidation
of the Company in which the  Company is not the  surviving  entity,  the Company
shall pay Mr. Quilty a severance  payment equal to the greater of his salary for
the remaining term of the Agreement or $125,000. Mr. Quilty may not disclose any
confidential  information  of the  Company  during  or  after  the  term  of the
Agreement, and may not compete with the Company during the term of the Agreement
and for a period of one year thereafter.

         The Company entered into a two-year  employment  agreement on April 14,
1997, as amended on November 5, 1997,  (the  "Agreement")  with Richard S. Mink,
its Chief  Operating  Officer  and former  Vice  President  for  Marketing.  The
Agreement  provides  that Mr.  Mink  receive the  following:  (1) base salary of
$150,000  per  year,  together  with a  $25,000  sign-on  bonus;  (2)  incentive
compensation  as may be  awarded  upon the  recommendation  of the Office of the
Chief  Executive  and  approved by the Board of  Directors;  provided,  however,
incentive compensation, if any, shall be predicated upon the extent to which the
Company  attains its earnings  goals and the extent of Mr. Mink's  contributions
thereto;  and (3) 118,000  incentive  and 32,000  non-qualified  stock  options,
exercisable at $1.125,  which options  become  exercisable to the extent of 50%,
75% and  100%  upon  completion  of six,  eighteen  and  twenty-four  months  of
employment,  respectively.  These options  become 100%  exercisable  if Mr. Mink
becomes  disabled,  the  Agreement is  terminated by the Company other than "for
cause," the Agreement is terminated by Mr. Mink for the Company's  breach,  upon
the sale of substantially all of the stock or assets of the Company, or upon the
merger or consolidation of the Company in which the Company is not the surviving
entity.  Upon the  sale of  substantially  all of the  stock  or  assets  of the
Company, or upon the merger or consolidation of the Company in which the Company
is not the surviving entity,  the Company shall pay Mr. Mink a severance payment
equal to the greater of his salary for the  remaining  term of the  Agreement or
$150,000. Mr. Mink may not disclose any confidential  information of the Company
during or after the term of the agreement,  and may not compete with the Company
during the term of the Agreement and for a period of one year thereafter.

         The Company entered into a two-year  employment  agreement on April 21,
1997, as amended on November 5, 1997, (the "Agreement") with Charles F. Caudell,
III, its Executive Vice President for Field Operations and former Vice President
for Sales.  The Agreement  provides that Mr. Caudell receive the following:  (1)
base salary of $150,000 per year; (2) incentive  compensation  as may be awarded
upon the recommendation of the Office of the Chief Executive and approved by the
Board of Directors;  provided, however, incentive compensation, if any, shall be
predicated  upon the extent to which the Company  attains its earnings goals and
the extent of Mr. Caudell's contributions thereto; and (3) 118,000 incentive and
32,000 non-qualified stock options,  exercisable at $1.125, which options become
exercisable to the extent of 50%, 75% and 100% upon completion of six,  eighteen
and twenty-four  months of employment,  respectively.  These options become 100%
exercisable if Mr. Caudell becomes disabled,  the Agreement is terminated by the
Company other than "for cause," the  Agreement is terminated by Mr.  Caudell for
the Company's breach,  upon the sale of substantially all of the stock or assets
of the Company,  or upon the merger or consolidation of the Company in which the
Company is not the surviving  entity.  Upon the sale of substantially all of the
stock or assets of the  Company,  or upon the  merger  or  consolidation  of the
Company in which the Company is not the surviving entity,  the Company shall pay
Mr. Caudell  a  severance payment  equal to  the greater  of his  salary for the

                                       38
<PAGE>

remaining  term of the Agreement or $150,000.  Mr.  Caudell may not disclose any
confidential  information  of the  Company  during  or  after  the  term  of the
agreement, and may not compete with the Company during the term of the Agreement
and for a period of one year thereafter.

