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




FORM 10-Q


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



For the quarterly period endedOctober 31,
2007




OR


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



For the transition period from _______ to
_______




Commission file number: 1-31642




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







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



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




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




Indicate by check mark whether
the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the
past 90 days.




Yes [X]  No [  ]




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




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




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




Yes [  ]  No [X]




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







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

---





PART I    FINANCIAL INFORMATION ITEM
1.  FINANCIAL STATEMENTS




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







|                                                                          |  |  |  | As at October 31, 2007 |        | As at January 31, 2007
|------------------------------------------------------------------------- |  |  |  | ---------------------- | ------ | ----------------------
|
|Assets                                                                    |  |  |  |                        |        |                       
|Current
assets:                                                           |  |  |  |                        |        |                       
|Cash and cash
equivalents                                                 |  |  |  | $                      | 2,035  |                       
|Restricted
cash                                                           |  |  |  |                        |       |                       
|Accounts
receivable, net                                                  |  |  |  |                        | 2,541  |                       
|Inventories,
net                                                          |  |  |  |                        | 3,441  |                       
|Prepaid
expenses                                                          |  |  |  |                        | 221    |                       
|Deferred
income tax asset                                                 |  |  |  |                        | 130    |                       
|Total current
assets                                                      |  |  |  |                        | 8,368  |                       
|Property,
plant and equipment, net                                        |  |  |  |                        | 19,606 |                       
|Other assets,
net                                                         |  |  |  |                        | 243    |                       
|Total
assets                                                              |  |  |  | $                      | 28,217 |                       
|                                                                          |  |  |  |                        |        |                       
|Liabilities and Stockholders Equity                                      |  |  |  |                        |        |                       
|                                                                          |  |  |  |                        |        |                       
|Current
liabilities:                                                      |  |  |  |                        |        |                       
|Accounts
payable and accrued liabilities                                  |  |  |  | $                      | 2,298  |                       
|Related party
payable                                                     |  |  |  |                        | 6      |                       
|Current
portion of long-term debt                                         |  |  |  |                        | 852    |                       
|Income taxes
payable                                                      |  |  |  |                        | 254    |                       
|Total current
liabilities                                                 |  |  |  |                        | 3,410  |                       
|                                                                          |  |  |  |                        |        |                       
|Deferred
income tax liability                                             |  |  |  |                        | 981    |                       
|Long-term
debt                                                            |  |  |  |                        | 6,755  |                       
|Total
liabilities                                                         |  |  |  |                        | 11,146 |                       
|                                                                          |  |  |  |                        |        |                       
|Stockholders equity:                                                     |  |  |  |                        |        |                       
|                                                                          |  |  |  |                        |        |                       
|Common stock,
no par value;                                               |  |  |  |                        |        |                       
|100,000,000
shares authorized,                                            |  |  |  |                        |        |                       
|6,410,328
issued and outstanding at October 31, 2007 and January 31, 2007 |  |  |  |                        | 8,487  |                       
|                                                                          |  |  |  |                        |        |                       
|Additional
paid in capital                                                |  |  |  |                        | 1,270  |                       
|                                                                          |  |  |  |                        |        |                       
|Retained
earnings                                                         |  |  |  |                        | 7,314  |                       
|Total
stockholders equity                                                |  |  |  |                        | 17,071 |                       
|Total
liabilities and stockholders equity                                |  |  |  | $                      | 28,217 |                       



2


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







|                                              |  |  |  | Nine Months Ended |        | Three Months Ended | 
|--------------------------------------------- |  |  |  | ----------------- | ------ | ------------------ | 
|
|
|                                              |  |  |  |                   |        |                    | 
|Sales,
net                                    |  |  |  | $                 | 24,794 |                    | 
|Cost of goods
sold                            |  |  |  |                   | 17,250 |                    | 
|                                              |  |  |  |                   | 7,544  |                    | 
|                                              |  |  |  |                   |        |                    | 
|Selling,
general and administrative expenses  |  |  |  |                   | 4,878  |                    | 
|                                              |  |  |  |                   |        |                    | 
|Income from
operations                        |  |  |  |                   | 2,666  |                    | 
|Interest
expense                              |  |  |  |                   | (291   | )                  | 
|Interest
income                               |  |  |  |                   | 65     |                    | 
|Income before
provision for income tax        |  |  |  |                   | 2,440  |                    | 
|                                              |  |  |  |                   |        |                    | 
|Income tax
provision                          |  |  |  |                   | (947   | )                  | 
|Net
income                                    |  |  |  | $                 | 1,493  |                    | 
|                                              |  |  |  |                   |        |                    | 
|Basic
earnings per share                      |  |  |  | $                 | .23    |                    | 
|Fully diluted
earnings per share              |  |  |  | $                 | .23    |                    | 
|                                              |  |  |  |                   |        |                    | 
|Weighted
average number of shares outstanding |  |  |  |                   |        |                    | 
|(in
thousands)                                |  |  |  |                   |        |                    | 
|Basic                                         |  |  |  |                   | 6,410  |                    | 
|Diluted                                       |  |  |  |                   | 6,474  |                    | 



