UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q



|                                                               |                                                                             
|-------------------------------------------------------------- | ----------------------------------------------------------------------------
|ý                                                              | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE 
|                                                               | ACT OF 1934                                                                 
|For the quarterly period ended:  July 31, 2008                
|                                                              
|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 ý   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.

|                                              |  |                             
|--------------------------------------------- |  | ----------------------------
|Large accelerated filer  £                    |  | Accelerated filer  £        
|Non-accelerated filer  £                      |  | Smaller reporting company  ý
|(Do not check if a smaller reporting company) |  |                             

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

Yes  ̈   No ý

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 August 31, 2008
|Common Shares, no par value per share |  | 6,410,328 shares              













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PART I - FINANCIAL INFORMATION



ITEM 1.

FINANCIAL STATEMENTS



INTERNATIONAL ABSORBENTS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(U.S. dollars, in thousands)



|                                           |  |                     |        |  |                        |   |        | 
|------------------------------------------ |  | ------------------- | ------ |  | ---------------------- | - | ------ | 
|                                           |  | As at
July 31,
2008 |        |  | As at
January 31,
2008 |  
|                                           |  |                     |       
|                                           |  |                     |       
|                                           |  | (unaudited)         |        |  | (audited)              |  
|Assets                                     |  |                     |        |  |                        |  
|Current assets:                            |  |                     |        |  |                        |  
|Cash and cash equivalents                  |  | $                   | 4,409  |  |                        | $ | 2,809  | 
|Accounts receivable, net                   |  |                     | 2,583  |  |                        |   | 2,359  | 
|Inventories, net                           |  |                     | 3,413  |  |                        |   | 3,166  | 
|Prepaid expenses                           |  |                     | 144    |  |                        |   | 155    | 
|Income taxes receivable                    |  |                     |       |  |                        |   | 44     | 
|Deferred income tax asset                  |  |                     | 137    |  |                        |   | 158    | 
|Total current assets                       |  |                     | 10,686 |  |                        |   | 8,691  | 
|                                           |  |                     |        |  |                        |   |        | 
|Property, plant and equipment, net         |  |                     | 19,061 |  |                        |   | 19,662 | 
|Other assets, net                          |  |                     | 221    |  |                        |   | 236    | 
|Total assets                               |  | $                   | 29,968 |  |                        | $ | 28,589 | 
|                                           |  |                     |        |  |                        |   |        | 
|Liabilities and Stockholders' Equity       |  |                     |        |  |                        |   |        | 
|                                           |  |                     |        |  |                        |   |        | 
|Current liabilities:                       |  |                     |        |  |                        |   |        | 
|Accounts payable and accrued liabilities   |  | $                   | 2,303  |  |                        | $ | 2,119  | 
|Related party payable                      |  |                     | 6      |  |                        |   | 6      | 
|Current portion of long-term debt          |  |                     | 867    |  |                        |   | 857    | 
|Income taxes payable                       |  |                     | 240    |  |                        |   | 98     | 
|Total current liabilities                  |  |                     | 3,416  |  |                        |   | 3,080  | 
|                                           |  |                     |        |  |                        |   |        | 
|Deferred income tax liability              |  |                     | 1,214  |  |                        |   | 1,110  | 
|Long-term debt                             |  |                     | 6,478  |  |                        |   | 6,664  | 
|Other long term liabilities                |  |                     | 46     |  |                        |   | 46     | 
|Total liabilities                          |  |                     | 11,154 |  |                        |   | 10,900 | 
|                                           |  |                     |        |  |                        |   |        | 
|                                           |  |                     |        |  |                        |   |        | 
|                                           |  |                     |        |  |                        |   |        | 
|Stockholders' equity:                      |  |                     |        |  |                        |   |        | 
|                                           |  |                     |        |  |                        |   |        | 
|Common stock, no par value;                |  |                     |        |  |                        |   |        | 
|Unlimited shares authorized,               |  |                     |        |  |                        |   |        | 
|6,410,328 issued and outstanding at        |  |                     | 8,487  |  |                        |   | 8,487  | 
|July 31, 2008 and January 31, 2008         |  |                     |        |  |                        |   |        | 
|                                           |  |                     |        |  |                        |   |        | 
|Additional paid in capital                 |  |                     | 1,585  |  |                        |   | 1,365  | 
|                                           |  |                     |        |  |                        |   |        | 
|Retained earnings                          |  |                     | 8,742  |  |                        |   | 7,837  | 
|Total stockholders' equity                 |  |                     | 18,814 |  |                        |   | 17,689 | 
|Total liabilities and stockholders' equity |  | $                   | 29,968 |  |                        | $ | 28,589 | 



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



2



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INTERNATIONAL ABSORBENTS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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



|                                              |  |                  |        |   |                    |   |        |             |  |   |             |   |  |   |       |  
|--------------------------------------------- |  | ---------------- | ------ | - | ------------------ | - | ------ | ----------- |  | - | ----------- | - |  | - | ----- | -
|                                              |  | Six Months Ended |        |   | Three Months Ended |  
|                                              |  | July 31,         |        |   | July 31,           |   |        | July 31,    |  |   | July 31,    |  
|                                              |  | 2008             |        |   | 2007               |   |        | 2008        |  |   | 2007        |  
|                                              |  | (unaudited)      |        |   | (unaudited)        |   |        | (unaudited) |  |   | (unaudited) |  
|                                              |  |                  |        |   |                    |   |        |             |  |   |             |  
|Sales, net                                    |  | $                | 17,759 |   |                    | $ | 15,766 |             |  | $ | 9,298       |   |  | $ | 7,401 |  
|Cost of goods sold                            |  |                  | 12,447 |   |                    |   | 10,963 |             |  |   | 6,496       |   |  |   | 5,365 |  
|                                              |  |                  | 5,312  |   |                    |   | 4,803  |             |  |   | 2,802       |   |  |   | 2,036 |  
|                                              |  |                  |        |   |                    |   |        |             |  |   |             |   |  |   |       |  
|                                              |  |                  |        |   |                    |   |        |             |  |   |             |   |  |   |       |  
|Selling, general and administrative expenses  |  |                  | 3,625  |   |                    |   | 3,391  |             |  |   | 1,820       |   |  |   | 1,721 |  
|                                              |  |                  |        |   |                    |   |        |             |  |   |             |   |  |   |       |  
|                                              |  |                  |        |   |                    |   |        |             |  |   |             |   |  |   |       |  
|Income from operations                        |  |                  | 1,687  |   |                    |   | 1,412  |             |  |   | 982         |   |  |   | 315   |  
|Interest expense                              |  |                  | (161   | ) |                    |   | (188   | )           |  |   | (79         | ) |  |   | (101  | )
|Interest income                               |  |                  | 28     |   |                    |   | 47     |             |  |   | 14          |   |  |   | 23    |  
|Income before provision for income tax        |  |                  | 1,554  |   |                    |   | 1,271  |             |  |   | 917         |   |  |   | 237   |  
|                                              |  |                  |        |   |                    |   |        |             |  |   |             |   |  |   |       |  
|Income tax provision                          |  |                  | (649   | ) |                    |   | (522   | )           |  |   | (355        | ) |  |   | (111  | )
|Net income                                    |  | $                | 905    |   |                    | $ | 749    |             |  | $ | 562         |   |  | $ | 126   |  
|                                              |  |                  |        |   |                    |   |        |             |  |   |             |   |  |   |       |  
|Basic earnings per share                      |  | $                | .14    |   |                    | $ | .12    |             |  | $ | .09         |   |  | $ | .02   |  
|Fully diluted earnings per share              |  | $                | .14    |   |                    | $ | .12    |             |  | $ | .09         |   |  | $ | .02   |  
|                                              |  |                  |        |   |                    |   |        |             |  |   |             |   |  |   |       |  
|Weighted average number of shares outstanding |  |                  |        |   |                    |   |        |             |  |   |             |   | 
|(in thousands)                                |  |                  |        |   |                    |   |        |             |  |   |             |   |  |   |       |  
|Basic                                         |  |                  | 6,410  |   |                    |   | 6,410  |             |  |   | 6,410       |   |  |   | 6,410 |  
|Diluted                                       |  |                  | 6,454  |   |                    |   | 6,464  |             |  |   | 6,440       |   |  |   | 6,511 |  



