UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)





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





For
the quarterly period ended December 31, 2009





o           TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT





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)
            (IRS
      Employer Identification No.)





8
Allerman Road, Oakland, NJ  07436


(Address
of principal executive offices) (Zip Code)





(201)
677-9311


(Registrant’s
telephone number, including area code)





_________________





Indicate
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 past 90 days.  x Yes o No





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or such shorted period that the
registrant was required to submit and post such files).  o Yes o No





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 (Check one):


Large
      accelerated filer o
            Accelerated
      filer oNon-accelerated
      filer o (Do
      not check if a smaller reporting company)
            Smaller
      reporting company x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  o Yes x No





As of
January 27, 2010, we had 11,989,914 shares of common stock
outstanding.







To Table of Contents


MEDIA SCIENCES INTERNATIONAL, INC.


AND
SUBSIDIARIES





FORM
10-Q


FOR
THE QUARTER ENDED DECEMBER 31, 2009





TABLE
OF CONTENTS








PART
I.  FINANCIAL INFORMATION





ITEM
      1.
            FINANCIAL STATEMENTS
            3Condensed Consolidated Balance Sheets as of December 31,
      2009 (Unaudited) and June 30, 2009
            3Condensed Consolidated Statements of Operations for the
      Three Months and Six Months Ended December 31, 2009 and 2008
      (Unaudited)
            4Condensed Consolidated Statement of Changes in
      Shareholders' Equity and Comprehensive Loss for the Six Months Ended
      December 31, 2009 (Unaudited)
            5Condensed Consolidated Statements of Cash Flows for the
      Six Months Ended December 31, 2009 and 2008
(Unaudited)
            6Notes to Condensed Consolidated Financial
      Statements
            7ITEM
      2.
            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
      CONDITION AND RESULTS OF OPERATIONS
            22ITEM
      3.
            QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
            30ITEM
      4.
            CONTROLS AND PROCEDURES
            30








PART
II.  OTHER INFORMATION





ITEM
      1.
            LEGAL PROCEEDINGS
            31ITEM
      1A.
            RISK FACTORS
            31ITEM
      2.
            UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS
            31ITEM
      3.
            DEFAULTS UPON SENIOR SECURITIES
            31ITEM
      4.
            SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS
            31ITEM
      5.
            OTHER INFORMATION
            31ITEM
      6.
            EXHIBITS
            32SIGNATURES
            
            33





2
 To Table of Contents


PART
I.  FINANCIAL INFORMATION





ITEM 1.   FINANCIAL STATEMENTS





MEDIA SCIENCES INTERNATIONAL, INC. AND
SUBSIDIARIES


CONDENSED
CONSOLIDATED BALANCE SHEETS





December
      31, 2009
            
            
            June
      30,ASSETS
            
            (Unaudited)
            
            
            2009CURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            438,163
            
            
            $
            550,602Accounts
      receivable, net
            
            
            2,931,038
            
            
            
            3,427,550Inventories,
      net
            
            
            6,895,198
            
            
            
            6,392,441Taxes
      receivable
            
            
            48,728
            
            
            
            20,257Deferred
      tax assets
            
            
            830,447
            
            
            
            830,447Prepaid
      expenses and other current assets
            
            
            420,593
            
            
            
            541,153Total
      Current Assets
            
            
            11,564,167
            
            
            
            11,762,450PROPERTY
      AND EQUIPMENT, NET
            
            
            1,785,973
            
            
            
            2,096,986OTHER
      ASSETS:Goodwill
      and other intangible assets, net
            
            
            3,584,231
            
            
            
            3,584,231Deferred
      tax assets
            
            
            378,074
            
            
            
            279,486Other
      assets
            
            
            66,578
            
            
            
            75,159Total
      Other Assets
            
            
            4,028,883
            
            
            
            3,938,876TOTAL
      ASSETS
            
            $
            17,379,023
            
            
            $
            17,798,312LIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable
            
            
            1,063,168
            
            
            
            1,128,187Accrued
      compensation and benefits
            
            
            428,900
            
            
            
            690,948Other
      accrued expenses and current liabilities
            
            
            884,787
            
            
            
            1,151,325Short-term
      capital lease obligation
            
            
            –
            
            
            
            69,815Accrued
      product warranty costs
            
            
            447,967
            
            
            
            436,578Deferred
      rent liability
            
            
            35,649
            
            
            
            63,863Deferred
      revenue
            
            
            81,274
            
            
            
            209,079Total
      Current Liabilities
            
            
            2,941,745
            
            
            
            3,749,795OTHER
      LIABILITIES:Long-term
      debt
            
            
            3,115,866
            
            
            
            2,749,132Deferred
      rent liability
            
            
            42,726
            
            
            
            58,010Convertible
      debt, net of discount of $333,978 in December and $401,830 in
      June
            
            
            916,022
            
            
            
            848,170Warrant
      liabilities
            
            
            11,742
            
            
            
            –Deferred
      revenue, less current portion
            
            
            4,398
            
            
            
            38,708Total
      Other Liabilities
            
            
            4,090,754
            
            
            
            3,694,020TOTAL
      LIABILITIES
            
            
            7,032,499
            
            
            
            7,443,815COMMITMENTS
      AND CONTINGENCIESSHAREHOLDERS'
      EQUITY:Preferred
      Stock, $.001 par valueAuthorized
      5,000,000 shares; none issued
            
            
            –
            
            
            
            –Common
      Stock, $.001 par value 25,000,000 shares authorized;issued
      and outstanding, respectively, 12,971,434 and 11,989,914
              shares
      in December and 12,397,757 and 11,771,966 shares in June
            
            
            11,990
            
            
            
            11,772Additional
      paid-in capital
            
            
            13,023,671
            
            
            
            13,000,680Accumulated
      other comprehensive income (loss)
            
            
            (41,625
            )
            
            
            216Accumulated
      deficit
            
            
            (2,647,512
            )
            
            
            (2,658,171
            )Total
      Shareholders' Equity
            
            
            10,346,524
            
            
            
            10,354,497TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
            
            $
            17,379,023
            
            
            $
            17,798,312





See
accompanying notes to condensed consolidated financial
statements.


3
 To Table of Contents


MEDIA SCIENCES INTERNATIONAL, INC. AND
SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(UNAUDITED)








Three
      Months Ended
              December
      31,
            
            
            Six
      Months Ended
              December
      31,2009
            
            
            2008
            
            
            2009
            
            
            2008NET
      REVENUES
            
            $
            5,586,319
            
            
            $
            5,156,705
            
            
            $
            11,093,069
            
            
            $
            10,909,110COST
      OF GOODS SOLD:Cost
      of goods sold, excluding depreciation and
              amortization,
      product warranty, shipping and freight
            
            
            2,366,827
            
            
            
            2,551,580
            
            
            
            4,980,605
            
            
            
            5,203,804Depreciation
      and amortization
            
            
            79,084
            
            
            
            139,627
            
            
            
            215,685
            
            
            
            257,116Product
      warranty
            
            
            519,491
            
            
            
            227,330
            
            
            
            987,863
            
            
            
            441,499Shipping
      and freight
            
            
            108,698
            
            
            
            116,141
            
            
            
            267,252
            
            
            
            263,766Total
      cost of goods sold
            
            
            3,074,100
            
            
            
            3,034,678
            
            
            
            6,451,405
            
            
            
            6,166,185GROSS
      PROFIT
            
            
            2,512,219
            
            
            
            2,122,027
            
            
            
            4,641,664
            
            
            
            4,742,925OTHER
      COSTS AND EXPENSES:Research
      and development
            
            
            372,004
            
            
            
            348,194
            
            
            
            712,884
            
            
            
            721,246Selling,
      general and administrative, excluding
              depreciation
      and amortization
            
            
            2,033,453
            
            
            
            2,495,540
            
            
            
            3,950,143
            
            
            
            5,248,447Depreciation
      and amortization
            
            
            62,956
            
            
            
            92,467
            
            
            
            137,798
            
            
            
            186,400Litigation
      settlement
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1,500,000
            )Total
      other costs and expenses
            
            
            2,468,413
            
            
            
            2,936,201
            
            
            
            4,800,825
            
            
            
            4,656,093INCOME
      (LOSS) FROM OPERATIONS
            
            
            43,806
            
            
            
            (814,174
            )
            
            
            (159,161
            )
            
            
            86,832Interest
      expense
            
            
            (89,914
            )
            
            
            (74,231
            )
            
            
            (176,769
            )
            
            
            (129,155
            )Interest
      income
            
            
            51
            
            
            
            2,307
            
            
            
            71
            
            
            
            2,966Gain
      (loss) on change in fair value of warrant liabilities
            
            
            14,205
            
            
            
            –
            
            
            
            (4,962
            )
            
            
            –Amortization
      of debt discount on convertible debt
            
            
            (35,173
            )
            
            
            (26,211
            )
            
            
            (67,852
            )
            
            
            (26,211
            )LOSS
      BEFORE INCOME TAXES
            
            
            (67,025
            )
            
            
            (912,309
            )
            
            
            (408,673
            )
            
            
            (65,568
            )Benefit
      for income taxes
            
            
            16,169
            
            
            
            395,572
            
            
            
            98,588
            
            
            
            26,227NET
      LOSS
            
            $
            (50,856
            )
            
            $
            (516,737
            )
            
            $
            (310,085
            )
            
            $
            (39,341
            )LOSS
      PER SHAREBasic
      and diluted
            
            $
            (0.00
            )
            
            $
            (0.04
            )
            
            $
            (0.03
            )
            
            $
            (0.00
            )WEIGHTED
      AVERAGE SHARES USED TO COMPUTE LOSS PER SHAREBasic
      and diluted
            
            
            11,945,712
            
            
            
            11,721,467
            
            
            
            11,891,969
            
            
            
            11,719,283





See
accompanying notes to condensed consolidated financial statements


.


