Annual Reports

  • 10-K (Apr 29, 2010)
  • 10-K (Apr 29, 2009)
  • 10-K (Apr 28, 2008)
  • 10-K (May 14, 2007)
  • 10-K (Apr 10, 2007)
  • 10-K (Apr 7, 2006)

 
Quarterly Reports

 
8-K

 
Other

International Absorbents 10-K 2009
United States Securities & Exchange Commission EDGAR Filing


 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

——————

FORM 10-K

——————

(Mark One)

ü

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

 

 ACT OF 1934

For the fiscal year ended: January 31, 2009

OR

 

 

 

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

 

 ACT OF 1934

For the transition period from: _____________ to _____________

Commission file number: 1-31642

INTERNATIONAL ABSORBENTS INC.

(Exact name of registrant as specified in its charter)

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

 

NYSE Amex LLC

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 þ

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 o   No þ

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.

Yesþ   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

£

Accelerated filer  

£

Non-accelerated filer  

£

Smaller reporting company  

þ

(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 ý

Aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of July 31, 2008, based upon the closing price of the common stock as reported by the American Stock Exchange on such date, was approximately $13,991,708.

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, 2009

Common Shares, no par value per share

 

6,410,282 shares


DOCUMENTS INCORPORATED BY REFERENCE


Document

 

Parts Into Which Incorporated

Portions of the Proxy Statement for the Annual General Meeting of Shareholders to be held on June 10, 2009

 

Part III


 

 



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INTERNATIONAL ABSORBENTS INC.

Annual Report on Form 10-K

For the Fiscal Year Ended January 31, 2009

TABLE OF CONTENTS

Item

 

 

Page

Number

 

 

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

18

8.

 

Financial Statements and Supplementary Data

26

9A(T).

 

Controls and Procedures

46

 

PART III

 

10.

 

Directors, Executive Officers and Corporate Governance

47

11.

 

Executive Compensation

47

12.

 

Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters

47

 

 

 

 

13.

 

Certain Relationships and Related Transactions, and Director Independence

47

14.

 

Principal Accountant Fees and Services

47

 

PART IV

 

15.

 

Exhibits and Financial Statement Schedules

48

SIGNATURES

49

EXHIBIT INDEX

50

 

 

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 ongoing efforts to improve our infrastructure and production facilities;

·

the impact of the ongoing global economic downturn on our financial condition and ability to remain competitive;

·

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; 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 cleanup 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.

The majority of our products, in both the animal care and industrial cleanup 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 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 in an effort to maximize shareholder value.

Products

Our leading product is small animal bedding made from cellulose fiber. It is used as a substrate for rodents, rabbits, reptiles and hand-fed exotic birds instead of wood shavings, hardwood chips or corn cobs. We believe that our product is superior to traditional bedding materials because it is better able to control and contain animal waste 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™ and CareFRESH® 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®. We also distribute our small animal pet bedding under the brands Healthy Pet™ and Critter Care™ in the grocery and/or mass merchandiser distribution channels.

Our Healthy Pet™ brand of cat litters consists of a range of natural products 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 also 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 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 two major pet supply retailers and one major general merchandise retailer, which are our three 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 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.

Our industrial cleanup 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 cleanup 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 cleanup 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.



6



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 cleanup 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 several years 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, if and when enacted, 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. We do not yet have enough information to determine how the ongoing economic downturn will impact trends discussed below or how it may affect demand for our products or our ability to maintain our current pricing strategy.

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 cleanup 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. Our 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 us with 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 by-products 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 diversity of raw material sources improves our ability to meet 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. However, as described below, we have in the past and may again 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. To date, 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 2009 we increased our investment in sales and marketing in an effort to increase distribution efficiencies, increase market share and launch new products, such as CareFRESH Confetti™ and Advanced Odor Control™.

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, Greece, France, 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 cleanup 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 $5,000 and $10,000 during fiscal years 2009 and 2008, respectively.

Intellectual Property

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 our issued patent, our competitors will have the ability to develop products that are currently protected by these patents.

Absorption has been issued three U.S. patents, of which one remains current and two have expired, and has one pending patent relating to various degradable particulate absorbent materials and our manufacturing process.

Number of Employees

As of March 2009, we had 135 employees, of which 130 were full-time employees and none of which were 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 in the foreseeable future. As a result, we believe that we are able to manage the design process and help minimize product liability risks. In addition we employ engineers and designers to design and test our products under development and maintain a quality control system in an ongoing effort to decrease defects in our products.



8



Environmental and Other Governmental Regulations

We are subject to environmental laws and regulations governing emissions into the air; discharges into the water; and 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, filed or furnished 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.




9



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 continue to work to build 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.

A decline in consumer spending or a change in consumer preferences, resulting from the downturn in the global economy or otherwise, could reduce our sales or profitability and harm our business.

 

Our sales depend on consumer spending, which is influenced by factors beyond our control, including general economic conditions, the availability of discretionary income and credit, weather, consumer confidence and unemployment levels. The global economy is experiencing an ongoing downturn, which may continue for a significant period of time. As a result, there may be decreased customer traffic at our major customer’s stores, and we may experience declines in sales, pressure to lower prices and/or changes in the types of products sold.

Any material decline in the amount of consumer spending could reduce our sales. In addition, our premium products are generally priced higher than our competitors’ products, and in an economic downturn, consumers may elect to purchase lower-priced products. This could further reduce our sales and/or force us to lower our prices, which could reduce profitability, and, in each case, harm our business. The success of our business depends in part on our ability to identify and respond to evolving trends in demographics and consumer preferences. Failure to timely identify or effectively respond to changing consumer tastes, preferences, spending patterns and animal care needs could adversely affect our relationship with our customers, the demand for our products and services, our market share and our profitability.

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

Our three largest customers accounted for approximately 26%, 23% and 10% of our net sales in fiscal year 2009, while the same customers accounted for approximately 24%, 24% and 9%, respectively, of our net sales in fiscal year 2008. We are dependent on these customers to maintain our financial condition and to generate forecasted operating results.

Any material deterioration in the financial condition of one of our major customers could have a material adverse effect on our sales, profitability and cash flow. 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. These risks are heightened as a result of the ongoing global economic downturn. For example, some customers such as Petsmart are projecting a modest rate of growth and others, such as Petcetera have recently declared bankruptcy,

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

With the ongoing 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.



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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 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.

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. 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, at times during fiscal year 2009, we experienced exceedingly high transportation expenses. When these costs are high they 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.

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; and generation, handling, storage, transportation, treatment, and disposal of waste materials. Environmental regulations may affect us by restricting the manufacturing or use of our products or regulating their disposal. We are also subject to other federal and state laws and regulations regarding health and safety matters.



11



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, 2009, we had total long-term and current indebtedness under three different bonds of $6,664,000. We make interest payments (and principal payments on the taxable bond) on the indebtedness under these bonds, which are due in 2014, 2019, and 2019. 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 a timely manner to the ongoing global 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 can be no assurance 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 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. Additionally our letter of credit on our Georgia bond financing expires in September 2011 and there can be no assurance we will be able to renew it. If the letter of credit is not renewed we will be required to pay off the bonds in full.

We will continue to incur substantial costs in connection with the requirements of the Sarbanes-Oxley Act of 2002.

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. Based on the requirements in effect as of the date of this Annual Report, at the end of fiscal year 2010 our auditors will be required to issue a report on our internal control over financial reporting for inclusion in our Annual Report on Form 10-K for the fiscal year ending January 31, 2010. We expect that the costs to comply with these requirements will continue to be significant and adversely affect our operating results.

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 that required 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. As we continue our ongoing review and analysis of internal control over financial reporting for compliance with the Act, we may encounter problems or delays in completing the review and evaluation and implementing improvements. Additionally, we may identify deficiencies that need to be addressed in our internal control over financial reporting or other matters that may raise concerns for investors. Should we, or our independent registered public accounting firm, determine in future periods that we have significant deficiencies or material weaknesses in our internal control over financial reporting, or if we are unable to receive a positive attestation from our independent auditors, our results of operations or financial condition may be adversely



12



affected, investors may lose confidence in the reliability of our financial statements and the price of our common stock may decline.

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, and current volatility and disruption to the global capital and credit markets may adversely affect our ability to access credit.

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, 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. Moreover, our current line of credit matures on May 23, 2009 and there can be no assurance that it will be renewed.

Financial turmoil affecting the banking system and financial markets and the risk that additional financial institutions may consolidate or become insolvent has resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and volatility in credit, currency and equity markets. In such an environment, there is a risk that lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments, including but not limited to: extending credit up to the maximum permitted by credit facility, renewing existing credit facilities and/or honoring loan commitments. If our lender fails to honor its legal commitments under our line of credit, or if we are unable to renew our credit facility on favorable terms or at all, it could be difficult in this environment to replace our credit facility on similar terms. 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 include 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 bonds and bank debt financing restrict our ability to, among other things, incur 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 believe that we are currently 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 move into 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 one remains current and two have expired, 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.



13



Issued patents may be subject to challenges and infringements. Moreover, upon expiration of our current patent other parties may be able to develop products that are currently protected by this patent, 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.

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 financial results 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 financial results. 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. For example, the calculation of share-based compensation expense 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



14



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. 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 NYSE Amex LLC.

In March 2003, we received official notice from the American Stock Exchange (now NYSE Amex LLC) 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 NYSE Amex LLC listing standards, including standards related to stock price, market capitalization and corporate governance. If we are unable to do so, NYSE Amex LLC 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 in Ferndale, Washington. The total purchase price of the land was $1,500,000, plus closing costs, which was determined through arms-length negotiations.

During 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. 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 in Note 8 (“Long-term debt”) to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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 Note 8 (“Long-term debt”) to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K 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 the foreseeable 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 $6,664,000 as of January 31, 2009.

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 2009 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 listed on NYSE Amex LLC (formerly AMEX), under the trading symbol IAX. Shown below are the high and low sale prices for our common shares for the periods indicated below as reported by NYSE Amex LLC and AMEX. The following quotations, as provided by the NYSE Amex LLC and AMEX represent prices between dealers and do not include retail markup, markdown or commission. In addition, these quotations may not represent actual transactions.

 

 

FISCAL YEAR

2009

 

FISCAL YEAR

2008

 

 

HIGH

 

LOW

 

HIGH

 

LOW

 

 

 

 

 

 

 

 

 

First quarter

     

4.99

     

3.62

     

5.42

 

3.84

Second quarter

 

4.98

 

2.75

 

6.50

 

4.19

Third quarter

 

3.65

 

2.09

 

6.68

 

3.47

Fourth quarter

 

4.80

 

1.66

 

4.00

 

3.20

Holders

We had 438 holders of record of our Common Shares as of April 16, 2009.

Dividends

We have not 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 remain 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 primarily to finance the continuing growth of our business and as such do not have any current plans to pay dividends.

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 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 Annual Report on Form 10-K.

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 cleanup 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 2009 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 2009 we were meeting expectations for improvements in gross profits, which we believe improved as a result of our ongoing plan to maximize the efficiencies of the manufacturing capital investments we have made during the past several years. Selling, general and administrative expenses grew as expected as investments were made in the development of new product lines and market channels.

During fiscal year 2009, we continued 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 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. To date our sales growth has come from our small animal bedding products and not from our cat litter products.