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



3



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INTERNATIONAL ABSORBENTS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(U.S. dollars, in thousands)



|                                                     |  |                  |       |   |             |   |        |  
|---------------------------------------------------- |  | ---------------- | ----- | - | ----------- | - | ------ | -
|                                                     |  | Six Months Ended |      
|                                                     |  | July 31,         |       |   | July 31,    |  
|                                                     |  | 2008             |       |   | 2007        |  
|                                                     |  | (unaudited)      |       |   | (unaudited) |  
|Cash flows from operating activities                 |  |                  |       |   |             |  
|                                                     |  |                  |       |   |             |  
|Net income                                           |  | $                | 905   |   |             | $ | 749    |  
|Adjustments to reconcile net income to net cash      |  |                  |       |   |             |   |        |  
|from operating activities                            |  |                  |       |   |             |   |        |  
|Depreciation and amortization                        |  |                  | 931   |   |             |   | 779    |  
|Loss on disposal of assets                           |  |                  |      |   |             |   | 164    |  
|Stock-based compensation                             |  |                  | 220   |   |             |   | 195    |  
|Deferred tax                                         |  |                  | 125   |   |             |   | 150    |  
|Changes in operating assets and liabilities          |  |                  |       |   |             |   |        |  
|Accounts receivable                                  |  |                  | (224  | ) |             |   | 26     |  
|Inventory                                            |  |                  | (247  | ) |             |   | (877   | )
|Prepaid expenses                                     |  |                  | 11    |   |             |   | (16    | )
|Accounts payable and accrued liabilities             |  |                  | 297   |   |             |   | (420   | )
|Income tax receivable/payable                        |  |                  | 186   |   |             |   | 45     |  
|Due to related party                                 |  |                  |      |   |             |   | 1      |  
|Net cash flows from operating activities             |  |                  | 2,204 |   |             |   | 796    |  
|                                                     |  |                  |       |   |             |   |        |  
|Cash flows from investing activities                 |  |                  |       |   |             |   |        |  
|Purchase of property, plant and equipment            |  |                  | (428  | ) |             |   | (2,600 | )
|Changes in restricted cash                           |  |                  |      |   |             |   | 1,146  |  
|Net cash flows from investing activities             |  |                  | (428  | ) |             |   | (1,454 | )
|                                                     |  |                  |       |   |             |   |        |  
|Cash flows from financing activities                 |  |                  |       |   |             |   |        |  
|Repayment of long-term debt                          |  |                  | (176  | ) |             |   | (134   | )
|Net cash flows from financing activities             |  |                  | (176  | ) |             |   | (134   | )
|                                                     |  |                  |       |   |             |   |        |  
|                                                     |  |                  |       |   |             |   |        |  
|Net change in cash                                   |  |                  | 1,600 |   |             |   | (792   | )
|                                                     |  |                  |       |   |             |   |        |  
|Cash and cash equivalents, beginning of period       |  |                  | 2,809 |   |             |   | 2,277  |  
|                                                     |  |                  |       |   |             |   |        |  
|Cash and cash equivalents, end of period             |  | $                | 4,409 |   |             | $ | 1,485  |  
|                                                     |  |                  |       |   |             |   |        |  
|Supplemental Cash flow Information                   |  |                  |       |   |             |   |        |  
|Cash paid for interest                               |  | $                | 147   |   |             | $ | 193    |  
|                                                     |  |                  |       |   |             |   |        |  
|Cash paid for income taxes                           |  | $                | 349   |   |             | $ | 330    |  
|                                                     |  |                  |       |   |             |   |        |  
|                                                     |  |                  |       |   |             |   |        |  
|Non-cash investing activities                        |  |                  |       |   |             |   |        |  
|Change in property, plant and equipment and accounts |  |                  |       |   |             |   |        |  
|payable for purchase of plant and equipment          |  | $                | 113   |   |             | $ | 45     |  





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



4



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INTERNATIONAL ABSORBENTS INC.

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 Annual Report on Form 10-K and therefore should be read in conjunction with our annual consolidated financial statements and notes thereto for the year ended January 31, 2008 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 July 31, 2008 and January 31, 2008, its results of operations for the six and three months ended July 31, 2008 and 2007 and the statements of cash flows for the six months ended July 31, 2008 and 2007. The results of operations for the six months ended July 31, 2008 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 September 2006, the Financial Accounting Standards Board (the FASB) issued FASB Statement No. 157, Fair Value Measures (SFAS 157), which defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS 157 did not have a material impact on the Companys results of operations or financial position.



In February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted. The adoption of SFAS 159 did not have a material impact on the Companys results of operations or financial position.



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



In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities.  This Statement significantly increases the disclosure requirements for derivative instruments.  The new requirements include the location and fair value amounts of all derivatives by category reported in the consolidated balance sheet; the location and amount of gains or losses of all derivatives and designated hedged items by category reported in the consolidated income statement or in other comprehensive income in the consolidated balance sheet; and measures of volume such as notional amounts.  For derivatives designated as hedges, the gains or losses must be divided into the effective portions and the



5



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ineffective portions.  The Statement also requires the disclosure of group concentrations of credit risk by counterparties, including the maximum amount of loss due to credit risk and policies concerning collateral and master netting arrangements.  Most disclosures are required on an interim and annual basis.  The effective date for this Statement is the second quarter of fiscal year 2009.  The Companys adoption of this Statement has not had a material impact on the Companys consolidated financial statements.



