International Absorbents (IAX) 10-Q 2008 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended October 31, 2007

OR

[  ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number:1-31642

INTERNATIONAL ABSORBENTS INC.
(Exact name of registrant as specified in its charter)

Province of British Columbia, Canada	98-0487410
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
1569 Dempsey Road North Vancouver, British Columbia, Canada	V7K 1S8
(Address of principal executive offices)	(Zip Code)

 

(604) 681-6181
(Registrant’s telephone number, including area code)

None
(Former name, former address and former fiscal year, if changed since last report)

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.

Yes [X]  No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Check one:

Large accelerated filer  [  ]        Accelerated filer [  ]        Non-accelerated filer [X]

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

Yes [  ]  No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at December 12, 2007
Common Shares, no par value per share	6,410,328 shares

 

PART I    FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

INTERNATIONAL ABSORBENTS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. dollars, in thousands)

	As at October 31, 2007		As at January 31, 2007
	(unaudited)		(audited)
Assets
Current assets:
Cash and cash equivalents	$	2,035	$	2,277
Restricted cash		—		1,146
Accounts receivable, net		2,541		2,373
Inventories, net		3,441		3,221
Prepaid expenses		221		126
Deferred income tax asset		130		186
Total current assets		8,368		9,329
Property, plant and equipment, net		19,606		18,096
Other assets, net		243		266
Total assets	$	28,217	$	27,691
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable and accrued liabilities	$	2,298	$	2,933
Related party payable		6		5
Current portion of long-term debt		852		805
Income taxes payable		254		202
Total current liabilities		3,410		3,945
Deferred income tax liability		981		835
Long-term debt		6,755		7,521
Total liabilities		11,146		12,301
Stockholders’ equity:
Common stock, no par value;
100,000,000 shares authorized,
6,410,328 issued and outstanding at October 31, 2007 and January 31, 2007		8,487		8,487
Additional paid in capital		1,270		999
Retained earnings		7,314		5,904
Total stockholders’ equity		17,071		15,390
Total liabilities and stockholders’ equity	$	28,217	$	27,691

 

2

INTERNATIONAL ABSORBENTS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(U.S. dollars, in thousands, except for per share amounts)

	Nine Months Ended						Three Months Ended
	October 31, 2007			October 31, 2006			October 31, 2007			October 31, 2006
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Sales, net	$	24,794		$	22,536		$	9,028		$	8,615
Cost of goods sold		17,250			15,254			6,287			5,546
		7,544			7,282			2,741			3,069
Selling, general and administrative expenses		4,878			6,294			1,487			2,924
Income from operations		2,666			988			1,254			145
Interest expense		(291	)		(272	)		(103	)		(95	)
Interest income		65			88			18			35
Income before provision for income tax		2,440			804			1,169			85
Income tax provision		(947	)		(331	)		(425	)		(16	)
Net income	$	1,493		$	473		$	744		$	69
Basic earnings per share	$	.23		$	.07		$	.12		$	.01
Fully diluted earnings per share	$	.23		$	.07		$	.11		$	.01
Weighted average number of shares outstanding
(in thousands)
Basic		6,410			6,402			6,410			6,410
Diluted		6,474			6,404			6,504			6,410

 

3

INTERNATIONAL ABSORBENTS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars, in thousands)

	Nine Months Ended
	October 31, 2007			October 31, 2006
	(unaudited)			(unaudited)
Cash flows from operating activities
Net income	$	1,493		$	473
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization		1,254			1,108
Loss on disposal of assets		164			—
Stock-based compensation		271			270
Deferred tax		119			(18	)
Changes in operating assets and liabilities
Accounts receivable		(168	)		(579	)
Inventory		(220	)		7
Prepaid expenses		(95	)		(86	)
Accounts payable and accrued liabilities		(563	)		1,402
Income tax receivable/payable		52			152
Due to related party		1			(1	)
Net cash flows from operating activities		2,308			2,728
Cash flows from investing activities
Purchase of short-term investments		—			—
Proceeds from short-term investments		—			109
Purchase of property, plant and equipment		(2,977	)		(1,887	)
Purchase of other assets		—			(29	)
Changes in restricted cash		1,146			(1,600	)
Net cash flows from investing activities		(1,831	)		(3,407	)
Cash flows from financing activities
Proceeds from long-term debt		—			1,600
Repayment of long-term debt		(719	)		(502	)
Proceeds from exercise of stock options		—			188
Net cash flows from financing activities		(719	)		1,286
Net change in cash		(242	)		607
Cash and cash equivalents, beginning of period		2,277			2,198
Cash and cash equivalents, end of period	$	2,035		$	2,805
Supplemental Cash flow Information
Cash paid for interest	$	297		$	135
Cash paid for income taxes	$	782		$	188
Non-cash investing activities
Change in property, plant and equipment and accounts payable for purchase of plant and equipment	$	(72	)	$	64

 

4

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Significant Accounting Policies

Basis of consolidation and presentation

The consolidated financial statements include the accounts of International Absorbents Inc. (the “Company” or “International Absorbents”) and its wholly owned subsidiary Absorption Corp (“Absorption”), a Nevada corporation doing business in the states of Washington and Georgia.

These unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. The accompanying interim condensed consolidated financial statements do not include all notes normally included in our audited annual consolidated financial statements and 10-K and therefore should be read in conjunction with our annual consolidated financial statements and notes thereto for the year ended January 31, 2007 included in the Company’s annual report on Form 10-K. The accompanying interim condensed consolidated financial statements include all normal recurring adjustments which, in the opinion of management, are necessary to present fairly the Company’s consolidated financial position at October 31, 2007 and January 31, 2007, its results of operations for the nine and three months ended October 31, 2007 and 2006 and the statement of cash flows for the nine months ended October 31, 2007 and 2006. The results of operations for the nine months ended October 31, 2007 are not necessarily indicative of the results to be expected for the entire fiscal year or future periods.

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for doubtful accounts and finance charges, income taxes, deferred income taxes and the related tax valuation allowance and sales incentives.

