10-K

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

FORM 10-K

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

For the fiscal year ended January 31, 2008
 
OR

o    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)

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)

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

Title of each class	Name of each exchange on which registered
Common Shares, no par value per share	American Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

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

Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.Yes oNo x

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 o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

Large accelerated filer o Accelerated filer o

Non-accelerated filer o Smaller reporting company x

(Do not check if a smaller reporting company)

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

Yes o No x

Aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of July 31, 2007, based upon the closing price of the common stock as reported by the American Stock Exchange on such date, was approximately $31,770,305.

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

Class	Outstanding at April 18, 2008
Common Shares, no par value per share	6,410,328 shares

DOCUMENTS INCORPORATED BY REFERENCE

Document	Parts Into Which Incorporated
Proxy Statement for the Annual General Meeting of Shareholders to be held on June 11, 2008	Part III

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INTERNATIONAL ABSORBENTS INC.
Annual Report on Form 10-K
For the Fiscal Year Ended January 31, 2008
 
TABLE OF CONTENTS

Item
Number Page
Number

PART I

1. Business 4

1A. Risk Factors 10

2. Properties 16

3. Legal Proceedings 16

4. Submission of Matters to a Vote of Security Holders 16

PART II

5. Market for Registrant’s Common Equity, Related Stockholder Matters and

Issuer Purchases of Equity Securities 17

7. Management's Discussion and Analysis of Financial Condition and Results of Operations 19

8. Financial Statements 28

9A. Controls and Procedures 50

PART III

10. Directors, Executive Officers and Corporate Governance 50

11. Executive Compensation 51

12. Security Ownership of Certain Beneficial Owners and Management and

Related Stockholder Matters 51

13. Certain Relationships and Related Transactions, and Director Independence 51

14. Principal Accounting Fees and Services 51

PART IV

15. Exhibits, Financial Statement Schedules 52

SIGNATURES 53

EXHIBIT INDEX 54

Unless otherwise indicated, all dollar amounts in this report are U.S. dollars.

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PART I

ITEM 1. BUSINESS

Unless otherwise indicated by the context, as used in this Annual Report on Form 10-K, “we,” “us” and “our” refer to International Absorbents Inc. (“International Absorbents”) and our wholly-owned U.S. subsidiary, Absorption Corp. (“Absorption”).

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) based on current expectations, estimates and projections about our industry and our management’s beliefs and assumptions. 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 below under “Item 1A-Risk Factors” and as described from time to time in our reports filed with the Securities and Exchange Commission (“SEC”), including this Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q. Such forward-looking statements include, but are not limited to, statements with respect to the following:

• our future growth strategies and prospects for the future;

• potential financial results, including anticipated revenue and gross profits;

• projected benefits from our three-phase expansion plan;

• our ability to control expenses and improve operating efficiencies;

• our market and product line growth and ability to enter new markets;

• our ability to introduce new products and remain competitive;

• the forecasted benefits from infrastructure improvements; and

• our competitiveness and profitability as a result of sales and marketing programs.

Readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date made. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.

General

International Absorbents is the parent company of its wholly owned U.S. subsidiary, Absorption. Absorption accounts for almost all of the consolidated entity’s assets and annual sales revenue. As such, International Absorbents is the holding company and Absorption is its operating entity. There are no other subsidiaries of International Absorbents.

Absorption is engaged in developing, manufacturing and marketing a wide range of animal care and industrial absorbent products made from off-specification and reclaimed cellulose fibers. International Absorbents was incorporated on May 13, 1983 under the laws of British Columbia, Canada. Absorption was incorporated on July 25, 1985 in the State of Nevada.

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 name CareFRESH^®. We consider the activities that surround the manufacture and distribution of CareFRESH^® to be our core business. We have also expanded the animal care segment of our business by the addition of new sales channels and the introduction of animal food and cat litter into our product line. We have also diversified our industrial/commercial line of products by introducing a line of hydro-mulch, which is used for soil erosion prevention.

The majority of our products, in both the animal care and industrial/commercial segments, are sold in the United States, though we do sell products internationally.

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Business Strategy

We design, manufacture, and sell products that are of high quality and performance, easy to use and cost effective for consumers. We also focus on producing products that are known for their environmentally friendly characteristics. We provide rapid delivery of our products and prompt service and sales support. Based on communication with our customers and other industry participants, we believe that our products have strong brand name recognition and we seek to continue to develop the value of our brands through a variety of customer-driven strategies. Information provided by customers has led to the development of many of our products and we expect that customer needs will continue to shape our product development, marketing, and services. In the pet industry, our products are designed to make owning a small animal a safe, healthy and enjoyable experience.

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 continue to dedicate significant resources to improving our 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 core CareFRESH^® product while expanding sales of new products and existing products in new market channels.

In recent years we have added significantly to our capital infrastructure to diversify our production facilities and accommodate sales growth. This process has reduced the risk of not being able to deliver product to our customers on a timely basis due to major break-downs; has resulted in the location of production facilities closer to the consumer, thereby reducing the cost of transportation and increasing our service levels; and has increased our production capacity, which gives us the ability to grow into the future.

Our long-term strategy includes developing, acquiring, and/or investing in product lines or businesses that (a) complement our existing product lines, (b) can be marketed through existing distribution channels, (c) might benefit from the use of our existing brand names, and (d) are responsive to the needs of our customers. In addition, we will continue to explore strategic opportunities for the company in an effort to maximize shareholder value.

Products

Our leading product is small animal bedding made from cellulose fiber. It is utilized as a substrate for rodents, rabbits, reptiles and hand-fed exotic birds instead of wood shavings, hardwood chips and corn cobs. We believe that our product is superior to traditional bedding materials because it is better able to control and contain ammonia odors. We are a significant bedding supplier to major pet store chains and to independent pet stores through the use of a wide North American network of wholesale distributors. The bedding is also widely used by universities and research facilities. We market our animal bedding under the CareFRESH^®, CareFRESH^®Colors™ andCareFRESH^®Ultra™ brands of small animal bedding in the pet specialty channel. CareFRESH^®Colors is our colored bedding offering and CareFRESH^® Ultra is our white small animal bedding. Both are premium line extensions to our core product, CareFRESH^®. Our CareFRESH^®Colors products were named the best new product of the year for 2006 by Petco Animal Supplies, one of the nation’s largest pet specialty retail chains.

We also distribute our pet bedding under the brands Healthy Pet™ and Critter Care™ in the grocery and/or mass merchandiser distribution channels. Our Healthy Pet™ brand consists of a range of “natural” cat litters made from cellulose fiber, wood, grain and plant-based materials. These products are aimed at the “holistic” market and are designed to be healthier for pets and people than traditional clay litter because of potential health problems associated with crystalline silica in clay products. Our products also generally prove to be less dusty and to weigh less than other mineral-based litter products, making their handling and disposal easier.

We were among the first to offer a dog litter product, which we believe created an entirely new retail category, and which helps provide a lifetime comfort solution for small house-bound dogs. We sell our dog litter products through pet specialty retailers and via mail order under the brand name Puppy Go Potty™.

Through our joint marketing alliance with Supreme Petfoods Ltd, a privately held British firm, we distribute a premium line of small animal food products to pet stores across North America under such brand names as Russel Rabbit™, Gerty Guinea Pig™ and Reggie Rat™ brand premium diets.

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We manufacture loose particulate, pillows, socks, booms, pads and spill kits for use in spill clean up and plant maintenance in the manufacturing, repair and operations (MRO) marketplace. These products are either general purpose in nature or specifically designed for oil-based liquids.

Absorbent W™ is a patented cellulose absorbent specially processed to absorb and retain hydrocarbons like diesel fuel, hydraulic fluid or lubricating oil, while at the same time repelling water. We believe that Absorbent W absorbs more, is better able to retain what it absorbs and is less costly from production to disposal than the polypropylene products with which it primarily competes.

Absorbent GP™ is a cellulose universal absorbent used to absorb all types of liquids including oil, water and chemicals. It is not compatible with aggressive caustics and acids but has a wide range of general purpose uses.

Spill-Sorb™ and Spill-Dri™ are two different types of floor sweep made from waste paper fiber. They are designed for a variety of floor surfaces and applications, and we believe that both products are more absorbent and lighter in weight than traditional clay floor sweeps, and do not pose the potential health problems associated with clay products.

Markets

A majority of our animal care products are sold in the pet specialty channel, through wholesale distributors throughout North America, and to the two major pet supply retailers, which are our two largest customers as described below under “Risk Factors.” Competition for the small animal bedding business comes primarily from regional suppliers of wood shavings and major small animal food/bird seed manufacturers who sell wood shavings and corncob bedding as product line extensions. These food manufacturers offer distributors and retailers the advantage of a single source supply, cross marketing opportunities between food and bedding and, in some cases, strong brand recognition within the pet specialty channel. While we believe no other company currently has a product that performs as well as our patented and proprietary flagship product, the success of our product has led to the entry of additional competitors in the cellulose bedding category.

The consolidation of the pet retail business that began over 10 years ago has expanded in recent years to the distributor level. This means that there are fewer, but larger, customers for our products. We believe that the logistical requirements of serving these larger customers are a barrier to entry into the market for many smaller companies. However, the larger customers frequently seek supply partners with more than one product line in order to reduce supply chain costs and to be able to deal with fewer suppliers. Manufacturers are being consolidated as well, primarily by private equity firms and two public companies. We will continue to expand our product offerings in order to take advantage of our existing relationships with major customers and the wholesale distributor network we have established. We estimate that we have product in 80% of the pet specialty stores in North America and enjoy a market share of approximately 30% in the pet specialty channel for our flagship CareFRESH^® brand.

The general merchandise channel, most notably Wal-Mart, Kmart and Target, accounted for approximately one-half of the wood shavings sold for pet bedding in the United States during 2006, the most recent date for which this information is available. Since general merchandise retailers typically offer most pet products as a convenience item, their product offering is generally not as broad as in the pet specialty channel, and the product duplication found in the pet specialty channel is generally lacking. As a result, niche products such as our pet bedding are generally only found at stores with larger pet departments. Additionally, since the three largest general merchandise retailers, namely Wal-Mart, Kmart and Target, account for approximately 70% of the dollar volume in this channel, products must be successful in one or more of these three major retailers in order to achieve significant market share. We currently sell our bedding products to Wal-Mart.

Our industrial sorbent products are currently marketed under the Absorbent GP™, Absorbent W™, SpillSorb™, and Spill-Dri™ trade names in North America, Europe and Pacific Rim countries. A significant portion of these industrial products is sold overseas through our international distributor channel. Our absorbents are sold in Canada through a master distributor agreement with ITW Devcon Plexus.

Our industrial sorbent products compete against clay-based floor sweep materials and polypropylene materials in “oil-only” and marine-based applications. The primary market for our products is in factories, warehouses and maintenance facilities. Additional markets include marine oil spill response and oil/water filtration applications, ranging from storm drain inserts to marine bilge cleanout.

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Clay absorbents are sold as commodities on a price basis. Competitors who offer clay-based floor sweep materials are generally regional mines and re-packagers. Other organic products such as corncobs also compete in this category. We believe that our products are superior in absorption rate and capacity, are lighter in weight, and have a lower environmental and financial cost from production to disposal than mineral-based absorbents. However, due to the price sensitivity in the MRO marketplace and less stringent regulations and enforcement on “low level waste generators,” our industrial sorbent products have limited sales, brand recognition and market share.

Polypropylene is used in a variety of marine spill and MRO-based applications. After years of strong downward price pressure, the polypropylene industry has consolidated, resulting in fewer manufacturers and converters. Polypropylene has also experienced strong upward price pressure over the past twelve months due to the price of crude oil. Together, this has resulted in a general increase in the price of polypropylene products, which is favorable to our higher priced, cellulose pads. However, we believe that established distribution networks, a reduction in the volume of sorbents used and the significant price differential that still exists in this market all limit our sales results at present. We have experienced the most success in selling Absorbent W™ for cleaning up hydrocarbons in the presence of water and for filtering hydrocarbons from contaminated liquids. Absorbent W™ is a low-cost way to enhance the performance of costly mechanical and carbon based filtration system. We believe that more stringent surface runoff regulations may eventually open up new opportunities for Absorbent W™ in storm water runoff applications.

Industry, Market Trends, and Competition

Based on information in trade publications, feedback received during our participation in trade and professional associations and communications with our customers and suppliers, we believe that over the past five years trends have resulted in changes in the markets that we serve. As discussed below, our products and distribution methods are designed to respond to changes in demand resulting from these trends.

Our primary small animal care product, CareFRESH^® , which is made from cellulose fibers,has become a product leader in its market segment. We believe this has caused a change in consumer buying habits away from the traditional wood shavings products and into cellulose fiber products. As a result, consumers in the pet specialty industry are more willing to try cellulose products, mainly based on the performance characteristics as compared to the performance of the traditional wood shavings products.

In addition to change in product preferences, consumers have also changed their shopping habits. Consumers traditionally purchased a majority of their small animal bedding products at pet specialty stores. In recent years, the consumer’s desire for the convenience of “one stop shopping” has resulted in a shift of these buyers to the mass merchandise and grocery channels. This shift has reduced the percentage of bedding and animal supply products sold in the pet specialty market. We have attempted to address this trend, while protecting the superior brand identity associated with our core business, by focusing sales efforts in the mass merchandise and grocery channels with brands specific to those channels.

We believe that the fastest growing segment of the cat litter market is the natural litter segment, though this segment remains less than 10% of the total cat litter market. This growth comes from increased consumer concern about how some traditional cat litter products affect the health of their pets, real and perceived performance benefits from the natural products, and the transference of consumer emotional buying motivations from human products to pet products. However, even with this growing level of concern, product performance is still a key factor with most consumers. We believe our animal care products address many of these factors.