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

         The Company entered into a three-year  employment agreement on December
29,  1995,  as amended  on April 30,  1997,  (the  "Agreement")  with  Robert P.
DiGiovine,  RPh, its  Director of  Regulatory  and  Clinical  Affairs and former
Director  of  Regulatory  Compliance  and  Product  Development.  The  Agreement
provides that Mr. DiGiovine will receive base salary of $100,000,  together with
such  incentive   and/or  bonus   compensation   as  may  be  awarded  upon  the
recommendation of the Office of the Chief Executive and approved by the Board of
Directors; provided, however, incentive and/or bonus compensation, if any, shall
be predicated  upon the extent to which the Company  attains its earnings  goals
and the extent of Mr. DiGiovine's contributions thereto; provided, further, that
such incentive and/or bonus compensation shall not exceed 35% of Mr. DiGiovine's
base compensation for a given year. In addition,  as further  compensation under
the Agreement,  the Company has granted Mr. DiGiovine 15,000 non-qualified stock
options  which vest in three  installments  during  the  period  January 1, 1996
through  January 1, 1998 at an exercise price of $2.50 per share.  These options
become 100%  exercisable if Mr.  DiGiovine  becomes  disabled,  the Agreement is
terminated by the Company other than "for cause," the Agreement is terminated by
Mr. DiGiovine for the Company's  breach,  upon the sale of substantially  all of
the stock or assets of the Company,  or upon the merger or  consolidation of the
Company  in which the  Company  is not the  surviving  entity.  Upon the sale of
substantially  all of the stock or assets of the Company,  or upon the merger or
consolidation  of the Company in which the Company is not the surviving  entity,
the Company shall pay Mr. DiGiovine a severance  payment equal to the greater of
his salary for the remaining  term of the Agreement or $100,000.  Mr.  DiGiovine
may not disclose any confidential information of the Company during or after the
term of the  Agreement,  and may not compete with the Company during the term of
the Agreement and for a period of one year thereafter.

                                       39
<PAGE>

STOCK OPTION PLAN

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

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

         At December 31,  1997,  there were  381,000  shares  subject to options
(ISOs) granted under the Plan with exercise  prices ranging from $0.80 to $1.125
per share.

SPECIAL CONSULTANT TO THE COMPANY

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


ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth as of March 24, 1998 certain information
regarding the current  beneficial  ownership of shares of the  Company's  Common
Stock, whether held outright or by virtue of Preferred Stock ownership,  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:

