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



| | FORM 10-K | 
| | --------- | 



|x                                                        | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|-------------------------------------------------------- | ----------------------------------------------------------------------------------
|For the fiscal year ended June 30, 2008                 
|                                                         |                                                                                   
|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.                    
|------------------------------------------------------
|(Exact name of registrant as specified in its charter)



|DELAWARE                                                       |  | 87-0475073                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of
incorporation or organization) |  | (I.R.S. Employer
Identification No.)
|                                                               |  |                                     
|8 Allerman Road, Oakland, NJ                                   |  | 07436                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



Registrants telephone number, including area code:(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        |  | The NASDAQ Stock Market LLC              



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



|Common Stock, par value $0.001
|------------------------------
|(Title of class)              



|Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. | oYes | xNo
|----------------------------------------------------------------------------------------------------------------------- | ---- | ---



|Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. | oYes | xNo
|---------------------------------------------------------------------------------------------------------------------------- | ---- | ---



Indicated by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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.xYesoNo



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not 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-K or any amendment to this Form 10-K.o



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.

| | Large accelerated filero                                            | Accelerated filero        
| | ------------------------------------------------------------------- | --------------------------
| | Non-accelerated filero(Do not check if a smaller reporting company) | Smaller reporting companyx



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



The aggregate market value of voting and non-voting stock of the issuer held by non-affiliates on December 31, 2007 was $39,470,496.



As of September 23, 2008, we had 11,951,036 shares of common stock issued and outstanding.



DOCUMENTS INCORPORATED BY REFERENCE

None.








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MEDIA SCIENCES INTERNATIONAL, INC.



INDEX



|           |                                                                                                              | Page
|---------- | ------------------------------------------------------------------------------------------------------------ | ----
|           |                                                                                                              |     
|PART I    
|           |                                                                                                              |     
|Item 1.    | Business                                                                                                     | 4   
|Item 1A.   | Risk Factors                                                                                                 | 13  
|Item 1B.   | Unresolved Staff Comments                                                                                    | 30  
|Item 2.    | Properties                                                                                                   | 30  
|Item 3.    | Legal Proceedings                                                                                            | 31  
|Item 4.    | Submission of Matters to a Vote of Security Holders                                                          | 31  
|           |                                                                                                              |     
|PART II   
|           |                                                                                                              |     
|Item 5.    | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 32  
|Item 6.    | Selected Financial Data                                                                                      | 32  
|Item 7.    | Managements Discussion and Analysis of Financial Condition and Results of Operations                        | 33  
|Item 7A.   | Quantitative and Qualitative Disclosures About Market Risk                                                   | 46  
|Item 8.    | Financial Statements and Supplementary Data                                                                  | 47  
|Item 9.    | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         | 76  
|Item 9A.   | Controls and Procedures                                                                                      | 76  
|Item 9B.   | Other Information                                                                                            | 76  
|           |                                                                                                              |     
|PART III  
|           |                                                                                                              |     
|Item 10.   | Directors, Executive Officers and Corporate Governance                                                       | 77  
|Item 11.   | Executive Compensation                                                                                       | 82  
|Item 12.   | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               | 87  
|Item 13.   | Certain Relationships and Related Transactions, and Director Independence                                    | 89  
|Item 14.   | Principal Accountant Fees and Services                                                                       | 90  
|Item 15.   | Exhibits, Financial Statement Schedules                                                                      | 90  
|           |                                                                                                              |     
|Signatures |                                                                                                              | 93  





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SPECIAL NOTE REGARDING

FORWARD-LOOKING STATEMENTS



This report contains 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. | 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 market and sell our products through international, indirect sales channels including wholesalers, distributors and dealers.  Approximately 78% of our revenues are generated in the United States, with the majority of our international sales generated in Western Europe.  Our business is derived from a single segment, that of imaging supplies.



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 Organizational History



Media Sciences International, Inc. is a holding company that conducts substantially all of its operations through its subsidiaries.  Media Sciences International, Inc. has two wholly-owned operating subsidiaries:  Media Sciences, Inc. and Cadapult Graphic Systems, Inc.



Media Sciences, Inc. manufactures and markets color printer supplies, including solid ink sticks and toner cartridges for use in business color printers.  Media Sciences, Inc. itself has three wholly-owned subsidiaries including Media Sciences UK, Ltd., Media Sciences Trading, Ltd. and MSIA, LLC, which house sales, manufacturing, development and distribution operations.  Media Sciences (Dongguan) Company Limited, the Companys legal entity in China, is a wholly-owned subsidiary of Media Sciences Trading, Ltd.



Cadapult Graphic Systems, Inc. no longer has any substantial operations.  In May 2005, we discontinued all electronic pre-press systems sales and service operations, the majority of the Cadapult business.  In September 2007, we ceased the balance of Cadapults operations.



We are a Delaware corporation that was originally incorporated in Utah in 1983 under the name Communitra Energy, Inc.  In 1998, we reincorporated in Delaware under the name Cadapult Graphic Systems, Inc.  In 2002, we changed our corporate name to Media Sciences International, Inc.



Our headquarters are located at 8 Allerman Road, Oakland, New Jersey 07436, and our telephone number is 201-677-9311.  Our website is www.mediasciences.com.



Industry and Market Overview



Color Business Printer Market



Historically, the office environment has been dominated by monochrome (black and white) printers for document printing.  However, with decreasing printer prices, and increasing print speeds, quality and reliability, color printing has become increasingly common.



Color laser and solid ink printer shipments are expected to grow at a compound annual growth rate of 13% between 2006 and 2011.  Color laser and solid ink multifunction devices are expected to grow at a compound annual growth rate of 30% during the same period.  Such growth would result in an increase in the worldwide installed base of color laser and solid ink printers and multifunction devices from approximately 11 million units in 2006 to just under 30 million units in 2011, reflecting a compound annual growth rate of 35%. (source: Lyra Research, Inc., January 2008)







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Shipments of color toner cartridges are expected to experience a compound annual growth rate of 20% between 2006 and 2011, while color toner cartridges revenues are expected to double from $9.5 billion in 2006 to $20 billion in 2011.  (source: Lyra Research, Inc., January 2008)



Color Business Printer Technologies



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



Inkjet printers are typically 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 color cartridges instead of a single black cartridge.



Solid ink printers, on the other hand, utilize a very different technology from that of laser.  These printers consume solid ink sticks, again in four colors.  Solid ink sticks can be thought of as large crayons, which when placed into the printer, are melted and jetted.



While color laser printers are available from all of the major printer vendors, only Xerox has been successful in commercializing solid ink for the office environment.  As a result, roughly 95% of the color business printer market is laser based, and only 5% solid ink based.



Color Business Printer Supplies



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, the strength of their established brands and distribution often result in their product being the only option offered to a consumer.



Today, the market is robust for monochrome aftermarket cartridges.  Aftermarket cartridges are those that are manufactured by companies other than the printer manufacturer.  Approximately 27% of the monochrome cartridges currently being purchased are aftermarket cartridges.  In contrast, only 5% of the color laser cartridges being purchased are aftermarket cartridges.  (source: InfoTrends)  Lyra Research estimates that the aftermarket share of color laser cartridge shipments will increase to 10% by 2011.  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%.



An industry dynamic of note is a trend towards an increasing cost of color printing.  Over the last couple of years, the cost to print as measured by the cost of the supplies (ink, paper, maintenance kits, etc.) has been increasing.  Further, there appears to be an inverse correlation between the cost of the printer and the cost of printing.  Typically, the data suggests, the lower the cost of the printer, the higher the cost of the supplies.



Industrial Printers



Industrial printers 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.



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.





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As with the business color market, the primary source of supplies for these coders is the manufacturer of the coder itself.  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 our existing and new products.  To support our growth in an increasingly competitive environment, we plan to vertically integrate our toner based product engineering with manufacturing capability.



The overall market growth, as discussed above, is driven by the increasing adoption of color printers.  Color printer manufacturers have increased the pace of new product introductions, and the number of cartridges available for any one printer (standard capacity, high capacity, etc.)  The growth of the overall market is outside of our control.



The goal of our product development group is to increase the percentage of the color printer market for which we manufacture supplies.  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 (a line extension), the margin structure of the proposed product, the costs and time to develop the product.



A vast majority of the business color market is toner based.  And, since we already manufacture supplies for substantially the entire color solid ink installed base, we expect the growth of our color toner cartridge revenues to outpace the growth of our solid ink revenues for the foreseeable future.



Concurrent with the goal of increasing our available market, we are focused on increasing our market share for the products we manufacture.  We are doing so by seeking to develop distribution partners that typically serve larger end users and/or unique geographic territories.



In order to foster and support our growth, in what we expect to be an increasingly competitive market, we are vertically integrating our existing toner based product engineering with manufacturing that is currently outsourced (see Integrated Xerographic Design, Engineering and Manufacturing section).  We believe this initiative is critical to our growth as it should allow us to achieve a lower product cost basis, decrease our time to market and fully control all aspects of quality.



To augment our core strategy, we may consider certain acquisitions to accelerate the expansion of our development or manufacturing resources or to extend our capabilities into new imaging markets or applications.  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 millions of colors can be produced.  Media Sciences manufactures cyan, magenta, yellow and black solid inks and color toner cartridges.



We currently offer color toner cartridges and solid ink for use in nine printer brands which represent 45% of the business color printer market and 91 printer models.  Typically, our products are priced to the end user at a 25-40% discount from the printer manufacturers brand supplies.







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Solid Ink.We manufacture and distribute solid ink sticks for use in substantially all business color solid ink printers.  Our solid inks offer the end user the opportunity to save 30-40% on their solid inks purchases versus buying the Xerox® brand.  We currently offer 59 different items supporting ten different Tektronix® and Xerox color solid ink printers.



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.Our Clearcase toner cartridges are newly manufactured, not remanufactured, and offer the end user the opportunity to save up to 30% on their color toner cartridge purchases versus the OEM brand.  Our Clearcase cartridges feature a unique clear case allowing the user to see the color toner within the cartridge.  This provides both functional and aesthetic benefits to the end user.



We currently offer approximately 500 items for use in over 80 color laser printers manufactured by Tektronix, Xerox, Konica-Minolta®, Oki®, Epson®, Brother®, Dell®, Samsung® and Ricoh® .



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 for two years, all for the cost of just the supplies.



We currently offer customers a choice of three solid ink based programs: $99 per month, $165 per month and $199 per month, each for two years.  And we offer one color laser based program at $189 per month for 24 months.  Upon successful completion of the program, the printer is the customers to keep at no additional charge.



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 years of supplies.



For the year ended June 30, 2008, revenue recognized from the shipment of INKlusive supplies represented approximately 3% of our total revenues, down from 5% of revenues for the year ended June 30, 2007.  As of June 30, 2008, deferred revenue totaled $0.7 million as compared with $0.8 million as of June 30, 2007.



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 30% versus the Markem brand.



In addition to our inks for use in Markem coders, we have developed inks for two industrial printer manufacturers.  We have a supply arrangement with one of these manufacturers, whereby we supply this manufacturer for the printers it manufactures and distributes with solid ink sticks which it distributes under its own brand.  Based on projected volumes over the next 12 months, we do not expect sales under this agreement to contribute materially to our revenues or earnings.  We have not yet entered into an agreement with the second printer manufacturer, but are actively working on one.  Should this opportunity come to fruition, it could materially contribute to both our revenues and earnings.







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Branding



We sell our products under the Media Sciences brand, and in a white-box or generic form.  Currently, our revenue mix of Media Sciences branded products to white-box 70:30.  Brand development is a priority for us.  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 believe the sale of Media Sciences branded product will increase to 75% of our revenues over the next two years.



In addition to our Media Sciences and white-box packaging, we have the ability to develop private brand programs for large, national or international entities that have developed significant brand equity and wish to extend their brand to our products.



Distribution Methods of the Products and Programs



We ship products to our customers in the United States from our Oakland, New Jersey facility.  We ship products to our customers throughout Western Europe from our third party logistics provider in the Netherlands.  Approximately 78% of our sales are in the United States, with a majority of the balance of our sales in Western Europe.  We believe our international sales will represent approximately 27% of our revenues by the end of fiscal 2009.



We sell our products through a network of distributor, wholesalers and dealers.  We directly employ sales personnel in the United States and Europe.  In the United States, we also use manufacturers representative organizations in the office products channel to extend the efforts of our direct sales team.  We do not sell our products directly to end users.



Our primary goal in building our distribution channels is to have our products readily available to the end users.  Consequently, we strive to mirror the distribution points of the printer manufacturers, and add additional, unique, distribution points that serve the cost-conscious end user.



Our INKlusive program is currently available only in the United States.  The program is marketed by Media Sciences branded product dealers.  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 in addition to those automatically shipped under the program.



Sales and Marketing Plans



We believe the market share of our products is in the low single digits.  Also noted above was the fact that 27% of monochrome cartridges sold are aftermarket brands.  The primary function of our sales and marketing efforts is to increase the market share for the products we manufacture.  To do so, we seek to increase end user awareness of Media Sciences products and to support and enable our distribution partners sales of our products.



Over the last 18 months, we have substantially transformed our sales team including its leadership.  In December 2006 we recruited an experienced industry sales professional to lead our European, Middle Eastern and African sales effort.  In January 2007, we recruited a new sales leader for the Americas with substantial office products experience.  Both of these individuals come to Media Sciences with a track record of significant revenue growth under their leadership.



We have defined three primary sales channels in the United States: Imaging Supplies, Technology and Office Products.  The imaging supplies channel includes distributors and dealers whose primary business is focused on selling imaging supplies.  The technology channel includes dealers and distributors whose primary business is focused on selling hardware such as printers and computers.  The office products channel includes dealers and wholesalers whose primary business is focused on selling office supplies from file folders to pencils to furniture and beyond.  Each of these channels conducts business in a different way.  The differences include semantics, promotional programs, expectations and customer set.







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Media Sciences historical growth in the United States has been driven by the imaging supplies channel.  However, we believe that the technology and office products channels serve more than 75% of the potential market.  Further, these channels (wholesalers, dealers and end users) typically value those traits core to our products  quality, support, warranty and intellectual property compliance, more than does the imaging supplies channel, which is driven by the price sensitive internet.



We believe the most significant opportunity for revenue (and revenue growth) exists within the office products channel and secondarily in the computer channel.  To that end, we are increasing the resources that we are mobilizing within these two channels.  We are building a team of sales and marketing professionals focused on the office products and computer channels, that include account specific sales professionals for each of the major office products dealers, an office products marketing director and a nationwide network of manufacturers representatives.



In Europe, our focus is on supporting the differing needs of our partners in each country.  In Europe however, as in the United States, we expect the office products channel to be a significant channel for business color printer supplies.  In order to pursue these opportunities, we recruited a pan-European office products sales director to address the unique needs of that channel.



The efforts of our sales team are reinforced by sales incentive programs for our channel partners to reward sales volume and growth and loyalty to Media Sciences products.  Our incentive programs are based on sales through to the dealer by our partners.  In this way, we align our goals with those of our partners.



Our end user sales activities are primarily focused on Fortune 1000 companies and other large color printer installations.  These activities, executed in concert with channel partners, 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.



Our marketing efforts include advertising in trade publications, direct mail, catalog placements, Internet banners and other organic and pay per click efforts, blitz days, trade shows and more.  Some of these efforts are funded directly by Media Sciences, while other are funded by the channel partner and reimbursed through discretionary marketing funds.



Competition



Media Sciences competes primarily with the original manufacturer (the OEM) of the printers for which we provide supplies, including Xerox, Konica-Minolta, Epson, Brother, Oki, Dell, Samsung and Ricoh.  These competitors use several tactics to limit the penetration of aftermarket supplies such as those offered by Media Sciences.  These tactics include protecting their technology through the use of patents, the development of sales and marketing programs that provide for incentives to distributors, wholesalers and dealers that sell exclusively the printer manufacturers brand supplies (loyalty programs), and through campaigns intended to instill fear, uncertainty and doubt about the quality of third party supplies into the minds of the end user.  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.



We believe we have been significantly impacted by loyalty programs.  In January 2006, Xerox instituted loyalty rebate programs at the distributor and wholesaler level.  Prior to that time, Xeroxs loyalty programs were limited to dealers.  Through these programs, the distributor, wholesaler or dealer is offered substantial rebates that are contingent upon that distributor, wholesaler or dealer selling exclusively Xerox brand solid inks.



Through fiscal 2005, Media Sciences solid ink revenues were growing at a strong pace, and in fact the growth rate was increasing year over year.  In fiscal 2006, midway through which Xerox instituted its distributor loyalty rebate programs, our solid ink growth rate slowed, as it did again in fiscal 2007.  In fiscal 2008, we experienced a contraction in our US solid ink revenues.  We believe the slowing and reversal of our growth rate in the United States can be principally attributed to the Xerox loyalty rebate program.







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We believe that Xeroxs loyalty rebate programs are in violation of U.S. antitrust laws and we are litigating this point with Xerox.  Should Media Sciences prevail and the loyalty rebates be eliminated, we expect a return to strong solid ink growth in the United States.  If Media Sciences does not prevail, we could see an expansion of loyalty rebate programs by Xerox and others.



We have also seen an increase in competition from other aftermarket participants.  Aftermarket competition can be categorized as remanufactured product and new build.  A remanufactured product is produced by procuring, disassembling and cleaning used OEM cartridges, and then replacing certain parts and refilling the cartridge.  Consistent quality and source of supply are challenging to remanufacturers of color toner cartridges.



Because of the challenges associated with remanufacturing color toner cartridges, there has been an increase in other new build color cartridges in the market.  While building a new cartridge addresses the source of supply issues, quality remains a significant issue for these competitive entities as does respect for the intellectual property rights of the printer manufacturers.



We have encountered competition primarily in the imaging channel, and particularly with dealers selling through the Internet.  Internet sales, driven by pay-per-click advertising, are highly price sensitive.  Many buyers on the Internet are just looking for the best price, and not necessarily valuing quality, warranty, technical support or compliance with intellectual property laws.  Consequently our revenues derived through Internet dealers have contracted.



Media Sciences value proposition versus other aftermarket competition remains strong.  While these competitive products can be purchased less expensively than Media Sciences products, our combination of consistent high quality, intellectual property compliance backed up with indemnification for anyone who buys, sells or uses our products, strong channel support, and warranty remain unique.  While certain classes of customers will look only to price, we believe that an overwhelming majority of potential business customers, who are our target market, do and will value more than just price.



Research and Development



We define the aggregate of all business color printers sold in a trailing three year period as the installed base.  Based on Media Sciences products available for sale at June 30, 2008, we believe we manufacture supplies for use in approximately 23% of the overall installed base of business color printers.



To increase the percentage of printers in the installed base for which we manufacture supplies, we have been, and will continue to expand our development resources.  Over the last two years we increased our development staff by 150% and invested approximately $500,000 in technology in support of 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
|1stto 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.  In fiscal 2007, we invested in rapid prototyping technology to accelerate the pace of our solid ink (and toner cartridge) introductions.  The result was the fastest introduction of a solid ink product in the history of the Company, in March 2007.



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.







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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 24 months, we significantly expanded our internal xerographic engineering and design capability.  Further, through new personnel and investments in analytical technology, we have partnered with our raw color toner vendors to speed development of raw toners for new color toner applications.



Our continued planned expansion of development resources includes two key areas: chip development and toner cartridge engineering.  We plan to add personnel and supporting technology in each of these areas.  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.



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, 2008 and 2007, our research, engineering and product development costs were approximately $1.9 million and $1.7 million, respectively.



Integrated Xerographic Design, Engineering and Manufacturing



We have embarked on a significant initiative to build a fully integrated xerographic design, engineering and manufacturing capability in Asia.  The goals of this initiative are to:



|(1)   Increase our operational efficiency, particularly in the area of inventory control;                                                                                      
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2)   Decrease the costs of future color toner products, while maintaining our Companys strict Science of Color standards for quality and intellectual property respect; and
|(3)   Decrease our dependency on third parties for the manufacturing of future color toner products.                                                                           



Operational Efficiency



Our current supply chain for toner based products is approximately five months.  Because of this long supply chain, and exacerbated by large minimum per-cartridge order quantities set by our manufacturing partners, and the fact that we maintain inventory in both white box and Media Sciences branded packaging, we have significantly expanded our inventories to better ensure an in-stock position of our products.  This strategy, while meeting the needs of our customers, is not an efficient use of working capital, distribution space and leaves us more vulnerable to inventory obsolescence.



To address this issue, while increasing our ability to meet customer demand, one of the first priorities of this integrated capability is to source semi-finished versions of our cartridges from our existing partners along with toner, chips and packaging, and fill, test, package and ship product to meet the demand.



By way of illustration, a single product launch may include as many as 32 or more packaged stock keeping units (SKUs).  These 32 SKUs may actually consist of as few as seven components or assemblies plus packaging.  By keeping inventory in component form and filling, testing, packaging and shipping to meet demand, toner based inventories can be reduced by almost 50% (in days in inventory) over time, while better meeting the demands of the market.







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Decrease Product Costs



Today our toner cartridges are manufactured by contract manufacturing partners.  Inherently there is cost in our sourced cartridges that contributes to the profitability of our partners.  By moving further down the supply chain and manufacturing the cartridges ourselves, we expect to be able to recapture profits that would otherwise inure to the benefit of our vendors.



Decrease Dependency



As noted above we currently use contract manufacturing partners to manufacture our toner cartridges.  Since we are not the only customer of these entities, and in fact are a small customer to most of them, we are subject to their prioritization of our business.  Further, as we have a limited number of manufacturing partners, we risk a disruption in supply of our cartridges.  By placing cartridge manufacturing under our control, we decrease the dependency and risks of using a third party.



Status of Capability



This initiative will be implemented in phases, with the cartridge filling capability expected to be in place early calendar 2009.  In parallel, we will be building our xerographic engineering team.  As a result, we expect to start realizing some of the operational benefits in early calendar 2009 and begin realizing the other benefits, as discussed above, in fiscal 2010.



During fiscal 2008 we formed our China-based entity, secured a manufacturing facility and recruited a core team of management level individuals.  In June 2008, we completed the build-out of our facility, but held the acquisition and installation of manufacturing equipment until funding was in place.