Environmental regulation and economics have reduced the volume of leaks, drips and spills in manufacturing settings over the past decade. As a result, fewer industrial absorbent products such as socks, pads and pillows are used as a part of routine maintenance. At the same time, the cost of non-compliance has resulted in more sophisticated solutions in prevention, control and remediation of liquid waste. Supply chain logistics have become a more important part of the sales and distribution model for large volume users while low volume waste generators continue to be serviced via a variety of methods and channels.

We face a variety of competition in all of the markets in which we participate. This competition ranges from subsidiaries of large national or international corporations to small regional manufacturers. While price is an important factor, we also compete on the basis of quality, breadth of product line, service, field support and product innovation. Markets tend to differ by region and as a result, within each region we compete with companies of varying sizes, several of which also distribute their products nationally. Our competitors include a variety of manufacturers that have operations in the United States and Canada. Most of our competitors do not compete with all of our product lines and many have products with which we do not compete.

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Raw Materials

Our animal care bedding, pet litter and industrial products are made from raw materials that are available from a number of suppliers. The cost of these raw materials varies widely based on the source and quality. These products are manufactured in our facilities located in Ferndale, Washington; and Jesup, Georgia. The main component for our products is a cellulose fiber by-product. Pulp and paper mills in British Columbia, Canada, the State of Washington, the State of Georgia, and the State of Florida provide this raw material. We do not have contracts for supply of all of our needed primary raw material, however, we believe that our production rates can be fully supported by combinations of fiber from various pulp and paper mills in all of our locations, although the cost of raw fiber stock for our east coast operations is currently higher than in Washington State, largely due to the product mix required. We believe that this diversification of raw material sources improves our ability to fill our fiber needs and improves the quality of our products.

Both of our production facilities have installed drying systems that can operate with either natural gas or sawdust as a combustion source for their burners. Neither operates full time on either source of energy. We believe there will be an adequate supply of these materials available to meet our fuel needs for the foreseeable future, provided, however, as described below, we may be subject to increased prices for these materials.

Other raw materials used in the production of our products include chemical binders which are readily available from several suppliers. We believe that the loss of one or two of our suppliers would not have a significant effect on our operations. The loss of any supplier may cause an increase in freight costs, the amount of which would depend on the distance to the alternative source. Our operations could be adversely affected if a general shortage of raw material were to occur and persist. We have not experienced any serious production delays because raw materials were unavailable.

Marketing and Distribution

Manufacturing, marketing and distribution activities are carried out by Absorption and its wholesale distributors. During fiscal year 2008, in an effort to manage costs, we maintained our investment in sales and marketing; as sales continue to increase, staffing is being adjusted to manage the demand.

Our products are sold through multiple wholesale distributions and direct buying retailers throughout North America. In addition our products are sold in markets in Canada, Great Britain, Belgium, Australia, Singapore, Japan, Taiwan, South Korea, Denmark, Israel and China.

Research and Development

Current research and development activities include refining existing products, as well as developing new pet products and related manufacturing processes for both the animal care industry and industrial markets. Our research and development department also analyzes and tests the competitive products to determine new applications for our existing products. Research and development expenses were $10,000 and $10,000 during fiscal years 2008 and 2007, respectively.

Intellectual Property

Our intellectual property is important to our success. In general, we attempt to protect our intellectual property rights through patent, copyright, trademark and trade secret laws and contractual arrangements. However, there can be no assurance that our efforts will be effective to prevent misappropriation of our technology, or to prevent the development and design by others of products or technologies similar to or competitive with those developed by us. Moreover, upon expiration of any of our issued patents, our competitors will have the ability to develop products that are the same as those developed by us.

Absorption has been issued three U.S. patents and has one pending patent relating to various degradable particulate absorbent materials and our manufacturing process.

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Number of Employees

As of March 2008, we had 132 employees, of which 126 are full-time employees and none of which are represented by labor unions. In addition, we employ a small number of temporary employees and contractors to provide management, administration, manufacturing, and marketing services.

Product Liability

We design and manufacture most of our standard products and expect that we will continue to do so. We employ engineers and designers to design and test our products under development and maintain a quality control system.

Environmental and Other Governmental Regulations

We are subject to environmental laws and regulations governing emissions into the air, discharges into the water, generation, handling, storage, transportation, treatment, and disposal of waste materials. We are also subject to other federal and state laws and regulations regarding health and safety matters. In addition, we are subject to regulations governing our food products, including those promulgated by the U.S. Department of Agriculture. We believe that we have obtained all material licenses and permits required by environmental, health, and safety laws and regulations in connection with our operations and that our policies and procedures comply in all material respects with existing environmental, health and safety laws and regulations. Non-compliance with such standards could result in the closure of our particulate manufacturing operations, expenditures for necessary corrective actions or the possible imposition of fines.

Internet Website

All our filings with the SEC, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on form 8-K and amendments to those reports, made pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge on our internet website, www.internationalabsorbents.com. Reports are posted as soon as reasonably practicable after such material is filed with, or furnished to, the SEC. They can be found through the investor relations section under the “SEC Filings” tab on our website.

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ITEM 1A. RISK FACTORS

The following risk factors and other information included in this Annual Report should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks occur, our business, financial condition, operating results and cash flows could be materially adversely affected.

We are still building our market presence and are subject to substantial competition that could inhibit our ability to succeed as planned.

We are one of many companies that compete in the animal care market. We continue to build and maintain our market presence as we compete with both domestic and foreign companies. Any reputation that we may successfully gain with retailers for quality product does not necessarily translate into name recognition or increased market share with the end consumer. Our products may not be well received by pet owners, or other companies may surpass us in product innovations. Any failure to continue to gain consumer awareness and market share could decrease our revenues and have an adverse effect on our financial results.

We may be adversely affected by trends in the retail industry.

With the growing trend towards retail trade consolidation, we are increasingly dependent upon key retailers whose bargaining strength is growing. As a result, our business may be negatively affected by changes in the policies of our retailer customers, such as inventory delisting, limitations on access to shelf space, price demands and other conditions. In addition, as a result of the desire of retailers to more closely manage inventory levels, there is a growing trend among retailers to make purchases on a “just-in-time” basis. This requires us to shorten our lead time for production in certain cases and more closely anticipate demand, which could in the future require the carrying of additional inventories and increase our working capital and related financing requirements.

Moreover, a significant deterioration in the financial condition of one of our major customers could have a material adverse effect on our sales, profitability and cash flow. We continually monitor and evaluate the credit status of our customers and attempt to adjust sales terms as appropriate. Despite these efforts, a bankruptcy filing by a key customer could have a material adverse effect on our business, results of operations and financial condition.

We depend on a few customers for a significant portion of our business.

Our two largest customers accounted for approximately 24% (Petco) and 24% (Petsmart) of our net sales in fiscal year 2008, while the same customers accounted for approximately 23% and 24%, respectively, of our net sales in fiscal year 2007.

The loss of, or significant adverse change in, our relationship with any of these key retailers could cause our net sales, income from operations and cash flow to decrease substantially. The loss of, or reduction in, orders from any significant customer, losses arising from customer disputes regarding shipments, fees, merchandise condition or related matters, or our inability to collect accounts receivable from any major customer could reduce our income from operations and cash flow.

We cannot be certain that our product innovations and marketing successes will continue.

We believe that our future success will partially depend upon our ability to continue to improve our existing products through product innovation and to develop, market and produce new products. We cannot assure you that we will be successful in the introduction, marketing and production of any new products or product innovations, or develop and introduce in a timely manner innovations to our existing products which satisfy customer needs or achieve market acceptance. Our failure to develop new products and introduce them successfully and in a timely manner could harm our ability to grow our business and could have a material adverse effect on our business, results of operations and financial condition.

Competition in our industries may hinder our ability to execute our business strategy, maintain profitability, or maintain relationships with existing customers.

We operate in highly competitive industries, which have experienced increased consolidation in recent years. We compete against numerous other companies, some of which are more established in their industries and have substantially greater revenue or resources than we do. Our products compete against national and regional products and private label products

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produced by various suppliers. To compete effectively, among other things, we must:

• maintain our relationships with key retailers and distributors;

• develop and grow brands that are attractive to consumers and gain market share;

• continually develop innovative new products that appeal to consumers;

• maintain strict quality standards; and

• deliver products on a reliable basis at competitive prices.

Competition could cause lower sales volumes, price reductions, reduced profits, losses, or loss of market share. Moreover, as we add new items to our line of products, they will need to compete for limited shelf space at the mass merchandiser and grocery stores with our competitors’ products. Our inability to compete effectively could have a material adverse effect on our business, results of operations and financial condition.

Additional increases in our costs of goods sold, including the costs of raw materials, transportation costs or labor expenses, could have an adverse effect on our financial condition.

Our business places heavy reliance on raw materials being readily available. Although we believe that there are a number of pulp and paper mills in British Columbia, Canada, the State of Washington, the State of Georgia, and the State of Florida that can provide us with the raw materials necessary to conduct our business, any significant decreases in supplies, or any increase in costs or a greater increase in delivery costs for these materials, could result in a decrease in our margins, which would harm our financial condition. For example, in the second quarter of fiscal year 2005, we experienced a decreased availability of our main raw material, waste wood fiber, which resulted in downward pressure on our gross profits for the period. We currently do not have ideal raw material sources for our needed primary raw material, waste wood pulp, to be supplied to our Georgia facility. Although we believe we will be able to obtain the required material in the region, any significant shortfall of material would result in a significant increase in the cost of producing our primary products.

In addition, we have recently experienced exceedingly high transportation expenses. Any further increases in these costs will continue to have an adverse effect on our financial results. Moreover, we face a risk of increased labor costs, including significant increases in worker's compensation insurance premiums and health care benefits, which could further negatively impact our results of operations.

Rising energy prices could adversely affect our operating results.

In the last few years, energy prices have risen dramatically, including the cost of natural gas, which has resulted in increased fuel costs for our businesses and raw materials costs for our branded products. Moreover, while we have installed new burners at our facilities to heat our dryers, due to the prevalence of high energy costs throughout the county, there is now a higher demand and a resulting shortage of the materials necessary to fuel these burners. Rising energy prices could adversely affect consumer spending and demand for our products and increase our operating costs, both of which would reduce our sales and operating income.

Any downturn in the U.S. economy generally, and the retail sector in particular, would substantially harm our business.

The success of our business initiatives is tied to the performance of the U.S economy in general, and the retail sector in particular. The U.S. economy has suffered a downturn in recent months and, in fact, many experts feel that the United States may experience a recession, which may continue for a significant period of time. An economic downturn in the United States could result in lower than expected sales growth of our products, as a result of decreased customer traffic at our major customer’s stores. Any such reduction in customer traffic at the stores of our major customers could result in a reduced demand for our products and/or a decrease in prices, either of which would have an adverse effect on our financial results.

Our business is subject to many regulations and noncompliance could be costly.

The manufacture, marketing and sale of our products are subject to the rules and regulations of various federal, provincial, and state agencies, including, without limitation, regulations governing emissions into the air, discharges into the water, generation, handling, storage, transportation, treatment, and disposal of waste materials. Environmental regulations may affect us by restricting the manufacturing or use of our products ore regulating their disposal. We are also subject to other federal and state laws and regulations regarding health and safety matters.

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If we do not obtain all material licenses and permits required by government, we may be subject to regulatory action by government authorities. Moreover, if our policies and procedures do not comply in all respects with existing laws and regulations, our activities may violate such laws and regulations. Even if our policies and procedures do comply, but our employees fail or neglect to follow them in all respects, we might incur similar liability. For example, if a regulatory authority finds that a current or future product or production run is not in compliance with any of these regulations, we may be fined, production may be stopped or a product may be pulled from the shelves, any of which could adversely affect our financial conditions and operations.

In addition, any adverse publicity associated with any noncompliance may damage our reputation and our ability to successfully market our products. Furthermore, the rules and regulations are subject to change from time to time and while we closely monitor developments in this area, we have no way of anticipating whether changes in these rules and regulations will be made that would impact our business adversely. Additional or revised regulatory requirements, whether labeling, environmental, health and safety, tax or otherwise, could have a material adverse effect on our financial condition and results of operations.

We have significant indebtedness which impacts our business in several ways, and the nonpayment of which could harm our business.

As of January 31, 2008, we had total long-term and current indebtedness under three different bonds of $7,521,000. We make interest payments (and principal payments on the taxable bond) on the indebtedness under three bonds, which are due in 2014, 2019, and 2019, respectively. We may incur substantial additional debt in the future. Our indebtedness could limit our ability to obtain necessary additional financing for working capital, capital expenditures, debt service requirements or other purposes in the future; to plan for, or react to, changes in technology and in our business and competition; and to react in the event of an economic downturn. In addition, our indebtedness makes us vulnerable to interest rate fluctuations because our bonds due (2019) bear interest at variable rates. Any significant interest rate increase could have an adverse effect on our financial condition. Moreover, there is no guarantee that we will be able to meet our debt service obligations. If we are unable to generate sufficient cash flow or obtain funds for required payments, or if we fail to comply with covenants in our indebtedness, we will be in default. The indebtedness underlying our bonds is secured by a mortgage on our real property and a security interest in our assets. If we are in default under the agreements governing our indebtedness, the creditors may be able to foreclose on our property and assets, which would substantially harm our business and financial condition.

If we fail to maintain an effective system of internal and disclosure controls, we may not be able to accurately report our financial results or prevent fraud.

