# UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-KSB

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| | x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
| | - | ------------------------------------------------------------------------------------

# For the
fiscal year ended June 30, 2006

| | o | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
                  EXCHANGE ACT OF 1934
| | - | ----------------------------------------------------------------------------------------------------

For the transition period from __________ to __________.

Commission file number: 1-16053



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

| | DELAWARE
(State or other jurisdiction of incorporation or organization) |  | 87-0475073
(I.R.S. Employer Identification No.) | 
| | ----------------------------------------------------------------------- |  | ----------------------------------------------- | 

| | 8 Allerman Road, Oakland, NJ
(Address of principal executive offices) |  | 07463
(Zip Code) | 
| | --------------------------------------------------------------------- |  | ---------------- | 

Issuers telephone number: (201) 677-9311

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

|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange on which registered
|Common Stock        |  | AMEX                                     

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

Common Stock(Title of Class)

Check whether the issuer (1) filed
all reports required to be filed by Section 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 the 90 past days.
Yesx
Noo

Check if there is no disclosure of
delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no
disclosure will be contained, to the best of registrants knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.o

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

State issuer's revenues for its most recent fiscal year:  $21,273,362.

The aggregate market value of voting
and non-voting stock of the issuer held by non-affiliates on September 15, 2006 was
$40,263,560.

# APPLICABLE ONLY TO
CORPORATE REGISTRANTS

As of September 15, 2006, we had
11,131,363 shares of common stock issued and outstanding.

# DOCUMENTS INCORPORATED
BY REFERENCE

None.

Transitional Small
Business Disclosure Format (check one):
YES
o
NO
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# MEDIA
SCIENCES INTERNATIONAL, INC.

# INDEX

|        | PART I                                              |   
|------- | --------------------------------------------------- | --
|Item 1. | Description of Business                             | 4 
|Item 2. | Properties                                          | 14
|Item 3. | Legal Proceedings                                   | 14
|Item 4. | Submission of Matters to a Vote of Security Holders | 15

|         | PART II                                                                              |   
|-------- | ------------------------------------------------------------------------------------ | --
|Item 5.  | Market for the Company's Common Equity and Related Stockholder Matters               | 16
|Item 6.  | Management's Discussion and Analysis                                                 | 17
|Item 7.  | Financial Statements and Supplementary Data                                          | 43
|         | Consolidated Balance Sheets                                                          | 45
|         | Consolidated Statements of Operations                                                | 46
|         | Consolidated Statements of Changes in Shareholders' Equity                           | 47
|         | Consolidated Statements of Cash Flows                                                | 48
|         | Notes to Consolidated Financial Statements                                           | 49
|         | Supplemental Information                                                             | 68
|Item 8.  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure | 72
|Item 8A. | Controls and Procedures                                                              | 72
|Item 8B. | Other Information                                                                    | 72

|           | PART III                                                       |   
|---------- | -------------------------------------------------------------- | --
|Item 9.    | Directors and Executive Officers of the Registrant             | 73
|Item 10.   | Executive Compensation                                         | 78
|Item 11.   | Security Ownership of Certain Beneficial Owners and Management | 84
|Item 12.   | Certain Relationships and Related Transactions                 | 87
|Item 13.   | Exhibits                                                       | 88
|Item 14.   | Principal Accountant Fees and Services                         | 90
|           |                                                                |   
|Signatures |                                                                | 91

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# SPECIAL NOTE REGARDINGFORWARD-LOOKING
STATEMENTS

This report contain forward-looking
information, within the meaning of Section 27A of the Securities Act of 1933 and Section
21E of the Securities Exchange Act of 1934, about our financial results and estimates,
business prospects and products in development that involve substantial risks and
uncertainties. You can identify these statements by the fact that they do not relate
strictly to historic or current facts. These forward-looking statements use terms such as
believes, expects, may, will,
should, anticipates, estimate, project,
plan, or forecast or other words of similar meaning relating to
future operating or financial performance or by discussions of strategy that involve risks
and uncertainties. From time to time, we also may make oral or written forward-looking
statements in other materials we release to the public.  These forward-looking
statements are based on many assumptions and factors, and are subject to many conditions,
including, but not limited to, our continuing ability to obtain additional financing,
dependence on contracts with suppliers and major customers, competitive pricing for our
products, demand for our products, changing technology, our introduction of new products,
industry conditions, anticipated future revenues and results of operations, retention of
key officers, management or employees, prospective business ventures or combinations and
their potential effects on our business.

Our actual results, performance or
achievements could differ materially from the results expressed in, or implied by, these
forward-looking statements. Forward-looking statements are made based upon
managements current expectations and beliefs concerning future developments and
their potential effects upon our business. We cannot guarantee that any forward-looking
statement will be realized, although we believe we have been prudent in our plans and
assumptions. We cannot predict whether future developments affecting us will be those
anticipated by management, and there are a number of factors that could adversely affect
our future operating results or cause our actual results to differ materially from the
estimates or expectations reflected in such forward-looking statements.  We undertake
no obligation to publicly update forward-looking statements, whether as a result of new
information, future events or otherwise.

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# PART I

## ITEM 1.   
DESCRIPTION OF BUSINESS

# Overview

Media Sciences is a leading
manufacturer of consumables (supplies) for use in color business printers and industrial
printers. Our products are a high-quality, lower cost, alternative to the printer
manufacturers brand of supplies. Behind every Media Sciences product is The Science
of Color  our proprietary process for delivering high quality products at the
very best price while including a commitment to exceptional, highly responsive technical
support and our longstanding industry leading warranty.

We sell and distribute our products
through international, indirect sales channels including wholesalers, distributors and
dealers. Approximately 82% of our revenues are generated in the United States, with the
majority of our international sales generated in Western Europe. We have a concentration
of sales with three customers representing 35% of our revenues.

Our growth has been, and will
continue to be, a function of the growth of the overall business color printer market,
expansion of our product line, and an increase in market share for our products.

Our business is derived from a single
segment, that of imaging supplies.

# Our Organizational
History

We are a Delaware corporation named Media Sciences International, Inc. Our web site address is
www.mediasciences.com.

We originally incorporated under the
laws of the State of Utah on August 11, 1983 under the name Communitra Energy, Inc. On
July 16, 1985, we amended our articles of incorporation to change our name to Seafoods
Plus, Ltd. We did not engage in any substantive business activity from approximately 1988
to June 18, 1998.

On June 18, 1998, we acquired
Cadapult Graphic Systems Inc., a privately-held New Jersey corporation formed on May 1,
1987 engaged in the business of providing computer graphics systems, peripherals, supplies
and services to visual communicators and graphics professionals, in a transaction viewed
as a reverse acquisition.

On August 14, 1998, we reincorporated
under the laws of the State of Delaware as Cadapult Graphic Systems, Inc. On August 11,
1999, we formed Media Sciences, Inc., as a wholly-owned New Jersey subsidiary, for the
manufacture and distribution of digital color printer supplies.

In December  1999,  Media  Sciences,  Inc.  acquired the assets of  ultraHue,  Inc.,  a New Mexico  corporation,  a
manufacturer of workgroup color printer supplies.

On April 19, 2002, we amended our
certificate of incorporation to change our corporate name to Media Sciences International,
Inc.

On April 26, 2002, we formed Cadapult
Graphic Systems, Inc., as a wholly-owned New Jersey subsidiary, for selling supplies
directly to certain end users and for the sale and servicing of electronic pre-press
systems.

In May 2005, we discontinued all
electronic pre-press systems sales and service operations, the majority of the Cadapult
business.

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Media Sciences International, Inc. is
a holding company and does not engage in substantive independent business operations. We
conduct substantially all of our operations through our subsidiaries. Media Sciences
International, Inc. has two wholly-owned operating subsidiaries: Media Sciences, Inc. and
Cadapult Graphic Systems, Inc. Our wholly-owned subsidiary, Media Sciences, Inc.,
manufactures and distributes color printer supplies, including solid ink sticks and toner
cartridges for use in Tektronix, Xerox, QMS-Minolta, Epson, Ricoh, Oki and other color
printers. Media Sciences, Inc. also has a wholly-owned subsidiary, Media Sciences UK
Limited, which was formed in February 2005.  Media Sciences UK Ltd. provides local
resources to support and grow our Media Sciences distribution partners and end users in
eastern and western Europe. Cadapult Graphic Systems, Inc., sells supplies directly to
certain end users through our INKlusive color printer program and to those with whom we
have a historical relationship.

As of September 15, 2006 we had
11,131,363 shares of common stock issued and outstanding, and no preferred shares
outstanding.

We have not been subject to
bankruptcy, receivership or any similar proceedings.

# Industry and Market
Overview

Color Business Printers

The office environment has been
dominated by monochrome (black and white) printers for document printing. Over the past
several years color printers have been introduced in the office for high impact
communications where color presentation was critical. Today, the production of color
documents in the office is less the exception and more the norm, and with many favorable
market drivers, the use of color documents is expected to grow. The result  while
monochrome printer shipments are flat to declining, color printer shipments are growing
rapidly.

While monochrome printers are
predominately based on laser technology, there are three significant technologies in color
printing: inkjet, toner-based color laser and color solid ink.

Inkjet printers are typically very
inexpensive to buy, print slowly, and produce their best images on expensive special
papers. In general, they are expensive to operate. However, their low purchase price
(sometimes almost free) has made them ubiquitous for home printing. As well, they are
often found in small businesses where print volumes are low.

Where faster print speeds and lower
cost of ownership are desired, color laser and color solid ink dominate. Color laser
printers are very similar to monochrome laser printers, except they use four toner
cartridges (cyan, magenta, yellow and black) instead of a single black cartridge. Color
solid ink printers utilize a very different technology. These printers consume solid ink
sticks, again in four colors. Solid ink sticks are like large crayons, which when placed
into the printer, are melted and jetted. While color laser printers are
available from almost all of the major printer vendors, only Xerox has been successful in
commercializing solid ink for the office environment.

The adoption of color in the office
has been facilitated by lower costs of acquisition such as sub-$1000 and sub-$500 color
laser and solid ink printers along with increased print speeds, quality and reliability.
In addition to the lower costs, favorable market dynamics are driving the use of office
color printers. Primary contributors are the use of internet, which has broadened the
acceptance of color communication, the distribute and print model, where
digital document delivery is enhanced with localized printing as a way to shorten turn
around times and reduce production costs as well as the dominance of color printing in the
home and school.

Worldwide shipments of color laser
and solid ink printers accelerated in 2003 through 2005 and are expected to grow steadily
from just over 3.5 million units in 2005 to almost 8.5 million units in 2010 resulting in
a compound annual growth rate of over 20% in that period of time (source: Lyra Research,
Inc. Hard Copy Industry Advisory Service, First-Half 2006 Forecast). In addition, the 2005
 2010 compound annual growth rate of worldwide color laser cartridge revenues
is expected to be 30%, resulting in a $13 Billion expansion of those revenues. The related
market for convenience color copiers and color Multi-Function Products, some of which are
essentially color printers with additional capabilities such as scanning and copying, is
expected to enjoy a blistering 2004-2009 compound annual growth rate of 55%.

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Today, the dominant sources of color
printer supplies are the printer manufacturers or Original Equipment Manufacturers (OEMs)
themselves. These manufacturers discount the cost of the printer hardware to gain market
share, in an effort to capture the recurring profitable revenue stream of supplies.
Further their established brands and distribution often result in their product being the
only option offered to a consumer.

Today, the aftermarket is robust for
monochrome, remanufactured and new build toner cartridges. Approximately 32% of the
monochrome cartridges purchased in 2005 were aftermarket cartridges. In contrast, only 7%
of the color laser cartridges purchased in 2005 were aftermarket cartridges. The
aftermarket for color cartridges has lagged monochromes adoption of aftermarket
supplies, as the cost of color printers has remained high relative to monochrome printers,
thereby sustaining a perception of risk when using an alternative to the printer
manufacturers brand. With recent declines in the cost of office color printers, the
perceived risk is diminishing and users are increasing their pace of adoption of
aftermarket color printer supplies. Further, the monochrome aftermarket has benefited from
Hewlett-Packards (HP®) dominance as it has allowed for a concentration of
resources to be focused on relatively few products that address a significant portion of
the market. While HP is the market leader in office color printers, the market is much
more diffuse, requiring many more unique products to address an equally broad segment of
the market.

Lyra Research estimates that the
aftermarket share of color laser cartridge shipments will increase to almost 12% by 2010.
As the market matures, we believe that the color market will ultimately mirror the
monochrome market with the aftermarket achieving an aggregate share of shipments of
25-30%.

Industrial Printers

Industrial printers or so called
coders are used in manufacturing environments to print date codes, lot codes,
bar codes and other information on products and packaging. These coders are single
color devices, but may print black, green, red, blue or other colors at any
given time. These printers may also be used to apply invisible symbols or codes, or apply
inks with special chemical or elemental markers to help verify the authenticity of goods,
or to reduce the diversion of goods from one country or distribution point to another.

There are three primary printing
technologies in the industrial space: solid ink, liquid ink and laser. The overall market
is relatively flat, with some growth being seen in the area of laser coders. In general,
there is an increasing move to radio frequency identification (RFID) technology to provide
the benefits of visible marking and more. However, the use of RFID tags is generally in
conjunction with a visible mark.

Industrial coders generally consume
relatively high volumes of ink as they may run 24 hours a day, 365 days of the year.
Because of the high volume, high speed manufacturing environments in which coders are
present, they are a mission critical component in the manufacturing process. By way of
example, a single candy bar line may have 1000 candy bars passing by the coder every
minute. Consequently, the reliability of the coder and its inks are paramount.

As with the business color market,
the primary source of supplies for these coders is the manufacturer of the coder itself.
There are a few aftermarket companies that have successfully entered the liquid ink-jet
space. Aside from the coder manufacturers, we are not aware of any other competition for
our industrial solid inks. In the industrial marking space, as in the business color
market, price is the primary reason for adoption of aftermarket supplies.

# Growth Strategy

Media Sciences growth has been,
and will continue to be driven by three factors: overall market growth, new product
development and an increase in market penetration for its existing and new products. In
addition, we are considering strategic acquisitions.

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Overall market growth, new products
and market penetration are all intimately interrelated. To understand this codependency,
it is important to understand the lifecycle of a printer, and more specifically a color
printer. Technology in general, and printers specifically, become obsolete over time. As
an integral part of our planning process, we generally model three year active
lives for color printers. That is, we assume that a printer sold in a particular period
will be used for three years, and in that same period three years later, will be disposed
of (the reality is that printers continued to be used to a lesser degree for years beyond
the three). These models reflect the bell curve nature of each printers
installed base. Media Sciences uses these models for budgeting, forecasting, and product
development analysis.

When looking at market growth and new
product development, it is important to understand that, because of the limited life of
any one printer, in order to keep up with the market growth, new products must be brought
to market to replace those that are falling off.

Based on our products available for
sale at March 31, 2006, and assuming the three year lives discussed above, we believe we
manufacture supplies for use in approximately 20% of the overall, active installed base
(the addressable market) of business color printers. We call this our
available market.

Our available market is dynamic and
changes as a function of the timing of our product introductions versus introductions of
new business color printers by the OEMs. The goal of our product development group is to
increase the size of our available market, or said another way, to increase our share of
the addressable market. To do so, we need to bring more products to market than are
falling off. Our decision as to which products to bring to market is impacted by the size
of a target installed base, the distribution required to bring those supplies to the
market, the existence within our product line of supplies for use in other printers by
that same OEM, the margin structure of the proposed product, the costs and time to develop
the product. Consequently, we may bring products to market that target a very large
installed base, or that may target a relatively small installed base.

Further, a vast majority of the
business color market is toner based. As we seek to align our business with the broader
addressable market, we expect increases in the size of our available market to be
generated primarily from new color toner cartridge product introductions. As a result, we
expect our growth of color toner cartridge revenues to outpace the growth of our solid ink
revenues for the foreseeable future.

To increase the size of our available
market, we have been, and will continue to expand our development resources. Over the last
12 months we approximately doubled our development staff under a new Director of
Engineering and invested $500,000 to expand our analytical lab. We plan to continue to
expand our development resources in both people and technology to accelerate our product
development timeline, and the number of simultaneous projects under development at any
given time. Our product development will focus on both expanding the number of products
that we offer for use in a particular manufacturers printer line, as well as
expanding the number of printer manufacturers that we target.

Concurrent with our goal of
increasing our available market, we are focused on increasing our market share within our
available market. We believe that we finished our Fiscal 2006 year with an aggregate 2.5%
market share of our available market, and a 0.6% share of the addressable market. The goal
of our sales and marketing efforts is to increase our market share within our available
market.

Any combined growth of the
addressable market, our available market and our market share would be multiplicative in
its impact on our overall growth.

To augment our core strategy, Media
Sciences may consider certain acquisitions. Acquisition targets may fall within one or two
categories. The first category is the opportunity to accelerate the expansion of our
development resources and competencies versus building these resources over time. Such
acquisition targets may include chip development entities, toner manufacturing joint
ventures, and cartridge engineering and design entities.

The second category of potential
targets would be entities that could bring Media Sciences into new imaging markets or
applications. Such acquisitions would allow Media Sciences to enter complementary markets
where substantial barriers to entry currently exist. These acquisitions may increase our
global business opportunity, diversify our business risks, and create synergies with our
existing business, while leveraging our core competencies.

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Potential acquisitions we might
consider could be larger or smaller than our current market capitalization. We are
currently evaluating the viability of certain potential acquisitions. We believe any
acquisition should be almost immediately accretive to our cash flow. We provide no
assurance that we will make any acquisitions or that if we do, that we will be successful
in achieving our objectives.

# Principal Products and
Programs

Color Business Printers

Color business printers consume a
number of supply items including toner cartridges or solid ink sticks, imaging units,
fuser units and waste bottles. There are typically four toner cartridges or solid inks in
a color printer: Cyan, Magenta, Yellow and Black. Through the combination of these four
colors, printed pages with seemingly millions of colors can be produced. Media Sciences
manufactures cyan, magenta, yellow and black solid inks and color toner cartridges.

Solid Ink.   We manufacture and
distribute solid ink sticks for use in certain business color printers. Our solid inks
offer the end user the opportunity to save 30-50% on their solid inks versus buying the
Xerox® brand.

We manufacture solid ink for use in
the following printers:

| |  | Tektronix® Phaser® 340, 350, 360, 840, 850
| | - | ------------------------------------------

| |  | Xerox Phaser 860, 8200, 8400, 8500, 8550
| | - | ----------------------------------------

| |  | Xerox WorkCentre® C2424 color multifunction device.
| | - | ---------------------------------------------------

We currently offer solid inks for all
of the business color solid ink printers currently available in the market. Consequently
we have no new color solid ink product introductions planned at this time. However, as
Xerox introduces additional solid ink printers, copiers or Multi-Function Products to the
market, we intend to develop supplies for those devices.

Further, we have the capability to
develop and produce specialty solid inks, including special colors and inks with markers
for product authentication and security applications. While we have no such products
planned for introduction, we are making this capability known, should one or more
customers have a need for specialty inks.

Toner Cartridges.   We offer two
lines of toner cartridges: Clearcase® color toner cartridges and our Premium line of
toner cartridges. Our Clearcase and Premium lines cartridges are both newly manufactured,
and both offer the end user the opportunity to save up to 30% on their color toner
cartridges versus the OEM brand. However, our Clearcase cartridges feature a unique clear
case allowing the user to see the color toner within the cartridge. We intend to migrate
our Premium cartridges to the Clearcase line and to introduce all future color toner
cartridges as Clearcase products.

We manufacture color toner cartridges
for use in certain Tektronix, Xerox, Konica-Minolta®, Oki®, Epson®,
Brother® and Ricoh® color printers as follows:

| |  | Clearcase  Our Clearcase line of toner cartridges are for use in the following printers:
| | - | -----------------------------------------------------------------------------------------

| |  |  | Tektronix Phaser 560, 740, 750 and 780
| |  | - | --------------------------------------

| |  |  | Xerox Phaser 790, 7700, 6200 and 6250
| |  | - | -------------------------------------

| |  |  | Konica-Minolta (formally QMS®) Magicolor® 2300, 330, 3100 and 3300
| |  | - | ------------------------------------------------------------------

| |  |  | Epson C900, C4000 and C4100
| |  | - | ---------------------------

| |  |  | Brother HL4000 and HL4200
| |  | - | -------------------------

| |  |  | Ricoh 3800 and 7000 series
| |  | - | --------------------------

| |  | Premium Color Toner Cartridges  Our Premium color toner cartridges are for use in
the following printers:
| | - | ----------------------------------------------------------------------------------------------------------

| |  |  | Xerox Phaser 1235, 2135 and 7300
| |  | - | --------------------------------

| |  |  | Konica 7812, 7820 and 7830
| |  | - | --------------------------

| |  |  | Oki 5000, 7000 and 9000 series
| |  | - | ------------------------------

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INKlusive®.   
          Our INKlusive color printer program provides a customer with a business color
          printer or multifunction device, on-site service and a defined, regular shipment
          of ink or toner supplies, all for the cost of just the supplies. It is truly a
          free color printer program. Consequently, the INKlusive program provides the
          customer with one of the lowest costs of ownership of a business color printer
          in the industry today.

There are currently three versions of
the program starting at $99 per month for two years through $199 per month for three
years. The program has included both color toner and solid ink based printers and a solid
ink based multifunction device. The program requires a 24 to 36 month commitment, and upon
successful completion of the program, the printer is the customers to keep at no
additional charge.

The INKlusive program is targeted at
small businesses, education, not-for-profits and real estate agents and brokers. The
program is advanced by our channel partners who receive a commission for each unit placed,
and are encouraged to sell additional Media Sciences supplies to the customer. More
information on the INKlusive program is available at www.inklusive.com.

Media Sciences offers this program in
conjunction with a financing company. Media Sciences does not own or otherwise finance the
cost of the printer, nor does Media Sciences guarantee the credit worthiness of the
customer. Under our agreement with the financing company, at the time of placement of the
INKlusive printer, we are paid in full for the printer and the two, or three, as the case
may be, years of supplies. We recognize the revenue from the supplies as they are shipped
over the term of the INKlusive agreement. Consequently, the difference in timing between
receipt of payment for the supplies and those that are shipped gives rise to deferred
revenue on our balance sheet.

For the year ended June 30, 2006
revenue recognized from the shipment of INKlusive supplies represented approximately 4% of
our total revenues, up from 3% of revenues for the year ended June 30, 2005, and gave rise
to an incremental $330,000 in deferred revenue which will be recognized as the supplies
are shipped over the remaining terms of those INKlusive agreements. As of
June 30, 2006, deferred revenue totaled $1.1 million as compared with $0.8 million as of
June 30, 2005.

Industrial Printers

We manufacture solid ink for use in
industrial marking, or coding, applications. These products include solid ink for use in
the Markem 9000 and 5000 series coders. These products, available in two colors, black and
blue, are sold under private label brands and offer a savings of up to 24-30% versus the
Markem brand.

We have entered into a supply
agreement with an industrial printer manufacturer. Under this agreement, we supply this
manufacturer with solid ink sticks for the printers they manufacture and distribute. Our
customer distributes these inks under their own brand.

Based on projected volumes over the
next 12 months, we do not expect sales under this agreement to materially contribute to
our revenues or earnings.

# Branding

Media Sciences has adopted a
tri-branding strategy for our products. Today, approximately 55% of our revenues are
derived from the sale of Media Sciences branded products and programs. The
balance of our revenues are derived from white-box and private brand revenues.

Under our white-box programs, we sell
our products in a plain white box. Our customers may custom label these products for
their customers, or sell them unmarked in a plain white box. Certain dealers prefer
white-box products as they are trying to differentiate their product from their
competitors. The result is analogous to the mattress industry where various stores market
essentially the same mattress under various labels.

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Our private brand program targets
large, national or international entities that have developed significant brand equity and
wish to extend their brand to our products. For example, certain large retail office
supplies companies have stated that they have a strategic objective to expand the number
of items in their stores carrying their brand. Under such a relationship we configure and
package our products in custom packaging, typically designed by the customer. As a result,
to support such a customer, we may have to produce and inventory in excess of 80
incremental four color boxes that reflect their branding. Therefore, we are careful about
committing to these programs unless certain commitments are made by the customer to either
guarantee certain minimum sales, or to be responsible for production costs, unused
corrugate inventories and inventory obsolescence.

We are intent upon building the Media
Sciences brand. We believe that by improving the recognition and value of the Media
Sciences brand, we will be less susceptible to abrupt shifts in demand for our products as
competition enters the market. We have a stated goal of increasing our Media Sciences
branded business to 75% of our revenues, over the next four years.

# Marketing and Sales Plans

As noted above, we believe we have an
aggregate 2.5% market share for those printers that comprise our available market. Also
noted above was the fact that over 30% of monochrome cartridges sold are aftermarket
brands. The primary function of our sales and marketing efforts is to increase our share
in our available market.

To increase share, we need to
increase the number of end users buying our products. To achieve this, we have been and
will continue to implement both channel and end user programs. We are focused on getting
more dealers to carry and sell our product, and having more end users ask for our
products.

We are in the process of building our
sales teams both in the United States and in Europe. Over the last year we have doubled
the number of sales personnel in the field, and we intend to double again the number of
sales personnel in the field over the next 12 months. The mission of these sales personnel
is to identify, recruit, train and grow new sales outlets for Media Sciences products, and
to support and grow our existing partners. Such efforts include regular face to face
visits, on-site training and promotional programs and joint sales calls.

The efforts of our sales team are
reinforced by sales incentive programs for our channel partners. Our programs reward the
growth in their Media Sciences business. In some instances overall business growth is
rewarded, other programs reward growth of older products, and some programs reward sell
through of individual items. Qualification for most of our sales incentive programs
precludes partners from selling competitive products.

Our end user sales activities are
primarily focused on Fortune 1000 companies and other large color printer installations.
These activities, often executed in concert with a channel partner, include identifying
large opportunities and pursuing them by consulting with the individual(s) within the
target organization responsible for evaluating, selecting and purchasing color printer
supplies, so that they can make an informed decision on Media Sciences as an alternative
to the printer manufacturers brand of supplies. This support may include cost of ownership
studies, reliability studies, and Media Sciences products to test and evaluate.

Our marketing strategy compliments
our sales strategy and is embodied by four objectives :

| | 1) | Build awareness among end users and dealers that Media Sciences products are a
               quality option for business color printer supplies.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Position Media Sciences as the leader in aftermarket office color printer
               supplies.
| | -- | --------------------------------------------------------------------------------------------------

| | 3) | Reinforce that not all aftermarket choices are the same, and that the safe and
               profitable choice is Media Sciences.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------

| | 4) | Educate our channels on the breadth of the market opportunity showing them that
               color is no longer a niche market.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------

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The execution of the above strategy
is multifaceted and is centered on three areas :

| | 1) | Product Marketing
| | -- | -----------------

| | 2) | Channel Marketing
| | -- | -----------------

| | 3) | End User Marketing
| | -- | ------------------

Product marketing encompasses all
product-centric marketing efforts including, but not limited to the identification of new
product development targets, packaging, product pricing, and product specific collateral
materials. We plan to expand our product line, brand of our warranty, and
improve the out-of-box experience with Media Sciences products. Our goal with our product
marketing efforts is show our partners, potential partners and the end user that Media
Sciences products are a quality alternative to the printer manufacturers brand.

Channel marketing encompasses all
communications, efforts and programs centered on the identification, recruitment, training
and growth of our channel partners. These efforts include product launches, regular
communications via e-mail, mail, telephone and webinars, and channel programs
such as our Clear Profits® program. The purpose of our channel marketing efforts is to
build awareness of the market and our products within the channel, and to help our channel
partners see the business opportunity presented by the sale of Media Sciences supplies. We
strive to show channel partners how they can increase their profitability and customer
satisfaction by selling Media Sciences supplies.

End user marketing is directed at the
owners and users of office color printers and those responsible for purchasing supplies
for these printers. Our efforts include direct mail, trade shows, advertising, end user
endorsements, and public relations. The goal of these efforts is to build awareness,
motivate trial of our products, and stimulate user conversions from OEM supplies to those
we manufacture.

# Distribution Methods of
the Products and Programs

Our primary goal in building our
distribution channels is to have our products readily available to the end users.
Consequently, we look to mirror the distribution points of the printer manufacturers, and
add additional, unique, distribution points that serve the cost-conscious end user. As a
result, we sell through an international network of channel partners, including
wholesalers, distributors, dealers, internet resellers, printer manufacturers and contract
stationers. In certain instances, our products may go through up to three levels of
distribution: wholesaler to distributor to dealer to end user. As the market for business
color supplies matures, it is unlikely that the market will support this many levels of
distribution. Consequently, we expect the distribution channels to flatten
over time.

Our products are available in most
parts of the world. However, approximately 82% of our sales are in the United States, with
a majority of the balance of our sales in Western Europe. Our goal is to have our
international sales represent no less than 30% of our revenues within two years, while
continuing to aggressively grow our US sales.

Our INKlusive program is available
only in the United States at this time. The program is marketed by Media Sciences branded
product dealers, and by our subsidiary Cadapult. Dealers who refer end users into the
INKlusive program are paid a commission upon consummation of a contract. Further,
INKlusive customers are encouraged to return to the dealer who referred them into the
program when they need supplies incremental to those automatically shipped under the
program.

# Competition

Media Sciences competes primarily
with the original manufacturer of the printers for which we provide supplies, including
Xerox, which sells printers under the Tektronix and Xerox brands, Konica-Minolta (formally
QMS), Epson, Brother, Oki and Ricoh. These competitors use several tactics to limit the
penetration of aftermarket supplies including remanufactured products and newly
manufactured products such as those offered by Media Sciences. These tactics include
protecting their technology through the use of patents, through the development of sales
and marketing programs that provide for incentives to distribution channels that sell
exclusively the printer manufacturers brand supplies, and through fear, uncertainty
and doubt. Media Sciences competes with these manufacturers primarily by offering a
compelling value proposition of quality, value (through lower end user costs and higher
channel margins) and choice.

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Media Sciences also competes with
entities that remanufacture certain color toner cartridges which compete with Media
Sciences newly manufactured cartridges. Remanufactured toner cartridges are often
available at lower prices than the corresponding newly manufactured, Media Sciences toner
cartridges. Media Sciences competes with these products based on quality, reliability,
warranty and excellent product availability. Some remanufacturers choose to sell Media
Sciences products to their customers rather than make the substantial investment in
developing the technologies and processes necessary to remanufacture color toner
cartridges.

Media Sciences buys certain color
toner cartridges from a supplier on a non-exclusive basis. While we believe Media
Sciences combination of distribution, warranty, channel programs, brand recognition
and product breadth will allow us to compete well with others selling similar products, we
may see increased competition for these particular products over time.

In the past, we observed some solid
ink products entering the market from a Korean manufacturer. We compete with these
products based on the quality of Media Sciences solid inks, our warranty, channel
programs, brand recognition and product breadth and our extensive efforts to avoid
infringement of the printer manufacturers intellectual property.

# Research and Development

We direct our research, engineering
and development efforts primarily toward developing new products and processes and
improving existing product performance. We have five goals in product development:

| |  | Non-infringing
| | - | --------------

| |  | Highest quality
| | - | ---------------

| |  | 1st to market
| | - | -------------

| |  | Exclusivity
| | - | -----------

| |  | Lowest cost
| | - | -----------

For our solid ink products, all
aspects of research, engineering and development are conducted by Media Sciences. This
includes formulation and ink stick shape design. As such, we have control over product
specifications, costs and development timelines. For our toner cartridge products, we
currently partner with other firms for cartridge engineering and raw toner formulation and
development. Consequently, we do not have the same level of control over color toner cartridge
development that we have over our solid inks.

In order to better and more
consistently achieve the above goals in our color toner cartridge development, we believe
we need to build our engineering and development resources to lessen our reliance on
external resources. Over the last 12 months we significantly upgraded and augmented our
analytical capabilities, with specific attention to color toner analysis. We have also
expanded our development personnel in this area.

Our planned expansion of development
resources includes three key areas: color toner analysis and development, chip development
and cartridge engineering. We plan to add personnel and supporting technology in each of
these areas. For color toner development, our goal is to become a true development partner
with our suppliers. In such a relationship, we will not only define the technical
specifications of a desired toner, but suggest formulations and processes that we believe
will result in a toner that meets those specifications. In the testing and troubleshooting
phase of development, we will not only identify issues or problems, but suggest solutions
as well.

For chip and cartridge development
and engineering, our goal is to build our capabilities such that all aspects of
engineering and development are executed internally by our development teams. While we may
still choose to partner externally on selected development projects, highly strategic
projects would be developed completely in-house. Consequently, we plan to add a number of
technical personnel including project, mechanical, software, electrical and manufacturing
engineers as well as the staff and technology to support these professionals.