New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income tax positions (“tax positions”) in accordance with Statement of Financial Accounting Standards (“SFAS”) 109, Accounting for Income Taxes. The Company adopted FIN No. 48 on January 1, 2007 and has recognized, in its consolidated financial statements, the tax effects of all tax positions that are “more-likely-than-not” to be sustained on audit based solely on the technical merits of those positions as of October 31, 2007. The term “more-likely-than-not” means a likelihood of more than 50%. FIN No. 48 also provides guidance on new disclosure requirements, reporting and accrual of interest and penalties, accounting in interim periods and transition. Only tax positions that meet the “more-likely-than-not” threshold on the reporting date may be recognized. The cumulative effect of adoption of FIN No. 48, which is reported as an adjustment to the beginning balance of retained earnings, was $83,000. The Company classifies interest and penalties on tax uncertainties as components of the provision for income taxes.

In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measures (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently reviewing the provisions of SFAS 157 to determine the impact to its consolidated financial statements.

In February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted. The Company is currently evaluating the requirements of SFAS No. 159 and has not yet determined the impact on the financial statements.

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Stock-based employee compensation

Effective February 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), “Share Based Payment” using the modified prospective transition method. Under that transition method, compensation cost recognized in the nine-and three-month periods ended October 31, 2006 includes: (a) compensation cost for all stock-based payments granted prior to, but not yet vested, as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all stock-based payments granted subsequent to February 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods have not been restated, as provided for under the modified-prospective method.

Total stock-based compensation expense recognized in the income statement for the nine-month periods ended October 31, 2007 and 2006 was $269,000 and $263,000, respectively, before income taxes, of which $11,000 and $28,000 was recognized in cost of goods sold and $258,000 and $235,000 was recognized in selling, general and administrative expenses, respectively. Related total deferred tax benefit was nil for the nine months ended October 31, 2007 and October 31, 2006. Total unrecognized compensation costs related to stock options at October 31, 2007 and October 31, 2006 was $537,000 and $800,000, respectively, net of estimated forfeitures. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures and is expected to be recognized over a weighted average period of approximately 29 months.

Total stock-based compensation expense recognized in the income statement for the three-month periods ended October 31, 2007 and 2006 was $77,000 and $67,000, respectively, before income taxes, of which $2,000 and $6,000 was recognized in cost of goods sold and $75,000 and $61,000 was recognized in selling, general and administrative expenses, respectively. Related total deferred tax benefit was nil for the three months ended October 31, 2007 and October 31, 2006.

SFAS No. 123(R) requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes-Merton (“BSM”) option valuation model, which incorporates various assumptions including volatility, expected life, and interest rates. The assumptions used for the nine- and three-month periods ended October 31, 2007 and October 31, 2006 and the resulting estimates of weighted-average fair value per share of options granted during those periods are as follows:

	2008			2007
a) risk free interest rate		4.68	%		4.93	%
b) expected volatility		106.0	%		128.5	%
c) expected dividend yield		0.00	%		0.00	%
d) estimated average life (in years)		5.80			5.80
e) weighted-average fair value per share	$	2.97		$	2.87

 

The expected life of the options represents a weighted average of the estimated period of time until exercise and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. The expected stock price volatility is based on the historical volatility of the Company’s stock, for the related vesting periods. The risk-free interest rate is based on the implied yield currently available in U.S. Treasury securities at maturity with an equivalent term. The Company has not paid dividends in the past and does not plan to pay any dividends in the near future.

Other stock-based compensation

The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees and non-employee directors in accordance with SFAS No. 123 and the conclusions reached by the Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling, Goods or Services” (“EITF 96-18”). Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably measurable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services as defined by EITF 96-18. Stock-based compensation recognized under SFAS No. 123 and EITF 96-18 was $3,000 and $6,000 during the nine-month periods ended October 31, 2007 and 2006, respectively.

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Options

Stock options outstanding at October 31, 2007 and January 31, 2007 were 564,150 and 536,100, respectively. During the nine months ended October 31, 2007, no options were exercised, 71,950 options were forfeited, and 100,000 options were granted.

2. Share Capital

Common Shares (U.S. dollars, in thousands)

	Shares		Capital
Common shares outstanding, January 31, 2007		6,410	$	8,487
Common shares outstanding, October 31, 2007		6,410	$	8,487

 

3. Segmented Information

The Company is involved primarily in the development, manufacture, distribution and sale of absorbent products. Its assets and operations are primarily located and conducted in the United States.

The Company defines its business segments based upon the market in which its customers sell products. The Company operates principally in two business segments: the animal care industry and the industrial/commercial industry. Management decisions on resource allocation and performance assessment are made based on these two identifiable segments.

Management of the Company evaluates these segments based upon the operating income before depreciation and amortization generated by each segment. Depreciation, amortization and interest expense are managed on a consolidated basis and as such are not allocated to individual segments. Certain segment information, including segment assets, asset expenditures and related depreciation expense, is not presented as all of the Company’s assets are commingled and are not available by segment. There are no inter-segment transactions or significant differences between segment accounting and corporate accounting basis.

Business Segment Data — Nine Months Ended October 31, 2007

(U.S. dollars, in thousands)

	Animal Care		Industrial			Consolidated
Revenues	$	24,187	$	607		$	24,794
Operating cost and expenses		20,236		638			20,874
Operating income (loss) before depreciation and amortization		3,951		(31	)		3,920
Depreciation and amortization							(1,254	)
Interest expense							(291	)
Interest Income							65
Net income before taxes						$	2,440

 

7

Business Segment Data — Nine Months Ended October 31, 2006

(U.S. dollars, in thousands)

	Animal Care		Industrial			Consolidated
Revenues	$	21,570	$	966		$	22,536
Operating cost and expenses		19,444		996			20,440
Operating income (loss) before depreciation and amortization		2,126		(30	)		2,096
Depreciation and amortization							(1,108	)
Interest expense							(272	)
Interest Income							88
Net income before taxes						$	804

 

Business Segment Data — Three Months Ended October 31, 2007

(U.S. dollars, in thousands)