Effective internal and disclosure controls help us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business and the trading price of our securities. We have in the past discovered deficiencies in our internal controls as defined under interim standards adopted by the Public Company Accounting Oversight Board (“PCAOB”) that require remediation. Furthermore, our independent auditor has, in the past, advised us that it had noted certain reportable conditions in our internal financial reporting and accounting controls. Additionally, it is possible that as we continue our ongoing review and analysis of internal control over financial reporting for compliance with the Sarbanes-Oxley Act of 2002, additional weaknesses in internal controls may be discovered.

If we need to raise additional capital for our operating plan, our business would be harmed if we were unable to do so on acceptable terms.

We currently anticipate that our existing capital resources and cash flows from operations will enable us to maintain our currently planned operations for the foreseeable future. However, our current operating plan may change as a result of many factors, including general economic conditions affecting the U.S. economy, which are beyond our control. If we are unable to generate and maintain positive operating cash flows and operating income in the future, we may need additional funding. We may also choose to raise additional capital due to market conditions or strategic considerations even if we believe that we have sufficient funds for our current or future operating plans. If additional capital were needed, our inability to raise capital on favorable terms would harm our business and financial condition. To the extent that we raise additional capital through the sale of equity or debt securities convertible into equity, the issuance of these securities could result in dilution to our shareholders.

The indentures governing our bonds and bank debt financing includes financial covenants that restrict certain of our activities and impose certain financial tests that we must meet in order to be in compliance with their terms.

The terms of the indentures governing our bondsand bank debt financingrestrict our ability to, among other things, incur

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additional indebtedness, pay dividends or make other restricted payments on investments, consummate asset sales or similar transactions, create liens, or merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of our assets. The terms also contain covenants that require us to meet financial tests. We currently are in compliance with these restrictions and covenants and expect that we will continue to comply. If we were not able to do so, we could be materially and adversely affected.

The loss of key senior management personnel could negatively affect our business.

We depend on the continued services and performance of our senior management and other key personnel. We do not have “key person” life insurance policies. The loss of any of our executive officers or other key employees could harm our business.

Our future growth may depend on our ability to penetrate new domestic and international markets, which could reduce our profitability.

Our current sales projections indicate that growth in sales may need to come from new products and new markets, including international markets. International small animal care customs, standards, techniques, and methods differ from those in the United States. Laws and regulations applicable in new markets may be unfamiliar to us. Compliance may be substantially more costly than we anticipate. As a result we may need to redesign products, or invent or design new products, to compete effectively and profitably in new markets. We expect that we will need significant time, which may be years, to generate substantial sales or profits in new markets.

Other significant challenges to conducting business in foreign countries include, among other factors, local acceptance of our products, political instability, currency controls, changes in import and export regulations, changes in tariff and freight rates, and fluctuations in foreign exchange rates. We might not be able to penetrate these markets and any market penetration that occurs might not be timely or profitable. If we do not penetrate these markets within a reasonable time, we will be unable to recoup part or all of the significant investments we may have made in attempting to do so.

The inability to successfully obtain or protect our patents could harm our competitive advantage.

Our success will depend, in part, on our ability to maintain protection for our products under U.S. patent laws, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. We have been issued three U.S. patents, of which two remain current, and have one pending patent on various degradable particulate absorbent materials and our manufacturing process. Patent applications may not successfully result in an issued patent. Issued patents may be subject to challenges and infringements. Moreover, upon expiration of any of our two current patents, one of which will expire within the foreseeable future, other parties may be able to develop competing products, which could decrease our sales and reduce our market share. Furthermore, others may independently develop similar products or otherwise circumvent our patent protection. Should we fail to obtain and protect our patents, our competitive advantage will be harmed.

The products that we manufacture could expose us to product liability claims, and our manufacturing process may pose additional risks.

Our business exposes us to potential product liability risks that are inherent in the manufacture and distribution of certain of our products. Although we generally seek to insure against such risks, there can be no assurance that such coverage is adequate or that we will be able to maintain such insurance on acceptable terms. A successful product liability claim in excess of our insurance coverage could have a material adverse effect on us and any successful material product liability claim could prevent us from obtaining adequate product liability insurance in the future on commercially reasonable terms. Moreover, as part of our manufacturing process, we use complex and heavy machinery and equipment that can pose severe safety hazards, especially if not properly and carefully used.

We will incur substantial costs to comply with the requirements of the Sarbanes-Oxley Act of 2002, and our internal controls may not be in compliance with all of the requirements prior to the currently proposed compliance date.

The Sarbanes-Oxley Act of 2002 (the “Act”) introduced new requirements regarding corporate governance and financial reporting. Among the many requirements is the requirement under Section 404 of the Act for management to annually assess and report on the effectiveness of our internal control over financial reporting and for our registered public accountant to attest to this report. The SEC has modified the effective date and adoption requirements of Section 404 implementation for non-accelerated filers, such as us, such that we are first required to issue our management report on

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internal control over financial reporting in our annual report on Form 10-K for the fiscal year ending January 31, 2008. We will be required to dedicate significant time and resources during fiscal year 2009 to continue to ensure compliance. The costs to comply with these requirements will likely be significant and adversely affect our operating results. In addition, at the end of fiscal year 2010 our auditors will be required to issue a report on our internal controls. There can be no assurance that we will be successful in our efforts to comply with Section 404 and, in fact, we may not be in compliance with all of the requirements prior to the currently proposed compliance date. Failure to do so could result in penalties and additional expenditures to meet the requirements, which could affect the ability of our auditors to issue an unqualified report which, in turn, may further adversely affect our business and operating results.

Natural disasters could decrease our manufacturing capacity.

Most of our current and planned manufacturing facilities are located in geographic regions that have experienced major natural disasters, such as earthquakes, floods, and hurricanes. Our disaster recovery plan may not be adequate or effective. We do not carry earthquake or flood insurance. Other insurance that we carry is limited in the risks covered and the amount of coverage. Our insurance would not be adequate to cover all of our resulting costs, business interruption and lost profits when a major natural disaster occurs. A natural disaster rendering one or more of our manufacturing facilities totally or partially unusable, whether or not covered by insurance, would materially and adversely affect our business and financial condition.

The price for our common shares may continue to be volatile.

The market price of our common shares, like that of many other small-cap companies, has been highly volatile, experiencing wide fluctuations not necessarily related to the operating performance of such companies. Factors such as our operating results, announcements by us or our competitors concerning innovations and new products or systems may have a significant impact on the market price of our securities. In addition, we have experienced limited trading volume in our common shares.

It might be difficult for a third-party to acquire us even if doing so would be beneficial to our shareholders.

In fiscal year 2007, we adopted a shareholder rights plan. The shareholder rights plan is designed to protect shareholders from unfair, abusive or coercive take-over strategies, including the acquisition of control of our company by a bidder in a transaction or series of transactions that does not treat all shareholders equally or fairly or provide all shareholders an equal opportunity to share in the premium paid on an acquisition of control. However, the shareholder rights plan may discourage certain types of take-over bids that might be made for us and may render more difficult a merger, tender offer, assumption of control by the holders of a large block of our securities or the removal of incumbent management, even though certain of such transactions or effects might be beneficial in the judgment of certain shareholders or shareholders generally. For example, the shareholder rights plan could have the effect of preventing a particular take-over bid from being made or being successful, even though a majority of our shareholders might wish to participate in that take-over bid. The shareholder rights plan will cause substantial dilution to a person or group that attempts to acquire us other than through a “permitted bid” (as defined in the plan) or on terms approved by the Board. If triggered, the shareholder rights plan will also likely cause substantial dilution to any shareholder who fails to or elects not to exercise its rights. The existence of these anti-takeover provisions could limit the price that investors might be willing to pay in the future for our common shares.

Our results of operations could vary as a result of the methods, estimates, and judgments we use in applying our accounting policies or as the result of the adoption of new accounting pronouncements.

The methods, estimates, and judgments we use in applying our accounting policies have a significant impact on our results of operations. Such methods, estimates, and judgments are, by their nature, subject to substantial risks, uncertainties, and assumptions, and factors may arise over time that lead us to change our methods, estimates, and judgments. Changes in those methods, estimates, and judgments could significantly affect our results of operations. In particular, the calculation of share-based compensation expense (as described below), requires us to use valuation methodologies and a number of assumptions, estimates, and conclusions regarding matters such as expected forfeitures, expected volatility of our share price, the expected dividend rate with respect to our common stock, and the exercise behavior of our employees. Furthermore, there are no means, under applicable accounting principles, to compare and adjust our expense if and when we learn about additional information that may affect the estimates that we previously made, with the exception of changes in expected forfeitures of share-based awards. Factors may arise over time that lead us to change our estimates and assumptions with respect to future share-based compensation arrangements, resulting in variability in our share-based compensation expense over time. Changes in forecasted share-based compensation expense could impact our gross margin percentage; research and development expenses; marketing, general and administrative expenses; and our tax rate.

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Moreover, the issuance and adoption of new accounting pronouncements may require us to change our accounting policies, which could have an adverse effect on our operating results.

The liquidity of our stock depends in part on our continued listing with the American Stock Exchange.

In March 2003, we received official notice from the American Stock Exchange (“AMEX”) that our common stock had been approved for listing. In order to continue to have our common shares listed, we must remain in compliance with the AMEX listing standards, including standards related to stock price, market capitalization and corporate governance. If we are unable to do so, AMEX could de-list our stock, in which event the liquidity and the value of our shares could be adversely impacted.

As a result of our principal executive offices being located in Canada, and a majority of our directors and certain of our officers residing in Canada, investors may find it difficult to enforce, within the United States, any judgments obtained against our company or our directors or officers.

Our principal executive offices, a majority of our directors and certain of our officers are located in and/or residents of Canada, and all or a substantial portion of such persons’ assets are located outside the United States. As a result, it may be difficult for investors to obtain jurisdiction over us or our directors or officers in courts in the United States in actions predicated on the civil liability provisions of the U.S. federal securities laws; enforce against us or our directors or officers judgments obtained in such actions; obtain judgments against us or our directors or officers in actions in non-U.S. courts predicated solely upon the U.S. federal securities laws; or enforce against us or our directors or officers in non-U.S. courts judgments of courts in the United States predicated upon the civil liability provisions of the U.S. federal securities laws.

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ITEM 2. PROPERTIES

Ferndale, Washington

On October 18, 2002, we purchased for cash approximately 15.6 acres of bare land, described as Lots 4, 5, and 6 of the Grandview Light Industrial Park, Ferndale, Washington. The total purchase price of the land was $1,500,000, plus closing costs, which was determined through arms-length negotiations.

During the fiscal year 2004, we completed the construction of a 105,000 square foot production, warehousing, and office space facility on this property. The construction of this facility was financed through the issuance of industrial revenue bonds in the amount of $2,910,000 and from cash on hand. Manufacturing of our animal care products and some ancillary products along with the majority of our warehousing takes place at this facility.

During fiscal year 2008 we completed the closure and move of our Bellingham, Washington manufacturing facility to our Ferndale, Washington location (engineering was started during the second quarter of fiscal year 2007). The cost of the move and additional facility related construction was approximately $4,900,000, of which $3,300,000 was financed through cash on hand and $1,600,000 was financed through bond financing with GE Capital Public Finance, Inc., as described below.

Jesup, Georgia

On August 20, 2003, we purchased 14 acres of land zoned light industrial in Jesup, Georgia for $140,000, which included a 41,000 square foot steel warehouse building. During fiscal year 2005, we constructed approximately 45,000 square feet of additional warehousing and manufacturing space on the property at a cost of $6,650,000 (including equipment we installed). The construction was financed with cash on hand and a debt facility from Branch Banking &Trust Co. (“BB&T”). Pursuant to our letter of credit with BB&T and in connection with the issuance of certain tax exempt bonds by Wayne County Industrial Development Authority (“Wayne County IDA”), we sold our real property in Jesup, Georgia to Wayne County IDA and are currently leasing the real property back from Wayne County IDA. Upon repayment of the bonds in full, Wayne County IDA will transfer all right, title and interest in the real property and related production facility to Absorption for no additional consideration. While the bonds remain outstanding, as security for the indebtedness underlying the letter of credit, BB&T will hold a mortgage on the real property and a security interest in the equipment assets located on that property. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” for additional information regarding this financing transaction. We manufacture and warehouse multiple product lines in both segments at this facility.

We believe that our Ferndale and Georgia facilities will be adequate for our manufacturing needs for products in both of our segments for the near future. We believe that our existing properties are in good condition, are adequately insured in a manner consistent with other similarly situated companies and will meet our manufacturing and warehousing needs for the foreseeable future.

Vancouver, British Columbia, Canada

We also share 1,640 square feet of office space with a related party in North Vancouver, British Columbia, Canada. The terms of our rental agreement call for monthly payments of $500 towards the office space and include the use of office furniture and equipment.

Our owned properties are subject to mortgages to secure the indebtedness under our bonds and long-term debt, which together amounted to $7,521,000 as of January 31, 2008.

ITEM 3. LEGAL PROCEEDINGS

Except for ordinary routine litigation incidental to our business, there are no material legal proceedings pending to which we are a party, or of which any of our properties is the subject.

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

During the fourth quarter of fiscal year 2008 there were no matters submitted to a vote of our security holders.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market information

Our Common Shares are currently listed on AMEX (since March 21, 2003), under the trading symbol IAX. Shown below are the high and low sale prices for the Common Shares for the periods indicated below as listed on AMEX. The following quotations, as provided by the AMEX and the OTC Bulletin Board (Nasdaq Trading & Market Services), represent prices between dealers and do not include retail markup, markdown or commission. In addition, these quotations may not represent actual transactions.

	FISCAL YEAR 2008		FISCAL YEAR 2007
	HIGH	LOW	HIGH	LOW
First quarter	5.42	3.84	3.60	2.95
Second quarter	6.50	4.19	3.15	2.35
Third quarter	6.68	3.47	3.14	2.34
Fourth quarter	4.00	3.20	4.11	2.53

Holders

We had 451 holders of record of our Common Shares as of April 16, 2008.