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Results of Operations

The following table illustrates our financial results for fiscal year 2009 as compared to the prior fiscal year. (U.S. dollars, in thousands):

 

 

January 31,
2009

 

Percent of
Sales

 

January 31,
2008

 

Percent of
Sales

 

Percentage
Change

Sales

     

 

35,752 

     

 

100%

     

 

33,095 

     

 

100%

     

 

8%

Cost of goods sold

 

 

24,270 

 

 

68%

 

 

23,139 

 

 

70%

 

 

5%

Gross profit

 

 

11,482 

 

 

32%

 

 

9,956 

 

 

30%

 

 

15%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling general and
administrative expenses

 

 

7,575 

 

 

21%

 

 

6,387 

 

 

19%

 

 

19%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

 

3,907 

 

 

11%

 

 

3,569 

 

 

11%

 

 

9%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

62 

 

 

0%

 

 

86 

 

 

0%

 

 

-28%

Interest expense

 

 

(315)

 

 

-1%

 

 

(385)

 

 

-1%

 

 

-18%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Profit before taxes

 

 

3,654 

 

 

10%

 

 

3,270 

 

 

10%

 

 

12%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income taxes

 

 

(1,415)

 

 

-4%

 

 

(1,254)

 

 

-4%

 

 

13%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

2,239 

 

 

6%

 

 

2,016 

 

 

6%

 

 

11%

Net Sales

In fiscal year 2009, our net sales increased by 8% over fiscal year 2008. All of the growth in net sales was a result of the growth in sales of our animal care products. During fiscal year 2009, net sales for animal care products grew from $32,271,000 to $34,934,000, as compared to fiscal year 2008. Net sales of our industrial cleanup products decreased from $824,000 in fiscal year 2008 to $818,000 in fiscal year 2009. We had strong growth with all of our bedding products, including CareFRESH®, CareFRESH® Ultra™, and CareFRESH® Colors products. Our strategy with regard to our industrial cleanup products has remained the same, which is to effectively service existing customers while focusing growth on animal care products.

We are uncertain how current economic conditions will affect our sales during fiscal year 2010. Some customers such as Petsmart are projecting a modest rate of growth and some, such as Petcetera have recently declared bankruptcy. The net result is that we believe that our overall annual net sales will be in the range of growing by approximately 5% to decreasing by approximately 5% over our fiscal year 2009 net sales levels. Specifically, during fiscal year 2010, we expect sales of natural, non-colored CareFRESH® in pet specialty channels to remain flat to slightly down over sales levels from fiscal year 2009. As a result of promotional activity on the retail level, we expect to see modest sales growth in CareFRESH Ultra™ and CareFRESH® Colors. We anticipate that natural CareFRESH® will continue to represent the majority of our sales through the 2010 fiscal year. We also see growth opportunities for our full line of bedding products and believe they will continue to gain market share and growing customer acceptance. However, 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. Also, 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. Further, the global economic downturn has resulted in lower than expected sales growth of our products, as a result of decreased consumer spending and reduced customer traffic at our major customers’ stores. With respect to our lines of cat litter products, subject to the considerations described above, we expect revenue growth to be flat during the coming fiscal year.

Gross Profit

As fiscal year 2009 came to an end, both of our production facilities were operating at efficiency levels that are at or near the pre-construction expectations of management. Nonetheless, during the year, our production facilities faced challenges that directly affected their production costs. These challenges included increased energy costs during the first half of the year, materials cost increases, ongoing maintenance costs associated with achieving a high rate of product quality and production efficiencies, and high freight cost during the first half of the year. There was also increased depreciation during the entire year as a result of our capital expansion program. Even in light of these additional cost, we were able to improve our gross margin (gross profit divided by sales) from 30% in fiscal year 2008 to 32% in fiscal year 2009.



19



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 7% in fiscal year 2009 as compared to fiscal year 2008.

For fiscal year 2010 we continue to expect that our gross margin will remain in the range of 31% to 36%. The reasons for this expectation are as follows. First, even though fuel and energy cost are currently at relative lows, economic conditions may not allow us to increase prices if they were to rise. 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 and uncertain reactions from raw material suppliers in response to our request for additional supplies; 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, any slowdown in sales could result in increased production costs on a per unit basis due to a loss of efficiencies gained from higher production rates.

We plan to continue to make capital investments in infrastructure and technology at all of our facilities to help decrease the costs of production.

Selling, General and Administrative and Expenses

During fiscal year 2009, our selling, general and administrative expenses increased by 19% as compared to fiscal year 2008. This increase was the result of investments we made in the creation and launch of our “new product development” division, additional personnel we hired to upgrade performance levels, expenses related to general sales and marketing programs, and increased costs resulting from our compliance with requirements of the SEC and the NYSE Amex, LLC.  Moreover, we now have overhead expenses related to operating our Georgia facility, increased property taxes, and increased depreciation expense.

We anticipate that investments in sales and marketing programs and new product development costs, along with our stock-based compensation expenses and growing public company reporting expenses, will continue to increase selling, general and administrative expenses during fiscal year 2010, though not at the rate at which they increased during the current fiscal year. During fiscal year 2010, we intend to continue our marketing and new product development initiatives. 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 completed our program of rounding out our sales staff during fiscal year 2009 and do not at this time anticipate adding any additional sales personnel during fiscal year 2010. We feel that the 2010 sales 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 NYSE 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 2009 totaled $315,000 as compared to $385,000 during fiscal year 2008. This decrease was due to a reduction in the variable interest rate we pay on the bonds that were used to finance the Jesup, Georgia facility and the reduction in principal amounts as we pay off our bonds according to their terms. 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 2010 as the principal portion of our existing debt is paid down. This projection assumes that variable interest rates will remain low during fiscal the year 2010.

Income Tax

Absorption incurred federal income taxes during fiscal year 2009 at an effective rate of 38%. The effective rate is consistent with the rate incurred during fiscal year 2008 (of 38%). 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. Deferred income tax assets in International Absorbents have been fully reserved through the recording of a valuation allowance as Canadian deferred tax assets are not expected to be utilized in future periods.

Net Income

Our net income for the year ended January 31, 2009 increased by 8% 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 improved gross profits. 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 remain profitable even if our sales were to slightly decrease during fiscal year 2010.



20



Our focus during fiscal year 2010 will be to maintain current sales levels through the ongoing global economic downturn, and minimize the growth of our selling general and administrative costs while targeting an improved gross profit margin. Our biggest challenges for the coming fiscal year will be maintaining existing sales levels as the buying habits of retail customers continue to change, continuing the improvement of our gross margin, and maintaining selling, general and administrative expenses at levels that create opportunities for future growth. 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 existing levels of depreciation resulting from our investment in plant and equipment will negatively affect our fiscal year 2010 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 2010, though not at the rate at which fiscal year 2009 increased over fiscal year 2008.

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 8% during fiscal year 2009 as compared to fiscal year 2008. The increase for fiscal year 2009 was substantially the result of increased sales and an improved gross margin.

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 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

 

 

 

 

 

 

January 31,
2009

 

January 31,
2008

 

 

Percentage
Change

 

(U.S. dollars in thousands)

 

 

                 

 

 

                 

 

 

                 

 

Net Income (as reported on Condensed Consolidated
Statement of Operations)

     

$

2,239 

     

$

2,016 

     

 

 

 

Interest expense

 

 

315 

 

 

385 

 

 

 

 

Interest income

 

 

(62)

 

 

(86)

 

 

 

 

Income tax provision

 

 

1,415 

 

 

1,254 

 

 

 

 

Depreciation & amortization

 

 

1,830 

 

 

1,719 

 

 

 

 

EBITDA

 

$

5,737 

 

$

5,288 

 

 

8%

 

During fiscal year 2010, management will continue to focus on EBITDA as a key performance indicator.

Liquidity and Capital Resources

During fiscal year 2009 we focused on improving the production efficiencies at both of our plants. Our improved gross margin in the last half of fiscal year 2009 was the result of both the success we had in improving production efficiencies and the reduction in energy and transportation costs. We believe that the improvement in our production facilities will help provide a solid return on the investments we have made in capital expansion over the past several years.



21



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,
2009

 

As of
January 31,
2008

 

Financial Condition

 

 

 

 

 

 

 

Total Assets

     

$

31,281

     

$

28,589

 

Total Liabilities

 

 

10,895

 

 

10,900

 

Total Equity

 

$

20,386

 

$

17,689

 

 

 

 

 

 

 

 

 

Debt/equity ratio

 

 

0.53

 

 

0.62

 

Assets/debt ratio

 

 

2.87

 

 

2.62

 

 

 

 

 

 

 

 

 

Working Capital

 

 

 

 

 

 

 

Current assets

 

$

11,465

 

$

8,691

 

Current liabilities

 

$

3,595

 

$

3,080

 

 

 

 

 

 

 

 

 

Current ratio

 

 

3.19

 

 

2.82

 

 

 

 

 

 

 

 

 

Cash Position

 

 

 

 

 

 

 

Cash, restricted cash & short term investments                     

 

$

4,146

 

$

2,809

 

Cash generated from operations

 

$

3,644

 

$

3,571

 

Financial Condition

During fiscal year 2009, the value of our total assets increased. This was primarily the result of an increase in current assets, which resulted from growing operational activities. As an example, both accounts receivable and inventories increased as a result of growing sales and cash position improved as a result of increased profits, in both cases offset by limited capital investments. We also had a decrease 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 2010 will come from meeting the covenants included in our debt facilities and the marketability of tax exempt industrial revenue bonds. As of the end of fiscal year 2009 we were over minimum financial requirements and under maximum requirements included in these covenants. The covenant-related ratios that we believe pose the most significant risk in the future are those based on cash flow. Any significant decrease in our cash flow could result in the breach of one or more of these loan covenants. If we fail to satisfy the financial covenants or other requirements contained in our debt facilities, our debts could become immediately payable at a time when we are unable to pay them, which would 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.

The marketability of tax exempt industrial revenue bonds is a potential industry-wide issue, and is not related to our liquidity or results from operations. The industrial revenue bonds for our Jesup, Georgia facility are remarketed and the industrial revenue bonds for our Ferndale, Washington facility are held by GE Capital Public Finance, Inc. If the industrial revenue bonds that are remarketed were not able to be sold, due to a market failure, according to the terms of the bond agreement, we would likely have to pay off the outstanding balance, which is currently $3,300,000.

Debt retirement is an alternative that we consider on an ongoing basis. Relevant factors in our analysis include the availability and cost of equity and the rate of interest on our debt. Our long-term debt has been at very favorable rates such that we believe it was and continues to be advantageous to use our existing capital for other applications. At this time, we do not intend to raise additional equity capital in the near term.



22



Working Capital

During fiscal year 2009, our working capital position continued to improve as current assets increased and current liabilities decreased. The majority of the increase in current assets was the result of increased cash used to fund our growing operations and an increase in inventories. Current liabilities decreased primarily due to decreases in accounts payable. These changes resulted in our current ratio (current assets divided by current liabilities) increasing from 2.82 at the end of fiscal year 2008 to 3.19 at the end of fiscal year 2009.

In fiscal year 2010 we expect that if sales are at projected our current assets will continue to increase as a result of positive cash flow and an increase in accounts receivable and inventories, if 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 increased during fiscal year 2009, primarily as a result of cash generated from operations. We expect cash on hand to increase during fiscal year 2010, 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 we anticipate should provide enough collateral to support the related debt. Interest is payable on funds advanced at the LIBOR rate plus 2.5%. The line of credit matures on May 23, 2009 and we expect it to be renewed. If the current conditions in the credit markets prevent us from renewing the existing line of credit, we may be able to obtain a new line of credit through a Canadian bank, due to the location of International Absorbents. As of January 31, 2009, no borrowings were outstanding under the line of credit. If we do borrow against this line of credit and it is renewed, we intend to pay it off before the end of fiscal year 2010. 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 2009 we generated $3,644,000 in cash from operating activities. The cash generated during fiscal year 2009 was a 2% increase over the $3,571,000 in cash generated during fiscal year 2008. 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 2010, although it cannot be assured that this will be the case.

Financing and Investing Activities

Cash used for financing activities during fiscal year 2009 was $857,000. This was the result of principal payments made on our long-term debt. Cash used in investing activities during fiscal year 2009 was approximately $1,450,000.  This cash was used for the acquisition of fixed assets. A portion of these assets were production-related items that were replaced as part of our ongoing maintenance program. We also made several investments during fiscal year 2009 to reduce costs and improve efficiencies in the areas of fiber recovery, energy use, and product handling.

We believe that for the near future we will not need to use cash to invest in significant capital improvements. We will continue to use cash to fully maintain our existing facilities and to make improvements which we expect will increase production efficiencies and reduce manufacturing costs.

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.



23



Critical Accounting Policies

Introduction

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, sales incentives and stock based compensation.  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 to 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 changes 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 overestimated. 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.



24



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 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 Emerging Issues Task Force (“EITF”) Issue No. 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 Financial Accounting Standards Board (“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

Effective February 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) Share-Based Payment (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 do not expect to change our methodology for calculating stock-based compensation in the future.



25



ITEM 8.