With funding now in place, we expect to order and install the required manufacturing equipment by the end of calendar 2008, and secure our final governmental licenses and regulatory approvals in early 2009.  The benefits from this initial capability are expected to be significantly better control over our inventories resulting in a reduction in our overall days in inventory, while increasing our ability to meet changing customer needs and while reducing obsolescence risk.



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, 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.  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, and in 2008, we applied for another patent.



Dependence on Major Customers



In 2008, two customers represented 19% and 13% of our net revenues and 26% and 15%, respectively, of accounts receivable at June 30, 2008.  In 2007, these same large customers represented 17% and 14% of our net revenues and 29% and 21%, respectively, of accounts receivable at June 30, 2007.







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Principal Suppliers



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.



In 2008, two vendors represented 31% of our cost of goods sold, with no single vendor accounting for more than 18%.  In 2007, two vendors represented 24% of our cost of goods sold, with no single vendor accounting for more than 13%.



Need for Government Approval



Not applicable.



Government Regulation



Not applicable.



Compliance with Environmental Laws



Not applicable.



Employees



We currently have 67 employees, who all work on a full-time basis.





|ITEM 1A. | RISK FACTORS
|-------- | ------------



We are subject to certain risks in our business operations.  We have identified below certain 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. Careful consideration of these risks should be made before making an investment decision.  The risks and uncertainties described below are not the only ones we face.  Additional risks and uncertainties not presently known or that are currently deemed immaterial may also impair our business operations.



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.



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, Dell, Samsung, Ricoh 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.







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If we do not effectively compete with new and existing competitors, our revenues and operating margins will decline.



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.



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.







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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.



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, Dacher Transport, Roadway Express, UPS Freight, United Parcel Service, and Yellow Freight.  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 cartridges for color business 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.







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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 concentrated.  Presently, two customers account for about 32% 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.  We may be exposed to substantial costs under the product warranty.  Costs covered 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.



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 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.







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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 financial position and 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 any of our third-party financing vendors are 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.  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 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 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 as a going concern.



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.



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, complete our manufacturing operations in China, or fulfill our present or future obligations.



We have incurred net losses in each of the prior five quarters totaling $2.2 million, contributing to our $1.1 million accumulated deficit at June 30, 2008.  We believe that we may continue to incur net losses for the foreseeable future, as we expect to make continued investment in product development, and sales and marketing, and develop our China manufacturing operations in an effort to grow our business and improve its profitability.  We may find that our expansion plans are more costly than we currently anticipate and that they do not ultimately result in commensurate increases in our sales, which would further increase our losses.



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, completion of our manufacturing operations in China, 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 on desirable terms.  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.







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RISKS RELATED TO OUR INTERNATIONAL BUSINESS AND SENSITIVITY

TO 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 affect 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 might not be successful.



Net revenue outside the U.S. accounted for approximately 22% of our consolidated net revenue in fiscal 2008.  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 in 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 three non-U.S. subsidiaries, Media Sciences U.K. Limited, Media Sciences Trading Ltd. (a Bermudan entity), and Media Sciences (Dongguan) Company Limited (a Peoples Republic of China entity).  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.



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.







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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 complex new chip technologies, 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.



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 can





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provide no assurance 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 provide assurance 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 have a material adverse affect on 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 counsel, 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.



On June 23, 2006, Xerox Corporation filed a lawsuit against the Company alleging Media Sciences 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 in combination with the Xerox ink stick feed assembly. The suit seeks unspecified damages and fees.  In the Companys answer and counterclaims in this action, it denied infringement and it seeks a finding of invalidity of the Xerox patents in question.  The Company also submitted counterclaims against Xerox for breach of contract and violation of U.S. antitrust laws, seeking treble damages and recovery of legal fees.  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 financial position and results of operations.







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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 can provide no assurance that this market we serve will continue to grow.  We also can provide no assurance 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.



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.







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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 began in our first quarter of fiscal 2007 (ending September 30, 2006), we recorded 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 the  NASDAQ 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, incurliability 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.



RISKS RELATED TO 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





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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, 2007, 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.



In the future we may 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







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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, and 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, 2008, 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, adversely impact our ability to provide financial guidance, and negatively affect our results of operations, stock price and our stock price volatility.



Policies, guidelines and interpretations related to revenue recognition, accounting for acquisitions, income taxes, facilities consolidation charges, allowances for doubtful accounts, stock-based compensation and other financial reporting matters require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance and the factors associated with estimates related to these matters may be subject to a great degree of variability.  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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As an example,  Financial Accounting Standards Board issued SFAS No. 123(R), Share-Based Payment.  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 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 require 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.



If we are required to remit significant payroll taxes resulting from employee stock option exercises, it could 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.



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 limited 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.



We are subject to internal control evaluations and attestation requirements of Section404 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, 2010, and annually thereafter, our Form 10-K must include, in addition to a report of our managements assessment of the adequacy of such internal control, a report from our independent registered public accounting firm publicly attesting to the adequacy and 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.







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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 due to many factors, including, but not limited to the following:



|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 22% 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;                                                                                                                                                                                                                                                                                                                                                                                                                                            
|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.                                                                                                                                                                                                                                                                                                                                                                                                                                    
|delays or unexpected costs incurred in starting our toner-based product manufacturing operations in China.                                                                                                                                                                                                                                                                                                                                                                                                                                           







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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 $6.22 per share to a low of $1.95 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, but are not limited to the following:



|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; and                
|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.



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.



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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We may not be able to maintain our listing on the NASDAQ, which may limit the ability of our stockholders to resell their common stock in the secondary market.



Although we are currently listed on the NASDAQ, we might not meet the criteria for continued listing on the NASDAQ in the future.  If we are unable to meet the continued listing criteria of the NASDAQ and become delisted, trading of our common stock could be conducted in the Over-the-Counter Bulletin Board.  In such case, an investor would likely find it more difficult to dispose of our common stock or to obtain accurate market quotations for it.  If our common stock is delisted from the NASDAQ, it will become subject to the Securities and Exchange Commissions penny stock rules, which impose sales practice requirements on broker-dealers that sell that common stock to persons other than established customers and accredited investors. Application of this rule could make broker-dealers unable or unwilling to sell our common stock and limit the ability of
stockholders to sell their common stock in the secondary market.







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|ITEM 1B. | UNRESOLVED STAFF COMMENTS
|-------- | -------------------------



Not applicable.





|ITEM 2. | PROPERTIES
|------- | ----------



We maintain our executive offices in Oakland, New Jersey, pursuant to a lease expiring on September 30, 2009.  We hold an option to extend the expiration of this lease to September 30, 2014.  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 $0.18 million.



We maintain warehouse, manufacturing facilities, offices and dormitory facilities in Dongguan City, Peoples Republic of China pursuant to a lease expiring on November 30, 2012.



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



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                                                                                  |  | Approximate
Square Feet |  | Approximate
Annual Rent |  | Use                                                       |  | Lease
Expiration Date
|----------------------------------------------------------------------------------------- |  | ----------------------- |  | ----------------------- |  | --------------------------------------------------------- |  | ---------------------
|8 Allerman Road
Oakland, NJ  07436                                                        |  | 41,800                  |  | $300,000                |  | Executive Offices,
Warehouse, and
Manufacturing Facility  |  | September 30, 2009   
|                                                                                          |  |                         |  |                         |  |                                                           |  |                      
|40 Boroline Road
Allendale, NJ 07401                                                      |  | 15,400                  |  | $209,000                |  | Former offices,
now being sublet.                         |  | May 31, 2011         
|                                                                                          |  |                         |  |                         |  |                                                           |  |                      
|Jiaxia River
South Industry Park of Changan Town
Dongguan City
PRC                       |  | 151,342                 |  | $297,000                |  | Warehouse, Manufacturing Facility, Offices, and Dormitory |  | November 30, 2012    
|                                                                                          |  |                         |  |                         |  |                                                           |  |                      
|Suite 216
The Commercial Centrel
Picket Piece, Andover
Hampshire, SP11 6RU
United Kingdom |  | 300                     |  | $    5,000              |  | Office                                                    |  | Month-to-month       
|                                                                                          |  |                         |  |                         |  |                                                           |  |                      
|Room F7 Worth Corner
Pound Hill
Crawley
West Sussex RH10 7SL
United Kingdom               |  | 195                     |  | $    5,000              |  | Office                                                    |  | Month-to-month       
|                                                                                          |  |                         |  |                         |  |                                                           |  |                      
|No. 008, Ninth Floor
CITIC City Plaza
Shennan Road Central
Shenzhen
China                 |  | 379                     |  | $    5,000              |  | Office                                                    |  | Month-to-month       







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|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------



On June 23, 2006, Xerox Corporation filed a patent infringement lawsuit in the United States District Court, for the  Southern District of New York, Case No. 06CV4872, against Media Sciences International, Inc. and Media Sciences, Inc., alleging that the Companys 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 in combination with the Xerox ink stick feed assembly.  The suit seeks unspecified damages and fees.  In the Companys answer and counterclaims in this action, it denied infringement and it seeks a finding of invalidity of the Xerox patents in question.  The Company also submitted counterclaims against Xerox for breach of contract and violation of  U.S. antitrust laws, seeking treble damages and recovery of legal fees.  On September 14, 2007, the court denied Xeroxs motion to dismiss the
antitrust counterclaims brought by the Company.  Pre-trial discovery on the infringement action was completed in September 2007.  Pre-trial discovery on the Companys antitrust action was completed in July 2008.  Both actions, which the court has ruled will be tried together, may be heard in the summer or fall of 2009.  The loss of all or a part of this lawsuit could have a material adverse affect on our results of operations and financial position.  The Company believes that its inks do not infringe any valid U.S. patents and therefore it has meritorious grounds for success in this case.  The Company intends to vigorously defend these allegations of infringement.  There can be no assurance, however, that the Company will be successful in its defense of this action.  Proceeds of this suit, if any, will be recorded in the period when received.



In May 2005, the Company filed suit in New Jersey state court against our former insurance broker for insurance malpractice.  This litigation was settled in August 2008.  Under the settlement, Media Sciences received proceeds of $1.5 million.  Proceeds of this settlement will be recognized in our results of operations in the Companys fiscal first quarter ended September 30, 2008.



Other than the above, as at June 30, 2008, 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 REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | ------------------------------------------------------------------------------------------------------------



Market Information



Our common stock is listed on the NASDAQ stock exchange under the symbol MSII.  Prior to November 14, 2006, our common stock was 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 NASDAQ and the American Stock Exchange.



|Fiscal Year |  | Quarter Ended      |  | High  |  | Low  
|----------- |  | ------------------ |  | ----- |  | -----
|2007        |  | September 30, 2006 |  | $5.34 |  | $4.40
|            |  | December 31, 2006  |  | $6.66 |  | $5.06
|            |  | March 31, 2007     |  | $6.86 |  | $5.20
|            |  | June 30, 2007      |  | $6.42 |  | $5.00
|2008        |  | September 30, 2007 |  | $6.22 |  | $5.04
|            |  | December 31, 2007  |  | $5.95 |  | $4.01
|            |  | March 31, 2008     |  | $4.35 |  | $2.80
|            |  | June 30, 2008      |  | $3.85 |  | $1.95



Holders



On September 15, 2008, there were 277 stockholders of record of shares of our common stock.  We estimate that approximately 1,400 pesons held shares in street name as of such date.



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 preferred stock are presently outstanding.



Transfer Agent



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





|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------



Not applicable.







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|ITEM 7. | 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 8, Financial Statements and Supplementary Data in this Annual Report on Form 10-K.  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-K.



EXECUTIVE SUMMARY



Our financial position and results of operations were adversely impacted through our fiscal year by three key themes: (1) the substantial costs of pretrial discovery associated with our litigation with Xerox; (2) start-up costs of China-based manufacturing initiative; and (3) continued substantial growth of our inventories.  The impact of these is summarized below:

| | Litigation During the year we incurred $1,689,000 of expense (about $1,013,000 after tax or about $0.09 per share) associated with litigation.  Most of this expense was associated with the substantial pretrial discovery associated with our defense of a patent infringement suit filed against us by Xerox and our prosecution of antitrust claims against Xerox.  Since all pretrial discovery concluded in early July and, based on expectations that the case may not be heard until the summer or fall of 2009, we are expecting a substantial reduction in our litigation expense in the fiscal year ahead.  We estimate that our 2009 litigation spend may be about one-third that of what we spent in 2008 or about $600,000.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Business Formation and Start-up Costs During the year we recognized about $885,000 (about $531,000 after tax or about $0.05 per share) of expenses associated with formation and start-up costs associated with our manufacturing operations in China.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | Inventory Growth During the year our inventories grew by $3,414,000 from $5,802,000 to $9,216,000. Inventory growth was the largest single use of our working capital in 2008.  Toner-based product raw materials and finished goods were the primary driver of this inventory growth.                                                                                                                                                                                                                                                                                                                                                                                                                                                   



Further, our 8% year-over-year revenue growth neither met our expectations nor kept pace with our operating expense growth, exclusive of our significant litigation and business start-up costs.  These expectations and operating expense growth were significantly driven by the expansion of our sales teams in the U.S. and Europe and our increased R&D efforts.  Our overall 2008 revenue growth was attenuated by a number of factors, the most significant of which include:

|(1) | Our penetration of the office product and technology distribution channels, which was a significant initiative for 2008, has been slower than expected.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Year-over-year, on a consolidated basis, we experienced a 12% decline in solid ink revenues that we attribute primarily to Xeroxs loyalty rebate program in the U.S.  In the U.S., where Xerox has instituted loyalty rebate programs, which are the subject of our antitrust action, we experienced a decline in our solid ink revenues.  However in Europe, where these programs do not exist, we experienced continued growth in our solid ink revenues.  We also attribute a portion of our year-over-year solid ink revenue decline to the availability of a Korean solid ink product in the market.  Despite an International Trade Commission exclusion order, some of this product continues to be available in the predominately internet centric imaging channel.                                                                                                                                                                                       
|(3) | While our toner-based product revenues grew 48% year-over-year in 2008, we had expected even stronger growth.  Our toner-based product revenues were tempered by the delayed shipment of certain products, most notably Clearcase cartridges for use in Samsung 500 and related products, and by aftermarket competition on certain of our products.  These competing aftermarket products, although distinguishable from ours in terms of quality, intellectual property respect, and warranty protection, did impact our growth in 2008, particularly in the internet centric imaging channel, where price tends to be the key driver of purchase decisions.  In addition to stepping up our efforts to distinguish our products higher consistent quality, its respect for intellectual property rights, and the unmatched warranty protection that comes with our products, we did respond to this
competition with selective reductions in our selling prices.







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Subsequent Events and Actions Taken to Improve Future Operating Performance

Reduction in Force. With the
objective of getting our operating costs in-line with our present level of revenue
generation, in July 2008, we implemented a reduction in force and initiated a cost
reduction plan to realize additional operating cost savings. Collectively, we expect these
efforts to help us realize a run-rate improvement in our annual pretax operating results
of about $1,610,000 and cash flows from operations of about $1,925,000. On July 10, 2008,
we reduced our employee headcount by about 20%. Concurrent with the reduction in force, we
made stock-based compensation awards under a program to retain key employees. Retention
grants were in lieu of annual grants typically awarded in October. Stock based
compensation grants made under this program are expected to generate about $315,000 of
non-cash stock based compensation expense in fiscal 2009.

Litigation Settlement.On August 6, 2008, we signed an agreement to settle litigation with our former insurance broker.  Under the terms of the agreement, we received a one-time payment on that date of $1,500,000.  The settlement will be recorded as a reduction to operating expense during the period in which it was received, our first quarter of 2009, ending September 30, 2008.  The settlement received represents a recovery of legal fees incurred to pursue the action and a partial recovery of product warranty expense the company incurred during its fiscal 2002 year.



Plans for Operations in China and Debt Financing.We believe that establishing product manufacturing operations in China is the best long-term solution to the supply chain issues that we face with our toner-based products.  These issues include: (1) product quality consistency; (2) long order lead times and large minimum order quantities and the growth in inventory levels that result; (3) future scalability of our toner-based product business and ensuring that we are a low-cost producer of such products; and (4) elimination of the potential and real competitive threats that result from our present use of contract manufacturers.  Given the compelling economic and strategic reasons to execute our manufacturing strategy, we are committed to the execution of this strategy.

On September 24, 2008, we completed a
$1.25 million convertible debt financing with MicroCapital Fund, LP and MicroCapital Fund,
Ltd. (MicroCapital). We issued three year notes, bearing interest at 10%
payable quarterly and convertible into shares of our common stock at $1.65 per share. We
also issued (a) five year warrants to purchase 387,787 shares of our common stock at $1.65
per share, and (b) three year warrants allowing MicroCapital to repeat its investment up
to $1.25 million on substantially the same terms and conditions. The three year warrants
may be called by us if certain criteria are met. We intend to use the proceeds to fund the
capital expenditure and working capital requirements associated with our China based
manufacturing operations.

Inventory Management Initiative.Our new Chief Operating Officer, Robert Ward, who succeeded Lawrence Anderson when he retired in late July 2008, has developed a multi-faceted plan to better manage our toner-based product inventories and supply chain.  Preliminary modeling suggests that the plan could yield a $2,000,000 reduction in inventories over fiscal 2009.  The plan, although not dependent upon execution of our plans for China, is expected to produce a more rapid achievement of the inventory level reduction we seek as a result of our plant in China becoming operational.  The plan integrates detailed SKU level sales forecasting, which was recently implemented, with statistical modeling that accounts for demand variability based on historic order volatility.  Other elements of the plan include a reduction in minimum order quantities through our providing vendors with rolling
forecasts of our production needs and the adoption of quality assurance and control processes at the vendor or closer to the production.



Analysis of 2008 and 2007 Results of Operation



The following items significantly impacted our reported results of operations in 2008 and 2007.  Collectively, these items reduced our reported gross profits by $134,000, pretax income by $3,183,000, net income by about $1,927,000 and earnings per share by about $0.17, fully diluted.



Litigation.During the year ended June 30, 2008, we incurred $1,689,000 of expense (about $1,013,000 after tax or about $0.09 per share) associated with litigation we have pending against our former insurance broker and in defense of a patent infringement suit brought by Xerox.  In August 2008, subsequent to our fiscal year end, we







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settled the matters with our former insurance broker in the amount of $1,500,000 (see Commitments, Litigation and Contingencies Note 5).  During the first quarter of fiscal 2008, we completed pretrial discovery associated with the defense of the Xerox patent infringement litigation.  During our fiscal third and fourth quarter of 2008, we completed the majority of pretrial discovery associated with the antitrust claims we are pursuing against Xerox.  In the comparative period, the year ended June 30, 2007, our costs of litigation totaled $1,182,000 (about $710,000 after tax or about $0.06 per share).  For more information regarding our litigation, see Note 5 to the Consolidated Financial Statements.  We estimate that our 2009 litigation spend may be about one-third that of what we spent in 2008 or about $600,000.



While each case is, in and of itself, non-recurring in nature, we may from time to time become involved in legal proceedings due to the nature of our business and our competitive environment.  The resulting unpredictability of our legal expenses may contribute to future volatility in our earnings, as it did in 2008 and 2007.



Business Formation and Start-up Costs.During the year ended June 30, 2008, we recognized about $885,000 of expenses associated with formation and start-up costs associated with our manufacturing operations in China.  These costs reduced our fiscal 2008 reported net income by about $531,000 or about $0.05 per share.  In the comparative period, the year ended June 30, 2007, we recognized about $81,000 (about $49,000 after tax or about $0.004 per share) of expenses associated with formation and start-up costs associated with our manufacturing operations in China.



SFAS No. 123(R) Non-cash Expense.Our operating results for the year ended June 30, 2008 include $475,000 of pretax non-cash stock-based compensation expense ($303,000 after tax or about $0.03 per share).  In the comparative period, the year ended June 30, 2007, we recognized $483,000 of pretax non-cash stock-based compensation expense ($307,000 after tax or about $0.03 per share).



Inventory Reserves.During the year ended June 30, 2008, we increased our inventory obsolescence reserves by $134,000.  This non-cash charge increased our cost of goods sold and reduced our reported gross profit by $134,000, reducing our reported gross margin by about 55 basis points.  This charge reduced our reported net income by about $83,000 or about $0.01 per share.  In the comparative period, the year ended June 30, 2007, we increased our inventory obsolescence reserves by $331,000, reduced our reported gross profit by the same amount, our reported gross margin by about 150 basis points, and reported net income by about $199,000 or about $0.02 per share.  For both periods, these additional reserves were primarily related to inventories of our older and slower-moving toner-based products.



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.  The above referenced litigation, business start-up and non-cash expenses are included in the summary information present below (in thousands, except per share data).



|            |                          | 1st     |         | 2nd     |         | 3rd     |         | 4th     |          | Full
|----------- | ------------------------ | ------- | ------- | ------- | ------- | ------- | ------- | ------- | -------- | ----
|Fiscal 2008 |                          | Quarter |         | Quarter |         | Quarter |         | Quarter |          | Year
|            | Net revenues             |         | $6,431  |         | $5,685  |         | $6,474  |         | $5,647   |     
|            | Cost of goods sold       |         | $3,486  |         | $3,083  |         | $3,409  |         | $3,156   |     
|            | Gross profit             |         | $2,945  |         | $2,602  |         | $3,065  |         | $2,491   |     
|            | Gross margin             |         | 45.8%   |         | 45.8%   |         | 47.4%   |         | 44.1%    |     
|            | (Loss) from operations   |         | $(334)  |         | $(839)  |         | $(791)  |         | $(1,080) |     
|            | Operating margin         |         | (5.2)%  |         | (14.8)% |         | (12.2)% |         | (19.1)%  |     
|            | Net (loss)               |         | $(187)  |         | $(485)  |         | $(488)  |         | $(664)   |     
|            | Diluted (loss) per share |         | $(0.02) |         | $(0.04) |         | $(0.04) |         | $(0.06)  |     







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|            |                                   |         | 1st    |         | 2nd    |         | 3rd    |         | 4th     |      | Full   
|----------- | --------------------------------- | ------- | ------ | ------- | ------ | ------- | ------ | ------- | ------- | ---- | -------
|Fiscal 2007 |                                   | Quarter |        | Quarter |        | Quarter |        | Quarter |         | Year
|            | Net revenues                      |         | $5,625 |         | $6,078 |         | $5,306 |         | $5,509  |      | $22,517
|            | Cost of goods sold                |         | $2,515 |         | $2,533 |         | $2,395 |         | $2,885  |      | $10,327
|            | Gross profit                      |         | $3,110 |         | $3,545 |         | $2,911 |         | $2, 624 |      | $12,190
|            | Gross margin                      |         | 55.3%  |         | 58.3%  |         | 54.9%  |         | 47.6%   |      | 54.1%  
|            | Income (loss) from operations     |         | $788   |         | $937   |         | $19    |         | $(753)  |      | $990   
|            | Operating margin                  |         | 14.0%  |         | 15.4%  |         | 0.4%   |         | (13.7)% |      | 4.4%   
|            | Net income (loss)                 |         | $542   |         | $625   |         | $26    |         | $(417)  |      | $777   
|            | Diluted earnings (loss) per share |         | $0.05  |         | $0.05  |         | $0.00  |         | $(0.04) |      | $0.07  





RESULTS OF OPERATIONS



Net Revenues.In fiscal 2008, consolidated net revenues increased by $1,721,000 or 8% to $24,238,000, from $22,517,000 in fiscal 2007.  Sales of color toner cartridges increased by about 48% over fiscal 2007 while sales of solid ink sticks contracted by about 12%.  Direct sales of supplies, through our Cadapult subsidiary, decreased by approximately 85% as we terminated direct sales of supplies to end users and focused on building sales through our indirect distribution channels.  In fiscal 2007, consolidated net revenues increased by $1,244,000, or 6% to $22,517,000.  2007 sales of color toner cartridges increased by about 26% over 2006 while sales of solid ink sticks increased by approximately 2%.