	Animal Care		Industrial			Consolidated
Revenues	$	8,834	$	194		$	9,028
Operating cost and expenses		7,102		197			7,299
Operating income (loss) before depreciation and amortization		1,732		(3	)		1,729
Depreciation and amortization							(475	)
Interest expense							(103	)
Interest income							18
Net income before taxes						$	1,169

 

Business Segment Data — Three Months Ended October 31, 2006

(U.S. dollars, in thousands)

	Animal Care		Industrial			Consolidated
Revenues	$	8,256	$	359		$	8,615
Operating cost and expenses		7,737		368			8,105
Operating income (loss) before depreciation and amortization		519		(9	)		510
Depreciation and amortization							(365	)
Interest Expense							(95	)
Interest Income							35
Net income before taxes						$	85

 

8

4. Inventories components

(U.S. dollars, in thousands)

	October 31, 2007		January 31, 2007
Raw materials and supplies	$	1,912	$	1,569
Finished goods		1,529		1,652
	$	3,441	$	3,221

 

5. Property, Plant and Equipment

(U.S. dollars, in thousands)

	October 31, 2007			January 31, 2007
Property, plant and equipment
Land	$	1,547		$	1,547
Buildings		8,745			8,534
Leasehold improvements		—			630
Equipment		14,962			10,996
Construction in progress		180			2,313
	$	25,434		$	24,020
Less: Accumulated depreciation		(5,828	)		(5,924	)
	$	19,606		$	18,096

 

6. Credit arrangements

On May 23, 2007, Absorption renewed a bank line of credit with Branch Banking & Trust Co. that provides for up to $2,000,000 of cash borrowings for general corporate purposes which is secured by accounts receivable and inventories of Absorption. Interest is payable on funds advanced at the one-month London Interbank Offered Rate (“LIBOR”) plus 2.5%. The line of credit matures on May 23, 2009. At October 31, 2007, the Company had not drawn against the line of credit.

7. Long-term debt

On September 14, 2006, the Company entered into a bond financing agreement in the amount of $1,600,000 with GE Capital Public Finance, Inc. (“GECPF”) to fund the purchase and installation of manufacturing equipment to be used in connection with the relocation of the Bellingham, Washington production facility to the new Ferndale, Washington manufacturing and warehouse facility. GECPF agreed to fund and guarantee the Economic Development Revenue Bond issued by the Washington State Economic Finance Authority at a fixed interest rate of 5.70%, amortized over 90 months with interest-only payments during the months of construction. If Absorption defaults under the terms of the loan agreement, including failure to pay any amount when due or violating any of the financial and other covenants, GECPF may accelerate all amounts then-owing under the bond. Costs incurred in issuing the bond were $32,000. The bond is secured by the equipment financed. At October 31, 2007 and January 31, 2007 the balance outstanding was $1,489,627 and $1,600,000, respectively.

In September of 2004, the Company completed a $4,900,000 tax-exempt bond financing. Of the total proceeds from the financing, $2,099,000 were used to pay off the loan held by Branch Banking &Trust Co., $98,000 was paid for costs of issuance and the remaining proceeds of $2,703,000 were initially placed in a trust account to be used to finish the construction of the Company’s production facility located in Jesup, Georgia, which occurred in fiscal year 2005. The bonds were issued by Wayne County Industrial Development Authority in the state of Georgia. The bonds have a variable rate equal to Branch Banking & Trust Co.’s Variable Rate Demand Bond “VRDB” rate (3.58 % as of October 25, 2007) plus a letter of credit fee of 0.95%, a remarketing fee of 0.125% and a $2,000 annual trustee fee. The term of these bonds is seven years for the equipment portion and 15 years for the real estate portion. At October 31, 2007 and January 31, 2007, the debt

 

9

outstanding was $3,800,000 and $4,300,000, respectively. The letter of credit expires September 2, 2011, at which time it will need to be renewed.

In March 2003, the Company completed a $2,910,000 bond financing, comprised of $2,355,000 as tax exempt and $555,000 as taxable. The bonds were issued through the Washington Economic Development Finance Authority in Washington State. The purchaser and holder of the bonds is GECPF. The tax exempt bonds have a fixed rate of 5.38% with a term of 190 months, maturing February 2019, and with interest-only payments for the first 52 months. The taxable bonds have a fixed rate of 5.53% a term of 52 months, with a maturity date of August 2007. The indebtedness underlying the bonds is secured by a mortgage on the real property, and a security interest in the equipment assets, located in Whatcom County, Washington. At October 31, 2007, the balance outstanding was $2,317,741 on the tax-exempt and $-0- on the taxable bonds, respectively. At January 31, 2007, the balance outstanding was $2,355,000 on the tax-exempt and $71,000 on the taxable bonds, respectively.

8. Earnings per share

(U.S. dollars)

	For the nine months ended October 31, 2007
	Net Income (numerator)		Shares (denominator)		Per share amount
Basic earnings per share
Net income available to stockholders	$	1,493,000		6,410,328	$	0.23
Effect of dilutive securities
Stock options to purchase common stock		—		63,219
Diluted earnings per shares
Net income available to stockholders	$	1,493,000		6,473,547	$	0.23

 

	For the nine months ended October 31, 2006
	Net Income (numerator)		Shares (denominator)		Per share amount
Basic earnings per share
Net income available to stockholders	$	473,000		6,401,682	$	0.07
Effect of dilutive securities
Stock options to purchase common stock		—		2,483
Diluted earnings per shares
Net income available to stockholders	$	473,000		6,404,165	$	0.07

 

10

(U.S. dollars)

	For the three months ended October 31, 2007
	Net Income (numerator)		Shares (denominator)		Per share amount
Basic earnings per share
Net income available to stockholders	$	744,000		6,410,328	$	0.12
Effect of dilutive securities
Stock options to purchase common stock		—		93,923
Diluted earnings per shares
Net income available to stockholders	$	744,000		6,504,251	$	0.11

 

	For the three months ended October 31, 2006
	Net Income (numerator)		Shares (denominator)		Per share amount
Basic earnings per share
Net income available to stockholders	$	69,000		6,401,328	$	0.01
Effect of dilutive securities
Stock options to purchase common stock		—		—
Diluted earnings per shares
Net income available to stockholders	$	69,000		6,401,328	$	0.01

 

The Company excludes all potentially dilutive securities from its diluted net income per share computation when their effect would be anti-dilutive (strike price less than market value). The following common stock equivalents were excluded from the earnings per share computation because the exercise prices of the stock options and rights were greater than or equal to the average price of the common shares, and therefore their inclusion would have been anti-dilutive:

	For the nine months ended October 31,
	2007		2006
Stock options excluded from the computation of diluted net income per share, other than those used in the determination of common stock equivalents disclosed above		284,150		497,150

 

	For the three months ended October 31,
	2007		2006
Stock options excluded from the computation of diluted net income per share, other than those used in the determination of common stock equivalents disclosed above		—		497,150

 

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

This discussion is intended to further the reader’s understanding of the consolidated financial statements, financial condition, and results of operations of International Absorbents and Absorption. It should be read in conjunction with the consolidated financial statements, notes and tables which are included elsewhere in this quarterly report.