3


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







|                                                                                                 |  |  |  | Nine Months Ended |       
|------------------------------------------------------------------------------------------------ |  |  |  | ----------------- | ------
|
|
|Cash flows
from operating activities                                                             |  |  |  |                   |       
|Net
income                                                                                       |  |  |  | $                 | 1,493 
|Adjustments
to reconcile net income to net cash from operating activities                        |  |  |  |                   |       
|Depreciation
and amortization                                                                    |  |  |  |                   | 1,254 
|Loss on
disposal of assets                                                                       |  |  |  |                   | 164   
|Stock-based
compensation                                                                         |  |  |  |                   | 271   
|Deferred
tax                                                                                     |  |  |  |                   | 119   
|Changes in
operating assets and liabilities                                                      |  |  |  |                   |       
|Accounts
receivable                                                                              |  |  |  |                   | (168  
|Inventory                                                                                        |  |  |  |                   | (220  
|Prepaid
expenses                                                                                 |  |  |  |                   | (95   
|Accounts
payable and accrued liabilities                                                         |  |  |  |                   | (563  
|Income tax
receivable/payable                                                                    |  |  |  |                   | 52    
|Due to
related party                                                                             |  |  |  |                   | 1     
|Net cash
flows from operating activities                                                         |  |  |  |                   | 2,308 
|                                                                                                 |  |  |  |                   |       
|Cash flows
from investing activities                                                             |  |  |  |                   |       
|Purchase of
short-term investments                                                               |  |  |  |                   |      
|Proceeds from
short-term investments                                                             |  |  |  |                   |      
|Purchase of
property, plant and equipment                                                        |  |  |  |                   | (2,977
|Purchase of
other assets                                                                         |  |  |  |                   |      
|Changes in
restricted cash                                                                       |  |  |  |                   | 1,146 
|Net cash
flows from investing activities                                                         |  |  |  |                   | (1,831
|Cash flows
from financing activities                                                             |  |  |  |                   |       
|Proceeds from
long-term debt                                                                     |  |  |  |                   |      
|Repayment of
long-term debt                                                                      |  |  |  |                   | (719  
|Proceeds from
exercise of stock options                                                          |  |  |  |                   |      
|Net cash
flows from financing activities                                                         |  |  |  |                   | (719  
|Net change in
cash                                                                               |  |  |  |                   | (242  
|Cash and cash
equivalents, beginning of period                                                   |  |  |  |                   | 2,277 
|Cash and cash
equivalents, end of period                                                         |  |  |  | $                 | 2,035 
|                                                                                                 |  |  |  |                   |       
|Supplemental Cash flow Information                                                               |  |  |  |                   |       
|Cash paid for
interest                                                                           |  |  |  | $                 | 297   
|Cash paid for
income taxes                                                                       |  |  |  | $                 | 782   
|                                                                                                 |  |  |  |                   |       
|Non-cash
investing activities                                                                    |  |  |  |                   |       
|Change in
property, plant and equipment and accounts payable for purchase of plant and equipment |  |  |  | $                 | (72   



4


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS




1. Significant Accounting Policies




Basis of consolidation and presentation




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




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




Use of estimates




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




New Accounting Pronouncements




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




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




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




5


---



Stock-based employee compensation




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




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




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




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







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



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




Other stock-based compensation




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




6


---



Options




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




2. Share Capital




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







|                                            |  |  |  | Shares |       | Capital
|------------------------------------------- |  |  |  | ------ | ----- | -------
|Common shares
outstanding, January 31, 2007 |  |  |  |        | 6,410 |        
|Common shares
outstanding, October 31, 2007 |  |  |  |        | 6,410 |        