During our fiscal fourth quarter ended June 30, 2008, we introduced several new toner-based products, which were well received by the market.  As a result, we ended the 2008 year with $200,000 of products on backorder.  Since we do not recognize revenues until orders are filled and shipped, revenues associated with these primarily new products were not recognized in the year ended June 30, 2008.  For the comparative period, we had $140,000 of products on backorder at June 30, 2007.



Overall, our net revenue growth in both fiscal 2008 and 2007 was driven primarily by sales from new products introduced to the market over the last 18 months, and to a lesser extent, an increase in market share for some of our existing products, and in general continued growth of the installed base of color business printers that consume products we manufacture.  During fiscal 2008 and 2007, the mix of both solid ink and toner-based products shifted from older models to newer models and reflected the introduction of a number of new products that were predominately toner-based.  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 fiscal 2008.  In June and July 2007, we began shipping  toner cartridges for use in most of the following products: Xerox Phaser 6360, Dell 5110 and Ricoh Aficio CL-2000/3000/3500 business color printers.  After initial delays due to problems with a contract manufacturing partner, cartridges for use in the Samsung CLP-500, 510 and 550 began shipping in volumes in January 2008.  Also in January 2008, we launched two new products: toner cartridges for use in Samsung CLP-300/CLX-3160/CLX-2160; and Xerox Phaser 6110/6110MFP business color printers.  We began shipping limited quantities of these products in December 2007.  In May 2008, we launched and began shipping toner cartridges for use in OKI C5500, C5600, C5700, C5800, C5900, C6100, and C5550MFP business color printers.



We expect the sales growth of color toner-based product to continue to outpace that of color solid ink products into fiscal 2009.  Currently, we offer products for a fraction of the toner-based color laser market.  According to industry data, provided by Lyra Research, the market for toner-based color business printer consumables is about twenty-five times larger than that of the color solid ink segment.  Our business strategy and development efforts recognize and are aligned with the greater market opportunity that the toner-based product segment of the market represents.  Accordingly, we expect our toner-based product sales growth to continue to outpace that of our solid ink products for the foreseeable future.  Media Sciences currently manufactures solid ink for use in almost all available color business solid ink printers.  As a result, until new solid ink printers are brought to market, we will continue
to have fewer solid ink development opportunities.  Outside the color business segment, we continue to formulate solid inks for our growing industrial marking business.







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Cost of Goods Sold



Cost of goods sold, excluding depreciation and amortization, product warranty, and shipping and freight In fiscal 2008, our cost of goods sold, excluding depreciation and amortization, product warranty, and shipping and freight costs, increased by $2,665,000 or 31% to $11,159,000 (46% of net revenues) from $8,494,000 (38% of revenues) in the prior fiscal year ended June 30, 2007.  About 45% or about $1,200,000, of the total 800 basis point decrease in margins is attributable to shifts in our product sales mix from a greater proportion of solid ink products to a greater proportion of toner-based products, which typically carry lower gross margins.  The remaining 55% or about $1,500,000, of the total 800 basis point decrease in margins is attributable to a combination of lower effective average selling prices, higher year-over-year production and shipping costs, and sales mix
shifts among our toner-based products.  Year-over-year, we have generally reduced our average selling prices to the office products and technology channels and reduced prices on some less differentiated products to address competitive offerings.   Some notable areas of increased costs include:  (1) raw materials; packaging and freight; (2) labor and supplies associated with custom labeling for certain new private label customers; (3) additional quality assurance labor associated with the growth of our toner-based product volumes; and (4) domestic personnel to fill and package toner-based products for sale to U.S. military and governmental entities.



Between fiscal 2006 and 2007, we achieved a $42,000 or 0.5% decrease in our cost of goods sold, exclusive of depreciation and amortization, product warranty, and shipping and freight, despite a 6% increase in net revenues.  This decrease is attributed to a transition in our toner-based product line from very low margin versions of cartridges to higher margin cartridges, and to year-over-year yield improvements in our solid ink manufacturing.  These favorable reductions in cost of goods sold were partially offset by $304,000 of charges taken through the year to increase our reserves for inventory obsolescence, as well as increased prices of certain raw materials and their associated shipping costs.



Depreciation and amortization Depreciation and amortization associated with our manufacturing decreased by $44,000 or 7% in fiscal 2008 over 2007.  These same costs increased by $88,000 or 17% in fiscal 2007 over 2006.  These year-over-year changes are primarily driven by retirements or additions to our installed base of tool and die assets.  These tool and die assets, which are used to create toner cartridges, are amortized over an average estimated useful life of three years.  During the year ended June 30, 2008, we invested $713,000 in various property and equipment that will be depreciated and amortized over useful lives of three to seven years.  During the preceding year ended June 30, 2007, we invested $1,108,000 in similar assets having comparable useful lives.  Most of these capital expenditures were associated with our manufacturing operations.  The depreciation and
amortization generated by these manufacturing assets is classified as a component of cost of goods sold.  Depreciation and amortization related to assets employed in our research and development activities is classified as a component of research and development expense.  All other depreciation and amortization is classified as a component of selling, general and administrative expense



Product warranty Product warranty costs represented 3.6% of fiscal 2008 net revenues, up slightly from the 3.2% level we experienced in 2007.  These ratios were significantly improved from the 4.1% and 6.2% of net revenues product warranty expense represented in our fiscal 2006 and 2005, respectively.  We believe that our substantial investments made in plant and equipment, including laboratory equipment, quality control processes and personnel, have been and will continue to be reflected in improved product quality and fewer warranty claims.  In fiscal 2009 and 2010, we expect to realize some further, though much more moderate, declines in our product warranty costs.



Shipping and freight Outbound shipping and freight cost to customers increased by $32,000 or 6% in fiscal 2008 over 2007, remaining stable at 2.2% of net revenues.  Despite noticeable year-over-year increases in the costs of shipping and freight, we were able to effectively manage this cost during 2008.  In fiscal  over 2006, shipping and freight cost to customers decreased by $23,000 or 4%.  In fiscal 2009, we do not expect to realize significant improvements in our ratio of shipping and freight costs to net revenues.  Further increases in transportation costs may actually result in increases to these costs unless we can successfully offset or pass along such costs.



Gross Profit.2008 consolidated gross profit decreased by $1,086,000 or 9% to $11,104,000 from $12,190,000 in 2007.  In fiscal 2008, our gross margin was 46% of net revenues as compared with 54% of net revenues in 2007.







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About 45% of this 800 basis point decrease in margins is attributable to shifts in our product sales mix from a greater proportion of solid ink products to a greater proportion of toner-based products, which typically carry lower gross margins.  The remaining 55% of the 800 basis point decrease in margins is attributable to a combination of lower effective average selling prices, higher year-over-year production and shipping costs, and sales mix shifts among our toner-based products.  Year-over-year, we have generally reduced our average selling prices to the office products and technology channels and reduced prices on some less differentiated products to address competitive offerings.  Some notable areas of increased costs include:  (1) raw materials; packaging and freight;(2) labor and supplies associated with custom labeling for certain new private label customers; (3) additional quality assurance labor
associated with the growth of our toner-based product volumes; and (4) domestic personnel to fill and package toner-based products for sale to U.S. military and governmental entities.



2007 consolidated gross profit increased by $1,369,000 or 13% to $12,190,000 from $10,821,000 in fiscal 2006.  In fiscal 2007, our gross margin was 54% of net revenues as compared with 51% of net revenues in 2006.  This 320 basis point increase in margin is attributed to the following: (1) our transition from lower to higher margin versions of cartridges; (2) some solid ink margin enhancements resulting from manufacturing yield improvements put in-place during the preceding fiscal year; (3) a decline in revenues in our Cadapult subsidiary, which typically carry lower margins; (4) a reduction in our product warranty costs; (5) and slightly lower outbound shipping and freight costs.  These improvements to our margins were partially offset by charges taken through the year to increase our reserves for inventory obsolescence and certain increases in our raw material costs and higher manufacturing depreciation and
amortization costs.



As in fiscal 2008, changes in our gross margins in fiscal 2009 will be a function of the significance of shifts we may experience in our solid ink versus toner-based product sales mix.  Fiscal 2009 gross margins will also be affected by the incremental impact of new products we may launch in the fiscal year and the extent of their success, measured in unit volumes.  We have in development several color toner-based products which if launched are expected to carry margins that are lower than our overall gross margins in fiscal 2008.  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 fiscal 2009 may reflect some erosion.  Increases in raw material or inbound shipping costs may also decrease our margins unless they can be offset by manufacturing efficiencies.  Further, competitive
pressures in the markets for our products may also adversely impact our margins as we may need to respond with reductions in our product ASPs to maintain market share.



Research and Development.In fiscal 2008, research and development spending increased by $114,000 or 7% over 2007.  In fiscal 2007 over 2006, research and development spending increased by $653,000 or 60%.  These increases in both years were driven by our initiatives to increase product breadth through the development and launch of new products.  The increases in our research and development spending were broad-based.  During fiscal 2007, 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 2009, we expect our research and development spending to remain at a similar to slightly lower percentage of net revenues.



Selling, General and Administrative.In fiscal 2008, selling, general and administrative expense, exclusive of depreciation and amortization, increased by $2,768,000 or 30% over 2007.  This increase was primarily driven by: (1) the $885,000 of costs associated with the start-up activities for our operations in China; (2) about $747,000 of additional compensation, benefit, travel and entertainment costs resulting from the expansion of our Sales teams; (3) about $507,000 of greater year-over-year litigation costs; (4) about $378,000 of greater compensation and benefit costs primarily related to our technical support and information technology operations; and (5) a $150,000 increase in our advertising and marketing spending.



In fiscal 2007, selling, general and administrative expense, inclusive of depreciation and amortization, increased by $2,908,000 or 47% over 2006.  The increase in selling, general and administrative expense in fiscal 2007 was primarily driven by the $1,182,000 of costs associated with litigation pretrial activity, about $328,000 of stock-based compensation expense resulting from the adoption of SFAS No. 123(R), and the remainder mostly attributed to greater sales and marketing compensation and benefits costs, including non-recurring severance costs associated with our sales reorganization.







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Depreciation and Amortization.In fiscal 2008, non-manufacturing and non-research and development depreciation and amortization expense increased by $65,000 or 21% over 2007.  The increase is attributed to leasehold improvements, information technology and furniture and fixture additions.  In fiscal 2007, non-manufacturing and non-research and development depreciation and amortization expense increased by $87,000 or 39% over 2006.  Both increases are attributed to leasehold improvements, information technology and furniture and fixture additions, driven by staff additions and upgrades to our information technology infrastructure.  In fiscal 2009, we expect selling, general and administrative depreciation and amortization to increase over 2008 levels, however, at a much slower pace.



Interest Expense, Net.In fiscal 2008, we had net interest expense of $93,000 versus net interest income of $61,000 in 2007.  This compares with $55,000 of net interest expense in fiscal 2006.  The year-over-year changes in net interest income and expense are due to variations in our level of borrowing and the level of our cash balances available for investment.



Income Taxes.For the year ended June 30, 2008, we recorded an income tax benefit of $1,312,000 as compared with an income tax provision of $274,000 for the year ended June 30, 2007.  For the years ended June 30, 2008 and 2007, our effective tax rate was 42% and 26%, 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.



We believe that it is more likely than not that the net remaining deferred tax assets of approximately $1,033,000 at June 30, 2008 will be realized, based primarily upon forecasted taxable income and to a lesser degree upon tax planning strategies.  Although the Company has experienced operating losses in the past year, we anticipate operating profits and taxable income in fiscal 2009 and thereafter, resulting from our July 2008 reduction-in-force, our cost reduction initiatives, and the realization of the $1,500,000 litigation settlement we received in August 2008.  The minimum annual taxable income required to realize the deferred tax assets over the 20-year net operating loss carry-forward period is approximately $125,000.



Net Income.For the year ended June 30, 2008, we lost $1,824,000 from operations or $0.16 per share basic and fully diluted, as compared to the year ended June 30, 2007, where we earned $777,000 or $0.07 per share basic and fully diluted.  As discussed in the Executive Summary, our fiscal 2008 results were adversely impacted by four items that collectively reduced our reported net income by about $1,927,000, or about $0.17 per share on a fully diluted basis.



LIQUIDITY AND CAPITAL RESOURCES



During the year ended June 30, 2008, our cash and equivalents decreased by $1,572,000 to $237,000.  $3,258,000 of this decrease resulted from operating activities and $713,000 occurred as a result of investing activities.  These decreases were partially offset by $2,384,000 of cash provided from financing activities, mostly proceeds received from borrowings under our credit facility.  Cash used in investing activities included the purchase of equipment, tooling and leasehold improvements in the amount of $713,000, representing a decrease of $395,000 or 36% from the comparable investment of $1,108,000 for the year ended June 30, 2007.



We used $3,258,000 of cash from operating activities for the year ended June 30, 2008 as compared with positive cash flows from operations of $839,000 for the year ended June 30, 2007.  The $3,258,000 of cash used by operating activities for the year ended June 30, 2008 resulted from a $1,824,000 loss from operations, add-back of net non-cash charges totaling $382,000, and $1,815,000 of cash used primarily to increase our  non-cash working capital (current assets less cash and cash equivalents net of current liabilities).  The most significant driver behind the $1,815,000 increase in our non-cash working capital was the $3,414,000 increase in our inventories.







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During the year ended June 30, 2008, our inventory levels, inclusive of inventory reserve changes, increased by $3,414,000 or about 59% to $9,216,000 from $5,802,000.  The increase in raw materials and finished goods inventories was partially due to new product introductions and those we are preparing to launch.  Lead times associated with manufacturing our toner-based products, which are as long as five months, combined with large minimum order quantities, also have a significant impact on our inventory levels.  During the last three fiscal quarters, much of our inventory growth was attributed to purchase orders placed in each of the preceding two fiscal quarters of 2008.  Our inventory levels can change significantly depending on sales activity during a given period and the timing of  receipt of inventories under such long lead time purchase commitments.  When our manufacturing operations in China become
operational, we expect to meaningfully reduce both our replenishment lead times and our minimum order quantities.  Until then, we will continue to bear some volatility in our working capital demands resulting from these factors.

On September 24, 2008, we completed a
$1.25 million convertible debt financing with MicroCapital Fund, LP and MicroCapital Fund,
Ltd. (MicroCapital). We issued three year notes, bearing interest at 10%
payable quarterly and convertible into shares of our common stock at $1.65 per share. We
also issued (a) five year warrants allowing MicroCapital to purchase 387,787
shares of our common stock at $1.65 per share, and (b) three year warrants allowing
MicroCapital to repeat its investment up to $1.25 million on substantially the same terms
and conditions. The three year warrants may be called by us if certain criteria are met.
We intend to use the proceeds to fund the capital expenditure and working capital
requirements associated with our China based manufacturing operations.

Our INKlusive program generates 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, 2008, deferred revenue associated with the program totaled $668,000, a $176,000 or 21% decrease over the June 30, 2007 balance of $844,000.  This decrease in the deferred revenue obligation represented a $176,000 use of cash from operating activities in our consolidated statements of cash flows in 2008, as compared with a $293,000 use of cash in 2007.



Fiscal 2007 cash flows from operating activities were $839,000, resulting from $777,000 of income from operations and add-back of net non-cash charges totaling $2,013,000, deduction of $408,000 associated with excess tax benefits from stock-based compensation, and $1,543,000 of cash used primarily to increase our non-cash working capital (current assets less cash and cash equivalents net of current liabilities).  During the year ended June 30, 2007, our inventory levels, inclusive of inventory reserve changes, increased by $1,347,000 or about 30% to $5,802,000 from $4,455,000.  The increase in inventories was generally due to the building of inventories associated with new product introductions and those we were preparing to launch.  The cash we used in investing activities for the year ended June 30, 2007 included the purchase of equipment, tooling and leasehold improvements in the amount of $1,108,000, a
decrease of $218,000 or 16% from the comparable spend of $1,326,000 in fiscal 2006



Prior to February 12, 2008, we had a revolving line of credit facility which provided for maximum borrowings of $3,000,000.  This line was replaced on February 12, 2008, when we entered into an agreement with Sovereign Bank for a three year revolving line of credit for up to $8,000,000.  As amended, the advance limit under the line of credit is the lesser of: (a) $8,000,000; or (b) up to 80% of eligible accounts receivable plus up to the lesser of: (i) $3,000,000; or (ii) 50% of eligible inventory; or (iii) 60% of the maximum amount available to be advanced under the line.  The line of credit is collateralized by a first priority security interest in substantially all of our U.S. based assets.  Proceeds were drawn down under this line to repay all revolving and term debt extended by our former bank.  On May 14, 2008, we entered into an amendment to the loan agreement that amended the range of interest rates
applicable to our borrowings.  As amended, under a prime rate option, the interest rate can vary from the banks prime rate to its prime rate plus 1%, and, under a LIBOR rate option, the interest rate can vary from LIBOR plus 225 basis points to LIBOR plus 275 basis points.  Both the term note and the line of credit bear interest at the banks Prime Rate plus 1% (6.0% at June 30, 2008) and require payments of interest only through the facilities three year term.



The revolving loan may be converted into one or more term notes upon mutual agreement of the parties. On February 12, 2008, we entered into a non-amortizing term note with the bank in the amount of $1,500,000, due February 12, 2011.  At June 30, 2008, this note had a principal balance of $1,500,000.  As of June 30, 2008, we had an outstanding balance of $1,094,209 under the revolving line.  The applicable interest rate on the revolving and term loans extended under the agreement varies based upon certain financial criteria.







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In the year ago period and at June 30, 2007, we had a revolving line of credit facility which provided for maximum borrowings of $3,000,000.  At June 30, 2007, we had no outstanding balance under this line.  At June 30, 2007, we had $471,083, respectively, outstanding to our former bank under two term notes.  These notes bore interest at rates greater than our present lending facility.  These term notes were repaid in full on February 12, 2008.



We have been subject to financial covenants in our current and former credit facilities. Our current financial covenants include monitoring a ratio of debt to tangible net worth and a fixed charge coverage ratio, as defined in the loan agreements. At June 30, 2007, we were in compliance with our financial covenants. At June 30, 2008, we were not in compliance with our financial covenants, which were waived by the bank via an amendment dated September 22, 2008.  As a result of a cross default and collateralization provision associated with our former debt facility, we agreed to refinance certain operating leases held by an affiliate of our former bank.  Under terms of a separate waiver and amendment with this leasing affiliate, we received an extension of time to refinance or payoff the lease obligation until March 31, 2009.  At June 30, 2008, the remaining obligation under the agreement was approximately
$567,000.  Under the terms of this amendment, we agreed to make six lease payments of $50,000 per month between October 2008 and March 2009 and refinance or otherwise payoff any remaining balance on or before March 31, 2009.  Upon full satisfaction of this obligation we will obtain title to the leased equipment.  Based on the amended lease terms, which include an agreed upon interest charge of prime plus 2.5% per annum, the remaining balance at March 31, 2009 would be approximately $245,000.  This obligation may be refinanced or otherwise prepaid at anytime without penalty.  The future minimum lease payments schedule, found in Note 5, reflects the amended terms of this lease obligation.



SOME SIGNIFICANT FACTORS AFFECTING FUTURE LIQUIDITY



Reduction in Force.With the objective of getting our operating costs in-line with our present level of revenue generation, in July 2008, we implemented a reduction in force and initiated a cost reduction plan to realize additional operating cost savings.  Collectively, we expect these efforts to help us realize a run-rate improvement in our annual pretax operating results of about $1,610,000.  On July 10, 2008, we executed the reduction in force, reducing our employee headcount by about 20%.  Concurrent with the reduction in force, we made stock-based compensation awards under a program to retain key employees.  Retention grants were in lieu of annual grants typically awarded in October.  Stock based compensation grants made under this program are expected to generate about $315,000 of non-cash stock based compensation expense in fiscal 2009.



Litigation Settlement.On August 6, 2008, we signed an agreement to settle litigation with our former insurance broker.  Under the terms of the agreement, we received a one-time payment on that date of $1,500,000.  The settlement will be recorded as a reduction to operating expense during the period in which it was received; our fiscal first quarter of 2009, ending September 30, 2008.  The settlement received represents a recovery of legal fees incurred to pursue the action and a partial recovery of product warranty expense incurred during its fiscal 2002 year.



Completion of Pretrial Discovery  Xerox Litigation.In July 2008, we completed all pretrial discovery in the litigation with Xerox.  This litigation includes both the patent infringement action, which we are defending, and our antitrust action against Xerox.  For more information regarding our litigation, see Note 5 to the Consolidated Financial Statements.  During the year ended June 30, 2008 and 2007, we incurred $1,689,000 and $1,182,000 pretax, respectively, for litigation costs, including its litigation with Xerox.  The litigation with Xerox is not expected to be tried until the summer or fall of 2009.  Accordingly, given the settlement of litigation with our former insurance broker and the completion of pretrial discovery in our litigation with Xerox, we expect a significant reduction in our litigation spending in fiscal 2009.