Some statements and information contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are not historical facts but are forward-looking statements. For a discussion of these forward-looking statements and important factors that could cause results to differ materially from the forward-looking statements, see “Forward-Looking Statements” below.

Overview

International Absorbents is the parent company of its wholly owned U.S. subsidiary, Absorption. International Absorbents is a holding company and Absorption is its operating entity. Management divides the activities of the operating company into two segments: the animal care industry and the industrial/commercial industry. We manufacture, distribute and sell products for these segments to both distributors and direct buying retailers.

Absorption is a leading manufacturer and seller of premium small animal bedding in North America. The primary product that we sell in this market is small animal bedding sold under the brand nameCareFRESH^®. We consider the activities that surround the manufacture and distribution ofCareFRESH^® to be our core business. Our business strategy is to promote and grow our core business and to create diversification in our market channels, our production methods, and our product lines in an effort to add strength and breadth to our business structure. As a result, we are dedicating significant resources to both building infrastructure for the support of our core business, and creating more product and customer diversification. We believe that this strategy has started to provide results. Specifically, we continue to grow sales in our core business and improve the production process of our coreCareFRESH^® product while expanding sales of new products and existing products into new market channels.

The year to date financial results for the nine months ended October 31, 2007 met the expectations of management both in terms of top line sales (see “Net Sales” below) and bottom line profits (see “Net Income” below). As described in the “Gross Profits” discussion below, by the end of the quarter we were meeting expectations for gross profits which had been down during the second quarter of the current fiscal year due to the move of our Bellingham, Washington manufacturing plant. We were also able to slightly reduce our sales, general and administrative expenses below our expectations.

During fiscal year 2008, we continue to focus our sales and marketing efforts on our market leadingCareFRESH^®,CareFRESH^® Ultra, andCareFRESH^® Colors brands of small animal bedding products. We also continue to aggressively sell our Healthy Pet^TM Cat Litter line.Healthy Pet^TM Cat Litter is a line of cat litters in which our distributors are offered a selection of five cat litters designed to be displayed together in one section of shelf space. They are all made of natural products in keeping with our corporate philosophy of being environmentally friendly. Because these are relatively new product lines, management believes it is too early to be able to predict if these growth trends will continue.

Even though we have recently experienced significant infrastructure-related costs, we believe our progress with the sales of new product lines will continue to move us toward developing more diversified sources of income, which we anticipate will help reduce the risks associated with a substantial reliance on sales from a single product.

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Results of Operations

The following table illustrates our financial results for the third quarter of fiscal year 2008 as compared to the same quarter of the prior fiscal year. (U.S. dollars, in thousands):

	October 31, 2007			Percent of Sales			October 31, 2006			Percent of Sales			Percentage Change
Sales		9,028			100	%		8,615			100	%		5	%
COGS		6,287			70	%		5,546			64	%		13	%
Gross Profit		2,741			30	%		3,069			36	%		–11	%
S G & A		1,487			16	%		2,924			34	%		–49	%
Income from operations		1,254			14	%		145			2	%		765	%
Interest Income		18			0	%		35			0	%		–49	%
Interest Expense		(103	)		–1	%		(95	)		–1	%		8	%
Profit before taxes		1,169			13	%		85			1	%		1275	%
Income Taxes		(425	)		–5	%		(16	)		0	%		2556	%
Net Income		744			8	%		69			1	%		978	%

 

The following table illustrates our financial results for the first nine months of fiscal year 2008 as compared to the same period of the prior fiscal year. (U.S. dollars, in thousands):

	October 31, 2007			Percent of Sales			October 31, 2006			Percent of Sales			Percentage Change
Sales		24,794			100	%		22,536			100	%		10	%
COGS		17,250			70	%		15,254			68	%		13	%
Gross Profit		7,544			30	%		7,282			32	%		4	%
S G & A		4,878			20	%		6,294			28	%		–22	%
Income from operations		2,666			11	%		988			4	%		170	%
Interest Income		65			0	%		88			0	%		–26	%
Interest Expense		(291	)		–1	%		(272	)		–1	%		7	%
Profit before taxes		2,440			10	%		804			4	%		203	%
Income Taxes		(947	)		–4	%		(331	)		–1	%		186	%
Net Income		1,493			6	%		473			2	%		216	%

 

Net Sales

In the third quarter of fiscal year 2008, our net sales increased by 5% over the same quarter in fiscal year 2007. For the nine months ended October 31, 2007, net sales grew by 10% as compared to the nine months ended October 31, 2006. All of this growth in net sales was a result of the growth in sales of our animal care products. During the third quarter of fiscal year 2008, net sales for animal care products grew from $8,256,000 to $8,834,000, as compared to the same period of fiscal year 2007. During the first nine months of the current fiscal year animal care sales grew from $21,570,000 to $24,187,000 as compared to the same nine months in the prior fiscal year. Net sales of our industrial products decreased from $359,000 to $194,000 for the third quarter of fiscal years 2007 and 2008, respectively. For the nine-month period ended October 31, 2006 and 2007, respectively, industrial sales decreased from $966,000 to $607,000.