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. Total stock-based compensation expense recognized in the income statement for the six-month periods ended July 31, 2008 and July 31, 2007 was $220,000 and $194,000, respectively, before income taxes, of which $10,000 and $10,000, respectively, was recognized in cost of goods sold and $210,000 and $184,000, respectively, was recognized in selling, general and administrative expenses. Total stock-based compensation expense recognized in the income statement for the three-month periods ended July 31, 2008 and July 31, 2007 was $112,000 and $101,000, respectively, before income taxes, of which $8,000 and $5,000, respectively, was recognized in cost of goods sold and $104,000 and $96,000, respectively, was recognized in selling, general and administrative expenses.  Related total deferred tax benefit was nil for the six and three months ended July 31, 2008 and July 31, 2007.  Total unrecognized compensation costs related to stock options at July 31, 2008 and July 31, 2007 was $547,000 and $618,000, 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 42 months.



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. No options were awarded for the six or three-month periods ended July 31, 2008. The assumptions used for the six and three-month periods ended July 31, 2007 and the resulting estimate of the weighted-average fair value per share of options granted during that period are as follows:





|                                         |      |       |  
|---------------------------------------- | ---- | ----- | -
|                                         | 2008 |      
|                                         |      |       |  
|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 ThanEmployees 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 $1,000 and $2,000 during thesix-month periods ended July 31, 2008 and 2007, respectively and $1,000 during both the three-month period ended July 31, 2008 and 2007.



6



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Options



Stock options outstanding at July 31, 2008 and January 31, 2008 were 561,833 and 564,150, respectively.  During the six months ended July 31, 2008, no options were exercised, 2,317 options were forfeited, and no options were granted.



2.

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  Six Months Ended July 31, 2008



|                                                              |  |             |        |  |            |   |     |              |  |   |        |  
|------------------------------------------------------------- |  | ----------- | ------ |  | ---------- | - | --- | ------------ |  | - | ------ | -
|(U.S. dollars, in thousands)                                  |  | Animal
Care |        |  | Industrial |   |     | Consolidated | 
|                                                              |  |             |        |  |            |  
|                                                              |  |             |        |  |            |   |     |              |  |   |        |  
|Revenues                                                      |  | $           | 17,346 |  |            | $ | 413 |              |  | $ | 17,759 |  
|Operating cost and expenses                                   |  |             | 14,741 |  |            |   | 400 |              |  |   | 15,141 |  
|Operating income (loss) before 
depreciation and amortization |  | $           | 2,605  |  |            | $ | 13  |              |  |   | 2,618  |  
|Depreciation and amortization                                 |  |             |        |  |            |   |     |              |  |   | (931   | )
|Interest expense                                              |  |             |        |  |            |   |     |              |  |   | (161   | )
|Interest Income                                               |  |             |        |  |            |   |     |              |  |   | 28     |  
|                                                              |  |             |        |  |            |   |     |              |  |   |        |  
|Net income before taxes                                       |  |             |        |  |            |   |     |              |  | $ | 1,554  |  





7



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Business Segment Data - Six Months Ended July 31, 2007

|                                                              |  |             |        |            |   |              |   |   |        |  
|------------------------------------------------------------- |  | ----------- | ------ | ---------- | - | ------------ | - | - | ------ | -
|(U.S. dollars, in thousands)                                  |  | Animal
Care |        | Industrial |   | Consolidated |  
|                                                              |  |             |        |           
|                                                              |  |             |        |            |   |              |   |   |        |  
|Revenues                                                      |  | $           | 15,353 |            | $ | 413          |   | $ | 15,766 |  
|Operating cost and expenses                                   |  |             | 13,134 |            |   | 441          |   |   | 13,575 |  
|Operating income (loss) before 
depreciation and amortization |  | $           | 2,219  |            | $ | (28          | ) |   | 2,191  |  
|Depreciation and amortization                                 |  |             |        |            |   |              |   |   | (779   | )
|Interest expense                                              |  |             |        |            |   |              |   |   | (188   | )
|Interest Income                                               |  |             |        |            |   |              |   |   | 47     |  
|                                                              |  |             |        |            |   |              |   |   |        |  
|Net income before taxes                                       |  |             |        |            |   |              |   | $ | 1,271  |  



Business Segment Data  Three Months Ended July 31, 2008



|                                                              |  |             |       |            |   |              |  |   |       |  
|------------------------------------------------------------- |  | ----------- | ----- | ---------- | - | ------------ |  | - | ----- | -
|(U.S. dollars, in thousands)                                  |  | Animal
Care |       | Industrial |   | Consolidated | 
|                                                              |  |             |       |           
|                                                              |  |             |       |            |   |              |  |   |       |  
|Revenues                                                      |  | $           | 9,075 |            | $ | 223          |  | $ | 9,298 |  
|Operating cost and expenses                                   |  |             | 7,667 |            |   | 222          |  |   | 7,889 |  
|Operating income (loss) before 
depreciation and amortization |  | $           | 1,408 |            | $ | 1            |  |   | 1,409 |  
|Depreciation and amortization                                 |  |             |       |            |   |              |  |   | (427  | )
|Interest expense                                              |  |             |       |            |   |              |  |   | (79   | )
|Interest income                                               |  |             |       |            |   |              |  |   | 14    |  
|                                                              |  |             |       |            |   |              |  |   |       |  
|Net income before taxes                                       |  |             |       |            |   |              |  | $ | 917   |  





Business Segment Data  Three Months Ended July 31, 2007



|                                                              |  |             |       |            |   |              |   |   |       |  
|------------------------------------------------------------- |  | ----------- | ----- | ---------- | - | ------------ | - | - | ----- | -
|(U.S. dollars, in thousands)                                  |  | Animal
Care |       | Industrial |   | Consolidated |  
|                                                              |  |             |       |           
|                                                              |  |             |       |            |   |              |   |   |       |  
|Revenues                                                      |  | $           | 7,189 |            | $ | 212          |   | $ | 7,401 |  
|Operating cost and expenses                                   |  |             | 6,437 |            |   | 222          |   |   | 6,659 |  
|Operating income (loss) before 
depreciation and amortization |  | $           | 752   |            | $ | (10          | ) |   | 742   |  
|Depreciation and amortization                                 |  |             |       |            |   |              |   |   | (427  | )
|Interest Expense                                              |  |             |       |            |   |              |   |   | (101  | )
|Interest Income                                               |  |             |       |            |   |              |   |   | 23    |  
|                                                              |  |             |       |            |   |              |   |   |       |  
|Net income before taxes                                       |  |             |       |            |   |              |   | $ | 237   |  





8



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3.