4
 To Table of Contents


MEDIA SCIENCES INTERNATIONAL, INC. AND
SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY AND


COMPREHENSIVE
LOSS


SIX
MONTHS ENDED DECEMBER 31, 2009


(UNAUDITED)





AccumulatedAdditional
            
            
            Other
            
            
            
            
            
            TotalCommon
      Stock
            
            
            Paid-in
            
            
            Comprehensive
            
            
            Accumulated
            
            
            Shareholders'Shares
            
            
            Amount
            
            
            Capital
            
            
            Income
      (loss)
            
            
            Deficit
            
            
            EquityBALANCES,
      JUNE 30, 2009
            
            
            11,771,966
            
            
            $
            11,772
            
            
            $
            13,000,680
            
            
            $
            216
            
            
            $
            (2,658,171
            )
            
            $
            10,354,497Cumulative
      effect of change in accountingprinciple
      – ASC Topic
      815-10 adoption
            
            
            –
            
            
            
            –
            
            
            
            (327,524
            )
            
            
            –
            
            
            
            320,744
            
            
            
            (6,780
            )Components
      of comprehensive loss:Net
      loss
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (310,085
            )
            
            
            (310,085
            )Cumulative
      translation adjustment
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (41,841
            )
            
            
            –
            
            
            
            (41,841
            )Total
      comprehensive loss
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (351,926
            )Vested
      restricted stock units
            
            
            217,948
            
            
            
            218
            
            
            
            (218
            )
            
            
            –
            
            
            
            –
            
            
            
            –Stock-based
      compensation expense
            
            
            –
            
            
            
            –
            
            
            
            350,733
            
            
            
            –
            
            
            
            –
            
            
            
            350,733BALANCES,
      DECEMBER 31, 2009
            
            
            11,989,914
            
            
            $
            11,990
            
            
            $
            13,023,671
            
            
            $
            (41,625
            )
            
            $
            (2,647,512
            )
            
            $
            10,346,524





See
accompanying notes to condensed consolidated financial
statements.


5
 To Table of Contents


MEDIA SCIENCES INTERNATIONAL, INC. AND
SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)





Six
      Months Ended
              December
      31,2009
            
            
            2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
            
            $
            (310,085
            )
            
            $
            (39,341
            )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Depreciation
      and amortization
            
            
            394,220
            
            
            
            471,108Stock-based
      compensation expense
            
            
            345,602
            
            
            
            363,416Deferred
      income taxes
            
            
            (98,588
            )
            
            
            (26,227
            )Provision
      for (reduction of) inventory obsolescence reserves
            
            
            (58,319
            )
            
            
            67,610Provision
      for (recovery of) returns and doubtful accounts allowance
            
            
            90,063
            
            
            
            (52,568
            )Amortization
      of debt discount on convertible debt
            
            
            67,852
            
            
            
            26,211Loss
      on change in fair value of warrant liabilities
            
            
            4,962
            
            
            
            –Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            370,662
            
            
            
            146,854Inventories
            
            
            (439,308
            )
            
            
            1,957,369Income
      taxes
            
            
            (29,074
            )
            
            
            (4,160
            )Prepaid
      expenses and other current assets
            
            
            110,598
            
            
            
            (25,863
            )Accounts
      payable
            
            
            (66,043
            )
            
            
            (1,625,183
            )Accrued
      compensation and benefits
            
            
            (266,793
            )
            
            
            (302,124
            )Other
      accrued expenses and current liabilities
            
            
            (244,740
            )
            
            
            (910,236
            )Accrued
      product warranty costs
            
            
            11,389
            
            
            
            (11,432
            )Deferred
      rent liability
            
            
            (43,498
            )
            
            
            (23,268
            )Deferred
      revenue
            
            
            (162,115
            )
            
            
            (204,920
            )Net
      cash used by operating activities
            
            
            (323,215
            )
            
            
            (192,754
            )CASH
      FLOWS FROM INVESTING ACTIVITIESPurchases
      of property and equipment
            
            
            (83,207
            )
            
            
            (597,482
            )Net
      cash used in investing activities
            
            
            (83,207
            )
            
            
            (597,482
            )CASH
      FLOWS FROM FINANCING ACTIVITIESDecrease
      in restricted cash
            
            
            18,450
            
            
            
            –Bank
      credit line proceeds
            
            
            366,734
            
            
            
            284,474Capital
      lease obligation repayments
            
            
            (69,815
            )
            
            
            (200,000
            )Proceeds
      from issuance of subordinated convertible debt
            
            
            –
            
            
            
            1,250,000Net
      cash provided by financing activities
            
            
            315,369
            
            
            
            1,334,474Effect
      of exchange rate changes on cash and cash equivalents
            
            
            (21,386
            )
            
            
            (61,334
            )NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            (112,439
            )
            
            
            482,904CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            550,602
            
            
            
            236,571CASH
      AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            438,163
            
            
            $
            719,475SUPPLEMENTAL
      CASH FLOW INFORMATIONInterest
      paid
            
            $
            158,426
            
            
            $
            111,447Income
      taxes paid
            
            $
            49,160
            
            
            $
            6,240SUPPLEMENTAL
      DISCLOSURE OF NON-CASH TRANSACTIONSCapital
      lease additions
            
            $
            –
            
            
            $
            528,488





See
accompanying notes to condensed consolidated financial
statements.


6
 To Table of Contents


MEDIA SCIENCES INTERNATIONAL, INC. AND
SUBSIDIARIES




NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
1 – NATURE OF BUSINESS AND BASIS OF PRESENTATION





Nature of
Business.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.





Basis of
Presentation.The condensed
consolidated financial statements have been prepared by the Company pursuant to
the rules and regulations of the Securities and Exchange Commission
(“SEC”).  Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted pursuant
to Article 8 of Rule S-X.  In the opinion of management, the unaudited
condensed consolidated financial statements reflect all adjustments (consisting
only of normal, recurring adjustments) necessary for a fair presentation of the
financial position, results of operations and cash flows for the periods
indicated.  You should read these condensed consolidated financial
statements in conjunction with the audited consolidated financial statements and
notes thereto included in the Company’s Annual Report on Form 10-K for the year
ended June 30, 2009, filed with the SEC on September 24, 2009.  The
June 30, 2009 consolidated balance sheet data was derived from audited
consolidated financial statements but does not include all disclosures required
by accounting principles generally accepted in the United States of
America.





The
consolidated financial statements include the accounts of Media Sciences
International, Inc., a Delaware corporation, and its
subsidiaries.  All significant intercompany balances and transactions
have been eliminated in consolidation.  As of December 31, 2009, other
than those resulting from adoption of recent accounting pronouncements discussed
in Note 2, there have been no significant changes to any of the Company’s
accounting policies as set forth in the Annual Report on Form 10-K for the year
ended June 30, 2009.  The Company has evaluated material subsequent
events through February 11, 2010, the date these financial statements were
issued.  No material subsequent events came to our attention except as
disclosed in Note 12.





The
results of operations for the three and six months ended December 31, 2009 are
not necessarily indicative of the results that may be expected for any other
interim period or for the full year ending June 30, 2010.





Liquidity.Over
the next twelve months, the Company’s operations may require additional funds
and it 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.  No assurance can be provided
that additional funding, if sought, will be available or, if available, will be
on acceptable terms to meet the Company’s 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 the Company’s
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 the Company’s ability to
operate its business.  An inability to fund its operations or fulfill
outstanding obligations could have a material adverse effect on the Company’s
business, financial condition and results of operations.





Accumulated Other
Comprehensive Income (loss).Accumulated other
comprehensive income (loss) represents currency translation
adjustments.  Assets and liabilities of the Company’s United Kingdom
and China subsidiaries 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 is as follows: Media Sciences UK, Ltd., the British pound;
Media Sciences Hong Kong Co. Limited, the Hong Kong dollar; and Media Sciences
(Dongguan) Company Limited, the Chinese yuan.  Realized foreign
currency transaction gains and losses are recorded as a component of selling,
general and administrative expense.





Reclassifications.Certain prior
period balances have been reclassified to conform to the current financial
statement presentation. These reclassifications had no impact on previously
reported results of operations or shareholders’ equity.


7
 To Table of Contents


MEDIA
SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES




NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
1 – NATURE OF BUSINESS AND BASIS OF PRESENTATION (CONTINUED)





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, warranty reserves, and certain accrued
expenses.  Actual results could differ from those
estimates.





Fair Value
Measurements.  The Company measures fair value in accordance
with authoritative guidance for fair value measurements, which defines fair
value, establishes a framework and gives guidance regarding the methods used for
measuring fair value, and expands disclosures about fair value
measurements.  The authoritative guidance defines fair value as an
exit price, representing the amount that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants.  As such, fair value is a market-based measurement that
should be determined based on assumptions that market participants would use in
pricing an asset or liability. As a basis for considering such assumptions,
there exists a three-tier fair value hierarchy, which prioritizes the inputs
used in measuring fair value as follows:





·
            Level
      1 – unadjusted quoted prices in active markets for identical assets or
      liabilities that the Company has the ability to access as of the
      measurement date.




·
            Level
      2 – inputs other than quoted prices included within Level 1 that are
      directly observable for the asset or liability or indirectly observable
      through corroboration with observable market
  data.




·
            Level
      3 – unobservable inputs for the asset or liability only used when there is
      little, if any, market activity for the asset or liability at the
      measurement date.





This
hierarchy requires the Company to use observable market data, when available,
and to minimize the use of unobservable inputs when determining fair
value.





Recurring Fair Value
Estimates.  The Company’s recurring fair value measurements at
December 31, 2009 were as follows:





Fair
      Value
              as
      of
              December
      31,2009
            
            
            Quoted
      Prices in
              Active
      Markets
              for
      Identical
              Assets
      (Level 1)
            
            
            Significant
              Other
              Observable
              Inputs (Level
      2)
            
            
            Significant
              Unobservable
              Inputs (Level
      3)
            
            
            Increases
      (decreases)
              during
      the six
              months
      ended
              December
      31, 2009Liabilities:Warrant
      obligations
            
            $
            11,742
            
            
            
            –
            
            
            
            –
            
            
            $
            11,742
            
            
            $
            4,962








Recurring Level 3
Activity, Reconciliation and Basis for Valuation.The table
below provides a reconciliation of the beginning and ending balances for the
major classes of assets and liabilities measured at fair value using significant
unobservable inputs (Level 3).  The table reflects gains and losses
for the quarter for all financial liabilities categorized as Level 3 as of
December 31, 2009.  See Note 2, Implementation of EITF Issue No.
07-5, "Determining Whether an Instrument (or an Embedded Feature) is Indexed to
an Entity’s Own Stock" (ASC Topic 815-10),for discussion regarding the
Company’s warrant obligations.