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Through the expansion of our color
toner analysis and development, chip development and cartridge engineering resources, we
expect to shorten our development times, bring products to market more quickly, and
develop more products.

Research, engineering and product
development costs, which consist of salary and related benefits costs of our technical
staff, as well as product development costs including conceptual formulation, design and
testing of product alternatives, construction of prototypes, are expensed as incurred. For
the years ended June 30, 2006 and 2005, our research, engineering and product development
costs were approximately $1.1 million and $0.6 million respectively.

# Intellectual Property

Although we believe the ownership of
patents, copyrights, trademarks and service marks is an important factor in our business
and that our success depends in part on the ownership thereof, the Company relies
primarily on the innovative skills, technical competence, and marketing abilities of its
personnel. Our success depends, to a large extent, on our ability to protect our
proprietary technology. We rely on a combination of patent, copyright, trademark, service
mark and trade secret rights, confidentiality procedures and licensing arrangements to
establish and protect our proprietary rights. As part of our confidentiality procedures,
we generally enter into non-disclosure agreements with our employees, distributors and
corporate partners with respect to our documentation and other proprietary information. We
have registered certain trademarks in the United States and have applied for the
registration of other trademarks in the United States. In 2004, we were granted certain
patents in the United States, the terms of which are 14 years.

# Dependence on Major
Customers

In 2006, two customers each
represented 14% of our net revenues and 17% and 20%, respectively, of accounts receivable
at June 30, 2006. In 2005, one of these same large customers represented 11% of our net
revenues and 3% of accounts receivable at June 30, 2005.

# Principal Suppliers

In both 2006 and 2005, three vendors
each represented at least 10% of our costs of goods sold. Only one of the 2005 vendors was
a repeat in 2006. The three vendors in 2006 represented 42% of our cost of goods sold,
with no single vendor accounting for more than 20%. The three vendors in 2005 represented
39% of our cost of goods sold, with no single vendor accounting for more than 13%.

Some key components and raw
materials, including certain toners and electronic chips, may be obtained only from a
single supplier or a limited group of suppliers, either because alternative sources are
not available or the relationship is advantageous due to performance, quality, support,
delivery, capacity, or price considerations. Even where alternative sources of supply may
be available, qualification of the alternative suppliers and establishment of reliable
supplies could result in delays and a possible loss of sales.

# Need for Government
Approval

Not applicable.

# Government Regulation

Not applicable.

# Compliance with
Environmental Laws

Not applicable.

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# Employees

We currently have 63 full-time
employees, including 16 management level employees and two part time employees.

# ITEM 2.   PROPERTIES

We maintain our executive offices at
Oakland, New Jersey, pursuant to a lease expiring on September 30, 2009. We occupy
approximately 41,800 square feet, including warehousing and manufacturing.

We are subject to a lease expiring on
May 31, 2011 for our former facility in Allendale, New Jersey. We have entered into a
sublease expiring on May 31, 2011, the expiration date of our lease. The sublease provides
for annual rent payments to us of $0.17 million.

Our offices are adequately covered by
insurance for claims arising out of such occupancies.

We believe our properties are
adequately maintained and suitable for their intended use and that our production
facilities have capacity adequate for our current needs.

The table below sets forth the
location, approximate square footage, approximate annual rent, use of each location and
expiration date of each lease. The leases summarized in the table provide for moderate
annual rental increases.

|Location               | ApproximateSquare Feet | ApproximateAnnual Rent | Use    | LeaseExpiration Date
|---------------------- | ---------------------- | ---------------------- | ------ | --------------------
|                       |                        |                        |        |                     
|                       |                        |                        |        |                     
|8 Allerman Road        |                        |                        | 41,800 |                     
|Oakland, NJ 07436      |                        |                        |        |                     
|                       |                        |                        |        |                     
|                       |                        |                        |        |                     
|40 Boroline Road       |                        |                        | 15,400 |                     
|Allendale, NJ 07401    |                        |                        |        |                     
|                       |                        |                        |        |                     
|Suite 216              |                        |                        | 300    |                     
|The Commercial Centrel |                        |                        |        |                     
|Picket Piece, Andover  |                        |                        |        |                     
|Hampshire, SP11 6RU    |                        |                        |        |                     
|United Kingdom         |                        |                        |        |                     

# ITEM 3.   LEGAL PROCEEDINGS

On June 23, 2006, Xerox Corporation
filed a patent infringement lawsuit in the United States District Court, Southern District
of New York, Case No. 06CV4872, against Media Sciences International, Inc. and Media
Sciences, Inc., alleging that our solid inks designed for use in the Xerox Phaser 8500 and
8550 printers infringe four Xerox-held patents related to the shape of the ink sticks. The
suit seeks unspecified damages, injunctive relief, and fees. We believe that our inks do
not infringe any valid U.S. patents. We intend to vigorously defend these allegations of
infringement. The loss of all or a part of this lawsuit could have a material adverse
affect on our operations. We recently submitted our answer and counterclaims in this
action. We denied infringement and the validity of the patents in question. Further, we
submitted counterclaims for breach of contract, unfair competition and trade libel. This
action is in its very early stages, and is expected to take approximately two years to
reach trial unless settled earlier.

In May 2005, we filed suit in New
Jersey state court against our former insurance broker for insurance malpractice. The suit
contends, in sum and substance, that the insurance broker was negligent and breached its
duty of care in connection with the procurement of an umbrella insurance policy. The suit
asserts four causes of action for negligent procurement, failure to procure required
coverage, breach of the standard of care, and failure to advise.

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In particular, the suit alleges that
the insurance broker breached its duty by failing to identify our subsidiary in insurance
applications; submitting insurance applications, without our review, incorrectly denying
the existence of our subsidiary; and failing to correct such an error. The suit further
alleges that our insurance broker failed to procure the umbrella insurance we required and
were led to believe we purchased. Finally, the suit alleges that our insurance broker
breached its duty by failing to be aware that our subsidiary did not have adequate
coverage and to advise us that our subsidiary was not adequately covered.

The suit seeks recovery of the
balance of unrecouped losses for third party damages that should have been covered under
the umbrella insurance procured by our insurance broker but was not due to the
aforementioned negligence and breaches of duty of care by our insurance broker. Pre-trial
discovery is currently being conducted on this case and a tentative trial date is expected
sometime during the summer of 2007.

Other than the above, as at June 30,
2006, we are not a party to any material pending legal proceeding, other than ordinary
routine litigation incidental to our business.

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

Not applicable.

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# PART II

# ITEM 5.   MARKET FOR THE
COMPANYS COMMON EQUITY AND RELATED STOCKHOLDER
          
       MATTERS

# Market Information

Our common stock is listed on the
American Stock Exchange under the symbol GFX.

The following table sets forth for
the periods indicated, the high and low closing sale prices for a share of our common
stock, during the relevant periods, as reported by the American Stock Exchange.

|            |                    |       |      
|----------- | ------------------ | ----- | -----
|Fiscal Year | Quarter Ended      | High  | Low  
|            |                    |       |      
|2005        | September 30, 2004 | $2.00 | $1.63
|            | December 31, 2004  | $1.70 | $1.39
|            | March 31, 2005     | $2.40 | $1.60
|            | June 30, 2005      | $2.15 | $1.60
|2006        | September 30, 2005 | $2.00 | $1.63
|            | December 31, 2005  | $2.60 | $1.69
|            | March 31, 2006     | $4.09 | $2.62
|            | June 30, 2006      | $5.89 | $3.91

# Holders

The number of holders of record of
our common stock as of September 15, 2006 was 288. At that date, there were approximately
2,000 beneficial owners of our common stock.

# Dividends

We have never declared any cash
dividends on our common stock. Future cash dividends on the common stock, if any, will be
at the discretion of our Board of Directors and will depend on our future operations and
earnings, capital requirements and surplus, general financial condition, contractual
restrictions, and other factors that the Board of Directors may consider important.

No shares of series A preferred stock
are presently outstanding. Prior to January 1, 2004, we had shares of series A preferred
stock issued and outstanding. Our series A preferred stock carried a fixed dividend at an
annual rate of 11.5%. Dividends were to be paid each quarter in arrears. The first
dividend payment occurred on January 1, 2000. The certificate of designation for the
series A preferred stock provided that unless and until we have fully paid all dividends
on the outstanding shares of series A preferred stock, we would not to declare or pay cash
dividends, or distribute or set aside assets, for any of our other securities. Further,
the certificate of designation for the series A preferred stock provided that we may not
pay dividends if payment of dividends would violate certain financial criteria of our
senior lending agreement with a financial institution.

# Transfer Agent

The transfer agent for our common
stock is Continental Stock Transfer & Trust Company, New York, New York.

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# ITEM 6.   
MANAGEMENTS DISCUSSION AND ANALYSIS

The following discussion of our
financial condition and results of operations should be read in conjunction with our
consolidated financial statements and the related notes included in Item 7,
Financial Statements and Supplementary Data in this Annual Report on Form
10-KSB. This discussion contains forward-looking statements, which involve risk and
uncertainties. Our actual results could differ materially from those anticipated in the
forward looking statements as a result of certain factors, including, but not limited to,
those discussed in Risk Factors and elsewhere in this Annual Report on Form
10-KSB.

# EXECUTIVE SUMMARY

Media Sciences International, Inc.
and Subsidiaries, collectively referred to as the Company, manufactures and
sells solid ink and toner-based consumable products for use in business color printers. We
distribute our products through an international network of dealers and distributors. We
also sell directly to end users located in the United States through programs designed to
foster our supplies business, such as our INKlusive free color printer program. In May
2005, we discontinued our electronic pre-press sales and service operations conducted by
our subsidiary, Cadapult Graphic Systems, Inc. (Cadapult) (see Note 10 to
Financial Statements.) Our corporate headquarters is located in New Jersey.

Net revenues, cost of goods sold,
gross profit, gross margin, income from operations, net income, and diluted earnings per
share are the key indicators we use to monitor our financial condition and operating
performance. We also use certain non-GAAP measures such as earnings before interest taxes,
depreciation and amortization (EBITDA) to assess business trends and performance, and to
forecast and plan future operations.  The following table sets forth the key
quarterly and annual GAAP financial measures we use to manage our business (in thousands,
except per share data).

|                                  |  |  |   |            | 
|--------------------------------- |  |  | - | ---------- | 
|Fiscal 2006                       |  |  |   | 1stQuarter | 
|                                  |  |  |   |            | 
|Net revenues                      |  |  | $ | 4,776      | 
|Costs of goods sold               |  |  | $ | 2,483      | 
|                                  |  |  |   |            | 
|Gross profit                      |  |  | $ | 2,294      | 
|Gross margin                      |  |  |   | 48.0%      | 
|Income from operations            |  |  | $ | 739        | 
|Operating margin                  |  |  |   | 15.5%      | 
|Net income                        |  |  | $ | 423        | 
|Diluted earnings per share        |  |  | $ | 0.04       | 
|                                  |  |  |   |            | 
|Fiscal 2005                       |  |  |   |            | 
|Net revenues                      |  |  | $ | 4,444      | 
|Costs of goods sold               |  |  | $ | 2,657      | 
|                                  |  |  |   |            | 
|Gross profit                      |  |  | $ | 1,787      | 
|Gross margin                      |  |  |   | 40.2%      | 
|Income (loss) from operations     |  |  | $ | 367        | 
|Operating margin                  |  |  |   | 8.3%       | 
|Net income (loss)                 |  |  | $ | 214        | 
|Diluted earnings (loss) per share |  |  | $ | 0.02       | 

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# RESULTS OF OPERATIONS

Net Revenues.   In fiscal 2006,
consolidated net revenues increased by $3.3 million, or 18% to $21.3 million, from $18.0
million in fiscal 2005. Sales of color toner cartridges increased by about 39% over 2005
while sales of solid ink sticks increased approximately 18%. Direct sales of supplies,
through our Cadapult subsidiary, decreased by approximately 37% as we focused on building
sales through our indirect distribution channels. In fiscal 2005, consolidated net
revenues increased by about $2.3 million, or 14% to $18.0 million. 2005 sales of color
toner cartridges increased by 3% over 2004 while sales of solid ink sticks increased by
approximately 50%.

Overall, our net revenue growth in
both fiscal 2006 and 2005 was driven primarily by sales from new products introduced to
the market, and to a lesser extent, an increase in market share for some of our existing
products, and general continued growth of the installed base of color business printers
that consume products we manufacture. During fiscal 2006 and 2005, the mix of both solid
ink and color toner cartridges shifted from older models to newer models and reflected the
introduction of a number of new products introduced that were primarily toner-based
cartridge products. This trend is expected to continue as lower color printer prices
encourage migration from older slower printers with higher service costs to newer, faster
color printers with lower service costs.

The following summarizes the products
we introduced in our fiscal 2006: In late September 2005, we started shipping color toner
cartridges for the Oki 5000 series of color printers. In late December 2005, we started
shipping solid ink sticks for the new Xerox Phaser 8500 and 8550, and color toner
cartridges for the Ricoh 3800 and related engines. In mid-March 2006, we started shipping
universal, high capacity cartridges for use in Xerox Phaser 7300, Oki 9300 and 9500, and
Konica 7830 office color printers. In early April 2006, we started shipping high capacity
cartridges for use in Xerox Phaser 6250, Konica Minolta magicolor 3300, Epson AcuLaser
C4100 and Brother HL-4200CN office color printers, the first independently manufactured,
new-build, office color toner cartridges featuring chip technology.

We expect the growth of color toner
cartridge sales to continue to outpace the growth of solid ink product sales into fiscal
2007. Today, we offer products for a very small fraction of the toner-based color laser
market. According to industry data, the toner-based color business printer laser market
today is about twenty-five times larger than that of the color solid ink segment. Because
our business strategy focuses on alignment of our development efforts with the broader
business color market, our toner sales growth has and, we expect, will continue to outpace
that of our solid ink for the foreseeable future. Media Sciences currently manufactures
solid ink for use in all available color business solid ink printers. As a result, until
new solid ink printers are brought to market, we have no new solid ink products to develop
for the color business segment. Outside the color business segment, we continue to
formulate solid inks for our growing industrial marking business.

# Cost of Goods Sold.

Cost of goods sold, excluding
depreciation and amortization, product warranty, and shipping and freight  Despite an 18% increase in net revenues between 2005 and 2006, we were able to achieve
a 4% decrease in our costs of goods sold, exclusive of depreciation and amortization,
product warranty, and shipping and freight. This decrease was attributed to substantial
yield improvements in our solid ink manufacturing, and the transition in our product line
from very low margin, sourced toner cartridges to Media Sciences manufactured, higher
margin Premium and Clearcase cartridges. Specifically, we benefited from the introduction
in late fiscal 2005 of our Clearcase cartridges for the Phaser 6200, which replaced,
previously sold, lower margin version of cartridges for that printer, and we benefited
from the introduction in late fiscal 2006 of our Premium cartridges for the Phaser 1235
and 7300, which replaced previously sold, zero margin versions of cartridges for those
printers. These favorable reductions in costs of goods sold were partially offset by
increased prices of certain raw materials and their associated shipping costs. In our
fiscal 2007, we do not expect to realize significant additional yield improvements in our
solid ink production, nor do we have any further product transitions which will reduce our
costs. Therefore, any further increases in raw material or inbound shipping costs may
increase our product costs unless offset by other manufacturing efficiencies.

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Depreciation and amortization
 Depreciation and amortization associated with our manufacturing increased by
$0.3 million or 121% in 2006 over 2005. This increase reflects the amortization of tool
and die costs (3 year life) for toner cartridges developed and placed-in-service, as well
as incremental depreciation and amortization associated with plant and equipment additions
in 2006 and 2005. Some of the noted yield improvement associated with our solid ink
manufacturing was the result of our capital spending in 2006. Manufacturing depreciation
and amortization is expected to increase in fiscal 2007 due to anticipated additional
investments in our plant and equipment and anticipated launches of new products for which
we have incurred or expects to incur capitalized tool and die costs.

During the year ended June 30, 2006,
we invested approximately $1.3 million in various fixed assets and leasehold improvements
that will be depreciated over useful lives of three to seven years. During the preceding
year ended June 30, 2005, we invested approximately $1.7 million in similar assets having
comparable depreciable lives. These investments in our plant and equipment drove our
greater year-over-year depreciation and amortization charges. Most of these capital
expenditures were associated with manufacturing operations and thus the resultant
depreciation and amortization was classified as a component of costs of goods sold.
Depreciation and amortization associated with our non-manufacturing operations was
classified as a separate component of selling, general and administrative expense.

Product warranty 
Product warranty costs declined by $0.2 million or 22% in 2006 over 2005. We believe this
decline is attributed to the improved quality of our products and our improved technical
ability to distinguish a competitors products from our own and thus avoid processing
warranty claims due to use of OEM or other competitive products. We believe that the
substantial investments it has made in plant and equipments, including laboratory
equipment, and in personnel, have been and will continue to be reflected in improved
product quality and fewer fraudulent warranty claims. In our fiscal 2007, we expect to
realize some further, though more moderate, declines in product warranty cost.

Shipping and freight 
Outbound shipping and freight cost to customers increased by $0.3 million or 113% in 2006
over 2005. Net of reimbursements from customers, we effectively gave up this increase in
costs as additional discounts to our customer in 2006. In fiscal 2007, we do not expect to
increase shipping and freight costs as a percentage of net revenues.

Gross Profit.   2006
consolidated gross profit increased by $3.3 million or 45% to $10.8 million from $7.5
million in 2005. In 2006 our gross margin was 51% of net revenues as compared with 42% of
net revenues in 2005. This 900 basis point increase in margin is attributed to substantial
yield improvements in our solid ink manufacturing, a transition from low margin versions
of cartridges to higher margin Clearcase and Premium cartridges, a decline in sales of low
margin product in our Cadapult subsidiary, and a reduction in our product warranty costs.
These favorable enhancements to our margins were partially offset by certain increases in
our raw material costs, higher manufacturing depreciation and amortization costs, and
greater costs of outbound shipping and freight.

In our fiscal 2007, we do not expect
to realize significant additional yield improvements in our solid ink production, nor do
we have any further product transitions which will reduce our costs. Therefore, any
further increases in raw material or inbound shipping costs may decrease our margins
unless offset by other manufacturing efficiencies. Further, we have in development several
color toner cartridges which if launched are expected to carry margins that are lower than
our fiscal 2006 margins. The impact on our margins will be a function of our sales volumes
associated with these products. If we are successful with these new products, it is likely
that our gross margins in 2007 may reflect some erosion.

Research and Development.   Research and development spending increased by $0.5 million or 73% in 2006 over 2005.
This increase was driven by our initiatives to increase product breadth through the
development and launch of new products. The increase in our research and development
spending was broad-based. During 2006, we added new technical personnel and management to
our research and development team. Also increased were research and development capital
and operating expenditures as we accelerated the pace of new product development. Looking
into fiscal 2007, we expect to increase our research and development spending both as a
percentage of net revenues and on a year-over-year basis.

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Selling, General and
Administrative.   Selling, general and administrative expense, exclusive of
depreciation, amortization and 2005 non-recurring items (loss from sublease, moving
expense, and impact of variable plan accounting) increased by $1.2 million or 24% in 2006
over 2005; represented 29% of 2006 and 28% of 2005 net revenues, respectively. Total
selling, general and administrative expense, inclusive of depreciation, amortization and
2005 non-recurring items, increased by $0.4 million or 7% in 2006 over 2005; representing
30% of 2006 and 34% of 2005 net revenues, respectively. The increase in selling, general
and administrative expense was primarily driven by greater compensation and benefits costs
resulting from greater bonuses in 2006 under our performance-based pay incentives and
hiring in 2006 of additional sales, marketing, and operations personnel. Selling, general
and administrative expense also increased due to greater professional fee spending in
2006.

2005 selling, general and
administrative expense included $0.55 million of non-recurring expenses that resulted from
the move of our administrative and manufacturing facilities and $0.20 million in non-cash
variable plan accounting compensation expense. In 2005, we terminated the cashless
exercise provisions of our stock option plan. As a result, in 2006 it was no longer
subject to variable plan accounting treatment. We do not anticipate further non-cash
compensation charges until our adoption of FAS 123(R) in fiscal 2007. In fiscal 2007, we
expect to increase our advertising, marketing, sales and administrative costs. However, we
do not expect our selling, general and administrative expenses to increase as a percent of
net revenues.

Depreciation and Amortization.   
Non-manufacturing depreciation and amortization expense decreased by $0.06 million or 21%
in 2006 over 2005. The decrease is attributed to asset retirements made in late 2005
associated with our discontinued use of our previous Allendale, New Jersey facility. In
fiscal 2007, we expect selling, general and administrative depreciation and amortization
to increase over 2006 levels, however, we do not expect it to increase substantially
faster than our rate of revenue growth.

Interest Expense, net.   2006
interest expense decreased by $0.12 million or 69% to $0.06 million from $0.18 million in
2005. The decrease in interest expense was due to decreased borrowings, reduced borrowing
costs, and greater interest income generated from our growing cash balances. In fiscal
2007, we expect our net interest expense to decrease as we generate greater interest
income from our cash and cash equivalents and our debt levels remain modest. These
expectations may change should we identify and complete any acquisitions during the year.
We would anticipate funding any acquisitions with some reasonable level of debt financing.
The level of potential debt associated with any acquisition would be dependent upon the
cash flow characteristics of an acquisition target.

Income Taxes.   For the year
ended June 30, 2006, we recorded an income tax expense from continuing operations of $1.1
million as compared with an income tax expense from continuing operations of $0.25 million
for the year ended June 30, 2005. On a consolidated basis, after discontinued operations,
we generated a net tax benefit for the year ended June 30, 2005 of $0.08 million. For the
years ended June 30, 2006 and 2005, our effective tax rate was 34% and 39%, respectively.
The effective aggregate state and federal tax rate varies due to the magnitude of various
permanent differences between reported pretax income and what is recognized as taxable income
by various taxing authorities. The availability of tax credits associated with
manufacturing and research and development activities, as well as exclusions, such as the
Extraterritorial Income Exclusion, can result in an effective rate that is lower than the
statutory rate.

In April 2006, we initiated a
thorough review of our historic tax compliance. As a result, we identified that we had not
historically taken advantage of all of the credits or income exemptions for which it was
entitled. Further, we implemented certain other fundamental tax planning to reduce our
current and future effective tax rate. As a result, we are in the process of amending a
number of our prior year tax returns. The 500 basis point decrease in effective tax rates
from 2005 to 2006 reflects the current year realization of the results of our tax planning
and application of available credits and income exclusions. We expect our consolidated
effective tax rate to remain at about 35% through fiscal 2007. This effective tax rate
could significantly decline further should we decide to manufacture all or a portion of
our products outside the U.S. in lower tax jurisdictions. We are still evaluating the
viability of such a strategy and can make no assurances that it will either pursue such a
strategy or, that if it does, that it will be successful in realizing the intended
benefits.

Income from Continuing
Operations.   For the year ended June 30, 2006, we earned $2.1 million from continuing
operations or $0.19 per share basic and $0.18 fully diluted, as compared to the year ended
June 30, 2005, where we earned $0.38 million from continuing operations or $0.04 per share
basic and fully diluted.

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# LIQUIDITY AND CAPITAL
RESOURCES

We experienced positive cash flows
from operating activities for the years ended June 30, 2006 and 2005. 2006 cash flows from
operating activities were $3.4 million, resulting from $2.1 million of income from
continuing operations and add-back of net non-cash charges totaling $1.3 million. 2005
cash flows from operating activities of $0.16 million resulted primarily from income from
continuing operations of $0.38 million and cash provided by discontinued operations of
$0.30 million, net non-cash charges of $0.79 million, receipt of an insurance claim
receivable of $0.50 million, cash received from landlord of $0.20 million, and an increase
in deferred revenue of $0.78 million, offset by increases in accounts receivable of $0.56
million and in inventories of $0.92 million and a decrease in accounts payable of $1.3
million.

During 2006, our inventory levels
increased by $1.3 million or 39% to $4.5 million at June 30, 2006. The increase in
inventories was due to the increase in the number of products in our product line,
increased sales, minimum order requirements necessary to secure advantageous pricing and
the extended lead time from our Asian suppliers. In addition, we sought to increase
certain inventory levels in order to assure an in-stock position on our products. An
initiative is under way to maintain or reduce our inventory levels while increasing the
breadth of our product line and while ensuring an in-stock position and advantageous
pricing from our vendors.

Our most recent INKlusive program has
generated positive cash flow since we are paid in advance for the ink to be shipped over a
two year period, thus giving rise to deferred revenues. As of June 30, 2006,
deferred revenue associated with the program totaled $1.1 million, a $0.3 million or 41%
increase over the June 30, 2005 balance of $0.8 million. The continued ability of the
INKlusive program to generate positive cash flow through increases in deferred revenue is
a function of customer acceptance of future programs and the structure of the financing of
those programs.

The cash we used in investing
activities for the year ended June 30, 2006 included the purchase of equipment, tooling
and leasehold improvements in the amount of $1.3 million, a decrease of $0.4 million or
22% from the comparable spend of $1.7 million in fiscal 2005. In fiscal 2007, we plan
additional capital expenditures of approximately $0.9 million. We plan to finance these
expenditures from cash generated by operations and, where appropriate, through the use of
operating leases.

We have a revolving line-of-credit
facility which provides for maximum borrowings of $3.0 million. As of June 30, 2006, we
had no outstanding balance under this line. In connection with the negotiation of this
facility during 2004, we granted a security interest in all of our assets. Borrowings
through January 23, 2006 bore interest at a rate of 0.75% over the banks Prime Rate.
On January 23, 2006 we entered into an Amended and Restated Committed Line of Credit Note,
and an Amendment to Loan Documents (collectively, the Amendments). The
Amendments reduced the interest rate by 0.75% to the banks Prime Rate, and extended
the expiration date of the facility by one year to November 30, 2007. The Amendments also
modified certain financial covenants, which are described below. Borrowings bear interest
at the banks Prime Rate (8.25% at June 30, 2006) and are payable on demand.

In March 2006, we entered into a
five-year term note with our bank in the amount of $0.25 million that bears interest at a
fixed rate of 7.75%, and requires monthly repayments of principal of $5,054. At June 30,
2006, this note had a remaining principal balance of $0.2 million. The proceeds were used
to finance the purchase of certain long-lived manufacturing property and equipment. The
note is cross collateralized and contains cross default provisions with the revolving line
of credit facility.

In July 2005, we entered into an
equipment lease line of credit with $1.0 million in availability with the bank. Borrowings
bear interest at a rate of approximately 1% over the banks Prime Rate, with terms of
three to seven years. The bank will hold title to the equipment leased under the line of
credit. Any unutilized balance on the line of credit expires on November 30,
2006.  In December 2005, we entered into an operating lease under this line,
reducing the availability under the line by $228,682. This lease requires monthly payments
of $3,453, for 72 months.

In March 2005, we entered into a
five-year term note with our bank in the amount of $0.5 million that bears interest at a
fixed rate of 6.5%, and requires monthly repayments of principal of $8,333. At June 30,
2006, this note had a remaining principal balance of $0.4 million. The proceeds were used
to finance the leasehold improvements to our Oakland facility. The note is cross
collateralized and contains cross default provisions with the revolving line of credit.

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Both the amended revolving
line-of-credit and the five-year term notes with the bank are subject to two amended
financial covenants as follows :

| | (a)   The Company will maintain, as of the end of each fiscal quarter, a ratio of
          Funded Debt to EBITDA of not more than 2.50 to 1.00, measured on a rolling four
          quarter basis commencing with quarter ending June 30, 2005.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b)   The Company will maintain, as of the end of each fiscal quarter, a ratio of
          EBITDA to Fixed Charge (EBITDA to Fixed Charge) of more than 1.00 to
          1.00, measured on a rolling four quarter basis commencing with quarter ending
          June 30, 2006. (Measurement will be on a six month basis for quarter ended March
          31, 2006 and a nine month basis for quarter ending March 31, 2006).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As used herein:
| | ---------------

| | CPLTD
means the scheduled payments of principal on all indebtedness for borrowed money having an
original term of more than one year (including but not limited to amortization of
capitalized lease obligations), as shown on the Companys financial statements as of
one year prior to the date of determination.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | EBITDA
means net income plus interest expense plus income tax expense plus
depreciation plus amortization.
| | ------------------------------------------------------------------------------------------------------------

| | EBITDA
to Fixed Charge means (i) EBITDA minus Unfunded Capital Expenditures divided
by (ii) taxes actually paid plus CPLTD and interest expense.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| | Funded
Debt means all borrowed debt including senior borrowed debt and subordinated
debt.
| | -------------------------------------------------------------------------------------------

| | Unfunded
Capital Expenditures represents the difference between actual capital
expenditures and term financing, the proceeds of which were used to purchase such capital
expenditures. In effect, this represents capital expenditures which were purchased with
operating cash flow.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

At no time since the inception of
this loan agreement have we been in violation of these covenants.

On March 2, 2005, we sold 500,000 shares
of common stock to an investor at $2.00 per share for net proceeds of $0.97 million. The
proceeds were used for working capital.

We believe that we will be able to
fund our cash requirements for the foreseeable future through a combination of internal
cash generation, the revolving line-of-credit and the lease line of credit.

# CAPITAL EXPENDITURES

We plan on various capital
expenditures over the next twelve months of approximately $0.9 million. These expenditures
will include toner cartridge tool and die development, evaluation printers, various
quality assurance and development, instruments, various leasehold improvements, and
equipment, upgrades to our information technology systems. In addition, we plan to acquire
certain manufacturing equipment to scale our manufacturing capability and to increase
productivity. We plan to finance these expenditures through internal cash generation and,
where appropriate, through operating leases.

# INFLATION

We have experienced increases in raw
materials costs and the costs of shipping and freight to deliver those material and
finished products to our facility over the last 12 months. While we have historically
offset any inflation in operating costs through increased productivity and improved yield,
the recent increases have impacted profit margins. We have embarked on a program to
improve our procurement of raw materials. We believe this program will greatly mitigate
the increases in raw material prices and shipping and freight costs that we have
experienced.

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# SEASONALITY

Historically, we have not experienced
any significant seasonality in our business. As we continue to grow our international
business relative to our North American business, we may experience a more notable level
of seasonality, especially during the summer months.

# CRITICAL ACCOUNTING
POLICIES

Use of EstimatesThe accompanying consolidated
financial statements have been prepared in conformity with accounting principles generally
accepted in the United States. When more than one accounting principle, or method of its
application, is generally accepted, management selects the principle or method that is
appropriate in our specific circumstances. Application of the accounting principles
requires our management to make estimates about the future resolution of existing
uncertainties and that affect the reported amounts of assets, liabilities, revenues, and
expenses, which in the normal course of business are subsequently adjusted to actual
results. Actual results could differ from such estimates. In preparing these financial
statements, management has made its best estimates and judgments of the amounts and
disclosures included in the consolidated financial statements giving due regard to
materiality.

Revenue Recognition
Revenue is recognized at the point of
shipment for goods sold, and ratably through the duration of INKlusive contracts
(generally, two years) provided collection is reasonably assured. Net revenues include
reimbursed shipping and freight expense. Provisions for rebates, product returns and
discounts to customers are recognized as reductions in determining net revenues in the
same period as the related revenues are recorded. Any sales or other taxes collected from
customers are not reflected in the consolidated
statements of operations but instead reflected as current obligations in the consolidated
balance sheets until disbursed to the respective taxing authority.

Under our INKlusive program, we
provide a customer with a business color printer or multifunction device, on-site service,
and a defined, regular shipment of supplies (ink or toner), all for the cost of just the
supplies. We offer this program in conjunction with a financing company. Media Sciences
does not own or otherwise finance the cost of the printer, nor does Media Sciences
guarantee the credit worthiness of the customer. Under our agreement with the financing
company, at the time of placement of the INKlusive printer, we are paid in full for the
printer and the two years of supplies. Consequently, the difference in timing between
receipt of contract payment from the finance company and when the supplies are shipped
gives rise to deferred revenue on our balance sheet. We amortize this deferred revenue
liability and recognizes revenue ratably over the contract term as we ship supplies to the
customer. The current and non-current components of the deferred revenue obligation are
reflected in the consolidated balance sheets.

Services associated with the program
do not represent a separate unit of accounting as we do not offer services separately from
an INKlusive product supply commitment. Regardless, services are provided equally over the
contract term in proportion to product shipments and revenue recognition under the
program. We are not exposed to the credit risk of any individual customer in the INKlusive
program.

Accounts Receivable and
Allowance for Doubtful AccountsWe market our products to an
international network of dealers and distributors. Credit is extended after a credit
review by management, which is based on a customers ability to perform its
obligations. Such reviews are regularly updated. The allowance for doubtful accounts is
based upon agings of customer balances and specific account reviews by management. Certain
exports of goods we produce in the United States are insured up to 90% of face value.
Media Sciences International, Inc. has no significant concentrations of credit risks and
generally does not require collateral or other security from its customers.