Inventory Management Initiative.Our new Chief Operating Officer, Robert Ward, who succeeded Lawrence Anderson when he retired in late July 2008, has developed a multi-faceted plan to better manage our toner-based product inventories and supply chain.  Preliminary modeling suggests that the plan could yield a $2,000,000 reduction in our inventories over 2009.  The plan, although not dependent upon execution of our plans for China, is expected to produce a more rapid achievement of the inventory level reduction we seek as a result of our plant in China becoming operational.  The plan integrates detailed SKU level sales forecasting, which was recently implemented, with statistical modeling that accounts for demand variability based on historic order volatility.  Other elements of the plan include a reduction in minimum order quantities through our providing vendors with rolling
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to the production.  Although management expects this initiative will be successful in reducing our inventory levels, whereby generating cash from operations, we can provide no assurance that these efforts, if successful, will realize the level of inventory reductions sought.

Business Formation and Start-up
Costs. During the year ended June 30, 2008, we recognized about $885,000 of expenses
associated with formation and start-up costs associated with our manufacturing operations
in China; about $376,000 of this cost was incurred in our last fiscal quarter ended June
30, 2008. On a quarterly basis, we expect to incur costs similar to those incurred in our
fiscal fourth quarter of 2008 related to the start-up and ongoing activities of our China
based manufacturing operations. Establishing and running our ongoing manufacturing
activities in China could be more costly and take longer than we presently anticipate.

FUTURE FINANCING REQUIREMENTS



Over the next twelve months, our operations may require additional funds and may seek to raise such additional funds through public or private sales of debt or equity securities, or securities convertible or exchangeable into such securities, strategic relationships, bank debt, lease financing arrangements, or other available means.  We cannot provide assurance that additional funding, if sought, will be available or, if available, will be on acceptable terms to meet our business needs.  If additional funds are raised through the issuance of equity securities, stockholders may experience dilution, or such equity securities may have rights, preferences, or privileges senior to those of the holders of our common stock.  If additional funds are raised through debt financing, the debt financing may involve significant cash payment obligations and financial or operational covenants that may restrict our ability to
operate our business.  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.



CAPITAL EXPENDITURES



We plan on various capital expenditures over the next twelve months of approximately $1,500,000, inclusive of approximate $750,000 budgeted for start-up manufacturing operations in China.  These capital expenditures 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/or increase productivity.  We plan to finance these expenditures from one or more of the following: existing cash, cash generated by operations, use of operating leases, debt financing, and/or equity funding.



SEASONALITY



Historically, we have not experienced 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 AND ESTIMATES



Use of Estimates

The 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.







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Revenue Recognition

Revenue is recognized at the point of shipment and transfer of title for goods sold, 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 recognize 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.



The INKlusive program is a multi-element program.  We recognize revenue under this program in accordance with the provisions of EITF 00-21.  Under those provisions, revenue is recognized for the printer upon shipment to the customers, while revenue for the supplies and services associated with the program are recognized equally over the contract term in proportion to product shipments.



We are not exposed to the credit risk of any individual customer in the INKlusive program.



Accounts Receivable and Allowance for Doubtful Accounts

We 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 aging of customer balances and specific account reviews by management.  For non-U.S. trade receivables and certain U.S. trade receivables, we maintain credit insurance.  Most U.S. trade receivables are not covered under this credit insurance.  We maintain an allowance for potential credit losses based upon expected collectability of its uninsured accounts receivable.  We have no significant concentrations of credit risks and generally do not require collateral or other security from our customers.



Inventories and Inventory Reserves

Inventories, 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.  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.



Warranty

We 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







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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 Litigation

We are named from time to time as a party to various legal proceedings.  While we currently believe the ultimate outcome of these proceedings, based on their merit, will not have a material adverse effect on our financial position, the results of complex legal proceedings are difficult to predict.



Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting Standards 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.  In projecting future taxable income, for the purpose of evaluating the need for a valuation allowance associated with its deferred tax assets, we consider all evidence, both positive and negative; whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.  To the extent that our deferred tax assets require valuation allowances in
the future, the recording of such valuation allowances, would result in an increase to our tax provision in the period in which we determine that such a valuation allowance is required.



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 forecasted 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 quarterly basis.  If actual results differ from these estimates, this could have a material effect on our financial condition and results of operations.



In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations.  As a result of the implementation of FIN 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, we recognize liabilities for uncertain tax positions based on the two-step process prescribed within the interpretation.  The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any.  The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.  We reevaluate these uncertain tax positions on a quarterly basis.  This evaluation is based
on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity.  Any change in these factors could result in the recognition of a tax benefit or an additional charge to the tax provision.



We adopted FIN 48 on July 1, 2007.  See Note 7, Income Taxes to the Consolidated Financial Statements for a detailed description.



Goodwill and Impairment

The 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.







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We have remaining net goodwill and net acquired intangible assets of approximately $3.58 million at June 30, 2008 and 2007.  This goodwill resulted from the acquisition of substantially all of the assets of ultraHue, Inc. in 1999.  We test goodwill for impairment at the reporting unit level.  We have determined that we have only one reporting unit.  Based on the impairment review performed during the first quarter of fiscal 2009, there was no impairment of goodwill in fiscal 2008.



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 May 2008, the Financial Accounting Standards Board (FASB) issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles.  This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States. The Company does not expect that this Statement will result in a change in any of its current accounting practices.



In April 2008, the FASB adopted FASB Staff Position SFAS No. 142-3, Determination of the Useful Life of Intangible Assets, amending the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. This FASB Staff Position is effective for intangible assets acquired on or after July 1, 2009. The Company is currently evaluating the impact of the implementation of FASB Staff Position SFAS No. 142-3 on the Companys consolidated financial position, results of operations and cash flows.



In September 2006, the FASB issued Statements of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurements (SFAS 157).  SFAS 157 is a pervasive pronouncement that defines how the fair value of assets and liabilities should be measured in more than 40 other accounting standards where such measurements are allowed or required.  In addition to defining fair value, the statement establishes a framework within GAAP for measuring fair value and expands required disclosures surrounding fair-value measurements.  While it will change the way companies currently measure fair value, it does not establish any new instances where fair-value measurement is required. SFAS 157 defines fair value as an amount that a company would receive if it sold an asset or paid to transfer a liability in a normal transaction between market participants in the same market where the company
does business.  It emphasizes that the value is based on assumptions that market participants would use, not necessarily only the company that might buy or sell the asset.  In February 2008, the FASB adopted FASB Staff Position No. 157-2 (FSP 157-2)  Effective Date of FASB Statement No. 157 delaying the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for non financial assets and non financial liabilities that arerecognized or disclosed at fair value in the financial statements on a nonrecurring basis.  Accordingly, SFAS 157 now takes effect for the Companys fiscal year beginning July 1, 2009.  The Company is currently evaluating the impact of adopting SFAS 157.



In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities  Including an Amendment of FASB Statement No. 115 (SFAS 159).  SFAS 159 permits all entities the option to measure many financial instruments and certain other items at fair value.  If a company elects the fair value option for an eligible item, then it will report unrealized gains and losses on those items at each subsequent reporting date.  SFAS 159 is effective for the Company is its fiscal year beginning July 1, 2008.  The adoption of SFAS No. 159 is not expected to have a material effect on the Companys consolidated financial position, results of operations or cash flows.







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In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations.  SFAS 141(R) retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations.  SFAS 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination, establishes the acquisition date as the date that the acquirer achieves control and requires the acquirer to recognize the assets acquired, liabilities assumed and any noncontrolling interest at their fair values as of the acquisition date.  In addition, SFAS 141(R) requires expensing of acquisition-related and restructure-related costs, remeasurement of earn out provisions at fair value, measurement of equity securities issued for purchase at the date of close of the transaction and non-expensing of in-process research and development related
intangibles.  SFAS 141(R) is effective for the Companys business combinations for which the acquisition date is on or after July 1, 2009.  The impact that adoption of SFAS 141(R) will have on the Companys financial statements will depend on the nature, terms and size of business combinations that occur after the effective date.





|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------



We are exposed to various market risks, including changes in foreign currency exchange rates and commodity price inflation.  Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange, commodity price inflation and interest rates.  We do not hedge our foreign currency exposures as the net impact of these exposures has historically been insignificant.  We had no forward foreign exchange contracts outstanding as of June 30, 2008.  In the future we may hedge these exposures based on our assessment of their significance.



Foreign Currency Exchange Risk

A large portion of our business is conducted in countries other than the U.S. We are primarily exposed to changes in exchange rates for the Euro, the British pound, the Japanese yen, and the Chinese yuan.  At June 30, 2008, about 32% of our receivables were invoiced in foreign currencies.  Beginning in our fiscal second quarter ended December 31, 2007, we were exposed to currency exchange risk from Euro and British pound-denominated sales.  For these transactions we expect to be a net receiver of the foreign currency and therefore benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar.



Today, a significant portion of our toner-based products are purchased in U.S. dollars from Asian vendors and contract manufacturers.  Although such transactions are denominated in U.S. dollars, over time, we are adversely affected by a weaker U.S. dollar, in the form of price increases, and, conversely, benefit from a stronger U.S. dollar.  A majority of operating expenses associated with the start-up of our Asian manufacturing operations are also settled in non-U.S. dollar denominated currencies, in particular the Chinese Yuan.  In these transactions, we benefit from a stronger U.S. dollar and are adversely affected by a weaker U.S. dollar.  Accordingly, changes in exchange rates, and in particular a weakening of the U.S. dollar, may adversely affect our consolidated operating expenses and operating margins which are expressed in U.S. dollars.



Commodity Price Inflation Risk

Over the last twelve months, we have experienced increases in raw material costs and the costs of shipping and freight to deliver those materials and finished products to our facility and, where paid for by us, shipments to customers.  While we have historically offset a significant portion of this inflation in operating costs through increased productivity and improved yield, recent increases have impacted profit margins.  We are pursuing efforts to improve our procurement of raw materials.  We can provide no assurance that our efforts to mitigate increases in raw materials and shipping and freight costs will be successful.



Interest Rate Risk

At June 30, 2008, we had about $2,594,000 of debt outstanding under its line of credit.  Interest expense under this line of credit is variable, based on its lenders prime rate.  Accordingly, we are subject to interest rate risk in the form of greater interest expense in the event of rising interest rates.  We estimate that a 10% increase in interest rates, based on our present level of borrowings, would result in the incurring about $16,000 pretax ($10,000 after tax) of greater interest expense.







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|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                                         | Page
|------------------------------------------------------------------------------------------------------------------------ | ----
|                                                                                                                         |     
|Report of Independent Registered Public Accounting Firm                                                                  | 48  
|Consolidated Balance Sheets at June 30, 2008 and 2007                                                                    | 49  
|Consolidated Statements of Operations for the years ended June 30, 2008 and 2007                                         | 50  
|Consolidated Statements of Shareholders Equity and Comprehensive Income/Loss for the years ended June 30, 2008 and 2007 | 51  
|Consolidated Statements of Cash Flows for the years ended June 30, 2008 and 2007                                         | 52  
|Notes to Consolidated Financial Statements                                                                               | 53  
|Supplemental Information  Unaudited Comparative Quarterly Statements of Operations                                      | 72  







47



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REPORT OF INDEPENDENT REGISTERED

PUBLIC 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, 2008 and 2007, and the related consolidated statements of operations, shareholders equity and comprehensive income/loss 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.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting.  Accordingly, we express no such opinion.  An audit 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.



As discussed in Note 7 to the consolidated financial statements, in 2008, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109.



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, 2008 and 2007, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Our audits were conducted for the
purpose of forming an opinion on the basic consolidated financial statements taken as a
whole. The additional supplemental information on pages 72 through 75 are presented for
the purpose of additional analysis and are not a required part of the basic consolidated
financial statements. The additional information is the responsibility of the
Companys management. Such information has not been subjected to the auditing
procedures applied in our audit of the basic consolidated financial statements and,
accordingly, we express no opinion on the supplemental information.





|/s/ Amper, Politziner & Mattia, LLP
|-----------------------------------





September 24, 2008

New York, New York







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



|ASSETS                                                                                                       | As of June 30,      
|------------------------------------------------------------------------------------------------------------ | --------------------
|                                                                                                             | 2008                
|                                                                                                             |                     
|CURRENT ASSETS:                                                                                              |                     
|Cash and cash equivalents                                                                                    | $      236,571      
|Accounts receivable, net                                                                                     | 3,082,516           
|Inventories, net                                                                                             | 9,216,439           
|Taxes receivable                                                                                             | 70,282              
|Deferred tax assets                                                                                          | 772,288             
|Prepaid expenses and other current assets                                                                    | 285,241             
|Total Current Assets                                                                                         | 13,663,337          
|                                                                                                             |                     
|PROPERTY AND EQUIPMENT, NET                                                                                  | 2,472,570           
|                                                                                                             |                     
|OTHER ASSETS:                                                                                                |                     
|Goodwill and other intangible assets, net                                                                    | 3,584,231           
|Deferred tax assets                                                                                          | 260,292             
|Other assets                                                                                                 | 124,359             
|Total Other Assets                                                                                           | 3,968,882           
|                                                                                                             |                     
|TOTAL ASSETS                                                                                                 | $  20,104,789       
|                                                                                                             |                     
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                         |                     
|                                                                                                             |                     
|CURRENT LIABILITIES:                                                                                         |                     
|Current maturities of long-term debt                                                                         | $                  
|Accounts payable                                                                                             | 3,046,563           
|Accrued compensation and benefits                                                                            | 731,744             
|Other accrued expenses and current liabilities                                                               | 1,829,919           
|Income taxes payable                                                                                         | 12,606              
|Accrued product warranty costs                                                                               | 198,666             
|Deferred revenue                                                                                             | 519,139             
|Total Current Liabilities                                                                                    | 6,338,637           
|                                                                                                             |                     
|OTHER LIABILITIES:                                                                                           |                     
|Long-term debt, less current maturities                                                                      | 2,594,209           
|Deferred rent liability                                                                                      | 166,969             
|Deferred revenue, less current portion                                                                       | 148,553             
|Deferred tax liabilities                                                                                     |                    
|Total Other Liabilities                                                                                      | 2,909,731           
|                                                                                                             |                     
|TOTAL LIABILITIES                                                                                            | 9,248,368           
|                                                                                                             |                     
|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                                                                                |                     
|25,000,000 shares authorized; issued and outstanding
11,708,964 shares in 2008 and 11,435,354 shares in 2007 | 11,709              
|Additional paid-in capital                                                                                   | 11,798,443          
|Accumulated other comprehensive income                                                                       | 29,167              
|Retained earnings (deficit)                                                                                  | (982,898)           
|Total Shareholders Equity                                                                                   | 10,856,421          
|                                                                                                             |                     
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                   | $  20,104,789       



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, 
|------------------------------------------------------------------------------------------------------- | --------------------
|                                                                                                        | 2008                
|                                                                                                        |                     
|NET REVENUES                                                                                            | $   24,237,566      
|                                                                                                        |                     
|COST OF GOODS SOLD:                                                                                     |                     
|Cost of goods sold, excluding depreciation and amortization,
product warranty, and shipping and freight | 11,159,459          
|Depreciation and amortization                                                                           | 568,837             
|Product warranty                                                                                        | 877,442             
|Shipping and freight                                                                                    | 528,228             
|Total cost of goods sold                                                                                | 13,133,966          
|                                                                                                        |                     
|GROSS PROFIT                                                                                            | 11,103,600          
|                                                                                                        |                     
|OTHER COSTS AND EXPENSES:                                                                               |                     
|Research and development                                                                                | 1,857,044           
|Selling, general and administrative, excluding depreciation
and amortization                            | 11,914,987          
|Depreciation and amortization                                                                           | 374,427             
|Total other costs and expenses                                                                          | 14,146,458          
|                                                                                                        |                     
|INCOME(LOSS) FROM OPERATIONS                                                                            | (3,042,858)         
|                                                                                                        |                     
|Interest expense                                                                                        | (119,358)           
|Interest income                                                                                         | 25,918              
|                                                                                                        |                     
|INCOME (LOSS) BEFORE INCOME TAXES                                                                       | (3,136,298)         
|Provision (benefit) for income taxes                                                                    | (1,312,091)         
|                                                                                                        |                     
|NET INCOME (LOSS)                                                                                       | $   (1,824,207)     
|                                                                                                        |                     
|                                                                                                        |                     
|EARNINGS (LOSS) PER SHARE                                                                               |                     
|Basic                                                                                                   | $             (0.16)
|Diluted                                                                                                 | $             (0.16)
|                                                                                                        |                     
|                                                                                                        |                     
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET EARNINGS (LOSS) PER SHARE                                   |                     
|Basic                                                                                                   | 11,610,128          
|Diluted                                                                                                 | 11,610,128          



See accompanying notes to consolidated financial statements







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND

COMPREHENSIVE INCOME/LOSS



|                                                                                       |              |  |            |  |             |  | Accumulated   |  |              |  |                   
|-------------------------------------------------------------------------------------- | ------------ |  | ---------- |  | ----------- |  | ------------- |  | ------------ |  | ------------------
|                                                                                       |              |  | Additional |  | Retained    |  | Other         |  | Deferred     |  | Total             
|                                                                                       | Common Stock |  | Paid-in    |  | Earnings    |  | Comprehensive |  | Stock-Based  |  | Shareholders     
|                                                                                       | Shares       |  | Amount     |  | Capital     |  | (Deficit)     |  | Income       |  | Compensation      
|BALANCES, JUNE 30, 2006                                                                | 11,131,363   |  | $11,131    |  | $10,210,132 |  | $     96,159  |  | $           |  | $  (292,996)      
|                                                                                       |              |  |            |  |             |  |               |  |              |  |                   
|Issuance of common stock for
exercise of stock options                                 | 258,991      |  | 259        |  | 302,330     |  |              |  |             |  |                  
|Issuance of common stock for
exercise of stock warrants                                | 25,000       |  | 25         |  | 24,975      |  |              |  |             |  |                  
|Vested restricted stock units                                                          | 20,000       |  | 20         |  | (20)        |  |              |  |             |  |                  
|Reclassification of deferred
stock-based compensation
upon adoption of SFAS No. 123(R) |             |  |           |  | (292,996)   |  |              |  |             |  | 292,996           
|Stock-based compensation                                                               |             |  |           |  | 484,450     |  |              |  |             |  |                  
|Tax benefit of stock-based
compensation                                                |             |  |           |  | 407,634     |  |              |  |             |  |                  
|Net income                                                                             |             |  |           |  |            |  | 776,964       |  |             |  |                  
|BALANCES, JUNE 30, 2007                                                                | 11,435,354   |  | $11,435    |  | $11,136,505 |  | $    873,123  |  |             |  | $                
|                                                                                       |              |  |            |  |             |  |               |  |              |  |                   
|Components of comprehensive income/loss:                                               |              |  |            |  |             |  |               |  |              |  |                   
|Net loss                                                                               |             |  |           |  |            |  | (1,824,207)   |  |             |  |                  
|Cumulative translation adjustment                                                      |             |  |           |  |            |  |              |  | 29,167       |  |                  
|Total comprehensive loss                                                               |              |  |            |  |             |  |               |  |              |  |                   
|Cumulative Change in
Accounting - FIN 48                                               |             |  |           |  |            |  | (31,814)      |  |             |  |                  
|Issuance of common stock for
exercise of stock options                                 | 251,431      |  | 252        |  | 260,681     |  |              |  |             |  |                  
|Vested restricted stock units                                                          | 22,179       |  | 22         |  | (22)        |  |              |  |             |  |                  
|Stock-based compensation                                                               |             |  |           |  | 477,584     |  |              |  |             |  |                  
|Tax benefit of stock-based compensation                                                |             |  |           |  | (76,305)    |  |              |  |             |  |                  
|BALANCES, JUNE 30, 2008                                                                | 11,708,964   |  | $11,709    |  | $11,798,443 |  | $  (982,898)  |  | $ 29,167     |  | $                



See accompanying notes to consolidated financial statements







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                             | Year Ended June 30,
|------------------------------------------------------------ | -------------------
|                                                             | 2008               
|CASH FLOWS FROM OPERATING ACTIVITIES:                        |                    
|Net income (loss)                                            | $   (1,824,207)    
|Adjustments to reconcile net income (loss)                   |                    
|to net cash provided (used) by operating activities:         |                    
|Depreciation and amortization                                | 992,241            
|Deferred income taxes                                        | (1,254,415)        
|Tax benefit from stock-based compensation                    |                   
|Provision for inventory obsolescence                         | 133,801            
|Provision for bad debts                                      | 34,336             
|Non-cash and stock-based compensation expense                | 475,822            
|Excess tax benefits from stock-based compensation            |                   
|Changes in operating assets and liabilities:                 |                    
|Accounts receivable                                          | (939,166)          
|Inventories                                                  | (3,546,952)        
|Current and long-term income taxes receivable/payable        | 297,468            
|Prepaid expenses and other assets                            | (89,095)           
|Accounts payable                                             | 1,618,851          
|Accrued compensation and benefits                            | (26,016)           
|Other accrued expenses and current liabilities               | 1,113,602          
|Deferred rent liability                                      | (67,409)           
|Deferred revenue                                             | (176,435)          
|Net cash provided (used) by operating activities             | (3,257,574)        
|                                                             |                    
|CASH FLOWS FROM INVESTING ACTIVITIES:                        |                    
|Purchases of property and equipment                          | (712,588)          
|Net cash used in investing activities                        | (712,588)          
|                                                             |                    
|CASH FLOWS FROM FINANCING ACTIVITIES:                        |                    
|Bank line of credit, net of repayments                       | 1,094,209          
|Bank term loan repayments                                    | (471,083)          
|Bank term loan proceeds                                      | 1,500,000          
|Excess tax benefits from stock-based compensation            |                   
|Proceeds from issuance of common stock, net                  | 260,933            
|Net cash provided by financing activities                    | 2,384,059          
|Effect of exchange rate changes on cash and cash equivalents | 14,389             
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS         | (1,571,714)        
|                                                             |                    
|CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                 | 1,808,285          
|                                                             |                    
|CASH AND CASH EQUIVALENTS, END OF YEAR                       | $       236,571    
|                                                             |                    
|SUPPLEMENTAL CASH FLOW  INFORMATION:                         |                    
|Interest paid                                                | $       100,956    
|Income taxes paid (refunded)                                 | $      (355,144)   



See accompanying notes to consolidated financial statements







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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:



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 or Media Sciences), and have been prepared in United States dollars, and in accordance with accounting principles generally accepted in the United States of America (GAAP).  Unless otherwise indicated, references in the consolidated financial statements and these notes to 2008 and 2007 are to the Companys fiscal years ended June 30, 2008 and 2007, 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 its INKlusive program.  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.