                                       40
<PAGE>
<TABLE>
<CAPTION>
                                                                 NUMBER OF SHARES                 PERCENT
             NAME AND ADDRESS OF BENEFICIAL OWNER (1)           BENEFICIALLY OWNED        BENEFICIALLY OWNED(14)
             ----------------------------------------           ------------------        ----------------------
<S>                                                                   <C>                          <C>
Hambrecht & Quist California (2)..........................            1,225,000                    21.15%
Galen III Partnerships (3)................................            1,000,000                    17.96%
Mary G. Clark, RN ........................................              775,474                    16.98%
Aries Funds (4)...........................................              750,000                    14.10%
Edward J. Quilty (5)......................................              670,500                    13.34%
Redwood Asset Management (6)..............................              500,000                     9.87%
John T. Borthwick (7).....................................              339,414                     7.30%
First Taiwan Investment Holding, Inc. (8).................              248,000                     5.43%
Charles F. Caudell, III (9) ..............................              160,000                     3.41%
Richard S. Mink (9) ......................................              157,500                     3.36%
Stephen T. Wills, CPA (10)................................              119,166                     2.56%
Laurence F. Lane (11).....................................               24,000                     (*)
Timothy J. Patrick .......................................                    0                     (*)
All directors and officers as a group (8 persons) (12) ...            2,246,054                    41.16%
</TABLE>
-------------------
(*)   Less than one percent
(1)   Except as otherwise  noted,  the address of each of the persons  listed is
      214 Carnegie Center, Suite 100, Princeton, New Jersey 08540.
(2)   Hambrecht  & Quist  California  can be reached  at: One Bush  Street,  San
      Francisco, California 94104. Ownership consists of 612,500 shares of Class
      A  Convertible  Preferred  Stock  ("Preferred  Stock")  which is  directly
      convertible to Common Stock and 612,500  warrants to purchase Common Stock
      exercisable at $0.90 per share ("Warrants").
(3)   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 250,000 shares of Common Stock,  375,000
      shares of Preferred Stock and 375,000 Warrants.
(4)   The Aries  Funds can be reached at:  Paramount  Capital,  Inc.,  The Aries
      Fund, 787 Seventh Avenue,  48th Floor, New York, New York 10019.  Includes
      shares owned by The Aries Fund, A Cayman  Islands Trust and Aries Domestic
      Fund,  L.P.  Ownership  consists of 375,000 shares of Preferred  Stock and
      375,000 Warrants.
(5)   Includes  412,500  shares  subject  to  options  and  Warrants   currently
      exercisable  and 47,500  additional  shares  subject to options  that will
      become exercisable within 60 days of March 24, 1998.
(6)   Redwood Asset  Management can be reached at: Ovre Ullorn Terrasse 32, 0358
      Oslo, Norway.  Ownership consists of 250,000 shares of Preferred Stock and
      250,000 Warrants.
(7)   Includes 70,000 shares subject to options currently exercisable and 10,000
      additional shares subject to options that will become  exercisable  within
      60 days of March 24, 1998.
(8)   First Taiwan Investment Holding,  Inc. can be reached at: 15/F, 563, Chung
      Hsiao, East Road, Section 4 Taipei, Taiwan R.O.C.
(9)   Includes  116,250  shares  subject  to  options  and  Warrants   currently
      exercisable  and 10,000  additional  shares  subject to options  that will
      become exercisable within 60 days of March 24, 1998.
(10)  Includes   72,083  shares  subject  to  options  and  Warrants   currently
      exercisable   and  8,333  shares  subject  to  options  that  will  become
      exercisable within 60 days of March 24, 1998.
(11)  Includes  16,000  shares  subject to  options  currently  exercisable.  No
      additional  shares  subject to options will become  exercisable  within 60
      days of March 24, 1998.
(12)  Includes  888,916  shares  subject  to  options  and  Warrants   currently
      exercisable and exercisable  within 60 days of March 24, 1998 by directors
      and officers of the Company.
(13)  The percent  beneficially  owned by each entity or individual  assumes the
      exercise  of all  exercisable  options  (including  those  that  would  be
      exercisable  within 60 days of March 24,  1998)  and the  exercise  of all
      Warrants owned by such entity or individual.


                                       41
<PAGE>

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The Company has entered into a five-year consulting agreement with Mary
G.  Clark,  a director  and the  Company's  founder and former  President.   The
agreement  provides that Mrs. Clark will provide  services to the Company as its
Special Consultant for Scientific  Affairs with annual  compensation of $70,000,
to be adjusted from time to time by the Company's  President and Chief Executive
Officer. Mrs. Clark's annual compensation for 1997 was $99,000.


ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

Exhibit
Number                          Description                                 Page
-------                        -------------                                ----
3.1     Articles of Incorporation  effective June 3, 1996 (Previously filed   --
        as Exhibit B to the Company's  Proxy  Statement  filed on April 23,
        1996 and incorporated herein by reference.)

3.2     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.)

3.3     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.)

10.1*   Stock Option Plan, dated July 18, 1991 (Previously filed as Exhibit   --
        10.01  to  the  Company's   statement   filed  on  Form  SB-2,  No.
        33-52246-NY,  declared  effective  on May 13,  1994  ["Registration
        Statement"] and incorporated herein by reference.)

10.2*   Stock Option Plan  Amendment,  dated  January 14, 1994  (Previously   --
        filed as Exhibit 10.02 to the Company's  Registration Statement and
        incorporated herein by reference.)

10.3*   Stock Option Plan  Amendment,  dated November 21, 1995  (Previously   --
        filed as Exhibit  10.03 to the  Company's  Form 10-KSB on March 29,
        1996 ["1996 Form 10-KSB"] and incorporated herein by reference.)

10.4*   Employment Agreement, dated August 1, 1996, between the Company and   --
        Edward  J.  Quilty.  (Previously  filed  as  Exhibit  10.41  to the
        Company's  Form 10-KSB on March 24, 1997  ["1997Form  10-KSB"]  and
        incorporated herein by reference.).