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NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
1 – NATURE OF BUSINESS AND BASIS OF PRESENTATION (CONTINUED)





Changes
in our Fair Value Measurements Using Significant Unobservable Inputs (Level
3):





Increases
      (decreases)Liabilities:Balance
      as of July 1, 2009
            
            $
            6,780Increase
      in fair value of warrants
            
            
            19,167Balance
      as of September 30, 2009
            
            $
            25,947Decrease
      in fair value of warrants
            
            
            (14,205
            )Balance
      as of December 31, 2009
            
            $
            11,742





The fair
value of each warrant group is estimated using the Black-Scholes option pricing
model with the following weighted average assumptions as of (number of warrants
in thousands):





Original
      Value
            
            July
      1, 2009
            
            December
      31, 2009Number
      of warrants
            1,515
            
            1,515
            
            1,515Exercise
      price
            $1.65
            
            $1.65
            
            $1.65Risk
      free interest rate
            2.13%
            
            1.53%
            
            1.08%Expected
      warrant lives in years
            3.0
            
            2.9
            
            2.0Expected
      volatility
            61.3%
            
            74%
            
            74%Expected
      dividend yields
            None
            
            None
            
            NoneFair
      value per share
            $0.216
            
            $0.005
            
            $0.008Common
      stock price
            $1.43
            
            $0.17
            (a)
            $0.225
            (a)Fair
      value of warrants
            $327,524
            
            $6,780
            
            $11,742





(a)
            Due
      to the low average daily trading volume of our common stock, we have
      discounted the common stock price in the Black-Scholes valuation model to
      reflect the adverse impact on our share price which would result from a
      dramatic increase in the number of shares of our common stock outstanding
      upon the exercise of these
warrants.





There are
no assets or liabilities measured at fair value on a nonrecurring
basis.





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 values approximate
their fair values 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.





Restricted
Cash.At December 31, 2009 and June 30, 2009, $122,451 and
$140,901, respectively, of bank deposits located in China were classified as
restricted due to regulatory restrictions impacting the availability of the
funds during dissolution of the legal entity.  This restricted cash is
reflected in other current assets in the condensed consolidated balance
sheets.


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NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
1 – NATURE OF BUSINESS AND BASIS OF PRESENTATION (CONTINUED)





Loss on change in
fair value of warrant liabilities.In
accordance with authoritative guidance, the Company is required to account for
investor warrants as if they were derivative liabilities (See Note 2, Implementation of EITF Issue No.
07-5, "Determining Whether an Instrument (or an Embedded Feature) is Indexed to
an Entity’s Own Stock" (ASC Topic 815-10)).  The Company is
required to mark to market each reporting quarter the value of the investor
warrants.  The periodic change in value of the deemed obligations
associated with these warrants is recorded as either non-cash gain (if the value
of the warrants decrease) or as non-cash loss (if the value of the warrants
increase).  Although the value of the warrants is affected by interest
rates, the remaining contractual conversion period, and the Company's stock
volatility, the primary cause of the change in the value of the embedded
derivative and investor warrants will be the value of the Company's common stock
at each measurement date.  If the stock price goes up, the value of
this deemed liability will generally increase and if the stock price goes down
the value of this deemed liability will generally decrease.





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.





The
Company evaluates the need for a deferred tax valuation allowance
quarterly.  A valuation allowance was required as of March 31, 2009 as
it was deemed more likely than not that certain State net operating loss carry
forwards and other future deductible temporary differences included in the
Company’s deferred tax assets will not be realized.  At December 31,
2009 and June 30, 2009, the valuation allowance associated with these state tax
attributes was $532,000.  This valuation allowance adjustment had no
impact on the Company’s cash flows or future prospects, nor does it alter the
Company’s ability to utilize these tax attributes, the utilization of which is
primarily dependent upon future taxable income.  Under United States
generally accepted accounting principles (“GAAP”), if and when the Company’s
results demonstrate a pattern of future profitability and reverse the current
cumulative loss trend, this valuation allowance may be adjusted and may result
in the reinstatement of all or a part of the net deferred tax
assets.





Although
the Company incurred substantial losses before income taxes for the quarter
ended December 31, 2009 and the years ended June 30, 2009 and 2008, management
believes that it is more likely than not that the Company will have sufficient
taxable income in future years to realize its remaining net federal deferred
income tax assets.  However, if future events change management’s
assumptions and estimates regarding the Company’s future earnings, a significant
deferred tax asset valuation allowance may have to be
established.


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NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
2 – RECENT ACCOUNTING PRONOUNCEMENTS





FASB
Establishes Accounting Standards CodificationTM





In June
2009, the FASB issued Accounting Standards Update No. 2009-01, “Generally
Accepted Accounting Principles” (Accounting Standards CodificationTM (“ASC”)
Topic 105) which establishes the FASB Accounting Standards Codification (“the
Codification”, “ASC”, or “authoritative guidance”) as the official single source
of authoritative U.S. GAAP.  All existing accounting standards are
superseded.  All other accounting guidance not included in the
Codification will be considered non-authoritative.  The Codification
also includes all relevant Securities and Exchange Commission (“SEC”) guidance
organized using the same topical structure in separate sections within the
Codification.





Following
the Codification, the Board will not issue new standards in the form of
Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts.
Instead, it will issue Accounting Standards Updates (“ASU”) which will serve to
update the Codification, provide background information about the guidance and
provide the basis for conclusions on the changes to the
Codification.





The
Codification is not intended to change GAAP, but it did change the way GAAP is
organized and presented.  The Codification was effective for our first
quarter 2010 financial statements and the principal impact on our financial
statements is limited to disclosures as all future references to authoritative
accounting literature will be referenced in accordance with the
Codification.  In order to ease the transition to the Codification, we
are providing the Codification cross-reference alongside the references to the
standards issued and adopted prior to the adoption of the
Codification.  ASC Topic 105 was effective for the Company’s interim
reporting period ending on September 30, 2009.  This authoritative
guidance did not have a material impact on the Company’s consolidated financial
position, results of operations or cash flows.





Implementation
of EITF Issue No. 07-5, "Determining Whether an Instrument (or an Embedded
Feature) is Indexed to an Entity’s Own Stock" (ASC Topic 815-10)





In June
2008, the FASB ratified EITF Issue No. 07-5 which provides that an entity should
use a two-step approach to evaluate whether an equity-linked financial
instrument (or embedded feature) is indexed to its own stock, including
evaluating the instrument's contingent exercise and settlement
provisions.  Equity-linked instruments (or embedded features) that
otherwise meet the definition of a derivative as outlined in SFAS No. 133,
"Accounting for Derivative
Instruments and Hedging Activities” (ASC Topic 815), are not accounted
for as derivatives if certain criteria are met, one of which is that the
instrument (or embedded feature) must be indexed to the entity's
stock.  ASC Topic 815-10 provides guidance on determining if
equity-linked instruments (or embedded features) such as warrants to purchase
our stock are considered indexed to our stock.





ASC Topic
815-10 became effective for the Company in its fiscal year beginning July 1,
2009 and was applied to outstanding instruments as of that date.  The
adoption of the pronouncement’s requirements can affect the accounting for
warrants and many convertible instruments with provisions that protect holders
from a decline in the stock price (or “down-round”
provisions).  Down-round provisions reduce the exercise price of a
warrant or convertible instrument if a company either issues equity shares for a
price that is lower than the exercise price of those instruments or issues new
warrants or convertible instruments that have a lower exercise
price.  All of the Company’s outstanding warrants and its convertible
debt contain such provisions.


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NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
2 – RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)





Outstanding
instruments evaluated included (a) the Company’s outstanding convertible debt
and (b) warrants issued concurrent with the convertible debt
issuance.  With respect to the convertible debt element, based on
guidance found in ASC Topic 815-10, we determined the economic characteristics
and risks of the conversion element are clearly and closely related to and
inseparable from the debt instrument.  Thus adoption of the
pronouncement did not affect the accounting treatment of the Company’s
convertible debt.  A contingent beneficial conversion amount is
required to be calculated and recognized when and if the adjusted conversion
price of the convertible debt, currently $1.65, is adjusted to reflect a down
round stock issuance that reduces the conversion price below the $1.22 fair
value of the common stock on the issuance date of the convertible
debt.





However,
because the Company’s warrants have “down-round” provisions, they can no longer
be recorded in equity.  Beginning July 1, 2009, the Company recognized
the fair value of these warrants as a liability on its consolidated balance
sheet, despite the fact that this deemed liability will never be settled in
cash.  Further, ASC Topic 815-10 requires warrants with “down-round”
features to be recognized as a derivative liability.  Accordingly,
changes in the fair value of the warrants at each reporting period are required
to be recognized as non-cash expense or income in the consolidated statement of
operations.  Future movements in the Company’s stock price alone can
materially affect both its results of operations and financial position in the
future.  Substantial movements in the Company’s stock price could
result in material volatility in our results of operations and financial
position.





Upon
adoption, a cumulative effect adjustment was recorded, based on amounts that
would have been recognized if this guidance had been applied from the issuance
date of the affected instruments.  The following table illustrates the
changes to the Company's consolidated balance sheet resulting from the
implementation of ASC Topic 815-10:





Balance
      at
              June
      30, 2009
            
            
            Cumulative
              Effect
              Adjustment
            
            
            Balance
      at
              July
      1, 2009Warrant
      liabilities
            
            
            –
            
            
            $
            6,780
            
            
            $
            6,780Additional
      paid-in capital
            
            $
            13,000,680
            
            
            $
            (327,524
            )
            
            $
            12,673,156Accumulated
      deficit
            
            $
            (2,658,171
            )
            
            $
            320,744
            
            
            $
            (2,337,427
            )





The fair
value of the warrants of $327,524 was included in additional paid-in capital on
the issuance date of the warrants (September 24, 2008).  As a result
of reclassifying these warrants from equity to liabilities, the cumulative
effect of these adjustments on July 1, 2009 was a reduction of additional
paid-in capital of $327,524 and a corresponding reduction of the Company’s
accumulated deficit, less the $6,780 fair value of the warrant obligation
recognized at July 1, 2009.