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Inventories and
Inventory ReservesInventories, consisting of materials,
labor, manufacturing overhead, and associated in-bound shipping and freight are stated at
the lower of cost or market, with cost being determined on a first-in, first-out (FIFO)
basis. We review the adequacy of our inventory reserves on a quarterly basis. We review
and set standard costs annually at current manufacturing costs in order to approximate
actual costs. Our actual manufacturing overhead for a period is allocated between cost of
goods sold and finished goods inventory based on calculated inventory turnover, adjusted
for excess capacity.  Abnormal inventory costs such as costs of idle facilities,
excess freight and handling costs, and wasted materials are recognized as current period
charges. We write down inventory based on forecasted demand and technological
obsolescence.  These factors are impacted by market and economic conditions,
technology changes, new product introductions and changes in strategic direction and
require estimates that may include uncertain elements.  Actual demand may differ from
forecasted demand and such differences may have a material effect on recorded inventory
values.

WarrantyWe provide a warranty for all of our
consumable supply products and under our INKlusive free color printer program. We warrant
our products suitability for use in the intended printer models and that our
products are free of defects that could cause damage to these printers. Costs covered
under the product warranty include customary charges for the repair or replacement of the
printer with an equivalent new or refurbished printer, at our sole discretion. The
warranty does not cover damage to the product or a printer caused by accident, abuse,
misuse, natural disaster, human error, unauthorized disassembly, repair, or modification.
We believe that our product warranty is relatively liberal, providing, in most cases,
broader and more complete coverage than that provided by the original equipment printer
manufacturer. We account for the estimated warranty cost as a charge to product warranty,
a captioned component of cost of goods sold, when revenue is recognized.  The
estimated warranty cost is based on historical product performance and field
expenses.  We update these estimated charges every quarter.  The actual product
performance and/or field expense profiles may differ, and in those cases we adjust
warranty accruals accordingly.

Contingencies and
LitigationWe are named from time to time as a
party to various legal proceedings.  While we currently believe the ultimate outcome
of these proceedings will not have a material adverse effect on our financial position,
the results of complex legal proceedings are difficult to predict.  We would accrue
the cost of an adverse judgment if, in our estimation, the adverse settlement is probable
and we can reasonably estimate the ultimate cost to us. We have made no such accruals as
of June 30, 2006.

Income TaxesWe account for income taxes in
accordance with Statement of Financial Accounting Standard No. 109, Accounting for
Income Taxes, (FAS 109) which requires that deferred tax assets and liabilities be
recognized using enacted tax rates for the effect of temporary differences between the
book and tax bases of recorded assets and liabilities. FAS 109 also requires that deferred
tax assets be reduced by a valuation allowance if it is more likely than not that a
portion of the deferred tax asset will not be realized. We have determined that our future
taxable income will be sufficient to recover all of our deferred tax assets. However,
should there be a change in our ability to recover our deferred tax assets, we could be
required to record a valuation allowance against our remaining deferred tax assets. 
This would result in an increase to our tax provision in the period in which we determined
that the recovery was not probable.

On a quarterly basis, we provide for
income taxes based upon an annual effective income tax rate. The effective tax rate is
highly dependent upon the geographic composition of worldwide earnings, tax regulations
governing each region, availability of tax credits and the effectiveness of our tax
planning strategies. We carefully monitor the changes in many factors and adjust our
effective income tax rate on a timely basis. If actual results differ from these
estimates, this could have a material effect on our financial condition and results of
operations.

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In addition, the calculation of our
tax liabilities involves dealing with uncertainties in the application of complex tax
regulations. We recognize liabilities for anticipated tax audit issues in the U.S. and
other tax jurisdictions based on our estimate of whether, and the extent to which,
additional tax payments are probable. If we ultimately determine that payment of these
amounts is unnecessary, we reverse the liability and recognize a tax benefit during the
period in which we determine that the liability is no longer necessary. We record an
additional charge in our provision for taxes in the period in which we determine that the
recorded tax liability is less than we expect the ultimate assessment to be.

Goodwill and ImpairmentThe excess of the purchase
consideration over the fair value of the net assets of acquired businesses is considered
to be goodwill. On June 29, 2001, the FASB pronounced under Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets(FAS 142) that purchased goodwill should not be amortized, but
rather, should be periodically reviewed for impairment. We review for impairment annually,
or sooner if events or changes in circumstances indicate that the carrying amount could
exceed fair value. Such impairment could be caused by internal factors as well as external
factors beyond our control. The FASB has further determined that at the time goodwill is
considered impaired, an amount equal to the impairment loss should be charged as an
operating expense in the statement of operations. The timing of such an impairment (if
any) of goodwill acquired in past and future transactions is uncertain and difficult to
predict. Our results of operations in periods following any such impairment could be
materially adversely affected.

In May 2005, we ceased certain sales
operations under Cadapult. Specifically, we ceased all sales and service of pre-press
computer graphics systems. We evaluated the goodwill resulting from the three Cadapult
acquisitions and determined that the goodwill resulting from those acquisitions was fully
impaired. Consequently, we incurred an impairment charge of approximately $0.88 million,
which is reflected in the results from discontinued operations in our statement of
operations for the year ended June 30, 2005. We have completed all transitional and annual
impairment tests necessary to date and concluded that no other goodwill is impaired. We
have remaining net goodwill and net acquired intangible assets of approximately $3.6
million at June 30, 2006. This goodwill resulted from the acquisition of substantially all
of the assets of UltraHue, Inc.

Due to uncertain market conditions
and potential changes in our strategy and product portfolio, it is possible that the
forecasts we use to support our goodwill and other intangible assets could change in the
future. Significant judgments are required to estimate the fair value of goodwill and
intangible assets, including estimating future cash flows, determining appropriate
discount rates, estimating the applicable tax rates, foreign exchange rates and interest
rates, projecting the future industry trends and market conditions, and making other
assumptions. Changes in these estimates and assumptions, including changes in our
reporting structure, could materially affect our determinations of fair value.

# RECENT ACCOUNTING
PRONOUNCEMENTS

In December 2004, the Financial
Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004),
Share-Based Payment, SFAS No. 123(R) which will require us to measure all
employee stock-based compensation awards using a fair value method and record such expense
in our consolidated financial statements.  In March 2005, the SEC issued SAB 107,
which provides the Staffs views regarding interactions between SFAS No. 123(R) and
certain SEC rules and regulations and provides interpretations of the valuation of
share-based payments for public companies. The adoption of SFAS No. 123(R) will
require additional accounting related to the income tax effects and additional disclosure
regarding the cash flow effects resulting from share-based payment arrangements. SFAS
No. 123(R) is effective for us beginning in the first quarter of fiscal 2007. The
adoption of SFAS No. 123(R) will have a material impact on our consolidated results
of operations, financial position and cash flows. We are evaluating what pricing model to
select upon adoption and the impact by financial statement line. Based on preliminary
analysis, we believe the impact on our consolidated results of operations will not be
materially greater than the pro forma impact disclosed under SFAS No. 123 in periods prior
to adoption of SFAS No. 123(R).

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In March 2005, the SEC released SEC
Staff Accounting Bulletin No. 107 (SAB 107). SAB 107
provides the SEC staffs position regarding the application of SFAS No. 123(R).
SAB 107 contains interpretive guidance relating to the interaction between
SFAS No. 123(R) and certain SEC rules and regulations, as well as the staffs
views regarding the valuation of share-based payment arrangements for public companies.
SAB 107 also highlights the importance of disclosures made related to the accounting
for share-based payment transactions. We are currently evaluating SAB 107 and will be
incorporating it as part of our adoption of SFAS No. 123(R) in the first fiscal
quarter of 2007.

In June 2005, the FASB issued SFAS
No. 154, Accounting Changes and Error Corrections, a replacement of APB
Opinion No. 20, Accounting Changes, and Statement No. 3, Reporting
Accounting Changes in Interim Financial Statements, (Statement 154).
Statement 154 changes the requirements for the accounting for and reporting of a change in
accounting principle. Previously, most voluntary changes in accounting principles were
required recognition via a cumulative effect adjustment within net income of the period of
the change. Statement 154 requires retrospective application to prior periods
financial statements, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. Statement 154 is effective for accounting
changes made in fiscal years beginning after December 15, 2005; however, Statement 154
does not change the transition provisions of any existing accounting pronouncements. The
adoption of Statement 154 is not expected have a material effect on our consolidated
financial position, results of operations, or cash flows.

In March 2006, the FASB Emerging
Issues Task Force (EITF) reached a consensus on EITF Issue No. 06-3, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should Be Presented in
the Income Statement (That Is, Gross versus Net Presentation),(EITF
06-3). The guidance prescribes the disclosure of our accounting treatment of any tax
assessed by a governmental authority that is directly imposed on a revenue-producing
transaction, which includes, but is not limited to sales, use, value added and some excise
taxes. Our accounting treatment of such taxes collected is to be made in our disclosure of
significant accounting policies, in accordance with APB Opinion 22, Disclosure of
Accounting Policies. The provisions of EITF 06-3 are effective for fiscal years
beginning after December 15, 2006. We disclose our net presentation accounting
policy in the Revenue Recognition caption of Note 1 of the consolidated
financial statements, in compliance with the requirements of guidance prescribed by EITF
06-3. EITF 06-3 will not have an effect on our consolidated financial position, results of
operations or cash flows.

In June 2006, the FASB issued
Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxesan interpretation of SFAS No. 109. FIN 48 will require us to recognize
the financial statement effects of a tax position when it is more likely than not, based
on the technical merits, that the position will be sustained upon examination. As used in
this Interpretation, the term more likely than notmeans a likelihood of more than
50 percent; the terms examinedand upon examinationalso include resolution
of the related appeals or litigation processes, if any. The determination of whether or
not a tax position has met the more-likely-than-not recognition threshold is to be
determined based on the facts, circumstances, and information available at the reporting
date. The provisions of FIN 48 are effective for fiscal years beginning after December 15,
2006. We believe our accounting for income taxes currently complies with this
interpretation. FIN 48 is not expected have a material effect on our consolidated
financial position, results of operations or cash flows.

# FACTORS AFFECTING
RESULTS INCLUDING RISKS AND UNCERTAINTIES

The factors, risks and uncertainties
should be considered by investors when reviewing any forward-looking statements contained
in this report, in any of our public filings or press releases or in any oral statements
made by us or any of our officers or other persons acting on our behalf. The important
factors that could affect forward-looking statements are subject to change, and we
disclaim any obligation or duty to update or modify any forward-looking statements.

If any of the following risks occurs,
our actual results could differ significantly, and the trading price of our common stock
could decline, and you may lose all or part of your investment. We have identified the
material risks which we believe may affect our business and the principal ways in which we
anticipate that they may affect our business or financial condition.

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# RISKS RELATED TO OUR
CORE BUSINESS OPERATIONS

We are at a competitive
disadvantage because we operate in a market that is dominated by companies that are the
original manufacturers of printers for which we supply products. If we do not effectively
compete with new and existing competitors, our revenues and operating margins will
decline.

The printer consumable industry is
highly competitive on both a worldwide basis and a regional geographic basis. Our
competitors and potential competitors range from large international original equipment
printer manufacturers to numerous large and small providers of discounted remanufactured
product. Our most formidable competition in the color business printer space is the
incumbent original equipment printer manufacturer (OEM). Our OEM competitors include
Xerox, Oki, Konica Minolta, and Epson. In most cases, these OEMs enjoy market shares well
in excess of 95%; some with shares as high as 99%. These OEMs have certain inherent
advantages due to the fact that they manufacturer the subject printers for which we
produce competing solid ink and toner consumables. These OEM competitors also have much
greater financial, technical, marketing, name recognition, and other resources. In
addition, the OEMs can influence dealer, distributor, and ultimately customer choice
through incentive and other programs that discourage sale or purchase of non-OEM products.
We expect competition to increase in the future from existing competitors and a number of
companies that may enter our existing or future markets. Increased competition could
adversely affect our revenue and profitability through price reductions and loss of market
share.

The principal competitive factors in
our products include: product performance and quality, time to market, marketing and
access to distribution channels, product warranty, customer services, and product design
and price. If we do not sufficiently differentiate our products on these factors, our
business, operating results and financial condition will suffer. Some of our current and
potential competitors have substantially greater financial, technical, sales and marketing
resources than we have. We may not be able to continue to compete successfully with our
existing competitors or with new competitors.

In addition, current and potential
competitors may make strategic acquisitions or establish cooperative relationships among
themselves or with third parties, thereby increasing the ability of their products to
address the needs of their current and prospective customers. Accordingly, it is possible
that new competitors or alliances among current and new competitors may emerge and rapidly
gain significant market share and production economies. Such competition could materially
adversely affect our ability to sell our products on terms favorable to us. Further,
competitive pressures and functionally competitive products could require us to reduce the
price of our products, which could materially adversely affect our business, operating
results and financial condition. We may not be able to compete successfully against
current and future competitors and any failure to do so would have a material adverse
effect on our business, operating results and financial condition.

# We may need to change
our pricing models to compete successfully.

The highly competitive markets in
which we compete can put pressure on us to reduce the prices of our products. As a result,
we may not be able to maintain our historical prices and margins, which could adversely
affect our business, results of operations and financial condition. We believe that
competition will increase in the future, which could require us to reduce prices, increase
advertising expenditures or take other actions which may have an adverse effect on our
operating results. Decreasing prices resulting from competition and technological changes
require us to sell a greater number of products to achieve the same level of net revenues
and gross profit. If this occurs and we are unable to attract new customers and sell
increased quantities of products, our revenue growth and profitability could be adversely
affected. Any broadly-based changes to our prices and pricing policies could cause our
revenues to decline or be delayed as our sales force implements and our customers adjust
to the new pricing policies. Some of our competitors may bundle products for promotional
purposes or as a long-term pricing strategy or provide guarantees of prices and product
implementations. These practices could, over time, significantly constrain the prices that
we can charge for our products.

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We rely on a small number of
suppliers to provide key components for our products.

Our manufacturing process requires a
high volume of quality raw materials and components from third-party suppliers. Defective
products received from these suppliers could reduce product reliability and harm our
reputation. Our reliance on suppliers may result in product delays or price increases. We
use some components that are not common to the rest of the personal computer and consumer
electronics industries. Further, a number of our products utilize custom components. Some
key components and raw materials (including certain toners and electronic chips), may be
obtained only from a single supplier or a limited group of suppliers, either because
alternative sources are not available or the relationship is advantageous due to
performance, quality, support, delivery, capacity, or price considerations.

We generally purchase raw materials,
components and products using purchase orders and have no guaranteed supply arrangements
with the suppliers. From time to time, vendors may cease to do business with us for
various reasons, or change our terms and conditions. Any such termination or the
implementation of such changes could have a material adverse impact on our financial
results. The loss of, or change in, business relationship with key suppliers, could
negatively impact our competitive position. Additionally, a merger or consolidation among
our suppliers could result in price increases which would adversely impact our results of
operations.

Even where alternative sources of
supply may be available, qualification of the alternative suppliers and establishment of
reliable supplies could result in delays and a possible loss of sales, which could have a
material adverse affect on our financial performance. Moreover, if actual demand for our
products is different than expected, we may purchase more/fewer parts than necessary or
incur costs for canceling, postponing or expediting delivery of products. Any or all of
these factors could materially and adversely affect our business, financial condition and
results of operations.

We rely on indirect distribution
channels and major distributors that we do not control.

We rely significantly on independent
distributors and resellers to market and distribute our products. We do not control our
distributors and resellers. Additionally, our distributors and resellers are not obligated
to buy our products and could also represent other lines of products. Some of our
distributors and resellers maintain inventories of our products for resale to their
customers. If distributors and resellers reduce their inventory of our products, our
business could be adversely affected. Further, we could maintain individually significant
accounts receivable balances with certain distributors. The financial condition of our
distributors could deteriorate and distributors could significantly delay or default on
their payment obligations. Any significant delays or defaults could have a material
adverse effect on our business, results of operations and financial condition.

Any failure to maintain on-going
sales through distribution channels could result in lower revenues.

To date, we have sold our products
principally through distributors and resellers. Our ability to achieve revenue growth in
the future will depend in large part on our success in maintaining existing relationships
and further establishing and expanding relationships with new distributors and resellers.
It is possible that we will not be able to successfully expand our distribution channels,
secure business with additional distributors and resellers on commercially reasonable
terms or at all, and otherwise adequately continue to develop and maintain our existing
distribution relationships. Moreover, even if we succeed in these endeavors, it still may
not increase our revenues. We need to carefully monitor the development and scope of our
indirect sales channels and create appropriate pricing, sales force compensation and other
distribution parameters. If we invest resources in these types of expansion and our
overall revenues do not correspondingly increase, our business, results of operations and
financial condition will be materially and adversely affected. Additionally, as we attempt
to attract and penetrate additional distributors and resellers, we may need to increase
corporate branding and marketing activities, which could increase our operating expenses.
Accordingly, these efforts, if not sufficiently effective, may actually reduce our
profits.

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We are dependent on commercial
delivery services for supply of raw materials and finished goods as well as delivery of
our products to customers.

We generally ship our products in
from our suppliers and to our customers by common carrier, including, but not limited to
Concordia, DHL, FedEx, and United Parcel Service. If we are unable to pass on to our
customers future increases in the costs of our commercial delivery services, our
profitability could be adversely affected. Additionally, strikes or other service
interruptions by such shippers could adversely affect our ability to deliver products on a
timely basis.

Product Concentration  Our
business derives revenues from a single group of similar and related products.

Our revenues are derived primarily
from a single group of similar and related products, and a decline in demand or prices for
these products or services could substantially adversely affect our operating
results.We currently derive the majority of our revenues from the
sale of solid ink sticks and toner consumables for color work group printers. We expect
these products to continue to account for the majority of our revenues in the future. As a
result, factors adversely affecting the pricing of or demand for such products, including
difficult economic conditions, future terrorist activities or military actions, any
decline in overall market demand, competition, product performance or technological
change, could have a material adverse effect on our business and consolidated results of
operations and financial condition.

Our future growth is expected to be
achieved through the development and introduction of new products, increasing market
penetration of our existing products, and continuation of the trend in growth of color
printing. There are substantial risks that we will be unable to realize any or all of this
expected growth. Nor can we provide any assurance that new products we introduce will be
successful in the market. All of our new product initiatives have substantial, entrenched
OEM competitors with greater resources and experience in these product areas. There can be
no assurances that all or any of these new products will be successful and contribute to
profitability or growth.

Customer Concentration 
Historically, a few customers have accounted for a large percentage of our revenues. The
loss of a significant customer would significantly reduce our revenues.

Our customer base is relatively
highly concentrated. Presently, three customers account for about 35% of our entire net
revenues. For the foreseeable future, we expect to continue to have a relatively highly
concentrated customer base. In addition, the mix and type of customers, and sales to any
single customer, may vary significantly from quarter to quarter and from year to year. If
customers do not place orders, or delay or cancel orders, we may not be able to replace
the business. Any changing, rescheduling or canceling orders by these customers may result
in a significant decline in our revenues and profitability. Major customers may also seek
and on occasion receive pricing, payment terms or other conditions that are less favorable
to us. In addition, certain customers may form strategic alliances or collaborative
efforts that could result in additional complexities in managing individual customer
relationships and transactions. These factors could have a material adverse effect on our
business, financial condition and results of operations.

Product Warranty  Because we
offer a liberal product warranty, expenses associated with the program could harm our
revenues and substantially increase our costs.

We provide warranties for our
products as to suitability for use in the intended printer models and that our products
are free of defects that could cause damage to these printers. Costs covered under the
product warranty include customary charges for the repair or replacement of the printer
with an equivalent new or refurbished printer, at our sole discretion. We believe that our
product warranty is relatively liberal, providing in most cases, broader and more complete
coverage than that provided by the original equipment printer manufacturer.

Some of the products we offer are
internally complex and, despite extensive testing and quality control, may contain
defects. We may need to recall defective products if these defects are not discovered
until after commercial shipments have been made, issue credits to customers, impair and
dispose of substantial inventories, and may incur substantial product warranty and service
costs if our products damage customer printers. Any product defects could also cause
damage to our reputation and result in loss of revenues, product returns or order
cancellations, lack of market acceptance of our products, as well as increase our product
warranty or service costs. Accordingly, any product defects could have a material and
adverse effect on our business, results of operations and financial condition.

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In 2002, we conducted a product
recall after manufacturing defects in certain solid ink sticks caused damage to some
customer print heads. The recall and related warranty expense cost us approximately $5.0
million. Since then, we have made substantial improvements in testing and quality
control processes. We cannot guarantee that the testing and quality control improvements
we have implemented will be effective in preventing future recalls and similar or more
substantial material adverse effects on our business and results of operations.

# We are exposed to
inventory risks.

We are exposed to inventory risks as
a result of the rapid technological changes that affect the market and pricing for the
products we sell. We seek to minimize our inventory exposure through a variety of
inventory management procedures and policies. However, if there were unforeseen product
developments that created more rapid obsolescence or if vendors were to change their terms
and conditions, our inventory risks could increase. We also periodically take advantage of
cost savings associated with certain opportunistic bulk inventory purchases offered by our
vendors. These bulk purchases could increase our exposure to inventory obsolescence. We
cannot guarantee that we will be successful in our efforts to mitigate our inventory risk
and, in fact, many of the competitive and technological factors that drive this risk are
beyond our control.

We are, and may become, involved
in litigation, which could materially harm our business.

We are a party to legal proceedings that
arise from time to time, involving our business, products or operations. We do not believe
that any currently pending or threatened litigation, based on our assessment of merit,
will have a material adverse effect on our financial condition. However, the litigation
process is inherently expensive, uncertain and includes the risk of an unexpected,
unfavorable result. Accordingly, it is possible in the future that the eventual outcome of
litigation could materially and adversely affect our results of operations.

If we are unable to finance our
INKlusive program, we may be required to use alternative sources of financing or attempt
to self-finance these activities.

We depend on our current third-party
financing sources to fund our INKlusive program. If either of our third-party financing
vendors is unable to access the capital markets, ceases to operate as a finance company,
or chooses not to participate in the financing of the INKlusive program, we may have to
cease or scale-back our INKlusive program to the extent we are unable to self-finance the
program. As a result, our revenues and operating results could be adversely affected.

Covenants in our debt instruments
could trigger a default adversely affecting our ability to execute our business plan, our
ability to obtain further financing, and potentially adversely affect the ownership of our
assets.

Upon the occurrence of an event of
default under any of our loan agreements, the lenders or trustees could elect to declare
all amounts outstanding thereunder to be immediately due and payable, and terminate all
commitments to extend further debt. If the lenders or trustees accelerate the repayment of
borrowings, we cannot provide assurance that we will have sufficient assets to repay our
debt facilities and our other indebtedness or be able to implement our business plan. If
we are unable to repay our outstanding indebtedness, the bank could foreclose on all of
our assets. Accordingly, the occurrence of an event of default could have a material
adverse affect on our financial position, results of operations, and our viability.

Our bank debt agreements contain
financial and other covenants. Although we believe none of these covenants are presently
restrictive to our operations, our ability to meet the financial covenants can be affected
by events beyond our control, and we cannot provide assurance that we will meet those
tests. A breach of any of these covenants could result in a default under our debt
agreements. We have a revolving line of credit with a financial institution, whereby we
can borrow funds, subject to availability of collateral. Borrowings under the credit line
are collateralized by all of our assets. Although we currently have no outstanding
balances under this line, we have several term notes with the same lender that are cross
collateralized and contain cross default provisions with the revolving line-of-credit.

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If we do not generate sufficient
cash flow from operations in the future, we may not be able to fund our product
development, potential acquisitions, or fulfill our future obligations.

Our ability to generate sufficient
cash flow from operations to fund our operations and product development, including the
payment of cash consideration in any potential acquisitions and the payment of our other
obligations, depends on a range of economic, competitive and business factors, many of
which are outside our control. We cannot assure you that our business will generate
sufficient cash flow from operations, or that we will be able to sell assets or raise
equity or debt financings when needed or desirable. An inability to fund our operations or
fulfill outstanding obligations could have a material adverse effect on our business,
financial condition and results of operations.

# RISKS RELATED TO OUR
INTERNATIONAL BUSINESS AND SENSITIVITYTO ECONOMIC CONDITIONS

Commodity price fluctuations may
increase our cost of goods and adversely affect our results.

A large percentage of our products
utilize petroleum, flax and soybean-based materials and paper and corrugated packaging.
Volatility in the prices of these commodities could increase the costs of our products,
which we may not be able to pass on to our customers, and thereby adversely effect our
results of operations and cash flows.

Our international operations
expose us to greater management, collections, currency, export licensing, intellectual
property, tax, regulatory and other risks. Expansion into international markets is
important to our long-term success, and our inexperience in the operation of our business
outside the U.S. increases the risk that our international expansion efforts will not be
successful.

Net revenue outside the
U.S. accounted for approximately 18% of our consolidated net revenue in fiscal 2006.
These non-U.S. sales are primarily concentrated in Western Europe and are expected to grow
at a rate faster than our U.S. business. We opened our first office outside the U.S. in
January 2005, and have only limited experience with operations outside the U.S. Expansion
into international markets requires management attention and resources. These risks could
harm our international expansion efforts, which would in turn harm our business and
operating results.

Our international business is subject
to a number of risks, including unexpected changes in regulatory practices and tariffs,
longer collection cycles, seasonality, potential changes in export licensing and tax laws,
and greater difficulty in protecting intellectual property rights. Also, the impact of
fluctuating exchange rates between the U.S. dollar and foreign currencies in markets where
we do business may significantly impact our revenues. For example, a strengthening of the
U.S. dollar could have an unexpected adverse impact on our international revenue. If the
value of the U.S. dollar relative to the European currencies were to significantly
increase, it could have an unexpected adverse impact on our revenues, profits and other
operating results. General economic and political conditions in these foreign markets,
including the military action in the Middle East, geopolitical instabilities on the Korean
peninsula and other parts of Asia and a backlash against U.S. based companies may also
impact our international revenues, as such conditions may cause decreases in demand or
impact our ability to collect payment from our customers. There can be no assurances that
these factors and other factors will not have a material adverse effect on our future
international revenues and consequently on our business and consolidated financial
condition and results of operations.

Currently, all of our toner-based
products are sourced and assembled in foreign locations, particularly Japan, China, and
Taiwan, which subject us to a number of economic and other risks.

Local laws in effect or that may
be enacted in foreign jurisdictions may afford less protection to holders of our
securities than those in effect in the United States.

We presently have one non-U.S.
subsidiary, Media Sciences U.K. Limited, and we may have others in the future. These
foreign subsidiaries are organized under the laws of their respective jurisdictions. Thus,
holders of our securities should not conclude that assets and interests held by such
foreign subsidiaries are subject to the same protections afforded similar entities
incorporated in a United States jurisdiction.

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Our earnings and growth rate could
be adversely affected by changes in general economic conditions and uncertain geopolitical
conditions.

Weak general economic conditions,
along with uncertainties in geopolitical conditions, could adversely impact our revenue
and growth rate and impair the value of our assets. In addition, our revenue, gross margin
and earnings could deteriorate in the future as a result of unfavorable economic or
political conditions.

# RISKS RELATED TO OUR
TECHNOLOGY AND THE NATURE OF OUR PRODUCTS

We operate in an industry
characterized by increasingly rapid technological changes and our sales are dependent on
the continued development of new technologies and products.

The markets for our products and
services are characterized by: rapid technological change; increasing technical complexity
of the products (i.e., new chemical toners, use of new smart chips, etc.); evolving
industry standards; fluctuations in customer demand; changes in customer requirements; and
frequent new product and service introductions and enhancements.

Our future success depends on our
ability to continually enhance our current products and develop and introduce new products
and services that our customers choose to buy. The timely availability of marketable new
products is critical to our future success. We cannot guarantee that we will be successful
in this effort. Our future success could be hindered by: delays in our introduction of new
products and services; delays in market acceptance of new products and services or new
releases of our current products and services; and our, or a competitors,
announcement of new product or service enhancements or technologies that could replace or
shorten the life cycle of our existing product and service offerings.

Execution risks associated with
product development and introduction are significant and could reduce the demand for our
products and the profitability of our operations.

Continuing improvements in technology
mean frequent new product introductions, short product life cycles, and improvement in
product performance characteristics. New product introductions present execution
challenges and risks for us. If we are unable to effectively manage a product
introduction, our business and results of operations could be unfavorably affected.

Our success is subject to many risks,
including, but not limited to, our ability to timely and cost-effectively:
(1) develop and market new products and price products appropriately;
(2) improve existing products and increase market share in our existing markets;
(3) expand into or develop related and new markets for our technology;
(4) achieve market acceptance of, and accurately forecast demand and meet production
schedules for, our products; (5) achieve cost efficiencies across product offerings;
(6) adapt to technology changes in related markets; (7) adapt to changes in
value offered by companies in different parts of the supply chain; (8) qualify
products for volume manufacturing with our customers; and (9) successfully implement
improvements in our manufacturing process. Furthermore, new or improved products may
involve higher costs and reduced efficiencies compared to our more established products
and could adversely affect our gross margins. In addition, we must successfully implement
changes in our design engineering methodology, including changes that result in:
significant decreases in material costs and cycle time; greater commonality of components
and types of parts used in different products; and effective product life cycle
management. If we do not successfully manage these challenges, our business, financial
condition and results of operations could be materially and adversely affected.

We cannot guarantee that our products
will achieve the broad market acceptance by our channel and entities with which we have a
technology relationship, customers and prospective customers necessary to generate
significant revenue. In addition, we cannot guarantee that we will be able to respond
effectively to technological changes or new product announcements by others. If we
experience material delays or sales shortfalls with respect to our new products and
services or new releases of our current products and services, those delays or shortfalls
could have a material adverse effect on our business, results of operations and financial
condition.

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Our intellectual property and
other proprietary rights could offer only limited protection. Competitors may use our
technology, which could weaken our competitive position, reduce our revenues and increase
our costs.

Our success depends, to a large
extent, on our ability to protect our proprietary technology. We rely on a combination of
patent, copyright, trademark, service mark, trade secret rights, and confidentiality
procedures to establish and protect our proprietary rights. As part of our confidentiality
procedures, we generally enter into non-disclosure agreements with our employees,
distributors and corporate partners with respect to our documentation and other
proprietary information. Despite precautions we may take to protect our intellectual
property, we cannot assure you that third parties will not try to challenge, invalidate or
circumvent these safeguards. It is possible that other companies could successfully
challenge the validity or scope of our current or future patents or that our competitors
may independently develop similar technology, duplicate our products, or design around
patents and other intellectual property rights that we hold. We also cannot assure you
that the rights granted under our patents or attendant to our other intellectual property
will provide us with any competitive advantages, or that patents will be issued on any of
our pending applications, or that future patents will be sufficiently broad to protect our
technology. Furthermore, the laws of foreign countries may not protect our proprietary
rights in those countries to the same extent as applicable law protects these rights in
the United States. Failure to protect our intellectual property could materially adversely
affect our business, operating results and financial condition.

Existing and future claims of
intellectual property infringement against us could seriously harm our business because it
could inhibit our ability to use certain technologies, divert our management efforts,
result in costly litigation, and subject us to significant uncertainty regarding the
ultimate outcome.

We are subject to legal proceedings
and claims that arise in the ordinary course of our business, that our products infringe
certain patent or other intellectual property rights. It is possible that third parties,
including competitors, technology partners, and other technology companies, could
successfully claim that our current or future products, whether developed internally or
acquired, infringe their rights, including their trade secret, copyright and patent
rights. These types of claims, with or without merit, can cause costly litigation that
absorbs significant management time, as well as impede our sales efforts due to any
uncertainty as to the outcome, all of which could materially adversely affect our
business, operating results and financial condition. These types of claims, with or
without merit, could also cause us to pay substantial damages or settlement amounts, cease
offering of any subject technology or products altogether, require us to enter into
royalty or license agreements, and damage our ability to sell products due to any
uncertainty generated as to intellectual property ownership. Under certain circumstances
our suppliers may be contractually obligated to indemnify us against certain expenses,
however those suppliers may ultimately be unable to meet their obligations. Further, by
successfully challenging the validity of patents or other intellectual property, we may
make it easier for other competitors to enter the market.

Because of technological changes in
our industry, current extensive patent coverage, and the rapid rate of issuance of new
patents, it is possible that certain of our products, including products obtained through
acquisitions, components, and business methods may unknowingly infringe existing patents
of others. We attempt to ensure that products we develop or acquire, and our processes, do
not infringe upon third party patents and other proprietary rights. We typically conduct
as many as three independent intellectual property reviews as an integral part of our
product development process: an extensive in-house review, a review by external council,
and our key suppliers conduct their own review. Before product launch, these independent
reviews are compared and reconciled. Despite these efforts, we cannot guarantee that this
process will be effective in preventing the infringement of the patent rights of others.