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.  The Companys most significant estimates and assumptions made in the preparation of the financial statements relate to revenue recognition, accounts receivable reserves, inventory reserves, income taxes, income tax valuation allowances, product warranty costs and certain accrued expenses.  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.



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.  Abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials, if any, are recognized as current period charges.  The Company reviews the adequacy of its inventory reserves on a quarterly basis.  Additions to inventory reserves are recognized as current period charges to cost of goods sold.  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.







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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):



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.  Depreciation and amortization related to assets employed in the Companys research and
development activities is classified as a component of research and development expense.  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 Standards (SFAS) 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 impairment adjustments to long-lived assets were made during the years ended June 30, 2008 or 2007.



Goodwill and Other Intangible Assets As required by SFAS 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 SFAS No. 144.  The Company completed its annual impairment test necessary as of June 30, 2008 and June 30, 2007 and concluded that no goodwill was impaired at the end of either reporting period.



Contingencies and Litigation The Company is subject to the possibility of losses from various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies.  An accrual is made in the period in which it becomes probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated.  With respect to litigation, the Company assesses the adequacy of any loss provisions based on the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case.  Based on experience, the Company believes that damage amounts claimed in the specific matters are not a meaningful indicator of the Companys potential liability.  Litigation is inherently unpredictable.  Accordingly, it is possible that
cash flows or results of operations could be materially and adversely affected in any particular period by the unfavorable resolution of a contingency or because of the diversion of managements attention and the creation of significant expenses (see Note 5 Commitments, Litigation and Contingencies).







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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):



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 from time to time may invest its cash 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 non-U.S. trade receivables and certain U.S. trade receivables the Company maintains credit insurance.  Most U.S. trade receivables are not covered under this credit insurance.  The Company maintains an allowance for potential credit losses based upon expected collectibility of its uninsured accounts receivable.



Vendor Concentrations In 2008, two vendors represented 31% of the Companys cost of goods sold, with no single vendor accounting for more than 18%.  In 2007, two vendors represented 24% of the Companys cost of goods sold, with no single vendor accounting for more than 13%.



Major Customers In 2008, two customers represented 19% and 13% of the Companys net revenues and 26% and 15%, respectively, of accounts receivable at June 30, 2008.  In 2007, two customers represented 17% and 14% of the Companys net revenues and 29% and 21%, respectively, of accounts receivable at June 30, 2008.



Revenue Recognition Revenue is recognized at the point of shipment and transfer of title for goods sold, provided collection is reasonably assured.  Net revenues include $60,000 and $95,000 of reimbursed shipping and freight expense for 2008 and 2007, 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 are reflected as current obligations in the consolidated balance sheets until disbursed to the respective taxing authority.



Under the INKlusive program, Media Sciences 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.  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 an agreement with the financing company, at the time of placement of the INKlusive printer, the Company is 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 the Companys 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, 2008 and 2007, the deferred revenue liability totaled $668,000 and $844,000, 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.  The Company recognizes revenue under this program in accordance with the provisions of EITF 00-21.  Under those provisions, revenue is recognized for the printer upon shipment to the customers, while revenue for the supplies and services associated with the program are recognized  equally over the contract term in proportion to product shipments.







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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):



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 6 Product Warranty Expenses).



Deferred Rent Liability Rent expense related to operating leases where scheduled rent increases exist is determined by expensing the total amount of rent due over the life of the operating lease on a straight-line basis.  The difference between the rent paid under the terms of the lease and the rent expensed on a straight-line basis is included in deferred rent liability on the accompanying consolidated balance sheets.



Shipping and Freight Shipping and freight costs are included as a separate captioned component of cost of goods sold in the consolidated statements 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.



Research and Development  Research and product development costs, which consist of salary and related benefits costs of its 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 2008 and 2007, its research and product development costs were $1,857,000 and $1,743,000, respectively.



Advertising Expense Advertising expenses are deferred until the first use of the advertising.  Deferred advertising costs at June 30, 2008 and 2007 totaled approximately $35,000 and $10,000, respectively.  Advertising expense for 2008 and 2007 amounted to approximately $1,168,000 and $1,006,000, respectively.



Employee Benefit Plan The Company maintains defined contribution plans for eligible employees.  The U.S. plan allows for employee contributions to be matched by the Company.  The U.K. plan is 100% Company funded.  The Companys contributions for 2008 and 2007 were $64,000 and $39,000, 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.  This determination is based on projected taxable income and tax planning strategies.  Otherwise, a valuation allowance is applied.  To the extent that the Companys deferred tax assets require valuation allowances in the future, the recording of such valuation allowances would result in an increase to its tax provision in the period in which the Company determines that such a valuation allowance is required.







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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):



Accounting for Stock-Based Compensation PlansBeginning July 1, 2006, the Company has accounted for stock-based compensation using the provisions of SFAS No. 123(R), Share-Based Payment. SFAS No. 123(R) establishes accounting for stock-based awards exchanged for employee services.  Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employees requisite service period.  The Company elected to adopt the modified prospective application method as provided by SFAS No. 123(R).  Accordingly, during fiscal years 2007 and 2008, the Company recorded stock-based compensation cost totaling the amount that would have been recognized had the fair value method under SFAS No. 123 been applied since the effective date of SFAS No. 123 for
the pre-fiscal 2007 year grants and under SFAS No. 123(R) for the fiscal year 2007 and 2008 grants.



Accumulated Other Comprehensive Income and Foreign Currency Translation.Other comprehensive income represents currency translation adjustments.  Assets and liabilities of the Companys United Kingdom subsidiary have been translated at current exchange rates, and related revenues and expenses have been translated at average rates of exchange in effect during the period.  The functional currency of the Companys foreign subsidiaries are as follows: Media Sciences UK, Ltd., the British Pound, and Media Sciences (Dongguan) Company Limited, the Chinese Yuan.  Foreign currency translation gains and losses are recorded as a component of selling, general and administrative expense.



Recent Accounting Pronouncements

In May 2008, the Financial Accounting Standards Board (FASB) issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles.  This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States. The Company does not expect that this Statement will result in a change in any of its current accounting practices.

In April 2008, the FASB adopted FASB Staff Position SFAS No. 142-3, Determination of the Useful Life of Intangible Assets,, amending the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets.  This FASB Staff Position is effective for intangible assets acquired on or after July 1, 2009. The Company is currently evaluating the impact of the implementation of FASB Staff Position SFAS No. 142-3 on the Companys consolidated financial position, results of operations and cash flows.



In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157).  SFAS 157 is a pervasive pronouncement that defines how the fair value of assets and liabilities should be measured in more than 40 other accounting standards where such measurements are allowed or required.  In addition to defining fair value, the statement establishes a framework within GAAP for measuring fair value and expands required disclosures surrounding fair-value measurements.  While it will change the way companies currently measure fair value, it does not establish any new instances where fair-value measurement is required. SFAS 157 defines fair value as an amount that a company would receive if it sold an asset or paid to transfer a liability in a normal transaction between market participants in the same market where the company does business.  It emphasizes that the value is based on
assumptions that market participants would use, not necessarily only the company that might buy or sell the asset.  In February 2008, the FASB adopted FASB Staff Position No. 157-2 (FSP 157-2)  Effective Date of FASB Statement No. 157 delaying the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for non financial assets and non financial liabilities that arerecognized or disclosed at fair value in the financial statements on a nonrecurring basis.  Accordingly, SFAS 157 now takes effect for the Companys fiscal year beginning July 1, 2009.  The Company is currently evaluating the impact of adopting SFAS 157.







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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):



Recent Accounting Pronouncements



In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities  Including an Amendment of FASB Statement No. 115 (SFAS 159).  SFAS 159 permits all entities the option to measure many financial instruments and certain other items at fair value.  If a company elects the fair value option for an eligible item, then it will report unrealized gains and losses on those items at each subsequent reporting date.  SFAS 159 is effective for the Company is its fiscal year beginning July 1, 2008.  The adoption of SFAS No. 159 is not expected to have a material effect on the Companys consolidated financial position, results of operations or cash flows.



In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations (SFAS 141(R)).  SFAS 141(R) retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations.  SFAS 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination, establishes the acquisition date as the date that the acquirer achieves control and requires the acquirer to recognize the assets acquired, liabilities assumed and any noncontrolling interest at their fair values as of the acquisition date.  In addition, SFAS 141(R) requires expensing of acquisition-related and restructure-related costs, remeasurement of earn out provisions at fair value, measurement of equity securities issued for purchase at the date of close of the transaction and non-expensing of in-process
research and development related intangibles.  SFAS 141(R) is effective for the Companys business combinations for which the acquisition date is on or after July 1, 2009.  The impact that adoption of SFAS 141(R) will have on the Companys financial statements will depend on the nature, terms and size of business combinations that occur after the effective date.



Earnings (Loss) Per Share Basic earnings (loss) per common share is computed using the weighted average number of common shares outstanding.  Diluted earnings (loss) 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.



The following table sets forth the computation of the basic and diluted earnings (loss) per common share:



|                                                                                                                  |  | Year Ended June 30,
|----------------------------------------------------------------------------------------------------------------- |  | -------------------
|                                                                                                                  |  | 2008               
|Numerator for basic and diluted:                                                                                  |  |                    
|Net income (loss)                                                                                                 |  | $  (1,824,207)     
|                                                                                                                  |  |                    
|Denominator :                                                                                                     |  |                    
|For basic earnings (loss) per common share
-  weighted average shares outstanding                                 |  | 11,610,128         
|Effect of dilutive securities -  stock options,
restricted stock units and warrants                               |  |                   
|For diluted earnings (loss) per common share
- weighted average shares outstanding
adjusted for assumed exercises |  | 11,610,128         
|                                                                                                                  |  |                    
|Basic earnings (loss) per share                                                                                   |  | $          (0.16)  
|                                                                                                                  |  |                    
|Diluted earnings (loss) per share                                                                                 |  | $         (0.16)   
|                                                                                                                  |  |                    







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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):



The following warrants and options to purchase common stock were excluded from the computation of diluted earnings per share for the years ended June 30, 2008 and 2007 because their exercise price was greater than the average market price of the common stock.  As the Company was in a net loss position for the year ended June 30, 2008, all potential common shares derived from stock options were excluded from the calculation of diluted loss per share as the shares would have had an anti-dilutive effect.



|                                   | Year Ended June 30,
|---------------------------------- | -------------------
|                                   | 2008               
|Anti-dilutive warrants and options | 372,677            





NOTE 2  FINANCIAL STATEMENT COMPONENTS:



CONSOLIDATED BALANCE SHEETS



|                                                |              | As of June 30,
|----------------------------------------------- | ------------ | --------------
|                                                |              | 2008          
|Accounts receivable, net                        |              |               
|Accounts receivable, gross                      |              | $ 3,177,516   
|Allowance for doubtful accounts                 |              | (95,000)      
|                                                |              | $ 3,082,516   
|Inventories, net of reserves                    |              |               
|Raw materials                                   |              | $ 3,281,742   
|Finished goods                                  |              | 6,513,609     
|Less:  reserves for obsolescence                |              | (578,912)     
|                                                |              | $ 9,216,439   
|                                                |              |               
|Property and Equipment, net                     | Useful Lives |               
|Equipment                                       | 3  7 years  | $ 2,074,649   
|Furniture and fixtures                          | 7 years      | 578,672       
|Automobiles                                     | 5 years      | 30,434        
|Leasehold improvements                          | 5  10 years | 916,252       
|Tooling and molds                               | 3 years      | 2,780,391     
|Construction-in-progress (tooling and die)      |              | 556,640       
|                                                |              | 6,937,038     
|Less: Accumulated depreciation and amortization |              | 4,464,468     
|                                                |              | $ 2,472,570   
|                                                |              |               
|Goodwill and other intangible assets, net       |              |               
|Goodwill                                        |              | $ 3,965,977   
|Other                                           | 1-5 years    | 46,000        
|                                                |              | 4,011,977     
|Less: Accumulated amortization                  |              | 427,746       
|                                                |              | $ 3,584,231   







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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,
|------------------------ | -------------------
|                         | 2008               
|Bank term notes          | $ 1,500,000        
|Bank line of credit      | 1,094,209          
|Less: current maturities |                   
|Long-term debt           | $ 2,594,209        



Prior to February 12, 2008, the Company had a revolving line of credit facility which provided for maximum borrowings of $3,000,000. This line was replaced on February 12, 2008, when the Company entered into an agreement with Sovereign Bank for a three year revolving line of credit for up to $8,000,000.  As amended, the advance limit under the line of credit is the lesser of: (a) $8,000,000; or (b) up to 80% of eligible accounts receivable plus up to the lesser of: (i) $3,000,000; or (ii) 50% of eligible inventory; or (iii) 60% of the maximum amount available to be advanced under the line.  The line of credit is collateralized by a first priority security interest in substantially all of the Companys U.S. based assets.  Proceeds were drawn down under this line to repay all revolving and term debt extended by the Companys former bank.  On May 14, 2008, the Company entered into an amendment to the loan
agreement that amended the range of interest rates applicable to the Companys borrowings.  As amended, under a prime rate option, the interest rate can vary from the banks prime rate to its prime rate plus 1%, and, under a LIBOR rate option, the interest rate can vary from LIBOR plus 225 basis points to LIBOR plus 275 basis points.  Both the term note and the line of credit bear interest at the banks Prime Rate plus 1% (6.0% at June 30, 2008) and require payments of interest only through the facilities three year term.



The revolving loan may be converted into one or more term notes upon mutual agreement of the parties.  On February 12, 2008, the Company entered into a non-amortizing term note with the bank in the amount of $1,500,000, due February 12, 2011.  At June 30, 2008, this note had a principal balance of $1,500,000.  As of June 30, 2008, the Company had an outstanding balance of $1,094,209 under the revolving line.  The applicable interest rate on the revolving and term loans extended under the agreement varies based upon certain financial criteria.



In the year ago period and at June 30, 2007, the Company had a revolving line of credit facility which provided for maximum borrowings of $3.0 million.  At June 30, 2007, the Company had no outstanding balance under this line. At June 30, 2007, the Company had $471,083 outstanding to its former bank under two term notes. These notes bore interest at rates greater than the present lending facility. These term notes were repaid in full on February 12, 2008.



The current and former credit facilities are/were subject to financial covenants.  The current financial covenants include monitoring a ratio of debt to tangible net worth and a fixed charge coverage ratio, as defined in the loan agreements. At June 30, 2007, the Company was in compliance with the financial covenants. At June 30, 2008, the Company was not in compliance with the financial covenants, which were waived by the Companys bank via an amendment dated September 22, 2008.  As a result of a cross default and collateralization provision associated with its former debt facility, the Company agreed to refinance certain operating leases held by an affiliate of the former bank.  Under terms of a separate waiver and amendment with this leasing affiliate, the Company received an extension of time to refinance or payoff the lease obligation until March 31, 2009.  At June 30, 2008, the remaining obligation
under the agreement was approximately $567,000.  Under the terms of this amendment, the Company agreed to make six lease payments of $50,000 per month between October 2008 and March 2009 and refinance or otherwise payoff any remaining balance on or before March 31, 2009.  Upon full satisfaction of this obligation we will obtain title to the leased equipment.  Based on the amended lease terms, which include an agreed upon interest charge of prime plus 2.5% per annum, the remaining balance at March 31, 2009 would be approximately $245,000.  This obligation may be refinanced or otherwise prepaid at anytime without penalty.  The future minimum lease payments schedule, found in Note 5, reflects the amended terms of this lease obligation.







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 3  DEBT (Continued):



Scheduled payments due on long-term debt for the next five years and thereafter are as follows as of June 30, 2008:



|                                              |  | Debt                     
|--------------------------------------------- |  | -------------------------
|Year Ending June 30,                          |  | Maturities               
|2009                                          |  | $                       
|2010                                          |  |                         
|2011                                          |  | 2,594,000                
|2012                                          |  |                         
|2013                                          |  |                         
|Aggregate future maturities of long-term debt |  | $        2,594,000       





NOTE 4  STOCK-BASED COMPENSATION:



The effect of recording stock-based compensation for the years ended June 30, 2008 and June 30, 2007 was as follows:



|                                                                 |  | Year ended
June 30, 2008 |  | Year ended
June 30, 2007
|---------------------------------------------------------------- |  | ------------------------ |  | ------------------------
|Stock-based compensation expense by type of award:               |  |                          |  |                         
|Employee stock options                                           |  | $   159,803              |  | $   196,790             
|Non-employee director stock options                              |  | 143,247                  |  | 220,507                 
|Employee restricted stock units                                  |  | 172,397                  |  | 67,153                  
|Amounts capitalized in inventory                                 |  | (1,762)                  |  | (1,560)                 
|Total stock-based compensation expense                           |  | $   473,685              |  | $   482,890             
|Tax effect of stock-based compensation recognized                |  | (170,527)                |  | (175,752)               
|Net stock-based compensation expense recognized in 2008 and 2007 |  | $   303,158              |  | $   307,138             
|                                                                 |  |                          |  |                         
|Excess tax benefit effect on:                                    |  |                          |  |                         
|Cash flows from operations                                       |  | $                       |  | $ (407,634)             
|Cash flows from financing activities                             |  | $                       |  | $   407,634             
|Effect on earnings (loss) per share:                             |  |                          |  |                         
|Basic                                                            |  | $         0.03           |  | $         0.03          
|Diluted                                                          |  | $         0.03           |  | $         0.03          



As of June 30, 2007, the unrecognized stock-based compensation balance was $801,552 after estimated forfeitures.   As of June 30, 2008, the unrecognized stock-based compensation balance was $817,187 after estimated forfeitures and will be recognized over an estimated weighted average amortization period of about 2.2 years.



Effective July 1, 2006, $292,996 of deferred stock-based compensation,  recorded as a reduction to stockholders equity, was reclassified as a reduction of additional paid-in capital in connection with the adoption of SFAS No. 123(R).



During the year ended June 30, 2007, the Company granted 222,124 stock options with an estimated total grant-date fair value of $559,295 after estimated forfeitures.  During the same period, the Company granted 44,159 shares of restricted stock with a grant date fair value of $234,706 after estimated forfeitures.







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 4  STOCK-BASED COMPENSATION (CONTINUED)



During the year ended June 30, 2008, the Company granted 236,260 stock options with an estimated total grant-date fair value of $479,866 after estimated forfeitures.  During the same period, the Company granted 3,157 shares of restricted stock with a grant date fair value of $13,890 after estimated forfeitures.



Valuation Assumptions.In connection with the adoption of SFAS No. 123(R), the Company reassessed its valuation technique and related assumptions.  The Company estimates the fair value of stock options using a Black-Scholes option-pricing model, consistent with the provisions of SFAS No. 123(R) and SEC Staff Accounting Bulletin (SAB) No. 107.  The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model and the straight-line attribution approach with the following weighted-average assumptions without regard to estimated forfeitures:



|                                 | Year Ended June 30,
|-------------------------------- | -------------------
|                                 | 2008               
|Risk-free interest rate          | 3.8%               
|Dividend yield                   | 0.0%               
|Expected stock price volatility  | 59%                
|Average expected life of options | 4.4 years          



SFAS No. 123(R) 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.  The expected stock price volatility assumption was determined using the historic volatility of a peer group of technology-based manufacturing companies with similar attributes, including market capitalization, annual revenues, and debt leverage.  The Company placed limited reliance on the historic volatility of its common stock given the substantial reorganization of the Company in 2005.  In 2005, the Company discontinued
the electronic pre-press sales and service operations of its Cadapult Graphic Systems subsidiary.  Historically, these discontinued operations represented a significant portion of the Companys operations.  These discontinued operations were also materially different, in many respects, from the Companys present technology-based manufacturing business.  For these reasons, the Company determined that historic peer group volatility was more reflective of market conditions and a better indicator of expected future volatility than its own historic volatility for years prior to 2005.



The Company is using the simplified method suggested by the SEC in Staff Accounting Bulletin (SAB) No. 107 for determining the expected life of the options.  Under this method, the Company calculates the expected term of an option grant by averaging its vesting and contractual term.  The Company estimates its applicable risk-free rate based upon the yield of U.S. Treasury securities having maturities similar to the estimated term of an option grant, adjusted to reflect its continuously compounded zero-coupon equivalent.



Equity Incentive Program.The Companys equity incentive program is a broad-based, long-term retention program that is intended to attract and retain qualified management and technical employees, and align stockholder and employee interests.  The equity incentive program presently consists of two plans (the Plans): the Companys 1998 Incentive Stock Plan (the 1998 Plan); and the Companys 2006 Incentive Stock Plan (the 2006 Plan).  Under both Plans, non-employee directors, officers, key employees, consultants and all other employees may be granted options to purchase shares of our stock, restricted stock units and other types of equity awards.  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







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 4  STOCK-BASED COMPENSATION (CONTINUED)



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.



Under the Plans, stock options generally have a vesting period of three to five years, are exercisable for a period not to exceed ten years from the date of issuance and are not granted at prices less than the fair market value of the Companys common stock at the grant date.  Restricted stock units may be granted with varying service-based vesting requirements.



On June 17, 2008, the Companys 1998 Plan ended.  Under the 1998 Plan, 978,550 common shares of the 1,000,000 common shares authorized were issuable as a result of awards of options or other equity instruments.  Under the Companys 2006 Plan, 1,000,000 common shares are authorized for issuance.  As of June 30, 2008, 159,642 common shares were issuable as a result of awards of options or other equity instruments under the 2006 Plan, leaving 840,358 common shares available under the Plan for future issuance.



Non-Plan Options.During the year ended June 30, 2003, the Company granted each of five employees stock options with a five-year life, which vested on April 6, 2004, to purchase up to 25,000 shares at an exercise price of $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 2008, one employee exercised the remaining 25,000 options for net proceeds to the Company of $12,500.