As of
December 31, 2009, the Company determined that, using the Black Scholes model,
the fair value of the warrant obligations had increased by
$4,962.  Accordingly, for the six months ended December 31, 2009, the
Company recorded a "Loss on change in fair value of warrant liabilities" to its
statement of operations.  See Note 1, Fair Value Measurements, for
more detail regarding the Black-Scholes assumptions used to estimate the fair
value of the Company’s warrant obligation.


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NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
2 – RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)





Fair Value
Accounting





In 2006,
the FASB issued SFAS No. 157, “Fair Value Measurements” (ASC Topic 820)
which defines fair value, establishes a market-based framework or hierarchy for
measuring fair value and expands disclosures about fair value
measurements.  This guidance is applicable whenever another accounting
pronouncement requires or permits assets and liabilities to be measured at fair
value.  It does not expand or require any new fair value measures;
however the application of this statement may change current
practice.  We adopted this guidance for financial assets and
liabilities effective July 1, 2008 and for non financial assets and
liabilities effective July 1, 2009.  The adoption did not have a
material effect on our financial condition or results of
operations.





In April
2009, the FASB issued the following updates that provide additional application
guidance and enhance disclosures regarding fair value measurements and
impairments of securities:





·
            FSP
      FAS 157-4, “Determining Fair Value When the Volume and Level of Activity
      for the Asset or Liability Have Significantly Decreased and Identifying
      Transactions That Are Not Orderly” (ASC Topic 820-10-65). This update
      relates to determining fair values when there is no active market or where
      the price inputs being used represent distressed sales. It reaffirms the
      need to exercise judgment to ascertain if a formerly active market has
      become inactive and in determining fair values when markets have become
      inactive.  The FSP was effective for the Company’s annual
      reporting for the fiscal year ended on June 30, 2009.  The
      implementation of FSP SFAS No. 157-4 did not materially impact the
      Company’s financial position, results of operations or cash
      flows.


·
            FSP
      FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial
      Instruments” (ASC Topic 320-10-65).  This update requires fair
      value disclosures for financial instruments that are not currently
      reflected on the balance sheet at fair value on a quarterly
      basis.  The disclosure requirement under this FSP was effective
      for the Company’s interim reporting period ending on September 30,
      2009 and all appropriate disclosures have been reflected
      herein.





In August
2009, the FASB issued authoritative guidance for measuring liabilities at fair
value that reaffirms the existing definition of fair value and reintroduces the
concept of entry value into the determination of fair value of
liabilities.  Entry value is the amount an entity would receive to
enter into an identical liability.  The guidance was effective for our
interim reporting period ending on December 31, 2009.  The
implementation did not have a material impact on our financial position, results
of operations or cash flows.





Other
Accounting Changes





In
October 2009, the FASB amended its Emerging Issues Task Force (“EITF”)
authoritative guidance addressing revenue arrangements with multiple
deliverables.  The guidance requires revenue to be allocated to
multiple elements using relative fair value based on
vendor-specific-objective-evidence, third party evidence or estimated selling
price. The residual method also becomes obsolete under this
guidance.  This guidance is effective for our interim reporting period
ending on September 30, 2010.  We are currently evaluating the impact
of the implementation of this guidance on our financial position, results of
operations and cash flows.


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NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
3 – CONDENSED CONSOLIDATED BALANCE SHEET COMPONENTS





December
      31,
              2009(Unaudited)
            
            
            June
      30, 2009Accounts
      receivable, netAccounts
      receivable, gross
            
            
            $
            3,107,307
            
            
            $
            3,513,756Allowance
      for doubtful accounts
            
            
            
            (40,000
            )
            
            
            (50,000
            )Allowance
      for returns
            
            
            
            (136,269
            )
            
            
            (36,206
            )$
            2,931,038
            
            
            $
            3,427,550Inventories,
      net of reservesRaw
      materials
            
            
            $
            2,160,293
            
            
            $
            2,184,245Finished
      goods
            
            
            
            5,017,821
            
            
            
            4,549,431Less:  reserves
      for obsolescence
            
            
            
            (282,916
            )
            
            
            (341,235
            )$
            6,895,198
            
            
            $
            6,392,441Property
      and Equipment, net
            Useful
      LivesEquipment
            3 –
      7 years
            
            $
            2,894,265
            
            
            $
            2,801,027Furniture
      and fixtures
            7
      years
            
            
            578,672
            
            
            
            578,672Automobiles
            5
      years
            
            
            30,434
            
            
            
            30,434Leasehold
      improvements
            5 –
      10 years
            
            
            909,772
            
            
            
            895,909Tooling
      and molds
            3
      years
            
            
            2,877,405
            
            
            
            2,908,778Construction-in-progress
            
            
            
            304,710
            
            
            
            297,2307,595,258
            
            
            
            7,512,050Less:
      Accumulated depreciation and amortization
            
            
            
            5,809,285
            
            
            
            5,415,064$
            1,785,973
            
            
            $
            2,096,986Goodwill
      and other intangible assets, netGoodwill
            
            
            $
            3,965,977
            
            
            $
            3,965,977Other
            1-5
      years
            
            
            46,000
            
            
            
            46,0004,011,977
            
            
            
            4,011,977Less:
      Accumulated amortization
            
            
            
            427,746
            
            
            
            427,746$
            3,584,231
            
            
            $
            3,584,231








NOTE
4 – DEBT





Bank
Debt





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





December
      31, 2009(Unaudited)
            
            
            June
      30, 2009Short-term
      capital lease obligation
            
            $
            –
            
            
            $
            69,815Bank
      term notes
            
            $
            1,500,000
            
            
            $
            1,500,000Bank
      line of credit
            
            
            1,615,866
            
            
            
            1,249,132Less:
      current maturities
            
            
            –
            
            
            
            –Long-term
      debt
            
            $
            3,115,866
            
            
            $
            2,749,132Total
      bank debt
            
            $
            3,115,866
            
            
            $
            2,818,947


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NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
4 – DEBT (CONTINUED)





On
February 12, 2008, the Company entered into an agreement with Sovereign Bank for
a three year revolving line of credit.  As amended, the advance limit
under the line of credit is the lesser of: (a) $4,900,000; or (b) up to 80% of
eligible domestic accounts receivable and up to the lesser of $750,000 or 75% of
eligible foreign receivables plus up to the lesser of: (i) $2,500,000; 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 and its foreign receivables and requires payments of interest only
through the facilities three year term.  As amended on October 27,
2009, the interest rate on the term note and the line of credit varies based on
the bank’s prime rate and is equal to the greater of the bank’s prime rate plus
3.25% or 7%.  At December 31, 2009 the applicable interest rate on
amounts drawn under the term note and the line of credit was 7%.





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 December 31, 2009, this note had a principal
balance of $1,500,000.  As of December 31, 2009, the Company had an
outstanding balance of $1,615,866 under the revolving line and approximately
$627,000 of undrawn availability under the credit line.  At June 30,
2009, the Company had outstanding with the bank the $1,500,000 term note and had
an outstanding balance of $1,249,132 drawn under its revolving credit line, with
about $1,005,000 of undrawn availability.





The
Company’s current credit facilities are subject to financial
covenants.  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 December 31, 2009 and June 30, 2009, the Company
was in compliance with all of its financial covenants.








Convertible
Debt





On
September 24, 2008, the Company completed a $1,250,000 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 the Company’s
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
$1,250,000 on substantially the same terms and conditions.





The
Company may call the three year warrants, subject to MicroCapital’s preemptive
right to exercise, at a redemption price of $0.001 per share.  The
three year warrants may only be called after the earlier of 90 days after the
registration statement is effective or June 24, 2009 if the closing sale price
of the Company’s common stock equals or exceeds $1.83 per share for at least 24
trading days within a 30 trading day period; this threshold price increases by
$0.02 per share starting with the end of the following calendar
month.  MicroCapital has agreed to limit the number of shares that may
be acquired upon the exercise of warrants by them to 4.999% of the Company’s
outstanding shares of common stock, which may be waived by MicroCapital upon 60
days notice.  MicroCapital has also agreed to limit the number of
shares that may be acquired upon the exercise the warrants to 9.999% of the
Company’s outstanding shares of common stock; this limit may not be
waived.  The Company has registered the shares potentially issuable as
a result of the transaction.


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NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
4 – DEBT (CONTINUED)





The
transaction was recorded in accordance with EITF 00-27 “Application of Issue
#98-5 to Certain Convertible Instruments” and EITF 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjusted Conversion Ratios" (ASC Topic 470-20), on a relative fair value
basis.  The $486,615 fair value of the warrants and the debt’s
beneficial conversion feature was recorded to equity and as a debt discount to
the value of the convertible note.  This discount is being amortized
using the effective interest method over the three year term of the convertible
note.  Amortization of debt discount on this convertible note payable
amounted to $35,173 and $67,852, respectively, for the three and six months
ended December 31, 2009.  The remaining unamortized discount was
$333,978 at December 31, 2009.  In connection with this transaction,
the Company also recognized a $63,955 increase in its deferred tax liabilities
reflecting the non-deductible nature of future debt discount amortization that
will result from the value of the beneficial conversion feature.





NOTE
5 – LOSS PER SHARE





Basic
loss per share is computed using the weighted average number of common shares
outstanding.  Diluted loss per share is computed using the weighted
average number of common shares outstanding as adjusted for the incremental
shares attributable to outstanding options, restricted stock units and warrants
to purchase common stock.