FINANCIAL STATEMENTS

INDEX


 

     

 

Report of Independent Registered Public Accounting Firm

 

Page 27

 

 

 

Consolidated Balance Sheets at January 31, 2009 and 2008

 

Page 28

 

 

 

Consolidated Statements of Income for the Fiscal Years ended January 31, 2009 and 2008

 

Page 29

 

 

 

Consolidated Statements of Changes In Stockholders’ Equity for the Fiscal Years ended
January 31, 2009 and 2008

 

Page 30

 

 

 

Consolidated Statements of Cash Flows for the Fiscal Years ending January 31, 2009 and 2008

 

Page 31

 

 

 

Notes to Consolidated Financial Statements, January 31, 2009 and 2008

 

Page 32

 

 

 





26



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, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the 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, 2009 and 2008, 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 Notes 2 and 5 to the consolidated financial statements, effective February 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements.

/s/ Moss Adams LLP

Seattle, Washington

April 28, 2009



27



International Absorbents Inc. and Subsidiary

Consolidated Balance Sheets

As at January 31, 2009 and 2008

(in thousands of U.S. dollars)

 

 

2009

 

2008

 

 

 

 

 

 

 

Assets

     

 

 

     

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

4,146 

 

$

2,809 

Accounts receivable, net

 

 

2,699 

 

 

2,359 

Inventories, net

 

 

4,286 

 

 

3,166 

Prepaid expenses

 

 

162 

 

 

155 

Income taxes receivable

 

 

— 

 

 

44 

Deferred income tax asset

 

 

172 

 

 

158 

Total current assets

 

 

11,465 

 

 

8,691 

 

 

 

 

 

 

 

Property, plant and equipment, net

 

 

19,610 

 

 

19,662 

Other assets, net

 

 

206 

 

 

236 

Total assets

 

$

31,281 

 

$

28,589 

 

 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

2,686 

 

$

2,119 

Related party payable

 

 

 

 

Current portion of long-term debt

 

 

877 

 

 

857 

Income taxes payable

 

 

27 

 

 

98 

Total current liabilities

 

 

3,595 

 

 

3,080 

 

 

 

 

 

 

 

Deferred income tax liability

 

 

1,364 

 

 

1,110 

Long-term debt

 

 

5,787 

 

 

6,664 

Other long term liabilities

 

 

149 

 

 

46 

Total liabilities

 

 

10,895 

 

 

10,900 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock, no par value - Unlimited shares authorized,
6,410,282 and 6,410,328 issued and outstanding at

 

 

 

 

 

 

January 31, 2009 and 2008, respectively

 

 

8,487 

 

 

8,487 

Additional paid in capital

 

 

1,823 

 

 

1,365 

Retained earnings

 

 

10,076 

 

 

7,837 

Total stockholders' equity

 

 

20,386 

 

 

17,689 

Total liabilities and stockholders' equity

 

$

31,281 

 

$

28,589 




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


28



International Absorbents, Inc. and Subsidiary

Consolidated Statements of Income

For the years ended January 31, 2009 and 2008

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

 

 

2009

 

2008

 

 

 

 

 

 

 

Sales, net

     

$

35,752 

     

$

33,095 

Cost of goods sold

 

 

24,270 

 

 

23,139 

Gross Profit

 

 

11,482 

 

 

9,956 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

 

7,575 

 

 

6,387 

 

 

 

 

 

 

 

Income from operations

 

 

3,907 

 

 

3,569 

Interest expense

 

 

(315)

 

 

(385)

Interest income

 

 

62 

 

 

86 

Income before provision for income taxes

 

 

3,654 

 

 

3,270 

 

 

 

 

 

 

 

Income tax provision

 

 

(1,415)

 

 

(1,254)

Net income

 

$

2,239 

 

$

2,016 

 

 

 

 

 

 

 

Basic earnings per share

 

$

.35 

 

$

.31 

Fully diluted earnings per share

 

$

.35 

 

$

.31 

 

 

 

 

 

 

 

Weighted average number of shares outstanding
(in thousands)

 

 

 

 

 

 

Basic

 

 

6,410 

 

 

6,410 

Diluted

 

 

6,446 

 

 

6,477 





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


29



International Absorbents Inc. and Subsidiary

Consolidated Statement of Changes in Stockholders’ Equity

For the years ended January 31, 2009 and 2008

(in thousands of U.S. dollars)

 

 

Common
Shares

 

Amount

 

Additional
Paid in
Capital

 

Retained
Earnings

 

Total
Stockholders'
Equity

 

 

(in 1,000's)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 

Stock based compensation

 

— 

 

 

— 

 

 

458 

 

 

— 

 

 

458 

Net income

 

— 

 

 

— 

 

 

— 

 

 

2,239 

 

 

2,239 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of January 31, 2009

 

6,410 

 

$

8,487 

 

$

1,823 

 

$

10,076 

 

$

20,386 






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


30



International Absorbents Inc. and Subsidiary

Consolidated Statement of Cash Flows

For the years ended January 31, 2009 and 2008

(in thousands of U.S. dollars)

 

 

2009

 

2008

 

 

 

 

 

 

 

Cash flows from operating activities

     

 

 

     

 

 

 

 

 

 

 

 

 

Net income

 

$

2,239 

 

$

2,016 

Adjustments to reconcile net income to net cash
used for operating activities

 

 

 

 

 

 

Depreciation and amortization

 

 

1,830 

 

 

1,719 

Loss on disposal of equipment

 

 

 

 

167 

Stock-based compensation

 

 

458 

 

 

366 

Deferred taxes

 

 

240 

 

 

303 

Changes in operating assets and liabilities

 

 

 

 

 

 

Accounts receivable

 

 

(340)

 

 

14 

Inventory

 

 

(1,120)

 

 

55 

Prepaid expenses

 

 

(7)

 

 

(29)

Accounts payable and accrued liabilities

 

 

268 

 

 

(856)

Income taxes receivable/payable

 

 

(27)

 

 

(148)

Due to related party

 

 

(1)

 

 

Other long term liabilities

 

 

103 

 

 

(37)

Net cash flows from operating activities

 

 

3,644 

 

 

3,571 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

Purchase of property, plant and equipment

 

 

(1,450)

 

 

(3,380)

Proceeds from restricted cash

 

 

— 

 

 

1,146 

Net cash flows from investing activities

 

 

(1,450)

 

 

(2,234)

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

Repayment of long-term debt

 

 

(857)

 

 

(805)

Net cash flows from financing activities

 

 

(857)

 

 

(805)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change in cash

 

 

1,337 

 

 

532 

 

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

 

2,809 

 

 

2,277 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

4,146 

 

$

2,809 

 

 

 

 

 

 

 

Cash paid for interest (net of amounts capitalized)

 

$

321 

 

$

394 

 

 

 

 

 

 

 

Cash paid for income taxes

 

$

1,099 

 

$

1,128 

 

 

 

 

 

 

 

Non-cash investing activities

 

 

 

 

 

 

Increase in property, plant and equipment and accounts
payable for purchase of plant and equipment

 

$

454 

 

$

154 






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


31



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 fiscal year 2009. 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.

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, 2009 and 2008, management considered all accounts receivable in excess of the allowances for doubtful accounts to be fully collectible.

Inventories

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.



32



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, 2009 and 2008, the deferred financing fees were $206,000 and $236,000, respectively, which are net of accumulated amortization of $138,000 and $108,000, respectively. Amortization expense was $30,000 and $30,000 for the years ended January 31, 2009 and 2008, 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 $433,000 and $458,000 in fiscal years 2009 and 2008, respectively. Shipping and handling costs for outbound and inbound shipping charges are included in cost of goods sold and were $4,645,000 and $4,732,000 in fiscal years 2009 and 2008, 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.

Advertising

The Company accounts for advertising expenses under Statement of Position (“SOP”) No. 93-7. Advertising costs are expensed when incurred and were $211,000 and $201,000 during fiscal years 2009 and 2008, 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.




33



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, 2009 and 2008 was $458,000 and $363,000, of which $18,000 and $13,000 was recognized in cost of goods sold and $440,000 and $350,000 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 years ended January 31, 2009 and 2008 and the resulting estimates of weighted-average fair value per share of options granted during those periods are as follows:

 

 

 

Jan. 31, 2009

 

Jan. 31, 2008

 

 

 

 

 

 

a) 

risk free interest rate

     

1.96%

     

4.17%

 

 

 

 

 

 

b)

expected volatility

 

110.41%

 

98.97%

 

 

 

 

 

 

c)

expected dividend yield

 

0.00%

 

0.00%

 

 

 

 

 

 

d)

estimated average life (in years)

 

4.47   

 

4.66   




34



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 $760,000 and $754,000 at January 31, 2009 and 2008, 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 $4,000 and $3,000 during 2009 and 2008, 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 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 Financial Accounting Standards Board (the “FASB”) issued FASB Statement No. 157, Fair Value Measures (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS 157 did not have a material impact on the Company’s results of operations or financial position.

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 adoption of SFAS 159 did not have a material impact on the Company’s results of operations or financial position.



35



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 adopted SFAS 141(R) in the first quarter of fiscal 2009 and will apply the provisions of this Statement for any acquisition after the adoption date. The adoption of SFAS 141(R) did not have a material impact on the Company’s results of operations or financial position.

In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities. This Statement significantly increases the disclosure requirements for derivative instruments. The new requirements include the location and fair value amounts of all derivatives by category reported in the consolidated balance sheet; the location and amount of gains or losses of all derivatives and designated hedged items by category reported in the consolidated income statement or in other comprehensive income in the consolidated balance sheet; and measures of volume such as notional amounts. For derivatives designated as hedges, the gains or losses must be divided into the effective portions and the ineffective portions. The Statement also requires the disclosure of group concentrations of credit risk by counterparties, including the maximum amount of loss due to credit risk and policies concerning collateral and master netting arrangements. Most disclosures are required on an interim and annual basis. The Company adopted this Statement effective the second quarter of fiscal year 2009. The adoption of this Statement did not have a material impact on the Company’s consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position (“FSP”) No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142. FSP FAS 142-3 requires a company estimating the useful life of a recognized intangible asset to consider its historical experience in renewing or extending similar arrangements or, in the absence of such experience, to consider assumptions that market participants would use about renewal or extension as adjusted for entity-specific factors. FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company does not anticipate the adoption of FSP FAS 142-3 will have a material effect on the Company’s financial position, results of operations or cash flows.

In October 2008, the FASB issued FSP FAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active (“FSP FAS 157-3”), which clarifies the application of SFAS No. 157, “Fair Value Measurements” in an inactive market. FSP FAS 157-3 addresses application issues such as how management’s internal assumptions should be considered when measuring fair value when relevant observable data do not exist; how observable market information in a market that is not active should be considered when measuring fair value and how the use of market quotes should be considered when assessing the relevance of observable and unobservable data available to measure fair value. FSP FAS 157-3 was effective upon issuance. The Company’s adoption of FSP FAS 157-3 did not have a material effect on the Company’s financial condition, results of operations or cash flows.



36



3.

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

 

 

2009

 

2008

Accounts receivable

     

 

 

     

 

 

Trade

 

$

2,744 

 

$

2,444 

Allowance for doubtful accounts

 

 

(45)

 

 

85)

 

 

$

2,699 

 

$

2,359 

 

 

 

 

 

 

 

Inventories

 

 

 

 

 

 

Raw materials

 

$

2,006 

 

$

1,714 

Finished goods

 

 

2,280 

 

 

1,452 

 

 

$

4,286 

 

$

3,166 

 

 

 

 

 

 

 

Accounts Payable and accrued liabilities

 

 

 

 

 

 

Accounts payable

 

 

 

 

 

 

Trade

 

$

1,031 

 

$

865 

Equipment and other

 

 

453 

 

 

155 

Accrued Liabilities

 

 

 

 

 

 

Payaroll

 

 

746 

 

 

614 

Other

 

 

456 

 

 

485 

 

 

$

2,686 

 

$

2,119 


4.