Dividends

We have never paid dividends to the holders of our Common Shares. The decision whether to pay dividends and the amount thereof is at the discretion of our board of directors, and will be governed by such factors as earnings, capital requirements and our operating and financial condition. In addition, our credit facility prohibits us from paying dividends without our lender’s consent. Furthermore, the indentures pursuant to which our bonds were issued each prohibit us from declaring a cash dividend unless, after giving effect to such dividend, we would not be in default under such indentures, we remained in compliance with certain financial ratios and the amount of the dividend did not exceed the limits set forth in the indentures. We intend to retain our earnings to finance the continuing growth of our business and, thus do not intend to pay dividends in the foreseeable future.

Exchange controls and other limitations affecting security holders

Canada has no system of exchange controls. There are no restrictions on the remittance of dividends, interest, or other similar payments to nonresidents of Canada holding our securities. There are generally no restrictions on the right of nonresidents of Canada to hold or vote securities in a Canadian company. However, the Investment Canada Act (the “Investment Act”) requires prior notification to the Government of Canada on the acquisition of control of Canadian businesses by non-Canadians. The term “acquisition of control” is defined as any one or more non-Canadian persons acquiring all or substantially all of the assets used in the Canadian business, the acquisition of the voting shares of a Canadian corporation carrying on the Canadian business or the acquisition of an entity controlling or carrying on the Canadian business. The acquisition of the majority of the outstanding shares is deemed to be an “acquisition of control” of a corporation unless it can be established that the purchaser will not control the corporation.

Subject to the exceptions noted below for World Trade Organization (“WTO”) investors, investments which require prior notification under the Investment Act are all direct acquisitions of Canadian businesses with assets of (Cdn) $5,000,000 or more and all indirect acquisitions of Canadian businesses with assets of more than (Cdn) $50,000,000 or with assets between (Cdn) $5,000,000 and (Cdn) $50,000,000 which represent more than 50% of the value of the total international operations. In addition, specific acquisitions or businesses in designated types of activities related to Canada’s cultural heritage or national identity could be reviewed if the government considers it to be in the public interest to do so.

The WTO investor exception to the Investment Act provides special review thresholds in the case of acquisitions by such

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investors. WTO investors include individuals who are a national of a WTO member or who has the right of permanent residence in relation to a WTO member, governments of WTO members and entities that are not Canadian controlled but which are WTO investor controlled. The United States is a member of the WTO. The WTO review thresholds are calculated using a formula and for 1996 and 1997 are (Cdn) $168,000,000 and (Cdn) $172,000,000.

Based on the current amount of our assets, the review provisions of the Investment Act will not be applicable to us. However, there can be no assurance that it will not become applicable to us in the future.

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ITEM 7. 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 Item 1 of Part I, “Business — Forward-Looking Statements” and Item 1A of Part I, “Risk Factors.”

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 name CareFRESH^®. We consider the activities that surround the manufacture and distribution of CareFRESH^® 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 continue to dedicate significant resources to improving our 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 core CareFRESH^® product while expanding sales of new products and existing products into new market channels.

The financial results from fiscal year 2008 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 fiscal year 2008 we were meeting expectations for gross profits, which had been down during the second quarter of fiscal year 2008 due to the closure and 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 leading CareFRESH^®, CareFRESH^®Colors and CareFRESH^® Ultra brands of small animal bedding products. CareFRESH^®Colors is our colored bedding offering and CareFRESH^® Ultra is our white small animal bedding. Both are premium line extensions to our core product, CareFRESH^®. We also continue to aggressively sell our Healthy Pet ™ cat litter line. Our Healthy Pet™ brand consists of a range of “natural” cat litters made from cellulose fiber, wood, grain and plant-based materials. These products are aimed at the “holistic” market and are designed to be healthier for pets and people than traditional clay litter because of potential health problems associated with crystalline silica in clay products. 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 continue to experience 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.

Results of Operations

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

	January 31, 2008	Percent of Sales	January 31, 2007	Percent of Sales	Percentage Change
Sales	33,095	100%	29,495	100%	12%
COGS	23,139	70%	19,902	67%	16%
Gross Profit	9,956	30%	9,593	33%	4%

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S G & A	6,387	19%	8,104	27%	-21%
Income from operations	3,569	11%	1,489	5%	140%
Interest Income	86	0%	150	1%	-43%
Interest Expense	(385)	-1%	(361)	-1%	7%
Profit before taxes	3,270	10%	1,278	4%	156%
Income Taxes	(1,254)	-4%	(577)	-2%	117%
Net Income	2,016	6%	701	2%	188%

Net Sales

In fiscal year 2008, our net sales increased by 12% over fiscal year 2007. All of the growth in net sales was a result of the growth in sales of our animal care products. During fiscal year 2008, net sales for animal care products grew from $28,288,000 to $32,271,000, as compared to the same period of fiscal year 2007. Net sales of our industrial products decreased from $1,207,000 to $824,000 for fiscal years 2008 and 2007, respectively. We had strong growth with all of our bedding products, including CareFRESH^®, CareFRESH^® Ultra™, and CareFRESH^®Colors products. Our strategy in regard to our industrial line of products has remained the same, which is to effectively service existing customers while focusing growth on animal care products.

We currently believe that our fiscal year 2009 overall annual net sales will grow approximately 8% to 15% over our fiscal year 2008 net sales levels. Specifically, during fiscal year 2009, we expect sales of natural, non-colored CareFRESH^® in pet specialty channels to grow slightly over sales levels from fiscal year 2008 as we fill in distribution holes throughout the United States. In recent years, we have also introduced line extensions such as CareFRESH Ultra™ and CareFRESH^®Colors. Therefore, although we anticipate that natural CareFRESH^® will continue to represent the majority of our sales through the 2009 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 our CareFRESH^® 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. Finally, an economic downturn in the United States could result in lower than expected sales growth of our products, as a result of reduced customer traffic at our major customer’s stores. Any such reduction in customer traffic at the stores of our major customers during fiscal year 2009 will reduce our overall sales growth rate. As such, a significant economic down turn may reduce our projected 8% to 15% growth to a lower rate. With respect to our lines of cat litter products, subject to the caveats described above, we continue to expect revenue growth from these products. During fiscal year 2009, we will continue our existing product line maintenance strategy with our industrial/commercial line of products.

Gross Profit

Both of our production facilities are now operating at efficiency levels that are at or near the initial expectations of management. Nonetheless, during fiscal year 2008, our production facilities continued to face challenges that directly affected their production costs. These challenges included down time and commissioning costs related to the closure and move of the Bellingham, Washington plant during the second quarter of fiscal year 2008, the additional burden of increases in utility rates, increased depreciation, and increased fuel surcharges on freight. Mostly as a result of these production costs and a shift in our product mix, our gross margin (gross profit divided by sales) decreased from 33% in fiscal year 2007 to 30% in fiscal year 2008.

As discussed in Note 14 (“Segmented Information”) to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, operating income including selling, general and administrative expenses, but before depreciation for our animal care product segment, increased by 79% in fiscal year 2008 as compared to fiscal year 2007. Operating loss before depreciation for our industrial product segment decreased by 25% comparing fiscal year 2007 to fiscal year 2008.

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For fiscal year 2009 we continue to expect that our gross margin will remain in the range of 30% to 34%. The reasons for this expectation are as follows. First, due to ongoing high fuel costs, transportation of our product to our customers continues to put downward pressure on our gross margins. 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, additional depreciation charges resulting from our new production facilities will also have a negative effect on our gross margin.Fourth, the cost of natural gas, which we use, in part, to fuel our facilities, continues to remain high.

To help offset the significant increases in the cost of natural gas, we have installed new burners to heat our dryers at our production facilities that operate at less than one-third the cost of our current natural gas burners. Unfortunately, due to the prevalence of high energy costs throughout the country, there is now a higher demand and a resulting shortage of the materials we need for our new burners. When we are able to obtain such materials, we are able to achieve the projected costs savings, even in the current economic climate. We plan to continue to make capital investments in technology at all of our facilities to help decrease the costs of production.

Selling, Administrative and General Expenses

During fiscal year 2008, our selling, general and administrative expenses decreased by 21% as compared to fiscal year 2007.

The table below illustrates the impact on our selling, general, and administrative expenses for fiscal years 2008 and 2007 resulting from (a) the one-time expense of $167,000 incurred during fiscal year 2008 as a result of the disposal of fixed assets associated with the closing and dismantling of our Bellingham, Washington production facility and (b) the $1,186,000 arbitration award issued against us in fiscal year 2007 (U.S. dollars in thousands):

	January 31, 2008	Percent of Sales	January 31, 2007	Percent of Sales	Percentage Change
Selling, administrative and general expenses	6,387	19%	8,104	27%	-21%
Arbitration award	0	0%	1,186	4%
Retirement of assets	167	1%	0	0%
Selling, administrative and general expenses adjusted for retirement of assets	6,220	19%	6,918	23%	-10%

As discussed in our Annual Report on Form 10-K filed for fiscal year 2007 Item 3, Part I, “Legal Proceedings,” on October 10, 2006, we were notified that the American Arbitration Association (the “Arbitrator”) 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 our 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.

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. We anticipate that these factors, along with our stock-based compensation expenses, will continue to increase general and administrative expenses during fiscal year 2009.

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During fiscal year 2009, we intend to continue our marketing initiatives at the rates greater than we completed in fiscal year 2008. 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 in fiscal year 2008 totaled $385,000 as compared to $361,000 during fiscal year 2007. This increase was due to the bond financing related to the closure and move of our Bellingham, Washington facility during fiscal year 2008. We currently have no plans to enter into additional debt financing, which means that we are projecting a decrease in interest expenses in fiscal year 2009 as the principal portion of our existing debt is paid down.

Income Tax

Absorption incurred federal income taxes during fiscal year 2008 at an effective rate of 38%. The effective rate is lower than the rate incurred during fiscal year 2007 (of 45%) due to the proportion of stock-based compensation expenses from stock options that are not deductible for federal income taxes as compared to net income before taxes. We anticipate that the effective rate going forward will fluctuate 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 year ended January 31, 2008 increased by 188% 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 increased sales and our ability to control selling, administrative and general expenses. 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 our anticipated increase in demand for our products and generate additional revenues.

We expect that in fiscal year 2009 we will be able to continue to increase sales and minimize the growth of our selling general and administrative costs. Our biggest challenges for the coming fiscal year will be improving our gross margin, especially with rising fuel and energy costs, and maintaining projected net sales growth rates if the economy goes into a significant or long term recession. We will continue to invest in future marketing programs to offset competitive pressures as necessary and anticipate additional administrative costs resulting from regulatory requirements. In addition, we anticipate that increased depreciation resulting from our investment in plant and equipment will negatively affect our fiscal year 2009 net income. If the U.S. economy has a minimal effect on our sales growth, then we anticipate that we will be able to continue to increase net income in fiscal year 2009, though not at the rate at which fiscal year 2008 increased over fiscal year 2007.

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 80% during fiscal year 2008 as compared to fiscal year 2007. The increase for fiscal year 2008 was substantially the result of increased sales 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, 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

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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 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 reported on our Condensed Consolidated Statement of Operations, which we believe is the most directly comparable GAAP measure:

For the year ended

(U.S. dollars in thousands)	January 31, 2008	January 31, 2007	Percentage Change
Net Income (as reported on Condensed Consolidated Statement of Operations)	$2,016	$701
Interest expense	385	361
Interest income	(86)	(150)
Income tax provision	1,254	577
Depreciation & amortization	1,719	1,455
EBITDA	$5,288	$2,944	80%

During fiscal year 2009 management will continue to focus on EBITDA as a key performance indicator.

Liquidity and Capital Resources

During fiscal year 2008 we completed the third phase of our three-phase capital expansion plan. This three-phase plan includes: 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 closure and move of the Bellingham, Washington manufacturing facility to the 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 third 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.

The table below illustrates the effects this capital expansion plan has had on our financial statements (U.S. dollars, in thousands):

		As of January 31, 2008	As of January 31, 2007
Financial Condition
	Total Assets	$28,589	$27,691
	Total Liabilities	10,900	12,301
	Total Equity	$17,689	$15,390
	Debt/equity ratio	0.62	0.80
	Assets/debt ratio	2.62	2.25
Working Capital
	Current assets	$8,691	$9,329
	Current liabilities	$3,080	$3,945
	Current ratio	2.82	2.36
Cash Position
	Cash, restricted cash & short term investments	$2,809	$3,423
	Cash generated from operations	$3,571	$ 2,416

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Financial Condition

During fiscal year 2008, the value of our total assets increased. This was primarily the result of an increase in fixed assets, which resulted from the closure and move of our Bellingham, Washington production facility. We also had an increase in total liabilities resulting from the payment of principal of long term debt and a reduction in current liabilities.

As discussed under Note 8 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, 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 2009 will come from meeting the covenants attached to our debt facilities by our lenders. As of the end of fiscal year 2008 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 fiscal year 2008, our working capital position continued to improve as current assets decreased at a rate slower than the decrease in current liabilities. The majority of the decrease in current assets was the result of cash used to finance the move of our Bellingham, Washington production facility to our Ferndale, Washington facility and to commission this new facility. Current liabilities decreased primarily due to decreases in accounts payable which were related to the closure and move of the Bellingham, Washington production facility. These changes resulted in our current ratio (current assets divided by current liabilities) increasing from 2.36 at the end of fiscal year 2007 to 2.82 at the end of fiscal year 2008.