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We currently believe that our fiscal year 2008 overall annual net sales will grow approximately 9% to 13% over our fiscal year 2007 net sales levels. Specifically, during fiscal year 2008, we expect sales of natural, non-coloredCareFRESH^® in pet specialty channels to be approximately the same as they were in fiscal year 2007 as we have now reached significant levels of distribution throughout the United States. We have also introduced line extensions such asCareFRESH Ultra^TM andCareFRESH^® Colors. Therefore, although we anticipate that naturalCareFRESH^® will continue to represent the majority of our sales through the 2008 fiscal year, we also see growth opportunities for our full line of bedding products as they continue to gain market share and growing customer acceptance, subject to the following challenges. First, as we add new items to our line of products, they will need to compete for limited shelf space at the pet specialty stores with our other existing products and those of our competitors, which could limit the number of products we are able to sell at a particular store. Second, although we believe that the high quality of ourCareFRESH^® line of products gives us a significant competitive advantage, many of our competitors have a larger breadth of products and more established relationships with the mass merchandiser and grocery stores, which makes competition in these channels more challenging for us. With respect to our lines of cat litter products, we continue to expect revenue growth from these products. Finally, at this time we do not have plans to invest additional sales resources in our industrial line of products.

Gross Profit

Our Georgia production facility continued to make progress at increasing its production rate and efficiencies during the first nine months of fiscal year 2008. Our facilities continue to work towards overcoming the additional burdens of increases in utility rates, increased depreciation, and increased fuel surcharges on freight. Gross margin (gross profit divided by sales) for the first nine months of fiscal year 2008 decreased to 30% from 32% as compared to the first nine months of fiscal year 2007. During the third quarter of fiscal year 2008 our gross margin dropped to 30% from 36% as compared to the same quarter in fiscal year 2007. The primary reasons for this drop in gross margin were the commissioning costs related to the move of our Bellingham, Washington production facility to our new facility in Ferndale, Washington. An investment was made in continuing the employment of critical staff members during this period. We feel that this investment significantly reduced the commissioning time of the new production plant in Ferndale, Washington, because of the experience of these employees. In addition, the high cost of energy, transportation, and raw materials were leading factors placing downward pressure on our gross margin, which were off-set by increased production efficiencies.

As discussed in Note 3 (“Segmented Information”) to the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, operating income including selling, general and administrative expenses, but before depreciation for our animal care product segment, increased by 234% in the third quarter of fiscal year 2008 as compared to the same quarter in fiscal year 2007. Operating income for the nine months ended October 31, 2007 increased by 86% as compared to the same period in fiscal year 2007. Operating loss before depreciation for our industrial product segment decreased by 67% comparing the third quarter of fiscal year 2007 to the same period in fiscal year 2008. Operating loss before depreciation for our industrial product segment increased by 3% comparing the first nine months of fiscal year 2007 to the first nine months of fiscal year 2008.

For fiscal year 2008 we expect that our gross margin will remain in the range of 30% to 33%. The reasons for this expectation are as follows. First, the cost savings we had projected from reduced transportation costs resulting from shipping to east coast customers from the Georgia production facility have been offset by increases in fuel charges. However, without this facility being located where it is, margin expectations would be even lower. Second, we are not achieving the overall reduced costs of raw materials that we had initially expected due to: our product mix (with increased sales of our higher-cost products); slow reactions from raw material suppliers in response to our request for additional supplies; increases in the prices of petroleum-based product prices, such as the cost of plastic bags; and the shortage of key low-cost raw material sources for certain of our facilities. Third, in the third quarter of fiscal year 2007 we began moving our Bellingham, Washington plant to our new Ferndale, Washington facility. During the fourth quarter of fiscal year 2007 and the first, second and third quarters of fiscal year 2008, we continued to incur relocation and commissioning costs, which could further reduce our gross margin. Fourth, additional depreciation charges resulting from our new production facilities will also have a negative effect on our gross margin.

To offset the significant increases in the cost of natural gas, we have installed new burners to heat our dryers at our Georgia facility that operate at less than one-third the cost of our current natural gas burners. The new burners became operational during the fourth quarter of fiscal year 2007. As we continue to use this technology, we expect it to become more efficient and, as a result, we should move closer to achieving the projected cost savings at our Georgia facility. The same type of burner technology has been installed at out Ferndale, Washington facility. We plan to continue to make capital investments in technology at all of our facilities to help decrease the costs of production.

 

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Selling, Administrative and General Expenses

During the third quarter of fiscal year 2008, our selling, general and administrative expenses decreased by 49% as compared to the same quarter in fiscal year 2007. During the first nine months of fiscal year 2008 our selling, general, and administrative expenses decreased by 22% as compared to the same period in fiscal year 2007.

A significant factor for this decrease was that on October 10, 2006, we were notified that the American Arbitration Association had issued a decision in the arbitration between R. Wilder Sales, R&D Midwest Pet Supply (the “Claimants”) and the Company (the “Wilder Arbitration”). As previously disclosed in the Company’s filings with the SEC, the Wilder Arbitration demand was filed against Absorption on February 23, 2004. At that time, the Claimants were seeking damages in the amount of approximately $1,000,000. The Wilder Arbitration demand related to a lawsuit that was filed on June 22, 1995 in the Boone Circuit Court of the Commonwealth of Kentucky against Absorption. The lawsuit was captioned Wilder et.al. v. Absorption Corp., Civil Action No. 95-CI-547, and alleged breach of contract, fraud, violation of the Kentucky Unfair Trade Practices Act and other related claims. The Arbitrator ruled in favor of the Claimants and ordered us to pay to the Claimants an aggregate amount totaling $1,186,435 for damages and recovery of attorney fees and expenses as well as the administrative fees, compensation and expenses of the Arbitrator. This amount was expensed as selling, general and administrative expenses as of October 10, 2006. We paid the full amount of the award on November 10, 2006.

The first quarter of fiscal year 2007 was the first period under which we were required to account for stock-based compensation under SFAS No. 123(R). As a result, we incurred $269,000 in stock-based compensation during the first nine months of fiscal year 2008 as compared to $263,000 during the same periods of the prior year. Of this amount, $258,000 was included in selling, general and administrative expenses. Costs resulting from our compliance with requirements of the SEC and the American Stock Exchange (“AMEX”) continue to have an impact on our general and administrative expenses. Moreover, we now have overhead expenses related to operating our Georgia facility, increased property taxes on both of our new facilities, and increased depreciation expense.