10.5*   Employment  Agreement -  Amendment  and  Restatement,  dated May 2,   --
        1997,  between the Company and Edward J. Quilty.  (Previously filed
        as Exhibit 10.04 to the Company's Form 8-K filed on May 6, 1997 and
        incorporated herein by reference.)

10.6*   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.)

10.7*   Employment Agreement,  dated April 14, 1997 between the Company and   --
        Richard  S.  Mink.  (Previously  filed  as  Exhibit  10.01  to  the
        Company's Form 8-K filed on May 6, 1997 and incorporated  herein by
        reference.)

10.8*   Employment Agreement,  dated April 21, 1997 between the Company and   --
        Charles F. Caudell,  III. (Previously filed as Exhibit 10.02 to the
        Company's Form 8-K filed on May 6, 1997 and incorporated  herein by
        reference.)

10.9*   Senior  Management  Stock Option  Agreement,  dated April 14, 1997,   --
        between  the  Company  and  Richard S. Mink.  (Previously  filed as
        Exhibit  10.10 to the  Company's  Form 8-K filed on May 6, 1997 and
        incorporated herein by reference.)

10.10*  Senior  Management  Stock Option  Agreement,  dated April 21, 1997,   --
        between the Company and Charles F. Caudell,  III. (Previously filed
        as Exhibit 10.08 to the Company's Form 8-K filed on May 6, 1997 and
        incorporated herein by reference.)

10.11*  Stock  Option  Agreement,  dated July 23, 1997, between the Company   --
        and Stephen T. Wills, CPA, MST. (Previously  filed as Exhibit 10.01
        to the Company's Form 10-QSB filed on August 15, 1997.)

10.12*  Employment Agreement, dated December 29, 1995,  between the Company   --
        and  John T.  Borthwick  (Previously  filed  as  Exhibit  10.37  to
        the  Company's  1996  Form  10-KSB  and   incorporated   herein  by
        reference.)

                                    42
<PAGE>

10.13*  Addendum to Employment Agreement,  dated March 5, 1997, between the   --
        Company and John T. Borthwick.  (Previously  filed as Exhibit 10.38
        to the  Company's  1997  Form  10-KSB  and  incorporated  herein by
        reference.)

10.14*  Senior  Management  Stock Option  Agreement,  dated April 30, 1997,   --
        between  the Company and John T.  Borthwick.  (Previously  filed as
        Exhibit  10.06 to the  Company's  Form 8-K filed on May 6, 1997 and
        incorporated herein by reference.)

10.15*  Employment  Agreement, dated December 29, 1995, between the Company   --
        and  Robert  P.  DiGiovine (Previously  filed as  Exhibit  10.41 to
        the  Company's  1996  Form  10-KSB  and  incorporated   herein   by
        reference.)

10.16*  Employment  Agreement - Amendment and Restatement,  dated April 30,   --
        1997, between the Company and Robert P. DiGiovine (Previously filed
        as Exhibit 10.03 to the Company's Form 8-K filed on May 6, 1997 and
        incorporated herein by reference.)

10.17*  Senior  Management  Stock Option  Agreement,  dated April 30, 1997,   --
        between the Company and Robert P. DiGiovine.  (Previously  filed as
        Exhibit  10.09 to the  Company's  Form 8-K filed on May 6, 1997 and
        incorporated herein by reference.)

10.18*  Promissory Note,  dated January  17, 1995,  between the Company and   --
        John T.  Borthwick  (Previously  filed  as  Exhibit  10.73  to  the
        Company's 1995 Form 10-KSB incorporated herein by reference.)

10.19*  Stock  Option  Agreement,  dated  November  21,  1995,  between the   --
        Company and Laurence F. Lane (Previously  filed as Exhibit 10.51 to
        the  Company's  1996  Form  10-KSB  and   incorporated   herein  by
        reference.)

10.30   Loan  Agreement,  dated July 15, 1993,  between the Company and PNC   --
        Bank   (Previously   filed  as  Exhibit   10.40  to  the  Company's
        Registration Statement and incorporated herein by reference.)