During the year ended June 30, 2003, the Company granted its Chief Executive Officer stock options with a five-year life to purchase up to 500,000 shares that were exercisable at $1.00 per share and expired in June 2008.  Options to purchase 250,000 shares vested immediately and options to purchase the remaining 250,000 shares vested ratably over the period from July 1, 2003 through June 30, 2005.  Through the year ended June 30, 2007, options covering 150,000 shares were exercised for net proceeds to the Company of $150,000.  During the year ended June 30, 2008, options covering 110,000 shares were exercised for net proceeds to the Company of $110,000.  Options covering the remaining 240,000 shares expired unexercised in June 2008.



During the year ended June 30, 2004, the Company granted each of two employees stock options with a ten-year life to purchase up to 100,000 shares, which were exercisable at $1.06 per share.  Options to purchase 50,000 shares each vested immediately and options to purchase the remaining 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 the Company received no cash proceeds.  50,000 options for that same employee were cancelled upon the termination of his employment.  During 2008, one employee exercised 100,000 shares for net proceeds to the Company of $106,000.



During the year ended June 30, 2005, the Company granted an employee stock options with a ten-year life 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 6, 2010.  On September 29, 2006, options covering 15,000 shares were exercised for net proceeds to the Company of $24,000.







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 4  STOCK-BASED COMPENSATION (CONTINUED)



During the year ended June 30, 2006, the Company granted an employee stock options with a ten-year life 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.  During the year ended June 30, 2007, options covering 50,000 shares were exercised for net proceeds to the Company of $82,500.



The following table summarizes the combined stock option plan and non-plan activity for the indicated periods:



|                                     | Number of
Shares |  | Weighted
Average
Exercise Price
|------------------------------------ | ---------------- |  | -------------------------------
|Balance outstanding at June 30, 2006 | 1,260,561        |  | $1.54                          
|Year ended June 30, 2007:            |                  |  |                                
|Options granted                      | 222,124          |  | 6.05                           
|Options exercised                    | (258,991)        |  | 1.17                           
|Options cancelled/expired/forfeited  | (35,000)         |  | 1.62                           
|Balance outstanding at June 30, 2007 | 1,188,694        |  | $2.46                          
|Year ended June 30, 2008:            |                  |  |                                
|Options granted                      | 236,260          |  | 4.82                           
|Options exercised                    | (251,431)        |  | 1.04                           
|Options cancelled/expired/forfeited  | (273,629)        |  | 1.21                           
|Balance outstanding at June 30, 2008 | 899,894          |  | $3.86                          





The options outstanding and exercisable at June 30, 2008 were in the following exercise price ranges:



|Options Outstanding      | Options Exercisable
|------------------------ | -------------------
|Range of
Exercise
Prices | Number
Outstanding 
|                         |                    
|$0.43 to $0.85           | 29,200             
|$1.00 to $2.00           | 201,753            
|$2.01 to $6.33           | 668,941            
|                         | 899,894            



The total number of in-the-money options exercisable as of June 30, 2008 was 240,688.  The aggregate intrinsic value for the options exercisable as of June 30, 2008 was $190,144.



The weighted average grant date fair value of options, as determined under SFAS No. 123(R), granted during the year ended June 30, 2008 and 2007 was $2.43 and $3.22 per share, respectively.







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 4  STOCK-BASED COMPENSATION (CONTINUED)



The total intrinsic value of options exercised during the years ended June 30, 2008 and 2007 was $959,824 and $1,158,499, respectively.  The total cash received from employees as a result of employee stock option exercises during the years ended June 30, 2008 and 2007 was $260,933 and $302,589, respectively.  In connection with these exercises, the tax benefits realized by the Company for the years ended June 30, 2008 and 2007 were $383,354 and $435,647, respectively.



The Company settles employee stock option exercises with newly issued common shares.



Restricted Stock Units.During the year ended June 30, 2008, the Companys Board of Directors approved the grant of 3,157 shares of restricted stock units to an employee.  These restricted stock units vest in equal installments on the first, second and third anniversaries of the grant date.  The value of the restricted stock units are based on the closing market price of the Companys common stock on the date of award.  The total grant date fair value of the restricted stock units granted during the year ended June 30, 2008 was $13,890 after estimated forfeitures.  Stock based compensation cost for restricted stock units for the year ended June 30, 2008 was $172,397.



During the year ended June 30, 2007, the Companys Board of Directors approved the grant of 44,159 shares of restricted stock units to selected employees.  These restricted stock units generally vest in equal installments on the first and second anniversaries of the grant date.  The value of the restricted stock units is based on the closing market price of the Companys common stock on the date of award.  The total grant date fair value of the restricted stock units granted during the year ended June 30, 2007 was $234,706 after estimated forfeitures.  Stock-based compensation cost for restricted stock units for the year ended June 30, 2007 was $67,153.



As of June 30, 2008, there was $208,582 of total unrecognized deferred stock-based compensation after estimated forfeitures related to non-vested restricted stock units granted under the Plans.  That cost is expected to be recognized over an estimated weighted average period of 1.7 years.  As of June 30, 2007, there was $373,713 of total unrecognized deferred stock-based compensation after estimated forfeitures.



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.  These restricted stock units were included in the calculation of diluted earnings per share utilizing the treasury stock method.  All restricted stock grants are approved by the Compensation Committee of the Board of Directors.







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 4  STOCK-BASED COMPENSATION (CONTINUED)



The following table summarizes the Companys restricted stock unit activity for the indicated periods:



|                                           | Number of
Shares |  | Grant Date
Fair Value |  | Weighted
Average Grant
Date Fair Value
Per Share
|------------------------------------------ | ---------------- |  | --------------------- |  | ------------------------------------------------
|Balance unvested at June 30, 2006          | 80,000           |  | $    314,300          |  | $      3.93                                     
|Year ended June 30, 2007:                  |                  |  |                       |  |                                                 
|Restricted stock units granted             | 44,159           |  | 258,803               |  | 5.86                                            
|Restricted stock units vested              | (20,000)         |  | (78,700)              |  | 3.94                                            
|Restricted stock units cancelled/forfeited |                 |  |                      |  |                                                
|Balance unvested at June 30, 2007          | 104,159          |  | $    494,403          |  | $      4.75                                     
|                                           |                  |  |                       |  |                                                 
|Year ended June 30, 2008:                  |                  |  |                       |  |                                                 
|Restricted stock units granted             | 3,157            |  | 17,837                |  | 5.65                                            
|Restricted stock units vested              | (22,179)         |  | (88,702)              |  | 4.00                                            
|Restricted stock units cancelled/forfeited |                 |  |                      |  |                                                
|Balance unvested at June 30, 2008          | 85,137           |  | $    423,538          |  | $      4.97                                     





NOTE 5  COMMITMENTS, LITIGATION AND CONTINGENCIES



Litigation On June 23, 2006, Xerox Corporation filed a patent infringement lawsuit in the United States District Court, for the Southern District of New York, Case No. 06CV4872, against Media Sciences International, Inc. and Media Sciences, Inc., alleging that the Companys 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 in combination with the Xerox ink stick feed assembly.  The suit seeks unspecified damages and fees.  In the Companys answer and counterclaims in this action, it denied infringement and it seeks a finding of invalidity of the Xerox patents in question.  The Company also submitted counterclaims against Xerox for breach of contract and violation of U.S. antitrust laws, seeking treble damages and
recovery of legal fees.  On September 14, 2007, the court denied Xeroxs motion to dismiss the antitrust counterclaims brought by the Company.  Pre-trial discovery on the infringement action was completed in September 2007.  Pre-trial discovery on the Companys antitrust action was completed in July 2008.  Both actions, which the court has ruled will be tried together, may be heard in the summer or fall of 2009.  The loss of all or a part of this lawsuit could have a material adverse affect on the Companys results of operations and financial position.  The Company believes that its inks do not infringe any valid U.S. patents and therefore it has meritorious grounds for success in this case.  The Company intends to vigorously defend these allegations of infringement.  There can be no assurance, however, that the Company will be successful in its defense of this action.  Proceeds of this suit, if any, will be recorded in the period when
received.



In May 2005, the Company filed suit in New Jersey state court against its former insurance broker for insurance malpractice.  This litigation was settled in August 2008.  Under the settlement, Media Sciences received proceeds of $1.5 million.  Proceeds of this settlement will be recognized in the Companys results of operations in the Companys fiscal first quarter ended September 30, 2008.







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 5  COMMITMENTS, LITIGATION AND CONTINGENCIES (CONTINUED):



Leases The Company leases its premises under operating lease agreements which expire through 2011 and equipment under operating leases that expire through 2013.



On July 27, 2005, the Company entered into an equipment lease line of credit with an affiliate of the former bank.  The former bank affiliate holds title to equipment leased under the facility.  In December 2005, the Company entered into an operating lease under this line that required monthly payments of $3,453, for 72 months.  This equipment was subsequently purchased for $163,668 on May 9, 2008.  In September 2006, the Company entered into an additional operating lease under this facility that requires monthly payments of $10,621, for 72 months.  As a result of a cross default and collateralization provision associated with the former debt facility, the Company agreed to refinance this remaining operating lease held by the leasing affiliate of the former bank.  Under terms of a separate waiver and amendment with this leasing affiliate, the Company received an extension of time to refinance or payoff the
lease obligation until March 31, 2009.  See Note 3 for amended terms of this lease agreement, which are reflected in the future minimum lease payments schedule below.



In January 2008, the Company entered in an operating lease agreement, covering various equipment used for research and development activities.  This lease requires monthly payments of $6,126 for 48 months.



Future minimum lease payments are as follows:



|                                    |  | Operating     | Sublease | Net Lease 
|----------------------------------- |  | ------------- | -------- | ----------
|Year Ending June 30,                |  | Leases        | Rents    | Obligation
|2009                                |  | $   1,403,863 | 232,300  | 1,171,563 
|2010                                |  | 638,720       | 232,300  | 406,420   
|2011                                |  | 542,587       | 212,942  | 329,645   
|2012                                |  | 300,000       |         | 300,000   
|2013                                |  | 125,000       |         | 125,000   
|Thereafter                          |  |              |         |          
|Total future minimum lease payments |  | $3,010,170    | 677,542  | 2,332,628 



Rent expense was $569,300, net of $241,200 of sublease rents, for the year ended June 30, 2008 and $401,435, net of $232,300 of sublease rents, for the year ended June 30, 2007.





NOTE 6  PRODUCT WARRANTY EXPENSES:



The Company provides a warranty for all of its consumable supply products and for printers under its INKlusive program.  The Companys warranty stipulates that it will pay reasonable and customary charges for the repair of printers requiring service as a result of using the Companys products.  The Company estimates warranty 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 obligation reserve include the volume of products shipped to customers, historical and anticipated rates of warranty claims and expected cost per claim.  The Company periodically assesses the adequacy of its recorded warranty reserve.  Product warranty expense is classified as a component of costs of goods sold.







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 6  PRODUCT WARRANTY EXPENSES (CONTINUED):



Changes in accrued product warranty reserve for the years ended June 30, 2008 and 2007 are as follows:



|                                              | Year Ended June 30,
|--------------------------------------------- | -------------------
|                                              | 2008               
|Warranty reserve at the beginning of the year | $  192,707         
|                                              |                    
|Warranties accrued during the period          | 877,442            
|Warranties settled during the period          | (871,483)          
|Net change in warranty reserve                | 5,959              
|                                              |                    
|Warranty reserve at the end of the year       | $  198,666         





NOTE 7  INCOME TAXES:



The components of income taxes are summarized as follows:



|                               | Year Ended June 30,
|------------------------------ | -------------------
|                               | 2008               
|Current:                       |                    
|Federal                        | $      (96,813)    
|State                          | 26,531             
|Foreign                        | 12,606             
|Total Current                  | $      (57,676)    
|Deferred:                      |                    
|Federal                        | $    (920,117)     
|State                          | (334,298)          
|Foreign                        |                   
|Total Deferred                 | (1,254,415)        
|Income tax provision (benefit) | $ (1,312,091)      



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,
|---------------------------------------------- | -------------------
|                                               | 2008               
|Expected income tax provision (benefit)        | $  (1,066,341)     
|State income taxes (net of federal benefit)    | (216,153)          
|State valuation allowance                      | 13,027             
|Export incentives                              |                   
|Net operating losses not previously benefitted |                   
|Other (including permanent differences)        | (42,624)           
|                                               | $  (1,312,091)     







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 7  INCOME TAXES (CONTINUED):



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



|                                    | As of June 30,
|----------------------------------- | --------------
|                                    | 2008          
|Deferred tax assets:                |               
|Accounts receivable                 | $       66,311
|Inventories                         | 345,367       
|Deferred compensation               | 270,936       
|Deferred rent liability             | 55,225        
|Accruals and reserves               | 94,347        
|Net operating loss carry-forwards   | 1,156,783     
|Federal and state credits           | 671,011       
|Other                               | 76,945        
|Total deferred tax assets           | $  2,736,925  
|                                    |               
|Valuation allowance (state credits) | (107,302)     
|                                    |               
|Deferred tax liabilities:           |               
|Intangible assets                   | $    (587,527)
|Fixed assets                        | (179,514)     
|Total deferred tax liabilities      | $    (767,041)
|                                    |               
|Net deferred tax assets             | $  1,862,582  



At June 30, 2008, the Company has available Federal net operating loss carry-forwards of approximately $3,400,000 which will expire as of June 30, 2028 and state net operating loss carry-forwards of approximately $5,100,000 which will begin to expire in the years ending June 30, 2009 through June 30, 2015.  In accordance with FAS123R, excess tax benefits of approximately $320,000 associated with approximately $800,000 of the Federal and state net operating loss carry-forwards will be credited to additional paid-in capital as such losses were the result of excess tax deductions related to share based compensation.



The Company believe that it is more likely than not that the net remaining deferred tax assets of approximately $1,033,000 at June 30, 2008 will be realized, based primarily upon forecasted taxable income and to a lesser degree upon tax planning strategies.  Although the Company has experienced operating losses in the past year, it anticipates operating profits and taxable income in fiscal 2009 and thereafter, resulting from a July 2008 reduction-in-force, implementation of cost reduction initiatives, and the realization of the $1,500,000 litigation settlement received in August 2008.  The minimum annual taxable income required to realize the deferred tax assets over the 20-year net operating loss carry-forward period is approximately $125,000.



As of June 30, 2008, the Company has recorded a valuation allowance and reserves for uncertain tax positions of approximately $42,000 and $65,000 related to various credit carry-forwards directly against additional paid-in capital.  If the realizability of the associated deferred tax assets becomes more likely than not in the future or the uncertain tax position can be benefitted, the release of the corresponding valuation allowance or FIN48 reserve will be directly credited to additional paid-in capital.







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 7  INCOME TAXES (CONTINUED):



In June 2006, the FASB issued FIN 48.  FIN 48 requires 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 not means a likelihood of more than 50 percent; the terms examined and upon examination also 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. FIN 48 was adopted by the Company beginning July 1, 2007.



As a result of adopting FIN 48, the Company recognized a net $31,814 increase in its liability for uncertain tax positions ($53,658 of uncertain other tax obligations net of a $21,844 deferred tax asset reflected as a reduction of non-current deferred tax liabilities). The $31,814 difference between the amounts recognized in the consolidated balance sheets prior to the adoption of FIN 48 and the amounts reported after adoption is accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings.



The adoption of FIN48 resulted in the reclassification of the deferred tax assets associated with the Companys uncertain tax positions.  Prior to adoption, such deferred tax assets were netted against the liability for the uncertain tax positions. As a result of the adoption, $117,304 of deferred tax assets were reclassified from the uncertain tax position liability to non-current deferred tax liabilities. In addition, the Company previously reflected the liability for uncertain tax positions in taxes payable.  As a result of the adoption, the liability for uncertain tax positions is separately stated from taxes payable as either a current or non-current liability. As of July, 1 2007, the total liability of $760,260 (as adjusted for the aforementioned deferred tax asset reclassification) was reclassified from current (taxes payable) to non-current (other tax obligations).



As of June 30, 2008, the Company had approximately $830,000 of unrecognized tax benefits associated with its uncertain tax positions, of which approximately $750,000 could ultimately reduce the Companys effective tax rate.  Also, as of June 30, 2008, the liability for uncertain tax positions is netted against long-term deferred tax assets and, as a result, presented on a net rather than gross basis.  Any potential adjustment to the underlying uncertain tax positions by the relevant tax authorities would only reduce net operating loss and/or tax credit carry-forwards without any impact to cash tax obligations.



During the twelve months beginning July 1, 2008, the Company does not expect any material change in the amount of its uncertain tax positions.  The Company is not currently under audit in any of the jurisdictions in which it conducts operations.  Generally, all tax years prior to and including June 30, 2004 are closed under statute.



It is the Companys continuing policy to account for interest and penalties associated with all of its income tax obligations as a component of income tax expense.  No interest or penalties were recognized as part of this provision during the twelve months ended June 30, 2008.  No interest or penalties were reported in the balance sheet as of June 30, 2008.



A rollforward of activity associated with the Companys uncertain tax position is as follows:



|Balance as of date of adoption, July 1, 2007         | $  760,260
|---------------------------------------------------- | ----------
|Changes in amounts related to prior year positions   | (5,259)   
|Changes in amounts related to current year positions | 75,000    
|Changes due to settlements                           |          
|Changes due to lapses in statutes of limitation      |          
|Balance as of June 30, 2008                          | $  830,001







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 8  SUBSEQUENT EVENT

On September 24, 2008, the Company
completed a $1.25 million convertible debt financing with MicroCapital Fund, LP and
MicroCapital Fund, Ltd. (MicroCapital). The Company issued three year notes,
bearing interest at 10% payable quarterly and convertible into shares of our common stock
at $1.65 per share. The Company also issued (a) five year warrants to purchase 378,787
shares of the Companys common stock at $1.65 per share, and (b) three year warrants
allowing MicroCapital to repeat its investment up to $1.25 million on substantially the
same terms and conditions. The three year warrants may be called by the Company if certain
criteria are met. The Company intends to use the proceeds to fund the capital expenditure
and working capital requirements associated with its China based manufacturing operations.

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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



SUPPLEMENTAL INFORMATION

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

(UNAUDITED)



|                                                                                                       | Three Months Ended September 30,
|------------------------------------------------------------------------------------------------------ | --------------------------------
|                                                                                                       | 2007                            
|                                                                                                       |                                 
|NET REVENUES                                                                                           | $   6,430,890                   
|                                                                                                       |                                 
|COST OF GOODS SOLD:                                                                                    |                                 
|Cost of goods sold, excluding depreciation and amortization,
product warranty and shipping and freight | 2,959,104                       
|Depreciation and amortization                                                                          | 147,007                         
|Product warranty                                                                                       | 212,117                         
|Shipping and freight                                                                                   | 167,572                         
|Total cost of goods sold                                                                               | 3,485,800                       
|                                                                                                       |                                 
|GROSS PROFIT                                                                                           | 2,945,090                       
|                                                                                                       |                                 
|OTHER COSTS AND EXPENSES:                                                                              |                                 
|Research and development                                                                               | 497,366                         
|Selling, general and administrative, excluding depreciation and amortization                           | 2,692,046                       
|Depreciation and amortization                                                                          | 89,395                          
|Total other costs and expenses                                                                         | 3,278,807                       
|                                                                                                       |                                 
|INCOME (LOSS) FROM OPERATIONS                                                                          | (333,717)                       
|                                                                                                       |                                 
|Interest income, net                                                                                   | 7,990                           
|                                                                                                       |                                 
|INCOME (LOSS) BEFORE INCOME TAXES                                                                      | (325,727)                       
|Provision (benefit) for income taxes                                                                   | (138,569)                       
|                                                                                                       |                                 
|NET INCOME (LOSS)                                                                                      | $     (187,158)                 
|                                                                                                       |                                 
|                                                                                                       |                                 
|EARNINGS (LOSS) PER SHARE                                                                              |                                 
|Basic and diluted                                                                                      | $          (0.02)               
|                                                                                                       |                                 
|                                                                                                       |                                 
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET EARNINGS (LOSS) PER SHARE                                  |                                 
|Basic                                                                                                  | 11,470,759                      
|Diluted                                                                                                | 11,470,759                      







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



SUPPLEMENTAL INFORMATION

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED DECEMBER 31, 2007 AND 2006

(UNAUDITED)



|                                                                                                       | Three Months Ended December 31,
|------------------------------------------------------------------------------------------------------ | -------------------------------
|                                                                                                       | 2007                           
|                                                                                                       |                                
|NET REVENUES                                                                                           | $   5,685,477                  
|                                                                                                       |                                
|COST OF GOODS SOLD:                                                                                    |                                
|Cost of goods sold, excluding depreciation and amortization,
product warranty and shipping and freight | 2,567,505                      
|Depreciation and amortization                                                                          | 153,293                        
|Product warranty                                                                                       | 199,234                        
|Shipping and freight                                                                                   | 163,136                        
|Total cost of goods sold                                                                               | 3,083,168                      
|                                                                                                       |                                
|GROSS PROFIT                                                                                           | 2,602,309                      
|                                                                                                       |                                
|OTHER COSTS AND EXPENSES:                                                                              |                                
|Research and development                                                                               | 468,914                        
|Selling, general and administrative, excluding depreciation and amortization                           | 2,876,776                      
|Depreciation and amortization                                                                          | 95,160                         
|Total other costs and expenses                                                                         | 3,440,850                      
|                                                                                                       |                                
|INCOME (LOSS) FROM OPERATIONS                                                                          | (838,541)                      
|                                                                                                       |                                
|Interest income, net                                                                                   | 1,052                          
|                                                                                                       |                                
|INCOME (LOSS) BEFORE INCOME TAXES                                                                      | (837,489)                      
|Provision (benefit) for income taxes                                                                   | (352,330)                      
|                                                                                                       |                                
|NET INCOME (LOSS)                                                                                      | $      (485,159)               
|                                                                                                       |                                
|                                                                                                       |                                
|EARNINGS (LOSS) PER SHARE                                                                              |                                
|Basic                                                                                                  | $            (0.04)            
|Diluted                                                                                                | $            (0.04)            
|                                                                                                       |                                
|                                                                                                       |                                
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET EARNINGS (LOSS) PER SHARE                                  |                                
|Basic                                                                                                  | 11,576,357                     
|Diluted                                                                                                | 11,576,357                     