Inventories components



|                             |  |               |       |                  |   |       | 
|---------------------------- |  | ------------- | ----- | ---------------- | - | ----- | 
|(U.S. dollars, in thousands) |  | July 31,
2008 |       | January 31,
2008 |  
|                             |  |               |      
|                             |  |               |       |                  |   |       | 
|Raw materials and supplies   |  | $             | 2,055 |                  | $ | 1,714 | 
|Finished goods               |  |               | 1,358 |                  |   | 1,452 | 
|                             |  | $             | 3,413 |                  | $ | 3,166 | 



4.

Property, Plant and Equipment





|                                |  |               |        |                  |   |        |  
|------------------------------- |  | ------------- | ------ | ---------------- | - | ------ | -
|(U.S. dollars, in thousands)    |  | July 31,
2008 |        | January 31,
2008 |  
|                                |  |               |       
|Property, plant and equipment   |  |               |        |                  |   |        |  
|Land                            |  | $             | 1,547  |                  | $ | 1,547  |  
|Buildings                       |  |               | 8,852  |                  |   | 8,759  |  
|Equipment                       |  |               | 15,780 |                  |   | 15,164 |  
|Construction in progress        |  |               | 51     |                  |   | 446    |  
|                                |  |               |        |                  |   |        |  
|                                |  | $             | 26,230 |                  | $ | 25,916 |  
|Less:  Accumulated depreciation |  |               | (7,169 | )                |   | (6,254 | )
|                                |  | $             | 19,061 |                  | $ | 19,662 |  



5.

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 July 31, 2008, the Company had not drawn against the line of credit.



6.

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 six months of construction.  If Absorption defaults under the terms of the loan agreement, including failure to pay any amount when due or violating any of the financial and other covenants, GECPF may accelerate all amounts then-owing under the bond.  Costs incurred in issuing the bond were $32,000.  The bond is secured by the equipment financed. At July 31, 2008 and January 31, 2008, the balance outstanding was $1,342,000 and $1,441,000, respectively.



In September of 2004, the Company completed a $4,900,000 tax-exempt bond financing.  Of the total proceeds from the financing, $2,099,000 were used to pay off the loan held by Branch Banking &Trust Co., $98,000 was paid for costs of issuance and the remaining proceeds of $2,703,000 were placed in a trust account to be used to finish the construction of the new production facility located in Jesup, Georgia.  The bonds were issued by Wayne County Industrial Development Authority in the state of Georgia.  The bonds have a variable rate equal to Branch Banking & Trust Co.s Variable Rate Demand Bond VRDB rate ( 2.36% as of  July 31, 2008) plus a  letter of credit fee of 0.95%, a remarketing fee of 0.125% and a $2,000 annual trustee fee.  The term of these bonds is seven years for the equipment portion and 15 years for the real estate portion. The bond is secured by the building, equipment and real estate. At both July 31, 2008 and January 31, 2008, the debt outstanding was $3,800,000.  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.



9



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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. 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. The taxable bonds matured August 2007and were paid off as of that date. The balance outstanding on the tax-exempt bonds at July 31, 2008 and January 31, 2008 was $2,203,000 and $2,280,000, respectively.



7.

Earnings per share



|                              |  |                                        |   |         |  |           |                          |   |               |  |           |  | 
|----------------------------- |  | -------------------------------------- | - | ------- |  | --------- | ------------------------ | - | ------------- |  | --------- |  | 
|(U.S. dollars)                |  | For the six months ended              
|                              |  |                                        |   |         |  |           | July 31, 2008           
|                              |  |                                        |   |         |  |           | Net Income               |   | Shares        |  | Per share
|                              |  |                                        |   |         |  |           | (numerator)              |   | (denominator) |  | amount   
|                              |  |                                        |   |         |  |           |                          |   |               |  |          
|Basic earnings per share      |  |                                        |   |         | 
|                              |  | Net income available to stockholders   | $ | 905,000 |  | 6,410,328 |                          | $ | 0.14         
|Effect of dilutive securities |  |                                        |   |         |  |           |                         
|                              |  | Stock options to purchase common stock |   |        |  | 43,785    |                          |   |              
|Diluted earnings per shares   |  |                                        |   |         |  |           |                         
|                              |  | Net income available to stockholders   | $ | 905,000 |  | 6,454,113 |                          | $ | 0.14         
|                              |  |                                        |   |         |  |           |                          |   |               |  |          
|                              |  |                                        |   |         |  |           | For the six months ended
|                              |  |                                        |   |         |  |           | July 31, 2007           
|                              |  |                                        |   |         |  |           | Net Income               |   | Shares        |  | Per share
|                              |  |                                        |   |         |  |           | (numerator)              |   | (denominator) |  | amount   
|                              |  |                                        |   |         |  |           |                          |   |               |  |          
|Basic earnings per share      |  |                                        |   |         | 
|                              |  | Net income available to stockholders   | $ | 749,000 |  | 6,410,328 |                          | $ | 0.12         
|Effect of dilutive securities |  |                                        |   |         |  |           |                         
|                              |  | Stock options to purchase common stock |   |        |  | 53,511    |                          |   |              
|Diluted earnings per shares   |  |                                        |   |         |  |           |                         
|                              |  | Net income available to stockholders   | $ | 749,000 |  | 6,463,839 |                          | $ | 0.12         









10



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|                              |  |                                        |   |         |  |           |                            |   |               |  |           |  |  |  | 
|----------------------------- |  | -------------------------------------- | - | ------- |  | --------- | -------------------------- | - | ------------- |  | --------- |  |  |  | 
|(U.S. dollars)                |  | For the three months ended            
|                              |  |                                        |   |         |  |           | July 31, 2008             
|                              |  |                                        |   |         |  |           | Net Income                 |   | Shares        |  | Per share
|                              |  |                                        |   |         |  |           | (numerator)                |   | (denominator) |  | amount   
|                              |  |                                        |   |         |  |           |                            |   |               |  |          
|Basic earnings per share      |  |                                        |   |         | 
|                              |  | Net income available to stockholders   | $ | 562,000 |  | 6,410,328 |                            | $ | 0.09         
|Effect of dilutive securities |  |                                        |   |         |  |           |                           
|                              |  | Stock options to purchase common stock |   |        |  | 29,677    |                            |   |              
|Diluted earnings per shares   |  |                                        |   |         |  |           |                           
|                              |  | Net income available to stockholders   | $ | 562,000 |  | 6,440,005 |                            | $ | 0.09         
|                              |  |                                        |   |         |  |           |                            |   |               |  |          
|                              |  |                                        |   |         |  |           | For the three months ended
|                              |  |                                        |   |         |  |           | July 31, 2007             
|                              |  |                                        |   |         |  |           | Net Income                 |   | Shares        |  | Per share
|                              |  |                                        |   |         |  |           | (numerator)                |   | (denominator) |  | amount   
|                              |  |                                        |   |         |  |           |                            |   |               |  |          
|Basic earnings per share      |  |                                        |   |         | 
|                              |  | Net income available to stockholders   | $ | 126,000 |  | 6,410,328 |                            | $ | 0.02         
|Effect of dilutive securities |  |                                        |   |         |  |           |                           
|                              |  | Stock options to purchase common stock |   |        |  | 100,682   |                            |   |              
|Diluted earnings per shares   |  |                                        |   |         |  |           |                           
|                              |  | Net income available to stockholders   | $ | 126,000 |  | 6,511,010 |                            | $ | 0.02         