Property, Plant and Equipment

 

 

2009

 

2008

Property, plant and equipment                               

 

 

 

 

 

 

Land

     

$

1,547 

     

$

1,547 

Buildings

 

 

8,950 

 

 

8,759 

Leasehold improvements

 

 

— 

 

 

— 

Equipment

 

 

15,961 

 

 

15,164 

Construction in progress

 

 

1,189 

 

 

446 

 

 

$

27,647 

 

$

25,916 

Less: Accumulated depreciation

 

 

(8,037)

 

 

(6,254)

 

 

$

19,610 

 

$

19,662 


Depreciation expense from property, plant and equipment for the fiscal years ended January 31, 2009 and 2008 was $1,800,000 and $1,689,000, respectively.

The Company incurred interest costs of $315,000 and $415,000 during the fiscal years 2009 and 2008, respectively, of which $-0- and $30,000 was capitalized as part of the purchase and installation of manufacturing equipment during fiscal years 2009 and 2008, 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, 2009 and 2008 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 three customers who individually exceeded 10% of sales, who collectively accounted for 44% and 46% of total trade accounts receivable at January 31, 2009 and 2008, respectively, and who collectively accounted for 59% and 58% of total sales during the fiscal year ending January 31, 2009 and 2008, respectively.



37



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.

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, 2009, the Company had no borrowings outstanding under this line of credit.

8.

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

 

 

2009

 

2008

Tax-exempt bonds

     

$

6,664 

     

$

7,521 

Taxable bonds

 

 

— 

 

 

— 

Total debt

 

 

6,664 

 

 

7,521 

Less: current portion

 

 

(877)

 

 

(857)

Long-term debt

 

$

5,787 

 

$

6,664 

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 were $32,000. The bond is secured by the equipment financed. At January 31, 2009 and 2008 the balance outstanding was $1,240,000 and $1,441,000, 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, 2009) 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. The bond is secured by the property, building, and equipment financed. At January 31, 2009 and 2008, the balance outstanding was $3,300,000 and $3,800,000, 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, and matured in 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, 2009 and 2008, the balance outstanding was $2,124,000 and $2,280,000 on the tax-exempt bonds, respectively.



38



The aggregate principal maturities on long-term debt for each of the twelve-month periods subsequent to January 31, 2009 are as follows (in thousands of U.S. dollars):

 

 

Long-term
Debt

Fiscal Year ending January 31,:

 

 

 

2010

 

$

877 

2011

 

 

899 

2012

 

 

922 

2013

 

 

646 

2014

 

 

671 

Thereafter

 

 

2,649 

 

 

 

 

 

 

$

6,664 


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 both fiscal years 2009 and 2008, no common stock options were exercised.

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.



39



The following table summarizes the Company’s stock option activity for the years ended January 31, 2009 and 2008:

 

 

2009

 

2008

 

 

 

Shares

 

Weighted
Average
Price

 

Shares

 

Weighted
Average
Price

 

Outstanding – beginning of year

     

563,517 

     

$

3.95 

     

536,100 

     

$

4.17 

 

Granted

 

174,680 

 

 

3.55 

 

140,000 

 

 

3.71 

 

Exercised

 

— 

 

 

— 

 

— 

 

 

— 

 

Repurchased, surrendered or expired

 

(42,517)

 

 

(3.24)

 

(112,583)

 

 

(4.70)

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding – end of year

 

695,680 

 

$

3.89 

 

563,517 

 

$

3.95 

 

Vested

 

141,000 

 

$

3.95 

 

166,667 

 

$

3.58 

 

The following table summarizes information about options outstanding at January 31, 2009:

 

Range of
exercise
prices

 

Number
outstanding at
January 31,
2009

 

Weighted
average
remaining
contractual life
(months)

 

 

Outstanding
weighted
average
exercise price

 

Number
exercisable at
January 31,
2009

 

 

Exercisable
weighted
average
exercise price

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3.20 

     

100,000 

     

51 

     

$

3.20 

     

10,000 

     

$

3.20 

 

3.25 

 

40,000 

 

11 

 

 

3.25 

 

40,000 

 

 

3.25 

 

3.55 

 

174,680 

 

71 

 

 

3.55 

 

— 

 

 

— 

 

3.60 

 

100,000 

 

62 

 

 

3.60 

 

— 

 

 

— 

 

4.00 

 

40,000 

 

23 

 

 

4.00 

 

40,000 

 

 

4.00 

 

4.60 

 

141,000 

 

32 

 

 

4.60 

 

41,000 

 

 

4.60 

 

4.70 

 

100,000 

 

26 

 

 

4.70 

 

10,000 

 

 

4.70 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3.20 – 4.70 

 

695,680 

 

46 

 

$

3.89 

 

141,000 

 

$

3.95 


At January 31, 2009, the Company had 404,320 remaining Common Shares available to be granted under the 2003 Omnibus Plan.

There were outstanding options to purchase 7,000 Common Shares issued to individuals who are not employees or directors of the Company as of January 31, 2009.

Restricted stock units

The Company granted 75,120 and -0- restricted stock units (“RSUs”) to employees during the years ended January 31, 2009 and 2008, respectively. The RSUs have both a service and a performance condition that must be satisfied before vesting will occur. The fair value of these RSUs is based on the fair value of the Companies common stock on the award date and the probability of achieving the performance condition. The weighted average grant date fair value of the RSUs was -0- and -0- during the years ended January 31, 2009 and 2008, respectively.

During fiscal year 2009 -0- RSUs expired. The outstanding RSUs at January 31, 2009 and 2008 were 75,120 and -0-, respectively.

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 participant’s contribution up to 3% of a participant’s eligible compensation and 50% of each participant’s contribution over 3% up to a maximum of 5%. The Company’s contributions to the plan totalled $107,000 and $100,000 for the years ended January 31, 2009 and 2008, respectively.

11.

Related party transactions

General and administrative expenses for 2009 and 2008 included $81,000 and $82,000, respectively, each year for office rent and related services which were incurred on a cost reimbursement basis from a corporation owned and controlled by an officer and director of the Company. At January 31, 2009 and 2008, $5,000 and $6,000, respectively, were owing to this related party.



40



12.

Income taxes

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

 

2009

 

2008

 

 

 

 

 

 

U.S.

$

3,784 

     

$

3,253 

Canada

 

(130)

 

 

17 

 

$

3,654 

 

$

3,270 

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

 

2009

 

2008

 

 

 

 

 

 

U.S.

$

1,103 

     

$

877 

State

 

52 

 

 

49 

Canada

 

20 

 

 

26 

 

$

1,175 

 

$

952 

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

 

2009

 

2008

 

 

 

 

 

 

U.S.

$

339 

     

$

264 

State

 

(99)

 

 

38 

Canada

 

— 

 

 

— 

 

$

240 

 

$

302 

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):

 

 

2009

 

2008

 

 

 

            

 

 

            

Income tax at statutory rate (Canada)

     

$

1,128 

     

$

1,108 

Difference in foreign tax rate

 

 

118 

 

 

Permanent differences

 

 

10 

 

 

(1)

Stock option expense

 

 

151 

 

 

127 

Domestic production deduction

 

 

(64)

 

 

(54)

Change in valuation allowance

 

 

(333)

 

 

38 

Net operating losses expired

 

 

— 

 

 

57 

Change in tax rate

 

 

32 

 

 

115 

Effect from remeasurement from Canadian currency

 

 

300 

 

 

(258)

State and local , net

 

 

(18)

 

 

78 

Other differences

 

 

91 

 

 

41 

 

 

$

1,415 

 

$

1,254 

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):

 

 

2009

 

2008

Deferred income tax assets

     

 

            

     

 

            

Net operating loss carryforward

 

$

— 

 

$

26 

Intangibles

 

 

16 

 

 

20 

Non-deductible liabilities and other

 

 

172 

 

 

158 

State tax credits

 

 

168 

 

 

49 

Unrealized loss

 

 

35 

 

 

338 

Valuation allowance

 

 

(51)

 

 

(384)

 

 

$

340 

 

$

207 

Deferred income tax liabilities

 

 

 

 

 

 

Property, plant and equipment

 

 

(1,532)

 

 

(1,159)

 

 

$

(1,532)

 

$

(1,159)




41



The deferred state tax credits referenced above are job tax credits from Georgia which are available to offset Georgia taxable income in future years. These credits can be carried forward 10 years and begin expiring January 31, 2018.

The Company has recorded a valuation allowance against deferred tax assets which relates to uncertainties related to utilization of Canadian deferred tax assets. The valuation allowance decreased by $333,000 during the year ended January 31, 2009 and increased by $38,000 during the year ended January 31, 2008.

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 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):

 

 

2009

 

2008

Balance at beginning of year

 

$

         45 

     

$

         83 

Settlements

 

 

— 

 

 

-46 

Additions for tax positions of current period

 

 

70 

 

 

Additions for tax positions of prior periods

 

 

34 

 

 

 

 

$

149 

 

$

45 

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 2004. 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 has entered into various operating lease agreements for equipment that expire in 2010 to 2013. Rental expenses for the year ended January 31, 2009 and 2008 were $251,000 and $223,000, respectively. Minimum annual rental payments under non-cancellable operating leases are approximately $94,000, $67,000, $50,000 and $1,000 for the years ending January 31, 2010, 2011, 2012 and 2013, respectively.

Legal matters

The Company is subject to ordinary routine litigation incidental to the Company’s business. Currently, 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.

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 cleanup industry. Management decisions on resource allocation and performance assessment are made currently based on these two identifiable segments.



42



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)

 

 

2009

 

 

Animal
Care

 

Industrial

 

Consolidated

 

     

 

 

     

 

 

     

 

 

Sales, net

 

$

34,934 

 

$

818 

 

$

35,752 

Operating cost and expenses

 

 

29,246 

 

 

769 

 

 

30,015 

Operating income (loss) before depreciation
and amortization

 

 

5,688 

 

 

49 

 

 

5,737 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

 

 

 

 

 

 

(1,830)

Interest expense

 

 

 

 

 

 

 

 

(315)

Interest Income

 

 

 

 

 

 

 

 

62 

 

 

 

 

 

 

 

 

 

 

Net income before taxes

 

 

 

 

 

 

 

$

3,654 


 

 

2008

 

 

Animal
Care

 

Industrial

 

Consolidated

 

     

 

 

     

 

 

     

 

 

Sales, net

 

$

32,271 

 

$

824 

 

$

33,095 

Operating cost and expenses

 

 

26,944 

 

 

863 

 

 

27,807 

Operating income (loss) before depreciation
and amortization

 

 

5,327 

 

 

(39)

 

 

5,288 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

 

 

 

 

 

 

(1,719)

Interest expense

 

 

 

 

 

 

 

 

(385)

Interest Income

 

 

 

 

 

 

 

 

86 

 

 

 

 

 

 

 

 

 

 

Net income before taxes

 

 

 

 

 

 

 

$

3,270 


Sales revenues by geographic areas are as follows:

 

 

2009

 

2008

 

 

 

 

 

 

 

United States 

     

33,512 

     

31,280 

Canada

 

 

1,093 

 

 

948 

Other countries

 

 

1,147 

 

 

867 

 

 

$

35,752 

 

$

33,095 

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

 

 

2009

 

2008

 

 

 

 

 

 

 

Customer A

     

$

8,084 

     

$

7,843 

Customer B

 

 

9,329 

 

 

8,080 

Customer C

 

 

3,631 

 

 

3,102 

 

 

$

21,044 

 

$

19,025 






43



15.