In fiscal year 2009 we expect that our current assets will continue to increase as a result of positive cash flow and an increase in accounts receivable and inventories, as sales levels grow. We also expect that current liabilities will increase as a result of growing accounts payable related to the general growth of the company. Even though we expect both current assets and current liabilities to grow, we believe that our net working capital position will improve over the coming 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 fiscal year 2008, primarily as a result of cash used for the closure and move of the Bellingham, Washington production facility. We expect cash to increase during fiscal year 2009, mostly 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. This line of credit is secured by inventory and accounts receivable, which will 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 January 31, 2008, 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 2009. 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 fiscal year 2008 we generated $3,571,000 in cash from operating activities. The cash generated during the fiscal year 2008 was a 48% increase over the $2,416,000 in cash generated during fiscal year 2007. 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 fiscal year 2009, although it cannot be assured that this will be the case.

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Financing and Investing Activities

Cash used for financing activities during fiscal year 2008 was $805,000. This was the result principal payments made on our long-term debt. Cash was used during fiscal year 2008 for investing activities mainly related to the closure and move of our Bellingham, Washington production facility. Also, the restricted cash related to the debt facility for the plant move was released as construction progressed. Cash used in investing activities during fiscal year 2008 was approximately $2,234,000.

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, 2006. 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 closure and 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 $4,300,000. Of this amount, $2,700,000 came from cash and the remaining $1,600,000 was generated through our September 2006 bond financing with GECPF, as described above. This facility was fully commissioned by the end of the third 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.

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

Introduction

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In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States, management makes judgments, assumptions and estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe that the material estimates that are particularly susceptible to significant change relate to the determination of the allowance for doubtful accounts, income taxes, including deferred income taxes and the related valuation allowance, accrual for self-insured medical insurance plans and sales incentives. As part of the financial reporting process, our management collaborates to determine the necessary information on which to base judgments and develop estimates used to prepare the consolidated financial statements. Historical experience and available information is used to make these judgments and estimates. However, different amounts could be reported using different assumptions and in light of different facts and circumstances. Therefore, actual amounts could differ from the estimates reflected in the consolidated financial statements.

In addition to the significant accounting policies described in Note 1 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe that the following discussion addresses our critical accounting policies.

Inventory

Unexpected change in market demand or buyer preferences could reduce the rate of inventory turnover and require us to record a reserve for obsolescence. Finished goods inventory are valued at the lower of cost (determined on the first-in, first-out basis) or net realizable value. Cost includes direct materials, labor and overhead allocation. Raw materials and supplies are valued at the lower of cost (determined on the first-in, first-out basis) or net realizable value. We have not historically experienced a period where a material amount of finished goods inventory or raw materials inventory has been required to be reduced in value as a result of changes in market demand or buyer preference. Because of this lack of historical change we have not yet had to record a reserve for obsolete inventory. Our assumptions and valuation methodology for inventory have historically not changed. Even though we have not historically had to record a reserve for obsolete inventory as a result of changes in market demand or buyer preference, there is no guarantee that one or both of these events will not happen. As a result, even though we believe that it is unlikely that a change will occur, we do recognize that change is possible and will record a reserve for obsolete inventory if the circumstances dictate as previously described.

Property, Plant and Equipment

There is a risk that our estimate of the useful life of a component of our property plant or equipment was over estimated. If that was the case the depreciated value of the equipment or building would be greater than its actual value, which would result in our recording a reserve to lower the net carrying value of the asset. Property, plant and equipment assets are recorded at cost. Our building and equipment are located on owned and leased land. Buildings are depreciated on a straight line basis over a period of 40 years. Leasehold improvements are depreciated on a straight line basis over the life of the lease agreement for property located on leased land. Most of our equipment is depreciated over its estimated useful life using a 15% declining balance method; the remainder is depreciated using a straight line method over five years. We have chosen to use the 15% declining value method over a fixed period straight line method to better reflect the fair market value and useful life of equipment which is typically used in our facilities. We also review the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The determination of any impairment would include a comparison of estimated future cash flows anticipated to be generated during the remaining life of the asset. Due to the nature of the buildings and equipment we purchase, the depreciation method that we use, and the cash flows generated during the life of the assets, we have not had to historically record a reserve to reflect a decrease in the net carrying value of assets. We have historically neither changed our depreciation methods, our assumptions behind the depreciation methods, or our methodology for determining impairment. Based on the length of time we have been manufacturing in the industry in which we operate, we believe that it is unlikely that an impairment of existing buildings or equipment will have to be recorded. If we were to expand into a manufacturing industry in which we do not have as much history, the likelihood of being required to record an impairment increases. If at some future date we enter an industry in which we have no historic knowledge, then the risk of recording an impairment would also increase.

Revenue Recognition

If the actual costs of sales returns and incentives were to significantly exceed the recorded estimated allowance, our sales would be adversely affected in that we would record additional reserves which would reduce our net sales revenue. Revenues from the sale of products are recognized at the time title passes to the purchaser, which is generally when the

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goods are conveyed to a carrier. When we sell F.O. B. destination point, title is transferred and we recognize revenue on delivery or customer acceptance, depending on terms of the sales of the agreement. Sales incentives are accounted for in accordance with the provisions of EITF 01-9 “Accounting for Consideration Given by a Vendor to a Customer.” Historically we have not had sales returns or incentive requests applied to a fiscal year in greater amounts than what was reserved for. By following our revenue recognition policies we have been able to accurately assess the value of both sales returns and sales incentives. We have annually updated the sales incentive amounts that are annually accrued to match the sales incentive agreements that we have with our customers. By doing so, we have maintained a consistent methodology while adjusting our estimates to more closely reflect our activities within the market place. We believe that it is unlikely that our assumptions or methodology for accounting for revenue recognition, sales returns, and sales incentives will change in the future. However, we do believe that it is likely that the actual estimates that we use for our sales incentive programs and sales returns may change in the future from time to time as a result of a dynamic marketplace.

Income Tax

We account for income taxes using the asset and liability method. The liability method recognizes the amount of tax payable at the date of the financial statements as a result of all events that have been recognized in the consolidated financial statements, as measured by the provisions of currently enacted tax laws and rates. The accumulated tax effect of all temporary differences is presented as deferred federal income tax assets and liabilities within the balance sheet. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Effective February 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes— an interpretation of FASB Statement No.109 (“FIN 48”), which prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. Though the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. Because of this, whether a tax position will ultimately be sustained may be uncertain. Under FIN 48, the impact of an uncertain tax position that is more likely than not of being sustained upon audit by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained.

Stock-Based Compensation

Prior to February 1, 2006, we accounted for our stock-based compensation plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion No. 25”) and related interpretations, as permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). Accordingly, no stock-based compensation expense was recognized in the income statement for the years ended January 31, 2006 and 2005 related to options issued to employees and non-employee directors, as all options granted under our stock-based employee compensation plans had an exercise price equal to the market value of the underlying common stock on the date of grant. As permitted by SFAS No. 123, stock-based compensation was included as a pro forma disclosure in the notes to our consolidated financial statements for the years ended January 31, 2006 and 2005.

Effective February 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R) using the modified prospective transition method. Under that transition method, compensation cost recognized in fiscal year ended January 31, 2007 and all subsequent fiscal years thereafter includes: (a) compensation cost for all stock-based payments granted prior to, but not yet vested, as of January 31, 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. For details regarding the effect on our financial statements of using this methodology, please see Note 2 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

In our calculation of stock-based compensation we use the Black-Scholes model. This model is an estimate of potential actual results. As such, actual results may vary significantly from our estimated stock-based compensation expense. Specifically, in the event that options were to expire at an exercise price which is below the option’s strike price and the options are not exercised, then we would have taken stock-based compensation expense for options which did not ultimately have a dilutive effect on the outstanding common shares. We believe that it is not likely that we will change our methodology for calculating stock based compensation in the future.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX

Report of Independent Registered Public Accounting Firm	Page 29
Consolidated Balance Sheets at January 31, 2008 and 2007	Page 30
Consolidated Statements of Income for the Fiscal Years ended January 31, 2008 and 2007	Page 31
Consolidated Statements of Changes In Stockholders’ Equity for the Fiscal Years ended January 31, 2008 and 2007	Page 32
Consolidated Statements of Cash Flows for the Fiscal Years ending January 31, 2008 and 2007	Page 33
Notes to Consolidated Financial Statements, January 31, 2008 and 2007	Page 34

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

International Absorbents, Inc.

We have audited the accompanying consolidated balance sheets of International Absorbents, Inc. and subsidiary (the “Company”) as of January 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of International Absorbents, Inc. and subsidiary as of January 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 2 to the consolidated financial statements, effective February 1, 2007, the Company adopted the provisions of the Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes.

/S/ Moss Adams LLP

Seattle, Washington

April 25, 2008

30

International Absorbents Inc. and Subsidiary

Consolidated Balance Sheets

As at January 31, 2008 and 2007

(in thousands of U.S. dollars)

			2008	2007
Assets
Current assets:
	Cash and cash equivalents		$ 2,809	$ 2,277
	Restricted cash		-	1,146
	Accounts receivable, net		2,359	2,373
	Inventories, net		3,166	3,221
	Prepaid expenses		155	126
	Income taxes receivable		44	-
	Deferred income tax asset		158	186
		Total current assets	8,691	9,329
Property, plant and equipment, net			19,662	18,096
Other assets, net			236	266
		Total assets	$ 28,589	$ 27,691
Liabilities and Stockholders' Equity
Current liabilities:
	Accounts payable and accrued liabilities		$ 2,119	$ 2,933
	Related party payable		6	5
	Current portion of long-term debt		857	805
	Income taxes payable		98	202
		Total current liabilities	3,080	3,945
Deferred income tax liability			1,110	835
Long-term debt			6,664	7,521
Other long term liabilities			46	-
		Total liabilities	10,900	12,301
Stockholders' equity:
Common stock, no par value -
	Unlimited shares authorized,
	6,410,328 and 6,410,328 issued and outstanding at
	January 31, 2008 and 2007, respectively		8,487	8,487
Additional paid in capital			1,365	999
Retained earnings			7,837	5,904
		Total stockholders' equity	17,689	15,390
		Total liabilities and stockholders' equity	$ 28,589	$ 27,691

The accompanying notes are an integral part of these consolidated financial statements.

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International Absorbents, Inc. and Subsidiary

Consolidated Statements of Income

For the years ended January 31, 2008 and 2007

(in thousands of U.S. dollars, except earnings per share amounts)

		2008	2007
Sales, net		$ 33,095	$ 29,495
Cost of goods sold		23,139	19,902
Gross Profit		9,956	9,593
Selling, general and administrative expenses		6,387	8,104
Income from operations		3,569	1,489
Interest expense		(385)	(361)
Interest income		86	150
Income before provision for income taxes		3,270	1,278
Income tax provision		(1,254)	(577)
Net income		$ 2,016	$ 701
Basic earnings per share		$ .31	$ .11
Fully diluted earnings per share		$ .31	$ .11
Weighted average number of shares outstanding
(in thousands)
	Basic	6,410	6,404
	Diluted	6,477	6,406

The accompanying notes are an integral part of these consolidated financial statements.

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International Absorbents Inc. and Subsidiary

Consolidated Statement of changes in Stockholders’ Equity

For the years ended January 31, 2008 and 2007

(in thousands of U.S. dollars)

	Common Shares (in 1,000’s)	Amount	Additional Paid in Capital	Retained Earnings	Total Stock- Holders' Equity
Balance as of January 31, 2006	6,321	$8,299	$   652	$5,203	$14,154
Exercise of stock options	89	188	-	-	188
Stock based compensation	-	-	347	-	347
Net income	-	-	-	701	701
Balance as of January 31, 2007	6,410	8,487	999	5,904	15,390
FIN 48 cumulative adjustment	-	-	-	(83)	(83)
Stock based compensation	-	-	366	-	366
Net income	-	-	-	2,016	2,016
Balance as of January 31, 2008	6,410	$ 8,487	$ 1,365	$ 7,837	$ 17,689

The accompanying notes are an integral part of these consolidated financial statements.

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International Absorbents Inc. and Subsidiary

Consolidated Statement of Cash Flows

For the years ended January 31, 2008 and 2007

(in thousands of U.S. dollars)

					2008	2007
Cash flows from operating activities
Net income					$ 2,016	$ 701
		Adjustments to reconcile net income to net cash
			used for operating activities
	Depreciation and amortization				1,719	1,455
	Loss on disposal of equipment				167	-
	Stock-based compensation				366	347
	Deferred taxes				303	(40)
Changes in operating assets and liabilities
	Accounts receivable				14	(213)
	Inventory				55	(575)
	Prepaid expenses				(29)	(13)
	Accounts payable and accrued liabilities				(856)	615
	Income taxes receivable/payable				(148)	140
	Due to related party				1	(1)
	Other long term liabilities				(37)	-
				Net cash flows from operating activities	3,571	2,416
Cash flows from investing activities
	Proceeds from investments				-	609
	Purchase of property, plant and equipment				(3,380)	(3,019)
	Purchase of other assets				-	(32)
	Investment in restricted cash				-	(1,600)
	Proceeds from restricted cash				1,146	454
				Net cash flows from investing activities	(2,234)	(3,588)
Cash flows from financing activities
	Proceeds from long-term debt				-	1,600
	Repayment of long-term debt				(805)	(537)
	Proceeds from exercise of stock options				-	188
				Net cash flows from financing activities	(805)	1,251
	Net change in cash				532	79
Cash and cash equivalents, beginning of period					2,277	2,198
Cash and cash equivalents, end of period					$ 2,809	$ 2,277
Cash paid for interest (net of amounts capitalized)					$ 394	$ 355
Cash paid for income taxes					$ 1,128	$ 409
Non-cash investing activities
	Increase in property, plant and equipment and accounts
	payable for purchase of plant and equipment				$ 154	$ 113

The accompanying notes are an integral part of these consolidated financial statements.