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



SUPPLEMENTAL INFORMATION

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007

(UNAUDITED)



|                                                                                                       | Three Months Ended March 31,
|------------------------------------------------------------------------------------------------------ | ----------------------------
|                                                                                                       | 2008                        
|                                                                                                       |                             
|NET REVENUES                                                                                           | $   6,473,997               
|                                                                                                       |                             
|COST OF GOODS SOLD:                                                                                    |                             
|Cost of goods sold, excluding depreciation and amortization,
product warranty and shipping and freight | 2,877,042                   
|Depreciation and amortization                                                                          | 150,040                     
|Product warranty                                                                                       | 260,754                     
|Shipping and freight                                                                                   | 120,707                     
|Total cost of goods sold                                                                               | 3,408,543                   
|                                                                                                       |                             
|GROSS PROFIT                                                                                           | 3,065,454                   
|                                                                                                       |                             
|OTHER COSTS AND EXPENSES:                                                                              |                             
|Research and development                                                                               | 467,031                     
|Selling, general and administrative, excluding depreciation and amortization                           | 3,298,070                   
|Depreciation and amortization                                                                          | 91,437                      
|Total other costs and expenses                                                                         | 3,856,538                   
|                                                                                                       |                             
|INCOME (LOSS) FROM OPERATIONS                                                                          | (791,084)                   
|                                                                                                       |                             
|Interest income (expense), net                                                                         | (50,444)                    
|                                                                                                       |                             
|INCOME (LOSS) BEFORE INCOME TAXES                                                                      | (841,528)                   
|Provision (benefit) for income taxes                                                                   | (353,548)                   
|                                                                                                       |                             
|NET INCOME (LOSS)                                                                                      | $        (487,980)          
|                                                                                                       |                             
|                                                                                                       |                             
|EARNINGS (LOSS) PER SHARE                                                                              |                             
|Basic and diluted                                                                                      | $            (0.04)         
|                                                                                                       |                             
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET EARNINGS (LOSS) PER SHARE                                  |                             
|Basic                                                                                                  | 11,687,517                  
|Diluted                                                                                                | 11,687,517                  







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MEDIA SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES



SUPPLEMENTAL INFORMATION

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED JUNE 30, 2008 AND 2007

(UNAUDITED)



|                                                                                                       | Three Months Ended June 30,
|------------------------------------------------------------------------------------------------------ | ---------------------------
|                                                                                                       | 2008                       
|                                                                                                       |                            
|NET REVENUES                                                                                           | $   5,647,202              
|                                                                                                       |                            
|COST OF GOODS SOLD:                                                                                    |                            
|Cost of goods sold, excluding depreciation and amortization,
product warranty and shipping and freight | 2,755,808                  
|Depreciation and amortization                                                                          | 118,497                    
|Product warranty                                                                                       | 205,335                    
|Shipping and freight                                                                                   | 76,815                     
|Total cost of goods sold                                                                               | 3,156,455                  
|                                                                                                       |                            
|GROSS PROFIT                                                                                           | 2,490,747                  
|                                                                                                       |                            
|OTHER COSTS AND EXPENSES:                                                                              |                            
|Research and development                                                                               | 423,734                    
|Selling, general and administrative, excluding depreciation and amortization                           | 3,048,095                  
|Depreciation and amortization                                                                          | 98,434                     
|Total other costs and expenses                                                                         | 3,570,263                  
|                                                                                                       |                            
|LOSS FROM OPERATIONS                                                                                   | (1,079,516)                
|                                                                                                       |                            
|Interest income (expense), net                                                                         | (52,038)                   
|                                                                                                       |                            
|LOSS BEFORE INCOME TAXES                                                                               | (1,131,554)                
|Benefit for income taxes                                                                               | (467,644)                  
|                                                                                                       |                            
|NET LOSS                                                                                               | $    (663,910)             
|                                                                                                       |                            
|                                                                                                       |                            
|LOSS  PER SHARE                                                                                        |                            
|Basic and diluted                                                                                      | $         (0.06)           
|                                                                                                       |                            
|                                                                                                       |                            
|WEIGHTED AVERAGE SHARES USED TO COMPUTE NET LOSS PER SHARE                                             |                            
|Basic                                                                                                  | 11,707,964                 
|Diluted                                                                                                | 11,707,964                 







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|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------



Not applicable.





|ITEM 9A. | CONTROLS AND PROCEDURES
|-------- | -----------------------



Evaluation of Disclosure Controls and Procedures



We have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify the Companys financial reports and to other members of senior management and the Board of Directors.  Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report.  Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures are effective.



Managements Report on Internal Control over Financial Reporting



Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act.  Our management has conducted an evaluation of the effectiveness of our internal control over financial reporting based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of June 30, 2008.  This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting.  We were not required to have, nor have we engaged our independent registered public accounting firm to perform, an audit on our internal control over financial reporting pursuant to
the rules of the Securities and Exchange Commission that permit us to provide only managements report in this annual report.



Changes in Internal Control Over Financial Reporting



There were no changes in our internal control over financial reporting during the quarter ended June 30, 2008 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



Limitations on Controls



Management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and fraud.  Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met.  Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.





|ITEM 9B. | OTHER INFORMATION
|-------- | -----------------

On September 24, 2008, in a
transaction deemed to be exempt from registration under the Securities Act in reliance on
Section 4(2) of the Securities Act, we entered into an agreement for the sale of $1.25
million convertible debt with two accredited investors, MicroCapital Fund, LP and
MicroCapital Fund, Ltd. We issued three year notes in the aggregate principal amount of
$1.25 million, bearing interest at 10% payable quarterly and convertible into shares of
our common stock at $1.65 per share. We also issued five year warrants to purchase 387,787
shares of our common stock at $1.65 per share, and three year warrants allowing the note
holders to same investment on substantially the same terms and conditions. The three year
warrants may be called by us if certain criteria are met. We intend to use the proceeds to
fund the capital expenditure and working capital requirements associated with our China
based manufacturing operations.





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PART III



|ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
|-------- | -------------------------------------------------------------------------------------------------------------------------------------



Our Management



The persons listed in the table below are our present directors and executive officers as of August 1, 2008.



|Name               |  | Age |  | Position                                         
|------------------ |  | --- |  | -------------------------------------------------
|Michael W. Levin   |  | 43  |  | Chief Executive Officer, President and a Director
|Kevan D. Bloomgren |  | 47  |  | Chief Financial Officer                          
|Robert M. Ward     |  | 41  |  | Chief Operating Officer                          
|Denise Hawkins     |  | 39  |  | Vice President, Controller and Secretary         
|Willem van Rijn    |  | 59  |  | Non-executive Chairman and Director              
|Paul C. Baker      |  | 71  |  | Director                                         
|Edwin Ruzinsky     |  | 75  |  | Director                                         
|Henry Royer        |  | 76  |  | Director                                         
|Dennis Ridgeway    |  | 59  |  | Director                                         
|Frank J. Tanki     |  | 68  |  | Director                                         





Management Profile



Michael W. Levin, Chief Executive Officer and President:

Michael W. Levin has served as our Chief Executive Officer and President since June 18, 1998, and as Chairman of the Board since June 18, 1998 through February 2008.  Before June 1998, he had served as President, Treasurer, Secretary and Chairman of Media Sciences predecessor, Cadapult Graphic Systems Inc. since 1987, when he founded Cadapult Graphic Systems Inc. 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 inBusiness 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 RBC Daniels, formerly 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  and the New Jersey State Society of Certified Public Accountants.



Robert M. Ward, Chief Operating Officer:

On July 28, 2008, Robert M. Ward was promoted to the position of Chief Operating Officer, succeeding Lawrence Anderson, who retired on July 25, 2008.  Mr. Ward has previously served as Managing Director for the Companys Asian operations since June 2007, where he set-up the Companys China-based product development and manufacturing subsidiary.  Mr. Ward has more than nineteen years of experience in operations, product







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management, engineering, and manufacturing.  Prior to joining the Company, from April 2006 to June 2007, Mr. Ward served as Director of Product Management for WatchGuard Technologies Inc., a Seattle, Washington based provider of Computer Network Firewalls and Software Security Services for Small to Medium Enterprises.  From November of 2001 to March 2006, Mr. Ward served as the Director of Operations for WatchGuard Technologies Inc.  Mr. Ward earned a Bachelor of Science Degree in Mechanical Engineering from the University of Minnesota Institute of Technology in 1989.  Mr. Ward earned a Masters of Business Administration from the University of Minnesota Carlson School of Management in 2001.



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 Chief Executive Officer 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 a member of the American Institute of CPAs, the New Jersey State Society of Certified Public Accountants, the Institute of Management Accountants and the Society for Human Resource Management.



Willem van Rijn, Director:

Willem van Rijn became a director on May 2, 2006 and was appointed non-executive Chairman of the Board on March 1, 2008.  In addition to his role as non-executive Chairman, Mr. van Rijn serves on the Compensation, Nominating and Corporate Governance committees.  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.  Mr. van Rijn also currently serves on the board of Computer Horizons Corp.



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.  Mr. Baker also currently serves
on the board of Pascack Community Bank.



Edwin Ruzinsky, Director:

Mr. Ruzinsky has served as a Director since August 27, 1999 and is the chairman of the Audit committee and also serves on the Nominating and Corporate Governance 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-







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Media Industry Services.  He previously served Times Mirror Company as Vice President of Finance & Administration/Book Publishing Group and Parents 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.  On June 15, 2007, Mr. Ruzinsky resigned as a director of Gentis, Inc., a bioscience company, due to its recapitalization.  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 is the chairman of the Nominating and Corporate Governance committee and also 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.  In 1999 he assisted in the organization and served as Chairman of the Board of Cedar Rapids Bank and Trust and as a member of the board of QCRH, a bank holding company, retiring in 2006.  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.



Dennis Ridgeway, Director:



Dennis Ridgeway became a director on February 22, 2006.  Mr. Ridgeway serves on the Nominating and Corporate Governance committee.  From 1998 through 2005, Mr. Ridgeway served as an independent management consultant and since 2004 has also served as a board member and technical advisor for a working museum in the United Kingdom.  From 1984 to 1998, Mr. Ridgeway held various positions with Katun Corporation, an aftermarket manufacturer of components and supplies for the business equipment industry.  Headquartered in the United Kingdom, his positions included European Sales Manager, General Manager, Assistant Vice President, and Vice President of European Operations from 1994 to 1998. Prior to 1984 Mr. Ridgeway held senior management positions with Kalle Infotec the business equipment subsidiary of Hoechst AG in Europe.



Frank J. Tanki, Director:



Frank Tanki joined our Board in December, 2006.  Mr. Tanki serves on the Audit committee.  He is a Certified Public Accountant and retired in 1998 as a Senior Partner of Coopers & Lybrand, the predecessor of PricewaterhouseCoopers.  Mr. Tanki was a member of the firms Executive Management Committee from 1994 to 1995.  During his time with the firm he served as Director of Accounting and SEC Technical Services and as the Business Assurance Partner In Charge of the New York Metro practice.  He has served on the Auditing Standards Board of the American Institute of Certified Public Accountants.  Mr. Tanki also currently serves on the board of directors of Computer Horizons Corp. and MonoSol Rx, Inc.



Other Information About Executive Officers and Directors



Our executive officers or directors are not associated with another by family relationships.  Based solely in reliance on representations made by our officers and directors, during the past five years, none of the following occurred with respect to such persons: (1) no petition under the Federal bankruptcy laws or any state insolvency law was filed by or against, or a receiver, fiscal agent or similar officer was appointed by a court for the business or property of such persons, or any partnership in which he or she was a general partner or any corporation or business association of which he or she was an executive officer at or within two years before the time of such filing; (2) no such persons were convicted in a criminal proceeding or are a named subject of a pending criminal proceeding (excluding traffic violations and other minor offenses); (3) no such persons were the subject of any order, judgment or
decree, not subsequently reversed, suspended or vacated, of any court of any competent jurisdiction, permanently or temporarily enjoining, or of any federal or state authority barring, suspending or otherwise limiting, their involvement in any type of business practice, or in securities or banking or other financial institution activities; and (4) no such persons







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were found by a court of competent jurisdiction in a civil action or by the SEC or by the Commodity Futures Trading Commission to have violated any federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.



Section 16(a) Beneficial Ownership Reporting Compliance



Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our executive officers, directors, and persons who beneficially own more than ten percent of our common stock to file with the Securities and Exchange Commission initial reports of beneficial ownership and reports of changes in beneficial ownership of our common stock.  Such persons are also required by Securities and Exchange Commission regulations to furnish us 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 us during and in connection with our 2008 fiscal year, we are not aware of any material delinquencies in the filing of such reports, other than the following:  Michael W. Levin filed a late Form 4 on January 7, 2008 reporting a December 13, 2007 gift transfer of 10,000 shares; and Willem van Rijn filed a late Form 4 on February 26, 2008
regarding open market purchases of 16,000 shares on February 19, 2008, and filed a late Form 4 on September 23, 2008 reporting the grant on March 1, 2008 of 30,889 options exercisable at $3.50 per share until March 1, 2015.



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.



Corporate Governance



The Board is responsible for the control and direction of the Company.  The Board represents the Companys shareholders and its primary purpose is to build long-term shareholder value.  Our Board currently consists of eight members.  Our bylaws provide that our Board consists of seven to nine persons.  Each director stands for election every year.  Directors hold office until the next annual meeting of the stockholders and until their successors are elected and qualified.



During the fiscal year ended June 30, 2008, 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.



Board Committees.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.



Members of the Board Committees are selected each year by our Board of Directors.  Selection to a committee of the Board of Directors is determined by the majority vote of the Board of Directors.  Each committee is comprised of at least three non-employee Board members, each of whom are the Board has determined satisfies applicable Nasdaq standards for independence.



During fiscal 2008, the Audit Committee met six times, the Compensation Committee met six times, and the Nominating and Corporate Governance Committee met once.







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Committee Membership.The following table summarizes the membership of the Board and each of its committees for our 2008 fiscal year.



|Name             |  | Audit
Committee |  | Compensation
Committee |  | Nominating and Corporate
Governance Committee
|---------------- |  | --------------- |  | ---------------------- |  | ---------------------------------------------
|Michael W. Levin |  |                 |  |                        |  |                                              
|Paul C. Baker    |  | Member          |  | Chairperson            |  |                                              
|Edwin Ruzinsky   |  | Chairperson     |  |                        |  | Member                                       
|Henry Royer      |  |                 |  | Member                 |  | Chairperson                                  
|Dennis Ridgeway  |  |                 |  |                        |  | Member                                       
|Willem van Rijn  |  |                 |  | Member                 |  | Member                                       
|Frank J. Tanki   |  | Member          |  |                        |  |                                              





Audit Committee Financial Expert.Mr. Ruzinsky and Mr. Tanki are financial experts serving on our Audit Committee and each are independent members of our Board.



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 NASDAQ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.



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.







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|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------



Compensation Summary



The following table summarizes the compensation paid to our Chief Executive Officer and our two other most highly compensated executive officers (collectively, the Named Executive Officers) who served during our last two fiscal years.



Summary Compensation Table



|Name and Principal Position           |  | Year |  | Salary
($) |  | Stock
awards
($)(1)(2) |  | Option
awards
($)(1)(3) |  | Nonequity
incentive
plan
compensation
earnings
($)(4) |  | All other
compensation
($)(5) |  | Total
($)
|------------------------------------- |  | ---- |  | ---------- |  | ---------------------- |  | ----------------------- |  | ----------------------------------------------------- |  | ----------------------------- |  | ---------
|Michael W. Levin                      |  | 2008 |  | 250,000    |  | 0                      |  | 0                       |  | 0                                                     |  | 19,441                        |  | 269,441  
|Chief Executive Officer and President |  | 2007 |  | 225,000    |  | 0                      |  | 0                       |  | 40,000                                                |  | 23,857                        |  | 288,857  
|Kevan D. Bloomgren                    |  | 2008 |  | 170,000    |  | 25,770                 |  | 20,615                  |  | 34,000                                                |  |                              |  | 250,385  
|Chief Financial Officer               |  | 2007 |  | 160,000    |  | 25,770                 |  | 17,800                  |  | 30,400                                                |  |                              |  | 233,970  
|Lawrence Anderson (a)                 |  | 2008 |  | 160,000    |  | 8,463                  |  | 6,252                   |  | 0                                                     |  |                              |  | 174,715  
|Chief Operating Officer (Former)      |  |      |  | 160,000    |  | 7,589                  |  | 6,252                   |  | 29,280                                                |  |                              |  | 203,121  



|(a) | Mr. Anderson resigned his position as Chief Operating Officer on July 25, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Represents the stock-based compensation recognized in the fiscal year in accordance with SFAS No. 123(R).  Option awards are valued at the fair value on the grant date using a Black-Scholes model.  Assumptions made in the valuation of stock and option awards are discussed in Note 4 to the consolidated financial statements.  The grant date fair value of each award, adjusted for estimated forfeiture, is recognized as stock-based compensation expense over the service period.                                                                                      
|(2) | On March 15, 2006, we granted Mr. Bloomgren, 50,000 shares of common stock, subject to vesting over five years at 20% per year on each anniversary of the grant.  10,000 shares vested in each of fiscal 2008 and fiscal 2007.  The total grant date fair value of the award is $195,500, disregarding estimates of forfeitures related to service-based vesting conditions.                                                                                                                                                                                                      
|    | On August 8, 2006, we granted Mr. Anderson 4,357 shares of common stock, subject to vesting over two years at 50% per year beginning on the first anniversary of the grant. The total grant date fair value of the award is $19,999, disregarding estimates of forfeitures related to service-based vesting conditions.                                                                                                                                                                                                                                                           
|(3) | 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 on each  anniversary of the grant.  10,000 of these options vested in each of fiscal 2008 and fiscal 2007.  The total grant date fair value of the award is $135,040, computed using a Black-Scholes model.                                                                                                                                                             
|    | On October 10, 2007, we granted Mr. Bloomgren stock options to purchase 5,027 shares of our common stock, exercisable for seven years at $5.65 per share, subject to vesting over three years at 33.3% per year on each anniversary of the grant.  None of these options vested in fiscal 2008.  The total grant date fair value of the award is $14,999, 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. 20,000 shares vested in each of fiscal 2006 and fiscal 2007. The total grant date fair value of the award is $47,430, computed using a Black-Scholes model.                                                                                                                                                              
|(4) | Refers to amounts under an incentive based bonus structure for certain executives.  See the discussion under the heading Performance Based Bonus Compensation for additional information.                                                                                                                                                                                                                                                                                                                                                                                       
|(5) | This column reports the total amount of perquisites and other benefits provided, if such total amount exceed $10,000. For fiscal 2008, for Mr. Levin, this includes $14,575 for lease of an automobile, $3,726 for a matching contribution under our 401(k) plan, and $1,140 for life insurance premiums, where the beneficiary is not the company.  For fiscal 2007, for Mr. Levin, this includes $18,773 for lease of an automobile, $3,944 for a matching contribution under our 401(k) plan, and $1,140 for life insurance premiums, where the beneficiary is not the company.







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In general, compensation payable to a Named Executive Officer consists of a base salary, a performance based bonus, an annual stock or stock option grant under our incentive stock plan and other benefits, which generally do not exceed $10,000 annually in the aggregate, such as 401(k) plan matching contributions and life insurance premiums, where the beneficiary is not the Company.  We did not have a written employment in effect during our 2008 fiscal year with a Named Executive Officer other than with Mr. Levin, our Chief Executive Officer, who was entitled to additional benefits under the terms of his employment agreement.



Employment Agreement with Chief Executive Officer



Michael W. Levin, our Chief Executive Officer and President, had a five-year employment agreement that began as of July 1, 2003 and ended in June 2008.  His annual salary for fiscal year 2008 was $250,000.  In 2003, we granted him 500,000 five-year stock options, exercisable at $1.00 per share, to purchase 500,000 shares of common stock, of which 50% vested on the grant date, 25% vested on June 30, 2004, and the remaining 25% vested on June 30, 2005. The employment agreement also provided that we may award him an annual performance bonus or other bonus as determined by the Board of Directors.



Under the employment agreement, he was 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.



The employment agreement also provided that if we underwent a change of control, as the term was defined in the employment agreement, we must pay him an amount equal to 290% of his base compensation. He was entitled to terminate his employment if we underwent a change in control. The employment agreement provided for termination for cause.



We are presently negotiating a new written employment agreement with Mr. Levin.  The proposed terms are expected to be similar to the terms of the recently expired employment agreement, but provide, among other things, for the following:  a two year term; a base annual salary of $250,000; if we undergo a change of control in the first year under the new term and Mr. Levin elects to terminate his employment, a payment of $540,000; and if we undergo a change of control after the first year of the new term and Mr. Levin elects to terminate his employment, a payment equal to 200% of his base compensation.  A change of control is proposed to be defined as follows:



|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 more than 50% 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 more than 50% of the voting power; or
|shareholder approval of our liquidation or dissolution.                                                                                                                                                                                                                                                                                      



The employment agreement is expected to provide for termination for cause, and for severance in the event of early termination for reason other than cause, in the amount of $290,000 if terminated during the first year of employment, and in an amount equal to one year of his base salary if terminated after the first year of employment.







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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 2008 fiscal year, we had in effect a performance based cash bonus compensation plan for certain executive officers.  In fiscal 2008, for our Chief Executive Officer, the potential cash bonus was $200,000, of which 20% was based on individualized performance goals (Individual Performance Bonus), and 80% determined wholly upon attaining earnings per share criteria determined by the Board (EPS Bonus). For other Named Executive Officers, the potential cash bonus was 20-40% of their base salary, of which 50% was based on the Individual Performance Bonus criteria, and 50% on the EPS Bonus.  Bonuses are paid after the fiscal year end.