The Company excludes all potentially dilutive securities from its diluted net income per share computation when their effect would be anti-dilutive. 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 six months ended
July 31,  
|                                                                                                                                                                    |  | 2008                                |  | 2007   
|                                                                                                                                                                    |  |                                     |  |        
|Stock options excluded from the computation of diluted net income per share, other than those used in the determination of common stock equivalents disclosed above |  | 281,833                             |  | 284,150
|                                                                                                                                                                    |  |                                     |  |        
|                                                                                                                                                                    |  |                                     |  |        
|                                                                                                                                                                    |  |                                     |  |        
|                                                                                                                                                                    |  |                                     |  |        
|                                                                                                                                                                    |  | For the three months ended
July 31,
|                                                                                                                                                                    |  | 2008                                |  | 2007   
|                                                                                                                                                                    |  |                                     |  |        
|Stock options excluded from the computation of diluted net income per share, other than those used in the determination of common stock equivalents disclosed above |  | 281,833                             |  |       







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 filing.



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 and Item 1A of Part II, Risk Factors, 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 continue to dedicate significant resources to improving our infrastructure for the support of our core business, and creating more product and customer diversification.  We believe that this strategy has started to provide results.  Specifically, we continue to grow sales in our core business and improve the production process of our core CareFRESH® product while expanding sales of new products and existing products into new market channels.



In light of the current general economy, management was satisfied with the financial results for the second quarter of fiscal year 2009, both in terms of top line sales (see Net Sales below) and bottom line profits (see Net Income below).  In particular, net sales for the second quarter of fiscal year 2009 exceeded net sales generated during the same quarter in the prior fiscal year and net sales for the first six months of fiscal year 2009 exceeded net sales during the same period in fiscal year 2008.  We were able to continue to be profitable during the second quarter of fiscal year 2009 and the first six months of fiscal year 2009, even in light of significant economy-driven cost increases.  As described in the Gross Profits discussion below, several factors, such as increasing energy costs, contributed to the challenges of continuing to operate profitably.  We believe that our investment in infrastructure and focus on managing costs over the past several years have left us in the position to remain financially healthy during the current economic slow down and to have the financial strength to invest in product lines that could lead to future growth.



During fiscal year 2009, we intend to continue to focus our sales and marketing efforts on our market leading CareFRESH®, CareFRESH®Colors and CareFRESH®Ultra brands of small animal bedding products.  CareFRESH®Colors is our colored bedding offering and CareFRESH®Ultra is our white small animal bedding.  Both are premium line extensions to our core product, CareFRESH®.  We expect to also continue to aggressively sell ourHealthy Pet TM cat litter line. Our Healthy PetTM brand consists of a range of “natural” cat litters made from cellulose fiber, wood, grain and plant-based materials.  These products are aimed at the “holistic” market and are designed to be healthier for pets and people than traditional clay litter because of potential health problems associated with crystalline silica in clay products.  However, because this is a relatively new product line, management believes it is too early to be able to predict if recently experienced growth trends will continue.



In fiscal year 2009, we intend to continue to make significant investments in the review of ancillary product lines and in the exploration of new synergistic business opportunities.  We believe that this investment in new product lines and business opportunities 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 line.



12



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Results of Operations



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



|                                  |  |                                   |       |                  |      |                                   |   |                  |  |                   |  |     
|--------------------------------- |  | --------------------------------- | ----- | ---------------- | ---- | --------------------------------- | - | ---------------- |  | ----------------- |  | ----
|                                  |  | Three months ended 
July 31, 2008 |       | Percent of Sales |      | Three months ended 
July 31, 2007 |   | Percent of Sales |  | Percentage Change
|Sales                             |  | $                                 | 9,298 |                  | 100% |                                   | $ | 7,401            |  | 100%              |  | 26% 
|Cost of goods sold                |  |                                   | 6,496 |                  | 70%  |                                   |   | 5,365            |  | 72%               |  | 21% 
|Gross Profit                      |  |                                   | 2,802 |                  | 30%  |                                   |   | 2,036            |  | 28%               |  | 38% 
|                                  |  |                                   |       |                  |      |                                   |   |                  |  |                   |  |     
|Selling, general & administrative |  |                                   | 1,820 |                  | 20%  |                                   |   | 1,721            |  | 23%               |  | 6%  
|                                  |  |                                   |       |                  |      |                                   |   |                  |  |                   |  |     
|Income from operations            |  |                                   | 982   |                  | 11%  |                                   |   | 315              |  | 4%                |  | 212%
|                                  |  |                                   |       |                  |      |                                   |   |                  |  |                   |  |     
|Interest Income                   |  |                                   | 14    |                  | 0%   |                                   |   | 23               |  | 0%                |  | -39%
|Interest Expense                  |  |                                   | (79)  |                  | -1%  |                                   |   | (101)            |  | -1%               |  | -22%
|                                  |  |                                   |       |                  |      |                                   |   |                  |  |                   |  |     
|Profit before taxes               |  |                                   | 917   |                  | 10%  |                                   |   | 237              |  | 3%                |  | 287%
|                                  |  |                                   |       |                  |      |                                   |   |                  |  |                   |  |     
|Income Taxes                      |  |                                   | (355) |                  | -4%  |                                   |   | (111)            |  | -1%               |  | 230%
|                                  |  |                                   |       |                  |      |                                   |   |                  |  |                   |  |     
|Net Income                        |  | $                                 | 562   |                  | 6%   |                                   | $ | 126              |  | 2%                |  | 338%