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Notes to Consolidated Financial Statements

International Absorbents Inc. and Subsidiary

1 Operations

International Absorbents Inc. (“IAX”) is a Canadian company operating in the States of Washington and Georgia, U.S.A. through its wholly-owned subsidiary, Absorption Corp (“Absorption,” and collectively with IAX, the “Company”).

The Company operates in two segments and is engaged in the development and sale of value added products made from waste short fiber pulp (“SFP”) utilizing proprietary technology. The Company markets and sells animal and pet bedding products that are sold in consumer retail and commercial bedding markets. In addition, the Company markets and sells SFP-based products used for general industrial spill cleanup, marine oil-cleanup, and oil/water filtration, and hydro mulch products, which hydro mulch products were not produced during the current fiscal year. The Company has established distribution primarily in North America.

2 Significant accounting policies

Generally accepted accounting principles

These consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America.

Basis of presentation

The consolidated financial statements include the accounts of IAX and its wholly-owned subsidiary, Absorption, a Nevada corporation doing business in the states of Washington and Georgia. All significant inter-company transactions are eliminated in consolidation.

Cash and cash equivalents

Cash and cash equivalents includes cash and highly liquid investments with original maturities of 90 days or less.

Restricted Cash

During fiscal year 2007, 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 closure and relocation of the Bellingham, Washington production facility to the new Ferndale, Washington manufacturing and warehouse facility. These funds had been placed in an escrow account during the purchase and installation of the equipment. Funds were drawn on the account as the equipment was purchased. The escrow account balance (restricted cash) at January 31, 2008 and 2007 was -0- and $1,146,000, respectively.

Accounts Receivable and Allowance for Doubtful Accounts

The Company typically offers credit terms to its customers without collateral. The Company records accounts receivable at the face amount less an allowance for doubtful accounts. On a regular basis, the Company evaluates its accounts receivable and establishes these allowances based on a combination of specific customer circumstances, as well as credit conditions and the history of write-offs and collections. Where appropriate, the Company obtains credit rating reports and financial statements of the customer to initiate and modify their credit limits. The Company obtains credit insurance for certain accounts that qualify for coverage in order to minimize credit risk exposure. If circumstances related to specific customers change, our estimates of the recoverability of receivables could materially change. At January 31, 2008 and 2007, management considered all accounts receivable in excess of the allowances for doubtful accounts to be fully collectible.

Inventories

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Finished good inventories are valued at the lower of cost (determined on the first-in, first-out basis) or net realizable value. Cost includes direct materials, labor and overhead allocation. Raw materials and supplies are valued at the lower of cost (determined on the first-in, first-out basis) or net realizable value.

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Property, plant and equipment

Property, plant and equipment assets are recorded at cost. The Company’s buildings and equipment are located on owned and leased land. Buildings located on land owned by the Company are depreciated on a straight line basis over a period of 40 years. Leasehold improvements are depreciated on a straight line basis over the shorter of the estimated useful life or the life of the lease agreement for property located on leased land. The Company’s manufacturing equipment is depreciated over the estimated useful life using a 15% declining balance method. The Company’s computer equipment, computer software and office equipment are depreciated on a straight-line basis over the estimated useful life of five, seven and ten years respectively. Maintenance and repairs are expensed as incurred.

Impairment of long lived assets

The Company reviews the carrying amount of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The determination of any impairment would include a comparison of estimated future operating cash flows anticipated to be generated during the remaining life with the net carrying value of the asset.

Other Assets

Other assets include deferred financing fees, which represent costs incurred in connection with long-term debt (see Note 8). As of January 31, 2008 and 2007, the deferred financing fees were $236,000 and $266,000, respectively, which are net of accumulated amortization of $108,000 and $78,000, respectively. Amortization expense was $30,000 and $26,000 for the years ended January 31, 2008 and 2007, respectively. The Company is amortizing into interest expense the deferred financing fees on a straight line basis which approximates the interest method over the term of the related debt.

Revenue recognition

Revenues from the sale of products are recognized at the time title passes to the purchaser, which is generally when the goods are conveyed to a carrier. When the Company sells F.O. B. destination point, title is transferred and the Company recognizes revenue on delivery or customer acceptance, depending on terms of the sales agreement. Sales incentives are recorded as a reduction of sales, the recognition of which is determined in accordance with the provisions of Emerging Issues Task Force (“EITF”) 01-09 “Accounting for Consideration Given by a Vendor to a Customer.”

Shipping and Handling Costs

Shipping and handling costs are accounted for under EITF No. 00-10: “Accounting for Shipping and Handling Fees and Costs.” Revenues generated from shipping and handling costs charged to customers are included in sales and were $458,000 and $662,000 in fiscal years 2008 and 2007, respectively. Shipping and handling costs for outbound and inbound shipping charges are included in cost of goods sold and were $4,732,000 and $4,643,000 in fiscal years 2008 and 2007, respectively.

Foreign exchange

The Company’s reporting currency is the U.S. dollar. The Company considers the U.S. dollar to be the functional currency in foreign jurisdictions. Accordingly, amounts denominated in foreign currencies are re-measured to U.S. dollars at historical and current exchange rates as required under SFAS No. 52. Gains and losses resulting from foreign currency transactions are included in the consolidated statement of earnings.

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Advertising

The Company accounts for advertising expenses under Statement of Position (“SOP”) No. 93-7. Advertising costs are expensed when incurred and were $201,000 and $394,000 during fiscal years 2008 and 2007, respectively.

Net earnings per share

Net earnings per share computations are in accordance with SFAS No. 128, “Earnings Per Share.” Basic net earnings per share is computed using the weighted average number of common shares outstanding. Diluted net earnings per share is computed using the weighted average number of common shares and potentially dilutive common share equivalents outstanding. Stock options and warrants that are anti-dilutive are not included in diluted net earnings per share.

Income taxes

The Company accounts for income taxes using the asset and liability method. The liability method recognizes the amount of tax payable at the date of the financial statements as a result of all events that have been recognized in the financial statements, as measured by the provisions of currently enacted tax laws and rates. The accumulated tax effect of all temporary differences is presented as deferred federal income tax assets and liabilities within the balance sheet. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Effective February 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes— an interpretation of FASB Statement No.109 (“FIN 48”), which prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. Though the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. Because of this, whether a tax position will ultimately be sustained may be uncertain. Under FIN 48, the impact of an uncertain tax position that is more likely than not of being sustained upon audit by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained.

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 this transition method, compensation cost recognized in fiscal year ended January 31, 2007 and all subsequent fiscal years thereafter 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 calculated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all stock-based payments granted subsequent to January 1, 2006, based on the grant date fair value calculated in accordance with the provisions of SFAS No. 123(R).

Total stock-based compensation expense recognized in the income statement for the year ended January 31, 2008 and 2007 was $363,000 and $340,000, of which $13,000 and $33,000 was recognized in cost of goods sold and $350,000 and $307,000 was recognized in selling, general and administrative expenses, respectively. All of the stock-base compensation was related to Incentive Stock Options (“ISO”s) held by employees and non-employee directors for which no tax benefit is recognized.

Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the consolidated statements of cash flows. SFAS No. 123(R) requires the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (“excess tax benefits”) to be classified and reported as both an operating cash outflow and a financing cash inflow on a prospective basis upon adoption.

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 forfeiture rate and risk-free interest rates. The assumptions used for the

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years ended January 31, 2008 and 2007 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	4.17%	4.88%
b)	expected volatility	98.97%	109.16%
c)	expected dividend yield	0.00%	0.00%
d)	estimated average life (in years)	4.66	4.66

The expected life of the options represents 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. Expected stock price volatility is based on historical volatility of the Company’s stock. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with an equivalent remaining term. The Company has not paid dividends in the past and does not plan to pay any dividends in the near future. As stock-based compensation expense recognized is based on awards ultimately expected to vest, it should be reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company forfeiture rate for 2008 was calculated based on its historical experience of awards which ultimately vested.

In November 2005, the Financial Accounting Staff Board (“FASB”) issued FASB Staff Position No. 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards”(“FSP 123R-3”). The Company has elected to adopt the “long form” method for calculating the tax effects of share-based compensation pursuant to SFAS No. 123(R). The “long form” method establishes the beginning balance of the additional paid-in capital pool related to the effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R).

The remaining unvested compensation for the fair value of stock options to be recognized was $754,000 and $757,000 at January 31, 2008 and 2007, respectively.

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 EITF in 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 $7,000 during 2008 and 2007, respectively.

Comprehensive income

The Company has adopted SFAS No. 130, “Reporting Comprehensive Income.” SFAS No. 130 establishes standards for reporting and presentation of comprehensive income and its components in consolidated financial statements. The statement requires only additional disclosures in the financial statements and it does not affect the Company’s financial position or results of operations. The Company has no material components of other comprehensive income or accumulated other comprehensive income.

Use of estimates

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 the disclosure of contingent assets and liabilities at the date of the financial statements and reported

39

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, deferred income taxes valuation allowance and sales incentives.

New accounting pronouncements

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. We are currently reviewing the provisions of SFAS 157 to determine the impact to our 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.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141(R)). SFAS 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008. The Company will adopt SFAS 141(R) in the first quarter of fiscal 2009 and apply the provisions of this Statement for any acquisition after the adoption date. The Company does not anticipate this statement will have a material effect on its financial condition or results of operations.

3. Balance sheet components (in thousands of U.S. dollars)

			2008	2007
Accounts receivable
	Trade		$ 2,444	$ 2,416
	Allowance for doubtful accounts		(85)	(43)
			$ 2,359	$ 2,373
Inventories
	Raw materials		$ 1,714	$ 1,569
	Finished goods		1,452	1,652
			$ 3,166	$ 3,221
Accounts Payable and accrued liabilities
	Accounts payable
		Trade	$ 865	$ 1,397
		Equipment and other	155	113
	Accrued Liabilities
		Payroll	614	511
		Other	485	912
			$ 2,119	$ 2,933

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4. Property, Plant and Equipment

		2008	2007
Property, plant and equipment
	Land	$ 1,547	$ 1,547
	Buildings	8,759	8,534
	Leashold improvements	-	630
	Equipment	15,164	10,996
	Construction in progress	446	2,313
		$ 25,916	$ 24,020
Less: Accumulated depreciation		(6,254)	(5,924)
		$ 19,662	$ 18,096

Depreciation expense from property, plant and equipment for the fiscal years ended January 31, 2008 and 2007 was $1,689,000 and $1,429,000, respectively.

During the third quarter of fiscal year 2007, the Company began the purchase and installation of manufacturing equipment to be used to relocate the Bellingham, Washington production facility to the new Ferndale,Washington manufacturing and warehouse facility (engineering was started during the second quarter of fiscal year 2007). The Company received a $1,600,000 bond financing from GE Capital. These funds were placed in an escrow account and drawn on during the purchase and installation of the equipment. The closure and move of the Bellingham, Washington facility was completed during the third quarter of fiscal year 2008. The escrow account balance (restricted cash) at January 31, 2008 and 2007 was $-0- and $1,146,000, respectively.

The Company incurred interest costs of $415,000 and $396,000 during the fiscal years 2008 and 2007, respectively, of which $30,000 and $35,000 was capitalized as part of the purchase and installation of manufacturing equipment during fiscal years 2008 and 2007, respectively.

5. Fair value of financial instruments

The fair value of cash and cash equivalents, restricted cash, investments, accounts receivable, accounts payable, and accrued liabilities, and amounts due to related parties approximate their carrying value due to the relatively short-term maturities of these instruments.

The fair value of the Company’s debt at January 31, 2008 and 2007 approximates the carrying value. The fair value is based on management’s estimate of current rates available to the Company for similar debt with the same remaining maturity.

6. Concentration of credit risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, restricted cash, short-term investments and trade accounts receivable. Receivables arising from sales to customers are generally not significant individually and are not collateralized; as a result, management continually monitors the financial condition of its customers to reduce the risk of loss. The Company had two customers who individually exceeded 10% of sales, who collectively accounted for 36% and 39% of total trade accounts receivable at January 31, 2008 and 2007, respectively, and who collectively accounted for 48% and 47% of total sales during the fiscal year ending January 31, 2008 and 2007, respectively.

The Company invests its cash and cash equivalents in high quality issuers. These cash balances may be insured by the Federal Deposit Insurance Corporation, the Canada Deposit Insurance Corporation, the Securities Investor Protection Corporation or through other private insurance purchased by the issuer. The Company maintains its cash in demand deposits and money market accounts held primarily by four banks and in the normal course of business, maintains cash balances in excess of these insurance limits.

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7. Operating line of credit

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 inventory 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 January 31, 2008, the Company had no borrowings outstanding.

8. Long-term debt (in thousands of U.S. dollars)

	2008	2007
Tax-exempt bonds	$ 7,521	$ 8,255
Taxable bonds	-	71
Total debt	7,521	8,326
Less: current portion	(857)	(805)
Long-term debt	$ 6,664	$ 7,521

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 closure and 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 six 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 was $32,000. The bond is secured by the equipment financed. At January 31, 2008 and 2007 the balance outstanding was $1,441,000 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 placed in a trust account to be used to finish the construction of the new production facility located in Jesup, Georgia. 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 ( 2.28 % as of March 27, 2008) 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 January 31, 2008 and 2007, the balance 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 had 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 January 31, 2008 and 2007, the balance outstanding was $2,280,000 and $2,355,000 on the tax-exempt and $-0- and $71,000 on the taxable bonds, respectively.