We do not believe that any currently
pending or threatened litigation, based on our assessment of merit, will have a material
adverse effect on our financial condition. However, the litigation process is inherently
expensive, uncertain and includes the risk of an unexpected, unfavorable result.
Accordingly, it is possible in the future that the eventual outcome of litigation could
materially and adversely affect our financial position and results of operations.

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On June 23, 2006, Xerox Corporation
filed a lawsuit against the Company alleging Media Sciences solid ink sticks for use
in the Xerox® Phaser® 8500/8550 printers infringe, actively induces others to
infringe, and/or contributorily infringes four patents held by Xerox concerning solid ink
stick shape. Xerox seeks a preliminary and permanent injunction, a finding of willful
infringement, damages (including treble damages), and costs. In August 2006, Media
Sciences answered the complaint and counterclaimed for declaratory judgment of
non-infringement and invalidity. Media Sciences believes the filing of this action by
Xerox violates an agreement between the companies that was reached in resolution of
similar litigation in 2001. We believe we have meritorious defenses and counterclaims and
intend to pursue them vigorously. There can be no assurance, however, that we will be
successful in our defense of this action. The loss of all or a part of this lawsuit could
have a material adverse affect on our operations.

# OTHER BUSINESS RISKS

Challenges of Growth  If we
fail to manage our operations and grow revenues or fail to continue to effectively control
expenses, our future operating results could be adversely affected.

The scope of our operations, the
number of our employees and the geographic area of our operations and our revenues have
grown rapidly. Our growth could place a significant strain on our managerial, operational
and financial resources. To manage our current growth and any future growth effectively,
we need to continue to implement and improve additional management and financial systems
and controls. We may not be able to manage the current scope of our operations or future
growth effectively and still exploit market opportunities for our products and services in
a timely and cost-effective way.

We attribute most of our growth
during recent years to the introduction of new products and general growth of the color
work group printer market. We cannot assure you that this market we serve will continue to
grow. We cannot assure you that we will be successful in developing and introducing new
products or that any new products we may introduce will actually increase our revenue
growth rate.

If we experience a shortfall in
revenue in any given quarter, due to the fixed nature of many of our expenses, we may not
be able to further reduce operating expenses quickly in response. Any significant
shortfall in revenue therefore could immediately and adversely affect our results of
operations for that quarter. Accordingly, our revenue growth, profitability and cash flows
from operating activities could be lower than in recent years.

If we are unable to attract and
retain key executive and management personnel, we may not be able to manage and execute
our business plan.

Our success depends, in large part,
upon the services of a number of key employees. Other than our founder and CEO, Michael W.
Levin, who has an employment agreement and for whom we maintain a key-person life
insurance policy, our executive officers and key employees are at-will employees and are
not covered by key-person life insurance policies. Competition for these types of
employees is intense, and it is possible that we will not be able to retain our key
employees and that we will not be successful in attracting, assimilating and retaining
qualified candidates in the future.

Further, we may have difficulty
attracting and retaining qualified board members and executive officers, which would
adversely affect our business. Recently enacted and proposed changes in the laws and
regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act
of 2002, mandate, among other things, that companies adopt new corporate governance
measures and impose comprehensive reporting and disclosure requirements, set stricter
independence and financial expertise standards for audit committee members and impose
increased civil and criminal penalties for companies, their chief executive officers,
chief financial officers and directors for securities law violations. In addition,
regulations adopted by stock exchanges require comprehensive rules and regulations
relating to corporate governance. These laws, rules and regulations have increased and
will make it more difficult and more expensive for us to obtain director and officer
(D&O) liability insurance in the future. Further, our board members, Chief Executive
Officer and Chief Financial Officer could face an increased risk of personal liability in
connection with the performance of their duties that cannot be addressed with D&O
insurance.

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If we lose key personnel or cannot
hire enough qualified employees, it will adversely affect our ability to manage our
business, develop, acquire new products and increase revenue.

The effective management of our
growth could depend upon our ability to retain our highly skilled technical, managerial,
finance and marketing personnel. If any of those employees leave, we will need to attract
and retain replacements for them. To achieve our growth objectives, we also need to add
key personnel in the future. The market for these qualified employees is competitive. We
could find it difficult to successfully attract, assimilate or retain sufficiently
qualified personnel in sufficient numbers. We might not attract and retain enough
qualified personnel to support our anticipated domestic or international growth and our
increasingly complex product offerings.

Furthermore, we may need to hire
additional personnel to develop new products, product enhancements and technologies. If we
cannot add the necessary staff and resources, our ability to develop future products could
be delayed. Similarly, we may need to hire key personnel in connection with potential
future acquisitions. If we cannot retain and add the necessary staff and resources for
these acquired businesses, our ability to develop acquired products, markets and customers
could be delayed. Any such delays could have a material adverse effect on our business,
results of operations and financial condition.

We may incur substantial
additional costs to motivate, attract, and retain key employees

As a result of our adoption of
Statement of Financial Accounting Standards, or SFAS, No. 123(R), Share-Based
Payments, which begins in our first quarter of fiscal 2007 (ending September 30,
2006), we will record a charge to earnings for all equity-based compensation, such as stock
options and restricted stock awards granted to employees. This requirement reduces the attractiveness of
granting equity-based compensation as the expense associated with these grants will
decrease our profitability. If we do not successfully attract, retain and motivate key
employees as a result of these or other factors, our operating results and ability to
capitalize on our opportunities may be materially and adversely affected.

In addition, regulations adopted by
AMEX and certain other exchanges require stockholder approval for new equity compensation
plans and significant amendments to existing plans, including increases in shares
available for issuance under such plans, and prohibit member organizations from giving a
proxy to vote on equity compensation plans unless the beneficial owner of the shares has
given voting instructions. These regulations could make it more difficult for us to grant
equity compensation to employees in the future. To the extent that these regulations make
it more difficult or expensive to grant equity compensation to employees, we may incur
increased compensation costs or find it difficult to attract, retain and motivate
employees, which could materially and adversely affect our business.

If we become subject to unfair
hiring claims, we could be prevented from hiring needed employees, incur liability
for damages and incur substantial litigation costs in defending ourselves.

Companies in our industry whose
employees accept positions with competitors frequently claim that those competitors have
engaged in unfair hiring practices or that the employment of these persons would involve
the disclosure or use of trade secrets. These claims could prevent us from hiring
employees or cause us to incur liability for damages. We could also incur substantial
costs in defending ourselves or our employees against these claims, regardless of their
merits. Defending ourselves from these claims could also divert the attention of our
management away from our operations.

Disruption of our operations at
our corporate headquarters could negatively impact our results of operations.

Although we have multiple sales
office locations in the United States and an office in Western Europe, essentially all of
our computer equipment, intellectual property resources and personnel, including critical
resources dedicated to research and development, manufacturing and administrative support
functions, are presently located at our corporate headquarters in Oakland, New Jersey. The
occurrence of natural disasters or other unanticipated catastrophes could cause
interruptions in our operations. Extensive or multiple interruptions in our operations due
to natural disasters or unanticipated catastrophes could severely disrupt our operations
and have a material adverse effect on our results of operations.

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# RISKS RELATED WITH OUR
INFORMATION TECHNOLOGY

Because our business relies upon a
variety of computer systems to operate effectively, the failure or disruption of, or
latent defects in, these systems could have a material adverse effect on our business.

We depend on our information
technology and manufacturing infrastructure to achieve our business objectives. The
effectiveness and efficiency of our operations depend on a variety of information systems,
including e-mail, enterprise resource planning, electronic data interchange, customer
resource management and e-commerce systems, and financial accounting. Disruption in the
operation of these systems, or difficulties in maintaining or upgrading these systems,
could have a material adverse effect on our business. An infrastructure disruption could
cause us to lose customers and revenue, and could require us to incur significant expense
to eliminate these problems and address related security concerns. The harm to our
business could be even greater if it occurs during a period of disproportionately heavy
demand. Difficulties that we have encountered, or may encounter, in connection with our
implementation and use of our computer systems, including human error or our reliance on,
or a failure or disruption of, or latent defects in, such systems, could adversely affect
our order management and fulfillment, financial reporting and supply chain management
processes, and any such difficulties could have a material adverse effect on our business.

The success of our business
depends on the continuing development, maintenance and operation of our information
technology systems.

Our success is dependent on the
accuracy, proper utilization and continuing development of our information technology
systems, including our business application systems, Web servers and telecommunications
network. The quality and our utilization of the information generated by our information
technology systems, and our success in implementing new systems and upgrades, affects,
among other things, our ability to:

| |  | conduct business with our customers;
| | - | ------------------------------------

| |  | manage our inventory and accounts receivable;
| | - | ---------------------------------------------

| |  | purchase, sell, ship and invoice our products efficiently and on a timely basis; and
| | - | ------------------------------------------------------------------------------------

| |  | maintain our cost-efficient operating model.
| | - | --------------------------------------------

The integrity of our information
technology systems is vulnerable to certain forms of disaster including, but not limited
to, natural disasters such as tornadoes. While we have taken steps to protect our
information technology systems from a variety of threats, including computer viruses and
malicious hackers, there can be no guarantee that those steps will be effective.
Furthermore, although we have redundant systems at a separate location to back up our
primary application systems, there can be no assurance that these redundant systems will
operate properly if and when required. Any disruption to or infiltration of our
information technology systems could significantly harm our business and results of
operations.

We have operations, clients, and
vendors throughout the world. Our operations are dependent upon the connectivity of our
operations throughout the world. Activities that interfere with our international
connectivity, such as computer hacking or the introduction of a virus into our
computer systems, could significantly interfere with our business operations.

# RISKS RELATED TO
ACQUISITIONS AND ALLIANCES

# We are exposed to risks
associated with acquisitions.

From our inception in May 1987, we
have made a number of strategic acquisitions. In connection with acquisitions completed
prior to June 30, 2006, we recorded approximately $4.9 million as intangible assets and
goodwill, of which approximately $0.4 million had been amortized and $0.9 million written
off. We intend to continue to address the need to develop new products and enhance
existing products through acquisitions of other companies, product lines and/or
technologies. Our growth is dependent upon market growth, growth in market share, our
ability to enhance existing products and services, and our ability to introduce new
products on a timely basis.

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In the future we expect to acquire,
or make significant investments in, businesses to achieve our strategic objectives. While
we expect to carefully analyze each potential acquisition before committing to the
transaction, we may not be able to integrate and manage acquired products and businesses
effectively. We cannot assure anyone that our previous acquisitions or any future
acquisitions will be successful in helping us reach our financial and strategic goals
either for that acquisition or for us generally. Acquisitions involve numerous risks,
including but not limited to: (1) diversion of managements attention from other
operational matters; (2) inability to complete acquisitions as anticipated or at all;
(3) inability to realize synergies expected to result from an acquisition;
(4) failure to commercialize purchased technologies; (5) ineffectiveness of an
acquired companys internal controls; (6) impairment of acquired assets as a
result of technological advancements or worse-than-expected performance of the acquired
company or its product offerings; (7) unknown, underestimated and/or undisclosed
commitments or liabilities, including those related to an acquired companys product
quality or unauthorized use of a third-partys intellectual property;
(8) substantial unanticipated costs; (9) material product liability or intellectual
property liability associated with the sale of the acquired companys products; (10)
failure to integrate and retain key employees; and (11) ineffective integration of
operations. Mergers and acquisitions are inherently subject to significant risks, and the
inability to effectively manage these risks could materially and adversely affect our
business, financial condition and results of operations.

In addition, acquisitions also expose
us to the risk of claims by terminated employees, shareholders of the acquired companies
or other third parties related to the transaction. If we undertake future acquisitions, we
may issue dilutive securities, assume or incur additional debt obligations, incur large
one-time expenses, utilize substantial portions of our cash, and acquire intangible assets
that would result in significant future amortization expense. In a number of our
acquisitions, we have agreed to make future payments, or earnouts, based on the
performance of the businesses we acquired. The performance goals pursuant to which these
future payments may be made generally relate to achievement by the acquired business of
certain specified bookings, revenue, product proliferation, product development or
employee retention goals during a specified period following completion of the applicable
acquisition. Future acquisitions may involve issuances of stock as payment of the purchase
price for the acquired business, grants of incentive stock or options to employees of the
acquired businesses (which may be dilutive to existing stockholders), expenditure of
substantial cash resources or the incurrence of material amounts of debt. Any of these
events could have a material adverse effect on our business, operating results and
financial condition.

If we determine that any of our
goodwill or intangible assets, including technology purchased in acquisitions, are
impaired, we would be required to take a charge to earnings, which could have a material
adverse effect on our financial condition and results of operations.

On June 29, 2001, the FASB
pronounced under Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets (FAS 142) that
purchased goodwill should not be amortized, but rather, should be periodically reviewed
for impairment. Such impairment could be caused by internal factors as well as external
factors beyond our control. The FASB has further determined that at the time goodwill is
considered impaired, an amount equal to the impairment loss should be charged as an
operating expense in the statement of operations. The timing of such an impairment (if
any) of goodwill acquired in past and future transactions is uncertain and difficult to
predict. Our results of operations in periods following any such impairment could be
materially adversely affected. We are required to determine whether goodwill and any
assets acquired in past acquisitions have been impaired in accordance with FAS 142
and, if so, charge such impairment as an expense. In the quarter ended June 30, 2005, we
took an asset impairment charge of $0.9 million related to past acquisitions. We have
remaining net goodwill and net acquired intangible assets of approximately $3.6 million at
June 30, 2006, so if we are required to take such additional impairment charges, or if
financial analysts or investors believe we may need to take such action in the future, our
stock price and operating results could be materially adversely affected.

We review for impairment annually, or
sooner if events or changes in circumstances indicate that the carrying amount could
exceed fair value. Due to uncertain market conditions and potential changes in our
strategy and product portfolio, it is possible that the forecasts we use to support our
goodwill and other intangible assets could change in the future. Significant judgments are
required to estimate the fair value of goodwill and intangible assets, including
estimating future cash flows, determining appropriate discount rates, estimating the
applicable tax rates, foreign exchange rates and interest rates, projecting the future
industry trends and market conditions, and making other assumptions. Changes in these
estimates and assumptions, including changes in our reporting structure, could materially
affect our determinations of fair value.

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# REGULATORY RISKS

We cannot provide any assurance
that current laws, or any laws enacted in the future, will not have a material adverse
effect on our business.

Our operations are subject to laws,
rules, regulations, including environmental regulations, government policies and other
requirements in each of the jurisdictions in which we conduct business. Changes in and
compliance with such laws, rules, regulations, policies or requirements could result in
increased costs, the need to modify our products and could affect the demand for our
products, which may have an adverse impact on our future operating results. If we do not
comply with applicable laws, rules and regulations, we could be subject to costs and
liabilities and our business may be adversely impacted.

Our operating results could be
adversely affected as a result of changes in our effective tax rates.

As a U.S. based multinational
company, we are subject to taxation in the United States and various other countries.
Significant judgment is required to determine and estimate worldwide tax liabilities. Our
future tax rates could be affected by changes in the following:

| |  | Earnings being lower than anticipated in countries where we are taxed at lower rates as
compared to the United States statutory tax rate;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------

| |  | An increase in expenses not deductible for tax purposes, including certain stock
compensation, write-offs of acquired in-process research and development and impairment of
goodwill;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Changes in the valuation of our
deferred tax assets and liabilities;
| | - | --------------------------------------------------------------------

| |  | Changes in tax laws or the interpretation of such
tax laws; or
| | - | --------------------------------------------------------------

| |  | New accounting standards or interpretations of such standards.
| | - | --------------------------------------------------------------

Any significant change in our future
effective tax rates could adversely impact our results of operations for future periods.
Accordingly, forecasting our estimated annual effective tax rate is complex and subject to
uncertainty, and material differences between forecasted and actual tax rates could have a
material impact on our results of operations.

Significant judgment is required in
determining our provision for income taxes. The calculation of our tax liabilities
involves dealing with uncertainties in the application of complex tax regulations. In
determining the adequacy of our provision for income taxes, we regularly assess the
likelihood of adverse outcomes resulting from tax examinations. We provide for tax
liabilities on our Consolidated Balance Sheets unless we consider it probable that
additional taxes will not be due. However, the ultimate outcome of tax examinations cannot
be predicted with certainty, including the total amount payable or the timing of any such
payments upon resolution of such issues. In addition, we cannot assure you that such
amounts will not be materially different than that which is reflected in our historical
income tax provisions and accruals. Should the IRS or other tax authorities assess
additional taxes as a result of a current or a future examination, we may be required to
record charges to operations in future periods that could have a material impact on the
results of operations, financial position or cash flows in the applicable period or
periods recorded.

Changes in accounting regulations
and related interpretations and policies, could cause us to recognize lower revenue and
profits.

Policies, guidelines and
interpretations related to revenue recognition, accounting for acquisitions, income taxes,
facilities consolidation charges, allowances for doubtful accounts and other financial
reporting matters require difficult judgments on complex matters that are often subject to
multiple sources of authoritative guidance. To the extent that managements judgment
is incorrect, it could result in an adverse impact on our financial statements. Some of
these matters are also among topics currently under re-examination by accounting standard
setters and regulators. These standard setters and regulators could promulgate
interpretations and guidance that could result in material and potentially adverse changes
to our accounting policies.

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If we are required to remit
significant payroll taxes, it will have an adverse impact on our future financial results.

When our employees exercise certain
stock options, we are subject to employer payroll taxes on the difference between the
price of our common stock on the date of exercise and the exercise price. These payroll
taxes are determined by the tax rates in effect in the employees taxing jurisdiction
and are treated as an expense in the period in which the exercise occurs. During a
particular period, these payroll taxes could be material, in particular if an increase in
our stock price causes a significant number of employees to exercise their options.
However, because we are unable to predict our stock price, the number of exercises, or the
country of exercise during any particular period, we cannot predict the amount, if any, of
employer payroll tax expense that will be recorded in a future period or the impact on our
future financial results. Stock price increases make it more likely that option holders
will exercise their options and, accordingly, that we would incur higher payroll taxes.

Changes in financial accounting
standards related to share-based payments are expected to have an adverse impact on our
reported results of operations.

In December 2004, the Financial
Accounting Standards Board issued SFAS No. 123(R), Share-Based Payment.
SFAS No. 123(R) is a very complex accounting standard that requires companies to
expense the fair value of employee stock options and similar awards and is effective as of
July 1, 2006 for us. The adoption of the new standard is expected to have an adverse
impact on our reported results of operations for periods after its implementation. SFAS
No. 123(R) also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an operating
cash flow as required under current financial accounting standards. This requirement will
reduce our net operating cash flows and increase net financing cash flows in periods after
implementation of the new standard. Additionally, SFAS No. 123(R) could adversely
impact our ability to provide accurate financial guidance concerning our expected results
of operations on a GAAP basis for periods after its effectiveness due to the variability
of the factors used to estimate the values of share-based payments. As a result, the
adoption of the new standard in the first quarter of our fiscal 2007 could negatively
affect our stock price and our stock price volatility.

Furthermore, the application of SFAS
No. 123(R) requires significant judgment and the use of estimates, particularly
surrounding stock price volatility, option forfeiture rates and expected option lives, to
build a model for appropriately valuing share-based compensation. There is little
experience or guidance with respect to developing these assumptions and models. There is
also uncertainty as to how SFAS No. 123(R) will be interpreted and applied as more
companies adopt the standard and companies and their advisors gain more experience with
the standard.

There is a risk that, as we and
others gain experience with SFAS No. 123(R) or as a result of subsequent accounting
guidelines, we could determine that the assumptions or model we used requires
modification. Any such modification could result in significantly different charges in
future periods and, potentially, could require us to correct the charges taken in prior
periods.  Any such corrections of charges taken in a prior period could negatively
affect our results of operations, stock price and our stock price volatility.

Failure to maintain effective
internal control over financial reporting may materially adversely impact our business.

Effective internal controls are
necessary for us to provide reasonable assurance with respect to our financial reports and
to effectively prevent fraud. If we cannot provide reasonable assurance with respect to
our financial reports and effectively prevent fraud, our brand and operating results could
be harmed. Pursuant to the Sarbanes-Oxley Act of 2002, we are required to furnish a report
by management on internal control over financial reporting, including managements
assessment of the effectiveness of such control. Internal control over financial reporting
may not prevent or detect misstatements because of its inherent limitations, including the
possibility of human error, the circumvention or overriding of controls, or fraud.
Therefore, even effective internal controls can provide only reasonable assurance with
respect to the preparation and fair presentation of financial statements. In addition,
projections of any evaluation of effectiveness of internal control over financial
reporting to future periods are subject to the risk that the control may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate. If we fail to maintain the adequacy of our internal controls,
including any failure to implement required new or improved controls, or if we experience
difficulties in their implementation, our business and operating results could be harmed,
we could fail to meet our reporting obligations, and there could be a material adverse
effect on our stock price.

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We are subject to internal control
evaluations and attestation requirements of Section 404 of the Sarbanes-Oxley Act.

Pursuant to the
Sarbanes-Oxley Act of 2002, our management must perform evaluations of our internal
control over financial reporting; as such standards may be modified, supplemented or
amended from time to time. Beginning during our fiscal year ending June 30, 2008 and
annually thereafter, our Form 10-KSB or Form 10K must include a report of our
managements assessment of the adequacy of such internal control, and our independent
registered public accounting firm must publicly attest to the adequacy of
managements assessment and the effectiveness of our internal controls. Ongoing
compliance with these requirements is complex, costly and time-consuming. If we fail to
maintain an effective internal control over financial reporting, if our management does
not timely assess the adequacy of such internal controls, or if our independent registered
public accounting firm does not timely attest to the evaluation, we could be subject to
regulatory sanctions and the publics perception of Media Sciences may decline and
the trading price of our stock could drop significantly.

# RISKS OF OWNING OUR
COMMON STOCK

Securities analysts or
investors expectations may not be met or exceeded, resulting in a decline in our
stock price.

If our revenues, operating results,
earnings or outlook are below the levels expected by investors or securities analysts, our
stock price is likely to decline. Moreover, even if our total revenues meet
investors and securities analysts expectations, if a component of our total
revenues or operating results does not meet these expectations, our stock price may
decline.

Deviations from expectations may be
the result of unreasonable or aggressive analyst or investor expectations and/or result
from fluctuations in our revenues and operating results. We may experience significant
fluctuations in our future revenues and operating results as a result of many factors,
including:

| |  | difficulty predicting the size and timing of customer orders;
| | - | -------------------------------------------------------------

| |  | potential fluctuations in demand or prices of our products and services;
| | - | ------------------------------------------------------------------------

| |  | the rate of customer acceptance of our new or existing products or the acceptance of such
products expected to be introduced in the future, and any delays in our launch of new
products or delays in orders caused by customer evaluations of these new products;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | periodic difficult economic conditions, particularly affecting the technology industry, as
well as economic uncertainties arising out of possible future terrorist activities;
military and security actions in Iraq and the Middle East in general; and geopolitical
instability in markets such as the Korean peninsula and other parts of Asia, all of which
have increased the likelihood that we may have product supply issues or that customers
will unexpectedly delay, cancel or reduce the size of orders, resulting in revenue
shortfalls;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | fluctuations in foreign currency exchange rates, which could have an adverse impact on our
international revenue, particularly in western Europe if the Euro or Pound Sterling were
to weaken significantly against the U.S. dollar;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the performance of our  international  business,  which accounts for approximately 18% of our consolidated
         revenues;
| | - | -----------------------------------------------------------------------------------------------------------------------------

| |  | changes  in the mix of  products  and  services  that  we sell or the  channels  through  which  they  are
         distributed;
| | - | --------------------------------------------------------------------------------------------------------------------------------

| |  | changes in our competitors' product offerings, marketing programs and pricing policies;
| | - | ---------------------------------------------------------------------------------------

| |  | any increased  price  sensitivity  by our  customers,  particularly  in the face of increased  competition,
including the availability of competitive illegally imported infringing product;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our ability to develop,  introduce and market new products and initiatives,  on a timely basis and whether
         any such new products are competitive or accepted in the market;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the lengthy sales cycle for some of our distribution agreements, particularly with regard
to government contracts or branded retail distribution agreements, which typically involve
more comprehensive qualifications and negotiations process and may require more detailed
customer evaluations;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our ability to control costs and expenses;
| | - | ------------------------------------------

| |  | loss of key personnel or inability to recruit and hire qualified additional or replacement key personnel;
| | - | ---------------------------------------------------------------------------------------------------------

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| |  | the degree of  success,  if any,  of our  strategy  to further  establish  and expand our  relationships  with
         distributors;
| | - | -------------------------------------------------------------------------------------------------------------------------------------

| |  | the  structure,  timing and  integration of  acquisitions  of businesses,  products and  technologies  and
         related disruption of our current business;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | costs  associated with  acquisitions,  including  expenses  charged for any impaired  acquired  intangible
         assets and goodwill;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------

| |  | the terms, timing and dilutive
impact of financing activities;
| | - | --------------------------------------------------------------

| |  | technological changes in printers that comprise our
current and potential market;
| | - | ---------------------------------------------------------------------------------

| |  | technological changes in toner and solid ink
manufacturing; and
| | - | ---------------------------------------------------------------

| |  | the ability of our products to satisfy market needs from a technical,
performance, price and quality perspective.
| | - | -----------------------------------------------------------------------------------------------------------------

Our stock price has been volatile,
and you could lose the value of your investment.

Our stock price has been volatile and has
fluctuated significantly in the past and your investment in our stock could lose some or
all of its value. For example, during the past twelve months, the closing sales price of
our common stock has fluctuated from a high of $5.89 per share to a low of $1.63 per
share. The trading price of our stock is likely to continue to be volatile and subject to
fluctuations in the future in response to various factors, some of which are beyond our
control. These factors include:

| |  | quarterly variations in our results of operations or those of our competitors.
| | - | ------------------------------------------------------------------------------

| |  | announcements  by us or our  competitors of new products,  product  improvements,  significant  contracts,
         commercial relationships or capital commitments.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the emergence of new sales or distribution channels in which we are unable to compete effectively.
| | - | --------------------------------------------------------------------------------------------------

| |  | our ability to develop and market new and enhanced products on a timely basis.
| | - | ------------------------------------------------------------------------------

| |  | commencement of, or our involvement in, litigation.
| | - | ---------------------------------------------------

| |  | recommendations by securities analysts or changes in earnings estimates.
| | - | ------------------------------------------------------------------------

| |  | announcements about our earnings that are not in line with analyst expectations.
| | - | --------------------------------------------------------------------------------

| |  | general economic conditions and slow or negative growth of related markets.
| | - | ---------------------------------------------------------------------------

The stock market in general and the
market for small market capitalization technology companies in particular have experienced
extreme price and volume fluctuations. These broad market and industry factors could
materially and adversely affect the market price of our stock, regardless of our actual
operating performance. Our fluctuating stock price also carries other risks, including the
increased risk of shareholder litigation.

Our officers, directors and
affiliates beneficially own approximately 35% of the outstanding shares of common stock,
allowing these shareholders to influence matters requiring approval of the stockholders.

As of June 30, 2006, our officers, directors and affiliates
beneficially owned shares of our common stock representing approximately 35% of our voting
stock. As a result of such ownership, and potential increased ownership, by our officers
and directors, other investors will have limited control over matters requiring approval
by the stockholders, including the election of directors. Such concentrated control may
also make it difficult for you to influence corporate matters, and our management may take
actions that our stockholders do not view as beneficial.

# We do not intend to pay
dividends on our common stock.

We have never declared or paid any
cash dividend on our common stock. We currently intend to retain any future earnings and
do not expect to pay any dividends in the foreseeable future. Future cash dividends on the
common stock, if any, will be at the discretion of our board, and will depend on our
future operations and earnings, capital requirements and surplus, general financial
condition, contractual restrictions imposed by lending or other agreements, and other
factors that the board may consider important.

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We have authorized a class of
preferred stock which may alter the rights of common stock holders by giving preferred
stock holders greater dividend rights, liquidation rights and voting rights than our
common stockholders have.

Our board is empowered to issue, without
stockholder approval, preferred stock with dividend, liquidation, conversion,
voting or other rights that could adversely affect the voting power or other rights of the
holders of common stock. Our Certificate of Incorporation, as amended, authorizes a class
of 5,000,000 shares of preferred stock with such designation, rights and preferences as
may be determined from time to time by the Board of Directors. In the event of issuance,
the preferred stock could be utilized, under certain circumstances, as a method of
discouraging, delaying or preventing a change in control of the company.

Anti-takeover defenses in our
governing documents and certain provisions under Delaware law could be dilutive and
prevent an acquisition of our company or limit the price that investors might be willing
to pay for our common stock.

Our governing documents and certain
provisions of the Delaware General Corporation Law could make it difficult for another
company to acquire control of our company. Our certificate of incorporation allows our
board to issue, at any time and without stockholder approval, preferred stock with voting
rights or such other rights, preferences and terms as it may determine. Also, Delaware law
generally prohibits a Delaware corporation from engaging in any business combination with
a person owning 15% or more of its voting stock, or who is affiliated with the corporation
and owned 15% or more of its voting stock at any time within three years prior to the
proposed business combination, for a period of three years from the date the person became
a 15% owner, unless specified conditions are met. All or any one of these factors could
limit the price that certain investors would be willing to pay for shares of our common
stock and could delay, prevent or allow our Board of Directors to resist an acquisition of
our company, even if the proposed transaction were favored by independent stockholders.

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# ITEM 7.   FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA

# INDEX TO CONSOLIDATED
FINANCIAL STATEMENTS

|                                                                                                               |   
|-------------------------------------------------------------------------------------------------------------- | --
|Report of Independent Registered Public Accounting Firm                                                        | 44
|Consolidated Balance Sheets at June 30, 2006 and June 30, 2005                                                 | 45
|Consolidated Statements of Operations for the years ended June 30, 2006 and June 30, 2005                      | 46
|Consolidated Statements of Changes in Shareholders' Equity for the years ended June 30, 2006 and June 30, 2005 | 47
|Consolidated Statements of Cash Flows for the years ended June 30, 2006 and June 30, 2005                      | 48
|Notes to Consolidated Financial Statements                                                                     | 49
|Supplemental Information  Unaudited Comparative Quarterly Statements of Operations                            | 68

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# REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM

The Board of Directors
and Shareholders
Media Sciences International, Inc.

We have audited the accompanying
consolidated balance sheets of Media Sciences International, Inc. and Subsidiaries as of
June 30, 2006 and 2005, and the related consolidated statements of operations, changes in
shareholders equity and cash flows for the years then ended. These consolidated
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated financial statements based
on our audits.

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

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
financial position of Media Sciences International, Inc. and Subsidiaries as of June 30,
2006 and 2005, and their results of operations and cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of America.