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



|                                  |  |                                 |        |                  |      |                                 |   |                  |  |                   |  |     
|--------------------------------- |  | ------------------------------- | ------ | ---------------- | ---- | ------------------------------- | - | ---------------- |  | ----------------- |  | ----
|                                  |  | Six months ended 
July 31, 2008 |        | Percent of Sales |      | Six months ended 
July 31, 2007 |   | Percent of Sales |  | Percentage Change
|Sales                             |  | $                               | 17,759 |                  | 100% |                                 | $ | 15,766           |  | 100%              |  | 13% 
|Cost of goods sold                |  |                                 | 12,447 |                  | 70%  |                                 |   | 10,963           |  | 70%               |  | 14% 
|Gross Profit                      |  |                                 | 5,312  |                  | 30%  |                                 |   | 4,803            |  | 30%               |  | 11% 
|                                  |  |                                 |        |                  |      |                                 |   |                  |  |                   |  |     
|Selling, general & administrative |  |                                 | 3,625  |                  | 20%  |                                 |   | 3,391            |  | 22%               |  | 7%  
|                                  |  |                                 |        |                  |      |                                 |   |                  |  |                   |  |     
|Income from operations            |  |                                 | 1,687  |                  | 10%  |                                 |   | 1,412            |  | 9%                |  | 20% 
|                                  |  |                                 |        |                  |      |                                 |   |                  |  |                   |  |     
|Interest Income                   |  |                                 | 28     |                  | 0%   |                                 |   | 47               |  | 0%                |  | -40%
|Interest Expense                  |  |                                 | (161)  |                  | -1%  |                                 |   | (188)            |  | -1%               |  | -14%
|                                  |  |                                 |        |                  |      |                                 |   |                  |  |                   |  |     
|Profit before taxes               |  |                                 | 1,554  |                  | 9%   |                                 |   | 1,271            |  | 8%                |  | 22% 
|                                  |  |                                 |        |                  |      |                                 |   |                  |  |                   |  |     
|Income Taxes                      |  |                                 | (649)  |                  | -4%  |                                 |   | (522)            |  | -3%               |  | 26% 
|                                  |  |                                 |        |                  |      |                                 |   |                  |  |                   |  |     
|Net Income                        |  | $                               | 905    |                  | 5%   |                                 | $ | 749              |  | 5%                |  | 19% 



Net Sales



During the second quarter of fiscal year 2009, our net sales increased by 26% as compared to the same quarter in fiscal year 2008.  This growth in net sales was a result of the growth in sales of our animal care products and promotional timing with some of our key customers as compared to the prior fiscal year.  For the first six months of fiscal year 2009, our net sales increased by 13% as compared to the same period in fiscal year 2008.  This increase in net sales was a result of increases in the sales of our core animal care products with significant customers and a sales program focused on filling in national distribution gaps.  During the second quarter of fiscal year 2009, net sales for animal care products grew from $7,189,000 to



13



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$9,075,000 as compared to the same period of fiscal year 2008.  In the first six months of fiscal year 2009, net sales for animal care products grew from $15,353,000 to $17,346,000 as compared to the same period of fiscal year 2008.  We had strong sales levels with all of our bedding products, including our CareFRESH®, CareFRESH®UltraTM, and CareFRESH®Colors products, particularly when the general economy is taken into consideration.  Net sales of our industrial products increased from $213,000 to $223,000 from the second quarter of fiscal years 2008 compared to the same period in 2009 and was unchanged for the first six months of fiscal year 2009 compared to the same period in 2008 at $413,000.  Our strategy in regard to our industrial line of products has remained the same, which is to effectively service existing customers while focusing growth on animal care products.



We currently believe that our fiscal year 2009 overall annual net sales will grow approximately 8% to 15% over our fiscal year 2008 net sales levels.  Specifically, during fiscal year 2009, we expect sales of natural, non-colored CareFRESH® in pet specialty channels to grow slightly over sales levels from fiscal year 2008 as we fill in distribution holes throughout the United States.  In recent years, we have also introduced line extensions such as CareFRESH UltraTMand CareFRESH®Colors.  Also, during the second quarter of fiscal year 2009, we rolled out our first private label product with Petco, which will solidify our relationship with a key customer and expand our product offerings in their pet bedding category.  Although we anticipate that naturalCareFRESH® will continue to represent the majority of our sales through fiscal year 2009, we also see growth opportunities for our full line of bedding products as they continue to gain market share and growing customer acceptance, subject to the following challenges.  First, as we add new items to our line of products, they will need to compete for limited shelf space at the pet specialty stores with our other existing products and those of our competitors, which could limit the number of products we are able to sell at a particular store.  Second, although we believe that the high quality of our CareFRESH® line of products gives us a significant competitive advantage, many of our competitors have a larger breadth of products and more established relationships with the mass merchandiser and grocery stores, which makes competition in these channels more challenging for us.  Finally, an economic downturn in the United States could result in lower than expected sales growth of our products, as a result of reduced customer traffic at our major customers stores.  Any such reduction in customer traffic at the stores of our major customers during fiscal year 2009 will reduce our overall sales growth rate.  As such, a significant economic downturn may reduce our projected 8% to 15% growth to a lower rate.  With respect to our lines of cat litter products, subject to the caveats described above, we continue to expect revenue growth from these products.  During fiscal year 2009, we will continue our existing product line maintenance strategy with our industrial/commercial line of products.



Gross Profit



Both of our production facilities are now operating at efficiency levels that are at or near the pre-construction expectations of management.  Nonetheless, during the first six months of fiscal year 2009, our production facilities continued to face challenges that directly affected their production costs.  These challenges included the additional burden of increases in utility rates, increased depreciation, increased costs of materials, and increased fuel surcharges on freight.  Mostly as a result of these production costs our gross margin (gross profit divided by sales) remained at 30% in the first six months of fiscal year 2009 as compared to 30% for the first six months of fiscal year 2008.  For the second quarter of fiscal year 2009 our gross margin rose to 30% as compared to 28% for the second quarter of fiscal year 2008.  This increase was due to costs in fiscal year 2008 which were directly related to the move of our Washington State production facility.



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 87% in  the second quarter of fiscal year 2009 as compared to the same period in fiscal year 2008, and for the first six months of fiscal year 2009 increased by 17% as compared to the same period in fiscal year 2008.  We also generated an operating profit before depreciation for our industrial product segment for the first six months of fiscal year 2008 as compared to an operating loss for the first six-months of fiscal year 2009.



For fiscal year 2009 we expect that our gross margin will be in the range of 30% to 33%.  The reasons for this expectation are as follows.  First, due to ongoing high fuel costs, transportation of our product to our customers is expected to put downward pressure on our gross margins.  Second, we are not achieving the overall reduced costs of raw materials that we had initially expected due to 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 and product lines.  Third, additional depreciation charges resulting from our new production facilities will also have a negative effect on our gross margin.  Fourth, the cost of natural gas, which we use, in part, to fuel our facilities, continues to remain high.