3. Segmented Information




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




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




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




Business Segment Data  Nine Months Ended October 31,
2007




(U.S. dollars, in thousands)







|                                                             |  |  |  | Animal Care |        | Industrial |  | Consolidated
|------------------------------------------------------------ |  |  |  | ----------- | ------ | ---------- |  | ------------
|Revenues                                                     |  |  |  | $           | 24,187 |            |  | $           
|Operating
cost and expenses                                  |  |  |  |             | 20,236 |            |  |             
|Operating
income (loss) before depreciation and amortization |  |  |  |             | 3,951  |            |  |             
|Depreciation
and amortization                                |  |  |  |             |        |            |  |             
|Interest
expense                                             |  |  |  |             |        |            |  |             
|Interest
Income                                              |  |  |  |             |        |            |  |             
|Net income
before taxes                                      |  |  |  |             |        |            |  |             



7


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Business Segment Data  Nine Months Ended October 31,
2006




(U.S. dollars, in thousands)







|                                                             |  |  |  | Animal Care |        | Industrial |  | Consolidated
|------------------------------------------------------------ |  |  |  | ----------- | ------ | ---------- |  | ------------
|Revenues                                                     |  |  |  | $           | 21,570 |            |  | $           
|Operating
cost and expenses                                  |  |  |  |             | 19,444 |            |  |             
|Operating
income (loss) before depreciation and amortization |  |  |  |             | 2,126  |            |  |             
|Depreciation
and amortization                                |  |  |  |             |        |            |  |             
|Interest
expense                                             |  |  |  |             |        |            |  |             
|Interest
Income                                              |  |  |  |             |        |            |  |             
|Net income
before taxes                                      |  |  |  |             |        |            |  |             



Business Segment Data  Three Months Ended October 31,
2007




(U.S. dollars, in thousands)







|                                                             |  |  |  | Animal Care |       | Industrial |  | Consolidated
|------------------------------------------------------------ |  |  |  | ----------- | ----- | ---------- |  | ------------
|Revenues                                                     |  |  |  | $           | 8,834 |            |  | $           
|Operating
cost and expenses                                  |  |  |  |             | 7,102 |            |  |             
|Operating
income (loss) before depreciation and amortization |  |  |  |             | 1,732 |            |  |             
|Depreciation
and amortization                                |  |  |  |             |       |            |  |             
|Interest
expense                                             |  |  |  |             |       |            |  |             
|Interest
income                                              |  |  |  |             |       |            |  |             
|Net income
before taxes                                      |  |  |  |             |       |            |  |             



Business Segment Data  Three Months Ended October 31,
2006




(U.S. dollars, in thousands)







|                                                             |  |  |  | Animal Care |       | Industrial |  | Consolidated
|------------------------------------------------------------ |  |  |  | ----------- | ----- | ---------- |  | ------------
|Revenues                                                     |  |  |  | $           | 8,256 |            |  | $           
|Operating
cost and expenses                                  |  |  |  |             | 7,737 |            |  |             
|Operating
income (loss) before depreciation and amortization |  |  |  |             | 519   |            |  |             
|Depreciation
and amortization                                |  |  |  |             |       |            |  |             
|Interest
Expense                                             |  |  |  |             |       |            |  |             
|Interest
Income                                              |  |  |  |             |       |            |  |             
|Net income
before taxes                                      |  |  |  |             |       |            |  |             



8


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4. Inventories components




(U.S. dollars, in thousands)







|                           |  |  |  | October 31, 2007 |       | January 31, 2007
|-------------------------- |  |  |  | ---------------- | ----- | ----------------
|Raw materials
and supplies |  |  |  | $                | 1,912 |                 
|Finished
goods             |  |  |  |                  | 1,529 |                 
|                           |  |  |  | $                | 3,441 |                 



5. Property, Plant and Equipment




(U.S. dollars, in thousands)







|                               |  |  |  | October 31, 2007 |        | January 31, 2007
|------------------------------ |  |  |  | ---------------- | ------ | ----------------
|Property, plant
and equipment  |  |  |  |                  |        |                 
|Land                           |  |  |  | $                | 1,547  |                 
|Buildings                      |  |  |  |                  | 8,745  |                 
|Leasehold
improvements         |  |  |  |                  |       |                 
|Equipment                      |  |  |  |                  | 14,962 |                 
|Construction
in progress       |  |  |  |                  | 180    |                 
|                               |  |  |  | $                | 25,434 |                 
|Less:
Accumulated depreciation |  |  |  |                  | (5,828 | )               
|                               |  |  |  | $                | 19,606 |                 