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

Roseland, New Jersey
August 14, 2006

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

|ASSETS                                                  | As of June 30,
|------------------------------------------------------- | --------------
|
|                                                        |               
|                                                        |               
|CURRENT ASSETS:                                         |               
|Cash and cash equivalents                               |               
|Accounts receivable, net                                |               
|Inventories, net                                        |               
|Deferred tax assets                                     |               
|Prepaid expenses and other current assets               |               
|                                                        |               
|Total Current Assets                                    |               
|                                                        |               
|PROPERTY AND EQUIPMENT, NET                             |               
|                                                        |               
|OTHER ASSETS:                                           |               
|Goodwill and other intangible assets, net               |               
|Other assets                                            |               
|                                                        |               
|Total Other Assets                                      |               
|                                                        |               
|TOTAL ASSETS                                            |               
|                                                        |               
|                                                        |               
|LIABILITIES AND SHAREHOLDERS' EQUITY                    |               
|                                                        |               
|CURRENT LIABILITIES:                                    |               
|Bank line of credit                                     |               
|Current maturities of long-term debt                    |               
|Accounts payable                                        |               
|Accrued compensation and benefits                       |               
|Other accrued expenses and other current liabilities    |               
|Income taxes payable                                    |               
|Accrued product warranty costs                          |               
|Deferred revenue                                        |               
|                                                        |               
|Total Current Liabilities                               |               
|                                                        |               
|OTHER LIABILITIES:                                      |               
|Long-term debt, less current maturities                 |               
|Deferred rent liability                                 |               
|Deferred revenue, less current portion                  |               
|Deferred tax liabilities                                |               
|                                                        |               
|Total Other Liabilities                                 |               
|                                                        |               
|                                                        |               
|TOTAL LIABILITIES                                       |               
|                                                        |               
|                                                        |               
|COMMITMENTS AND CONTINGENCIES                           |               
|                                                        |               
|SHAREHOLDERS' EQUITY:                                   |               
|Series A Convertible Preferred Stock, $.001 par value   |               
|Authorized 1,000,000 shares; none issued                |               
|Common Stock, $.001 par value                           |               
|Authorized 20,000,000 shares; issued  11,131,363 shares |               
|in 2006 and 10,953,606 shares in 2005                   |               
|Additional paid-in capital                              |               
|Cost of common stock in treasury, 54,577 shares in 2005 |               
|Deferred stock-based compensation                       |               
|Retained earnings (accumulated deficit)                 |               
|                                                        |               
|Total Shareholders' Equity                              |               
|                                                        |               
|TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY              |               
|                                                        |               

See accompanying
notes to consolidated financial statements

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# CONSOLIDATED
STATEMENTS OF OPERATIONS

|                                                                      | Year Ended June 30,
|--------------------------------------------------------------------- | -------------------
|
|                                                                      |                    
|                                                                      |                    
|NET REVENUES                                                          |                    
|                                                                      |                    
|COST OF GOODS SOLD:                                                   |                    
|Cost of goods sold, excluding depreciation and amortization,          |                    
|product warranty, and shipping and freight                            |                    
|Depreciation and amortization                                         |                    
|Product warranty                                                      |                    
|Shipping and freight                                                  |                    
|                                                                      |                    
|Total cost of goods sold                                              |                    
|                                                                      |                    
|                                                                      |                    
|GROSS PROFIT                                                          |                    
|                                                                      |                    
|OTHER COSTS AND EXPENSES:                                             |                    
|Research and development                                              |                    
|Selling, general and administrative, excluding depreciation,          |                    
|amortization, loss from sublease, moving expenses and                 |                    
|impact of variable plan accounting                                    |                    
|Depreciation and amortization                                         |                    
|Loss from sublease and moving expenses                                |                    
|Impact of variable plan accounting                                    |                    
|                                                                      |                    
|Total other costs and expenses                                        |                    
|                                                                      |                    
|                                                                      |                    
|INCOME FROM OPERATIONS                                                |                    
|                                                                      |                    
|Interest expense, net                                                 |                    
|                                                                      |                    
|                                                                      |                    
|INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES                 |                    
|Provision for income taxes                                            |                    
|                                                                      |                    
|                                                                      |                    
|INCOME FROM CONTINUING OPERATIONS                                     |                    
|                                                                      |                    
|LOSS FROM DISCONTINUED OPERATIONS                                     |                    
|Benefit for income taxes                                              |                    
|                                                                      |                    
|                                                                      |                    
|LOSS FROM DISCONTINUED OPERATIONS                                     |                    
|                                                                      |                    
|                                                                      |                    
|NET INCOME (LOSS)                                                     |                    
|                                                                      |                    
|                                                                      |                    
|BASIC EARNINGS (LOSS) PER SHARE                                       |                    
|Income from continuing operations                                     |                    
|Income (loss) from discontinued operations                            |                    
|                                                                      |                    
|Net income (loss)                                                     |                    
|                                                                      |                    
|                                                                      |                    
|DILUTED EARNINGS (LOSS) PER SHARE                                     |                    
|Income from continuing operations                                     |                    
|Income (loss) from discontinued operations                            |                    
|                                                                      |                    
|Net income (loss)                                                     |                    
|                                                                      |                    
|                                                                      |                    
|                                                                      |                    
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET EARNINGS (LOSS) PER SHARE |                    
|Basic                                                                 |                    
|Diluted                                                               |                    

See accompanying
notes to consolidated financial statements

46

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

|                                        | Common Stock | AdditionalPaid-in | Treasury | RetainedEarnings | DeferredStock-Based | TotalShareholders'
|--------------------------------------- | ------------ | ----------------- | -------- | ---------------- | ------------------- | ------------------
|
|                                        |              |                   |          |                  |                     |                   
|                                        |              |                   |          |                  |                     |                   
|BALANCES, JUNE 30, 2004                 |              |                   |          | 9,857,210        |                     | $                 
|                                        |              |                  
|Sale of common stock, net of expenses   |              |                   |          | 500,000          |                     |                   
|Issuance of common stock for            |              |                  
|exercise of stock options               |              |                   |          | 287,396          |                     |                   
|Issuance of common stock for            |              |                   |          |                  |                     |                   
|exercise of stock warrants              |              |                   |          | 309,000          |                     |                   
|Impact of variable plan accounting      |              |                   |          |                 |                     |                   
|Net loss                                |              |                   |          |                 |                     |                   
|                                        |              |                   |          |                  |                     |                   
|BALANCES, JUNE 30, 2005                 |              |                   |          | 10,953,606       |                     | $                 
|                                        |              |                   |          |                  |                     |                   
|Issuance of common stock for            |              |                  
|exercise of stock options               |              |                   |          | 57,334           |                     |                   
|Issuance of common stock for            |              |                   |          |                  |                     |                   
|exercise of stock warrants              |              |                   |          | 175,000          |                     |                   
|Issuance of restricted stock units      |              |                   |          |                 |                     |                   
|Amortization of stock-based             |              |                   |          |                  |                     |                   
|compensation                            |              |                   |          |                 |                     |                   
|Cancellation of shares held in treasury |              |                  
|and return to unissued status           |              |                   |          | (54,577          | )                   |                   
|Net income                              |              |                   |          |                 |                     |                   
|                                        |              |                   |          |                  |                     |                   
|BALANCES, JUNE 30, 2006                 |              |                   |          | 11,131,363       |                     | $                 
|                                        |              |                   |          |                  |                     |                   

See accompanying
notes to consolidated financial statements

47

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# CONSOLIDATED
STATEMENTS OF CASH FLOWS

|                                                           | Year Ended June 30,
|---------------------------------------------------------- | -------------------
|
|                                                           |                    
|CASH FLOWS FROM OPERATING ACTIVITIES:                      |                    
|Income from continuing operations                          |                    
|Adjustments to reconcile income from continuing operations |                    
|to net cash provided by operating activities:              |                    
|Depreciation and amortization                              |                    
|Deferred income taxes                                      |                    
|Provision for bad debts                                    |                    
|Impact of variable plan accounting                         |                    
|Loss on write-off of leasehold improvements                |                    
|Cash provided by discontinued operations                   |                    
|Non-cash and stock-based compensation expense              |                    
|Changes in operating assets and liabilities:               |                    
|Accounts receivable                                        |                    
|Receivable from landlord                                   |                    
|Inventories                                                |                    
|Prepaid expenses and other current assets                  |                    
|Other assets                                               |                    
|Insurance claim receivable                                 |                    
|Accounts payable                                           |                    
|Accrued compensation and benefits                          |                    
|Other accrued expenses and other current liabilities       |                    
|Income taxes payable                                       |                    
|Deferred revenue                                           |                    
|Deferred rent liability                                    |                    
|                                                           |                    
|Net cash provided by operating activities                  |                    
|                                                           |                    
|                                                           |                    
|CASH FLOWS FROM INVESTING ACTIVITIES:                      |                    
|Purchases of property and equipment                        |                    
|Sale of Cadapult service contracts                         |                    
|                                                           |                    
|Net cash used in investing activities                      |                    
|                                                           |                    
|                                                           |                    
|CASH FLOWS FROM FINANCING ACTIVITIES:                      |                    
|Bank line of credit, net                                   |                    
|Term debt                                                  |                    
|Payments of other short-term debt                          |                    
|Proceeds from issuance of common stock, net                |                    
|                                                           |                    
|Net cash provided by (used in) financing activities        |                    
|                                                           |                    
|                                                           |                    
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS       |                    
|                                                           |                    
|CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR               |                    
|                                                           |                    
|CASH AND CASH EQUIVALENTS, END OF YEAR                     |                    
|                                                           |                    
|                                                           |                    
|SUPPLEMENTAL CASH FLOW INFORMATION:                        |                    
|Interest paid                                              |                    
|Income taxes paid                                          |                    
|NON-CASH INVESTING AND FINANCING TRANSACTIONS:             |                    
|Cashless exercise of stock options                         |                    

See accompanying
notes to consolidated financial statements

48

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1  BASIS OF
PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Basis of Presentation The consolidated financial statements include the accounts of Media
Sciences International, Inc., a Delaware corporation, and its subsidiaries, collectively
referred to as the Company, Media Sciences, we or
our, and have been prepared in United States dollars, and in accordance with
accounting principles generally accepted in the United States (GAAP). Unless
otherwise indicated, references in the consolidated financial statements and these notes
to 2006 and 2005 are to Media Sciences fiscal years ended June 30, 2006 and 2005,
respectively.

Nature of Business and
Principles of ConsolidationMedia Sciences International, Inc. is a
holding company which conducts its business through its operating subsidiaries. The
Company is a manufacturer of business color printer supplies, which the Company
distributes through an international network of dealers and distributors and directly to
end users in the United States through various programs. The Company consolidates
companies in which it owns or controls more than fifty percent of the voting shares. All
significant intercompany balances and transactions have been eliminated in consolidation.
If the Company had any variable interest entities in which the Company bore a majority of
the entities potential losses or stood to benefit from the entities expected
returns, it would also consolidate such entities.

In 2005, one of our subsidiaries,
Cadapult Graphic Systems, Inc. (Cadapult), discontinued its electronic
pre-press sales and service operations. The loss associated with these discontinued
operations is separately reflected in the Companys consolidated statements of
operations.

Estimates and
Uncertainties  The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the
reporting period. Actual results, as determined at a later date, could differ from those
estimates.

Reclassifications  Certain reclassifications of prior year amounts have been made to
conform to the current year presentation. In the fourth quarter of fiscal 2006, the
Company revised its methodology for reporting cost of goods sold. The Companys
management believes the presentation used in these consolidated financial statements
improves the transparency of the Companys operating results and as a result the
utility of its consolidated financial statements. These reclassifications have no effect
on previously reported operating income or net income. These reclassifications include:

| |  | Product warranty expense has been reclassified to cost of goods sold on the consolidated
statement of operations. These expenses were previously classified as a component of
selling, general and administrative expense.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Shipping and freight expense, representing out-bound costs incurred to ship goods to
customers, has been reclassified to cost of goods sold on the consolidated statement of
operations. This expense was previously classified as a component of selling, general and
administrative expense. Associated reimbursements received from customers for such costs
were also reclassified on the consolidated statement of operations. These reimbursements,
previously classified as reductions to shipping and freight expense in selling, general
and administrative expense, have been reclassified as an addition to net revenue in the
consolidated statement of operations. Shipping and freight reimbursements amounted to
$93,000 and $117,000 in 2006 and 2005, respectively.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

49

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1  BASIS OF
PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED):

| |  | Research and development expense has been presented as a separate line item on the
consolidated statement of operations. This expense was previously classified as a
component of selling, general and administrative expense. In order to conform to the
current year presentation, certain facility costs and intellectual property research costs
related to the Companys research and development activities in 2005 were
reclassified to research and development expense. These expenses amounting to $128,000 in
2005 were previously classified as a component of selling, general and administrative
expense.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Accrued compensation and benefits has been presented as a separate captioned item in the
consolidated balance sheet. These liabilities were previously presented as a component of
other accrued expenses and current liabilities.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Fair Value of Financial
Instruments  The carrying value of cash and cash equivalents,
accounts receivable, accounts payable and short-term debt reasonably approximate their
fair value due to the relatively short maturities of these instruments. Long-term debt
carrying value approximates their fair value at the balance sheet
dates. The fair value estimates presented herein were based on market or other information
available to management. The use of different assumptions and/or estimation methodologies
could have a significant effect on the estimated fair value amounts.

Cash Equivalents  All highly-liquid debt instruments with original or remaining
maturities of less than three months at the date of purchase are considered to be cash
equivalents.

Inventories  Inventories, consisting of materials, labor, manufacturing overhead, and
associated in-bound shipping and freight costs, are stated at the lower of cost or market,
with cost being determined on a first-in, first-out (FIFO) basis. The Company reviews the
adequacy of its inventory reserves on a quarterly basis.  The Company reviews and
sets standard costs annually at current manufacturing costs in order to approximate actual
costs.  The Companys actual manufacturing overhead for a period is allocated
between cost of goods sold and finished goods inventory based on calculated inventory
turnover, adjusted for excess capacity.  Abnormal inventory costs such as costs of
idle facilities, excess freight and handling costs, and wasted materials are recognized as
current period charges.  The Company writes down inventory based on forecasted demand
and technological obsolescence.  These factors are impacted by market and economic
conditions, technology changes, new product introductions and changes in strategic
direction and require estimates that may include uncertain elements.  Actual demand
may differ from forecasted demand and such differences may have a material effect on
recorded inventory values.

Property and
Equipment  Property and equipment are reported at cost, net of
accumulated depreciation and amortization. Depreciation of property and equipment is based
on the straight-line method over the estimated useful lives of the assets, which are three
to seven years for furniture, equipment, automobiles, tooling and molds. Leasehold
improvements are amortized by the straight-line method over the shorter of the life of the
related asset or the term of the underlying lease. Construction in progress is not
depreciated until the assets are placed in service. Depreciation and amortization
associated with the Companys manufacturing operations, including tooling and molds,
are classified in the consolidated statements of operations as components of cost of goods
sold. All other depreciation and amortization is classified as a component of selling,
general and administrative expense.

Impairment of Long-Lived
Assets  The Company evaluates the carrying value of its long-lived
assets with finite lives whenever events or changes in circumstances indicate that the carrying value of the
asset may be impaired in accordance with the provisions of Statement of Financial
Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets.  An impairment loss is recognized when estimated future cash flows
expected to result from the use of the asset including disposition are less than the
carrying value of the asset.  No material impairment adjustments to long-lived assets
were made during the years ended June 30, 2006 or 2005.

50

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1  BASIS OF
PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED):

Goodwill and Other Intangible
Assets  As required by Statement of Financial Accounting Standard No.
142,Goodwill and Other Intangible Assets, goodwill has an indefinite life and
is not amortized but subject to impairment testing annually, or earlier if indicators of
potential impairment exist, using a two-step process. The first is to identify any
potential impairment by comparing the carrying value of reporting units to their fair
value. If a potential impairment is identified, the second step is to compare the implied
fair value of goodwill with its carrying amount to measure the impairment loss. Reporting
unit fair value is estimated using the income approach, which assumes that the value of a
reporting unit can be computed as the present value of the assumed future returns of an
enterprise discounted at a rate of return that reflects the riskiness of an
investment.  Purchased technology, patents, trademarks and other intangible assets
with finite lives are presented at cost, net of accumulated amortization.  Intangible
assets with finite lives are amortized over their estimated useful lives and assessed for
impairment under Statement of Financial Accounting Standard No. 144.  Based on the
Companys testing of goodwill and the decision to discontinue certain Cadapult
operations, the net goodwill resulting from three acquisitions by Cadapult, in the amount
of $880,000 was deemed impaired and written off at June 30, 2005. The impairment charge is
reflected in the results from discontinued operations in our consolidated statements of
operations for 2005. We have completed our annual impairment test necessary as of June 30,
2006 and concluded that no goodwill is impaired.

Concentrations of Credit
Risk  Financial instruments that potentially subject the Company to
significant concentrations of credit risk consist principally of cash, cash equivalents
and trade accounts receivable. The Company invests its cash directly and indirectly in a variety of money-market
instruments, including, but not limited to, commercial paper, repurchase agreements,
variable rate obligations, certificates of deposit, United States Treasury and agency
securities. The Company also maintains cash balances with financial institutions which are
insured by the Federal Deposit Insurance Corporation up to $100,000 each. At various times
during the year, such balances do exceed the FDIC limit. The Company has not experienced
any credit losses with respect to its cash and cash equivalent assets.

Concentration of credit risk with
respect to all trade receivables is considered to be limited due to the quantity and
diversity of customers comprising the Companys customer base. The Company performs
ongoing credit evaluations of its customers financial condition and does not require
collateral to secure accounts receivable. When considered appropriate, the Company may
utilize letters of credit or other means to mitigate credit risk. For its U.S.
manufactured solid ink product, the Company maintains credit insurance on its foreign
receivables, through government sponsored programs. Non-U.S. manufactured product,
including the Companys current line of toner-based products, are not covered under
this same export insurance. The Company maintains an allowance for potential credit losses
based upon expected collectibility of all accounts receivable.

Vendor
Concentrations  In both 2006 and 2005 three vendors each represented
at least 10% of our costs of goods sold. Only one of the 2005 vendors was a repeat in
2006. The three vendors in 2006 represented 42% of our cost of goods sold, with no single
vendor accounting for more than 20%. The three vendors in 2005 represented 39% of our cost
of goods sold, with no single vendor accounting for more than 13%.

Major Customers
 In 2006, two customers each represented 14% of the Companys net revenues and
17% and 20%, respectively, of accounts receivable at June 30, 2006. In 2005, one of these
same large customers represented 11% of the Companys net revenues and 3% of accounts
receivable at June 30, 2005.

Foreign Currencies and Derivative Financial Instruments  The functional currency of the
Companys foreign subsidiary, Media Sciences UK, Ltd., is currently the U.S. dollar.
The Company does not currently employ financial instruments, such as forward exchange
contracts, to hedge its risks associated with its non-U.S. business, including the
substantial risks associated with appreciation of the U.S. dollar relative to the local
currency of the Companys non-U.S. customers.

51

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1  BASIS OF
PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED):

Revenue
Recognition  Revenue is recognized at the point of shipment for goods
sold, and ratably through the duration of INKlusive contracts (generally, two years)
provided collection is reasonably assured. Net revenues include $93,000 and $117,000 of
reimbursed shipping and freight expense for 2006 and 2005, respectively. Provisions for
rebates, product returns and discounts to customers are recognized as reductions in
determining net revenues in the same period as the related revenues are recorded. Any
sales or other taxes collected from customers are not reflected in the consolidated
statements of operations but instead reflected as current obligations in the consolidated
balance sheets until disbursed to the respective taxing authority.

Under the INKlusive program, the
Company provides a customer with a business color printer or multifunction device, on-site
service and a defined, regular shipment of supplies (ink or toner), all for the cost of
just the supplies. We offer this program in conjunction with a financing company. Media
Sciences does not own or otherwise finance the cost of the printer, nor does Media
Sciences guarantee the credit worthiness of the customer. Under our agreement with the
financing company, at the time of placement of the INKlusive printer, we are paid in full
for the printer and the two years of supplies. Consequently, the difference in timing
between receipt of contract payment from the finance company and when the supplies are
shipped gives rise to a deferred revenue liability on our balance sheet. The Company
amortizes this deferred revenue liability and recognizes revenue ratably over the contract
term as the Company ships supplies to the customer. At June 30, 2006 and 2005, the
deferred revenue liability totaled $1,137,000 and $807,000, respectively. The current and
non-current components of the deferred revenue obligation are reflected in the
consolidated balance sheets.

The INKlusive program is a
multi-element program. However, services associated with the program are not offered
separately from an INKlusive product supply commitment. Services are provided equally over
the contract term in proportion to product shipments and, accordingly, revenue is
recognized ratably under the program.

Cost of Goods Sold Inventoried costs are recognized as cost of goods sold as revenues are
recognized upon shipment of products sold.

Product Warranty  The Company warranties its products suitability for use in the intended printer
models and that its products are free of defects that could cause damage to these
printers. Costs covered under the product warranty include customary charges for the
repair or replacement of the printer with an equivalent new or refurbished printer, at the
Companys sole discretion. The warranty does not cover damage to the product or a
printer caused by accident, abuse, misuse, natural disaster, human error, unauthorized
disassembly, repair, or modification. The Company believes that its product warranty is
relatively liberal, providing, in most cases, broader and more complete coverage than that
provided by the original equipment printer manufacturer. The Company accounts for the
estimated warranty cost as a charge to product warranty, a captioned component of cost of
goods sold, when revenue is recognized.  The Companys estimated warranty
liability is based on historic product performance and program expense.  The Company
updates its warranty program estimates, based on actual experience, every quarter. 
The actual product performance and/or program expense profiles may differ, and in those
cases the Company adjusts warranty accruals accordingly (see Note 7 Product Warranty
Expenses).

Shipping and Freight  Shipping and freight costs are included as a separate captioned component of cost of
goods sold in the consolidated statement of operations and represent out-bound costs
incurred to ship goods to customers. These amounts exclude in-bound shipping and freight
expense associated with acquired raw materials and finished goods, which are included in
cost of goods sold. Reimbursements by customers of out-bound shipping and freight expense
are included in net revenues.

52

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1  BASIS OF
PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED):

Research and
Development  Research and product development costs, which consist of
salary and related benefits costs of our technical staff, as well as product development
costs including research of existing patents, conceptual formulation, design and testing
of product alternatives, and construction of prototypes, are expensed as incurred. It also
includes indirect costs, including facility costs based on the departments
proportionate share of facility use. For 2006 and 2005, our engineering and product
development costs were $1,090,000 and $629,000, respectively.

Advertising
Expense  Advertising expenses are deferred until the first use of the
advertising. Deferred advertising costs at June 30, 2006 and 2005 totaled approximately
$14,000 and $51,000, respectively. Advertising expense for 2006 and 2005 amounted to
approximately $1,008,000 and $950,000, respectively.

Employee Benefit
Plan  We maintain a 401(k) savings/retirement plan for all eligible
employees. The plan allows for employee contributions to be matched by the Company. Our
contributions for 2006 and 2005 were $42,000 and $37,000, respectively.

Income Taxes  The Company recognizes deferred tax assets, net of applicable valuation allowances,
related to net operating loss carry-forwards and certain temporary differences and
deferred tax liabilities related to certain temporary differences. The Company recognizes
a future tax benefit to the extent that realization of such benefit is considered to be
more likely than not. Otherwise, a valuation allowance is applied. At June 30, 2006, the
Company believes that the more likely than not criteria have been met and,
accordingly, has recorded a net deferred tax asset to recognize a future tax benefit.

Accounting for Stock-Based
Compensation Plans  The Company accounts for its employee stock options
under the intrinsic value recognition and measurement principles of Accounting Principles
Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees, and related Interpretations, and has adopted the disclosure-only
provisions of Statement of Financial Accounting Standard (SFAS) No. 123,
Accounting for Stock-Based Compensation, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosures.

Prior to May 10, 2005, certain stock
options permitted cashless exercise and were accounted for pursuant to variable plan
accounting treatment. Under variable plan accounting treatment, non-cash compensation
expense is increased or decreased as a result of changes in the market price of the
Companys common stock. For 2005, non-cash compensation expense was $212,000, of
which $13,000 was included in the loss from discontinued operations.

On May 10, 2005, the Board of
Directors of the Company rescinded the cashless exercise provisions for all of the
Companys outstanding option grants. Consequently, the Companys stock options
have not been subject to variable plan accounting treatment after that date.

53

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1  BASIS OF
PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED):

On May 9, 2006, the Board of
Directors approved the acceleration of vesting of certain non-executive stock option
awards of 1,000 shares or less. Options to purchase 17,350 shares of common stock, or
about 7% of the outstanding unvested options, were subject to the acceleration. The
weighted average exercise price of the options that were accelerated was $2.55. Concurrent
with this vesting acceleration, the Board of Directors also approved eliminating,
effective July 1, 2006, the Companys prior policy of granting all new employees
stock options covering 1,000 shares at an exercise price established at the close of
trading on the employees first day of employment. Before the acceleration, these
stock option awards would have vested at the employees first anniversary date. The
purpose of these Board actions was to help simplify the Companys adoption of
SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No.
123(R)) effective July 1, 2006. Upon adoption of SFAS No. 123(R) the Company will be
required to expense the fair value of employee stock options and other stock-based
compensation over the service period of the grant. The accelerated vesting had no effect
on the Companys 2006 net income reported in the consolidated statement of
operations. This action reduces the Companys future stock-based compensation expense
by approximately $17,000. The effect of the acceleration is included in the 2006
stock-based compensation expense reflected in the following pro-forma information.

Pro forma information regarding net
income and net earnings per share is required by SFAS No. 123, and has been determined as
if the Company had accounted for its employee stock options under the fair value method of
SFAS No. 123.  The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option valuation model and the single option approach with the
following weighted-average assumptions:

|                                                     | Year Ended June 30,
|---------------------------------------------------- | -------------------
|
|                                                     |                    
|                                                     |                    
|Risk-free interest rate                              |                    
|Dividend yield                                       |                    
|Expected common stock market price volatility factor |                    
|Average expected life of stock options               |                    

SFAS
No. 123 requires the use of option pricing models that were not developed for use in
valuing employee stock options. The Black-Scholes option-pricing model was developed for
use in estimating the fair value of short-lived exchange traded options that have no
vesting restrictions and are fully transferable. In addition, option-pricing models
require the input of highly subjective assumptions, including the options expected
life and the price volatility of the underlying stock. Because the Companys employee
stock options have characteristics significantly different from those of traded options,
and because changes in the subjective input assumptions can materially affect the fair
value estimate, in the opinion of management, the existing models do not necessarily
provide a reliable single measure of the fair value of employee stock options.  For
purposes of pro forma disclosures required by SFAS No. 123, the estimated fair value of
the options is amortized to expense over the options vesting periods using the
straight-line method.  Under APB 25, because the exercise price of all of the
Companys stock options has equaled the market price of the underlying stock on the
date of grant, the options had no intrinsic value and no compensation expense was
recognized at the time the options were granted. The Companys pro-forma information
is as follows:

54

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1  BASIS OF
PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED):

|                                                   | Year Ended June 30,
|-------------------------------------------------- | -------------------
|
|                                                   |                    
|                                                   |                    
|Net income (loss) as reported                      |                    
|                                                   |                    
|Impact of variable plan accounting, net of related |                    
|tax effects                                        |                    
|                                                   |                    
|Stock-based employee compensation expense          |                    
|under fair value method, net of related            |                    
|tax effects                                        |                    
|                                                   |                    
|Pro forma net income                               |                    
|                                                   |                    
|                                                   |                    
|Basic net earnings (loss) per common share:        |                    
|As reported                                        |                    
|Pro forma                                          |                    
|                                                   |                    
|Diluted net earnings (loss) per common share:      |                    
|As reported                                        |                    
|Pro forma                                          |                    

Recent Accounting
Pronouncements In December 2004, the Financial Accounting Standards Board
(the FASB) issued SFAS No. 123(R) which will require the Company to
measure all employee stock-based compensation awards using a fair value method and record
such expense in our consolidated financial statements.  The adoption of SFAS
No. 123(R) will require additional accounting related to the income tax effects and
additional disclosure regarding the cash flow effects resulting from share-based payment
arrangements. SFAS No. 123(R) is effective for the Company beginning in the first
quarter of fiscal 2007. The adoption of SFAS No. 123(R) could have a material impact
on the Companys consolidated results of operations, financial position and cash flows.  The Company is evaluating what pricing model to select upon adoption
and the impact by financial statement line. Based on preliminary analysis, the Company
believes the impact on the Companys consolidated results of operations in future
periods will not be materially greater than the pro forma impact calculable under the
methods prescribed by SFAS No. 123.

In March 2005, the SEC released SEC
Staff Accounting Bulletin No. 107 (SAB 107). SAB 107
provides the SEC staffs position regarding the application of SFAS No. 123(R).
SAB 107 contains interpretive guidance relating to the interaction between
SFAS No. 123(R) and certain SEC rules and regulations, as well as the staffs views
regarding the valuation of share-based payment arrangements for public companies.
SAB 107 also highlights the importance of disclosures made related to the accounting
for share-based payment transactions. The Company is currently evaluating SAB 107 and
will be incorporating it as part of its adoption of SFAS No. 123(R) in the first fiscal
quarter of 2007.

55

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1  BASIS OF
PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED):

In June 2005, the FASB issued SFAS
No. 154, Accounting Changes and Error Corrections, a replacement of APB
Opinion No. 20, Accounting Changes, and Statement No. 3, Reporting
Accounting Changes in Interim Financial Statements, (Statement 154).
Statement 154 changes the requirements for the accounting for and reporting of a change in
accounting principle. Previously, most voluntary changes in accounting principles required
recognition via a cumulative effect adjustment in the determination of net income of the
period of the change. Statement 154 requires retrospective application to prior
periods financial statements, unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. Statement 154 is effective
for accounting changes made in fiscal years beginning after December 15, 2005; however,
Statement 154 does not change the transition provisions of any existing accounting
pronouncements. The adoption of Statement 154 is not expected have a material effect on
the Companys consolidated financial position, results of operations or cash flows.

In March 2006, the FASB Emerging
Issues Task Force (EITF) reached a consensus on EITF Issue No. 06-3, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should Be Presented in
the Income Statement (That Is, Gross versus Net Presentation), (EITF
06-3). The guidance prescribes the disclosure of the Companys accounting
treatment of any tax assessed by a governmental authority that is directly imposed on a
revenue-producing transaction, which includes, but is not limited to, sales, use, value
added and some excise taxes. The Companys accounting treatment of such taxes
collected is to be made in the Companys disclosure of significant accounting
policies. The provisions of EITF 06-3 are effective for fiscal years beginning after
December 15, 2006. As disclosed under Revenue Recognition, the Company
already complies with the requirements of the guidance prescribed by EITF 06-3.

In June 2006, the FASB issued
Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxes an interpretation of SFAS No. 109. FIN 48 will require the Company to
recognize the financial statement effects of a tax position when it is more likely than
not, based on the technical merits, that the position will be sustained upon examination.
As used in this Interpretation, the term more likely than notmeans a likelihood of
more than 50 percent; the terms examinedand upon examinationalso include
resolution of the related appeals or litigation processes, if any. The determination of
whether or not a tax position has met the more-likely-than-not recognition threshold is to
be determined based on the facts, circumstances, and information available at the
reporting date. The provisions of FIN 48 are effective for fiscal years beginning after
December 15, 2006. The Company believes its accounting for income taxes currently complies
with this interpretation.

Earnings (Loss) Per
Share  Basic earnings (loss) per common share is computed using the
weighted average number of common shares outstanding. Diluted earnings per common share is
computed using the weighted average number of shares outstanding as adjusted for the
incremental shares attributable to the assumed exercise of outstanding options and
warrants to purchase common stock, and other potentially dilutive securities.

56

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1  BASIS OF
PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED):

Earnings (Loss) Per Share
(Continued)

The following table sets forth the
computation of the basic and diluted earnings (loss) per common share from continuing
operations, discontinued operations, and net income (loss):

|                                               | Year Ended June 30,
|---------------------------------------------- | -------------------
|
|                                               |                    
|Numerator for basic and diluted:               |                    
|Income from continuing operations              |                    
|Loss from discontinued operations              |                    
|                                               |                    
|Net income (loss)                              |                    
|                                               |                    
|                                               |                    
|Denominator :                                  |                    
|For basic earnings (loss) per common share     |                    
|from continuing operations -                   |                    
|weighted average shares outstanding            |                    
|Effect of dilutive securities -  stock options |                    
|and warrants                                   |                    
|                                               |                    
|For diluted earnings (loss) per common share   |                    
|- weighted average shares adjusted for         |                    
|assumed exercises                              |                    
|                                               |                    
|                                               |                    
|Basic earnings (loss) per share                |                    
|Income from continuing operations              |                    
|Loss from discontinued operations              |                    
|                                               |                    
|Net income (loss)                              |                    
|                                               |                    
|                                               |                    
|Diluted earnings (loss) per share              |                    
|Income from continuing operations              |                    
|Loss from discontinued operations              |                    
|                                               |                    
|Net income (loss)                              |                    
|                                               |                    

The following warrants and options to
purchase common stock were excluded from the computation of diluted earnings (on a
continuing basis) or net loss per share for the years ended June 30, 2006 and 2005 because
their exercise price was greater than the average market price of the common stock for
those periods :

|                                   | Year Ended June 30,
|---------------------------------- | -------------------
|
|                                   |                    
|Anti-dilutive warrants and options |                    

57

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 2  FINANCIAL
STATEMENT COMPONENTS:

CONSOLIDATED BALANCE
SHEETS

|                                                |  | As of June 30,
|----------------------------------------------- |  | --------------
|
|                                                |  |               
|Accounts receivable, net                        |  |               
|Accounts receivable, gross                      |  |               
|Allowance for doubtful accounts                 |  |               
|                                                |  |               
|                                                |  |               
|                                                |  |               
|Inventories, net of reserves                    |  |               
|Raw materials                                   |  |               
|Finished goods                                  |  |               
|                                                |  |               
|                                                |  |               
|                                                |  |               
|                                                |  |               
|Property and Equipment, net                     |  |               
|                                                |  |               
|Equipment                                       |  |               
|Furniture and fixtures                          |  |               
|Automobiles                                     |  |               
|Leasehold improvements                          |  |               
|Tooling and molds                               |  |               
|                                                |  |               
|                                                |  |               
|Less: Accumulated depreciation and amortization |  |               
|                                                |  |               
|                                                |  |               
|                                                |  |               
|                                                |  |               
|Goodwill and other intangible assets, net       |  |               
|Goodwill                                        |  |               
|Other                                           |  |               
|                                                |  |               
|                                                |  |               
|Less: Accumulated amortization                  |  |               
|                                                |  |               
|                                                |  |               
|                                                |  |               

58

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 3  DEBT:

The Companys indebtedness under
secured commercial loan agreements consisted of the following:

|                                        | Year Ended June 30,
|--------------------------------------- | -------------------
|
|                                        |                    
|Short-term debt:                        |                    
|Revolving bank line of credit           |                    
|Current maturities of long-term debt    |                    
|                                        |                    
|                                        |                    
|Long-term debt:                         |                    
|Long-term debt, less current maturities |                    
|                                        |                    
|                                        |                    
|Total Bank Debt                         |                    
|                                        |                    

We have a revolving line of credit
facility which provides for maximum borrowings of $3,000,000. As of June 30, 2006, we had
no outstanding balance under this line. In connection with the negotiation of this
facility during 2004, we granted a security interest in all of our assets. Borrowings
through January 23, 2006 bore interest at a rate of 0.75% over the banks Prime Rate.
On January 23, 2006 we entered into an Amended and Restated Committed Line of Credit Note,
and an Amendment to Loan Documents (collectively, the Amendments). The
Amendments reduced the interest rate by 0.75% to the banks Prime Rate, and extended
the expiration date of the facility by one year to November 30, 2007. The Amendments also
modified certain financial covenants. Borrowings bear interest at the banks Prime
Rate (8.25% at June 30, 2006) and are payable on demand.