10.31   Commitment  Letter,  dated June 17,  1993,  to the Company from PNC   --
        Bank relative to line of credit  (Previously filed as Exhibit 10.41
        to the Company's  Registration Statement and incorporated herein by
        reference.)

10.32   Promissory  Note, dated July 15, 1993, from the Company to PNC Bank   --
        (Previously  filed as Exhibit 10.42 to the  Company's  Registration
        Statement and incorporated herein by reference.)

10.33   Commercial  Security  Agreement,  dated July 15, 1993,  between the   --
        Company  and PNC Bank  (Previously  filed as  Exhibit  10.43 to the
        Company's   Registration   Statement  and  incorporated  herein  by
        reference.)

10.34   Assignment  of Trademarks  from the Company in connection  with the   --
        PNC  Bank  financing  (Previously  filed  as  Exhibit  10.44 to the
        Company's   Registration   Statement  and  incorporated  herein  by
        reference.)

10.35   Trademark  Security  Agreement  between  the  Company  and PNC Bank   --
        (Previously  filed as Exhibit 10.45 to the  Company's  Registration
        Statement and incorporated herein by reference.)

10.36   Assignment of Patents from the Company in  connection  with the PNC   --
        Bank financing  (Previously filed as Exhibit 10.46 to the Company's
        Registration Statement and incorporated herein by reference.)

10.37   Patent  Security   Agreement  between  the  Company  and  PNC  Bank   --
        (Previously  filed as Exhibit 10.47 to the  Company's  Registration
        Statement and incorporated herein by reference.)

10.38   Financing  Statement executed July 15, 1993 between the Company and   --
        PNC Bank  (Previously  filed  as  Exhibit  10.48  to the  Company's
        Registration Statement and incorporated herein by reference.)

10.39   Agreement to Provide  Insurance,  dated July 15, 1993,  between the   --
        Company  and PNC Bank  (Previously  filed as  Exhibit  10.49 to the
        Company's   Registration   Statement  and  incorporated  herein  by
        reference.)

10.40   Patent  Assignment,  dated  April  22,  1994,  from PNC Bank to the   --
        Company  (Previously  filed  as  Exhibit  10.91  to  the  Company's
        Registration Statement and incorporated herein by reference.)

10.41   Rider to the  Security  Agreement - Patents,  dated April 27, 1994,   --
        between the Company and PNC Bank (Previously filed as Exhibit 10.92
        to the Company's  Registration Statement and incorporated herein by
        reference.)

                                    43
<PAGE>

10.42   Changes  in Terms  Agreement,  dated  June 27,  1994,  between  the   --
        Company  and PNC Bank.  (Previously  filed as Exhibit  10.52 to the
        Company's 1995 Form 10-KSB incorporated herein by reference.)

10.43   Changes in Terms Agreement, dated July 7, 1995, between the Company   --
        and PNC Bank  (Previously  filed as Exhibit  10.28 to the Company's
        1996 Form 10-KSB incorporated herein by reference.)

10.44   Lease Agreement,  dated July 1, 1997, between the Company and Cross   --
        Creek Pointe.

10.45   Lease Agreement,  dated September 1, 1993,  between the Company and   --
        Mariotti  Building  Products  (Previously filed as Exhibit 10.51 to
        the Company's  Registration  Statement and  incorporated  herein by
        reference.)

10.46   License  Agreement,  dated June 24,  1994,  between the Company and   --
        P.T.  Tempo  Scan  Pacific  (Previously  filed as  Exhibit 1 to the
        Company's Form 8-K dated June 24, 1994 and  incorporated  herein by
        reference.)

10.47   License  Agreement,  dated May 10,  1995,  between  the Company and   --
        Trans  CanaDerm,  Inc.  (Previously  filed as Exhibit  10.03 to the
        Company's  Form  10-QSB  filed  on June 30,  1995 and  incorporated
        herein by reference.)

10.48   License Agreement,  dated October 31, 1996, between the Company and   --
        Gamida-MedEquip  Ltd.  (Previously  filed as  Exhibit  10.33 to the
        Company's 1997 Form 10-KSB and incorporated herein by reference.)