Earnings per share

 

 

2009

 

 

Net Income
(numerator)

 

Shares
(denominator)

 

Per share
amount

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

     

 

 

     

 

 

     

 

 

Net income available to stockholders

 

$

2,239,000 

 

 

6,410,000 

 

$

0.35 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

Stock options to purchase common stock

 

 

— 

 

 

36,000 

 

 

 

Diluted earnings per shares

 

 

 

 

 

 

 

 

 

Net income available to stockholders

 

$

2,239,000 

 

 

6,446,000 

 

$

0.35 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2008

 

 

Net Income
(numerator)

 

Shares
(denominator)

 

Per share
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 

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:

 

 

2009

 

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

 

  555,680

 

  244,150

 

  536,100




44



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 2009 and 2008:

 

 

2009

 

 

Fourth
Quarter

 

Third
Quarter

 

Second
Quarter

 

First
Quarter

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales, net

     

$

8,390 

     

$

9,603 

     

$

9,298 

     

$

8,461 

Cost of goods sold

 

 

5,471 

 

 

6,352 

 

 

6,496 

 

 

5,951 

Gross Profit

 

 

2,919 

 

 

3,251 

 

 

2,802 

 

 

2,510 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

 

1,960 

 

 

1,990 

 

 

1,820 

 

 

1,805 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

 

959 

 

 

1,261 

 

 

982 

 

 

705 

Interest expense

 

 

(66)

 

 

(88)

 

 

(79)

 

 

(82)

Interest income

 

 

10 

 

 

24 

 

 

14 

 

 

14 

Income before provision for income taxes

 

 

903 

 

 

1,197 

 

 

917 

 

 

637 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax provision

 

 

(405)

 

 

(361)

 

 

(355)

 

 

(294)

Net income

 

$

498 

 

$

836 

 

$

562 

 

$

343 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

.08 

 

$

.13 

 

$

.09 

 

$

.05 

Fully diluted earnings per share

 

$

.08 

 

$

.13 

 

$

.09 

 

$

.05 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding
(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

6,410 

 

 

6,410 

 

 

6,410 

 

 

6,410 

Diluted

 

 

6,485 

 

 

6,446 

 

 

6,440 

 

 

6,467 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2008

 

 

Fourth
Quarter

 

Third
Quarter

 

Second
Quarter

 

First
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 




45



ITEM 9A(T).

CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our filings pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. 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. 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 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 United States generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the disposition of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary for preparation of our financial statements in accordance with generally accepted accounting principles; (iii) provide reasonable assurance that our receipts and expenditures are made only in accordance with authorizations of our management and board of directors; 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, 2009, based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of January 31, 2009.

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, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.




46



PART III

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

For information regarding our directors and executive officers see the sections titled “Proposal One - Election of Directors” and “Executive Officers of the Company” in our definitive Proxy Statement (“Proxy Statement”) for our Annual and Special Meeting of Shareholders to be held on June 10, 2009 (“Annual Meeting”), which information is incorporated herein by this reference.

For information regarding compliance with Section 16(a) of the Exchange Act see the section titled “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement, which information is incorporated herein by this reference.

For information regarding the code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, see the section titled “Code of Business Conduct and Ethics” 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.

ITEM 11.

EXECUTIVE COMPENSATION

For information regarding compensation of named executive officers and directors, see the section titled “Compensation of Named 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 regarding 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 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 regarding 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 regarding 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 ACCOUNTANT FEES AND SERVICES

For information regarding our principal accountant fees and services, see the section titled “Proposal Two - Ratification of Independent Auditors” in our Proxy Statement, which information is incorporated herein by this reference.




47



PART IV

ITEM 15.

EXHIBITS, AND 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 27

 

 

 

Consolidated Balance Sheets at January 31, 2009 and 2008

 

Page 28

 

 

 

Consolidated Statements of Income for the Fiscal Years ended January 31, 2009 and 2008

 

Page 29

 

 

 

Consolidated Statements of Changes In Stockholders’ Equity for the Fiscal Years ended
January 31, 2009 and 2008

 

Page 30

 

 

 

Consolidated Statements of Cash Flows for the Fiscal Years ending January 31, 2009 and 2008

 

Page 31

 

 

 

Notes to Consolidated Financial Statements, January 31, 2009 and 2008

 

Page 32

 

 

 


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 52 are filed or incorporated by reference as part of this Annual Report on Form 10-K.



48



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 29, 2009

Gordon L. Ellis

 

President and Chief Executive Officer

 

 

 

 

(Principal Executive Officer)

 

 

 

 

 

 

 

/s/ DAVID H. THOMPSON

 

Chief Financial Officer

 

April 29, 2009

David H. Thompson

 

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 29, 2009

Gordon L. Ellis

 

President and Chief Executive Officer

 

 

 

 

(Principal Executive Officer)

 

 

 

 

 

 

 

/s/ JOHN J. SUTHERLAND

 

Director

 

April 29, 2009

John J. Sutherland

 

 

 

 

 

 

 

 

 

/s/ DANIEL J. WHITTLE

 

Director

 

April 29, 2009

Daniel J. Whittle

 

 

 

 

 

 

 

 

 

/s/ LIONEL G. DODD

 

Director

 

April 29, 2009

Lionel G. Dodd

 

 

 

 

 

 

 

 

 

/s/ MICHAEL P. BENTLEY

 

Director

 

April 29, 2009

Michael P. Bentley

 

 

 

 

 

 

 

 

 

/s/ DAVID H. THOMPSON

 

Chief Financial Officer

 

April 29, 2009

David H. Thompson

 

Secretary

 

 

 

 

 (Principal Financial and Accounting Officer)

 

 




49





EXHIBIT INDEX

(Mark One)

ü

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

 

 ACT OF 1934

For the fiscal year ended: January 31, 2009

OR

 

 

 

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

 

 ACT OF 1934

For the transition period from: _____________ to _____________

Commission file number: 1-31642

INTERNATIONAL ABSORBENTS INC.

(Exact name of registrant as specified in its charter)

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

 

NYSE Amex LLC

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 þ

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 o   No þ

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.

Yesþ   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

£

Accelerated filer  

£

Non-accelerated filer  

£

Smaller reporting company  

þ

(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 ý

Aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of July 31, 2008, based upon the closing price of the common stock as reported by the American Stock Exchange on such date, was approximately $13,991,708.

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, 2009

Common Shares, no par value per share

 

6,410,282 shares


DOCUMENTS INCORPORATED BY REFERENCE


Document

 

Parts Into Which Incorporated

Portions of the Proxy Statement for the Annual General Meeting of Shareholders to be held on June 10, 2009

 

Part III


 

 



2



INTERNATIONAL ABSORBENTS INC.

Annual Report on Form 10-K

For the Fiscal Year Ended January 31, 2009

TABLE OF CONTENTS

Item

 

 

Page

Number

 

 

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

18

8.

 

Financial Statements and Supplementary Data

26

9A(T).

 

Controls and Procedures

46

 

PART III

 

10.

 

Directors, Executive Officers and Corporate Governance

47

11.

 

Executive Compensation

47

12.

 

Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters

47

 

 

 

 

13.

 

Certain Relationships and Related Transactions, and Director Independence

47

14.

 

Principal Accountant Fees and Services

47

 

PART IV

 

15.

 

Exhibits and Financial Statement Schedules

48

SIGNATURES

49

EXHIBIT INDEX

50

 

 

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

 




3



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 ongoing efforts to improve our infrastructure and production facilities;

·

the impact of the ongoing global economic downturn on our financial condition and ability to remain competitive;

·

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; 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 cleanup 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.

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



4



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 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 in an effort to maximize shareholder value.

Products

Our leading product is small animal bedding made from cellulose fiber. It is used as a substrate for rodents, rabbits, reptiles and hand-fed exotic birds instead of wood shavings, hardwood chips or corn cobs. We believe that our product is superior to traditional bedding materials because it is better able to control and contain animal waste 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™ and CareFRESH® 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®. We also distribute our small animal pet bedding under the brands Healthy Pet™ and Critter Care™ in the grocery and/or mass merchandiser distribution channels.

Our Healthy Pet™ brand of cat litters consists of a range of natural products 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.



5



We also 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 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 two major pet supply retailers and one major general merchandise retailer, which are our three 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 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.

Our industrial cleanup 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 cleanup 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 cleanup 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.



6



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 cleanup 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 several years 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, if and when enacted, 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. We do not yet have enough information to determine how the ongoing economic downturn will impact trends discussed below or how it may affect demand for our products or our ability to maintain our current pricing strategy.

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.



7



Raw Materials

Our animal care bedding, pet litter and industrial cleanup 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. Our 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 us with 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 by-products 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 diversity of raw material sources improves our ability to meet 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. However, as described below, we have in the past and may again 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. To date, 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 2009 we increased our investment in sales and marketing in an effort to increase distribution efficiencies, increase market share and launch new products, such as CareFRESH Confetti™ and Advanced Odor Control™.

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, Greece, France, 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 cleanup 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 $5,000 and $10,000 during fiscal years 2009 and 2008, respectively.

Intellectual Property

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 our issued patent, our competitors will have the ability to develop products that are currently protected by these patents.

Absorption has been issued three U.S. patents, of which one remains current and two have expired, and has one pending patent relating to various degradable particulate absorbent materials and our manufacturing process.

Number of Employees

As of March 2009, we had 135 employees, of which 130 were full-time employees and none of which were 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 in the foreseeable future. As a result, we believe that we are able to manage the design process and help minimize product liability risks. In addition we employ engineers and designers to design and test our products under development and maintain a quality control system in an ongoing effort to decrease defects in our products.



8



Environmental and Other Governmental Regulations

We are subject to environmental laws and regulations governing emissions into the air; discharges into the water; and 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, filed or furnished 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.




9



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 continue to work to build 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.

A decline in consumer spending or a change in consumer preferences, resulting from the downturn in the global economy or otherwise, could reduce our sales or profitability and harm our business.

 

Our sales depend on consumer spending, which is influenced by factors beyond our control, including general economic conditions, the availability of discretionary income and credit, weather, consumer confidence and unemployment levels. The global economy is experiencing an ongoing downturn, which may continue for a significant period of time. As a result, there may be decreased customer traffic at our major customer’s stores, and we may experience declines in sales, pressure to lower prices and/or changes in the types of products sold.

Any material decline in the amount of consumer spending could reduce our sales. In addition, our premium products are generally priced higher than our competitors’ products, and in an economic downturn, consumers may elect to purchase lower-priced products. This could further reduce our sales and/or force us to lower our prices, which could reduce profitability, and, in each case, harm our business. The success of our business depends in part on our ability to identify and respond to evolving trends in demographics and consumer preferences. Failure to timely identify or effectively respond to changing consumer tastes, preferences, spending patterns and animal care needs could adversely affect our relationship with our customers, the demand for our products and services, our market share and our profitability.

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

Our three largest customers accounted for approximately 26%, 23% and 10% of our net sales in fiscal year 2009, while the same customers accounted for approximately 24%, 24% and 9%, respectively, of our net sales in fiscal year 2008. We are dependent on these customers to maintain our financial condition and to generate forecasted operating results.

Any material deterioration in the financial condition of one of our major customers could have a material adverse effect on our sales, profitability and cash flow. 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. These risks are heightened as a result of the ongoing global economic downturn. For example, some customers such as Petsmart are projecting a modest rate of growth and others, such as Petcetera have recently declared bankruptcy,

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

With the ongoing 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.



10



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 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.

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. 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, at times during fiscal year 2009, we experienced exceedingly high transportation expenses. When these costs are high they 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.

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; and generation, handling, storage, transportation, treatment, and disposal of waste materials. Environmental regulations may affect us by restricting the manufacturing or use of our products or regulating their disposal. We are also subject to other federal and state laws and regulations regarding health and safety matters.



11



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, 2009, we had total long-term and current indebtedness under three different bonds of $6,664,000. We make interest payments (and principal payments on the taxable bond) on the indebtedness under these bonds, which are due in 2014, 2019, and 2019. 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 a timely manner to the ongoing global 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 can be no assurance 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 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. Additionally our letter of credit on our Georgia bond financing expires in September 2011 and there can be no assurance we will be able to renew it. If the letter of credit is not renewed we will be required to pay off the bonds in full.

We will continue to incur substantial costs in connection with the requirements of the Sarbanes-Oxley Act of 2002.

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. Based on the requirements in effect as of the date of this Annual Report, at the end of fiscal year 2010 our auditors will be required to issue a report on our internal control over financial reporting for inclusion in our Annual Report on Form 10-K for the fiscal year ending January 31, 2010. We expect that the costs to comply with these requirements will continue to be significant and adversely affect our operating results.

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 that required 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. As we continue our ongoing review and analysis of internal control over financial reporting for compliance with the Act, we may encounter problems or delays in completing the review and evaluation and implementing improvements. Additionally, we may identify deficiencies that need to be addressed in our internal control over financial reporting or other matters that may raise concerns for investors. Should we, or our independent registered public accounting firm, determine in future periods that we have significant deficiencies or material weaknesses in our internal control over financial reporting, or if we are unable to receive a positive attestation from our independent auditors, our results of operations or financial condition may be adversely



12



affected, investors may lose confidence in the reliability of our financial statements and the price of our common stock may decline.