On March 17, 2006, we entered into a
five-year term note with the bank in the amount of $250,000 that bears interest at a
fixed rate of 7.75%, and requires monthly repayments of principal of $5,054. At June 30,
2006, this note had a remaining principal balance of $239,450. The proceeds were used to
finance the purchase of certain long-lived manufacturing property and equipment. The note
is cross collateralized and contains cross default provisions with the revolving line of
credit facility.

On July 27, 2005, we entered into an
equipment lease line of credit with $1,000,000 in availability with the bank. Borrowings
bear interest at a rate of approximately 1% over the banks Prime Rate, with terms of
three to seven years. The bank will hold title to the equipment leased under the line of
credit. Any unutilized balance on the line of credit expires on November 30,
2006.  In December 2005, we entered into an operating lease under this line,
reducing the availability under the line by $228,682. This lease requires monthly payments
of $3,453, for 72 months.

In March 2005, we entered into a
five-year term note with our bank in the amount of $500,000 that bears interest at a fixed
rate of 6.5%, and requires monthly repayments of principal of $8,333. At June 30, 2006,
this note had a remaining principal balance of $375,000. The proceeds were used to finance
the leasehold improvements to our Oakland facility. The note is cross collateralized and
contains cross default provisions with the revolving line of credit.

Both the amended revolving
line of credit and the five-year term notes with the bank are subject to two amended
financial covenants. At June 30, 2006 and 2005, the Company was in compliance with all of
its financial covenants.

59

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 4  INCOME
TAXES:

The components of income taxes
applicable to both continuing and discontinued operations are summarized as follows:

|                               | Year Ended June 30,
|------------------------------ | -------------------
|
|                               |                    
|Current:                       |                    
|Federal                        |                    
|State                          |                    
|Foreign                        |                    
|                               |                    
|Total Current                  |                    
|Deferred:                      |                    
|Federal                        |                    
|State                          |                    
|Foreign                        |                    
|                               |                    
|Total Deferred                 |                    
|                               |                    
|                               |                    
|Income tax provision (benefit) |                    
|                               |                    

A reconciliation of the total income
tax provision (benefit) provided at the federal statutory rate (34%) to income tax
provision (benefit) is as follows:

|                                            | Year Ended June 30,
|------------------------------------------- | -------------------
|
|                                            |                    
|Expected income tax provision (benefit)     |                    
|State income taxes (net of federal benefit) |                    
|Other (including permanent differences)     |                    
|                                            |                    
|                                            |                    
|                                            |                    

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

|                                  | As of June 30,
|--------------------------------- | --------------
|
|                                  |               
|Deferred tax assets :             |               
|Accounts receivable               |               
|Inventories                       |               
|Deferred compensation             |               
|Deferred rent liability           |               
|Accruals and reserves             |               
|Net operating loss carry-forwards |               
|Federal and state credits         |               
|                                  |               
|Total deferred tax assets         |               
|                                  |               
|Deferred tax liabilities :        |               
|Fixed assets                      |               
|Intangible assets                 |               
|                                  |               
|Total deferred tax liabilities    |               
|                                  |               
|                                  |               
|Net deferred tax assets           |               
|                                  |               

At June 30, 2006, the Company has
available state net operating loss carry-forwards of approximately $1,800,000 which will
begin to expire in the year ended June 30, 2008 through June 30, 2013.

60

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 5 
SHAREHOLDERS EQUITY:

Stock Compensation Plan.  We
have an incentive stock option plan (the 1998 Plan or the Plan)
pursuant to which 1,000,000 shares of common stock have been reserved. The stock options
(which may be incentive stock options within the meaning of Section 422 of the
Internal Revenue Code of 1986, as amended) entitle the holder to purchase shares of the
Companys common stock for up to ten years from the date of grant (five years for
persons owning more than 10% of the total combined voting power of the Company) at a price
not less than the fair market value (110% of fair market value for persons owning more
than 10% of the combined voting power of the Company) of the common stock on the date of
grant. In general, any employee, director, officer or exclusive agent of, or advisor or
consultant to, the Company or a related entity, is eligible to participate in the Plan.
Vesting periods, if any, are determined by the Board of Directors. The outstanding option
grants vest over periods not exceeding five years. The stock options are nontransferable,
except upon death. As of June 30, 2006, 299,792 shares of the Companys common stock
were available for grant under the Plan in the form of restricted stock or stock options.

Non-Plan Options.  During the
year ended June 30, 2003, the Company granted each of five employees five-year stock
options to purchase up to 25,000 shares, which vested on April 6, 2004 and are exercisable
at $0.50 per share. In 2005, two of these employees exercised 25,000 options each
for net proceeds to the Company of $25,000 and one employee executed a cashless exercise
of 25,000 options, for which the Company received 6,250 shares of common stock with a fair
value of $12,500, and no cash proceeds. During 2006, one employee exercised 25,000 options
for net proceeds to the Company of $12,500.

During the year ended June 30, 2003,
the Company granted its President five-year stock options to purchase up to 500,000 shares
that are exercisable at $1.00 per share and expire in June 2008. Options to purchase
250,000 shares vested immediately and options to purchase an additional 250,000 shares
vested ratably over the period from July 1, 2003 through June 30, 2005. A total of 500,000
options are vested at June 30, 2005.

During the year ended June 30, 2004,
the Company granted each of two employees ten-year stock options to purchase up to
100,000 shares, which are exercisable at $1.06 per share. Options to purchase 50,000
shares each vested immediately and options to purchase an additional 50,000 shares each
vested ratably over the period from May 24, 2004 through May 23, 2006. During 2005, one
employee executed a cashless exercise of 50,000 options for which the Company received
25,090 shares of common stock with a fair value of $53,000, and no cash proceeds. 50,000
options for that same employee were cancelled upon the termination of his employment.

During the year ended June 30, 2005,
the Company granted an employee ten-year stock options to purchase up to 100,000 shares,
which are exercisable at $1.60 per share and expire in June 2015. The options vest
ratably, on an annual basis, over the period from June 6, 2005 through June 5, 2010.

During the year ended June 30, 2006,
the Company granted an employee ten-year stock options to purchase up to 100,000 shares,
which are exercisable at $1.65 per share and expire in August 2015. Options to purchase
50,000 shares were originally scheduled to vest ratably, on an annual basis, over the period from August 9, 2005
through August 8, 2010. Options to purchase the remaining 50,000 shares were originally
scheduled to vest fully upon relocation. The option grant was modified by an agreement
dated March 31, 2006 between the Company and the employee. As modified, stock options to
purchase 50,000 shares of common stock became fully vested as of April 2006, and the other
stock options were forfeited.

61

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 5 
SHAREHOLDERS EQUITY (CONTINUED):

Option Summary.  The following table summarizes the 1998 Plan and non-plan stock option activity for 2005 and
2006:

|                                     | Number ofShares | WeightedAverageExercise Price
|------------------------------------ | --------------- | -----------------------------
|                                     |                 |                              
|Options outstanding at June 30, 2004 |                 |                              
|                                     |                 |                              
|Year ended June 30, 2005:            |                 |                              
|Granted                              |                 |                              
|Exercised                            |                 |                              
|Cancelled                            |                 |                              
|                                     |                 |                              
|                                     |                 |                              
|Options outstanding at June 30, 2005 |                 |                              
|                                     |                 |                              
|Year ended June 30, 2006:            |                 |                              
|Granted                              |                 |                              
|Exercised                            |                 |                              
|Cancelled                            |                 |                              
|                                     |                 |                              
|                                     |                 |                              
|Options outstanding at June 30, 2006 |                 |                              
|                                     |                 |                              

The following table summarizes
information about outstanding and exercisable 1998 Plan and non-Plan options at June 30,
2006:

|Options Outstanding | Options Exercisable
|------------------- | -------------------
|                    |                    
|
|                    |                    
|                    |                    
|$0.43 to $0.85      |                    
|$1.00 to $2.00      |                    
|$2.01 to $4.80      |                    
|                    |                    
|                    |                    
|                    |                    

Warrants.  Between October 1999 and March 2000, the Company issued 1,926,500 warrants
          to purchase common stock in connection with the issuance of the Series A
          Preferred shares as more fully described below. 1,100,000 warrants exercisable
          at $4.50 per share expired on September 29, 2004, 40,000 warrants exercisable at
          $3.75 per share expired on December 10, 2004, 236,500 warrants exercisable at
          $1.65 per share expired on March 9, 2005 and 550,000 warrants exercisable at
          $3.75 per share expired on March 9, 2005. The value of the warrants was
          recognized as a cost of issuance of the Series A Preferred shares. In March
          2005, 221,500 warrants exercisable at $1.65 per share were exercised for net
          proceeds to the Company of $365,475. The balance of these warrants expired
          between October 2004 and March 2005.

62

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 5 
SHAREHOLDERS EQUITY (CONTINUED):

In June 2001, the Company issued
200,000 warrants to purchase its common stock at $1.00 per share in consideration for
consulting services. In July 2004, 75,000 warrants were exercised for net proceeds to the
Company of $75,000. In August 2005, 25,000 warrants were exercised for net proceeds to the
Company of $25,000. In March 2006, 75,000 warrants were exercised for net proceeds to the
Company of $75,000. In April 2006, the remaining 25,000 warrants associated with this
issuance were exercised for net proceeds to the Company of $25,000.

In June 2002, the Company issued
87,500 warrants to purchase its common stock at $1.00 per share in connection with its
notes payable. The warrants were valued at $43,400 and expire in June 2007. In May 2005,
12,500 warrants were exercised for net proceeds to the Company of $12,500. In 2006, 50,000
warrants were exercised for net proceeds to the Company of $50,000.

The following table summarizes the
warrant activity for the two years ended June 30, 2006:

|                                      |  | 
|------------------------------------- |  | 
|
|                                      |  | 
|Warrants outstanding at June 30, 2004 |  | 
|                                      |  | 
|Year ended June 30, 2005:             |  | 
|Granted                               |  | 
|Exercised                             |  | 
|Cancelled                             |  | 
|                                      |  | 
|                                      |  | 
|Warrants outstanding at June 30, 2005 |  | 
|                                      |  | 
|Year ended June 30, 2006:             |  | 
|Granted                               |  | 
|Exercised                             |  | 
|Cancelled                             |  | 
|                                      |  | 
|                                      |  | 
|Warrants outstanding at June 30, 2006 |  | 
|                                      |  | 

The following table summarizes
information about outstanding warrants at June 30, 2006:

|Warrants Outstanding | Warrants Exercisable
|-------------------- | --------------------
|                     |                     
|
|                     |                     
|                     |                     
|$1.00                |                     

63

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##### Back to Index

# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 5 
SHAREHOLDERS EQUITY (CONTINUED):

Common  Stock.  On March 2, 2005,  the  Company  sold  500,000  shares of common  stock to an investor at $2.00 per
share for net proceeds of $975,000.

Restricted Stock.  During 2006,
the Company granted 80,000 shares of restricted stock to members of the Companys
senior management, concurrent with their start of employment.  For substantially all
restricted stock grants, at the date of grant, the recipient has all rights of a
stockholder, subject to certain restrictions on transferability and a risk of forfeiture.
These restricted stock grants generally vest in equal installments over three to five
years from the date of grant.  The Company recorded the $314,300 value of these
restricted stock grants as a component of stockholders equity and will amortize that
amount to compensation expense over the service period.  The value of the restricted
stock awards was based on the closing market price of the Companys common stock on
the date of award.  Amortization expense for these awards for 2006 was $21,300.
$11,400 was included in selling, general and administrative expense.  The remaining
$9,900 was included in research and development expense. These restricted stock units were
included in the calculation of diluted earnings per share utilizing the treasury stock
method.

Treasury Stock.  On February 7,
2006, the Board of Directors voted to cancel 54,577 shares of treasury stock. This action
had no impact on total shareholders equity. The treasury stock was cancelled and
returned to unissued status.

Preferred Stock.  The
Companys Certificate of Incorporation authorizes the issuance of up to 5,000,000
shares of Preferred Stock. The Board of Directors is authorized to issue shares of
Preferred Stock from time to time in one or more series and to establish and designate any
such series and to fix the number of shares and the relative conversion rights, voting
rights, terms of redemption and liquidation. In December 1999, the Board authorized the
issuance of up to 1,000,000 shares of Series A Preferred Stock. No preferred shares were
outstanding at June 30, 2006 or 2005.

# NOTE 6 
COMMITMENTS AND CONTINGENCIES:

Leases  We
lease our premises under operating lease agreements which expire through 2011 and
equipment under operating leases that expire through 2006.

Future minimum lease payments are as
follows:

| | Year Ending June 30, | OperatingLeases
| | -------------------- | ---------------
| |                      |                
| |                      |                
| |                      |                
| |                      |                
| |                      |                
| |                      |                
| |                      |                
| |                      |                
| |                      |                
| |                      |                

Net rent expense amounted to $581,000
and $449,000 for the years ended June 30, 2006 and 2005, respectively.

64

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 6 
COMMITMENTS AND CONTINGENCIES (CONTINUED):

Employment
Agreement  On July 1, 2003, the Company entered into a five-year
employment agreement with its President for a base salary of $200,000 per annum, subject
to certain adjustments. Effective July 1, 2006, the Board of Directors approved an
increase in the Presidents base salary to $225,000.

Litigation  In
May 2005, we filed suit in New Jersey state court against our former insurance broker for
insurance malpractice. The suit contends, in sum and substance, that the insurance broker
was negligent and breached its duty of care in connection with the procurement of an
umbrella insurance policy. The suit asserts four causes of action for (1) negligent
procurement; (2) failure to procure required coverage; (3) breach of the standard of care;
and (4) failure to advise.

In particular, the suit alleges that
the insurance broker breached its duty by failing to identify our subsidiary in insurance
applications; submitting insurance applications, without our review, incorrectly denying
the existence of our subsidiary; and failing to correct such an error. The suit further
alleges that our insurance broker failed to procure the umbrella insurance we required and
were led to believe we purchased. Finally, the suit alleges that our insurance broker
breached its duty by failing to be aware that our subsidiary did not have adequate
coverage and to advise us that our subsidiary was not adequately covered.

The suit seeks recovery of the
balance of unrecouped losses for third party damages that should have been covered under
the umbrella insurance procured by our insurance broker but was not due to the
aforementioned negligence and breaches of duty of care by our insurance broker. Proceeds
of this suit, if any, will be recorded in the period when received.

On June 23, 2006, Xerox Corporation
filed a lawsuit against the Company alleging Media Sciences solid ink sticks for use
in the Xerox® Phaser® 8500/8550 printers infringe, actively induces others to
infringe, and/or contributorily infringes on four patents held by Xerox concerning solid
ink stick shape. Xerox seeks a preliminary and permanent injunction, a finding of willful
infringement, damages (including treble damages), and costs. We recently submitted our
answer and counterclaims in this action. We denied infringement and the validity of the
patents in question. Further, we submitted counterclaims for breach of contract, unfair
competition and trade libel. Media Sciences believes the filing of this action by Xerox
violates a contract between the companies that was reached in resolution of similar
litigation in 2001. The Company believes it has meritorious defenses and counterclaims and
intends to pursue them vigorously. There can be no assurance, however, that the Company
will be successful in its defense of this action.

The Company is subject to legal
proceedings and other claims that arise in the ordinary course of business, such as those
arising from domestic and foreign tax authorities, intellectual property matters and
employee related matters. While management currently believes the amount of ultimate
liability, if any, with respect to these actions will not materially affect the
Companys financial position, results of operations or liquidity, the ultimate
outcome could have a material adverse effect on the Company.

# NOTE 7  PRODUCT
WARRANTY EXPENSES:

The Company provides a warranty for
all of its consumable supply products and for its INKlusive printer program. The
Companys warranty stipulates that it will pay reasonable and customary charges for
the repair of a printer needing service as a result of using the Companys products.
The Company estimates the costs that may be incurred and records a liability in the amount
of such costs at the time product revenue is recognized. Factors that may affect the
warranty include the number of units shipped to customers, historical and anticipated
rates of warranty claims and cost per claim. The Company periodically assesses the
adequacy of the recorded warranty liability and adjusts the amount as necessary. These
expenses are classified as a component of costs of goods sold.

65

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 7  PRODUCT
WARRANTY EXPENSES (CONTINUED):

Changes in accrued product warranty
for the years ended June 30, 2006 and 2005 are as follows:

|                                              | Year Ended June 30,
|--------------------------------------------- | -------------------
|
|                                              |                    
|Warranty reserve at the beginning of the year |                    
|                                              |                    
|Warranties accrued during the period          |                    
|Warranties settled during the period          |                    
|                                              |                    
|Net change in warranty reserve                |                    
|                                              |                    
|Warranty reserve at the end of the year       |                    
|                                              |                    

# NOTE 8 
HEADQUARTERS FACILITY MOVE:

On September 30, 2004, we entered
into a lease agreement, effective October 1, 2004, for office facilities in Oakland, New
Jersey. The lease is for a term of five years, at an annual rate of $296,318. Pursuant to
the lease, our landlord provided us with a $200,000 cash allowance for improvements to the
facility. These improvements have been capitalized and are being amortized over the term
of the lease. The $200,000 allowance also gives rise to a deferred rent liability on our
balance sheet, which is also being amortized over the lease term. The benefit of the
amortization of the deferred rent liability is equal to and offset by the amortization
expense of the $200,000 in landlord funded leasehold improvements. In addition to the
above $200,000 in leasehold improvements, we invested approximately $400,000 in additional
leasehold improvements which are being amortized over the lease term.

The direct costs of moving amounted
to approximately $100,000 for 2005. These expenses were recorded as general and
administrative operating expenses. Indirect costs of the move, which were also recorded as
general and administrative operating expenses, include rent and utility expenses resulting
from operating both the Allendale and Oakland facilities for two months and significant
personnel overtime resulting from the breakdown, move and set-up of operations.

# NOTE 9  SUBLEASE
OF PREVIOUS FACILITY:

On January 20, 2005, we entered into
a sublease agreement with Dynamic Imaging, Inc. (Dynamic). Pursuant to the
sublease agreement, we agreed to sublease to Dynamic our leased premises in Allendale, New
Jersey (the Allendale Facility), at an annual rent of $177,100. The sublease
is for a term of six years and three months commencing March 1, 2005 and expiring on May
30, 2011, concurrent with the expiration date of our lease. In addition, we provided the
tenant with four months of rent at no charge. Our current annual rent for the Allendale
Facility is $184,800 and will increase to $209,440 effective June 2006.

As a result of the discontinued use
of the Allendale Facility, we incurred the following expenses in 2005: the write-off of
the Allendale Facility leasehold improvements, the real estate broker commission for the
sublease, and the present value of the rent differential between our remaining rent
liability and our expected rental income. The aggregate value of these non-recurring
expenses was $443,061 and was recorded as a general and administrative operating expense.
The present value of the rent differential of $204,834 was recorded as a deferred rent
liability on our balance sheet. As a result of this accounting treatment, the effects of
the sublease will not impact our future results of operations.

66

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 10 
DISCONTINUED OPERATIONS:

In May 2005, a decision was made to
cease certain sales and service operations under Cadapult. Specifically we ceased all
electronic pre-press sales and service operations. In connection with the discontinuance
of these operations, on May 7, 2005, Cadapult, entered into an Asset Purchase Agreement
with IO Integration, Inc. Pursuant to the agreement, for the consideration of $1, Cadapult
sold to IO Integration certain assets related to its systems integration business,
consisting of its service and support contracts and pre-paid expenses and IO Integration
assumed all obligations and liabilities in connection with the performance of the service
and support contracts. Accordingly, the results of operations of the electronic pre-press
sales and service operations have been reclassified and are included in discontinued
operations. Sales and service revenues from the discontinued operations in 2005 were
$1,456,000. The pre-tax loss from discontinued operations in 2005 was $789,000.

We evaluated the goodwill resulting
from three Cadapult acquisitions associated with the discontinued operations and
determined that the goodwill resulting from those acquisitions was fully impaired.
Consequently, we incurred an impairment charge of approximately $880,000 which is
reflected in the results from discontinued operations for 2005 in our statement of
operations.

Further, we wrote off approximately
$90,000 of inventory associated with the discontinued operations.

Cadapult continues to sell Media
Sciences supplies and the INKlusive free color printer program to end users. Since this is
essentially the same business as the rest of the Companys continuing operations, and
as a result of the presentation of Cadapults electronic pre-press sales and service
operations as discontinued operations, segment information will no longer be presented.

# NOTE 11  RELATED
PARTY TRANSACTION:

In the year ended June 30, 2006,
pursuant to the employment contract with the Companys Chief Executive Officer, dated
July 1, 2003, the Company incurred a non-cash compensation expense of $56,934.

67

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# SUPPLEMENTAL INFORMATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)

|                                                              | Three Months Ended September 30,
|------------------------------------------------------------- | --------------------------------
|
|                                                              |                                 
|                                                              |                                 
|NET REVENUES *                                                |                                 
|                                                              |                                 
|COST OF GOODS SOLD:                                           |                                 
|Cost of goods sold, excluding depreciation and amortization,  |                                 
|product warranty and shipping and freight                     |                                 
|Depreciation and amortization                                 |                                 
|Product warranty                                              |                                 
|Shipping and freight                                          |                                 
|                                                              |                                 
|Total cost of goods sold                                      |                                 
|                                                              |                                 
|                                                              |                                 
|GROSS PROFIT                                                  |                                 
|                                                              |                                 
|OTHER COSTS AND EXPENSES:                                     |                                 
|Research and development                                      |                                 
|Selling, general and administrative, excluding depreciation,  |                                 
|amortization and impact of variable plan accounting           |                                 
|Depreciation and amortization                                 |                                 
|Impact of variable plan accounting                            |                                 
|                                                              |                                 
|Total other costs and expenses                                |                                 
|                                                              |                                 
|                                                              |                                 
|INCOME FROM OPERATIONS                                        |                                 
|                                                              |                                 
|Interest expense, net                                         |                                 
|                                                              |                                 
|                                                              |                                 
|INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES         |                                 
|                                                              |                                 
|Provision for income taxes                                    |                                 
|                                                              |                                 
|                                                              |                                 
|INCOME FROM CONTINUING OPERATIONS                             |                                 
|                                                              |                                 
|Income from discontinued operations                           |                                 
|Provision for income taxes                                    |                                 
|                                                              |                                 
|                                                              |                                 
|INCOME FROM DISCONTINUED OPERATIONS                           |                                 
|                                                              |                                 
|                                                              |                                 
|NET INCOME                                                    |                                 
|                                                              |                                 
|                                                              |                                 
|                                                              |                                 
|BASIC EARNINGS PER SHARE                                      |                                 
|Income from continuing operations                             |                                 
|Income from discontinued operations                           |                                 
|                                                              |                                 
|Net income                                                    |                                 
|                                                              |                                 
|                                                              |                                 
|DILUTED EARNINGS PER SHARE                                    |                                 
|Income from continuing operations                             |                                 
|Income from discontinued operations                           |                                 
|                                                              |                                 
|Net income                                                    |                                 
|                                                              |                                 
|                                                              |                                 
|                                                              |                                 
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET EARNINGSPER SHARE |                                 
|Basic                                                         |                                 
|Diluted                                                       |                                 

* 2006 and 2005 net revenues include $18,107 and $32,221, respectively, of reimbursed shipping and freight expense.

68

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# SUPPLEMENTAL INFORMATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS
ENDED DECEMBER 31, 2005 AND 2004
(UNAUDITED)

|                                                                          | Three Months Ended December 31,
|------------------------------------------------------------------------- | -------------------------------
|
|                                                                          |                                
|                                                                          |                                
|NET REVENUES *                                                            |                                
|                                                                          |                                
|COST OF GOODS SOLD:                                                       |                                
|Cost of goods sold, excluding depreciation and amortization,              |                                
|product warranty and shipping and freight                                 |                                
|Depreciation and amortization                                             |                                
|Product warranty                                                          |                                
|Shipping and freight                                                      |                                
|                                                                          |                                
|Total cost of goods sold                                                  |                                
|                                                                          |                                
|                                                                          |                                
|GROSS PROFIT                                                              |                                
|                                                                          |                                
|OTHER COSTS AND EXPENSES:                                                 |                                
|Research and development                                                  |                                
|Selling, general and administrative, excluding depreciation, amortization |                                
|and impact of variable plan accounting                                    |                                
|Depreciation and amortization                                             |                                
|Impact of variable plan accounting                                        |                                
|                                                                          |                                
|Total other costs and expenses                                            |                                
|                                                                          |                                
|                                                                          |                                
|INCOME FROM OPERATIONS                                                    |                                
|                                                                          |                                
|Interest expense, net                                                     |                                
|                                                                          |                                
|                                                                          |                                
|INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES                     |                                
|Provision for income taxes                                                |                                
|                                                                          |                                
|                                                                          |                                
|INCOME FROM CONTINUING OPERATIONS                                         |                                
|                                                                          |                                
|Income from discontinued operations                                       |                                
|Provision for income taxes                                                |                                
|                                                                          |                                
|                                                                          |                                
|INCOME FROM DISCONTINUED OPERATIONS                                       |                                
|                                                                          |                                
|                                                                          |                                
|NET INCOME                                                                |                                
|                                                                          |                                
|                                                                          |                                
|                                                                          |                                
|BASIC EARNINGS PER SHARE                                                  |                                
|Income from continuing operations                                         |                                
|Income from discontinued operations                                       |                                
|                                                                          |                                
|Net income                                                                |                                
|                                                                          |                                
|                                                                          |                                
|DILUTED EARNINGS PER SHARE                                                |                                
|Income from continuing operations                                         |                                
|Income from discontinued operations                                       |                                
|                                                                          |                                
|Net income                                                                |                                
|                                                                          |                                
|                                                                          |                                
|                                                                          |                                
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET EARNINGS(LOSS) PER SHARE      |                                
|Basic                                                                     |                                
|Diluted                                                                   |                                

*
2006 and 2005 net revenues include $22,322 and $28,264, respectively, of reimbursed
shipping and freight expense.

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# SUPPLEMENTAL INFORMATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS
ENDED MARCH 31, 2006 AND 2005
(UNAUDITED)

|                                                                                | Three Months Ended March 31,
|------------------------------------------------------------------------------- | ----------------------------
|
|                                                                                |                             
|                                                                                |                             
|NET REVENUES *                                                                  |                             
|                                                                                |                             
|COST OF GOODS SOLD:                                                             |                             
|Cost of goods sold, excluding depreciation and amortization,                    |                             
|product warranty and shipping and freight                                       |                             
|Depreciation and amortization                                                   |                             
|Product warranty                                                                |                             
|Shipping and freight                                                            |                             
|                                                                                |                             
|Total cost of goods sold                                                        |                             
|                                                                                |                             
|                                                                                |                             
|GROSS PROFIT                                                                    |                             
|                                                                                |                             
|OTHER COSTS AND EXPENSES:                                                       |                             
|Research and development                                                        |                             
|Selling, general and administrative, excluding depreciation, amortization, loss |                             
|from sublease, moving expenses and impact of variable plan accounting           |                             
|Depreciation and amortization                                                   |                             
|Loss from sublease and moving expenses                                          |                             
|Impact of variable plan accounting                                              |                             
|                                                                                |                             
|Total other costs and expenses                                                  |                             
|                                                                                |                             
|                                                                                |                             
|INCOME (LOSS) FROM OPERATIONS                                                   |                             
|                                                                                |                             
|Interest expense, net                                                           |                             
|                                                                                |                             
|                                                                                |                             
|INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE                                 |                             
|INCOME TAXES (BENEFIT)                                                          |                             
|Provision (benefit) for income taxes                                            |                             
|                                                                                |                             
|                                                                                |                             
|INCOME (LOSS) FROM CONTINUING OPERATIONS                                        |                             
|                                                                                |                             
|Loss from discontinued operations                                               |                             
|Benefit for income taxes                                                        |                             
|                                                                                |                             
|                                                                                |                             
|LOSS FROM DISCONTINUED OPERATIONS                                               |                             
|                                                                                |                             
|                                                                                |                             
|NET INCOME (LOSS)                                                               |                             
|                                                                                |                             
|                                                                                |                             
|                                                                                |                             
|BASIC EARNINGS (LOSS) PER COMMON SHARE                                          |                             
|Income (loss) from continuing operations                                        |                             
|Loss from discontinued operations                                               |                             
|                                                                                |                             
|Net income (loss)                                                               |                             
|                                                                                |                             
|                                                                                |                             
|DILUTED EARNINGS (LOSS) PER COMMON SHARE                                        |                             
|Income (loss) from continuing operations                                        |                             
|Loss from discontinued operations                                               |                             
|                                                                                |                             
|Net income (loss)                                                               |                             
|                                                                                |                             
|                                                                                |                             
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET                                     |                             
|EARNINGS (LOSS) PER SHARE                                                       |                             
|Basic                                                                           |                             
|Diluted                                                                         |                             

*
2006 and 2005 net revenues include $24,555 and $30,936, respectively, of reimbursed
shipping and freight expense.

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# MEDIA SCIENCES INTERNATIONAL,
INC.AND SUBSIDIARIES

# SUPPLEMENTAL INFORMATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS
ENDED JUNE 30, 2006 AND 2005
(UNAUDITED)

|                                                                                | Three Months Ended June 30,
|------------------------------------------------------------------------------- | ---------------------------
|
|                                                                                |                            
|                                                                                |                            
|NET REVENUES *                                                                  |                            
|                                                                                |                            
|COST OF GOODS SOLD:                                                             |                            
|Cost of goods sold, excluding depreciation and amortization,                    |                            
|product warranty and shipping and freight                                       |                            
|Depreciation and amortization                                                   |                            
|Product warranty                                                                |                            
|Shipping and freight                                                            |                            
|                                                                                |                            
|Total cost of goods sold                                                        |                            
|                                                                                |                            
|                                                                                |                            
|GROSS PROFIT                                                                    |                            
|                                                                                |                            
|OTHER COSTS AND EXPENSES:                                                       |                            
|Research and development                                                        |                            
|Selling, general and administrative, excluding depreciation, amortization, loss |                            
|from sublease, moving expenses and impact of variable plan accounting           |                            
|Depreciation and amortization                                                   |                            
|Loss from sublease and moving expenses                                          |                            
|Impact of variable plan accounting                                              |                            
|                                                                                |                            
|Total other costs and expenses                                                  |                            
|                                                                                |                            
|                                                                                |                            
|INCOME FROM OPERATIONS                                                          |                            
|                                                                                |                            
|Interest expense, net                                                           |                            
|                                                                                |                            
|                                                                                |                            
|INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES                           |                            
|Provision for income taxes                                                      |                            
|                                                                                |                            
|                                                                                |                            
|INCOME FROM CONTINUING OPERATIONS                                               |                            
|                                                                                |                            
|Loss from discontinued operations                                               |                            
|Benefit for income taxes                                                        |                            
|                                                                                |                            
|                                                                                |                            
|LOSS FROM DISCONTINUED OPERATIONS                                               |                            
|                                                                                |                            
|                                                                                |                            
|NET INCOME (LOSS)                                                               |                            
|                                                                                |                            
|                                                                                |                            
|                                                                                |                            
|BASIC EARNINGS (LOSS) PER COMMON SHARE                                          |                            
|Income from continuing operations                                               |                            
|Loss from discontinued operations                                               |                            
|                                                                                |                            
|Net income (loss)                                                               |                            
|                                                                                |                            
|                                                                                |                            
|DILUTED EARNINGS (LOSS) PER COMMON SHARE                                        |                            
|Income from continuing operations                                               |                            
|Loss from discontinued operations                                               |                            
|                                                                                |                            
|Net income (loss)                                                               |                            
|                                                                                |                            
|                                                                                |                            
|                                                                                |                            
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET EARNINGS(LOSS) PER SHARE            |                            
|Basic                                                                           |                            
|Diluted                                                                         |                            

* 2006 and 2005 net revenues include
$28,291 and $25,590, respectively, of reimbursed shipping and freight expense.