The tables below illustrates the effect that our the fiscal year 2008 one-time expense of $164,000 and the $1,186,000 arbitration award in fiscal year 2007 had on our selling, general, and administrative expenses during both the third quarter and first nine months of the current fiscal year as compared to the same periods in the prior fiscal year. This one-time expense was the result of a loss incurred as a result of the disposal of fixed assets associated to the closing and dismantling of our Bellingham, Washington production facility.

The following table illustrates our selling, administrative and general expenses for the third quarter of fiscal year 2008 as compared to the same quarter in fiscal year 2007. (U.S. dollars, in thousands):

	October 31, 2007		Percent of Sales			October 31, 2006		Percent of Sales			Percentage Change
Selling, administrative and general expenses		1,487		16	%		2,924		34	%		–49	%
Arbitration award		0		0	%		1,186		14	%
Retirement of assets		164		2	%		0		0	%
Selling, administrative and general expenses adjusted for retirement of assets		1,323		15	%		1,738		20	%		–24	%

The following table illustrates our selling, administrative and general expenses for the first nine months of fiscal year 2008 as compared to the first nine months of fiscal year 2007 (U.S. dollars in thousands):

	October 31, 2007		Percent of Sales			October 31, 2006		Percent of Sales			Percentage Change
Selling, administrative and general expenses		4,878		20	%		6,294		28	%		–22	%
Arbitration award		0		0	%		1,186		5	%
Retirement of assets		164		1	%		0		0	%
Selling, administrative and general expenses adjusted for retirement of assets		4,714		19	%		5,108		23	%		–8	%

 

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During fiscal year 2008, we intend to continue our marketing initiatives at the rate at which we completed fiscal year 2007. Our seasoned sales staff is respected in the animal care industry and has proven to be efficient and effective in selling to the wholesale distribution segment of the pet specialty channel. We expect to enhance our sales staff to include expertise in specific markets where we see growth opportunities. In addition, if our product mix were to change with more emphasis on food, treats or accessories, we would need to add sales people at the retail level. We feel that this plan should enable us to achieve our strategic objectives without significantly increasing our selling expenses, provided that this projection may change depending on the reaction of our competitors. On the administrative side, costs resulting from compliance with SEC and AMEX requirements are projected to continue to grow and we may also need to hire additional administrative personnel growth as sales levels increase.

Interest Expense

Interest expense during the third quarter of fiscal year 2008 totaled $103,000 as compared to $95,000 during the third quarter of fiscal year 2007. During the first nine months of fiscal year 2008 interest expenses increased to $291,000 as compared to $272,000 for the same period of the prior year. This increase was due to interest rate increases for our variable interest rate bonds that constitute the debt facility for the Georgia plant. In addition, we are now expensing the interest on the Industrial Revenue Bonds which were issued to finance the move of our Bellingham, Washington plant.

Income Tax

Absorption incurred federal income taxes during the first three quarters of fiscal year 2008 at an effective rate of 39%. The effective rate is higher due to the recognition of stock-based compensation expenses from stock options that are not deductible for federal income taxes. We anticipate that we will have a higher effective rate going forward, although the rate itself will be higher or lower depending on the ratio of net income before taxes to stock-based compensation recognized in a particular period. Losses incurred in Canada by International Absorbents have been fully reserved through the recording of a valuation allowance as Canadian net operating losses and deferred tax assets are not expected to be utilized in future periods.

Net Income

Our net income for the quarter ended October 31, 2007 increased by 978% as compared to the same period in the prior fiscal year. This increase in net income over the prior fiscal year was primarily caused by the reduction of sales general and administrative expenses during this period for the reasons described above. During the nine months ended October 31, 2007, our net income increased by 216% as compared to the same period of the prior fiscal year. We feel that continued concentration on the implementation of the key components of our business plan that focus on production efficiencies and controlled costs should provide us with continued increases in production rates, which should help us to service the increase in demand for our products and generate additional revenues.

We expect that the production efficiencies that we saw at our Georgia facility in our most recent fiscal quarters will continue, as has been demonstrated by the results of the quarter just ended. Operations at our new Ferndale, Washington production facility continue to become more efficient and are expected to meet year-end objectives of management. Once these efficiencies are stabilized and moving in the right direction, we anticipate being able to produce product at the higher end of our gross margin projections, unless there are additional downward pressures from the costs of raw materials or energy. We project that selling and administrative costs will continue to grow, but only marginally during the coming fiscal year. We will continue to invest in future marketing programs to offset competitive pressures as necessary and anticipate additional administrative costs resulting from regulatory requirements, all of which may continue to lead to increased expenses and lower net income. During fiscal year 2008 we will incur additional interest expense as a result of financing the move of our Bellingham, Washington production facility. In addition, we anticipate that increased depreciation resulting from our investment in plant and equipment will negatively affect our fiscal year 2008 net income.

 

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Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

We believe that one of our key financial and operating performance metrics is Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA). Our EBITDA increased by 87% during the first three quarters of fiscal year 2008 as compared to the same period in fiscal year 2007. The increase was substantially the result of increased sales, improved gross profit margins, and controlled selling, administrative, and general expenses.