The
following table sets forth the computation of the basic and diluted loss per
share:





Three
      Months Ended
              December
      31,
            
            
            Six
      Months Ended
              December
      31,2009
            
            
            2008
            
            
            2009
            
            
            2008Numerator
      for basic and diluted:Net
      loss
            
            $
            (50,856
            )
            
            $
            (516,737
            )
            
            $
            (310,085
            )
            
            $
            (39,341
            )Denominator
      :For
      basic loss per common share –
              weighted
      average shares outstanding
            
            
            11,945,712
            
            
            
            11,721,467
            
            
            
            11,891,969
            
            
            
            11,719,283Effect
      of dilutive securities -  stock options,
              restricted
      stock units and warrants
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –For
      diluted loss per common share –
              weighted
      average shares outstanding adjusted
              for
      assumed exercises
            
            
            11,945,712
            
            
            
            11,721,467
            
            
            
            11,891,969
            
            
            
            11,719,283Basic
      loss per share
            
            $
            (0.00
            )
            
            $
            (0.04
            )
            
            $
            (0.03
            )
            
            $
            (0.00
            )Diluted
      loss per share
            
            $
            (0.00
            )
            
            $
            (0.04
            )
            
            $
            (0.03
            )
            
            $
            (0.00
            )





The
following options and warrants to purchase common stock were excluded from the
computation of diluted loss per share for the three and six months ended
December 31, 2009 and 2008 because their exercise price was greater than the
average market price of the common stock or as a result of the Company’s net
loss for those periods:





Three
      Months Ended
              December
      31,
            
            
            Six
      Months Ended
              December
      31,2009
            
            
            2008
            
            
            2009
            
            
            2008Anti-dilutive
      options and warrants
            
            
            1,108,436
            
            
            
            791,605
            
            
            
            1,108,436
            
            
            
            786,105


16
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MEDIA
SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES




NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS









NOTE
6 – STOCK-BASED COMPENSATION





The
effect of recording stock-based compensation for the three and six months ended
December 31, 2009 and 2008 was as follows:





Three
      Months Ended
              December
      31,
            
            
            Six
      Months Ended
              December
      31,2009
            
            
            2008
            
            
            2009
            
            
            2008Stock-based
      compensation expense by type of award:Employee
      stock options
            
            $
            69,411
            
            
            $
            83,634
            
            
            $
            140,556
            
            
            $
            162,346Non-employee
      director stock options
            
            
            –
            
            
            
            16,738
            
            
            
            –
            
            
            
            71,299Non-employee
      restricted stock units
            
            
            –
            
            
            
            7,350
            
            
            
            –
            
            
            
            14,700Employee
      restricted stock units
            
            
            72,972
            
            
            
            61,425
            
            
            
            142,024
            
            
            
            140,756Non-employee
      director restricted stock units
            
            
            19,653
            
            
            
            35,848
            
            
            
            68,153
            
            
            
            35,848Forfeiture
      rate adjustment
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (56,751
            )Amounts
      capitalized as inventory
            
            
            (3,237
            )
            
            
            3,010
            
            
            
            (5,130
            )
            
            
            (4,782
            )Total
      stock-based compensation expense
            
            $
            158,799
            
            
            $
            208,005
            
            
            $
            345,603
            
            
            $
            363,416Tax
      effect of stock-based compensation recognized
            
            
            (53,591
            )
            
            
            (78,721
            )
            
            
            (116,247
            )
            
            
            (163,154
            )Net
      effect on net loss
            
            $
            105,208
            
            
            $
            129,284
            
            
            $
            229,356
            
            
            $
            200,262Excess
      tax benefit effect on:Cash
      flows from operations
            
            $
            –
            
            
            $
            –
            
            
            $
            –
            
            
            $
            –Cash
      flows from financing activities
            
            $
            –
            
            
            $
            –
            
            
            $
            –
            
            
            $
            –Effect
      on loss per share:Basic
            
            $
            0.01
            
            
            $
            0.01
            
            
            $
            0.02
            
            
            $
            0.02Diluted
            
            $
            0.01
            
            
            $
            0.01
            
            
            $
            0.02
            
            
            $
            0.02





As of
December 31, 2009, the unrecorded deferred stock-based compensation balance was
$580,136 after estimated forfeitures and will be recognized over an estimated
weighted average amortization period of about 1.7 years.  During the
three and six months ended December 31, 2009, the Company did not grant any
stock options.  During the three and six months ended December 31,
2009, the Company granted 577,000 shares of restricted stock with a grant date
fair value of $243,050 after estimated forfeitures.





During
the quarter ended September 30, 2008, the Company reviewed its forfeiture rate
experience associated with historic stock-based compensation
grants.  In doing so, it was determined that an increase in its
forfeiture rate estimates were appropriate.  In connection with this
revision in estimate, the Company recognized a non-recurring cumulative effect
pretax benefit in the amount of $56,751 during the quarter ended September 30,
2008.





Valuation
Assumptions





The
Company estimates the fair value of stock options using a Black-Scholes
option-pricing model.  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:





Three
      Months Ended
              December
      31,
            
            
            Six
      Months Ended
              December
      31,2009(b)
            
            
            2008(a)
            
            
            2009(b)
            
            
            2008Risk-free
      interest rate
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            2.8%Dividend
      yield
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            0.0%Expected
      stock price volatility
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            58%Average
      expected life of options
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            3.2
      years(a)No
      stock options were granted during the three months ended December 31,
      2008.(b)No
      stock options were granted during the three or six months ended December
      31, 2009.


17
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MEDIA
SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES




NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS









NOTE
6 – STOCK-BASED COMPENSATION (CONTINUED)





Authoritative
guidance issued by the FASB 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.  For the current fiscal
year, the expected stock price volatility assumption was determined using the
Company’s historic volatility.





The
Company uses the simplified method suggested by the SEC in authoritative
guidance 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.  Based on studies of the Company’s
historic actual option terms, compared with expected terms predicted by the
simplified method, the Company has concluded that the simplified method yields
materially accurate expected term estimates.  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 three plans (the “Plans”): the Company's
1998 Incentive Plan, as Amended and Restated (the “1998 Plan”); the Company’s
2006 Stock Incentive Plan, as Amended and Restated (the “2006 Plan”); and the
Company’s 2009 Stock Incentive Plan (the “2009 Plan”).  Under these
Plans, non-employee directors, officers, key employees, consultants and all
other employees may be granted options to purchase shares of the Company’s
stock, restricted stock units and other types of equity awards.  Under
the equity incentive program, 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.





As of
December 31, 2009, there are no common shares remaining available for future
issuance under the 1998 Plan, which expired on June 17, 2008.  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 December 31,
2009, 6,875 common shares were available for future issuance under the 2006
Plan.  Under the Company’s 2009 Plan, 1,250,000 common shares are
authorized for issuance through awards of options or other equity
instruments.  As of December 31, 2009, 498,000 common shares were available
for future issuance under the 2009 Plan.





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





Number
      of
              Shares
            
            
            Weighted
              Average
              Exercise
      PriceBalance
      outstanding at June 30, 2009
            
            
            1,085,216
            
            
            $
            3.41Six
      months ended December 31, 2009:Options
      granted
            
            
            –
            
            
            
            –Options
      exercised
            
            
            –
            
            
            
            –Options
      cancelled/expired/forfeited
            
            
            (12,300
            )
            
            
            2.07Balance
      outstanding at December 31, 2009
            
            
            1,072,916
            
            
            $
            3.42


18
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MEDIA
SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES




NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
6 – STOCK-BASED COMPENSATION (CONTINUED)





The options outstanding and exercisable
at December 31, 2009 were in the following exercise price ranges:




Options
      Outstanding
            
            
            Options
      ExercisableRange
      of
              Exercise
              Prices
            
            
            Number
              Outstanding
            
            
            Weighted
              Average
              Remaining
              Contractual
              Life-Years
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Number
              Vested
      and
              Exercisable
            
            
            Weighted
              Average
              Exercise
              Price$
            0.43
      to $0.85
            
            
            
            26,600
            
            
            
            3.3
            
            
            $
            0.59
            
            
            
            26,600
            
            
            $
            0.59$
            1.00
      to $2.00
            
            
            
            418,915
            
            
            
            3.6
            
            
            
            1.95
            
            
            
            272,700
            
            
            
            1.93$
            2.01
      to $6.33
            
            
            
            627,401
            
            
            
            5.0
            
            
            
            4.52
            
            
            
            440,349
            
            
            
            4.531,072,916
            
            
            
            4.7
            
            
            $
            3.42
            
            
            
            739,649
            
            
            $
            3.43





At
December 31, 2009, 10,000 of the Company’s exercisable options were
in-the-money.  At December 31, 2009, the aggregate intrinsic value of
options outstanding and exercisable was $4,500.  No options were
exercised during the three or six months ended December 31, 2009.





No stock
options were granted during the three or six months ended December 31,
2009.  No stock options were granted during the three months ended
December 31, 2008.  The weighted average grant date fair value of
options granted during the six months ended December 31, 2008 was
$0.84.





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





Restricted
Stock Units





During
the three months ended December 31, 2009, the Company’s Board of Directors
approved the grant of 252,000 shares of restricted stock units to non-employee
directors and 325,000 shares of restricted stock units to
employees.  These restricted stock units vest over two years from the
grant date for non-employee directors and over three years from the grant date
for employees.  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.  Stock-based compensation expense, net of estimate forfeitures,
for restricted stock units for the three and six months ended December 31, 2009
was $92,625 and $210,177,  respectively.





As of
December 31, 2009, there was $322,733 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 2.0 years.





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
      ShareBalance
      unvested at June 30, 2009
            
            
            625,791
            
            
            $
            773,510
            
            
            $
            1.24Six
      months ended December 31, 2009:Restricted
      stock units granted
            
            
            577,000
            
            
            
            403,900
            
            
            
            0.70Restricted
      stock units vested
            
            
            (217,948
            )
            
            
            (354,325
            )
            
            
            1.63Restricted
      stock units cancelled/forfeited
            
            
            (3,323
            )
            
            
            (6,646
            )
            
            
            2.00Balance
      unvested at December 31, 2009
            
            
            981,520
            
            
            $
            816,439
            
            
            $
            0.83


19
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MEDIA
SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE 7 – ACCRUED PRODUCT
WARRANTY COSTS





The
Company provides a warranty for all of its consumable supply products and for
its INKlusive printer program, which was discontinued on April 1,
2009.  Although no new INKlusive contracts were originated after April
1, 2009, remaining service and supply commitments under the program continue to
be honored.  The Company’s warranty stipulates that it will pay
reasonable and customary charges for the repair of a printer needing service as
a result of using the Company’s products.  The Company estimates the
costs that may be incurred and records a liability in the amount of such costs
at the time product revenue is recognized.  Factors that may affect
the warranty liability and expense include the number of units shipped to
customers, historical and anticipated rates of warranty claims and cost per
claim.  The Company periodically assesses the adequacy of the recorded
warranty liability and adjusts the amount as necessary.  These
expenses are classified as a separately captioned item in cost of goods
sold.