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, and current volatility and disruption to the global capital and credit markets may adversely affect our ability to access credit.

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, 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. Moreover, our current line of credit matures on May 23, 2009 and there can be no assurance that it will be renewed.

Financial turmoil affecting the banking system and financial markets and the risk that additional financial institutions may consolidate or become insolvent has resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and volatility in credit, currency and equity markets. In such an environment, there is a risk that lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments, including but not limited to: extending credit up to the maximum permitted by credit facility, renewing existing credit facilities and/or honoring loan commitments. If our lender fails to honor its legal commitments under our line of credit, or if we are unable to renew our credit facility on favorable terms or at all, it could be difficult in this environment to replace our credit facility on similar terms. 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 include 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 bonds and bank debt financing restrict our ability to, among other things, incur 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 believe that we are currently 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 move into 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 one remains current and two have expired, 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.



13



Issued patents may be subject to challenges and infringements. Moreover, upon expiration of our current patent other parties may be able to develop products that are currently protected by this patent, 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.

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 financial results 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 financial results. 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. For example, the calculation of share-based compensation expense 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



14



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. 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 NYSE Amex LLC.

In March 2003, we received official notice from the American Stock Exchange (now NYSE Amex LLC) 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 NYSE Amex LLC listing standards, including standards related to stock price, market capitalization and corporate governance. If we are unable to do so, NYSE Amex LLC 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.



15



ITEM 2.

PROPERTIES

Ferndale, Washington

On October 18, 2002, we purchased for cash approximately 15.6 acres of bare land in Ferndale, Washington. The total purchase price of the land was $1,500,000, plus closing costs, which was determined through arms-length negotiations.

During 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. 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 in Note 8 (“Long-term debt”) to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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 Note 8 (“Long-term debt”) to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K 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 the foreseeable 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 $6,664,000 as of January 31, 2009.

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 2009 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 listed on NYSE Amex LLC (formerly AMEX), under the trading symbol IAX. Shown below are the high and low sale prices for our common shares for the periods indicated below as reported by NYSE Amex LLC and AMEX. The following quotations, as provided by the NYSE Amex LLC and AMEX represent prices between dealers and do not include retail markup, markdown or commission. In addition, these quotations may not represent actual transactions.

 

 

FISCAL YEAR

2009

 

FISCAL YEAR

2008

 

 

HIGH

 

LOW

 

HIGH

 

LOW

 

 

 

 

 

 

 

 

 

First quarter

     

4.99

     

3.62

     

5.42

 

3.84

Second quarter

 

4.98

 

2.75

 

6.50

 

4.19

Third quarter

 

3.65

 

2.09

 

6.68

 

3.47

Fourth quarter

 

4.80

 

1.66

 

4.00

 

3.20

Holders

We had 438 holders of record of our Common Shares as of April 16, 2009.

Dividends

We have not 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 remain 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 primarily to finance the continuing growth of our business and as such do not have any current plans to pay dividends.

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 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 Annual Report on Form 10-K.

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 cleanup 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 2009 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 2009 we were meeting expectations for improvements in gross profits, which we believe improved as a result of our ongoing plan to maximize the efficiencies of the manufacturing capital investments we have made during the past several years. Selling, general and administrative expenses grew as expected as investments were made in the development of new product lines and market channels.

During fiscal year 2009, we continued 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 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. To date our sales growth has come from our small animal bedding products and not from our cat litter products.



18



Results of Operations

The following table illustrates our financial results for fiscal year 2009 as compared to the prior fiscal year. (U.S. dollars, in thousands):

 

 

January 31,
2009

 

Percent of
Sales

 

January 31,
2008

 

Percent of
Sales

 

Percentage
Change

Sales

     

 

35,752 

     

 

100%

     

 

33,095 

     

 

100%

     

 

8%

Cost of goods sold

 

 

24,270 

 

 

68%

 

 

23,139 

 

 

70%

 

 

5%

Gross profit

 

 

11,482 

 

 

32%

 

 

9,956 

 

 

30%

 

 

15%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling general and
administrative expenses

 

 

7,575 

 

 

21%

 

 

6,387 

 

 

19%

 

 

19%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

 

3,907 

 

 

11%

 

 

3,569 

 

 

11%

 

 

9%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

62 

 

 

0%

 

 

86 

 

 

0%

 

 

-28%

Interest expense

 

 

(315)

 

 

-1%

 

 

(385)

 

 

-1%

 

 

-18%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Profit before taxes

 

 

3,654 

 

 

10%

 

 

3,270 

 

 

10%

 

 

12%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income taxes

 

 

(1,415)

 

 

-4%

 

 

(1,254)

 

 

-4%

 

 

13%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

2,239 

 

 

6%

 

 

2,016 

 

 

6%

 

 

11%

Net Sales

In fiscal year 2009, our net sales increased by 8% over fiscal year 2008. All of the growth in net sales was a result of the growth in sales of our animal care products. During fiscal year 2009, net sales for animal care products grew from $32,271,000 to $34,934,000, as compared to fiscal year 2008. Net sales of our industrial cleanup products decreased from $824,000 in fiscal year 2008 to $818,000 in fiscal year 2009. We had strong growth with all of our bedding products, including CareFRESH®, CareFRESH® Ultra™, and CareFRESH® Colors products. Our strategy with regard to our industrial cleanup products has remained the same, which is to effectively service existing customers while focusing growth on animal care products.

We are uncertain how current economic conditions will affect our sales during fiscal year 2010. Some customers such as Petsmart are projecting a modest rate of growth and some, such as Petcetera have recently declared bankruptcy. The net result is that we believe that our overall annual net sales will be in the range of growing by approximately 5% to decreasing by approximately 5% over our fiscal year 2009 net sales levels. Specifically, during fiscal year 2010, we expect sales of natural, non-colored CareFRESH® in pet specialty channels to remain flat to slightly down over sales levels from fiscal year 2009. As a result of promotional activity on the retail level, we expect to see modest sales growth in CareFRESH Ultra™ and CareFRESH® Colors. We anticipate that natural CareFRESH® will continue to represent the majority of our sales through the 2010 fiscal year. We also see growth opportunities for our full line of bedding products and believe they will continue to gain market share and growing customer acceptance. However, 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. Also, 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. Further, the global economic downturn has resulted in lower than expected sales growth of our products, as a result of decreased consumer spending and reduced customer traffic at our major customers’ stores. With respect to our lines of cat litter products, subject to the considerations described above, we expect revenue growth to be flat during the coming fiscal year.

Gross Profit

As fiscal year 2009 came to an end, both of our production facilities were operating at efficiency levels that are at or near the pre-construction expectations of management. Nonetheless, during the year, our production facilities faced challenges that directly affected their production costs. These challenges included increased energy costs during the first half of the year, materials cost increases, ongoing maintenance costs associated with achieving a high rate of product quality and production efficiencies, and high freight cost during the first half of the year. There was also increased depreciation during the entire year as a result of our capital expansion program. Even in light of these additional cost, we were able to improve our gross margin (gross profit divided by sales) from 30% in fiscal year 2008 to 32% in fiscal year 2009.



19



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 7% in fiscal year 2009 as compared to fiscal year 2008.

For fiscal year 2010 we continue to expect that our gross margin will remain in the range of 31% to 36%. The reasons for this expectation are as follows. First, even though fuel and energy cost are currently at relative lows, economic conditions may not allow us to increase prices if they were to rise. 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 and uncertain reactions from raw material suppliers in response to our request for additional supplies; 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, any slowdown in sales could result in increased production costs on a per unit basis due to a loss of efficiencies gained from higher production rates.

We plan to continue to make capital investments in infrastructure and technology at all of our facilities to help decrease the costs of production.

Selling, General and Administrative and Expenses

During fiscal year 2009, our selling, general and administrative expenses increased by 19% as compared to fiscal year 2008. This increase was the result of investments we made in the creation and launch of our “new product development” division, additional personnel we hired to upgrade performance levels, expenses related to general sales and marketing programs, and increased costs resulting from our compliance with requirements of the SEC and the NYSE Amex, LLC.  Moreover, we now have overhead expenses related to operating our Georgia facility, increased property taxes, and increased depreciation expense.

We anticipate that investments in sales and marketing programs and new product development costs, along with our stock-based compensation expenses and growing public company reporting expenses, will continue to increase selling, general and administrative expenses during fiscal year 2010, though not at the rate at which they increased during the current fiscal year. During fiscal year 2010, we intend to continue our marketing and new product development initiatives. 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 completed our program of rounding out our sales staff during fiscal year 2009 and do not at this time anticipate adding any additional sales personnel during fiscal year 2010. We feel that the 2010 sales 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 NYSE 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 2009 totaled $315,000 as compared to $385,000 during fiscal year 2008. This decrease was due to a reduction in the variable interest rate we pay on the bonds that were used to finance the Jesup, Georgia facility and the reduction in principal amounts as we pay off our bonds according to their terms. 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 2010 as the principal portion of our existing debt is paid down. This projection assumes that variable interest rates will remain low during fiscal the year 2010.

Income Tax

Absorption incurred federal income taxes during fiscal year 2009 at an effective rate of 38%. The effective rate is consistent with the rate incurred during fiscal year 2008 (of 38%). 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. Deferred income tax assets in International Absorbents have been fully reserved through the recording of a valuation allowance as Canadian deferred tax assets are not expected to be utilized in future periods.

Net Income

Our net income for the year ended January 31, 2009 increased by 8% 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 improved gross profits. 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 remain profitable even if our sales were to slightly decrease during fiscal year 2010.



20



Our focus during fiscal year 2010 will be to maintain current sales levels through the ongoing global economic downturn, and minimize the growth of our selling general and administrative costs while targeting an improved gross profit margin. Our biggest challenges for the coming fiscal year will be maintaining existing sales levels as the buying habits of retail customers continue to change, continuing the improvement of our gross margin, and maintaining selling, general and administrative expenses at levels that create opportunities for future growth. 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 existing levels of depreciation resulting from our investment in plant and equipment will negatively affect our fiscal year 2010 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 2010, though not at the rate at which fiscal year 2009 increased over fiscal year 2008.

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 8% during fiscal year 2009 as compared to fiscal year 2008. The increase for fiscal year 2009 was substantially the result of increased sales and an improved gross margin.

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 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

 

 

 

 

 

 

January 31,
2009

 

January 31,
2008

 

 

Percentage
Change

 

(U.S. dollars in thousands)

 

 

                 

 

 

                 

 

 

                 

 

Net Income (as reported on Condensed Consolidated
Statement of Operations)

     

$

2,239 

     

$

2,016 

     

 

 

 

Interest expense

 

 

315 

 

 

385 

 

 

 

 

Interest income

 

 

(62)

 

 

(86)

 

 

 

 

Income tax provision

 

 

1,415 

 

 

1,254 

 

 

 

 

Depreciation & amortization

 

 

1,830 

 

 

1,719 

 

 

 

 

EBITDA

 

$

5,737 

 

$

5,288 

 

 

8%

 

During fiscal year 2010, management will continue to focus on EBITDA as a key performance indicator.

Liquidity and Capital Resources

During fiscal year 2009 we focused on improving the production efficiencies at both of our plants. Our improved gross margin in the last half of fiscal year 2009 was the result of both the success we had in improving production efficiencies and the reduction in energy and transportation costs. We believe that the improvement in our production facilities will help provide a solid return on the investments we have made in capital expansion over the past several years.