To help offset the significant increases in the cost of natural gas, we installed, prior to the current year, new sawdust burners to heat our dryers at our production facilities.  These operate at less than one-third the cost of our current natural gas burners.  Unfortunately, due to the prevalence of high energy costs throughout the country, there is now a higher demand and a resulting shortage of the materials we need for our new burners.  When we are able to obtain such materials, we are able to



14



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achieve the projected costs savings, even in the current economic climate.  We plan to continue to make capital investments in technology at all of our facilities to help decrease the costs of production.



Selling, General and Administrative Expenses



During the second quarter of fiscal year 2009, our selling, general and administrative expenses increased by 6% as compared to the same quarter in fiscal year 2008.  For the first six months of fiscal year 2009 our selling, general, and administrative expenses increased by 7% as compared to the same period in the prior year.



Costs resulting from our compliance with requirements of the SEC continue to have an impact on our general and administrative expenses.  We are investing in infrastructure, mainly in the form of additional personnel, to review our ancillary product lines and explore new synergistic business opportunities.  We believe that this investment in new product lines and business opportunities 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.



During fiscal year 2009, we intend to fund marketing initiatives at rates greater than in fiscal year 2008.  Our seasoned sales staff is respected in the animal care industry and has proven to be efficient and effective in selling to the wholesale distribution segment of the pet specialty channel.  We expect to enhance our sales staff to include expertise in specific markets where we see growth opportunities.  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 requirements are projected to continue to grow and we may also need to hire additional administrative personnel as sales levels increase.



Interest Expense



Interest expense in the second quarter of fiscal year 2009 totaled $79,000 as compared to $101,000 during the second quarter of fiscal year 2008.  Interest expense in the first six months of fiscal year 2009 totaled $161,000 as compared to $188,000 during the same period in fiscal year 2008.  These decreases were due to payment during fiscal year 2008 of principal amounts on the bonds used to finance the construction of both of our manufacturing facilities and to lower average interest rates during the current periods.  We currently have no plans to enter into additional debt financing, which means that we are projecting a decrease in interest expense in fiscal year 2009 as the principal portion of our existing debt continues to be paid down.



Income Tax



We incurred federal income taxes during the first six months of fiscal year 2009 at an effective rate of 43%.  The effective rate is the same as the rate incurred during fiscal year 2008 (of 43%) due to the proportion of stock-based compensation expense from stock options that are not deductible for federal income taxes as compared to net income before taxes.  We anticipate that the effective rate going forward will fluctuate depending on the ratio of net income before taxes to stock-based compensation recognized in a particular period. Losses incurred in Canada by International Absorbents have been fully reserved through the recording of a valuation allowance as Canadian net operating losses and deferred tax assets are not expected to be utilized in future periods.



Net Income



Our net income for the quarter ended July 31, 2008 increased by 338% as compared to the same period in the prior fiscal year.  For the six months ended July 31, 2008, net income increased by 19% as compared to the same period in fiscal year 2008.  These increases in net income from the same periods in the prior fiscal year were primarily caused by an increase in our gross profits slightly off-set by an increase in our selling, general and administrative expenses.  The increases in sales at a gross margin equivalent to the same periods in the prior year increased our gross profit at a rate greater than the investment we are making in future product lines.  We feel that these investments will add long term value to the Company.



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





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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 94% during the second quarter of fiscal year 2009 as compared to the second quarter of fiscal year 2008.  For the first six months of fiscal year 2009 our EBITDA increased by 19% as compared to the same period in the prior fiscal year.  The increases were primarily the result of increased sales while maintaining our gross margin which was off-set by increases in our selling, administrative, and general expenses.



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





|                                                                           |  |                       |       |               |   |                    |  |    
|-------------------------------------------------------------------------- |  | --------------------- | ----- | ------------- | - | ------------------ |  | ---
|                                                                           |  | For the quarter ended |       |              
|(U.S. dollars, in thousands)                                               |  | July 31, 2008         |       | July 31, 2007 |   | Percentage 
Change
|                                                                           |  |                       |       |               |   |                   
|Net income (as reported on Condensed Consolidated Statement of Operations) |  | $                     | 562   |               | $ | 126                |  |    
|Interest expense                                                           |  |                       | 79    |               |   | 101                |  |    
|Interest income                                                            |  |                       | (14)  |               |   | (23)               |  |    
|Income tax provision                                                       |  |                       | 355   |               |   | 111                |  |    
|Depreciation & amortization                                                |  |                       | 460   |               |   | 427                |  |    
|EBITDA                                                                     |  | $                     | 1,442 |               | $ | 742                |  | 94%





|                                                                           |  |                          |       |               |   |                    |  |    
|-------------------------------------------------------------------------- |  | ------------------------ | ----- | ------------- | - | ------------------ |  | ---
|                                                                           |  | For the six months ended |       |              
|(U.S. dollars, in thousands)                                               |  | July 31, 2008            |       | July 31, 2007 |   | Percentage 
Change
|                                                                           |  |                          |       |               |   |                   
|Net income (as reported on Condensed Consolidated Statement of Operations) |  | $                        | 905   |               | $ | 749                |  |    
|Interest expense                                                           |  |                          | 161   |               |   | 188                |  |    
|Interest income                                                            |  |                          | (28)  |               |   | (47)               |  |    
|Income tax provision                                                       |  |                          | 649   |               |   | 522                |  |    
|Depreciation & amortization                                                |  |                          | 931   |               |   | 779                |  |    
|EBITDA                                                                     |  | $                        | 2,618 |               | $ | 2,191              |  | 19%





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





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Liquidity and Capital Resources



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



|                    |  |                                                |  |                       |        |                          |   |       
|------------------- |  | ---------------------------------------------- |  | --------------------- | ------ | ------------------------ | - | ------
|                    |  |                                                |  | As of 
July 31, 
2008 |        | As of 
January 31, 
2008
|Financial Condition |  |                                                |  |                       |        |                         
|                    |  | Total Assets                                   |  | $                     | 29,968 |                          | $ | 28,589
|                    |  | Total Liabilities                              |  |                       | 11,154 |                          |   | 10,900
|                    |  | Total Equity                                   |  | $                     | 18,814 |                          | $ | 17,689
|                    |  |                                                |  |                       |        |                          |   |       
|                    |  | Debt/equity ratio                              |  |                       | 0.59   |                          |   | 0.62  
|                    |  | Assets/debt ratio                              |  |                       | 2.69   |                          |   | 2.62  
|                    |  |                                                |  |                       |        |                          |   |       
|Working Capital     |  |                                                |  |                       |        |                          |   |       
|                    |  | Current assets                                 |  | $                     | 10,686 |                          | $ | 8,691 
|                    |  | Current liabilities                            |  | $                     | 3,416  |                          | $ | 3,080 
|                    |  |                                                |  |                       |        |                          |   |       
|                    |  | Current ratio                                  |  |                       | 3.13   |                          |   | 2.82  
|                    |  |                                                |  |                       |        |                          |   |       
|Cash Position       |  |                                                |  |                       |        |                          |   |       
|                    |  | Cash, restricted cash & short term investments |  | $                     | 4,409  |                          | $ | 2,809 
|                    |  | Cash generated from operations                 |  | $                     | 2,204  |                          | $ | 3,571*
|                    |  |                                                |  |                       |        |                         
|                    |  | * for the entire year ended January 31, 2008   |  |                       |        |                         



Financial Condition



During the first six months of fiscal year 2009, the value of our total assets increased.  This was primarily the result of an increase in cash balances due to cash generated from operations.  Liabilities for the period remained relatively flat.