Changes
in accrued product warranty costs for the three and six months ended December
31, 2009 and 2008 were as follows:





Three
      Months Ended
              December
      31,
            
            
            Six
      Months Ended
              December
      31,2009
            
            
            2008
            
            
            2009
            
            
            2008Accrued
      product warranty costs
              at
      the beginning of the period
            
            $
            436,578
            
            
            $
            205,563
            
            
            $
            436,578
            
            
            $
            198,666Warranties
      accrued during the period
            
            
            519,491
            
            
            
            227,330
            
            
            
            987,863
            
            
            
            441,499Warranties
      settled during the period
            
            
            (508,102
            )
            
            
            (245,659
            )
            
            
            (976,474
            )
            
            
            (452,931
            )Net
      change in accrued warranty costs
            
            
            11,389
            
            
            
            (18,329
            )
            
            
            11,389
            
            
            
            (11,432
            )Accrued
      product warranty costs
              at
      the end of the period
            
            $
            447,967
            
            
            $
            187,234
            
            
            $
            447,967
            
            
            $
            187,234








NOTE
8 – RESEARCH AND DEVELOPMENT





Research
and product development costs, which consist of salary and related benefits
costs of the Company’s 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
the three months ended December 31, 2009 and 2008, the Company’s research and
product development costs were $372,004 and $348,194,
respectively.  For the six months ended December 31, 2009 and 2008,
the Company’s research and product development costs were $712,884 and $721,246,
respectively.








NOTE
9 – ADVERTISING EXPENSES





Advertising
expenses are deferred until the first use of the
advertising.  Deferred advertising costs at December 31, 2009 and 2008
totaled $44,555 and $15,276, respectively.  Advertising expense for
the three months ended December 31, 2009 and 2008 amounted to $172,168 and
$180,559, respectively.  Advertising expense for the six months ended
December 31, 2009 and 2008 amounted to $307,504 and $392,206,
respectively.


20
 To Table of Contents


MEDIA
SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES




NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







NOTE
10 – LITIGATION AND CONTINGENCIES





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.  In March 2009 the court dismissed, without
prejudice, the Company’s antitrust claims relating to Xerox’s loyalty rebate
programs.  In the ruling, the court relied on a 2001 Settlement
Agreement between the parties resulting from a different matter, and found that
before such claims are pursued, the Company must submit to
arbitration.  In September 2009 the court dismissed the Company’s
remaining antitrust claims not relating to Xerox’s loyalty rebate
programs.  The patent infringement claims remaining before the court
may be heard in the spring or summer of 2010.  The loss of all or a
part of the patent infringement claims 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 that it
therefore 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 $1,500,000.  Proceeds of this settlement are recognized in
the Company’s results of operations.  The settlement is recorded as a
reduction to operating expense during the quarter ended 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.





Other
than the above, as at December 31, 2009, the Company was not a party to any
material pending legal proceeding, other than ordinary routine litigation
incidental to its business.




NOTE
11 – IMPAIRMENT CHARGE





In
conjunction with a plan approved by the Company’s Board of Directors, the
Company closed its not yet operational manufacturing facility in
China.  The impairment costs were recognized in accordance with the
provisions of SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (ASC Topic 360).During the three
and six months ended December 31, 2009, cash charges totaling $6,917 and
$26,976, respectively, were incurred against impairment reserves established in
the prior fiscal year.  At December 31, 2009, the remaining reserve
for these impairment costs was $13,475.




NOTE
12 – SUBSEQUENT EVENT
  On
February 9, 2010, the Company became aware that a printer original equipment
manufacturer (OEM) had sent notices to several of the Company’s European
distribution customers alleging that a product line sold by them, that the
Company manufactures and distributes, infringes on the OEM’s European patent
rights and demanding that each customer cease sale of the
product.  The Company has decided to cease offering these products for
sale in Europe and the U.S. while the Company evaluates these
claims.  At this time the Company is unable to determine the potential
impact this event may have on its financial position, results of operations, or
cash flows.  For the three months ended December 31, 2009, sale of
these affected products in the U.S. and Europe represented about 4%
of  the Company’s consolidated net revenues and less than 2% of its
gross profits.  At December 31, 2009, these products represented less
than 6% of  the Company’s consolidated inventories.


21
 To Table of Contents


ITEM 2.   MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





FORWARD
LOOKING STATEMENTS





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





We cannot
guarantee that any forward-looking statement will be realized, although we
believe we have been prudent in our plans and assumptions. We cannot predict
whether future developments affecting us will be those anticipated by
management, and there are a number of factors that could adversely affect our
future operating results or cause our actual results to differ materially from
the estimates or expectations reflected in such forward-looking statements.
 Factors that might cause or contribute to such differences include, but
are not limited to, those discussed in this section and those set forth in Item
6, “Factors Affecting Results Including Risks and Uncertainties” included
in  our Form 10-K for the year ended June 30, 2009, filed September
24, 2009.  You should carefully review these risks and also review the
risks described in other documents we file from time to time with the SEC. 
You are cautioned not to place undue reliance on these forward-looking
statements.  We undertake no obligation to publicly update
forward-looking statements, whether as a result of new information, future
events or otherwise.





You
should read the following discussion and analysis in conjunction with the
information set forth in the unaudited financial statements and notes thereto,
included elsewhere herein, and the audited financial statements and the notes
thereto, included in our Form 10-K for the year ended June 30, 2009, filed
September 24, 2009.








EXECUTIVE
SUMMARY





Media
Sciences International, Inc. is the leading independent manufacturer of color
toner cartridges and solid inks for use in business color
printers.  Our products are distributed through an international
network of dealers and distributors.





For the
three and six months ended December 31, 2009 we experienced 8% and 2% top line
net revenue growth over same year ago periods.  Within this growth we
continued to experience attrition of more price sensitive, lower margin, and
less quality oriented imaging channel volume.  This attrition was more
than offset by continued growth of our sales volume into the office products and
technology distribution channel.  These channels tend to place greater
value on product quality that is intellectual property safe and backed by
warranty and technical support.   Our top-line also continues to
benefit from the continued higher growth rate of our European
business.





Our gross
margins have been favorably affected by these shifts in our revenue
mix.  These shifts have resulted in a year-over-year reduction in the
level of customer rebates and our European growth was further benefitted by the
combination of a European price increase we implemented last year and improved
euro exchange rates.  Collectively, these items enhanced both our top
line revenues and margins during the quarter.  These favorable trends
continue to be offset by warranty costs that remain elevated at historically
high levels.  Reducing warranty expense has been and remains a high
priority of management.


22
 To Table of Contents


Following
a year of cost reduction efforts that included closure of our start-up
manufacturing operation in China, a reduction in our employee headcount of about
27%, and temporary company-wide compensation concessions, we are focused on
efforts to grow our top line and further improve our profitability.





The
following items significantly impacted our comparative reported results of
operations for the three and six months ended December 31, 2009:





Product
Warranty.During the three and six months ended December 31,
2009, we recognized $519,000 and $988,000 of warranty expense, respectively,
representing a $292,000 and $546,000 increase, respectively over the amount of
warranty expense recognized in the comparative year ago
periods.  These increases represent after tax increases of about
$193,000 ($0.02 per share) and $360,000 ($0.03 per share), respectively, for the
three and six months ended December 31, 2009.





Foreign Currency
Effects.For the three months ended December 31, 2009, as
compared with the year ago period, appreciation of the euro helped benefit our
top line revenues and margins by about $75,000.  On top of this, we
estimate that the European price increases we implemented last January added
another $50,000 in revenues and margins on a comparative basis.  For
the six months ended December 31, 2009, as compared with the year ago period, we
estimate on a constant dollar basis, the devaluation of the British pound
adversely affected our revenues and margins by about
$125,000.  However, we estimate that our European price increases more
than compensated this devaluation.





Stock-Based
Compensation.For the three and six months ended December 31,
2009, our non-cash stock-based compensation expense recognized under
authoritative guidance totaled $159,000 ($105,000 after tax or $0.01 per share)
and $346,000 ($229,000 after tax or $0.02 per share),
respectively.  In the prior fiscal year, non-cash stock-based
compensation expense totaled $208,000 ($129,000 after tax or $0.01 per share)
and $363,000 ($200,000 after tax or $0.02 per share), respectively, for the
three and six months ended December 31, 2008.





Temporary Company-wide Compensation
Concessions.In January 2009, we implemented a company-wide
10% salary, wage and bonus concession.  In the fall of 2008, our
directors also waived their cash compensation.  Effective October 1,
2009, half of these temporary concessions were reinstated and are reflected in
our operating results.  For the three and six months ended December
31, 2009, the savings associated with these temporary concessions were about
$65,000 (about $43,000 after tax or about $0.00 per share) and $196,000 (about
$129,000 after tax or about $0.01 per share), respectively.





Litigation.  For the
three and six months ended December 31, 2009, litigation costs totaled $18,000
(about $12,000 after tax or about $0.00 per share) and $23,000 (about $15,000
after tax or about $0.00 per share).  In the comparative year ago
periods, litigation costs totaled $79,000 (about $47,000 after tax or about
$0.00 per share) and $263,000 (about $158,000 after tax or about $0.01 per
share), respectively, for the three and six months ended December 31,
2008.  In August 2008, the first fiscal quarter of 2009, we settled
litigation with our former insurance broker in the amount of $1,500,000 (about
$990,000 after tax or about $0.08 per share).  For more information
regarding our litigation, see Note 10 to the condensed consolidated financial
statements.





Business Formation and Start-up
Costs.For the three and six months ended December 31, 2009,
we incurred no formation and start-up costs associated with the China operations
due to closure of the facility and ceasing the start-up activities
late  in our prior fiscal year.  In the prior fiscal year,
formation and start-up costs associated with these operations totaled $344,000
(about $206,000 after tax or about $0.02 per share) and $643,000 (about $386,000
after tax or about $0.03 per share), respectively, for the three and six months
ended December 31, 2008.