6. Credit arrangements




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




7. Long-term debt




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




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




9


---



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




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




8. Earnings per share




(U.S. dollars)







|                                       |  |  |  | For the nine months ended October 31, 2007 |          
|-------------------------------------- |  |  |  | ------------------------------------------ | ---------
|
|Basic
earnings per share               |  |  |  |                                            |          
|Net income
available to stockholders   |  |  |  | $                                          | 1,493,000
|Effect of
dilutive securities          |  |  |  |                                            |          
|Stock options
to purchase common stock |  |  |  |                                            |         
|Diluted
earnings per shares            |  |  |  |                                            |          
|Net income
available to stockholders   |  |  |  | $                                          | 1,493,000






|                                       |  |  |  | For the nine months ended October 31, 2006 |        
|-------------------------------------- |  |  |  | ------------------------------------------ | -------
|
|Basic
earnings per share               |  |  |  |                                            |        
|Net income
available to stockholders   |  |  |  | $                                          | 473,000
|Effect of
dilutive securities          |  |  |  |                                            |        
|Stock options
to purchase common stock |  |  |  |                                            |       
|Diluted
earnings per shares            |  |  |  |                                            |        
|Net income
available to stockholders   |  |  |  | $                                          | 473,000



10


---



(U.S. dollars)







|                                       |  |  |  | For the three months ended October 31, 2007 |        
|-------------------------------------- |  |  |  | ------------------------------------------- | -------
|
|Basic
earnings per share               |  |  |  |                                             |        
|Net income
available to stockholders   |  |  |  | $                                           | 744,000
|Effect of
dilutive securities          |  |  |  |                                             |        
|Stock options
to purchase common stock |  |  |  |                                             |       
|Diluted
earnings per shares            |  |  |  |                                             |        
|Net income
available to stockholders   |  |  |  | $                                           | 744,000






|                                       |  |  |  | For the three months ended October 31, 2006 |       
|-------------------------------------- |  |  |  | ------------------------------------------- | ------
|
|Basic
earnings per share               |  |  |  |                                             |       
|Net income
available to stockholders   |  |  |  | $                                           | 69,000
|Effect of
dilutive securities          |  |  |  |                                             |       
|Stock options
to purchase common stock |  |  |  |                                             |      
|Diluted
earnings per shares            |  |  |  |                                             |       
|Net income
available to stockholders   |  |  |  | $                                           | 69,000



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







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






|                                                                                                                                                                    |  |  |  | For the three months ended October 31, |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | -------------------------------------- | -
|
|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 |  |  |  |                                        | 



11


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|ITEM
2. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
|------- |  | -------------------------------------------------------------------------------------



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




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




Overview




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




Absorption is a leading manufacturer and seller of premium
small animal bedding in North America. The primary product that we sell in this market is small animal bedding sold under the brand 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 are dedicating significant resources to both building
infrastructure for the support of our core business, and creating more product and customer diversification. We believe that this strategy has started
to provide results. Specifically, we continue to grow sales in our core business and improve the production process of our core CareFRESH® product while expanding sales of new products and existing products into new market
channels.