As discussed in Note 6 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, we currently have three long-term secured 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 Branch Banking & Trust Co. (BB&T).



We believe that our main credit risk exposure in fiscal year 2009 will come from meeting the covenants associated with our debt facilities by our lenders.  As of the end of both fiscal year 2008 and the second quarter of fiscal year 2009, 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, financial condition and have an impact on secured assets.  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 six months of fiscal year 2009, our working capital position continued to improve as current assets increased while current liabilities remained flat.  The majority of the increase in current assets was the result of cash generated from operating activities, resulting in an increase in cash on hand.  This change resulted in our current ratio (current assets divided



17



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by current liabilities) increasing from 2.82 at the end of fiscal year 2008 to 3.13 at the end of the second quarter of fiscal year 2009.



In fiscal year 2009 we expect that our current assets will continue to increase as a result of positive cash flow and an increase in accounts receivable and inventories as sales levels grow.  We also expect that current liabilities will increase as a result of growing accounts payable related to the general growth of the Company.  Even though we expect both current assets and current liabilities to grow, we believe that our net working capital position will improve during the remainder of the fiscal year.



Cash Position



We believe that our existing cash on hand, long-term debt and available line of credit currently provide us with enough cash to meet our existing needs for the foreseeable future.  Cash and investments increased during the first six months of fiscal year 2009, primarily as a result of cash generated from operating activities.  We expect cash to increase during the remainder of fiscal year 2009, mostly as a result of cash generated from operations.  We believe that our existing $2,000,000 line of credit with BB&T will suffice in covering any potential cash shortfall.  This line of credit is secured by inventory and accounts receivable, which will provide enough collateral to support the related debt. Interest is payable on funds advanced at the LIBOR rate plus 2.5%.  The line of credit matures on May 23, 2009.  As of July 31, 2008, no borrowings were outstanding under the line of credit. If we do borrow against this line of credit, we intend to pay it off before the end of fiscal year 2009.  We will continue to closely monitor both current liabilities and current assets as they relate to the generation of cash, with an emphasis on maximizing potential sources of cash.



Cash Generated from Operations



During the first six months of fiscal year 2009 we generated $2,204,000 in cash from operating activities as compared to $3,571,000 in cash generated during the twelve months of fiscal year 2008.  If our sales continue to increase and we are able to continue to profitably produce our products, we should be able to continue to generate cash from operating activities during fiscal year 2009, although it cannot be assured that this will be the case.



Financing and Investing Activities



Cash used for financing activities during the first six months of fiscal year 2009 was $176,000.  This was the result of principal payments made on our long-term debt.  During the third quarter of the current fiscal year we will make a $500,000 principle payment on the bonds used to finance the construction of our Jesup, Georgia facility.  Cash used during the first six months of fiscal year 2009 for investing activities was for the acquisition of equipment used in our production process.  Cash used in investing activities during the first six months of fiscal year 2009 was approximately $428,000.



During the balance of fiscal year 2009, we are currently budgeted to spend approximately $1,700,000 on additional property plant and equipment to maintain and improve our production facilities and processes.  This is an approved  increase of $200,000 over the prior quarters budgeted amount.  The majority of these funds will be used to construct warehousing and materials handling facilities in our Jesup, Georgia plant.  These additional facilities will add to our ability to meet increased product demand and more efficiently produce certain product lines.  We anticipate that these amounts will be funded by cash generated from operations.



Environmental Matters



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



Off-Balance Sheet Arrangements



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



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



18



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Critical Accounting Policies



Use of Estimates



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



During the quarter ended July 31, 2008 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, 2008 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 1A.

RISK FACTORS



Please see our Annual Report on Form 10-K for the year ended January 31, 2008 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 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



At the annual general meeting of shareholders held on June 11, 2008, the following proposals were adopted by the margins indicated.



1.

Election of the following directors, who will serve until their successors are elected and qualified, or their earlier death or resignation:







|                   |  |                  |           |          |  |  |        | 
|------------------ |  | ---------------- | --------- | -------- |  |  | ------ | 
|                   |  |                  |           |          |  |  |        | 
|                   |  | Number of Shares
|                   |  | For              |           | Withheld
|Gordon L. Ellis    |  |                  | 5,127,786 |          |  |  | 90,962 | 
|Michael P. Bentley |  |                  | 5,193,017 |          |  |  | 25,731 | 
|                   |  |                  |           |          |  |  |        | 





The Companys other directors include John J. Sutherland, Lionel G. Dodd and Daniel J. Whittle each of whose terms will expire in 2009 unless re-elected.



2.

The selection of Moss Adams, LLP to continue as the auditors for International Absorbents Inc. was ratified by the following vote: For 5,193,594 shares; Withheld  25,153 shares.



ITEM 6.

EXHIBITS

Exhibit

Number

Exhibit Description



3.1

Notice of Articles of the Company (Amended) (incorporated by reference to Exhibit 3.1 to the Companys Form 10-Q for the quarter ended October 31, 2006).

3.2

Articles of the Company (incorporated by reference to Exhibit 3.1 to the Companys Form 10-Q for the quarter ended October 31, 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 L. 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 H. 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 L. Ellis, President and Chief Executive Officer of International Absorbents Inc., pursuant to 18 U.S.C. Section 1350.

32.2

Certification of David H. Thompson, Chief Financial Officer of International Absorbents Inc., pursuant to 18 U.S.C. Section 1350.







20



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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: September 12, 2008 |  | /s/ GORDON L. ELLIS                  
|                         |  | Gordon L. Ellis                      
|                         |  | President and Chief Executive Officer
|                         |  | (Principal Executive Officer)        
|                         |  |                                      
|Date: September 12, 2008 |  | /s/ DAVID H. THOMPSON                
|                         |  | David H. Thompson                    
|                         |  | Secretary and Chief Financial Officer
|                         |  | (Principal Financial Officer)        





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