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


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The
following table sets forth the key quarterly and annual GAAP financial measures
we use to manage our business (in thousands, except per share
data).





Fiscal
      Year 2010
            
            Fiscal
      Year 20091st
            2st
            
            1st
            
            2nd
            
            3rd
            
            4thQuarter
            Quarter
            
            Quarter
            
            Quarter
            
            Quarter
            
            QuarterNet
      revenues
            $5,507
            $5,586
            
            $5,752
            
            $5,157
            
            $5,184
            
            $5,625Cost
      of goods sold
            $3,377
            $3,074
            
            $3,131
            
            $3,035
            
            $3,081
            
            $3,576Gross
      profit
            $2,129
            $2,512
            
            $2,621
            
            $2,122
            
            $2,103
            
            $2,049Gross
      margin
            38.7%
            45.0%
            
            45.6%
            
            41.2%
            
            40.6%
            
            36.4%Income
      (loss) from operations (a)(c)
            $(203)
            $44
            
            $901
            
            $(814)
            
            $(1,583)
            
            $0Operating
      margin
            (3.7)%
            (0.0)%
            
            15.7%
            
            (15.8)%
            
            (30.5)%
            
            0.0%Net
      income (loss)(b)(c)(d)(e)
            $(259)
            $(51)
            
            $477
            
            $(517)
            
            $(1,496)
            
            $(140)Diluted
      earnings (loss) per share
            $(0.02)
            $(0.00)
            
            $0.04
            
            $(0.04)
            
            $(0.13)
            
            $(0.01)Stock-based
      compensation included in above results:(a)Pretax
            $187
            $159
            
            $155
            
            $208
            
            $217
            
            $197(b)After-tax
            $124
            $105
            
            $84
            
            $141
            
            $145
            
            $132(c)1st
      quarter 2009 includes the benefit of the $1,500 litigation settlement
      (about $990 after tax).
              (d)
      3rdquarter 2009 includes $1,121
      (about $740 after tax) of impairment charges primarily associated with the
      closure of the Company’s manufacturing operations in
      China.  4thquarter 2009 includes $112
      (about $74 after tax) of recoveries and cash charges realized related to
      the impairment.
              (e)3rd
      & 4th
      quarter 2009, respectively, include a $323 and $209 non-cash charge
      related to a deferred tax asset valuation
  allowance.








RESULTS
OF OPERATIONS





Net Revenues. For the three
months ended December 31, 2009, as compared to the same period last year, net
revenues increased by $430,000 or 8% from $5,157,000 to
$5,586,000.  This increase in net revenues was primarily driven by the
revenue impact of greater year-over-year sales of toner-based products and
continued rapid growth of our European sales.  Year-over-year for the
three months, sales of color toner cartridges increased by about 18% and solid
ink product sales decreased by about 10%.





For the
six months ended December 31, 2009, as compared to the same period last year,
net revenues increased by $184,000 or 2% from $10,909,000 to
$11,093,000.  This increase in net revenues was primarily driven by
the revenue impact of greater year-over-year sales of toner-based products and
continued rapid growth of our European sales, partially offset by attrition in
our sales volumes to the price sensitive and less quality oriented imaging
channel.  Year-over-year for the six months, sales of color toner
cartridges increased by about 11% and solid ink product sales decreased by about
12%.





Price
increases we implemented in January 2009 materially offset the effects of
currency exchange rates for the six months ended December 31, 2009 and provided
a positive benefit to our revenues, as discussed in the Executive Summary,
versus the comparable year ago periods.  We ended the quarter with an
order backlog of $326,000, representing a $47,000 increase over the prior
quarter ended September 30, 2009.  For the comparative year ago
period, we had $343,000 of order backlog at December 31, 2008.





Gross Profit. Consolidated gross
profit for the three months ended December 31, 2009, compared to the same period
last year, increased by $390,000 or 18% to $2,512,000 from
$2,122,000.  For the three months ended December 31, 2009, our gross
margins increased by about 380 basis points to 45.0% from 41.2% in the
comparative year ago period.  The year-over-year improvement in our
gross profit and margins for the quarter was attributed to a number of factors
including: decreased level of customer rebates; lower tool and die depreciation;
decreases in our inventory obsolescence reserves and sales mix.  As
discussed in the Executive Summary, a combination of favorable exchange rate
movements, a price increase we implemented last January in our European pricing,
and growth in our European revenues also had a positive impact on
margins.  These favorable items were partially offset by the large
year-over-year increase in our warranty expense and higher inbound freight
costs.


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Consolidated
gross profit for the six months ended December 31, 2009, compared to the same
period last year, decreased by $101,000 or 2% to $4,642,000 from
$4,743,000.  For the six months ended December 31, 2009, our gross
margins decreased by about 170 basis points to 41.8% from 43.5% in the
comparative year ago period.  The year-over-year decrease in our gross
profit and margins for the six months was primarily attributed to an increase in
our warranty expense, partially offset by lower year-over-year customer rebates
and a decrease in our inventory obsolescence reserves.





Our
margins reflect a portfolio of products.  Generally, solid ink
products generate greater margins than do toner-based products.  While
margins within the solid ink product line are very consistent, margins within
the toner-based product line vary quite significantly.  As a result,
our margins can vary materially, not only as a function of the solid ink to
toner sales mix, but of the sales mix within the toner-based product line
itself.  We expect to see changes in our margins, both favorable and
unfavorable, as a result of continued changes in our sales mix.





Research and Development.
  Research and development spending for the three months ended
December 31, 2009, compared to the same period last year, increased by $24,000
or 7% to $372,000 from $348,000.  For the six months ended December
31, 2009, compared to the same period last year, decreased by $8,000 or 1% to
$713,000 from $721,000.  The nominal year-to-date decrease in our
research and development costs is attributed to our cost reduction efforts over
the past year.  Looking forward, we expect our research and
development spending to represent a similar proportion of our net
revenues.





Selling, General and
Administrative. Selling, general
and administrative expense, exclusive of depreciation and amortization, for the
three months ended December 31, 2009, compared to the same period last year,
decreased by $463,000 or 19% to $2,033,000 from $2,496,000.   For
the six months ended December 31, 2009, selling, general and administrative
expense, exclusive of depreciation and amortization, as compared to the same
period last year, decreased by $1,298,000 or 25% to $3,950,000 from
$5,248,000.





The
decrease in selling, general and administrative expense was primarily driven by
our cost reduction efforts and lower year-over-year costs of litigation and
improvements in our currency translation loss experience.  These are
described in more detail in the Executive Summary.





Depreciation and Amortization.
Non-manufacturing
depreciation and amortization expense for the three months ended December 31,
2009 compared to the same period last year, decreased by $29,000 or 32% to
$63,000 from $92,000.  For the six months ended December 31, 2009,
compared to the same period in 2008, non-manufacturing depreciation and
amortization expense decreased by $48,000 or 26% to $138,000 from
$186,000.  The decrease in non-manufacturing depreciation and
amortization expense reflects the decline in our non-manufacturing fixed asset
additions over the comparative periods.





Interest Expense. For the three and
six months ended December 31, 2009, we incurred interest expense of $90,000 and
$177,000, respectively.  This compares with interest expense of
$74,000 and $129,000, respectively, for the prior year’s three and six months
ended December 31, 2008.  These changes were the result of
year-over-year increases in the Company’s level of debt and higher interest
rates.





Income Taxes. For the three and
six months ended December 31, 2009, we recorded an income tax benefit of $16,000
and $99,000, respectively.  This compares with income tax benefits of
$396,000 and $26,000, respectively, for the three and six months ended December
31, 2008.  For the three and six months ended December 31, 2009, our
effective tax rates were 24.1%.  This compares with 43.4% and 40.0%,
respectively, for the three and six months ended December 31,
2008.  Our effective blended 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.





Net Loss. For the three and
six months ended December 31, 2009, we lost $51,000 ($0.00 per share basic and
diluted) and $310,000 ($0.03 per share basic and diluted).  This
compares with a net loss of $517,000 ($0.04 per share basic and diluted) and
$39,000 ($0.00 per share basic and diluted), respectively, for the three and six
months ended December 31, 2008.  Excluding the benefit of the
non-recurring litigation settlement recognized in the comparative year ago
period ended December 31, 2008, we would have generated a net loss of about
$1,029,000 on a pro forma basis.


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RECENT
ACCOUNTING PRONOUNCEMENTS





See Note
2 to the condensed consolidated financial statements, included in Item 1 of Part
I of this report, for a full description of recent accounting pronouncements,
including the expected dates of adoption and estimated effects on our
consolidated financial statements, which is incorporated herein by
reference.








CRITICAL
ACCOUNTING POLICIES





For a
description of our critical accounting policies see Management’s Discussion and
Analysis of Financial Condition and Results of Operations and Note 1 to the
audited financial statements included in our Form 10-K for the year ended June
30, 2009 filed September 24, 2009.  With the exception of changes to
our accounting policies and related disclosures resulting from the Accounting
Standards Codification  and adoption of authoritative guidance for
fair value measurements and that associated  with derivatives and
hedging related to whether an instrument of an embedded feature is considered to
be indexed to an entity’s own stock under ASC 715-10 (pre-codification EITF
Issue No. 07-5), there were no significant changes in our critical accounting
policies during the six months ended December 31, 2009.  See Note 2 to
the condensed consolidated financial statements, included in Item 1 of Part I of
this report, for a complete discussion of the impact adoption of this
authoritative guidance had on our accounting policies.








LIQUIDITY
AND CAPITAL RESOURCES





During
the six months ended December 31, 2009, our cash and equivalents decreased by
$112,000 to $438,000.  $323,000 of this decrease resulted from
operating activities, $83,000 was used in investing activities, and $315,000 was
provided by financing activities.  Net cash used in investing
activities of $83,000 included the purchase of plant equipment, tooling and IT
hardware and software, representing a decrease of $514,000 or 86% over the
$597,000 invested during the comparative six months year ended December 31,
2008.  These capital investments were primarily funded by draws on our
bank credit line.