EBITDA is not a measure of financial performance under generally accepted accounting principles (GAAP) in the United States. Accordingly, it should not be considered a substitute for net income (loss), cash flow provided by operating activities, or other income or cash flow data prepared in accordance with GAAP. However, we believe that EBITDA may provide additional information with respect to our financial performance and our ability to meet our future debt service, capital expenditures and working capital requirements. This measure is widely used by investors and rating agencies in the valuation, comparison, rating, and investment recommendations of companies. In addition, we use EBITDA as one of several factors when determining the compensation for our executive officers. Because EBITDA excludes some, but not all items that affect net income (loss) and may vary among companies, the EBITDA presented by us may not be comparable to similarly titled measures of other companies. The following schedule reconciles EBITDA to net income (loss) reported on our Condensed Consolidated Statement of Operations, which we believe is the most directly comparable GAAP measure:

	For the quarter ended
(U.S. dollars in thousands)	October 31, 2007			October 31, 2006			Percentage Change
Net Income (Loss) (as reported on Condensed Consolidated Statement of Operations)	$	744		$	69
Interest expense		103			95
Interest income		(18	)		(35	)
Income tax provision		425			16
Depreciation & amortization		475			365
EBITDA	$	1,729		$	510			239	%

 

	For the nine months ended
(U.S. dollars in thousands)	October 31, 2007			October 31, 2006			Percentage Change
Net Income (Loss) (as reported on Condensed Consolidated Statement of Operations)	$	1,493		$	473
Interest expense		291			272
Interest income		(65	)		(88	)
Income tax provision		947			331
Depreciation & amortization		1,254			1,108
EBITDA	$	3,920		$	2,096			87	%

 

During the balance fiscal year 2008 management will continue to focus on EBITDA as a key performance indicator.

Liquidity and Capital Resources

During the second quarter of fiscal year 2008 we completed the third phase of our three-phase capital expansion plan. This three-phase plan included: the building of the new manufacturing and warehousing facility in Ferndale, Washington, which is now complete; the building of a new production facility in Georgia, which has also been completed; and the move of our Bellingham, Washington manufacturing facility to our Ferndale, Washington location, which we commenced during the third quarter of fiscal year 2007 (engineering was started during the second quarter of fiscal year 2007) and completed during the second quarter of fiscal year 2008. The intent of this capital expansion plan is first, to protect our core business by reducing our production costs and decreasing the cost of shipping product to our customers; second, to give us the ability to manufacture, warehouse and distribute a wider diversity of product; and third, to increase our production capacity.

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The table below illustrates our current financial condition, working capital and cash positions (U.S. dollars, in thousands):

	As of October 31, 2007		As of January 31, 2007
Financial Condition
Total Assets	$	28,217	$	27,691
Total Liabilities		11,146		12,301
Total Equity	$	17,071	$	15,390
Debt/equity ratio		0.65		0.80
Assets/debt ratio		2.53		2.25
Working Capital
Current assets	$	8,368	$	9,329
Current liabilities	$	3,410	$	3,945
Current ratio		2.45		2.36
Cash Position
Cash, restricted cash & short term investments	$	2,035	$	3,423
Cash generated from operations	$	2,308	$	2,416	*
* for the entire year ended January 31, 2007

 

Financial Condition

During the first nine months of fiscal year fiscal year 2008, the value of our total assets increased. This was primarily the result of the addition of fixed assets related to the move of our Bellingham, Washington plant and from cash generated from operating activities. We also had a decrease in total liabilities resulting from principal payments made on long-term debt.

As discussed under Note 7 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, we currently have three long-term debt facilities, including our September 2006 bond financing arrangement with GE Capital Public Finance, Inc (“GECPF”), our March 2003 bond financing with GECPF and our September 2004 tax-exempt bond financing with BB & T.

We believe that our main credit risk exposure in fiscal year 2008 will come from meeting the covenants attached to our debt facilities by our lenders. As of the end of fiscal year 2007 we were over minimum financial requirements and under maximum requirements. The covenant-related ratios that could pose a potential risk in the future are those based on cash flow. As such, any significant decrease in our current cash flow could result in the breach of one or more of these loan covenants. If we fail to satisfy the financial covenants and other requirements contained in our debt facilities, our debts could become immediately payable at a time when we are unable to pay them, which could adversely affect our liquidity and financial condition. In addition, if we are to make cash flow decisions to remain within our loan covenants, these decisions could affect our ability to effectively execute on our long term business strategy.

Debt retirement is an alternative that we consider on an ongoing basis. Relevant factors in our analysis include the cost of equity and the rate of interest on our debt. Our long-term debt has been at very favorable rates such that it was and continues to be considered advantageous to use our capital for other applications.

Working Capital

During the first nine months of fiscal year 2008, our working capital position decreased. The majority of the decrease was due to cash spent on moving the Bellingham, Washington facility to our new Ferndale, Washington location, which resulted in a decrease of current assets. Current liabilities decreased primarily due to using cash to pay down accounts payable balances resulting from credit purchases made relating to the plant move, off-set by a slight increase in the current portion of long term debt as a result of the issuance of industrial revenue bonds during the prior fiscal year.

In fiscal year 2008 we expect that our current assets will continue to increase, though not at the rate they have increased during the past year, as a result of positive cash flow and an increase in accounts receivable as sales levels grow. We also expect that current liabilities will remain essentially flat. Any expected improvement in net working capital is not expected to be significant during the balance of the current fiscal year.

Cash Position

We believe that our existing cash on hand, long-term debt and available line of credit currently provide us with enough cash to meet our existing needs for the foreseeable future. Cash and investments decreased during the first nine months of fiscal year 2008, primarily as a result of cash being invested in capital assets related to the move of our Bellingham, Washington

 

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plant to our Ferndale, Washington facility. We expect cash to increase during the final three months of fiscal year 2008 primarily as a result of cash generated from operations. We believe that our existing $2,000,000 line of credit with BB&T will suffice in covering any potential cash shortfall for the foreseeable future. This line of credit is secured by inventory and accounts receivable, which we anticipate should provide enough collateral to support the related debt. Interest is payable on funds advanced at the LIBOR rate plus 2.5%. The line of credit matures on May 23, 2009. As of October 31, 2007, no borrowings were outstanding under the line of credit. If we do borrow against this line of credit, we intend to pay it off before the end of fiscal year 2008. We will continue to closely monitor both current liabilities and current assets as they relate to the generation of cash, with an emphasis on maximizing potential sources of cash.

Cash Generated from Operations

During the first nine months of fiscal year fiscal year 2008 we generated $2,308,000 in cash from operating activities. If our sales continue to increase and we are able to continue to profitably produce our products, we should be able to continue to generate cash from operating activities during the balance of fiscal year 2008, although it cannot be assured that this will be the case.