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

Not applicable.

# ITEM 8A.   CONTROLS AND
PROCEDURES

The Companys management, with
the participation of our Chief Executive Officer and Chief Financial Officer, has
evaluated the effectiveness of the Companys disclosure controls and procedures (as
such term is defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act) as of the
end of the period covered by this report. Based on that evaluation, the Companys
Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of
such period, the Companys disclosure controls and procedures are effective.

There have not been any changes,
except for the improvements described below, in the Companys internal controls over
financial reporting during the fiscal quarter ended June 30, 2006, that have materially
affected, or are reasonably likely to materially affect, the Companys internal
controls over financial reporting. We attempt to proactively identify opportunities to
continually improve our internal controls, including those over financial reporting, to
ensure they continue to operate effectively and efficiently.

In March 2006, the Company hired a
Chief Financial Officer, with substantial Sarbanes-Oxley compliance experience.  With
the hiring of its Chief Financial Officer, the Company has been developing a detailed plan
to address compliance with Section 404 of the Sarbanes-Oxley Act of 2002.  In
mid-March 2006, the Company initiated and since then has made progress on several projects
focused on assessing potential risks, better understanding and documenting its processes,
and implementing certain preventative or detective controls to address key risks. These
are important first steps toward designing and implementing an effective compliance
plan.  As a non-accelerated filer with a fiscal year end of June 30, the Company must
first begin to comply with the requirements of Section 404 for the fiscal year ending June
30, 2008.

During the quarter ended June 30,
2006, the Company implemented additional procedures and controls in purchasing, receiving,
and inventory management, and had segregated certain duties. We will continue to conduct a
thorough risk assessment, document our processes, and where necessary, enhance our system
of internal controls.  The Company is committed to the continued improvement of its
control systems and financial reporting process.

The Companys management,
including its Chief Executive Officer and its Chief Financial Officer, does not expect
that disclosure controls or internal controls over financial reporting will prevent all
errors or all instances of fraud, even as the same are improved to address any
deficiencies. The design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future conditions. A
control system, no matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the control systems objectives will be met. Over time,
controls may become inadequate because of changes in conditions or deterioration in the
degree of compliance with policies or procedures. Further, the design of a control system
must reflect the fact that there are resource constraints, and the benefits of controls
must be considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that all control
issues and instances of fraud, if any, within the Company have been detected.

Because of the inherent limitations
of a cost-effective control system, misstatements due to error or fraud may occur and not
be detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple error or
mistake. Controls can also be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls.

# ITEM 8B.   OTHER
INFORMATION

On August 8, 2006, our Compensation
Committee authorized the grant to Lawrence Anderson, Chief Operating Officer, 4,357
restricted shares, subject to vesting in equal installments over a two year period
starting on the first anniversary date of grant.

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# PART III

# ITEM 9.   DIRECTORS AND
EXECUTIVE OFFICERS OF THE REGISTRANT

# Our Management

The persons listed in the table below
are our present directors and executive officers.

|                   |  |    
|------------------ |  | ---
|Name               |  | Age
|                   |  |    
|                   |  |    
|Michael W. Levin   |  | 41 
|Kevan D. Bloomgren |  | 45 
|Lawrence Anderson  |  | 54 
|Frances Blanco     |  | 45 
|Denise Hawkins     |  | 37 
|Paul C. Baker      |  | 69 
|Edwin Ruzinsky     |  | 73 
|Henry Royer        |  | 74 
|Alan Bazaar        |  | 36 
|Dennis Ridgeway    |  | 57 
|Willem van Rijn    |  | 56 

Our directors are elected annually to serve
for one year and hold office until the next annual meeting of the shareholders and until
their successors are elected and qualified. Our Board of Directors may increase the size
of the Board of Directors. Any director who fills a position created by the Board of
Directors serves until the next annual meeting of the shareholders. Our officers are
elected by the Board of Directors at the first meeting after each annual meeting of our
shareholders, and hold office until their death, resignation or removal from office.

# Management Profile

Michael W. Levin, Chief
Executive Officer, President and Chairman of the Board:

Michael W. Levin has served as our
Chief Executive Officer, President and Chairman of the Board since June 18, 1998. Mr.
Levin serves on the compensation committee. Before June 1998, he had served as President,
Treasurer, Secretary and Chairman of Media Sciences predecessor, Cadapult Graphic
Systems Inc. (CGSI) since 1987, when he founded CGSI while attending Lehigh
University. He is responsible for a senior management team as well as merger and
acquisition activity and corporate finance. In 2002, Mr. Levin was recognized in
Business News New Jerseysannual 40 under 40 issue, which
profiles the states outstanding business leaders under the age of 40. He also was
selected as the honorary annual fundraising chairman for the Childrens Cancer
Research Fund of New York Medical College in 1999. In 1987, Mr. Levin graduated summa cum
laude from Lehigh University, receiving a Bachelor of Science Degree in Mechanical
Engineering.

Kevan D. Bloomgren, Chief
Financial Officer:

Kevan D. Bloomgren joined Media
Sciences International, Inc. in the position of Chief Financial Officer on March 15, 2006.
From 2004 to March 10, 2006, Mr. Bloomgren was Chief Financial Officer for Rapid Solutions
Group, a digital communications company located in Melville, New York. From 1997 to 2004,
he was Managing Partner of Crown Investment Management, LLC, a financial services company
located in Sparta, New Jersey. From 1992 to 1996, he was Vice President and Chief
Financial Officer of Satellite Paging, a telecommunications company located in Fairfield,
New Jersey. Mr. Bloomgren also held the following positions: Vice President of Daniels and
Associates, a boutique investment bank specializing in merger and acquisitions (1988-1992)
and Senior Auditor and Consultant for Arthur Andersen & Co. (1983-1986). In 1983, Mr.
Bloomgren graduated cum laude from University of Denver with a B.S. degree in Business
Administration, and Accounting, and in 1988, he received a MBA in Finance from The Wharton
School, University of Pennsylvania. Mr. Bloomgren is a Certified Public Accountant and a
member of the American Institute of CPAs.

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Lawrence Anderson, Chief
Operating Officer:

Lawrence Anderson has served as Chief
Operating Officer since December 5, 2005, and served as Vice President of Operations from
June 6, 2005 to December 2005. From April 1997 to November 2000, Mr. Anderson was Vice
President World Wide Operations for Katun Corporation, located in Bloomington, Minnesota.
From January 2001 to November 2004, Mr. Anderson was Vice President
Manufacturing/Operations for WatchGuard Technologies Inc., located in Seattle, Washington.
Prior to joining our company, Mr. Anderson had been retired since November 2004.

Frances Blanco, Vice
President of Marketing and Investor Relations, and Director:

Frances Blanco has served as our Vice
President of Marketing and Investor Relations, Treasurer, and a Director since June 18,
1998. She also served as Secretary from June 18, 1998 through June 30, 2004. From 1993 to
June 18, 1998, she served as Vice President of Marketing and Investor Relations,
Treasurer, Secretary and a director of CGSI. Blanco manages all aspects of marketing,
including brand identity, demand creation and vendor relationships for us as well as
investor relations. From 1984 through 1989, Blanco was a Reseller Account Manager at
Lotus, where she designed and implemented tactical channel programs. From August 1989
through June 1993, Blanco served as a Business Development Manager at Tektronix, Inc.,
where she was responsible for the development of color printing standards in strategic
customers. She earned a Bachelor of Science degree in Marketing from Bentley College in
1982 and a Masters of Business Administration degree from Boston College in 1985.

Denise Hawkins, Vice
President, Controller and Secretary:

Denise Hawkins has served as Vice
President for Media Sciences since February 12, 2003, and as Secretary since July 1, 2004.
Ms. Hawkins manages the accounting aspects of the business while working closely with the
President and senior management team. She is a Certified Public Accountant and a Certified
Management Accountant. She began her employment with the company in July of 2001 as the
Controller. Ms. Hawkins graduated from the State University of New York-The College at New
Paltz with a Bachelor of Science degree in Accountancy in 1990 and graduated from Marist
College in 1998 with a Masters in Business Administration in Finance. Prior to her
position at Media Sciences, Ms. Hawkins was the controller for NFK Excavating and
Construction, Inc. (2000-2001), Horizon Medical Group, PC (1998-2000) and VAC Service
Corp. (1992-1998). She is currently serving as the Treasurer for the Board of Helping
Hands Christian Pre-School. Ms Hawkins is affiliated with the New Jersey State Society of
Certified Public Accountants, the Institute of Management Accountants and the Society for
Human Resource Management.

Paul C. Baker, Director:

Paul C. Baker has served as a
Director since June 18, 1998. Mr. Baker is the chairman of the Compensation committee and
also serves on the audit committee. From 1986 to 2000 he was President of Sherwood
Partners, Inc., a venture capital and management consulting company, which he founded,
that focused on developing companies with high growth potential. From 2000 to present, he
has been General Partner of PCB Associates, LLC which performs similar services. Prior to
1986, Baker held various management positions during 25 years of employment with American
Cyanamid Co., including President of Cyanamids Shulton, Inc. subsidiary from 1977 to
1979 and Group Vice President of Cyanamid from 1979 to1984. Baker graduated from Lehigh
University in 1959 and 1960 with degrees in Engineering and Liberal Arts and
received his MBA degree from Fairleigh Dickinson University in 1963.

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Edwin Ruzinsky, Director:

Mr. Ruzinsky has served as a Director since August 27, 1999 and is the chairman of
          the Audit Committee. He is a Certified Public Accountant and a Certified
          Management Consultant. Prior to his retirement on June 1, 1996 as a Partner in
          Deloitte Consulting LLC, a wholly-owned subsidiary of Deloitte & Touche LLP,
          he served for many years as the firms National Director-Media Industry
          Services. He previously served Times Mirror Company as Vice President of Finance
          & Administration/Book Publishing Group and Parents Magazine
          Enterprises, Inc. as Chief Accounting Officer. Mr. Ruzinsky continues serving as
          a member of the Pace University/Dyson School of Liberal Arts &
          Sciences/Master of Science in Publishing Advisory Board. He is currently a
          member of the Board of Gentis, Inc., engaged in the research and development of
          therapeutic products for the repair and regeneration of human tissues (such as
          cartilage tissue and intervertebral disc tissue) through the use of scaffolds
          that beneficially affect progenitor and other cells at the site of repair or
          regeneration. On March 31, 2005, Dowden Health Media, Inc. on whose board Mr.
          Ruzinsky served, was sold.

Henry Royer, Director:

Henry Royer has served as a Director
since December 23, 1999. Mr. Royer serves on the Compensation committee. From 1965 to
1983, Mr. Royer held several positions at First National Bank of Duluth, serving as
Executive Vice President/Loans when he left First National Bank. He then joined The
Merchants National Bank of Cedar Rapids, now named US Bank Cedar Rapids, N.A., where he
served as Chairman and President until August 1994. From September 1994 through December
31, 1997, he served as the President and Chief Executive Officer of River City Bank,
Sacramento, California. He served as an Independent Trustee of Berthel Growth & Income
Trust I from its date of inception in 1995 through February 5, 1999, when he resigned to
join Berthel Fisher & Company Planning Inc., and was elected President of Berthel
Trust in July 1999. He was elected President of Berthel SBIC, LLC in August 1999. He
currently serves as Chairman of the board of Cedar Rapids Bank and Trust and as a member
of the board of QCRH a bank holding company. He also serves on various Boards of
privately-held companies. He graduated in 1953 from Colorado College with a B.A. in Money
and Banking.

Alan Bazaar, Director:

Alan Bazaar has served as a Director
since June 30, 2004. Mr. Bazaar serves on both the audit committee and the compensation
committee. He is a Certified Public Accountant. Mr. Bazaar is a Vice President and
Portfolio Manager at Richard L. Scott Investments, LLC. His responsibilities include
co-managing a public company portfolio for Richard L. Scott Investments, LLC, a
value-oriented, family investment office, focused on both public and private equity
investments. Mr. Bazaar performs all elements of due diligence on perspective investment
companies. From 1995 to July 1999, Mr. Bazaar was with Arthur Andersen LLP. At Arthur
Andersen, he worked for both the Assurance and Financial Buyers Practices and in his
last position he served as a Supervisory Senior Consultant in their Business Fraud and
Investigation Services Unit. Mr. Bazaar graduated from Bucknell University in 1992 with a
degree in History, and he received a MBA from New York University, Leonard N. Stern School
of Business in 1997.

Dennis Ridgeway, Director:

Dennis Ridgeway became a director on
February 22, 2006. From 1998 through 2005, Mr. Ridgeway served as an independent
management consultant in the United Kingdom. From 1984 to 1998, Mr. Ridgeway held various
positions with Katun Corporation, an aftermarket manufacturer headquartered in the United
Kingdom, including European Sales Manager, General Manager, Assistant Vice President, and
Vice President of European Operations from 1994 to 1998.

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Willem van Rijn, Director:

Willem van Rijn became a director on
May 2, 2006. Mr. van Rijn has been Senior Advisor to the founder and management committee
of Capco, an international operations and technology consulting and solutions firm, since
2002. From 1995 to 2002, Mr. van Rijn was a Senior Partner at PricewaterhouseCoopers
Consulting, and its predecessor firm Coopers & Lybrand, where he served as the
Managing Partner of the Japanese financial services consulting practice from 1998 to 2002,
and of the global strategy and financial risk management consulting practices from 1995 to
1998. Mr. van Rijns business experience includes: President of Rhode Island-based
Gtech International (a division of Gtech Corporation), a provider of state and national
lottery technology, outsourcing, software and professional services, from 1994-1995;
Partner in the New York office of Coopers & Lybrand from 1990 to 1994; Partner at Bank
Street Consulting Group, a management consulting firm, from 1986 to 1990; Senior Vice
President in charge of international banking activities in the United States for Bank of
America from 1981 to 1986; Corporate Treasurer and member of the Managing Committee for
global window covering and machine tooling company Hunter Douglas NV from 1976 to 1981;
and Vice President, Account Manager of large accounts for commercial banking services,
based in The Netherlands, for Bank of America from 1971 to 1976.

# Other Information About
Executive Officers and Directors

Our executive officers or directors
are not associated with another by family relationships, and during the past five years
has not been: involved in a bankruptcy petition or a pending criminal proceeding;
convicted in a criminal proceeding excluding traffic and minor offenses; subject to any
order, judgment, or decree, permanently or temporarily enjoining, barring, suspending or
otherwise limiting his involvement in any type of business, securities or banking
activities; or found by a court, the Securities and Exchange Commission or the Commodity
Futures Trading Commission to have violated a federal or state securities or commodities
law.

None of our executive officers or
directors are directors of other reporting companies, except as follows:

| |  | Mr. Baker serves on the board of Pascack Community Bank; and
| | - | ------------------------------------------------------------

| |  | Mr. van Rijn serves on the board of Computer Horizons Corporation.
| | - | ------------------------------------------------------------------

# Board Committees and
Meetings

During the fiscal year ended June 30,
2006, the Board of Directors held five meetings. During this period, each director
attended or participated in more than 75% of the total meetings of the Board of Directors
and the committee or committees on which he or she served.

The Board has three principal
committees: Audit Committee; Compensation Committee, and Nominating and Corporate
Governance Committee. The charter of each committee can be found on our web site at
www.mediasciences.com. The Audit Committee met five times in connection with fiscal
year 2006. The Compensation Committee met five times in connection with fiscal year 2006.
The Nominating and Corporate Governance Committee met three times in connection with
fiscal year 2006.

Audit Committee.  The function
of the Audit Committee includes reviewing internal financial information, monitoring cash
flow, budget variances and credit arrangements, reviewing the audit program of Media
Sciences, reviewing with Media Sciences independent accountants the results of all
audits upon their completion, annually selecting and recommending independent accountants,
overseeing the quarterly unaudited reporting process and taking such other action as may
be necessary to assure the adequacy and integrity of all financial information
distribution by Media Sciences. Each member of the Audit Committee is independent as
defined under the American Stock Exchanges listing standards. The Audit Committee
consists of non-employee directors whom Media Sciences has determined are free of any
relationship that could influence their judgment as a committee member and are not
associated with a major vendor to, or a customer of, Media Sciences.

Compensation Committee.  The
function of the Compensation Committee is to make determinations concerning salaries and
incentive compensation for our officers and employees.

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Nominating and Corporate
Governance Committee.  The primary function of the Nominating and Corporate Governance
Committee is to identify individuals qualified to become members of the Board consistent
with criteria approved by the Board, and to select, or recommend that the Board select,
the director nominees for each annual meeting of stockholders or when vacancies occur. The
Committee shall also develop and recommend to the Board corporate governance principles
applicable to the Company and be responsible for leading the annual review of Board
performance.

Committee Membership.  Members
of the Board Committees are selected each year by our Board of Directors after our annual
stockholders meeting. Selection to a committee of the Board of Directors is
determined by the majority vote of the Board of Directors. The Board of Directors intends
to elect incumbent directors who are re-elected to the Board of Directors to continue to
serve on the committees they presently serve. Mr. Ruzinsky and Mr. Bazaar are financial
experts.

The following table summarizes the
membership of the Board and each of its committees for our 2006 fiscal year.

|                 |  |  |               
|---------------- |  |  | --------------
|Name             |  |  | AuditCommittee
|                 |  |  |               
|                 |  |  |               
|Michael W. Levin |  |  |               
|Frances Blanco   |  |  |               
|Paul C. Baker    |  |  | Member        
|Edwin Ruzinsky   |  |  | Chairperson   
|Henry Royer      |  |  |               
|Alan Bazaar      |  |  |               
|Dennis Ridgeway  |  |  |               
|Willem van Rijn  |  |  | Member        

# Section 16(a) Beneficial
Ownership Reporting Compliance

Section 16(a) of the Securities
Exchange Act of 1934, as amended, requires Media Sciences executive officers,
directors, and persons who beneficially own more than ten percent of Media Sciences
common stock to file with the Securities and Exchange Commission initial reports of
beneficial ownership and reports of changes in beneficial ownership of Media
Sciences common stock. Such persons are also required by Securities and Exchange
Commission regulations to furnish Media Sciences with copies of all such Section 16(a)
forms filed by such person. Based solely on a review of the copies of such reports
furnished to Media Sciences during and in connection with Media Sciences fiscal year
ended 2006, Media Sciences is not aware of any material delinquencies in the filing of
such reports, except as follows: Donald Gunn did not file a Form 4 or Form 5 reporting the
cessation of his status as an officer and director subject to Section 16.

# Code of Ethics

We have adopted a Code of Ethics that
applies to our Chief Executive Officer, Chief Financial Officer and all other executive
officers. Our Code of Ethics is publicly available on our website at
www.mediasciences.com.

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# ITEM 10.  EXECUTIVE
COMPENSATION

# Compensation Summary

The table below sets forth
information concerning the annual and long-term compensation during our last three fiscal
years of our Chief Executive Officer and all of our other officers (Named Executive
Officers). Option grants were valued at date of grant using the Black-Scholes model.

# Summary Compensation
Table

| |  |  | 
| |  |  | 
| |  |  | 
| |  |  | 

|                           |  |  |      |  |  |  |             
|-------------------------- |  |  | ---- |  |  |  | ------------
|Nameand Principal Position |  |  | Year |  |  |  | Salary($)(1)
|                           |  |  |      |  |  |  |             
|                           |  |  |      |  |  |  |             
|Michael W. Levin           |  |  | 2006 |  |  |  | 200,000     
|Chief Executive Officer    |  |  | 2005 |  |  |  | 200,000     
|and President              |  |  | 2004 |  |  |  | 200,000     
|Kevan D. Bloomgren         |  |  | 2006 |  |  |  | 43,077      
|Chief Financial Officer    |  |  |      |  |  |  |             
|Lawrence Anderson          |  |  | 2006 |  |  |  | 160,000     
|Chief Operating Officer    |  |  | 2005 |  |  |  | 13,333      
|Frances Blanco             |  |  | 2006 |  |  |  | 160,000     
|Vice President             |  |  | 2005 |  |  |  | 130,000     
|                           |  |  | 2004 |  |  |  | 120,000     
|Denise Hawkins             |  |  | 2006 |  |  |  | 84,140      
|Vice President             |  |  | 2005 |  |  |  | 68,890      
|and Secretary              |  |  | 2004 |  |  |  | 64,890      

|(1) | Mr. Anderson joined our company on June 6, 2005. Mr. Bloomgren joined our company on March 15, 2006.
|--- | ----------------------------------------------------------------------------------------------------

|(2) | For fiscal year 2006, refers to amounts under the companys Performance Based Bonus Compensation plan, which are paid after fiscal year end.
For Mr. Bloomgren, includes a $25,000 signing bonus.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | For each year,  refers to perquisites  and other personal  benefits, unless the aggregate  amount of such compensation
is the lesser of either $50,000 or 10% of the total of annual salary and bonus reported
for the named executive officer. For Mr. Levin, refers to dollar value of purchase option
on company leased vehicle used by executive.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Represents the grant of stock awards under which the executive has the right to
          receive shares of common stock. The value set forth above is based on the
          closing price on the date of grant. On March 15, 2006, we granted Mr. Bloomgren,
          50,000 shares of common stock, subject to vesting over five years at
          20% per year beginning on the first anniversary of the grant. The grant
          date fair value of the award is $195,500. At June 30, 2006, the value of this
          award was $217,000.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | On March 15, 2006, we granted Mr. Bloomgren stock options to purchase 50,000
          shares of our common stock, exercisable for ten years at $3.91 per share,
          subject to vesting over five years at 20% per year beginning on the first
          anniversary of the grant. The grant date fair value of the award is $135,040,
          computed using a Black-Scholes model.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
June 6, 2005, we granted Mr. Anderson stock options to purchase 100,000 shares of our
common stock, exercisable for ten years at $1.60 per share, subject to vesting over five
years at 20% per year beginning on the first anniversary of the grant. The grant date fair
value of the award is $47,430, computed using a Black-Scholes model.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
March 24, 2004, we granted Ms. Blanco stock options to purchase 100,000 shares of our
common stock, exercisable for ten years at $1.06 per share, of which 50,000 options vested
on the grant date, and the remaining 50,000 options were subject to vesting over the
period May 25, 2004 through May 24, 2006. The grant date fair value of the award is
$91,173, computed using a Black-Scholes model.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | On
January 12, 2005, we granted Ms. Hawkins stock options to purchase 20,000 shares of our
common stock, exercisable for ten years at $1.91 per share, subject to vesting over three
years at 33% per year beginning on the first anniversary of the grant. The grant date fair
value of the award is $7,340, computed using a Black-Scholes model.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Refers to our matching contribution under our 401(k) plan and premiums for life
          insurance where the beneficiary is not the company.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------

# Performance Based Bonus
Compensation

From year to year, our Compensation
Committee may establish certain performance criteria for our executive officers, based on
factors and criteria as the Compensation Committee may deem relevant. For our 2006 fiscal
year, we had in effect a performance based cash bonus compensation plan for certain
executive officers. Bonuses are paid after the fiscal year end. As of June 30, 2006, the
Compensation Committee had not established a bonus compensation plan or performance goals
for fiscal year 2007 and subsequent years. In June 2006, the Compensation Committee
engaged a consulting firm to benchmark the Companys executive compensation and
provide it with recommendations regarding potential bonus and long-term incentive plan
design. The Compensation Committee is evaluating the consultants recommendations and
formulating a plan for fiscal 2007 and future years.

For our Chief Executive Officer, the
potential cash bonus was based upon 100% of his base salary, determined wholly upon
attaining earnings per share criteria determined by the Board (Performance
Bonus). For other executives, the potential cash bonus was based upon 40% of base
salary, measured 50% on the Performance Bonus criteria, and 50% on individualized
performance goals (Individual Bonus). Factors in determining the Individual
Bonus includes matters such as achieving specified leadership initiatives, and the
achievement of certain strategic and business goals including, but not limited to,
customer growth, new product development, information technology upgrades, manufacturing
efficiencies and corporate compliance goals. The Performance Bonus was to be earned if our
Companys earnings per share equaled or exceeded a minimum level established by the
Compensation Committee. If the minimum level was not achieved, no Performance Bonus was
earned. If the minimum level is achieved or exceeded, the amount of the Performance Bonus
was based upon the level of earnings per share achieved by the Company.

The following table summarizes the
payout structure under the fiscal year 2006 bonus structure. The Performance Bonus range
set forth in the table assumed that the achievement of the minimum targeted level and up
to 100% of the targeted goal. If the maximum targeted goal was exceeded, the Performance
Bonus payable would exceed the Performance Bonus potential set forth in the table below.

|                  |  |  |  |                          
|----------------- |  |  |  | -------------------------
|Name              |  |  |  | PerformanceBonusRange ($)
|                  |  |  |  |                          
|                  |  |  |  |                          
|Michael W. Levin  |  |  |  | 40,000 - 200,000         
|Kevan Bloomgren   |  |  |  | 3,200 -   11,200         
|Lawrence Anderson |  |  |  | 6,400 -   32,000         
|Frances Blanco    |  |  |  | 6,400 -   32,000         
|Denise Hawkins    |  |  |  | 1,700 -     8,500        

# Stock Option Information

The table below sets forth
information concerning stock options granted during the fiscal year ended June 30, 2006 to
the Named Executive Officers. The percentage of total stock options is based on 311,352
stock options granted to officers, directors, and employees during the 2006 fiscal year.

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# Option Grants in
Fiscal 2006

|                   |  |  |  |                                                
|------------------ |  |  |  | -----------------------------------------------
|Name               |  |  |  | Number ofSecuritiesUnderlyingOptions Granted(#)
|                   |  |  |  |                                                
|                   |  |  |  |                                                
|Kevan D. Bloomgren |  |  |  | 50,000                                         

The following table sets forth
information concerning the value of unexercised stock options at June 30, 2006 for the
Named Executive Officers. The dollar values of the options was determined by multiplying
the number of stock options by the difference between the fair market value of a share of
common stock underlying an option and the exercise price of the option. Out-of-the-money
options are reported as having a dollar value of $0. The last sale price of a share of our
common stock on June 30, 2006 was $4.34, as reported by AMEX.

| |  |  |  | 
| |  |  |  | 
| |  |  |  | 
| |  |  |  | 

|                   |  |  |  |                               |  | 
|------------------ |  |  |  | ----------------------------- |  | 
|Name               |  |  |  | SharesAcquired onExercise (#) |  | 
|                   |  |  |  |                               |  | 
|                   |  |  |  |                               |  | 
|Michael W. Levin   |  |  |  | 0                             |  | 
|Kevan D. Bloomgren |  |  |  | 0                             |  | 
|Lawrence Anderson  |  |  |  | 0                             |  | 
|Frances Blanco     |  |  |  | 0                             |  | 
|Denise Hawkins     |  |  |  | 0                             |  | 

# 1998 Incentive Stock Plan

Under our 1998 incentive stock plan
for employees, which was adopted by our Board of Directors and approved by our
shareholders in 1998, and amended in 2005, we reserved up to 1,000,000 shares of our
common stock for issuance pursuant to awards of restricted stock and stock options. A
stock option entitles the holder to purchase a share of our common stock at a purchase
price equal to the fair market value of the common stock on the day of grant. During the
year ended June 30, 2006, 32,334 stock options granted under this plan were exercised. As
of June 30, 2006, stock options to purchase 485,561 shares of common stock were
outstanding. These awards, subject to vesting, may be exercised for ten years from the
date of grant at prices of $0.43 to $4.80. Since the effective date of the plan, 134,647
shares of common stock have been issued through exercise of options awarded under the
plan. As of June 30, 2006, we also had outstanding 80,000 shares of restricted stock which
have been awarded under the plan. Accordingly, at of June 30, 2006, 299,792 shares of the
Companys common stock were available for grant under the plan. Under terms of the
plan, should we undergo a change of control, stock options and restricted
stock awarded under the plan may be subject to accelerated vesting.

# Employee Profit Sharing
Plan

We have a tax-qualified employee
paired profit sharing plan sponsored by DWS Scudder Deutsche Bank Group. This 401(k) plan
covers all of our employees that have been employed for at least six months and meet other
age and eligibility requirements. Under the 401(k) plan, employees may choose to reduce
their current compensation by up to 15% each year and have that amount contributed to the
401(k) plan. We make matching contributions equal to 25% of the employees
contribution. In our discretion, we may contribute unmatched contributions. The 401(k)
plan qualifies under Section 401 of the Internal Revenue Code, so that we can deduct
contributions by employees or by us. Employee contributions to the 401(k) plan are fully
vested at all times, and our contributions, if any, vest at the rate of 25% after two
years and after two years at the rate of 25% a year until fully vested. The companys
contributions to the plan were $41,500 in 2006 and $36,700 in 2005.

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# Director Compensation

We have a compensation plan for our
independent directors. Through fiscal 2006, eligible outside directors were paid $10,000
per year, payable quarterly, for attendance at regular and special meetings and may be
reimbursed for their reasonable out-of-pocket expenses incurred in connection with their
attendance at meetings of the Board of Directors and for other expenses incurred in their
capacity as directors of Media Sciences. Outside directors are granted five or ten year
stock options under the incentive stock option plan to purchase 10,000 shares of common
stock, exercisable at the fair market value on the date of appointment to the Board.
Outside directors will also be granted, annually, additional stock options to purchase
10,000 shares of common stock.