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




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




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




12


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Results of Operations




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







|                       |  |  |  | October 31, 2007 |       | Percent of Sales |  | October 31, 2006 |     | Percent of Sales |  | Percentage Change
|---------------------- |  |  |  | ---------------- | ----- | ---------------- |  | ---------------- | --- | ---------------- |  | -----------------
|Sales                  |  |  |  |                  | 9,028 |                  |  |                  | 100 | %                |  |                  
|COGS                   |  |  |  |                  | 6,287 |                  |  |                  | 70  | %                |  |                  
|Gross
Profit           |  |  |  |                  | 2,741 |                  |  |                  | 30  | %                |  |                  
|                       |  |  |  |                  |       |                  |  |                  |     |                  |  |                  
|S G &
A                |  |  |  |                  | 1,487 |                  |  |                  | 16  | %                |  |                  
|                       |  |  |  |                  |       |                  |  |                  |     |                  |  |                  
|Income from
operations |  |  |  |                  | 1,254 |                  |  |                  | 14  | %                |  |                  
|                       |  |  |  |                  |       |                  |  |                  |     |                  |  |                  
|Interest
Income        |  |  |  |                  | 18    |                  |  |                  | 0   | %                |  |                  
|Interest
Expense       |  |  |  |                  | (103  | )                |  |                  | 1  | %                |  |                  
|                       |  |  |  |                  |       |                  |  |                  |     |                  |  |                  
|Profit before
taxes    |  |  |  |                  | 1,169 |                  |  |                  | 13  | %                |  |                  
|                       |  |  |  |                  |       |                  |  |                  |     |                  |  |                  
|Income
Taxes           |  |  |  |                  | (425  | )                |  |                  | 5  | %                |  |                  
|                       |  |  |  |                  |       |                  |  |                  |     |                  |  |                  
|Net
Income             |  |  |  |                  | 744   |                  |  |                  | 8   | %                |  |                  



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







|                       |  |  |  | October 31, 2007 |        | Percent of Sales |  | October 31, 2006 |     | Percent of Sales |  | Percentage Change
|---------------------- |  |  |  | ---------------- | ------ | ---------------- |  | ---------------- | --- | ---------------- |  | -----------------
|Sales                  |  |  |  |                  | 24,794 |                  |  |                  | 100 | %                |  |                  
|COGS                   |  |  |  |                  | 17,250 |                  |  |                  | 70  | %                |  |                  
|Gross
Profit           |  |  |  |                  | 7,544  |                  |  |                  | 30  | %                |  |                  
|                       |  |  |  |                  |        |                  |  |                  |     |                  |  |                  
|S G &
A                |  |  |  |                  | 4,878  |                  |  |                  | 20  | %                |  |                  
|                       |  |  |  |                  |        |                  |  |                  |     |                  |  |                  
|Income from
operations |  |  |  |                  | 2,666  |                  |  |                  | 11  | %                |  |                  
|                       |  |  |  |                  |        |                  |  |                  |     |                  |  |                  
|Interest
Income        |  |  |  |                  | 65     |                  |  |                  | 0   | %                |  |                  
|Interest
Expense       |  |  |  |                  | (291   | )                |  |                  | 1  | %                |  |                  
|                       |  |  |  |                  |        |                  |  |                  |     |                  |  |                  
|Profit before
taxes    |  |  |  |                  | 2,440  |                  |  |                  | 10  | %                |  |                  
|                       |  |  |  |                  |        |                  |  |                  |     |                  |  |                  
|Income
Taxes           |  |  |  |                  | (947   | )                |  |                  | 4  | %                |  |                  
|                       |  |  |  |                  |        |                  |  |                  |     |                  |  |                  
|Net
Income             |  |  |  |                  | 1,493  |                  |  |                  | 6   | %                |  |                  



Net Sales




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




13


---



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




Gross Profit




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




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




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




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




14


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Selling, Administrative and General
Expenses




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




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




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




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




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







|                                                                               |  |  |  | October 31, 2007 |       | Percent of Sales |  | October 31, 2006 |    | Percent of Sales |  | Percentage Change
|------------------------------------------------------------------------------ |  |  |  | ---------------- | ----- | ---------------- |  | ---------------- | -- | ---------------- |  | -----------------
|Selling,
administrative and general expenses                                   |  |  |  |                  | 1,487 |                  |  |                  | 16 | %                |  |                  
|Arbitration
award                                                              |  |  |  |                  | 0     |                  |  |                  | 0  | %                |  |                  
|Retirement of
assets                                                           |  |  |  |                  | 164   |                  |  |                  | 2  | %                |  |                  
|Selling,
administrative and general expenses adjusted for retirement of assets |  |  |  |                  | 1,323 |                  |  |                  | 15 | %                |  |                  