The aggregate principal maturities on long-term debt for each of the twelve-month periods subsequent to January 31, 2008 are as follows (in thousands of U.S. dollars):

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	Long-term
	Debt
Fiscal Year ending January 31,:
2009	$ 857
2010	877
2011	898
2012	921
2013	646
Thereafter	3,322
	$ 7,521

9. Capital stock

Common Shares

Holders of Common Shares are entitled to one vote per share and to share equally in any dividends declared and in distributions on liquidation.

During fiscal years 2008 and 2007, -0- and 89,560 common stock options, respectively, were exercised for proceeds of $-0- and $188,076, respectively.

Stock options

The 2003 Omnibus Plan permits the granting of stock options (including nonqualified stock options and incentive stock options qualifying under Section 422 of the Code and for residents of Canada under the terms and conditions of the Income Tax Act of Canada), stock appreciation rights (including free-standing, tandem and limited stock appreciation rights), restricted or unrestricted share awards, phantom stock, performance awards, or any combination of the foregoing. The 2003 Omnibus Plan has 1,100,000 Common Shares reserved for issuance and/or grant.

The exercise price of stock options under the 2003 Omnibus Plan will be at least equal to the fair market value of the Common Shares on the date of grant for each incentive stock option or an amount equal to no less than 85% of fair market value for each non-qualified stock option, or the acceptable discount amount allowed under applicable securities laws. The exercise price of options granted under the 2003 Omnibus Plan must be paid in cash, property, qualifying services or under a qualifying deferred payment arrangement. In addition, subject to applicable law, the Company may make loans to individual grantees on such terms as may be approved by the Board of Directors for the purpose of financing the exercise of options granted under the 2003 Omnibus Plan and the payment of any taxes that may be due in respect of such exercise. The Compensation Committee will fix the term of each option, but no option under the 2003 Omnibus Plan will be exercisable more than ten years after the option is granted. Each option will be exercisable at such time or times as determined by the Compensation Committee, provided, however, that no stock option granted under the 2003 Omnibus Plan, or any portion thereof, to any grantee who is subject to Section 16 of the Exchange Act shall be exercisable prior to seven (7) months after the grant date of the option; and stock options, or any portion thereof, granted to grantees who are not subject to Section 16 of the Exchange Act shall not be exercisable prior to ninety (90) days after the grant date of the option. Upon a grantee’s termination of employment with the Company or its subsidiary (other than as a result of death), the 2003 Omnibus Plan provides for an expiration of any outstanding options expire immediately or within a period of 12 months or less, depending upon the cause of termination. No option shall be transferable by the option holder otherwise than by will or the laws of descent.

The following table summarizes the Company’s stock option activity for the years ended January 31, 2008 and 2007:

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	2008		2007
		Weighted		Weighted
	Shares	Average	Shares	Average
		Price		Price
Outstanding - beginning of year	536,100	$ 4.17	546,360	$ 4.02
Granted	140,000	3.71	140,000	3.21
Exercised	-	-	(89,560)	2.10
Repurchased, surrendered or expired	(112,583)	(4.70)	(60,700)	3.65
Outstanding - end of year	563,517	$ 3.95	536,100	$ 4.17
Vested	109,434	$ 3.58	166,667	$ 4.32

The following table summarizes information about options outstanding at January 31, 2007:

Range of exercise prices	Number outstanding at January 31, 2008	Weighted average remaining contractual life (months)	Outstanding weighted average exercise price	Number exercisable at January 31, 2008	Exercisable weighted average exercise price
$ 3.15	40,000	11	$ 3.15	40,000	$ 3.15
3.20	100,000	63	3.20	-	3.20
3.25	40,000	23	3.25	40,000	3.25
3.60	100,000	74	3.60	-	3.60
4.00	40,000	35	4.00	-	4.00
4.60	143,517	44	4.60	29,434	4.60
4.70	100,000	38	4.70	-	4.70
$ 3.15 – 4.70	563,517	48	$ 3.03	109,434	$ 3.58

At January 31, 2008, the Company had 536,483 remaining Common Shares available to be granted under the 2003 Omnibus Plan.

There were outstanding options to purchase 4,000 Common Shares issued to individuals who are not employees or directors of the Company as of January 31, 2008.

10. Employee Benefit Plan

The Company initiated a 401(k) savings plan for employees during fiscal year 2006. Employees with at least 12 months of service are eligible to participate. Under the terms of the retirement savings plan, the Company provides matching contributions equal to 100% of each participants contribution up to 3% of a participant’s eligible compensation and 50% of each participants contribution over 3% up to a maximum of 5%. The Company’s contributions to the plan totalled $100,000 and $84,000 for the years ended January 31, 2008 and 2007, respectively.

11. Related party transactions

General and administrative expenses for 2008 and 2007 included $82,000 and $70,000, respectively, each year for office rent and related services which were incurred on a cost reimbursement basis from a corporation owned

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and controlled by an officer and director of the Company. At January 31, 2008 and 2007, $6,000 and $5,000, respectively, were owing to this related party.

12. Income taxes

The components of income before income taxes are as follows (in thousands of U.S. dollars):

	2008	2007
U.S.	$3,253	$1,661
Canada	17	(383)
	$3,270	$ 1,278

The components of the provision for current income taxes consist of the following (in thousands of U.S. dollars):

	2008	2007
U.S.	$ 877	$ 614
State	49	3
Canada	26	-
	$ 952	$ 617

The components of the provision for deferred income taxes consist of the following (in thousands of U.S. dollars):

	2008	2007
U.S.	$ 264	$ (8)
State	38	(32)
Canada	-	-
	$ 302	$ (40)

The provision for income taxes differs from the amount computed by applying the statutory income tax rate to net income before taxes as follows (in thousands of U.S. dollars):

		2008	2007
Income tax at statutory rate (Canada)		$ 1,108	$ 436
Difference in foreign tax rate		3	(2)
Permanent differences		(1)	9
Stock option expense		127	114
Domestic production deduction		(54)	(13)
Change in valuation allowance		38	(160)
Net operating losses expired		57	91
Change in tax rate		115
Effect from remeasurement from
	Canadian currency	(258)	58
State and local , net		78	(28)
Other differences		41	72
		$ 1,254	$ 577

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Deferred income taxes are provided for temporary differences. Deferred income tax assets and liabilities are comprised of the following (in thousands of U.S. dollars):

		2008	2007
Deferred income tax assets
	Net operating loss carryforward	$ 26	$ 125
	Intangibles	20	23
	Non-deductible liabilities and other	158	187
	State tax credits	49	50
	Unrealized loss	338	163
	Valuation allowance	(384)	(311)
		$ 207	$ 237
Deferred income tax liabilities
	Property, plant and equipment	(1,159)	(886)
		$ (1,159)	$ (886)

The Company has Canadian tax losses from prior years which are available to offset taxable income of future years. These tax losses expire as follows (in thousands of U.S. dollars):

	Canadian operations
	Loss	Expiry date
Year incurred	carryforward
2003	1	January 31, 2010
2004	57	January 31, 2011
2005	38	January 31, 2015
	$ 96

The Company has recorded a valuation allowance against deferred tax assets which relates to uncertainties related to utilization of Canadian Net Operating Loss Carry Forwards and other Canadian deferred tax assets. The valuation allowance increased by $73,000 during the year ended January 31, 2008 and decreased by $160,000 during the year ended January 31, 2007.

The Company has not provided for Canadian deferred income taxes on undistributed earnings of International Absorbent’s U.S. subsidiary because of its intention to indefinitely reinvest these earnings in the U.S. The determination of the amount of the unrecognized deferred U.S. income tax liability related to the undistributed earnings is not practicable.

In June 2006, the Financial Accounting Standards Board (the “FASB”) issued interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes – interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting interim periods, disclosure and transition. FIN 48 applies to all tax positions related to income taxes. On February 1, 2007 the Company adopted the provisions of FIN 48. The adoption and implementation of FIN 48 resulted in a $83,000 increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the February 1, 2007 balance of retained earnings. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

Balance at February 1, 2008	83
Settlements	(46)
Additions for tax positions of current period	2
Additions for tax positions of prior periods	6
	45

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The Company is subject to taxation in the United States, Canada and various state jurisdictions. The material jurisdictions that are subject to examination by tax authorities are for tax years after fiscal year 2003. The Company classifies interest and penalties on tax uncertainties as components of the provision for income taxes.

13. Commitments and Contingencies

Operating Leases

The Company’s Bellingham, Washington plant was leased from the Port of Bellingham under a lease that expired in August 2007. The terms and conditions of the lease required monthly payments of the excise tax only. The normal monthly lease payments were waived in lieu of Absorption agreeing to remove the building and associated utilities at the expiration of the lease. The cost for this work was $120,000 and has been accounted for in accordance with FIN 47, “Accounting for Conditional Asset Retirement Obligation.” The removal of the building was required to commence six months prior to the expiration of the lease.

The Company has entered into various operating lease agreements for equipment that expire in 2009 to 2012. Rental expenses for the year ended January 31, 2008 and 2007 were $223,000 and $246,000, respectively. Minimum annual rental payments under non-cancellable operating leases are approximately 122,000, $79,000, $57,000 and $46,000 for the years ending January 31, 2009, 2010, 2011 and 2012, respectively.

Legal matters

On October 10, 2006, the Company was notified that the American Arbitration Association (the “Arbitrator”) 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 the Company 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. The Company expensed this amount as selling, general and administrative expenses as of October 10, 2006 and paid the award and fees to the Claimants on November 10, 2006.

Except as described above and for ordinary routine litigation incidental to the Company’s business, there are no material legal proceedings pending to which the Company is a party, or of which any of the Company’s properties is the subject.

Self Insurance

During the period from January 2004 to December 2006, Absorption had been self-insured for medical insurance through a third-party administrator. Claims exceeding $30,000 for any one individual or $250,000 for the group were covered under a stop loss insurance policy. As of January 31, 2008 and 2007, the Company accrued $-0- and $56,000, respectively, for the self-insured medical insurance.

14. Segmented information

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

The Company defines its business segments primarily based upon the market in which its customers sell products, as well as how the Company internally manages its various business activities. 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 currently based on these two identifiable segments. As a result, management has elected to combine what historically were the Company’s two smallest segments (industrial cleanup and hydro mulch) into one new segment, the industrial/commercial segment, effective during the third quarter

47

of fiscal year 2005. Comparative amounts for prior periods have been similarly combined.

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 (in thousands of U.S. dollars)

		2008
		Animal	Industrial	Consolidated
		Care
Sales, net		$ 32,271	$ 824	$ 33,095
Operating cost and expenses		26,944	863	27,807
Operating income (loss) before depreciation		5,327	(39)	5,288
	and amortization
Depreciation and amortization				(1,719)
Interest expense				(385)
Interest Income				86
Net income before taxes				$ 3,270

		2007
		Animal	Industrial	Consolidated
		Care
Sales, net		$ 28,288	$ 1,207	$ 29,495
Operating cost and expenses		25,318	1,259	26,577
Operating income (loss) before depreciation		2,970	(52)	2,918
	and amortization
Depreciation and amortization				(1,429)
Interest expense				(361)
Interest Income				150
Net income before taxes				$ 1,278

Sales revenues by geographic areas are as follows:

	2008	2007
United States	$ 31,280	$ 28,051
Canada	948	909
Other countries	867	535
	$ 33,095	$ 29,495

Two customers from the Animal Care segment represent 10% or more of the Company’s sales.

48

	2008	2007
Customer A	$ 7,843	$ 6,957
Customer B	8,080	7,205
	$ 15,923	$ 14,162

15. Earnings per share

		2008
		Net Income	Shares	Per share
		(numerator)	(denominator)	amount
Basic earnings per share
	Net income available to stockholders	$ 2,016,000	6,410,000	$ 0.31
Effect of dilutive securities
	Stock options to purchase common stock	-	67,000
Diluted earnings per shares
	Net income available to stockholders	$ 2,016,000	6,477,000	$ 0.31

		2007
		Net Income	Shares	Per share
		(numerator)	(denominator)	amount
Basic earnings per share
	Net income available to stockholders	$ 701,000	6,404,000	$ 0.11
Effect of dilutive securities
	Stock options to purchase common stock	-	2,000
Diluted earnings per shares
	Net income available to stockholders	$ 701,000	6,406,000	$ 0.11

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:

	2008	2007
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	244,150	536,100

16. Selected Quarterly Financial Data (in thousands of U.S. dollars, except per share amounts)

The following table sets forth selected quarterly financial data for each of the quarters in fiscal years 2008 and 2007:

49

		2008
		Fourth	Third	Second	First
		Quarter	Quarter	Quarter	Quarter
Sales, net		$ 8,301	$ 9,028	$ 7,401	$ 8,365
Cost of goods sold		5,889	6,287	5,365	5,598
Gross Profit		2,412	2,741	2,036	2,767
Selling, general and administrative expenses		1,509	1,487	1,721	1,670
Income from operations		903	1,254	315	1,097
Interest expense		(94)	(103)	(101)	(87)
Interest income		21	18	23	24
Income before provision for income taxes		830	1,169	237	1,034
Income tax provision		(307)	(425)	(111)	(411)
Net income		$ 523	$ 744	$ 126	$ 623
Basic earnings per share		$ .07	$ .12	$ .02	$ .10
Fully diluted earnings per share		$ .08	$ .11	$ .02	$ .10
Weighted average number of shares outstanding
(in thousands)
	Basic	6,410	6,410	6,410	6,410
	Diluted	6,486	6,504	6,511	6,428

		2007
		Fourth	Third	Second	First
		Quarter	Quarter	Quarter	Quarter
Sales, net		$ 6,959	$ 8,615	$ 7,300	$ 6,621
Cost of goods sold		4,648	5,546	5,142	4,566
Gross Profit		2,311	3,069	2,158	2,055
Selling, general and administrative expenses		1,810	2,924	1,656	1,714
Income from operations		501	145	502	341
Interest expense		(89)	(95)	(91)	(86)
Interest income		62	35	35	18
Income before provision for income taxes		474	85	446	273
Income tax provision		(246)	(16)	(184)	(131)
Net income		$ 228	$ 69	$ 262	$ 142
Basic earnings per share		$ .04	$ .01	$ .04	$ .02
Fully diluted earnings per share		$ .04	$ .01	$ .04	$ .02
Weighted average number of shares outstanding
(in thousands)
	Basic	6,410	6,410	6,410	6,384
	Diluted	6,413	6,410	6,410	6,393

50

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain a set of disclosure controls and procedures and internal controls designed to ensure that information required to be disclosed in our filings pursuant to Rule 13a-15(b) of the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms in a manner that allows timely decisions regarding required disclosures. We carried out, under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, our CEO and CFO concluded that the current disclosure controls and procedures are effective.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those policies and procedures that: (i) in reasonable detail accurately and fairly reflect our transactions; (ii) provide reasonable assurance that transactions are recorded as necessary for preparation of our financial statements; (iii) provide reasonable assurance that our receipts and expenditures are made in accordance with management authorization; and (iv) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting, however well designed and operated, can provide only reasonable, and not absolute, assurance that the controls will prevent or detect misstatements. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there is only the reasonable assurance that our controls will succeed in achieving their goals under all potential future conditions.