10.49   License  Agreement,  dated May 1, 1995,  between  the  Company  and   --
        Canadian Medical Supply, Inc. (Previously filed as Exhibit 10.04 to
        the Company's  Form 10-QSB filed on June 30, 1995 and  incorporated
        herein by reference.)

10.50   Distribution  Agreement,  dated April 8, 1995,  between the Company   --
        and  Inter-Health,  Inc.  Previously  filed as Exhibit 10.02 to the
        Company's  Form  10-QSB  filed  on June 30,  1995 and  incorporated
        herein by reference.)

10.51   Distribution Agreement, dated January 29, 1996, between the Company   --
        and  Manta  Medical  (Previously  filed  as  Exhibit  10.36  to the
        Company's 1996 Form 10-KSB and incorporated herein by reference.)

10.52   Private Label  Agreement,  dated  September  29, 1997,  between the   --
        Company and Innovative  Technologies Limited.  (Previously filed as
        Exhibit  10.02 to the  Company's  Form 10-QSB filed on November 10,
        1997.)

10.53** Product  Development and  Manufacturing  Agreement,  dated November   --
        11, 1997, between the Company and Innovative Technologies Limited.

10.54   Generic Products  Agreement,  dated September 29, 1997, between the   --
        Company and Innovative  Technologies  Limited  (Previously filed as
        Exhibit  10.01 to the  Company's  Form 10-QSB filed on November 10,
        1997.)

10.55   Asset Purchase Agreement,  dated June 21, 1996, between the Company   --
        and Morgan Paris,  Inc.  (Previously  filed as Exhibit 10.01 to the
        Company's Form 8-K filed on June 27, 1996.)

10.56   Settlement  Agreement  and Mutual  Release,  dated  June 21,  1996,   --
        between the Company and Morgan  Paris,  Inc.  (Previously  filed as
        Exhibit 10.02 to the Company's Form 8-K filed on June 27, 1996.)

10.57   Agreement and Release,  dated May 29, 1997, between the Company and   --
        Gary L. Borthwick  (Previously filed as Exhibit 10 to the Company's
        Form 8-K filed on July 1, 1997.)

10.58   Consulting Agreement, dated March 14, 1994, between the Company and   --
        Mary G. Clark  (Previously  filed as Exhibit 10.80 to the Company's
        Registration Statement and incorporated herein by reference.)

10.59   Agreement and Release, dated December 23, 1996, between the Company   --
        and Donald F.  McHale  (Previously  filed as  Exhibit  10.01 to the
        Company's Form 8-K filed on January 6, 1997.)

10.60*  Company's  401(k)  Plan,  dated June 30, 1995 (Previously  filed as   --
        Exhibit 10.56 to the  Company's 1996  Form 10-KSB  and incorporated
        herein by reference.)

27      Financial Data Schedule
--------------------
*       Management contract or compensatory plan.

**      The Company has requested  confidential treatment of  certain provisions
        contained  in Exhibit  10.53.  The copy  filed as an  exhibit  omits the
        information subject to the confidentiality request.

                                    44
<PAGE>

(b)  Reports on Form 8-K

          A current  report on Form 8-K was filed on November 24, 1997  relative
to the Company's private placement of securities.



                                       45
<PAGE>

                                   SIGNATURES


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


                                             DERMA SCIENCES, INC.



March 27, 1998                               By:   /s/ Edward J. Quilty
                                                   ---------------------
                                                   Edward J. Quilty
                                                   Chairman of the Board


         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 27, 1998.

         Signatures:                              Title:

    /s/ Edward J. Quilty            Chairman of the Board (Principal
---------------------------         Executive Officer)
Edward J. Quilty

    /s/ Stephen T. Wills            Vice President and Chief Financial Officer
--------------------------          (Principal Financial and Accounting Officer)
Stephen T. Wills

    /s/ Mary G. Clark               Director
--------------------------
Mary G. Clark

    /s/ John T. Borthwick           Director
--------------------------
John T. Borthwick

    /s/ Laurence F. Lane            Director
--------------------------
Laurence F. Lane

    /s/ Timothy J. Patrick          Director
--------------------------
Timothy J. Patrick