Financing and Investing Activities

Cash used for financing activities during the first nine months of fiscal year 2008 was $719,000. This was the result of cash used to make principal payments on long-term debt. Cash was used during the first nine months of fiscal year 2008 for investing activities mainly related to the move of our Bellingham, Washington production facility. Also, the cash related to the debt facility for the plant move was drawn from a restricted account to be released as construction progresses. Cash used in investing activities during the first nine months of fiscal year 2008 was approximately $1,831,000.

The first phase of our production expansion plan was substantially completed during the third quarter of fiscal year 2004. This was the construction of our new west coast facility located in Ferndale, Washington. We had previously been operating in five separate long-term leased facilities in Whatcom County, Washington. This new facility, which was financed approximately half through debt and half through cash, consolidated four of these leased facilities, resulting in annual savings of approximately $450,000 in lease payments. The consolidation of these facilities has also provided us with savings in other expenses caused by inefficient logistics. The annual interest expense of the debt used to finance this facility is approximately $144,000 per year.

Phase two of our production expansion plan was the commissioning of the facility located in Georgia. We purchased approximately fifteen acres of real property in Jesup, Georgia, with an existing 41,000 square foot facility, during August 2003 for $140,000, which we subsequently sold to, and leased back from, Wayne County IDA, as described in more detail in our Annual Report on Form 10-K for the fiscal year ended January 31, 2007. We began construction during the fourth quarter of fiscal year 2004 on this property. The total project was completed at a cost of $6,650,000. Of the total cost, approximately $4,900,000 was financed through a long-term bank debt instrument and the balance was financed with cash on hand. The annual interest expense of the debt used to finance this facility is approximately $149,000 a year. This plant is now fully functional.

The third phase of our production expansion plan was the relocation of our Bellingham, Washington production facility to our new Ferndale, Washington facility. This phase began during the second quarter of fiscal year 2007 and cost approximately $4,200,000. Of this amount, $2,600,000 came from cash and the remaining $1,600,000 was generated through our September 2006 bond financing with GECPF, as described above. This production facility became operational during the second quarter of fiscal year 2008.

We believe that this three-phase plan will give us the ability to continue to grow our business, achieve significant cost savings, better serve our customers, expand our production lines, diversify and expand our production capacity and physically move manufacturing in a manner which is transparent to the users of our products.

Environmental Matters

We are committed to being an environmentally friendly company and to manufacturing products which benefit the quality of the environment. Hazardous wastes are not produced, treated, or stored at any company-owned or operated facilities. State, federal, and local laws all have jurisdiction over production activities. We believe we are currently in compliance with these laws and expect to remain so in the foreseeable future.

 

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Off-Balance Sheet Arrangements

The SEC requires companies to disclose off-balance sheet arrangements. As defined by the SEC, an off-balance sheet arrangement includes any contractual obligation, agreement or transaction arrangement involving an unconsolidated entity under which a company 1) has made guarantees, 2) has a retained or a contingent interest in transferred assets, 3) has an obligation under derivative instruments classified as equity, or 4) has any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the company, or that engages in leasing, hedging or research and development services with the company.

We have examined our contractual obligation structures that may potentially be impacted by this disclosure requirement and have concluded that no arrangements of the types described above exist with respect to our company.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated condensed financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q. The SEC has defined a company’s most critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. For additional information, see the notes to consolidated condensed financial statements included elsewhere in this Quarterly Report on Form 10-Q and also please refer to our Annual Report on Form 10-K for the year ended January 31, 2007 for a more detailed discussion of our critical accounting policies. Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions or conditions.

During the quarter ended October 31, 2007, we did not make any material changes in or to our critical accounting policies.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements. They can be identified by the use of forward-looking words such as “believes,” “expects,” “plans,” “may,” “will,” “would,” “could,” “should” or “anticipates” or other comparable words, or by discussions of strategy, plans or goals that involve risks and uncertainties that could cause actual results to differ materially from those currently anticipated. You are cautioned that any forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those set forth in our Annual Report on Form 10-K for the year ended January 31, 2007 and as described from time to time in our reports filed with the SEC, including this Quarterly Report on Form 10-Q. Forward-looking statements include, but are not limited to, statements referring to our future growth strategies, prospects for the future, potential financial results, market and product line growth, abilities to enter new markets, ability to introduce new products, benefits from infrastructure improvements and our competitiveness and profitability as a result of new sales and marketing programs.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we performed an evaluation under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures. Based upon that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

No change in our internal control over financial reporting occurred during our last fiscal quarter 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

We are subject from time to time to claims and legal actions that may arise in the ordinary course of business. We do not believe that any of these pending claims or legal actions will have a material effect on our business, financial position or results of operations.

ITEM 1A. RISK FACTORS

Please see our Annual Report on Form 10-K for the year ended January 31, 2007 for a detailed description of some of the risks and uncertainties that we face. There have been no material changes in our risk factors from those described in that Annual Report. If any of those risks were to occur, our business, operating results and financial condition could be seriously harmed.

ITEM 6. EXHIBITS

Exhibit Number		Exhibit Description
3.1	��	Notice of Articles of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Form 10Q filed on September 11, 2006).
3.2		Articles of the Company (incorporated by reference to Exhibit 3.2 to the Company’s Form 10Q filed on September 11, 2006).
4.1		Shareholder Rights Plan dated May 1, 2006 (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed May 4, 2006).
31.1		Certification of Gordon Ellis, President and Chief Executive Officer of International Absorbents Inc., pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
31.2		Certification of David Thompson, Chief Financial Officer of International Absorbents Inc., pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
32.1		Certification of Gordon Ellis, President and Chief Executive Officer of International Absorbents Inc., pursuant to 18 U.S.C. Section 1350.
32.2		Certification of David Thompson, Chief Financial Officer of International Absorbents Inc., pursuant to 18 U.S.C. Section 1350.

 

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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.

INTERNATIONAL ABSORBENTS INC.
(Registrant)

Date:December 13, 2007

/s/ GORDON L. ELLIS
Gordon L. Ellis
President and Chief Executive Officer
(Principal Executive Officer)

Date:December 13, 2007

/s/ DAVID H. THOMPSON
David H. Thompson
Secretary and Chief Financial Officer
(Principal Financial Officer)

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