Management conducted an evaluation of the effectiveness of our internal control over financial reporting as of January 31, 2008, based on the framework in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (or the COSO criteria). Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of January 31, 2008.

This Annual Report on Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this Annual Report.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during our fourth quarter ended January 31, 2008, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

For information with respect to our directors and executive officers see the sections titled “Election of Directors” and “Executive Officers of the Company,” respectively, in our definitive Proxy Statement (“Proxy Statement”) for our Annual General Meeting of Shareholders to be held on June 11, 2008 (“Annual Meeting”), which information is incorporated herein by this reference.

For information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 by our directors and executive officers and holders of ten percent of a registered class of our equity securities, see the section titled “Section

51

16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement, which information is incorporated herein by this reference.

For information regarding our audit committee and audit committee financial expert and any material changes to the procedures by which shareholders may recommend nominees to our board of directors, see the section titled “Board Matters and Committees” in our Proxy Statement, which information is incorporated herein by this reference.

We have adopted a Code of Business Conduct and Ethics in compliance with the applicable rules of the SEC that applies to our principal executive officer, our principal financial officer and our principal accounting officer or controller, or persons performing similar functions. A copy of this policy is available free of charge on our website at www.internationalabsorbents.com under the “Governance” tab. We intend to disclose any amendment to, or a waiver from, a provision of our code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions and that relates to any element of the code of ethics enumerated in applicable rules of the SEC on our website at www.internationalabsorbents.com under the “Governance” tab.

ITEM 11. EXECUTIVE COMPENSATION

For information required by this item regarding compensation of our executive officers and directors, see the section titled “Compensation of Executive Officers and Directors” in our Proxy Statement, which information is incorporated herein by this reference.

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

For information with respect to the security ownership of certain beneficial owners and management, see the section titled “Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement, which information is incorporated herein by this reference.

For information required by this item regarding equity compensation plan information, see the section titled “Equity Compensation Plan Information” in our Proxy Statement, which information is incorporated herein by this reference.

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

For information with respect to certain relationships and related transactions, see the section titled “Transactions with Related Persons” in our Proxy Statement, which information is incorporated herein by this reference.

For information with respect to the independence of our directors, see the section titled “Board Matters and Committees” in our Proxy Statement, which information is incorporated herein by this reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

For information with respect to our principal accounting fees and services, see the section titled “Ratification of Independent Auditors” in our Proxy Statement, which information is incorporated herein by this reference.

52

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) The following documents are filed as part of this report:

1. Financial Statements.

The following Financial Statements are included in Part II, Item 8:

Report of Independent Registered Public Accounting Firm	Page 29
Consolidated Balance Sheets at January 31, 2008 and 2007	Page 30
Consolidated Statements of Income for the Fiscal Years ended January 31, 2008 and 2007	Page 31
Consolidated Statements of Stockholders’ Equity for the Fiscal Years ended January 31, 2008 and 2007	Page 32
Consolidated Statements of Cash Flows for the Fiscal Years ending January 31, 2008 and 2007	Page 33
Notes to Consolidated Financial Statements, January 31, 2008 and 2007	Page 34

2. Financial Statement Schedules.

Financial Statement Schedules not included herein have been omitted because they are either not required, not applicable, or the information is otherwise included herein.

3. Exhibits.

The exhibits listed in the accompanying Index to Exhibits on page 55 are filed or incorporated by reference as part of this Annual Report on Form 10-K.

53

SIGNATURES

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

INTERNATIONAL ABSORBENTS INC., a

British Columbia, Canada corporation

Signature                                  Title                                                        Date                  

/s/GORDON L. ELLIS

______________________ Chairman of the Board of Directors, April 25, 2008

Gordon L. Ellis President and Chief Executive Officer

(Principal Executive Officer)

/s/DAVID H. THOMPSON

David H. Thompson Chief Financial Officer April 25, 2008

Secretary

(Principal Financial and Accounting Officer)

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Gordon L. Ellis his attorney-in-fact, with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file same, with exhibits thereto and other documents in connection therewith, with the U.S. Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his substitutes, may do or cause to be done by virtue hereof.

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

Signature                                  Title                                                         Date                 

/s/GORDON L. ELLIS

______________________ Chairman of the Board of Directors, April 25, 2008

Gordon L. Ellis President and Chief Executive Officer

(Principal Executive Officer)

/s/JOHN J. SUTHERLAND

______________________ Director April 25, 2008

John J. Sutherland

/s/DANIEL J. WHITTLE

______________________ Director April 25, 2008

Daniel J. Whittle

/s/LIONEL G. DODD Director April 25, 2008

_____________________

Lionel G. Dodd

/s/MICHAEL P. BENTLEY Director April 25, 2008

_____________________

Michael P. Bentley

/s/DAVID H. THOMPSON

______________________ Chief Financial Officer April 25, 2008

David H. Thompson Secretary

(Principal Financial and Accounting Officer)

54

EXHIBIT INDEX

Exhibit 3. Articles of Incorporation and By-laws

3.1¹⁹ Notice of Articles of the Company (Amended)

3.2²⁰ Articles of the Company

Exhibit 4. Instruments Defining the Rights of Security Holders, Including Indentures

4.1¹⁸ Shareholder Rights Plan dated May 1, 2006

Exhibit 10. Material Contracts

10.1¹ Employment Agreement between the Company and Gordon L. Ellis, CEO and President dated October, 1, 1998.

10.2² Employment Agreement between the Company and David H. Thompson, CFO and Secretary dated February 1, 2002.

10.3³ Tax Exempt Loan Agreement Among GE Capital Public Finance, Inc., as Lender, and Washington Economic Development Finance Authority, as Issuer, and Absorption Corp., as Borrower, dated as of March 1, 2003.

10.4⁴ Taxable Rate Loan Agreement Between GE Capital Public Finance, Inc., as Lender, and Absorption Corp, as Borrower, dated as of March 1, 2003

10.5⁵ The Commercial Deed of Trust, Security Agreement, Assignment of Leases and Rents and Fixture Filing made as of March 1, 2003, by the Grantor, Absorption Corp, to the Trustee, First American Title Insurance Company, as Trustee for the benefit of the Beneficiary, GE Capital Public Finance, Inc.

10.6⁶ Loan Agreement among BB&T and Absorption Corp. dated August 20, 2003.

10.7⁷ Employment Agreement between the Company and Shawn Dooley, Vice President for Sales and Marketing of Absorption Corp. dated December 18, 2003.

10.8⁸ Employment Agreement dated August 26, 2004 between Absorption Corp and Douglas Ellis, Chief Operations Officer for the Company.

10.9⁹ 2003 Omnibus Incentive Plan

10.10¹⁰ Wayne County Industrial Development Authority Tax-Exempt Industrial Development Revenue Bonds (Absorption Corp Project), Series 2004 dated September 2, 2004.

10.11¹¹ Letter of Credit and Reimbursement Agreement between Absorption Corp and Branch Banking and Trust Company dated September 1, 2004.

10.12¹² BB&T Security Agreement dated September 1, 2004 between Absorption Corp and Branch Banking and Trust Company.

10.13¹³ BB&T Guaranty Agreement between Branch Banking and Trust Company and International Absorbents Inc. dated September 1, 2004.

10.14¹⁴ Lease Agreement dated as September 1, 2004 by and between Wayne County Industrial Development Authority and Absorption Corp.

10.15¹⁵ Washington Economic Development Finance Authority Economic Development Revenue Bond dated September 14, 2006.

10.16¹⁶ Loan Agreement among GE Capital Public Finance, Inc., as lender, Washington Economic Development Finance Authority, as issuer, and Absorption Corp., as borrower, dated as of September 1, 2006.

10.17¹⁷ Corporate Guaranty and Negative Pledge Agreement given by International Absorbents Inc. dated as of September 1, 2006.

10.18²¹ Rental contracts between the Company and ABE Industries (1980) Inc. dated March 15, 2003.

Exhibit 21. Subsidiaries of the Registrant

21.1²² List of Subsidiaries of the Registrant.

Exhibit 23. Consent of Experts and Counsel

23.1²² Consent of Moss Adams, LLP

Exhibit 24. Power of Attorney

24.1 The power of attorney can be located on the signature page of this Form 10-K.

Exhibit 31. Rule 13a-14(a)/15d-14(a) Certifications

55

31.1²² Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14.

31.2²² Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14.

Exhibit 32. Section 1350 Certifications

32.1²² Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.

32.2²² Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350

___________________________________________________________________________________________

¹ Incorporated by reference to Exhibit 10.3 filed with the Company’s Annual Report on form 10-KSB for the fiscal year ended January 31, 2003.

² Incorporated by reference to Exhibit 10.6 filed with the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2003.

³ Incorporated by reference to Exhibit 10.7 filed with the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2003.

⁴ Incorporated by reference to Exhibit 10.8 filed with the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2003.

⁵ Incorporated by reference to Exhibit 10.9 filed with the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2003.

⁶ Incorporated by reference to Exhibit 10.1 filed with the Company’s Quarterly Report on Form 10-QSB for the quarter ended October 31, 2003.

⁷ Incorporated by reference to Exhibit 10.8 filed with the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2004.

⁸ Incorporated by reference to Exhibit 10.19 filed with the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2005.

⁹ Incorporated by reference to Exhibit 99.1 to Amendment No. 1 to Company’s Registration Statement on Form S-8 filed on May 18, 2005.

¹⁰ Incorporated by reference to Exhibit 10.14 filed with the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004.

¹¹ Incorporated by reference to Exhibit 10.15 filed with the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004.

¹² Incorporated by reference to Exhibit 10.16 filed with the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004.

¹³ Incorporated by reference to Exhibit 10.17 filed with the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004.

¹⁴ Incorporated by reference to Exhibit 10.18 filed with the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004.

¹⁵ Incorporated by reference to Exhibit 10.19 filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2006.

¹⁶ Incorporated by reference to Exhibit 10.20 filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2006.

¹⁷ Incorporated by reference to Exhibit 10.21 filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2006.

¹⁸ Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed May 4, 2006

¹⁹ Incorporated by reference to Exhibit 3.1 filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2006.

²⁰ Incorporated by reference to Exhibit 3.2 filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2006.

²¹ Incorporated by reference to Exhibit 10.18 filed with the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2007.

²² Filed herewith.

56

EX-21.1

EXHIBIT 21.1

Subsidiaries of the Registrant.

1. Absorption Corp.

Incorporated in the State of Nevada

EX-23.1

EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statements Nos. 333-105146 and 333-114526 on Form S-8 of International Absorbents, Inc. of our report dated April 25, 2008, relating to the financial statements appearing in this Annual Report on Form 10-K of International Absorbents, Inc. for the year ended January 31, 2008.

/S/ Moss Adams LLP

Seattle, Washington

April 25, 2008

EX-31.1

EXHIBIT 31.1

CERTIFICATION PURSUANT TO

EXCHANGE ACT RULE 13a-14

I, Gordon Ellis, certify that:

1. I have reviewed this Annual Report on Form 10-K of International Absorbents Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-13(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: April 25, 2008
/s/ GORDON ELLIS
                                                                           
Gordon Ellis
President and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION PURSUANT TO

EXCHANGE ACT RULE 13a-14

I, David Thompson, certify that:

1. I have reviewed this Annual Report on Form 10-K of International Absorbents Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-13(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: April 25, 2008
/S/ DAVID THOMPSON
                                                                           
David Thompson
Secretary and Chief Financial Officer

EX-32.1

EXHIBIT 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350

Pursuant to 18 U.S.C. § 1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, I, Gordon Ellis, President and Chief Executive Officer, certify that:

1.To my knowledge, this report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2.To my knowledge, the information in this report fairly presents, in all material respects, the financial condition and results of operations of International Absorbents Inc. as of January 31, 2008.

Date: April 25, 2008
/s/ GORDON ELLIS
                                                                           
Gordon Ellis
President andChief Executive Officer

EX-32.2

EXHIBIT 32.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350

Pursuant to 18 U.S.C. § 1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, I, David Thompson, Secretary and Chief Financial Officer, certify that:

1.To my knowledge, this report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2.To my knowledge, the information in this report fairly presents, in all material respects, the financial condition and results of operations of International Absorbents Inc. as of January 31, 2008.

Date: April 25, 2008
/s/ DAVID THOMPSON
                                                                           
David Thompson
Secretary and Chief Financial Officer