# 2006 Compensation of
Non-Employee Directors

|                   |  |                               |  |                    
|------------------ |  | ----------------------------- |  | -------------------
|Name               |  | Fees Earned orPaid in Cash($) |  | OptionsAwards($)(a)
|                   |  |                               |  |                    
|                   |  |                               |  |                    
|Paul Baker         |  | 10,000                        |  | 18,596             
|Dennis Ridgeway    |  | 5,000                         |  | 23,279             
|Henry Royer        |  | 10,000                        |  | 18,596             
|Edwin Ruzinsky     |  | 10,000                        |  | 18,596             
|Willem van Rijn    |  | 2,500                         |  | 26,475             
|Alan L. Bazaar (b) |  | 10,000                        |  | 18,596             

|(a) | At 2006 fiscal year end, the total number of outstanding options, granted as
          director compensation, for each director was: Mr. Baker, 78,000 options; Mr.
          Ridgeway, 10,000 options; Mr. Royer, 10,000 options; Mr. Ruzinsky, 55,000
          options, Mr. van Rijn, 10,000 options; and Mr. Bazaar, 25,000 options. Option
          awards are valued at the fair value on the date of grant using a Black-Scholes
          model.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(a) | Director compensation to Mr. Bazaar is paid to GFX Investments, LLC. Mr. Bazaar
          is a Vice President and Portfolio Manager at Richard L. Scott Investments, LLC.
          Mr. Bazaar disclaims beneficial ownership of the securities held by Richard L.
          Scott Investments, LLC and its affiliates.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In 2006, the Compensation Committee
engaged a third-party consultant to review our director compensation structure. In
September 2006, consistent with the findings of the study conducted by the third-party
consultant, the Board approved a director compensation structure for fiscal 2007, as
follows:

| |  | Increase cash compensation by $5,000 per year.
| | - | ----------------------------------------------

| |  | Initiate Committee Chairperson additional compensation:
| | - | -------------------------------------------------------

| | Governance/Nominating | $500 per year
| | --------------------- | -------------

| | Compensation | $1,000 per year
| | ------------ | ---------------

| | Audit | $1,500 per year
| | ----- | ---------------

| |  | Retain present structure of annual issuance of stock options.
| | - | -------------------------------------------------------------

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# Tally Sheet for Chief
Executive Officer

The following table is a summary of
the executive pay package for our Chief Executive Officer for our 2006 fiscal year.

|Compensation Element                        | Amount ($) | Description                     | Terms and Conditions                                                                                              
|------------------------------------------- | ---------- | ------------------------------- | ------------------------------------------------------------------------------------------------------------------
|                                            |            |                                 |                                                                                                                   
|Base Salary                                 | $200,000   | See footnote 1.                 | Effective July 1, 2006 Base Salary was increased to $225,000.                                                     
|Annual Incentive                            |            |                                 |                                                                                                                   
|Discretionary Bonus                         | 0          | Not applicable.                 |                                                                                                                   
|Performance Bonus                           | 200,000    | See footnote 2.                 | Target:  $200,000
Actual earned:  $200,000                                                                        
|Stock Options                               | 0          | Not applicable.
See footnote 3. | Grant date:  N/A
Number granted:
Grant date value:
Stock price at grant:
Exercise price:
Vesting:                 
|Restricted Stock                            | 0          | Not applicable.
See footnote 4. | Number granted:  N/A
Vesting:
Grant value:                                                                        
|Performance Shares                          | 0          | Not applicable.
See footnote 5. | Minimum:  N/A
Target:
Maximum:
Actual earned:
Grant value:                                                        
|Deferred Compensation                       | 0          | Not applicable.                 | Executive portion:  N/A
Company match (if any):
Accumulated executive portion:
Accumulated company match (if any):
|401(k) Plan                                 | 3,642      | See footnote 6.                 |                                                                                                                   
|Supplemental retirement benefit             | 0          | Not applicable.                 | Actual projected payment obligations: N/A                                                                         
|Executive perquisites                       | 74,947     | See footnote 7.                 |                                                                                                                   
|Term life insurance                         | 1,140      | $2,000,000                      | A fifteen-year term life insurance policy                                                                         
|Gross-ups (if any)                          | 0          | Not applicable.                 |                                                                                                                   
|Severance associated with
change-in-control | 0          | See footnote 8.                 | Estimated payout amount for cash:  N/A                                                                            
|Severance for termination
for cause         | 0          | Not applicable.                 | Estimated payout amounts for cash, equity and benefits:  N/A                                                      
|Severance for termination
without cause     | 0          | Not applicable.                 | Estimated payout amounts for cash, equity and benefits: N/A                                                       
|Post retirement package                     | 0          | Not applicable.                 | Estimated payout amounts for cash, equity and benefits: N/A                                                       
|Post retirement package                     | 0          | Not applicable.                 | Estimated value of consulting agreement and continuation of benefits: N/A                                         
|                                            |            |                                 |                                                                                                                   
|                                            |            |                                 |                                                                                                                   
|Estimated 2006 Package                      | $461,716   |                                 |                                                                                                                   

|(1) | The base salary for our CEO has remained the same since fiscal 2004.
|--- | --------------------------------------------------------------------

|(2) | On an annual basis, our Compensation Committee set forth the terms of a
          performance bonus to which our CEO, and other executives, may be eligible. For
          our CEO, the potential bonus is 100% tied to company performance, based upon
          measures determined by the Compensation Committee. For additional information,
          refer to the heading entitled Performance Based Bonus Compensation.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | We did not grant stock options to our CEO in fiscal 2006. In 2003, we granted
          our CEO 500,000 stock options in connection with his July 2003 employment
          agreement. Our common stock traded at $0.45 on the grant date, July 1, 2003, and
          the exercise price was set at a substantial premium to the market price, $1.00.
          Options are exercisable for 5 years from grant. 250,000 options vested upon
          grant. The other options vested over a two year period from grant. The options
          had a value of $0 on the grant date, determined by multiplying the number of
          stock options by the difference between the common stock market price and the
          option exercise price at the time of grant. As at June 30, 2006, the options
          would have a value of $1,670,000, due to an increase in our stock price since
          July 2003.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|(4) | We have never granted restricted stock as compensation to our CEO. All of his
          ownership of our common stock, except for open market purchases of 10,000 shares
          in 2001 and 2002, were initially acquired when he founded our companys
          predecessor business in 1987.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | We have never granted performance shares to our CEO.
|--- | ----------------------------------------------------

|(6) | Refers to our matching
          contributions under the plan
|--- | -------------------------------------------------------------

|(7) | Refers to $18,013 paid during the Companys fiscal 2006 to lease vehicles
          used by our CEO and the fair market value he received of $56,934 resulting from
          exercise of a purchase option he exercised on a leased vehicle. The use of a
          leased vehicle and the purchase option were in accordance with terms of the
          CEOs employment agreement.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | In the event of a change of control the Company is obligated to pay
          our CEO 290% of his annual base compensation. Based on his Base Salary in 2006
          of $200,000, this contingent obligation could be $580,000 in 2006. Based on his
          current Base Salary, which was increased to $225,000 on July 1, 2006, this
          contingent obligation could be $652,500.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Employment Agreement
with Named Executive Officer

Michael W. Levin serves as our Chief
Executive Officer and President pursuant to a five-year employment agreement that began as
of July 1, 2003. His current annual salary for fiscal year 2007 is to be $225,000. We
granted him 500,000 five-year stock options to purchase 500,000 shares of common stock.
The exercise price for the stock options is $1.00 per share. Stock options to purchase
250,000 shares vested on the date of grant, additional stock options to purchase 125,000
shares vested on June 30, 2004, and the remaining stock options to purchase 125,000 shares
vested on June 30, 2005. These stock options are cumulative and are subject to
anti-dilution rights.

He is also entitled to receive:

| |  | death benefits of $100,000;
| | - | ---------------------------

| |  | a fifteen-year term life insurance policy for $2,000,000;
| | - | ---------------------------------------------------------

| |  | a luxury automobile;
| | - | --------------------

| |  | reimbursement for reasonable travel and other business related expenses;
| | - | ------------------------------------------------------------------------

| |  | six weeks vacation;
| | - | -------------------

| |  | medical and dental insurance; and
| | - | ---------------------------------

| |  | participation in any employee plan, perquisite and other benefits made available to Media
Sciences employees or management in general.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

We may also award him an annual
performance bonus or other bonus as determined by the Board of Directors.

If we undergo a change of control,
we must pay him an amount equal to 290% of his base compensation. He has the right to
terminate his employment if we undergo a change in control. As defined in his employment
agreement, a change of control refers to:

| |  | a change in our  ownership  or  management  that is required to be reported  under the federal  securities
         laws;
| | - | -------------------------------------------------------------------------------------------------------------------------

| |  | the acquisition, other than directly from Media Sciences, of 25% or more of our common
stock or our voting securities by persons other than Media Sciences or Levin;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a change in a majority of the current Board of Directors, excluding a Board approved
change that does not result from a proxy contest;
| | - | --------------------------------------------------------------------------------------------------------------------------------------

| |  | a reorganization, merger, consolidation or sale of substantially all of our assets, after
which our shareholders do not own, in the same proportion, more than 50% of the voting
power, after which a majority of the board of directors changes, and after which a new
shareholder beneficially owns 25% or more of the voting power; or
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | shareholder approval of our liquidation or dissolution.
| | - | -------------------------------------------------------

The employment agreement provides for
termination for cause.

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# ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

# Security Ownership of
Certain Beneficial Owners

The table below sets forth, as of
June 30, 2006, the shares of our common stock beneficially owned by each person known to
us to be the beneficial owner of more than five percent of our outstanding shares of
common stock, except that the security ownership of management is provided in a separate
table. This information was determined in accordance with Rule 13(d)-3 under the
Securities Exchange Act of 1934, and is based upon the information provided by the persons
listed below. As of June 30, 2006, we had 11,131,363 shares of common stock issued and
outstanding.

All persons named in the table have
the sole voting and dispositive power with respect to common stock beneficially owned.
Beneficial ownership of shares of common stock that are acquirable within 60 days upon the
exercise or conversion of stock options and warrants are listed separately. For each
person named in the table, the calculation of percent of class gives effect to those
acquirable shares.

|Name and Address            | Amount and Nature   | Additional Shares         | Percent 
|--------------------------- | ------------------- | ------------------------- | --------
|of Beneficial Owner         | of Beneficial Owner | Acquirable Within 60 days | of Class
|                            |                     |                           |         
|Richard L. Scott (a)        | 1,789,750           |                           | 25,000  
|100 First Stamford Place    |                     |                           |         
|Stamford, CT 06902          |                     |                           |         
|MicroCapital LLC (c)        | 708,300             |                           | 0       
|201 Post Street, Suite 1001 |                     |                           |         
|San Francisco, CA  94108    |                     |                           |         

|(a) | Beneficially owns securities through different entities, including: 1,000,000
          shares held by GFX Investments, LLC, for which he is the beneficial owner;
          606,050 shares held by Scott Family Florida Partnership Trust; 93,300 shares
          held by F. Annette Scott Florida Trust, of which his spouse is the trustee; and
          90,400 shares held by Richard L. Scott Florida Trust.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | Refers to shares acquirable upon exercise of options: 10,000 options exercisable
          at $1.69 per share until June 30, 2009; 5,000 options exercisable at $1.45 per
          share until December 17, 2009; and 10,000 options exercisable at $2.71 per share
          until January 30, 2016.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(c) | Holds the securities through different entities, including MicroCapital Fund LP
          and MicroCapital Fund Ltd.
|--- | --------------------------------------------------------------------------------------------------------------------

# Security Ownership of
Management

The table below sets forth, as of
June 30, 2006, the shares of our common stock beneficially owned by each of our officers
and directors, and by all of our officers and directors as a group. This information was
determined in accordance with Rule 13(d)-3 under the Securities Exchange Act of 1934, and
is based upon the information provided by the persons listed below. As of June 30, 2006,
we had 11,131,363 shares of common stock issued and outstanding.

All persons named in the table have
the sole voting and dispositive power with respect to common stock beneficially owned.
Beneficial ownership of shares of common stock that are acquirable within 60 days upon the
exercise or conversion of stock options and warrants are listed separately. For each
person named in the table, the calculation of percent of class gives effect to those
acquirable shares.

The address of each of the persons
named in the table is c/o Media Sciences International, Inc., 8 Allerman Road, Oakland,
New Jersey 07463, unless otherwise indicated.

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|Name and Address                   | Amount and Nature   | Additional Shares         | Percent 
|---------------------------------- | ------------------- | ------------------------- | --------
|of Beneficial Owner                | of Beneficial Owner | Acquirable Within 60 days | of Class
|                                   |                     |                           |         
|Michael W. Levin                   | 1,343,450           | (a)                       | 500,000 
|Kevan D. Bloomgren                 | 90,000              | (c)                       | 0       
|Frances Blanco                     | 42,775              | (e)                       | 132,741 
|Lawrence Anderson                  | 2,000               |                           | 20,000  
|Denise Hawkins                     | 500                 |                           | 16,669  
|Paul Baker                         | 92,500              |                           | 90,500  
|Dennis Ridgeway                    | 0                   |                           | 10,000  
|Henry Royer                        | 5,000               | (k)                       | 10,000  
|Edwin Ruzinsky                     | 20,000              |                           | 55,000  
|Willem van Rijn                    | 0                   |                           | 10,000  
|Alan L. Bazaar (o)                 | 1,789,750           |                           | 25,000  
|                                   |                     |                           |         
|All present officers and directors |                     |                           |         
|as a group (11 persons)            | 3,385,975           |                           | 869,910 

|(a) | Includes 120,000 shares owned by his minor children
|--- | ---------------------------------------------------

|(b) | Refers to shares acquirable upon exercise of options, exercisable at $1.00 per
          share until June 29, 2008.
|--- | -------------------------------------------------------------------------------------------------------------------

|(c) | Includes 50,000 restricted shares, granted on
          March 15, 2006, subject to vesting annually in equal installments
over a five year period.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------

|(d) | Does not include shares acquirable upon exercise of 50,000 options, exercisable
          at $3.91 per share until March 14, 2016. The options are to subject to vesting
          in equal installments annually over a five year period, commencing on March 15,
          2007.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(e) | Includes 2,000 shares owned by spouse.
|--- | --------------------------------------

|(f) | Refers to shares acquirable upon the exercise of options: 7,741 options
          exercisable at $1.25 per share until June 18, 2008; 25,000 options exercisable
          at $0.50 per share until April 6, 2008; and 100,000 options exercisable at $1.06
          per share until May 24, 2014.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(g) | Refers to shares acquirable upon exercise of options, exercisable at $1.60 per
          share until June 6, 2015. Does not include shares acquirable upon the exercise
          of 80,000 options, exercisable at $1.60 per share until June 5, 2015, that are
          subject to vesting in equal installments annually over a four year period,
          commencing on June 6, 2007.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(h) | Refers to shares acquirable upon exercise of options: 10,002 options exercisable
          at $1.70 per share until July 16, 2011 and 6,667 options exercisable at $1.91
          per share until January 11, 2015. Does not include shares acquirable upon the
          exercise of 13,333 options, exercisable at $1.91 per share until January 11,
          2015, that are subject to vesting in equal installments on January 12, 2007 and
          2008.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(i) | Refers to shares acquirable upon exercise of options: 3,000 options exercisable
          at $2.00 per share until August 11, 2008; 30,000 options exercisable at $3.31
          per share until April 6, 2009; 5,000 options exercisable at $2.19 per share
          until July 3, 2010; 5,000 options exercisable at $2.00 per share until July 2,
          2011; 5,000 options exercisable at $0.65 per share until September 24, 2012;
          10,000 options exercisable at $0.43 per share until May 6, 2013; 5,000 options
          exercisable at $0.85 per share until February 10, 2014; 5,000 options
          exercisable at $1.45 per share until December 17, 2014; and 10,000 options
          exercisable at $2.71 per share until January 30, 2016. Also includes beneficial
          ownership of shares underlying 12,500 warrants held by spouse, exercisable at $1
          until June 12, 2007.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(j) | Refers to shares acquirable upon the exercise of 10,000 options, exercisable at
          $3.38 per share until February 26, 2016.
|--- | ----------------------------------------------------------------------------------------------------------------------------------

|(k) | Does not include 95,000 shares held by Heffernen 1966 Trust B, a trust
          controlled by Mr. Royers spouse. Mr. Royer disclaims beneficial ownership
          of such shares.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(l) | Refers to shares acquirable upon the exercise of 10,000 options, exercisable at
          $2.71 per share until January 30, 2016.
|--- | ---------------------------------------------------------------------------------------------------------------------------------

|(m) | Refers to shares acquirable upon exercise of options: 10,000 options exercisable
          at $2.06 per share until August 27, 2009; 5,000 options exercisable at $2.19 per
          share until July 3, 2010; 5,000 options exercisable at $2.00 per share until
          July 2, 2011; 5,000 options exercisable at $0.65 per share until September 24,
          2012; 10,000 options exercisable at $0.43 per share until May 6, 2013; 5,000
          options exercisable at $0.85 per share until February 10, 2014; 5,000 options
          exercisable at $1.45 per share until December 17, 2014; and 10,000 options
          exercisable at $2.71 per share until January 30, 2016.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|(n) | Refers to shares acquirable upon the exercise of 10,000 options, exercisable at
          $4.09 per share until May 2, 2016.
|--- | ----------------------------------------------------------------------------------------------------------------------------

|(o) | For purposes of the table, Mr. Bazaars reported beneficial ownership
          refers to the beneficial ownership of Richard L. Scott Investments, LLC and its
          affiliates. Mr. Bazaar is a Vice President and Portfolio Manager at Richard L.
          Scott Investments, LLC. Mr. Bazaar disclaims beneficial ownership of the
          securities held by Richard L. Scott Investments, LLC and its affiliates.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(p) | Refers to shares acquirable upon exercise of options: 10,000 options exercisable
          at $1.69 per share until June 30, 2009; 5,000 options exercisable at $1.45 per
          share until December 17, 2014; and 10,000 options exercisable at $2.71 per share
          until January 30, 2016.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Changes in Control

We do not have any arrangements that
may result in a change in control.

# Securities Authorized
for Issuance under Equity Compensation Plans

The following table set forth
outstanding securities authorized for issuance under equity compensation plans as of June
30, 2006.

|                               |  |  | 
|------------------------------ |  |  | 
|Plan Category                  |  |  | 
|                               |  |  | 
|                               |  |  | 
|Equity compensation plans      |  |  | 
|approved by securities holders |  | 
|Equity compensation plans not  |  |  | 
|approved by security holders   |  |  | 
|                               |  |  | 
|Total                          |  |  | 

|(a) | Does not include the number, or value, of restricted shares, which are subject
          to outstanding awards and do not have an exercise price.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------

Plans in the Shareholder
Approved Category

Our 1998 incentive stock plan, as
amended, for employees, directors and consultants provides for the issuance of up to
1,000,000 shares of our common stock pursuant to stock options and restricted stock
awards. An incentive stock option entitles the holder to purchase a share of our common
stock at a purchase price equal to the fair market value of the common stock on the day of
grant. As of June 30, 2006, stock options to purchase 485,561 shares of common stock were
outstanding. These awards, subject to vesting, may be exercised for ten years from the
date of grant at prices of $0.43 to $4.80. Since the effective date of the plan, 134,647
shares of common stock have been issued through exercise of options awarded under the
plan. As of June 30, 2006, we also had outstanding 80,000 shares of restricted stock which
have been awarded under the plan. Accordingly, at of June 30, 2006, 299,792 shares of the
Companys common stock were available for grant under the plan.

On April 7, 2003, we issued to
Frances Blanco stock options to purchase 25,000 shares of common stock. The stock options
vest on April 6, 2004 and are exercisable until April 5, 2008 at $0.50 per share.

In June 2003, we issued to Michael W.
Levin stock options to purchase up to 500,000 shares of common stock, exercisable at $1.00
per share and expiring in June 2008.

On May 24, 2004, we issued to Frances
Blanco options to purchase 100,000 shares of our common stock, of which 50,000 options
vested on the grant date, 25,000 options vested as of May 25, 2005, and the remaining
25,000 options are subject to vesting as of May 24, 2006. The options are exercisable for
ten years at $1.06 per share.

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On June 6, 2005, we issued to
Lawrence Anderson options to purchase 100,000 shares of our common stock, which vest
ratably, on an annual basis, over the period June 6, 2005 through June 5, 2010. The
options are exercisable for ten years at $1.60 per share.

On August 8, 2005, we issued to
Donald Gunn, an officer, stock options to purchase 100,000 shares of our common stock
exercisable for ten years at $1.65 per share. The options were subject to vesting, upon
Gunns relocation to corporate offices, as follows: 50,000 stock options on such
date, and the other 50,000 stock options at the rate of 10,000 stock options per year for
five years starting on the first anniversary of such date. The option grant was modified
by an agreement dated March 31, 2006 between the Company and Mr. Gunn. As modified, stock
options to purchase 50,000 shares of common stock became fully vested as of April 2006,
and the other stock options were forfeited.

# ITEM 12.  CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS

On May 24, 2004, we issued to each of
Frances Blanco an officer and director, and Duncan Huyler, a former officer, stock options
to purchase 100,000 shares of our common stock, of which 50,000 options vested on the
grant date, and the remaining 50,000 options are subject to vesting over the period May
25, 2004 through May 24, 2006. The options are exercisable for ten years at $1.06 per
share.In May 2005, Duncan Huyler executed a cashless exercise of 50,000 options.
The balance of Mr. Huylers options were forfeited upon the termination of his
employment.

On June 30, 2004, we sold 1,000,000
shares of common stock to GFX Investments, LLC, an entity controlled by Richard L. Scott,
for $1.25 million. In conjunction with the investment, we agreed to appoint a nominee of
GFX Investments, Alan Bazaar, Vice President and Portfolio Manager for Richard L. Scott
Investments, LLC, to our board of directors, and we granted Mr. Scott 10,000 stock
options, exercisable at $1.69 per share for five years in connection with Board of
Directors services.

On March 2, 2005, we sold an
aggregate of 500,000 shares of our common stock at a price of $2 per share to MicroCapital
Fund LP and MicroCapital Fund Ltd. for aggregate gross proceeds of $1 million.
MicroCapital Fund LP purchased 375,000 shares and MicroCapital Fund Ltd. purchased 125,000
shares.

On June 6, 2005, we issued to
Lawrence Anderson, an officer, stock options to purchase 100,000 shares of our common
stock, which vest ratably, on an annual basis, over the period June 6, 2005 through June
5, 2010. The options are exercisable for ten years at $1.60 per share.

On August 8, 2005, we issued to
Donald Gunn, an officer, stock options to purchase up to 100,000 shares of our common
stock. The options were subject to vesting, upon Gunns relocation to corporate
offices, as follows: 50,000 stock options on such date, and the other 50,000 stock options
at the rate of 10,000 stock options per year for five years starting on the first
anniversary of such date. The options were exercisable for ten years at $1.65 per share.

On February 21, 2006, Scott Family
Florida Partnership Trust, an entity controlled by Richard L. Scott, sold 40,000 shares of
our common stock at $3.00 per share to Kevan D. Bloomgren prior to the start of his
employment as Media Sciences Chief Financial Officer.

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On March 15, 2006, concurrent with
the start date of his employment, we granted Mr. Bloomgren 50,000 shares of unregistered
common stock and stock options to purchase 50,000 shares of our common stock, exercisable
for ten years at $3.91 per share, in each case subject to vesting annually over a five
year period from March 15, 2006 at the rate of 20% per year. In the event of termination
of employment by the Company for reasons other than cause or in the event of a change of
control event, we agreed to accelerate all non-vested stock options and grants, and we
agreed to reimburse Mr. Bloomgren for certain tax payments paid under an IRS 83(b)
election for the common stock granted on March 15, 2006, limited to the taxes paid on the
unvested stock grants.

In April 2006, we entered into an
agreement, effective as of March 31 2006, with Donald Gunn, a former officer and director,
in connection with his separation from employment with us. Under the separation agreement,
Mr. Gunn was entitled to: a lump sum of $16,153.85, constituting six weeks salary; a
lump sum of $21,000, constituting 75% of a personal performance-based bonus to which he
would have been eligible for in connection with our 2006 fiscal year; continued
eligibility, at a 75% rate, for a potential earnings-based cash bonus in connection with
our 2006 fiscal year; immediate acceleration of the vesting of 50,000 stock options,
exercisable at $1.65 per share, granted on August 8, 2005, which were previously subject
to vesting at the rate of 10,000 stock options per year for five years; and continuation
of health coverage for up to twelve months. The earnings-based bonus incentive, in the
amount of $21,000, was paid in September 2006, consistent with the terms of the separation
agreement.

# ITEM 13.  EXHIBITS

Exhibits required to be filed by Item
601 of Regulation S-B are included in Exhibits to this Report as follows:

|Exhibit | Description
|------- | -----------

| | 
| | 

|3(i)(1) | Certificate of Incorporation of Cadapult Graphic Systems, Inc., a Delaware
               corporation (Incorporated by reference to Exhibit 3.1 of Quarterly Report on
               Form 10-QSB/A filed on September 1, 1998)
|------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3(i)(2) | Certificate of Amendment of Certificate of Incorporation of Cadapult Graphic
               Systems, Inc. (Incorporated by reference to Exhibit 3(i)(5) of Annual Report on
               Form 10-KSB filed on September 28, 1999)
|------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3(i)(3) | Certificate of Amendment of Certificate of Incorporation of Cadapult Graphic
               Systems, Inc. (Incorporated by reference to Exhibit 3(i)(1) of Quarterly Report
               on Form 10-QSB filed on May 15, 2002)
|------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3(i)(4) | Certificate of Designation (Incorporated by reference to Exhibit 4.5 of
               Registration Statement on Form SB-2, Registration Number 333-91005, originally
               filed on November 15, 1999)
|------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3(i)(5) | Certificate of Amendment of Certificate of Designation of Series A Preferred
               Stock (Incorporated by reference to Exhibit 3(i)(6) of Annual Report on Form
               10-KSB filed on September 15, 2003)
|------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3(i)(6) | Certificate of Amendment of Certificate of Designation of Series A Preferred
               Stock (Incorporated by reference to Exhibit 4.7 of Registration Statement on
               Form SB-2, Registration Number 333-112340, filed on January 30, 2004)
|------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3(ii) | By-Laws, as Amended (Incorporated by reference to Exhibit 3(ii) of Current
               Report on Form 8-K filed on November 14, 2005)
|----- | ----------------------------------------------------------------------------------------------------------------------------------------

|4.1 | 1998  Incentive  Plan,  as Amended  and  Restated  (Incorporated  by  reference  to  Exhibit  4.10 of
               Registration Statement on Form S-8 filed on March 22, 2006)
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.1 | Lease Agreement  (Incorporated by reference to Exhibit 10.13 of Annual Report on Form 10-KSB filed on
               or about September 28, 2000)
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------

|10.2 | Sublease Agreement (Incorporated by reference to Exhibit 10 of Current Report on Form 8-K filed on
               January 24, 2005)
|---- | -----------------------------------------------------------------------------------------------------------------------------------

|10.3 | Master Lease Agreement, July 2005 (Incorporated by reference to Exhibit 10.27 of Annual
Report on Form 10-KSB filed on September 13, 2005)
|---- | ------------------------------------------------------------------------------------------------------------------------------------------

|10.4 | Agreement with Consonant Services Group (Incorporated by reference to Exhibit 10.6 of
Registration Statement on Form SB-2, Registration Number 333-83668, filed on March 4,
2002)
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.5 | Form of Warrant Agreement with Consonant Services Group (Incorporated by reference to
Exhibit 10.11 of Registration Statement on Form SB-2, Registration Number 333-83668, filed
on March 4, 2002)
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.6 | Form of Promissory Note issued in June 2002 (Incorporated by reference to Exhibit 10.14 of
Annual Report on Form 10-KSB filed on October 15, 2002)
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------

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|10.7 | Form of Warrants issued in June 2002 (Incorporated by reference to Exhibit 10.14 of Annual
Report on Form 10-KSB filed on October 15, 2002)
|---- | -------------------------------------------------------------------------------------------------------------------------------------------

|10.8 | Common Stock Purchase Agreement, dated June 30, 2004 (Incorporated by reference to Exhibit
10.20 of Registration Statement on Form SB-2, filed on July 30, 2004)
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.9 | Registration Rights Agreement, dated June 30, 2004 (Incorporated by reference to Exhibit
10.21 of Registration Statement on Form SB-2, filed on July 30, 2004)
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.10 | Form of Amended Option Agreement with Frances Blanco (Incorporated by reference to Exhibit
10.8 of Registration Statement on Form SB-2, Registration Number 333-83668, filed on March
4, 2002)
|----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.11 | Form of Amended Option Agreement with Donald Gunn (Incorporated by reference to Exhibit
10.12 of Registration Statement on Form SB-2, Registration Number 333-83668, filed on
March 4, 2002)
|----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.12 | Form of Employment  Agreement  with Michael W. Levin  (Incorporated  by reference to Exhibit 10.16 of
               Annual Report on Form 10-KSB filed on September 15, 2003)
|----- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.13 | Form of Option Agreement with Management issued April 2003 (Incorporated by reference to
Exhibit 10.15 of Registration Statement on Form SB-2, Registration Number 333-112340,
filed on January 30, 2004)
|----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.14 | Option Agreement with Frances Blanco issued May 2004 (Incorporated by reference to Exhibit
10.16 of Registration Statement on Form SB-2, filed on July 30, 2004)
|----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.15 | Option Agreement with Lawrence Anderson, June 2005 (Incorporated by reference to Exhibit
10.28 of Annual Report on Form 10-KSB filed on September 13, 2005)
|----- | -----------------------------------------------------------------------------------------------------------------------------------------------------------

|10.16 | Option Agreement with Donald Gunn, August 2005 (Incorporated by reference to Exhibit 10.29
of Annual Report on Form 10-KSB filed on September 13, 2005)
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|10.17 | Agreement with Donald Gunn, dated March 31, 2006 (Incorporated by reference to Exhibit
10.1 of Form 8-K/A filed on April 24, 2006)
|----- | ----------------------------------------------------------------------------------------------------------------------------------

|10.18 | Loan Agreement with PNC Bank (Incorporated by reference to Exhibit 10 of Current Report on
Form 8-K filed on December 20, 2004)
|----- | -------------------------------------------------------------------------------------------------------------------------------

|10.19 | Term Note with PNC Bank, dated as of March 28, 2005 (Incorporated by reference to Exhibit
10.1 of Current Report on Form 8-K filed on April 4, 2005)
|----- | ----------------------------------------------------------------------------------------------------------------------------------------------------

|10.20 | Amendment to Loan Documents with PNC Bank, dated a of March 28, 2005 (Incorporated by
reference to Exhibit 10.2 of Current Report on Form 8-K filed on April 4, 2005)
|----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.21 | Second Amendment to Loan Documents, June 2005 (Incorporated by reference to Exhibit 10.26
of Annual Report on Form 10-KSB filed on September 13, 2005)
|----- | ------------------------------------------------------------------------------------------------------------------------------------------------------

|10.22 | Amendment to Loan Documents, dated as of January 23, 2006 (Incorporated by reference to
Exhibit 10.1 of Form 10-QSB filed on February 9, 2006)
|----- | ----------------------------------------------------------------------------------------------------------------------------------------------

|10.23 | Amendment to Loan Documents, dated as of January 23, 2006 (Incorporated by reference to
Exhibit 10.1 of Form 10-QSB filed on February 9, 2006)
|----- | ----------------------------------------------------------------------------------------------------------------------------------------------

|10.24 | Guaranty and Suretyship Agreement, dated January 23, 2006 (Incorporated by reference to
Exhibit 10.3 of Form 10-QSB filed on February 9, 2006)
|----- | ----------------------------------------------------------------------------------------------------------------------------------------------

|10.25 | Term Note with PNC Bank, dated March 17, 2006, with Security Agreement and Guarantee
(Incorporated by reference to Exhibit 10.4 of Form 10-QSB filed on May 15, 2006)
|----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|21* | Subsidiaries of the Registrant
|--- | ------------------------------

|23.1* | Consent of J.H. Cohn LLP
|----- | ------------------------

|31.1* | Certification of Chief
Executive Officer Pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)
|----- | -----------------------------------------------------------------------------------------------------

|31.2* | Certification of Chief Financial Officer Pursuant to Securities Exchange Act Rule
13a-14(a)/15d-14(a)
|----- | -----------------------------------------------------------------------------------------------------

|32.1* | Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350
|----- | ---------------------------------------------------------------------------

|32.2* | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section
1350
|----- | ---------------------------------------------------------------------------

|________*  Filed herewith. |  | 
|-------------------------- |  | 

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# ITEM 14.  PRINCIPAL
ACCOUNTANT FEES AND SERVICES

# Audit Fees

Fees for audit services provided by
J.H. Cohn LLP, our current principal independent registered public accounting firm, during
the years ended June 30, 2006 and 2005 were $118,196 and $56,105, respectively.

Audit services consisted primarily of
the annual audits, review of our interim financial statements, services provided in
connection with restatements of our financial statements, and services that are normally
provided by our accountants in connection with statutory and regulatory filings or
engagements for those fiscal years.

# Audit-Related Fees

Fees for audit-related services
provided by J.H. Cohn LLP, our current principal independent registered public accounting
firm, during the years ended June 30, 2006 and 2005 were $5,258 and $7,511, respectively.
Audit-related fees consisted primarily of the review of financial statements for inclusion
in registration statements filed by the Company.

# Tax Fees

Fees for tax services provided by
J.H. Cohn LLP, our current principal independent registered public accounting firm, during
the years ended June 30, 2006 and 2005 were $11,200 and $5,117, respectively. Tax services
related primarily to the preparation of Company tax filings with regulatory agencies.

# All Other Fees

There were no other fees billed for
services.

# Pre-Approval Policies
and Procedures

The Audit Committee has adopted a
policy that requires advance approval of all audit, audit-related, tax services, and other
services performed by the independent registered public accounting firm.  The policy
provides for pre-approval by the Audit Committee of specifically defined audit and
non-audit services.  Unless the specific service has been pre-approved with respect
to that year, the Audit Committee must approve the permitted service before the
independent registered public accounting firm is engaged to perform it.  All services
performed in our fiscal year 2006 were pre-approved.

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##### Back to Index

# SIGNATURES

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

| | MEDIA SCIENCES INTERNATIONAL, INC.
| | ----------------------------------

| | By:/s/ Michael W. Levin
      Michael W. Levin
      Chief Executive Officer and President
| | ------------------------------------------------------------------------------------------

| | Dated: September 28, 2006
| | -------------------------

In
accordance with the Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities indicated:

|SIGNATURES | TITLE | DATE
|---------- | ----- | ----

|/s/ Michael W. LevinMichael W. Levin | Chairman of the Board, Presidentand Chief Executive Officer | September 28, 2006
|------------------------------------ | ----------------------------------------------------------- | ------------------

|/s/ Kevan D. BloomgrenKevan D. Bloomgren | Chief Financial Officer | September 28, 2006
|---------------------------------------- | ----------------------- | ------------------

|/s/ Willem van RijnWillem van Rijn | Director | September 28, 2006
|---------------------------------- | -------- | ------------------

|/s/ Edwin RuzinskyEdwin Ruzinsky | Director | September 28, 2006
|-------------------------------- | -------- | ------------------

|/s/ Henry RoyerHenry Royer | Director | September 28, 2006
|-------------------------- | -------- | ------------------

|/s/ Alan L. BazaarAlan L. Bazaar | Director | September 28, 2006
|-------------------------------- | -------- | ------------------

|/s/ Dennis RidgewayDennis Ridgeway | Director | September 28, 2006
|---------------------------------- | -------- | ------------------

|/s/ Willem van RijnWillem van Rijn | Director | September 28, 2006
|---------------------------------- | -------- | ------------------

|/s/ Willem van RijnWillem van Rijn | Director | September 28, 2006
|---------------------------------- | -------- | ------------------

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