The following table summarizes the payout structure under the fiscal year 2008 bonus structure.  The EPS Bonus was to be earned if our Companys earnings per share equaled or exceeded a minimum level established by the Compensation Committee.  The EPS Bonus range set forth in the table assumed the achievement of the minimum targeted level and up to 100% of the targeted goal.  If the minimum level was not achieved, no EPS Bonus was earned.  If the minimum level is achieved or exceeded, the amount of the EPS Bonus was based upon the level of earnings per share achieved by the Company.  If the maximum targeted goal was exceeded, the EPS Bonus payable could exceed the EPS Bonus potential set forth in the table below.  Factors in determining the Individual Performance 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.



|                   | Fiscal 2008 Bonus Potential |                   | Fiscal 2008 Bonus Earned
|------------------ | --------------------------- | ----------------- | ------------------------
|Name               |                             | EPS
Bonus ($)     |                         
|Michael W. Levin   |                             | 80,000  160,000  |                         
|Kevan D. Bloomgren |                             | 17,000    34,000 |                         
|Lawrence Anderson  |                             | 16,000    32,000 |                         



In July 2008, the Compensation Committee adopted a performance based bonus compensation plan for the 2009 fiscal year, similar in structure to the fiscal 2008 plan.  For our Chief Executive Officer, the potential cash bonus in fiscal 2009 is $240,000, of which $80,000 is based on individualized performance goals (Individual Performance Bonus), and $160,000 is determined wholly upon attaining earnings per share criteria determined by the Board (EPS Bonus).  For the other officer, the potential cash bonus is 20-40% of their base salary, of which 50% is based on the Individual Performance Bonus criteria, and 50% on the EPS Bonus.



Outstanding Equity Awards at 2008 Fiscal Year End



The following table sets forth information concerning outstanding option and stock awards held by the Named Executive Officers as at June 30, 2008.







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|                       | Option Awards |                                                                     | Stock Awards
|---------------------- | ------------- | ------------------------------------------------------------------- | ------------
|Name                   |               | Number of
securities
underlying
unexercised
options
(#)
exercisable |             
|Michael W. Levin       |               |                                                                    |             
|Kevan D. Bloomgren (1) |               |                                                                    |             
|Kevan D. Bloomgren (2) |               | 20,000                                                              |             
|Kevan D. Bloomgren (3) |               |                                                                    |             
|Lawrence Anderson (4)  |               | 45,000                                                              |             
|Lawrence Anderson (5)  |               |                                                                    |             



|(a) | The amounts in this column reflect the fair market value of outstanding restricted stock awards for the named executive officers using the closing price on June 30, 2008 of $2.36, the last trading day of our common stock in fiscal 2008.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Granted March 15, 2006.  Subject to vesting annually in increments of 10,000 on March 15 of 2009, 2010 and 2011.                                                                                                                            
|(2) | Granted March 15, 2006.  Unexercisable options are subject to vesting annually in increments of 10,000 on March 15 of 2009, 2010 and 2011.                                                                                                  
|(3) | Granted October 10, 2007.  Unexercisable options are subject to vesting annually in equal increments on October 10 of 2008, 2009 and 2010.                                                                                                  
|(4) | Granted June 6, 2005.  Unexercisable options are subject to vesting annually in equal increments on June 6 of 2009 and 2010.                                                                                                                
|(5) | Granted August 8, 2006.  Subject to vesting on August 8, 2008.                                                                                                                                                                              





Incentive Stock Plans



Our equity incentive program is a broad-based, long-term retention program that is intended to attract and retain qualified management and technical employees, and align stockholder and employee interests.  The equity incentive program presently consists of two plans: the Companys 1998 Incentive Plan and the Companys 2006 Incentive Stock Plan.  Under both plans, non-employee directors, officers, key employees, consultants and all other employees may be granted options to purchase shares of our stock, restricted stock units and other types of equity awards.  Both plans provides for the issuance of up to 1,000,000 shares of our common stock.



On June 17, 2008, the Companys 1998 Plan ended and we can issue no further awards under the plan.  Under the 1998 plan, 978,550 common shares of the 1,000,000 common shares authorized were issued through awards of options or other equity instruments.  As of June 30, 2008,we had outstanding under the 1998 plan, subject to vesting, stock options to purchase 655,165 shares of common stock, exercisable for up to ten years at prices of $0.43 to $6.33 per share, and 127,316 shares issuable pursuant to restricted stock awards.  Since the effective date of the 1998 plan, 323,385 shares have been issued, including 127,316 shares as stock grants and 196,069 shares through exercise of options.



Under the Companys 2006 Plan, 1,000,000 common shares are authorized for issuance through awards of options or other equity instruments.  As of June 30, 2008, we had outstanding under the 2006 plan, subject to vesting, stock options to purchase 159,642 common shares, exercisable for up to seven years at prices of $3.00 to $5.65 per share.  As of June 30, 2008, 840,358 common shares remain available for future issuance under the 2006 plan.







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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.  We also maintain a defined
contribution plan for our eligible UK employees.  The U.K. plan is 100% Company funded.  Our contributions to the these plans totaled $64,000 in 2008 and $39,000 in 2007.



Director Compensation



We have a compensation plan for our independent directors.  In fiscal 2008, eligible outside directors were paid $15,000 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.  Through fiscal 2007, outside directors are granted five or ten year stock options under our incentive stock plan to purchase 10,000 shares of common stock on the date of appointment to the Board, and additional stock options to purchase 10,000 shares of common stock each year thereafter.  In fiscal 2008, we paid eligible outside directors $15,000 in cash and granted them stock options having a seven year life with a grant date fair value of $24,999.  Chairpersons of the following
committees were also paid an additional fee for their committee service: Audit $1,500; Compensation $1,000; and Governance $500.  Willem van Rijn was nominated and approved as the non- executive Chairman of the Board of Directors effective March 1, 2008.  The compensation plan in effect for the non-executive Chairman is $45,000 per year, payable quarterly, and stock options valued at $75,000 per year, granted at the same time as the options for the other outside directors.



2008 Compensation of Non-Employee Directors



|Name            |  | Fees earned
or paid in cash
($) |  | Option
awards
($)(a)(b) |  | All other
compensation
($) |  | Total
($)
|--------------- |  | ------------------------------- |  | ----------------------- |  | -------------------------- |  | ---------
|Paul Baker      |  | 16,000                          |  | 18,070                  |  |                           |  | 34,070   
|Dennis Ridgeway |  | 15,000                          |  | 18,070                  |  |                           |  | 33,070   
|Henry Royer     |  | 15,000                          |  | 18,070                  |  |                           |  | 33,070   
|Edwin Ruzinsky  |  | 16,500                          |  | 18,070                  |  |                           |  | 34,570   
|Willem van Rijn |  | 25,000                          |  | 34,828                  |  |                           |  | 59,828   
|Frank J. Tanki  |  | 15,000                          |  | 18,070                  |  |                           |  | 33,070   



|(a) | Represents the stock-based compensation recognized in fiscal 2008 in accordance with SFAS No. 123(R).  Option awards are valued at the fair value on the grant date using a Black-Scholes model.  Assumptions made in the valuation of stock and option awards are discussed in Note 4 to the consolidated financial statements.                                                                                                                                                                                                                                                                                                                           
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | On October 10, 2007, each director was granted options, vesting on October 10, 2008 and expiring on October 10, 2014, covering 9,123 common shares.  On March 1, 2008, concurrent with his appointment as non-executive Chairman, Mr. van Rijn was awarded options, vesting on March 1, 2009 and expiring on March 1, 2015, covering 30,889 shares.  At June 30, 2008, the total number of outstanding options, granted as director compensation, held by each director was:  Mr. Baker, 97,123 options; Mr. Ridgeway, 29,123 options; Mr. Royer, 29,123 options; Mr. Ruzinsky, 54,123 options, Mr. van Rijn, 60,012 options; and Mr. Tanki 19,123 options.







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|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------



The tables below sets forth, as of June 30, 2008, the shares of our common stock beneficially owned by (i) each of our officers and directors, and by all of our officers and directors as a group, and (ii) by each person known to us to be the beneficial owner of more than five percent of our outstanding shares of common stock.  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.



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 tables is c/o Media Sciences International, Inc., 8 Allerman Road, Oakland, New Jersey 07463, unless otherwise indicated.



Security Ownership of Directors and Management



|Name and Address
of Beneficial Owner                       |  | Amount and Nature
of Beneficial Owner |     | Additional Shares
Acquirable Within 60 days |         | Percent
of Class
|---------------------------------------------------------- |  | ------------------------------------- | --- | ------------------------------------------- | ------- | ----------------
|Michael W. Levin                                           |  | 1,258,450                             | (a) |                                             | 0       |                 
|Kevan D. Bloomgren                                         |  | 90,000                                | (b) |                                             | 20,000  | (c)             
|Lawrence Anderson                                          |  | 21,357                                | (d) |                                             | 45,000  | (e)             
|Denise Hawkins                                             |  | 3,657                                 | (f) |                                             | 30,002  | (g)             
|Paul Baker                                                 |  | 90,000                                |     |                                             | 88,000  | (h)             
|Dennis Ridgeway                                            |  | 0                                     |     |                                             | 20,000  | (i)             
|Henry Royer                                                |  | 10,000                                | (j) |                                             | 20,000  | (k)             
|Edwin Ruzinsky                                             |  | 40,000                                |     |                                             | 45,000  | (l)             
|Willem van Rijn                                            |  | 16,000                                |     |                                             | 20,000  | (m)             
|Frank J. Tanki                                             |  | 12,993                                |     |                                             | 10,000  | (n)             
|All present officers and directors
as a group (10 persons) |  | 1,542,457                             |     |                                             | 298,002 |                 



|*   | Represents less than 1%                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Includes 120,000 shares owned by his minor children.                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(b) | Includes 50,000 restricted shares, granted on March 15, 2006, subject to vesting in equal installments on the next five anniversary dates of the grant.                                                                                                                                                                                                                                                                                                                                                
|(c) | Includes shares acquirable upon exercise of 20,000 of 50,000 options granted on March 15, 2006, exercisable at $3.91 per share until March 14, 2016 and subject to vesting in equal installments on the next five anniversary dates of the grant.  Does not include shares acquirable upon exercise of 5,027 options, granted on October 10, 2007, exercisable at $5.65 per share until October 10, 2014 and subject to vesting in equal installments on the next three anniversary dates of the grant.
|(d) | Includes 4,357 restricted shares, granted on August 8, 2007, subject to vesting annually in equal installments over a two year period.                                                                                                                                                                                                                                                                                                                                                                 
|(e) | 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 40,000 options, exercisable at $1.60 per share until June 5, 2015, that are subject to vesting in equal installments annually on June 6 of 2009 and 2010.                                                                                                                                                                            
|(f) | Includes 3,157 restricted shares, granted on October 10, 2007, subject to vesting in equal installments on the next three anniversary dates of the grant.                                                                                                                                                                                                                                                                                                                                              
|(g) | Refers to shares acquirable upon exercise of the following options:  10,002 options exercisable at $1.70 per share until July 16, 2011; and 20,000 options exercisable at $1.91 per share until January 11, 2015.                                                                                                                                                                                                                                                                                      







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|(h) | Refers to shares acquirable upon exercise of the following 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; 10,000 options exercisable at $2.71 per share until January 30, 2016; and 10,000 options exercisable at $6.30 per share until December 14, 2016.  Does not include 9,123 options, to vest on October 10, 2008, exercisable at $5.65
per share until October 10, 2014.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(i) | Refers to shares acquirable upon the exercise of the following options:  10,000 options, exercisable at $3.38 per share until February 26, 2016; and 10,000 options, exercisable at $6.30 per share until December 14, 2016.  Does not include 9,123 options, to vest on October 10, 2008, exercisable at $5.65 per share until October 10, 2014.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(j) | Does not include 50,000 shares held by Heffernen 1966 Trust B, a trust controlled by Mr. Royers spouse. Mr. Royer disclaims beneficial ownership of such shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(k) | Refers to shares acquirable upon the exercise of the following options:  10,000 options, exercisable at $2.71 per share until January 30, 2016; and 10,000 options, exercisable at $6.30 per share until December 14, 2016.  Does not include 9,123 options, to vest on October 10, 2008, exercisable at $5.65 per share until October 10, 2014.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(l) | Refers to shares acquirable upon exercise of the following 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 $1.45 per share until December 17, 2014; 10,000 options exercisable at $2.71 per share until January 30, 2016; and 10,000 options exercisable at $6.30 per share until December 14, 2016.  Does not include 9,123 options, to vest on October 10, 2008, exercisable at $5.65 per share until October 10, 2014.                                                                                                                                                                                                                                                                                
|(m) | Refers to shares acquirable upon the exercise of the following options:  10,000 options, exercisable at $4.09 per share until May 2, 2016; and 10,000 options, exercisable at $6.30 per share until December 14, 2016. Does not include 9,123 options, to vest on October 10, 2008, exercisable at $5.65 per share until October 10, 2014, and 30,889 options, to vest on March 1, 2009, exercisable at $3.50 per share until March 1, 2015.                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|(n) | Refers to shares acquirable upon exercise of the following options:  10,000 options exercisable at $6.30 per share until December 14, 2016; and 9,123 options exercisable at $5.65 per share until October 10, 2014.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   





Security Ownership of 5% Beneficial Owners



|Name and Address
of Beneficial Owner                                              |  | Amount and Nature
of Beneficial Owner |  | Additional Shares
Acquirable Within 60 days |        | Percent
of Class
|--------------------------------------------------------------------------------- |  | ------------------------------------- |  | ------------------------------------------- | ------ | ----------------
|Richard L. Scott (a)
1400 Gulfshore Boulevard North,
Suite 145
Naples, FL 34102   |  | 992,050                               |  |                                             | 44,123 | (b)             
|Richard E. Teller and Kathleen A. Rogers
545 Boylston Street
Brookline, MA  02445 |  | 596,256                               |  |                                             | 0      |                 



|(a) | Beneficially owns securities through different entities, including: 202,300 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; 10,000 options exercisable at $2.71 per share until January 30, 2016; 10,000 options exercisable at $6.30 per share until December 14, 2011; and 9,123 options exercisable at $5.65 per share until October 10, 2014.







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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, 2008.



|Plan Category                                              |  | Number of securities
to be issued upon
exercise of outstanding
options, warrants
and rights (a) |  | Weighted average
exercise price
of outstanding
options, warrants
and rights (b) |  | Number of
securities
remaining
available for
future issuance
|---------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------- |  | ------------------------------------------------------------
|                                                           |  |                                                                                                 |  |                                                                                 |  |                                                             
|Equity compensation plans
approved by securities holders   |  | 899,894                                                                                         |  | $3.86                                                                           |  | 840,358                                                     
|Equity compensation plans not
approved by security holders |  |                                                                                                |  |                                                                                |  |                                                            
|Total                                                      |  | 899,894                                                                                         |  | $3.86                                                                           |  | 840,358                                                     



|(a) | Does not include 127,316 shares issuable pursuant to restricted stock awards.  There is no exercise price associated with a restricted stock award.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | Calculation excludes shares subject to restricted stock awards.                                                                                    





Plans in the Shareholder Approved Category



Our equity incentive program is a broad-based, long-term retention program that is intended to attract and retain qualified management and technical employees, and align stockholder and employee interests.  The equity incentive program presently consists of two plans: the Companys 1998 Incentive Plan and the Companys 2006 Incentive Stock Plan.  Under both plans, non-employee directors, officers, key employees, consultants and all other employees may be granted options to purchase shares of our stock, restricted stock units and other types of equity awards.  Both plans provides for the issuance of up to 1,000,000 shares of our common stock.  On June 17, 2008, the 1998 plan ended and no new awards can be made under it.  As of June 30, 2008,we had outstanding under the 1998 plan, subject to vesting, stock options to purchase 655,165 shares of common stock, exercisable for up to ten years at prices of
$0.43 to $6.33 per share, and 127,316 shares issuable pursuant to restricted stock awards.  Since the effective date of the 1998 plan, 323,385 shares have been issued, including 127,316  shares as stock grants and 196,069 shares through exercise of options.  As of June 30, 2008, we had outstanding under the 2006 plan, subject to vesting, stock options to purchase 159,642, exercisable for up to seven years at prices of $3.00 to $5.65 per share.



Changes in Control



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





|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|-------- | -------------------------------------------------------------------------



All of our directors, other than Michael W. Levin, our Chief Executive Officer, and all members of Board committees, are non-employee members that the Board has determined satisfies applicable Nasdaq standards for independence.  Reference is made to Item 10 of Part III of this Report on Form 10-K for additional information about our Board and Board Committees, including their composition.







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|ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------



Audit Fees



Fees for audit services provided by Amper, Politziner & Mattia, LLP, our current principal independent registered public accounting firm, for the years ended June 30, 2008 and 2007 were $161,000 and $102,000, respectively.



Audit fees consist of fees billed for the audits of our annual financial statements, reviews of our interim financial statements, and services that are normally provided 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 former principal independent registered public accounting firm, during the years ended June 30, 2008 and 2007 were $1,185 and $18,096, respectively.  Audit-related fees consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements outside of those fees disclosed above under the caption Audit Fees.



Tax Fees



There were no other fees billed for tax services.



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 2008 and 2007 fiscal years were pre-approved.





|ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES
|-------- | ---------------------------------------



|(a) | List of documents filed as a part of this report:
|--- | -------------------------------------------------



|(1) | Index to Consolidated Financial Statements
|--- | ------------------------------------------



Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets at June 30, 2008 and 2007

Consolidated Statements of Operations for the years ended June 30, 2008 and 2007

Consolidated Statements of Changes in Shareholders Equity and Comprehensive Income/Loss for the years ended June 30, 2008 and 2007

Consolidated Statements of Cash Flows for the years ended June 30, 2008 and 2007

Notes to Consolidated Financial Statements



|(2) | Index to Financial Statement Schedules
|--- | --------------------------------------



Not required.







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|(3) | Index to Exhibits
|--- | -----------------



|Exhibit No. |  | 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 Amendment of Certificate of Incorporation of Media Sciences International, Inc. (Incorporated by reference to Exhibit 3(i)(1) of Current Report on Form 8-K filed on June 28, 2007)                             
|3(i)(5)     |  | 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)(6)     |  | 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)(7)     |  | 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 and restated (Incorporated by reference to Exhibit 3(ii) of Current Report on Form 8-K filed on August 2, 2007)                                                                                            
|10.1+       |  | 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)                                                                         
|10.2+       |  | 2006 Stock Incentive Plan (Incorporated by reference to Exhibit 4.9 of Registration Statement on Form S-8, filed on October 9, 2007)                                                                                           
|10.3+       |  | 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)                                                                    
|10.4+       |  | 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)                      
|10.5+       |  | 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)                                                                    
|10.6        |  | 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)                                                                                 
|10.7        |  | Guaranty and Suretyship Agreement, dated January 23, 2006 (Incorporated by reference to Exhibit 10.3 of Form 10-QSB filed on February 9, 2006)                                                                                 
|10.8        |  | 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)                                                          
|10.9        |  | Fourth Amendment to Loan Documents (Incorporated by reference to Exhibit 10.1 of Form 8-K, filed on October 3, 2007)                                                                                                           
|10.10       |  | Form of Loan Agreement Documents (incorporated by reference to Exhibit 10.1 of Form 8-K, filed on February 14, 2008)                                                                                                           
|10.11*      |  | Waiver to Loan and Security Agreement, February 12, 2008                                                                                                                                                                       
|10.12*      |  | Waiver and Amendment to Lease, dated February 13, 2008                                                                                                                                                                         
|10.13*      |  | Amendment to Lease, dated May 13, 2008                                                                                                                                                                                         
|10.14*      |  | Agreement with PNC, dated as of September 2008                                                                                                                                                                                 
|10.15*      |  | Second Agreement of Amendment to Revolving Loan and Security Agreement                                                                                                                                                         
|10.14       |  | Lease Agreement (Incorporated by reference to Exhibit 10.13 of Annual Report on Form 10-KSB filed on or about September 28, 2000)                                                                                              
|10.15       |  | Sublease Agreement (Incorporated by reference to Exhibit 10 of Current Report on Form 8-K filed on January 24, 2005)                                                                                                           
|10.16       |  | Master Lease Agreement, July 2005 (Incorporated by reference to Exhibit 10.27 of Annual Report on Form 10-KSB filed on September 13, 2005)                                                                                     





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|11    |  | Statement re: computation of per share earnings is hereby incorporated by reference to Part II, Item 8 of this report
|----- |  | ---------------------------------------------------------------------------------------------------------------------
|21*   |  | Subsidiaries of the Registrant                                                                                       
|23.1* |  | Consent of Amper, Politziner & Mattia, 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

+  Represents executive compensation plan or agreement







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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of September 24, 2008.



| | MEDIA SCIENCES INTERNATIONAL, INC.   
| | -------------------------------------
| |                                      
| | By:/s/ Michael W. Levin              
| | Michael W. Levin                     
| | Chief Executive Officer and President
| |                                      
| | Dated:  September 25, 2008           



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



|Signature              |  | Title                                           |  | Date              
|---------------------- |  | ----------------------------------------------- |  | ------------------
|                       |  |                                                 |  |                   
|/s/ Michael W. Levin   |  | Chief Executive Officer, President and Director |  | September 25, 2008
|Michael W. Levin       |  |                                                 |  |                   
|                       |  |                                                 |  |                   
|/s/ Kevan D. Bloomgren |  | Chief Financial Officer                         |  | September 25, 2008
|Kevan D. Bloomgren     |  |                                                 |  |                   
|                       |  |                                                 |  |                   
|/s/ Willem van Rijn    |  | Director and Non-executive Chairman             |  | September 25, 2008
|Willem van Rijn        |  |                                                 |  |                   
|                       |  |                                                 |  |                   
|/s/ Paul C. Baker      |  | Director                                        |  | September 25, 2008
|Paul C. Baker          |  |                                                 |  |                   
|                       |  |                                                 |  |                   
|/s/ Edwin Ruzinsky     |  | Director                                        |  | September 25, 2008
|Edwin Ruzinsky         |  |                                                 |  |                   
|                       |  |                                                 |  |                   
|/s/ Henry Royer        |  | Director                                        |  | September 25, 2008
|Henry Royer            |  |                                                 |  |                   
|                       |  |                                                 |  |                   
|/s/ Dennis Ridgeway    |  | Director                                        |  | September 25, 2008
|Dennis Ridgeway        |  |                                                 |  |                   
|                       |  |                                                 |  |                   
|/s/ Frank J. Tanki     |  | Director                                        |  | September 25, 2008
|Frank J. Tanki         |  |                                                 |  |                   







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