We used
$323,000 of cash in our operating activities for the six months ended December
31, 2009 as compared with $193,000 used during the comparative six months ended
December 31, 2008.  The $323,000 of cash used by operating activities
during the six months ended December 31, 2009 resulted from a $310,000 loss from
operations, non-cash charges totaling $746,000, and $759,000 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 drivers
behind the $759,000 increase in our non-cash working capital include: (1) a
$578,000 reduction in our trade obligations and other accrued expenses; (2) a
$439,000 increase in our inventories; and (3) a collective $206,000 decrease in
our deferred revenue and deferred rent liabilities.  These increases
were partially offset by a $371,000 decrease in our accounts receivable and a
$111,000 decrease in prepaid expenses and other current assets during the
quarter.





Our
INKlusive program generated operating cash flow in advance of the income
statement recognition associated with printer consumables being shipped and
revenues being recognized over the two year term of our typical INKlusive supply
agreement.  This advanced funding of the INKlusive contract
consideration by a third-party leasing company resulted in up-front cash
receipts and corresponding deferred revenue obligations.  As of
December 31, 2009, deferred revenue associated with the program totaled $86,000,
a decrease of $162,000 from $248,000 at June 30, 2009.  The operating
cash flow effect of this decrease in liability was a corresponding decrease in
cash flow generated by operations.  Based on declining INKlusive sales
volume, we made the decision to discontinue the program effective April 1,
2009.  Although no new INKlusive contracts were originated after April
1, 2009, remaining commitments under existing INKlusive supply obligations
continue to be honored.


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In the
comparative year ago period ended December 31, 2008 our financial position and
cash flows benefited from the following:





·
            A
      $1,500,000 litigation settlement received in August 2008.  The
      settlement was recorded as a reduction in operating expense as it
      represented a recovery of legal fees previously incurred;
    and


·
            A
      $1,250,000 convertible debt financing completed on September 24,
      2008.  In the transaction 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 the investor to purchase 387,787 shares of our common stock at
      $1.65 per share; and (b) three year warrants allowing the investor to
      repeat its investment up to $1,250,000 on substantially the same terms and
      conditions.  The three year warrants may be called by us if
      certain criteria are met.





On
February 12, 2008, we entered into an agreement with Sovereign Bank for a three
year revolving line of credit.  As amended, the advance limit under
the line of credit is the lesser of: (a) $4,900,000; or (b) up to 80% of
eligible domestic accounts receivable and up to the lesser of $750,000 or 75% of
eligible foreign receivables plus up to the lesser of: (i) $2,500,000; 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
and its foreign receivables and requires payments of interest only through the
facilities three year term.  As amended on October 27, 2009, the
interest rate on the term note and the line of credit varies based on the bank’s
prime rate and is equal to the greater of the bank’s prime rate plus 3.25% or
7%.  At December 31, 2009 the applicable interest rate on amounts
drawn under the term note and the line of credit was 7%.





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 December 31, 2009, this note had a principal balance of
$1,500,000.  As of December 31, 2009, we had an outstanding balance of
$1,615,866 under the revolving line and approximately $627,000 of undrawn
availability under the credit line.  At June 30, 2009, we had
outstanding with the bank the $1,500,000 term note and had an outstanding
balance of $1,249,132 drawn under its revolving credit line, with about
$1,005,000 of undrawn availability.





Our
current credit facilities are subject to financial covenants.  At June
30, 2009 and December 31, 2009, we were in compliance with all of our financial
covenants.  Current financial covenants include monitoring a ratio of
debt to tangible net worth and a fixed charge coverage ratio, each are described
below:





·
            Ratio of Debt to Tangible Net
      Worth -- The Borrower is not to cause or permit its ratio of total
      liabilities to Tangible Net Worth to be more than 2.5:1, tested quarterly.
      Tangible Net Worth is defined as book net worth less all intangible
      assets. Both total liabilities and Tangible Net Worth are to be determined
      according to GAAP.




·
            Fixed Charge Coverage Ratio --The Borrower is not to cause or permit its Fixed Charge coverage
      ratio, tested quarterly, on a rolling three month basis for the quarter
      ended December 31, 2009, on a rolling six, nine and twelve month basis for
      each quarter ending thereafter until quarter ending September 30, 2010;
      and thereupon for the quarter ending September 30, 2010 and each quarter
      thereafter based upon a trailing twelve month basis, to be less than
      1.05:1.  Fixed Charge is defined as earnings before interest,
      taxes, depreciation and amortization ("EBITDA") (including an add back for
      non-cash stock based compensation) less the sum
      of: cash taxes; cash capital expenditures; any cash dividends,
      distributions or loans, and other cash payments not captured on the
      current profit and loss statement, divided by
      principal payments on term debt (or capital leases), and cash interest.
      For all of the foregoing determinations, any equity contribution made to
      the Borrower will be applied to offset cash capital expenditures. For
      those of the foregoing determinations made during fiscal periods 2009 and
      2010 only which will be determined on a rolling twelve month basis, cash
      received by Borrower from convertible debt offerings and associated
      warrants will be applied to offset cash capital expenditures together with
      the payments made to PNC Equipment Finance LLC/PNC Leasing pursuant to
      paragraph 5 of the Third
Amendment.


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The most
restrictive of these covenants is the Fixed Charge Coverage
Ratio.  For the three months ended December 31, 2009, our Fixed Charge
Coverage Ratio was 2.9:1.  Reference should also be made to our “Risk
Factors” found in of our Form 10-K for the year ended June 30, 2009, filed
September 24, 2009, where we specifically discuss: “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.”





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.





SEASONALITY





Historically,
we have not experienced any significant seasonality in our
business.  As we continue to grow our international business relative
to our North American business and as our distribution channel customer mix
changes, we may experience a more notable level of seasonality, especially
during the summer months and other periods such as calendar year
end.





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 December 31, 2009.  In the future
we may hedge these exposures based on our assessment of their
significance.





Foreign
Currency Exchange Risk





A
significant 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 December
31, 2009, about 58% of our receivables were invoiced and collected in U.S.
dollars.  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.  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.





See the
discussion above under the heading "Executive Summary" in Item 2 of this report
regarding the impact during the current reporting periods of changes in foreign
exchange rates.


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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
December 31, 2009, we had about $3,116,000 of debt outstanding under its line of
credit and term notes.  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
Company incurring about $22,000 pretax ($15,000 after tax) of greater interest
expense.


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ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK





Reference
is made to the information set forth under the caption “Market Risk” included in
Item 2 of Part I of this report, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations.”  Also refer to the
last paragraph of “Liquidity and Capital Resources” contained in Item 2 of Part
I this report for additional discussion of issues regarding
liquidity.








ITEM 4.   CONTROLS AND PROCEDURES





Evaluation of Disclosure Controls
and Procedures.As required by Rule 13a-15(b) under the
Exchange Act, our management, with the participation of our Chief Executive
Officer and Chief Financial Officer, carried out an evaluation of 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 to ensure that information required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission's rules and forms,
and is accumulated and communicated to the Company's management, including its
Chief Executive Officer and Chief Financial Officer, or persons performing
similar functions, as appropriate, to allow timely decisions regarding required
disclosure.





Changes in Internal Control Over
Financial Reporting.  There has been no change in our internal
control over financial reporting identified in connection with the evaluation
required by Rule 13a-15(d) under the Exchange Act, that occurred during the
quarter ended December 31, 2009, that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.


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PART
II.  OTHER INFORMATION





ITEM 1.   LEGAL PROCEEDINGS





The
information set forth above under Note 10 contained in the “Notes to condensed
consolidated financial statements” in Item 1 of Part I of this report is
incorporated herein by reference.





ITEM 1A.   RISK FACTORS





A
description of factors that could materially affect our business, financial
condition or operating results is included in Item 1A “Risk Factors” of our Form
10-K for the year ended June 30, 2009, filed September 24, 2009 and is
incorporated herein by reference.





ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE
OF PROCEEDS





Not
applicable.





ITEM 3.  DEFAULTS UPON SENIOR SECURITIES





Not
applicable.





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





We held
an annual meeting of stockholders on December 17, 2009, at which our
stockholders voted on the following items:





1.
            the
      election of directors to serve until the next annual meeting and until
      their successors have been duly elected and qualified;
  and2.
            the
      ratification of the selection of Amper, Politziner & Mattia, P.C. as
      our independent registered public accounting firm for the fiscal year
      ending June 30, 2010.





The
nominees for directors were elected based upon the following votes:





For
            
            Votes
      Withheld1.
            Election
      of directorsMichael
      W. Levin
            8,714,617
            
            969,219Willem
      van Rijn
            8,705,070
            
            978,765Paul
      C. Baker
            8,734,124
            
            949,711Edwin
      Ruzinsky
            8,704,970
            
            978,865Henry
      Royer
            8,682,891
            
            1,000,944Dennis
      Ridgeway
            8,741,224
            
            942,611





The
voting results on the other proposals were as follow:





For
            
            Against
            
            Abstentions
            
            Non-Votes2.
            Ratification
      of selection of independent registered public accounting
    firm
            9,663,273
            
            20,330
            
            232
            
            –





ITEM 5.  OTHER INFORMATION





Not
applicable.




31
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ITEM 6.   EXHIBITS





The
following exhibits are filed with this report:





Exhibit
      No.
            
            Description10.1
            
            Fourth
      Agreement of Amendment to Revolving Loan and Security Agreement and Other
      Documents (incorporated by reference to Exhibit 10.1 of Form 8-K, filed on
      October 29, 2009)10.2
            
            Lease
      Extension Rider (incorporated by reference to Exhibit 10.1 of Form 8-K,
      filed on November 24, 2009)10.3+
            
            Form
      of Employment Agreement with Michael Levin (incorporated by reference to
      Exhibit 10.2 of Form 8-K, filed on November 24, 2009)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
    135032.2*
            
            Certification
      of Chief Financial Officer Pursuant to 18 U.S.C. Section
    1350


* Filed
herewith


+
Represents executive compensation plan or agreement


32
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SIGNATURES





Pursuant to the requirements 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.





MEDIA
      SCIENCES INTERNATIONAL, INC.Dated:  February
      11, 2010
            By:/s/ Michael W.
      LevinMichael
      W. LevinChief
      Executive OfficerDated:  February
      11, 2010
            By:/s/ Kevan D.
      BloomgrenKevan
      D. BloomgrenChief
      Financial Officer





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