21



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,
2009

 

As of
January 31,
2008

 

Financial Condition

 

 

 

 

 

 

 

Total Assets

     

$

31,281

     

$

28,589

 

Total Liabilities

 

 

10,895

 

 

10,900

 

Total Equity

 

$

20,386

 

$

17,689

 

 

 

 

 

 

 

 

 

Debt/equity ratio

 

 

0.53

 

 

0.62

 

Assets/debt ratio

 

 

2.87

 

 

2.62

 

 

 

 

 

 

 

 

 

Working Capital

 

 

 

 

 

 

 

Current assets

 

$

11,465

 

$

8,691

 

Current liabilities

 

$

3,595

 

$

3,080

 

 

 

 

 

 

 

 

 

Current ratio

 

 

3.19

 

 

2.82

 

 

 

 

 

 

 

 

 

Cash Position

 

 

 

 

 

 

 

Cash, restricted cash & short term investments                     

 

$

4,146

 

$

2,809

 

Cash generated from operations

 

$

3,644

 

$

3,571

 

Financial Condition

During fiscal year 2009, the value of our total assets increased. This was primarily the result of an increase in current assets, which resulted from growing operational activities. As an example, both accounts receivable and inventories increased as a result of growing sales and cash position improved as a result of increased profits, in both cases offset by limited capital investments. We also had a decrease 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 2010 will come from meeting the covenants included in our debt facilities and the marketability of tax exempt industrial revenue bonds. As of the end of fiscal year 2009 we were over minimum financial requirements and under maximum requirements included in these covenants. The covenant-related ratios that we believe pose the most significant risk in the future are those based on cash flow. Any significant decrease in our cash flow could result in the breach of one or more of these loan covenants. If we fail to satisfy the financial covenants or other requirements contained in our debt facilities, our debts could become immediately payable at a time when we are unable to pay them, which would 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.

The marketability of tax exempt industrial revenue bonds is a potential industry-wide issue, and is not related to our liquidity or results from operations. The industrial revenue bonds for our Jesup, Georgia facility are remarketed and the industrial revenue bonds for our Ferndale, Washington facility are held by GE Capital Public Finance, Inc. If the industrial revenue bonds that are remarketed were not able to be sold, due to a market failure, according to the terms of the bond agreement, we would likely have to pay off the outstanding balance, which is currently $3,300,000.

Debt retirement is an alternative that we consider on an ongoing basis. Relevant factors in our analysis include the availability and cost of equity and the rate of interest on our debt. Our long-term debt has been at very favorable rates such that we believe it was and continues to be advantageous to use our existing capital for other applications. At this time, we do not intend to raise additional equity capital in the near term.



22



Working Capital

During fiscal year 2009, our working capital position continued to improve as current assets increased and current liabilities decreased. The majority of the increase in current assets was the result of increased cash used to fund our growing operations and an increase in inventories. Current liabilities decreased primarily due to decreases in accounts payable. These changes resulted in our current ratio (current assets divided by current liabilities) increasing from 2.82 at the end of fiscal year 2008 to 3.19 at the end of fiscal year 2009.

In fiscal year 2010 we expect that if sales are at projected our current assets will continue to increase as a result of positive cash flow and an increase in accounts receivable and inventories, if 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 increased during fiscal year 2009, primarily as a result of cash generated from operations. We expect cash on hand to increase during fiscal year 2010, 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 we anticipate should provide enough collateral to support the related debt. Interest is payable on funds advanced at the LIBOR rate plus 2.5%. The line of credit matures on May 23, 2009 and we expect it to be renewed. If the current conditions in the credit markets prevent us from renewing the existing line of credit, we may be able to obtain a new line of credit through a Canadian bank, due to the location of International Absorbents. As of January 31, 2009, no borrowings were outstanding under the line of credit. If we do borrow against this line of credit and it is renewed, we intend to pay it off before the end of fiscal year 2010. 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 2009 we generated $3,644,000 in cash from operating activities. The cash generated during fiscal year 2009 was a 2% increase over the $3,571,000 in cash generated during fiscal year 2008. 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 2010, although it cannot be assured that this will be the case.

Financing and Investing Activities

Cash used for financing activities during fiscal year 2009 was $857,000. This was the result of principal payments made on our long-term debt. Cash used in investing activities during fiscal year 2009 was approximately $1,450,000.  This cash was used for the acquisition of fixed assets. A portion of these assets were production-related items that were replaced as part of our ongoing maintenance program. We also made several investments during fiscal year 2009 to reduce costs and improve efficiencies in the areas of fiber recovery, energy use, and product handling.

We believe that for the near future we will not need to use cash to invest in significant capital improvements. We will continue to use cash to fully maintain our existing facilities and to make improvements which we expect will increase production efficiencies and reduce manufacturing costs.

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.



23



Critical Accounting Policies

Introduction

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, sales incentives and stock based compensation.  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 to 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 changes 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 overestimated. 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.



24



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 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 Emerging Issues Task Force (“EITF”) Issue No. 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 Financial Accounting Standards Board (“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

Effective February 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) Share-Based Payment (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 do not expect to change our methodology for calculating stock-based compensation in the future.



25



ITEM 8.

FINANCIAL STATEMENTS

INDEX


 

     

 

Report of Independent Registered Public Accounting Firm

 

Page 27

 

 

 

Consolidated Balance Sheets at January 31, 2009 and 2008

 

Page 28

 

 

 

Consolidated Statements of Income for the Fiscal Years ended January 31, 2009 and 2008

 

Page 29

 

 

 

Consolidated Statements of Changes In Stockholders’ Equity for the Fiscal Years ended
January 31, 2009 and 2008

 

Page 30

 

 

 

Consolidated Statements of Cash Flows for the Fiscal Years ending January 31, 2009 and 2008

 

Page 31

 

 

 

Notes to Consolidated Financial Statements, January 31, 2009 and 2008

 

Page 32

 

 

 





26



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, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the 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, 2009 and 2008, 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 Notes 2 and 5 to the consolidated financial statements, effective February 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements.

/s/ Moss Adams LLP

Seattle, Washington

April 28, 2009



27



International Absorbents Inc. and Subsidiary

Consolidated Balance Sheets

As at January 31, 2009 and 2008

(in thousands of U.S. dollars)

 

 

2009

 

2008

 

 

 

 

 

 

 

Assets

     

 

 

     

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

4,146 

 

$

2,809 

Accounts receivable, net

 

 

2,699 

 

 

2,359 

Inventories, net

 

 

4,286 

 

 

3,166 

Prepaid expenses

 

 

162 

 

 

155 

Income taxes receivable

 

 

— 

 

 

44 

Deferred income tax asset

 

 

172 

 

 

158 

Total current assets

 

 

11,465 

 

 

8,691 

 

 

 

 

 

 

 

Property, plant and equipment, net

 

 

19,610 

 

 

19,662 

Other assets, net

 

 

206 

 

 

236 

Total assets

 

$

31,281 

 

$

28,589 

 

 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

2,686 

 

$

2,119 

Related party payable

 

 

 

 

Current portion of long-term debt

 

 

877 

 

 

857 

Income taxes payable

 

 

27 

 

 

98 

Total current liabilities

 

 

3,595 

 

 

3,080 

 

 

 

 

 

 

 

Deferred income tax liability

 

 

1,364 

 

 

1,110 

Long-term debt

 

 

5,787 

 

 

6,664 

Other long term liabilities

 

 

149 

 

 

46 

Total liabilities

 

 

10,895 

 

 

10,900 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock, no par value - Unlimited shares authorized,
6,410,282 and 6,410,328 issued and outstanding at

 

 

 

 

 

 

January 31, 2009 and 2008, respectively

 

 

8,487 

 

 

8,487 

Additional paid in capital

 

 

1,823 

 

 

1,365 

Retained earnings

 

 

10,076 

 

 

7,837 

Total stockholders' equity

 

 

20,386 

 

 

17,689 

Total liabilities and stockholders' equity

 

$

31,281 

 

$

28,589 




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


28



International Absorbents, Inc. and Subsidiary

Consolidated Statements of Income

For the years ended January 31, 2009 and 2008

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

 

 

2009

 

2008

 

 

 

 

 

 

 

Sales, net

     

$

35,752 

     

$

33,095 

Cost of goods sold

 

 

24,270 

 

 

23,139 

Gross Profit

 

 

11,482 

 

 

9,956 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

 

7,575 

 

 

6,387 

 

 

 

 

 

 

 

Income from operations

 

 

3,907 

 

 

3,569 

Interest expense

 

 

(315)

 

 

(385)

Interest income

 

 

62 

 

 

86 

Income before provision for income taxes

 

 

3,654 

 

 

3,270 

 

 

 

 

 

 

 

Income tax provision

 

 

(1,415)

 

 

(1,254)

Net income

 

$

2,239 

 

$

2,016 

 

 

 

 

 

 

 

Basic earnings per share

 

$

.35 

 

$

.31 

Fully diluted earnings per share

 

$

.35 

 

$

.31 

 

 

 

 

 

 

 

Weighted average number of shares outstanding
(in thousands)

 

 

 

 

 

 

Basic

 

 

6,410 

 

 

6,410 

Diluted

 

 

6,446 

 

 

6,477 





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


29



International Absorbents Inc. and Subsidiary

Consolidated Statement of Changes in Stockholders’ Equity

For the years ended January 31, 2009 and 2008

(in thousands of U.S. dollars)

 

 

Common
Shares

 

Amount

 

Additional
Paid in
Capital

 

Retained
Earnings

 

Total
Stockholders'
Equity

 

 

(in 1,000's)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 

Stock based compensation

 

— 

 

 

— 

 

 

458 

 

 

— 

 

 

458 

Net income

 

— 

 

 

— 

 

 

— 

 

 

2,239 

 

 

2,239 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of January 31, 2009

 

6,410 

 

$

8,487 

 

$

1,823 

 

$

10,076 

 

$

20,386 






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


30



International Absorbents Inc. and Subsidiary

Consolidated Statement of Cash Flows

For the years ended January 31, 2009 and 2008

(in thousands of U.S. dollars)

 

 

2009

 

2008

 

 

 

 

 

 

 

Cash flows from operating activities

     

 

 

     

 

 

 

 

 

 

 

 

 

Net income

 

$

2,239 

 

$

2,016 

Adjustments to reconcile net income to net cash
used for operating activities

 

 

 

 

 

 

Depreciation and amortization

 

 

1,830 

 

 

1,719 

Loss on disposal of equipment

 

 

 

 

167 

Stock-based compensation

 

 

458 

 

 

366 

Deferred taxes

 

 

240 

 

 

303 

Changes in operating assets and liabilities

 

 

 

 

 

 

Accounts receivable

 

 

(340)

 

 

14 

Inventory

 

 

(1,120)

 

 

55 

Prepaid expenses

 

 

(7)

 

 

(29)

Accounts payable and accrued liabilities

 

 

268 

 

 

(856)

Income taxes receivable/payable

 

 

(27)

 

 

(148)

Due to related party

 

 

(1)

 

 

Other long term liabilities

 

 

103 

 

 

(37)

Net cash flows from operating activities

 

 

3,644 

 

 

3,571 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

Purchase of property, plant and equipment

 

 

(1,450)

 

 

(3,380)

Proceeds from restricted cash

 

 

— 

 

 

1,146 

Net cash flows from investing activities

 

 

(1,450)

 

 

(2,234)

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

Repayment of long-term debt

 

 

(857)

 

 

(805)

Net cash flows from financing activities

 

 

(857)

 

 

(805)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change in cash

 

 

1,337 

 

 

532 

 

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

 

2,809 

 

 

2,277 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

4,146 

 

$

2,809 

 

 

 

 

 

 

 

Cash paid for interest (net of amounts capitalized)

 

$

321 

 

$

394 

 

 

 

 

 

 

 

Cash paid for income taxes

 

$

1,099 

 

$

1,128 

 

 

 

 

 

 

 

Non-cash investing activities

 

 

 

 

 

 

Increase in property, plant and equipment and accounts
payable for purchase of plant and equipment

 

$

454 

 

$

154 






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


31



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 fiscal year 2009. 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.

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, 2009 and 2008, management considered all accounts receivable in excess of the allowances for doubtful accounts to be fully collectible.

Inventories

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.



32



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, 2009 and 2008, the deferred financing fees were $206,000 and $236,000, respectively, which are net of accumulated amortization of $138,000 and $108,000, respectively. Amortization expense was $30,000 and $30,000 for the years ended January 31, 2009 and 2008, 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 $433,000 and $458,000 in fiscal years 2009 and 2008, respectively. Shipping and handling costs for outbound and inbound shipping charges are included in cost of goods sold and were $4,645,000 and $4,732,000 in fiscal years 2009 and 2008, 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.

Advertising

The Company accounts for advertising expenses under Statement of Position (“SOP”) No. 93-7. Advertising costs are expensed when incurred and were $211,000 and $201,000 during fiscal years 2009 and 2008, 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.