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







|                                                                               |  |  |  | October 31, 2007 |       | Percent of Sales |  | October 31, 2006 |    | Percent of Sales |  | Percentage Change
|------------------------------------------------------------------------------ |  |  |  | ---------------- | ----- | ---------------- |  | ---------------- | -- | ---------------- |  | -----------------
|Selling,
administrative and general expenses                                   |  |  |  |                  | 4,878 |                  |  |                  | 20 | %                |  |                  
|Arbitration
award                                                              |  |  |  |                  | 0     |                  |  |                  | 0  | %                |  |                  
|Retirement of
assets                                                           |  |  |  |                  | 164   |                  |  |                  | 1  | %                |  |                  
|Selling,
administrative and general expenses adjusted for retirement of assets |  |  |  |                  | 4,714 |                  |  |                  | 19 | %                |  |                  



15


---



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




Interest Expense




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




Income Tax




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




Net Income




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




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




16


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




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




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







|                                                                                  |  |  |  | For the quarter ended |      
|--------------------------------------------------------------------------------- |  |  |  | --------------------- | -----
|(U.S. dollars in thousands)                                                       |  |  |  | October 31, 2007      |      
|Net Income
(Loss) (as reported on Condensed Consolidated Statement of Operations) |  |  |  | $                     | 744  
|Interest
expense                                                                  |  |  |  |                       | 103  
|Interest
income                                                                   |  |  |  |                       | (18  
|Income tax
provision                                                              |  |  |  |                       | 425  
|Depreciation
& amortization                                                       |  |  |  |                       | 475  
|EBITDA                                                                            |  |  |  | $                     | 1,729






|                                                                                  |  |  |  | For the nine months ended |      
|--------------------------------------------------------------------------------- |  |  |  | ------------------------- | -----
|
|Net Income
(Loss) (as reported on Condensed Consolidated Statement of Operations) |  |  |  | $                         | 1,493
|Interest
expense                                                                  |  |  |  |                           | 291  
|Interest
income                                                                   |  |  |  |                           | (65  
|Income tax
provision                                                              |  |  |  |                           | 947  
|Depreciation
& amortization                                                       |  |  |  |                           | 1,254
|EBITDA                                                                            |  |  |  | $                         | 3,920



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




Liquidity and Capital Resources




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




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







|                                               |  |  |  | As of October 31, 2007 |        | As of January 31, 2007
|---------------------------------------------- |  |  |  | ---------------------- | ------ | ----------------------
|Financial
Condition                            |  |  |  |                        |        |                       
|Total
Assets                                   |  |  |  | $                      | 28,217 |                       
|Total
Liabilities                              |  |  |  |                        | 11,146 |                       
|Total
Equity                                   |  |  |  | $                      | 17,071 |                       
|                                               |  |  |  |                        |        |                       
|Debt/equity
ratio                              |  |  |  |                        | 0.65   |                       
|Assets/debt
ratio                              |  |  |  |                        | 2.53   |                       
|                                               |  |  |  |                        |        |                       
|Working
Capital                                |  |  |  |                        |        |                       
|Current
assets                                 |  |  |  | $                      | 8,368  |                       
|Current
liabilities                            |  |  |  | $                      | 3,410  |                       
|                                               |  |  |  |                        |        |                       
|Current
ratio                                  |  |  |  |                        | 2.45   |                       
|                                               |  |  |  |                        |        |                       
|Cash
Position                                  |  |  |  |                        |        |                       
|Cash,
restricted cash & short term investments |  |  |  | $                      | 2,035  |                       
|Cash
generated from operations                 |  |  |  | $                      | 2,308  |                       
|* for the
entire year ended January 31, 2007   |  |  |  |                        |        |                       



Financial Condition




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




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




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




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




Working Capital




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




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




Cash Position




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




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




Cash Generated from
Operations




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




Financing and Investing
Activities




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




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




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




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




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




Environmental Matters




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




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Off-Balance Sheet Arrangements




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




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




Critical Accounting Policies




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




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




FORWARD-LOOKING STATEMENTS




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




ITEM 4. CONTROLS AND PROCEDURES




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




No change in our internal control over financial reporting
occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial
reporting.




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PART IIOTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS




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




ITEM 1A. RISK FACTORS




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




ITEM 6. EXHIBITS


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



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SIGNATURES




Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.




INTERNATIONAL ABSORBENTS INC.(Registrant)




Date: December 13, 2007




/s/ GORDON L.
ELLISGordon L. EllisPresident and Chief Executive
Officer(Principal Executive
Officer)




Date: December 13, 2007




/s/ DAVID H.
THOMPSONDavid H.
ThompsonSecretary and Chief Financial
Officer(Principal Financial
Officer)




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