33



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, 2009 and 2008 was $458,000 and $363,000, of which $18,000 and $13,000 was recognized in cost of goods sold and $440,000 and $350,000 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 years ended January 31, 2009 and 2008 and the resulting estimates of weighted-average fair value per share of options granted during those periods are as follows:

 

 

 

Jan. 31, 2009

 

Jan. 31, 2008

 

 

 

 

 

 

a) 

risk free interest rate

     

1.96%

     

4.17%

 

 

 

 

 

 

b)

expected volatility

 

110.41%

 

98.97%

 

 

 

 

 

 

c)

expected dividend yield

 

0.00%

 

0.00%

 

 

 

 

 

 

d)

estimated average life (in years)

 

4.47   

 

4.66   




34



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 $760,000 and $754,000 at January 31, 2009 and 2008, 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 $4,000 and $3,000 during 2009 and 2008, 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 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 Financial Accounting Standards Board (the “FASB”) issued FASB Statement No. 157, Fair Value Measures (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS 157 did not have a material impact on the Company’s results of operations or financial position.

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 adoption of SFAS 159 did not have a material impact on the Company’s results of operations or financial position.



35



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 adopted SFAS 141(R) in the first quarter of fiscal 2009 and will apply the provisions of this Statement for any acquisition after the adoption date. The adoption of SFAS 141(R) did not have a material impact on the Company’s results of operations or financial position.

In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities. This Statement significantly increases the disclosure requirements for derivative instruments. The new requirements include the location and fair value amounts of all derivatives by category reported in the consolidated balance sheet; the location and amount of gains or losses of all derivatives and designated hedged items by category reported in the consolidated income statement or in other comprehensive income in the consolidated balance sheet; and measures of volume such as notional amounts. For derivatives designated as hedges, the gains or losses must be divided into the effective portions and the ineffective portions. The Statement also requires the disclosure of group concentrations of credit risk by counterparties, including the maximum amount of loss due to credit risk and policies concerning collateral and master netting arrangements. Most disclosures are required on an interim and annual basis. The Company adopted this Statement effective the second quarter of fiscal year 2009. The adoption of this Statement did not have a material impact on the Company’s consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position (“FSP”) No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142. FSP FAS 142-3 requires a company estimating the useful life of a recognized intangible asset to consider its historical experience in renewing or extending similar arrangements or, in the absence of such experience, to consider assumptions that market participants would use about renewal or extension as adjusted for entity-specific factors. FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company does not anticipate the adoption of FSP FAS 142-3 will have a material effect on the Company’s financial position, results of operations or cash flows.

In October 2008, the FASB issued FSP FAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active (“FSP FAS 157-3”), which clarifies the application of SFAS No. 157, “Fair Value Measurements” in an inactive market. FSP FAS 157-3 addresses application issues such as how management’s internal assumptions should be considered when measuring fair value when relevant observable data do not exist; how observable market information in a market that is not active should be considered when measuring fair value and how the use of market quotes should be considered when assessing the relevance of observable and unobservable data available to measure fair value. FSP FAS 157-3 was effective upon issuance. The Company’s adoption of FSP FAS 157-3 did not have a material effect on the Company’s financial condition, results of operations or cash flows.



36



3.

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

 

 

2009

 

2008

Accounts receivable

     

 

 

     

 

 

Trade

 

$

2,744 

 

$

2,444 

Allowance for doubtful accounts

 

 

(45)

 

 

85)

 

 

$

2,699 

 

$

2,359 

 

 

 

 

 

 

 

Inventories

 

 

 

 

 

 

Raw materials

 

$

2,006 

 

$

1,714 

Finished goods

 

 

2,280 

 

 

1,452 

 

 

$

4,286 

 

$

3,166 

 

 

 

 

 

 

 

Accounts Payable and accrued liabilities

 

 

 

 

 

 

Accounts payable

 

 

 

 

 

 

Trade

 

$

1,031 

 

$

865 

Equipment and other

 

 

453 

 

 

155 

Accrued Liabilities

 

 

 

 

 

 

Payaroll

 

 

746 

 

 

614 

Other

 

 

456 

 

 

485 

 

 

$

2,686 

 

$

2,119 


4.

Property, Plant and Equipment

 

 

2009

 

2008

Property, plant and equipment                               

 

 

 

 

 

 

Land

     

$

1,547 

     

$

1,547 

Buildings

 

 

8,950 

 

 

8,759 

Leasehold improvements

 

 

— 

 

 

— 

Equipment

 

 

15,961 

 

 

15,164 

Construction in progress

 

 

1,189 

 

 

446 

 

 

$

27,647 

 

$

25,916 

Less: Accumulated depreciation

 

 

(8,037)

 

 

(6,254)

 

 

$

19,610 

 

$

19,662 


Depreciation expense from property, plant and equipment for the fiscal years ended January 31, 2009 and 2008 was $1,800,000 and $1,689,000, respectively.

The Company incurred interest costs of $315,000 and $415,000 during the fiscal years 2009 and 2008, respectively, of which $-0- and $30,000 was capitalized as part of the purchase and installation of manufacturing equipment during fiscal years 2009 and 2008, 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, 2009 and 2008 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 three customers who individually exceeded 10% of sales, who collectively accounted for 44% and 46% of total trade accounts receivable at January 31, 2009 and 2008, respectively, and who collectively accounted for 59% and 58% of total sales during the fiscal year ending January 31, 2009 and 2008, respectively.



37



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.

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, 2009, the Company had no borrowings outstanding under this line of credit.

8.

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

 

 

2009

 

2008

Tax-exempt bonds

     

$

6,664 

     

$

7,521 

Taxable bonds

 

 

— 

 

 

— 

Total debt

 

 

6,664 

 

 

7,521 

Less: current portion

 

 

(877)

 

 

(857)

Long-term debt

 

$

5,787 

 

$

6,664 

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 were $32,000. The bond is secured by the equipment financed. At January 31, 2009 and 2008 the balance outstanding was $1,240,000 and $1,441,000, 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, 2009) 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. The bond is secured by the property, building, and equipment financed. At January 31, 2009 and 2008, the balance outstanding was $3,300,000 and $3,800,000, 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, and matured in 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, 2009 and 2008, the balance outstanding was $2,124,000 and $2,280,000 on the tax-exempt bonds, respectively.



38



The aggregate principal maturities on long-term debt for each of the twelve-month periods subsequent to January 31, 2009 are as follows (in thousands of U.S. dollars):

 

 

Long-term
Debt

Fiscal Year ending January 31,:

 

 

 

2010

 

$

877 

2011

 

 

899 

2012

 

 

922 

2013

 

 

646 

2014

 

 

671 

Thereafter

 

 

2,649 

 

 

 

 

 

 

$

6,664 


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 both fiscal years 2009 and 2008, no common stock options were exercised.

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.



39



The following table summarizes the Company’s stock option activity for the years ended January 31, 2009 and 2008:

 

 

2009

 

2008

 

 

 

Shares

 

Weighted
Average
Price

 

Shares

 

Weighted
Average
Price

 

Outstanding – beginning of year

     

563,517 

     

$

3.95 

     

536,100 

     

$

4.17 

 

Granted

 

174,680 

 

 

3.55 

 

140,000 

 

 

3.71 

 

Exercised

 

— 

 

 

— 

 

— 

 

 

— 

 

Repurchased, surrendered or expired

 

(42,517)

 

 

(3.24)

 

(112,583)

 

 

(4.70)

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding – end of year

 

695,680 

 

$

3.89 

 

563,517 

 

$

3.95 

 

Vested

 

141,000 

 

$

3.95 

 

166,667 

 

$

3.58 

 

The following table summarizes information about options outstanding at January 31, 2009:

 

Range of
exercise
prices

 

Number
outstanding at
January 31,
2009

 

Weighted
average
remaining
contractual life
(months)

 

 

Outstanding
weighted
average
exercise price

 

Number
exercisable at
January 31,
2009

 

 

Exercisable
weighted
average
exercise price

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3.20 

     

100,000 

     

51 

     

$

3.20 

     

10,000 

     

$

3.20 

 

3.25 

 

40,000 

 

11 

 

 

3.25 

 

40,000 

 

 

3.25 

 

3.55 

 

174,680 

 

71 

 

 

3.55 

 

— 

 

 

— 

 

3.60 

 

100,000 

 

62 

 

 

3.60 

 

— 

 

 

— 

 

4.00 

 

40,000 

 

23 

 

 

4.00 

 

40,000 

 

 

4.00 

 

4.60 

 

141,000 

 

32 

 

 

4.60 

 

41,000 

 

 

4.60 

 

4.70 

 

100,000 

 

26 

 

 

4.70 

 

10,000 

 

 

4.70 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3.20 – 4.70 

 

695,680 

 

46 

 

$

3.89 

 

141,000 

 

$

3.95 


At January 31, 2009, the Company had 404,320 remaining Common Shares available to be granted under the 2003 Omnibus Plan.

There were outstanding options to purchase 7,000 Common Shares issued to individuals who are not employees or directors of the Company as of January 31, 2009.

Restricted stock units

The Company granted 75,120 and -0- restricted stock units (“RSUs”) to employees during the years ended January 31, 2009 and 2008, respectively. The RSUs have both a service and a performance condition that must be satisfied before vesting will occur. The fair value of these RSUs is based on the fair value of the Companies common stock on the award date and the probability of achieving the performance condition. The weighted average grant date fair value of the RSUs was -0- and -0- during the years ended January 31, 2009 and 2008, respectively.

During fiscal year 2009 -0- RSUs expired. The outstanding RSUs at January 31, 2009 and 2008 were 75,120 and -0-, respectively.

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 participant’s contribution up to 3% of a participant’s eligible compensation and 50% of each participant’s contribution over 3% up to a maximum of 5%. The Company’s contributions to the plan totalled $107,000 and $100,000 for the years ended January 31, 2009 and 2008, respectively.

11.

Related party transactions

General and administrative expenses for 2009 and 2008 included $81,000 and $82,000, respectively, each year for office rent and related services which were incurred on a cost reimbursement basis from a corporation owned and controlled by an officer and director of the Company. At January 31, 2009 and 2008, $5,000 and $6,000, respectively, were owing to this related party.



40



12.

Income taxes

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

 

2009

 

2008

 

 

 

 

 

 

U.S.

$

3,784 

     

$

3,253 

Canada

 

(130)

 

 

17 

 

$

3,654 

 

$

3,270 

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

 

2009

 

2008

 

 

 

 

 

 

U.S.

$

1,103 

     

$

877 

State

 

52 

 

 

49 

Canada

 

20 

 

 

26 

 

$

1,175 

 

$

952 

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

 

2009

 

2008

 

 

 

 

 

 

U.S.

$

339 

     

$

264 

State

 

(99)

 

 

38 

Canada

 

— 

 

 

— 

 

$

240 

 

$

302 

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):

 

 

2009

 

2008

 

 

 

            

 

 

            

Income tax at statutory rate (Canada)

     

$

1,128 

     

$

1,108 

Difference in foreign tax rate

 

 

118 

 

 

Permanent differences

 

 

10 

 

 

(1)

Stock option expense

 

 

151 

 

 

127 

Domestic production deduction

 

 

(64)

 

 

(54)

Change in valuation allowance

 

 

(333)

 

 

38 

Net operating losses expired

 

 

— 

 

 

57 

Change in tax rate

 

 

32 

 

 

115 

Effect from remeasurement from Canadian currency

 

 

300 

 

 

(258)

State and local , net

 

 

(18)

 

 

78 

Other differences

 

 

91 

 

 

41 

 

 

$

1,415 

 

$

1,254 

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):

 

 

2009

 

2008

Deferred income tax assets

     

 

            

     

 

            

Net operating loss carryforward

 

$

— 

 

$

26 

Intangibles

 

 

16 

 

 

20 

Non-deductible liabilities and other

 

 

172 

 

 

158 

State tax credits

 

 

168 

 

 

49 

Unrealized loss

 

 

35 

 

 

338 

Valuation allowance

 

 

(51)

 

 

(384)

 

 

$

340 

 

$

207 

Deferred income tax liabilities

 

 

 

 

 

 

Property, plant and equipment

 

 

(1,532)

 

 

(1,159)

&